Understanding corporate finance: derivative contracts: futures
The term future is normally applied to an exchange-traded forward contract (although you may also see some OTC contracts described as futures). A future commits the holder to take or make delivery of a standard amount of a specified commodity or financial instrument, on a fixed future date, for an agreed price.
In practice, most futures contracts are not held to maturity. The holder of the contract can close out his or her position by entering into an equal and opposite transaction. For example, a company which has bought 150 FTSE 100 futures could close out the position by selling 150 futures. A company which has sold 300 US Treasury Bond futures could close out its position by buying 300 of the same contracts.
Futures contracts are highly standardised. The underlying physical or financial asset is closely defined (for example, soybeans futures contracts might specify the minimum protein level, maximum moisture content and so on), and the delivery date normally runs on a fixed cycle of March, June, September and December each year. A company which holds a future at maturity will not necessarily receive or deliver any physical asset - most futures are cash settled (CFM13040).
Futures differ from forward contracts in that they are marked to market at the end of each trading day. Instead of each party’s obligations being settled at the end of the contract, a company trading in futures realises its profits or losses on a day-to-day basis. It will have to make an initial cash payment, known as initial margin, as a guarantee that it will be able to cover a loss arising from one day’s price movements in the event of default (CFM13070).