01 · Futures Basics: What a Contract Is
Futures are among the "cleverest" and most "dangerous" instruments in the trading world. They were born from the need to hedge spot price risk, yet over a century of evolution they grew into a giant market where speculation and hedging coexist. This article starts from zero: what futures are, where they came from, what a contract contains, how trading works, and which exchanges you trade on in the domestic market.
1. What Futures Are
A futures contract is a standardized contract, uniformly defined by an exchange, to deliver a specified quantity of an underlying asset at a specific time and place in the future.
Break it down:
- Standardized: The product, quantity, quality, delivery location, and delivery time are all set by the exchange. The two parties can only choose to "buy" or "sell", to open or to close — no bargaining as in spot deals.
- Future delivery: Sign today, perform later. Buying one lot of rebar futures does not mean you own a ton of steel now; it means you have agreed to buy it at the delivery month at a pre-agreed price.
- Margin trading: You do not pay the full value — only a small fraction of the contract value (e.g. 8%–15%) is posted as margin, yet you control the full value. That is the source of leverage.
The essence of futures is the standardization of forward transactions. It upgrades private deals like "Zhang San agrees to buy 100 tons of soybeans from Li Si in three months at a price negotiated today" into a public market instrument where "anyone buying one lot of soybean futures today locks in a price for some future month".
In one sentence: a futures contract is a "price contract for the future" — the price is set now, performance comes later.
2. The Birth of Futures: Hedging in the Spot Market
Futures were not invented out of thin air; they emerged from one plain pain point: price volatility hurt everyone doing real business.
2.1 Background: the 19th-century American grain market
In the mid-19th century, Chicago became the grain hub of the United States. Farmers planted in spring and harvested in autumn; merchants stockpiled in autumn and shipped year-round. Two sharp conflicts ran through this chain:
- Farmers: At harvest, supply surged and prices collapsed — "cheap grain ruined farmers"; in spring, when supplies ran out, prices soared, but farmers had nothing left to sell.
- Grain merchants / warehouse operators: Bought cheap in autumn and stockpiled, betting on higher prices next year; if prices fell instead, the stockpile became a huge loss, even bankruptcy.
Both sides faced enormous price uncertainty. Whoever bore that risk paid for it in blood.
2.2 The emergence of the forward contract
The market spontaneously evolved the "forward contract": in spring, a farmer agreed with a grain merchant — "in autumn I will sell you 100 bushels of corn at X dollars per bushel". The price was locked in advance and both sides' risk was hedged: the farmer no longer feared a harvest-time price drop, and the merchant no longer feared the stockpile losing value.
But forward contracts had fatal flaws:
| Flaw | Consequence |
|---|---|
| Non-standard terms | Quantity, quality, and timing of every contract were privately negotiated; resale was extremely difficult |
| Reliance on counterparty credit | If the other side defaulted, the hedge promise evaporated (credit risk) |
| No liquidity | The contract was locked between the two signatories and could not be transferred to a third party |
2.3 Standardization and the clearing house: the birth of modern futures
In 1848, 82 Chicago merchants founded the Chicago Board of Trade (CBOT) on the shore of Lake Michigan, initially trading spot grain only.
In 1865, CBOT launched the standardized futures contract: quantity, quality, and delivery months were unified, and a margin system was introduced (both sides post margin to guarantee performance).
Over the following decades, exchanges refined the rules:
- Margin system: The cost of defaulting was paid up front, and credit risk dropped sharply.
- The clearing house: The exchange itself became the "central counterparty" of every trade — the buyer's counterparty is the clearing house, and so is the seller's. Even if one side defaults, the clearing house guarantees performance — credit risk was structurally eliminated.
- Open outcry → electronic trading: From hand signals in the trading pit to today's millisecond-level electronic matching.
After CBOT's grain futures succeeded, cotton, coffee, and metals followed; from the 1970s, financial futures (FX, rates, stock indices) exploded. Today the global futures market turns over trillions of dollars a day, and the notional size of derivatives far exceeds spot markets.
The lesson: The core mission of futures has been "transferring price risk" since birth — letting those who do not want price volatility (farmers, airlines, steel mills) pass the risk to those willing to bear it for profit (speculators). Speculators are not parasites; they are the risk "buyers of last resort". It is precisely their existence that allows hedgers to exit smoothly.
3. The Eight Elements of a Futures Contract
Every futures contract is precisely defined by its exchange. The following eight elements form the complete profile of a contract:
| Element | Meaning | Example (rebar rb) |
|---|---|---|
| Underlying | The commodity or financial asset the contract references | Rebar (HRB400 and other standard grades) |
| Contract multiplier / trading unit | How much one lot represents | 10 tons/lot |
| Quotation unit | The unit of the price | CNY/ton |
| Tick size | The minimum price increment | 1 CNY/ton (one "tick" = 10 CNY per lot) |
| Price limit | The daily price move cap | ± 4% of the previous settlement price (adjusted with market conditions) |
| Margin rate | The fraction of contract value posted to open | Exchange baseline ~7%; futures firms typically add on to 10%–14% |
| Delivery months | Months in which the contract can be delivered | Jan/Mar/May/Jul/Aug/Sep/Oct/Nov/Dec |
| Delivery method | How the contract settles at expiry | Physical delivery (rebar); cash settlement for index futures |
3.1 Element by Element
① Underlying It can be a commodity (soybeans, gold, crude oil) or a financial asset (stock index, government bond, FX rate). Domestically these are the two big categories: "commodity futures" and "financial futures".
② Contract multiplier / trading unit Futures trade in "lots"; one lot represents a fixed quantity. For example, rebar is 10 tons/lot, gold is 1000 grams/lot, and CSI 300 index futures are 300 CNY per index point. Total value of one lot = price × multiplier — the basis for calculating margin and P&L.
③ Quotation unit Such as CNY/ton, CNY/gram, CNY/point. The quotation unit determines the magnitude of the price figure and indirectly shapes the tick size design.
④ Tick size The minimum increment of price movement. Rebar 1 CNY/ton → each tick per lot = 1 CNY × 10 tons = 10 CNY; CSI 300 index 0.2 points → each tick per lot = 0.2 × 300 = 60 CNY.
⑤ Price limit The cap on the daily move relative to the "previous trading day's settlement price" (note: settlement price, not close). Exchanges adjust it near delivery months or during unusual markets; extreme conditions can trigger "consecutive limit" circuit-breaker-like measures.
⑥ Margin rate The fraction of contract value frozen at opening, typically 5%–15%. This rate determines the leverage multiple: 10% margin = 10x leverage (see Article 02).
⑦ Delivery months Contracts have a life cycle. The dominant contract is usually the month with the largest volume and open interest (e.g. Jan/May/Oct for rebar). Contracts near delivery suffer drained liquidity and special rules — retail traders should avoid them (see Article 03).
⑧ Delivery method
- Physical delivery: Mainly commodity futures; at expiry, goods are delivered/received at standard quality.
- Cash settlement: Financial futures such as stock index and bond futures; funds are transferred by the settlement price spread at expiry, with no physical goods.
3.2 The Three Functions of the Futures Market
With contract elements understood, one question remains: what is the futures market for? The answer is three functions:
| Function | Meaning | Who benefits |
|---|---|---|
| Price discovery | Futures prices formed by the competition of many traders reflect the market's consensus on future supply and demand, more "authoritative" than any single company's quote | Spot traders, policymakers, all market participants |
| Risk management | Hedgers transfer price risk to speculators; production and trade can now be "priced" | Farmers, airlines, steel mills, foreign-trade firms |
| Asset allocation / speculation | Investors earn returns by bearing risk; institutions use futures to hedge stock and bond portfolios | Speculators, institutional investors |
Why are futures prices "authoritative"? Because they aggregate supply-and-demand information across the whole market, and every participant's judgment is backed by real money (margin). Lying has a cost.
3.3 The Three Types of Participants
| Participant | Goal | Position characteristics |
|---|---|---|
| Hedgers | Hedge spot price risk | Position matched to spot; long holding periods, often held to delivery |
| Speculators | Profit from price volatility | Light positions, quick in and out; the vast majority close same-day or short-term |
| Arbitrage traders | Earn the near-certain profit of spread convergence | Hold both long and short legs simultaneously, earning "riskless" profit |
The three are counterparties to one another and mutually dependent: without speculators, hedgers find no counterparty; without hedgers, speculators lose the source of liquidity.
4. The Futures Trading Process
The complete flow for an individual trading futures:
Open account → Deposit funds → Place order → Mark to market → Close / Deliver4.1 Opening an Account
- Choose a licensed futures firm, prepare your ID and bank card, and sign the brokerage contract and risk disclosure.
- You must pass the suitability assessment (risk tolerance evaluation) and a knowledge test (some products also have capital thresholds).
- Thresholds for special products: stock index futures (CFFEX) require available funds ≥ 500k CNY plus relevant trading experience; crude oil futures (INE) ≥ 500k; iron ore, PTA and other specific products ≥ 100k (exchange rules differ; refer to the latest regulations).
4.2 Depositing Funds
- Funds move via bank-futures transfer (bank account ↔ futures account), available T+0.
- Account funds split into margin occupied (frozen on positions) and available funds (can open new positions or be withdrawn).
4.3 Placing Orders
- Order types: market order, limit order, stop-loss order (some platforms support conditional orders), spread orders, etc.
- Directions: buy to open (open long), sell to open (open short), sell to close (close long), buy to close (close short).
- Matching: price priority, time priority. Sessions split into day (9:00–11:30 a.m., 1:30–3:00 p.m.) and night (from 21:00; end time varies by product).
4.4 Mark to Market
- Futures use mark-to-market: after each close, the exchange recalculates your position P&L at the "daily settlement price", and gains/losses are credited/debited to your account the same day.
- If floating losses drain your equity, the account will face a margin call or trigger forced liquidation — one of the biggest differences from stocks (see Article 02).
4.5 Closing / Delivery
- The vast majority of traders (> 99%) never reach delivery; they close the position (an offsetting trade) and keep only the price difference.
- If you hold into the delivery month and meet delivery conditions, delivery proceeds: physical delivery for commodity futures, cash settlement for financial futures.
- Individual investors are usually barred by the exchange or futures firm from physical delivery (individuals cannot take physical delivery of commodity futures and must close before the delivery month).
4.6 The Costs of Trading Futures
| Cost item | Description | Typical magnitude (reference) |
|---|---|---|
| Commission on open/close | Charged per lot or per traded value, both sides | Rebar ~0.01%–0.03% per side (close-today discounts vary) |
| Margin interest | Cost of occupied capital (opportunity cost) | Depends on cost of funds |
| Slippage / market impact | Gap between fill price and expected price | Depends on liquidity |
| Rollover cost | Double-sided cost of closing the old contract and opening the new at roll (see Article 03) | Depends on the term structure |
Never underestimate commissions: a high-frequency day trader can pay more in fees per year than their principal. Trading costs are the only "loss" you are 100% certain of.
4.7 Quick Glossary
| Term | Meaning |
|---|---|
| Long / Short | Holder of long positions (bullish) / holder of short positions (bearish) |
| Open / Close | Establish a new position / exit an existing position |
| Open interest (OI) | Total number of unsettled contracts in the market |
| Volume | Number of contracts traded that day |
| Settlement price | The official price used for daily P&L and margin calculations |
| Dominant contract | The contract month with the largest volume and open interest |
| Rollover / roll | Moving a position from the old contract month to a new one |
| Long squeeze on longs | Longs stampede over each other to close in panic, accelerating the fall |
| Corner / squeeze | Players with spot and position advantages force counterparties to buy back at extreme prices |
4.8 The Logic of Short Selling: Profiting from Falls
Stocks can only be bought long; futures can be sold short — sell high first, buy back low, and pocket the downside spread:
- You expect rebar to fall from 3500 to 3300.
- Action: sell to open 1 lot (you hold no steel at all; you are selling "a promise of a future price").
- After it falls to 3300, buy to close.
- Profit = (3500 − 3300) × 10 tons = 2000 CNY (fees excluded).
⚠️ Shorting is equally leveraged: if the price rises 10%, your margin loses 10% just the same. Shorting is not a "safer" game — the direction is simply reversed.
🎯 Shorting Is Not Safer, Only Reversed
Shorting is equally leveraged: if the price rises 10%, your margin loses 10% just the same. Shorting is not a "safer" game — the direction is simply reversed; the P&L structure and the forced-liquidation mechanism are identical to going long.
5. The Domestic Futures Market
Domestic futures are regulated by the CSRC. There are currently 5 commodity/financial futures exchanges (plus GFEX):
| Exchange | Abbreviation | HQ | Major products |
|---|---|---|---|
| Shanghai Futures Exchange | SHFE | Shanghai | Copper, aluminum, zinc, nickel, gold, silver, rebar, hot-rolled coil, rubber, fuel oil, bitumen, pulp, stainless steel, alumina |
| Shanghai International Energy Exchange | INE | Shanghai | Crude oil, low-sulfur fuel oil, TSR 20 rubber, international copper, container shipping index (EC), paraxylene |
| Dalian Commodity Exchange | DCE | Dalian | Soybean meal, soybean oil, palm oil, corn, soybean No.1/No.2, eggs, live hogs, coke, coking coal, iron ore, LLDPE (plastics), polypropylene, ethylene glycol, styrene, LPG |
| Zhengzhou Commodity Exchange | CZCE | Zhengzhou | Sugar, cotton, cotton yarn, PTA, methanol, glass, soda ash, urea, rapeseed oil, rapeseed meal, apples, red dates, peanuts, staple fiber, caustic soda, paraxylene |
| China Financial Futures Exchange | CFFEX | Shanghai | CSI 300 / SSE 50 / CSI 500 / CSI 1000 index futures, 2/5/10/30-year treasury bond futures |
| Guangzhou Futures Exchange | GFEX | Guangzhou | Industrial silicon, lithium carbonate |
Mnemonic: Copper, aluminum, gold and silver on SHFE; petrochemicals and coal in Dalian; farm goods and chemicals in Zhengzhou; index and bonds at CFFEX; new energy in Guangzhou.
Characteristics of the domestic futures market:
- T+0 trading: Positions opened today can be closed today, unlike the T+1 of A-shares.
- Two-way trading: You can go long (buy) or short (sell); falling prices can be profitable too.
- Margin leverage: Typically 7–15x; financial futures run slightly lower leverage but steeper swings.
- Night session: Most commodity futures have a night session covering European and American hours — volatility risk does not pause while you sleep.
- Price limit system: Daily moves are capped, but consecutive limit boards carry extreme liquidity risk.
6. Futures vs. Stocks: One Table Says It All
| Dimension | Futures | Stocks (A-shares) |
|---|---|---|
| Underlying | Standardized contracts on commodities, indices, rates | Shares of listed companies |
| Direction | Two-way (long and short) | Long only (short selling restricted) |
| Trading system | T+0, closeable same day | T+1, shares bought today sell tomorrow |
| Capital occupied | Margin (5%–15%), leveraged | Full value, no leverage (except margin financing) |
| Source of profit | Price movement (spread) + hedging/arbitrage | Rising prices + dividends |
| Loss profile | Can lose all principal and even blow through to negative balance | At worst goes to 0; you cannot owe money |
| Expiry | Has delivery months; must close or deliver | No expiry; can hold indefinitely |
| Price limits | Yes (varies by product) | Main board 10%, ChiNext/STAR 20% |
| Settlement | Mark-to-market; P&L transferred daily | No daily settlement; floating losses not transferred |
| Trading cost | Commission + margin interest (low) | Commission + stamp duty |
| Volatility risk | High (amplified by leverage) | Relatively low |
| Participants | Hedgers + speculators + arbitrageurs | Mostly investors |
The core difference in one sentence: A stock is a "cash-for-goods" asset investment; a futures contract is a "small-stakes, big-exposure" risk-transfer contract — a losing stock can be held and waited out, but holding a losing futures position burns margin continuously until the account blows up.
💀 Holding a Losing Futures Position = Margin Burned Until Liquidation
A losing stock can be held and waited out; the cost of holding a losing futures position is margin consumed until forced liquidation. The biggest difference between futures and stocks is not the returns but the exit — stocks leave you a chance to come back, futures eject you at the line.
Risk Warning
⚠️ Risk Warning
Futures are margin (leveraged) trading; both gains and losses are multiplied. A common beginner mistake is treating futures like stocks — "buy and hold" or "hold and hope" — which under leverage can easily end in forced liquidation or even a negative-balance blow-through (losses exceeding principal). This article covers basic concepts only; before any live trading, read Article 02 "Margin, Leverage & Forced Liquidation" in full and confirm you understand everything about forced liquidation and negative balances. This content does not constitute investment advice; contract rules are subject to the latest exchange regulations.
Summary
- Futures = standardized forward contracts = "price now, performance later".
- Born in 1848 from spot hedging needs in Chicago's grain market; margin and the clearing house solved credit risk.
- Eight contract elements: underlying, multiplier, quotation unit, tick size, price limit, margin rate, delivery months, delivery method.
- Trading flow: open account → deposit → order → mark to market → close/deliver.
- Five domestic commodity/financial exchanges plus GFEX, covering the full range of commodity and financial products.
- Futures vs. stocks: T+0, two-way, leverage, expiry — every difference means more risk and more professionalism required.