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Marking to market refers to the process adopted by clearinghouses/exchanges to calculate and settle the net payoff on futures contracts periodically, typically daily. If as a result of the marking to market process, the party’s balance decreases below the maintenance margin, the minimum margin that they are required to maintain, they receive a margin call. Initial margin refers to the amount that the parties deposit with the clearinghouse at the inception of the futures contract.

It gives the exchange an assurance that they have necessary funds to honor their obligation in event of any adverse price movement. Parties looking to purchase or sell futures contracts are required to maintain a margin with the exchange. New York Mercantile Exchange (NYMEX), Chicago Board of Trade (CBOT) and Chicago Board Options Exchange (CBOE) are the main exchanges on which futures can be traded.

Such an exchange is called a clearinghouse. Clearinghouseīecause futures contracts are standardized, there is an active market in which participants can trade their futures contracts before their expiry date. Futures contract vs forward contractĪ futures contract differs from a forward contract in that it is traded on an exchange, it requires an upfront margin to be paid to the exchange and that it is periodically marked to market. The buyer of a futures contract has a long position to the underlying asset while the seller has a short exposure. Similarly, selling a futures contract means you are actually selling the underlying. Buying vs selling a futures contractīuying a futures contract means that you commit to purchase the underlying asset (stock, commodity, etc.) at the mentioned exercised price. They are also used by investors to obtain exposure to a stock, a bond, a stock market index or any other financial asset. (called the underlying asset or just underlying) in which the buyer agrees to purchase the underlying in future at a price agreed today.Ī futures contract is an important risk management tool which allows companies to hedge their interest rate risk, exchange rate risk and some business risks associated with commodity prices. A futures contract is a standardized exchange-traded contract on a currency, a commodity, stock index, a bond etc.