Forwards and futures: contract specifications, initial margin and daily settlement
Read a futures contract specification and calculate initial margin, daily variation margin and margin calls step by step.
What you will learn
- How a future differs from a forward
- How to read a contract specification: multiplier, tick size, tick value and settlement
- How initial margin, maintenance margin and variation margin work
- How to follow a futures account day by day, including a margin call
Explanation
A forward is a private contract. Its terms can be tailored, but each side carries the risk that the other side will not pay (counterparty risk), and the gain or loss is usually only paid at maturity.
A future solves these problems. It is standardised (same size, same dates for everyone), traded on an exchange, and every trade is taken over by a central counterparty (CCP), also called a clearing house. The CCP becomes the buyer to every seller and the seller to every buyer, and it protects itself with margin.
The contract specification
Every exchange publishes a specification for each future. The key items are:
- Underlying and contract size or multiplier, for example "€25 per index point" or "1,000 barrels".
- Tick size: the smallest price step, and tick value: what one tick is worth in money. Tick value = tick size × multiplier.
- Contract months: for example quarterly (March, June, September, December) or monthly.
- Last trading day and settlement method: cash or physical delivery.
- Trading hours and the daily settlement price that the exchange sets each day.
The notional value of one contract = futures price × multiplier. Always calculate it before trading, because your profit or loss moves with the full notional, not with the margin you deposit.
Margin and daily settlement
Initial margin is the deposit required to open a position. It is a security deposit, not a price you pay. The CCP sets a minimum based on how volatile the underlying is, and brokers may ask for more.
Mark-to-market (daily settlement): at the end of each trading day, every open position is valued at the settlement price. The difference to the previous day is paid as variation margin: losers pay, winners receive, in cash, every day.
Many brokers also use a maintenance margin, a lower threshold. If your account falls below it, you receive a margin call and must deposit money to bring the account back up (in the convention used here, to the initial margin). If you do not pay in time, the broker can close your position. Rules differ between brokers and exchanges, so read your broker's margin policy.
Because a future has no built-in loss limit, a loss can exceed the initial margin. A gap at the open or a fast market can produce losses larger than your deposit.
Worked example
Hypothetical example: an equity index future with a multiplier of €25 per index point. You buy 1 contract at 18,000 points. Assumptions: initial margin €40,000, maintenance margin €32,000, no fees, no interest on the account. These figures are invented for teaching; real margins change often.
Notional value: 18,000 × €25 = €450,000. The deposit of €40,000 is about 8.9% of that.
| Day | Settlement price | Change (points) | Variation margin | Account after settlement |
|---|---|---|---|---|
| Open | 18,000 | - | - | €40,000 |
| 1 | 17,850 | −150 | −150 × €25 = −€3,750 | €36,250 |
| 2 | 17,600 | −250 | −250 × €25 = −€6,250 | €30,000 (below €32,000) |
| 2 (call) | - | - | deposit €40,000 − €30,000 = €10,000 | €40,000 |
| 3 | 17,900 | +300 | +300 × €25 = +€7,500 | €47,500 |
You close at 17,900 on day 3. Total result: (17,900 − 18,000) × €25 = −€2,500.
Check: you deposited €40,000 + €10,000 = €50,000 and you have €47,500, a difference of −€2,500. The market moved only 100 points against you overall (about 0.6%), but on day 2 you had to find €10,000 in cash at short notice. Excluded: commissions, exchange fees and slippage.
Common mistake
Practice activity
Hypothetical: you sell 2 contracts of an index future at 4,000 points. Multiplier €10 per point. Initial margin €3,000 per contract, maintenance margin €2,400 per contract. Settlement prices: day 1 = 4,040, day 2 = 4,080, day 3 = 4,020. You close at 4,020. Build the account table, show any margin call (top up to initial margin) and the total result.
Show solution
Start: 2 × €3,000 = €6,000. Maintenance level: 2 × €2,400 = €4,800. Value per point for the position: 2 × €10 = €20.
Day 1: +40 points against a short = −40 × €20 = −€800 → €5,200.
Day 2: +40 points = −€800 → €4,400, below €4,800. Margin call: €6,000 − €4,400 = €1,600 → €6,000.
Day 3: −60 points = gain of 60 × €20 = €1,200 → €7,200.
Total: (4,000 − 4,020) × €20 = −€400. Check: deposits €6,000 + €1,600 = €7,600; €7,200 − €7,600 = −€400.
Limitations: real brokers may calculate margin in real time during the day, not only at the settlement price, and may close positions without waiting for a deposit.
Key takeaways
- Futures are standardised, exchange-traded forwards guaranteed by a central counterparty.
- Tick value = tick size × multiplier; notional = price × multiplier.
- Gains and losses are settled in cash every day through variation margin.
- Initial margin is a deposit, not your maximum loss; losses can exceed it.
Next step
In the next lesson you will learn what happens when a future approaches expiry, how to roll a position, and why futures prices differ from spot prices (contango and backwardation).
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