Overview

A future is a contract for an underlying asset, to be delivered at a specific date (maturity date) and a price. When two traders enter into a futures contract, no money is exchanged up front, rather, as the futures price moves day to day, the traders exchange cash to level up the contract.

Valuing a Future

A future is similar to a forward. The only difference is that a future requires payment each day, as the future price moves. That is, the difference is only in the timing of the payments. However, timing can have an influence on value (see time value of money)

Backwardation and Contango

Contango in the futures market occurs when the future price is higher than the spot price. This is thought to be the typical scenario, as the future price should be close the spot price compounded at the given period interest rate.

Backwardation occurs when the future price is less than the spot price. Arbitrage would seem to preclude backwardation, however, it can be a common occurence in commodities markets.