Commodity Futures Explained: Contracts, Rolling and the Hidden Cost

A futures contract is a binding agreement to buy or sell a specific quantity of something at a specific price on a specific date.

The idea comes from agriculture, and the original purpose was insurance rather than speculation. A farmer facing harvest in six months does not know what wheat will fetch. A mill needs to plan its input costs. A contract agreed today removes that uncertainty for both.

Everything else about futures markets grew from that.

What makes a contract tradable

Standardisation. Every contract in a series specifies identical quantity, quality, delivery location and delivery month. Only the price is negotiated.

That uniformity is what allows contracts to trade on an exchange rather than being individually negotiated, and it is why the market is liquid.

A crude oil contract, for example, specifies a set number of barrels of a defined grade delivered at a named location in a named month. Anyone buying knows exactly what they have agreed to.

Margin and daily settlement

You do not pay the full value of a futures contract. You post initial margin, a fraction of the contract's notional value.

That makes futures inherently leveraged, and it introduces something unusual: daily mark to market.

At the end of each trading day, gains and losses are settled in cash. If your position moved against you, money leaves your account that day. If your balance falls below the maintenance margin, you receive a margin call and must deposit more or have the position closed.

This differs from most instruments, where losses are unrealised until you sell. In futures, a losing position demands cash immediately, and it does so every day the loss persists. A trader can be right about where a price ends up and still be forced out along the way for lack of margin.

Expiry: the part that costs money

Contracts expire. That single fact creates the most important practical issue in commodity investing.

If you want continuous exposure to oil for a year, you cannot simply hold one contract. You hold the nearest month, and before it expires you roll: close it and open the equivalent in a later month.

What that roll costs depends on the shape of the futures curve.

Curve shape	Later contracts	Rolling means	Effect
Contango	More expensive	Selling cheap, buying dear	A repeated loss
Backwardation	Cheaper	Selling dear, buying cheap	A repeated gain

In contango, every roll locks in a small loss. Repeated monthly over a year, that drag compounds.

This is why commodity ETFs frequently underperform the spot price they track. They hold futures rather than physical barrels, because storing oil is not practical for a fund. During sustained contango, an investor can be correct that oil rose over a year and still lose money in a fund tracking it.

Anyone considering a commodity fund should check whether it holds futures and what the curve currently looks like. It is the difference between the return you expect and the one you get.

Who uses futures, and why

Hedgers have real exposure to the underlying and want to remove uncertainty. An airline fixing fuel costs, a miner fixing an output price, a food manufacturer fixing input costs. They are not trying to profit from the contract; they are trying to make planning possible.

Speculators have no interest in the physical commodity and take positions purely on price. They are frequently criticised, and they perform a necessary function: hedgers need someone to take the other side. Without speculators, a farmer wanting to sell forward would have to find a mill wanting to buy exactly that quantity on exactly that date.

Arbitrageurs keep futures prices tied to physical prices by exploiting gaps between them.

The risks, plainly

Leverage. Margin is a fraction of notional, so both gains and losses are magnified relative to capital posted.

Daily margin calls. Being right eventually is no help if you cannot fund the position in the meantime.

Roll costs. The largest hidden cost for anyone holding exposure over time.

Gap risk. Markets can move sharply between sessions, and a stop does not protect against a gap.

Delivery. Physically settled contracts held to expiry create an obligation to deliver or receive the actual commodity. Financial participants close or roll well before this, but knowing which type you hold matters.

Practical notes

• Check whether a contract is physically or cash settled before trading it.
• Check the curve shape before taking long-term commodity exposure through futures or a fund that uses them.
• Understand that margin requirements can change, and exchanges raise them during volatility — often at the worst moment for existing positions.
• Contract sizes are large. One crude oil contract represents a substantial notional value, which is why smaller "mini" contracts exist.

The bottom line

Futures are the mechanism by which producers and consumers transfer price risk to people willing to bear it. That function is genuinely useful and considerably older than modern financial markets.

For anyone using them to hold a long-term view rather than to hedge a real exposure, the decisive detail is not direction but expiry. Contracts run out, positions must be rolled, and in contango that roll quietly takes money every time.

This article is educational and is not financial advice. Futures are leveraged instruments and carry a high risk of loss, which can exceed the initial margin.