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FRM Exam Part I · Introduction to Derivatives

Futures Contract Mechanics for FRM Part I

Updated 11 October 2026 · Fact-checked

A futures contract is a standardized, exchange-traded agreement to buy or sell an asset at a set price on a future date. It is marked to market daily through a margin account, and its price converges to spot at delivery. To solve questions, track daily price changes times contract size, then adjust the margin balance.

Understand Futures Contracts and Mechanics

A futures contract is an agreement to buy or sell an asset at a fixed price (the futures price) on a set future date. You can think of it as a forward contract that has been standardized and moved onto an exchange.

Standardization means the exchange fixes the asset grade, contract size, delivery months and delivery location. Only the price is negotiated. This makes contracts interchangeable, so they trade easily and you can close a position by taking the opposite trade. Most futures are closed out before delivery, and few end in physical delivery.

Daily settlement (marking to market) is the key mechanic. At the end of each day the exchange clearing house computes your gain or loss from the change in the settlement price. It moves that cash between margin accounts. You post initial margin when you open the position. If your balance falls below the maintenance margin, you get a margin call and must restore the account to the initial margin level, not just to the maintenance level. Cash above the initial margin can usually be withdrawn.

The clearing house stands between buyer and seller, so each side faces the clearing house rather than the other party. Daily settlement keeps losses small and limits credit risk. A forward, by contrast, is usually OTC, customized, and settled only at maturity, so credit risk builds up until the end.

Convergence means the futures price moves toward the spot price as maturity approaches, and equals spot at delivery (ignoring small delivery frictions). If it did not, arbitrage would be possible. The difference between spot and futures price is the basis, and it goes to zero at maturity. A long futures position gains if the futures price rises, and a short gains if it falls.

Key formulas to remember

Daily gain or loss
Daily P&L (long) = (F_t − F_(t−1)) × contract size × number of contracts
For a short position, reverse the sign. F is the daily settlement price.
Total gain over holding period
Total P&L (long) = (F_exit − F_entry) × size × contracts
The sum of daily settlements equals this, ignoring interest on margin.
Basis
Basis = Spot price − Futures price
Check which sign convention the question uses. Basis converges to zero at maturity.
Margin call rule
If balance < maintenance margin, variation margin = initial margin − balance
The top-up restores the initial margin level, not the maintenance level.
Convergence
F_T = S_T at delivery
Holds at maturity for the deliverable asset, ignoring delivery options and frictions.

How to solve Futures Contracts and Mechanics questions

Use this routine for margin, settlement and conceptual questions on futures.

  1. 1Identify your position: long or short, and the number of contracts.
  2. 2Note the contract size, initial margin and maintenance margin.
  3. 3List the daily settlement prices and compute each day's change.
  4. 4Multiply each change by contract size and contracts. Flip the sign for a short.
  5. 5Update the margin balance day by day, adding gains and subtracting losses.
  6. 6Check each day whether the balance is below maintenance. If so, a margin call restores the account to the initial margin.
  7. 7For conceptual questions, ask: what is standardized, who bears credit risk, and when is cash paid?
  8. 8Sanity check: total P&L should equal the final price minus the entry price, times size.

Quickest way: Compare balance to maintenance, then top up to initial

When to use it: Use for margin-call questions with one or two price moves.

  1. Compute the total price change from the last margin reset, times size.
  2. Add to or subtract from the balance.
  3. If the result is below maintenance, the call equals initial margin minus the new balance.
  4. If no call is triggered, the balance is simply the new figure.

Common mistakes in Futures Contracts and Mechanics

  • Topping up to the maintenance margin after a margin call.

    The trigger level is maintenance, so students assume it is also the target.

    Fix: The call restores the balance to the initial margin. Calculate initial margin minus current balance.

  • Getting the sign wrong for short positions.

    Students apply the long formula by habit.

    Fix: Write long or short first. A short gains when the futures price falls.

  • Saying futures have no credit risk.

    The clearing house is mentioned and the risk is assumed to vanish.

    Fix: Credit risk is greatly reduced by margin and daily settlement, and shifted to the clearing house, but not eliminated.

  • Thinking the futures price converges to spot only at delivery by chance.

    Convergence is memorized without the arbitrage logic.

    Fix: If F were above spot at maturity, you would buy spot, sell futures and deliver for a riskless profit. Arbitrage forces equality.

  • Using the original entry price for each day's gain.

    Students forget that the account resets daily.

    Fix: Use the change from the previous settlement price each day, or use the total change consistently.

  • Assuming most futures end in physical delivery.

    Contract descriptions stress delivery terms.

    Fix: Most positions are closed out with an offsetting trade before delivery. Some contracts are cash settled.

Worked examples

Example 1

You go long 10 futures contracts on an asset with contract size 100 units at ₹... use USD: price $50.00. Initial margin is $400 per contract and maintenance margin is $300 per contract. Day 1 settlement price is $48.50. Is there a margin call, and for how much?

Show the solution
  1. Total initial margin = 10 × $400 = $4,000. Total maintenance margin = 10 × $300 = $3,000.
  2. Price change = 48.50 − 50.00 = −$1.50 per unit.
  3. Loss = −1.50 × 100 × 10 = −$1,500.
  4. New balance = 4,000 − 1,500 = $2,500.
  5. $2,500 is below the $3,000 maintenance level, so a margin call occurs.
  6. Variation margin = initial margin − balance = 4,000 − 2,500 = $1,500.

Answer: Yes. The margin call is $1,500, restoring the balance to $4,000.

Example 2

You are short 5 futures contracts, each on 1,000 units, entered at $20.00. Settlement prices are $20.40 on day 1 and $20.10 on day 2. What are the day 1 and day 2 gains or losses, and the cumulative result?

Show the solution
  1. Day 1 change = 20.40 − 20.00 = +$0.40. A short loses when price rises.
  2. Day 1 P&L = −0.40 × 1,000 × 5 = −$2,000.
  3. Day 2 change = 20.10 − 20.40 = −$0.30. A short gains.
  4. Day 2 P&L = +0.30 × 1,000 × 5 = +$1,500.
  5. Cumulative = −2,000 + 1,500 = −$500.
  6. Check: (20.00 − 20.10) × 1,000 × 5 = −$500. It matches.

Answer: Day 1: −$2,000. Day 2: +$1,500. Cumulative: −$500.

Exam tips

  • Always read whether the question gives margin per contract or in total, and multiply by the number of contracts.
  • Remember that a margin call restores the initial margin. This is a frequent trap.
  • For futures vs forwards questions, think in terms of standardization, exchange vs OTC, daily settlement and credit risk.
  • Convergence questions usually ask what happens to the basis. It tends to zero at maturity.
  • Write the sign of each cash flow for long and short positions before computing.

Practice questions from Introduction to Derivatives

Futures Contracts and Mechanics in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Futures Contracts and Mechanics: frequently asked questions

How does daily settlement work in futures?

At the end of each trading day, the clearing house sets a settlement price. Gains are credited and losses debited to each margin account based on the price change. If your balance drops below maintenance margin, you must top it up.

What is futures convergence to the spot price?

As the contract nears maturity, the futures price moves toward the spot price. At delivery they are equal, so the basis becomes zero. Arbitrage enforces this.

What is the difference between futures and forwards for FRM Part I?

Futures are standardized, exchange-traded and settled daily through a clearing house. Forwards are customized, usually OTC and settled at maturity, so they carry more counterparty risk.

Do most futures contracts end in delivery?

No. Most traders close their positions with an offsetting trade before expiry. Some contracts are cash settled instead of delivered.