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CFA® Level I · Derivatives · free lesson
Pricing and Valuation of Futures Contracts
Futures are priced much like forwards, but daily settlement changes how their value behaves and how cash flows through a hedger's accounts. This module explains futures valuation and margin mechanics, why futures and forward prices can differ when interest rates move with the underlying, and how short-term interest rate futures such as SOFR futures are quoted and used.
What you will learn
1. Explain how daily mark-to-market settlement affects the value of a futures contract and compare futures valuation with forward valuation.
- Futures gains and losses are settled daily against the settlement price through margin accounts.
- Futures value is zero right after each daily settlement.
- Between settlements, long value = (current futures price - last settlement price) x contract size.
- Futures prices converge to the spot price at expiration.
- Total futures gain = forward gain, but paid in daily installments, creating liquidity needs.
2. Calculate margin account balances, variation margin and margin calls on futures positions.
- Initial margin is posted at the start; maintenance margin is the minimum balance.
- Daily gains and losses are credited or debited using settlement prices.
- Below maintenance margin: deposit variation margin to restore the balance to initial margin.
- Trigger price for a long: f_0 - (IM - MM) / contract size.
- Margin calls cluster in volatile markets, when exchanges also tend to raise margin requirements.
3. Explain why futures and forward prices on the same underlying can differ, considering the correlation between the underlying and interest rates.
- Constant or uncorrelated interest rates: futures price = forward price.
- Underlying positively correlated with rates: futures price > forward price.
- Underlying negatively correlated with rates: futures price < forward price.
- Differences are small for short maturities; larger for long-dated and interest rate contracts (convexity bias).
- Credit terms, collateral and delivery options can also create small differences.
4. Describe how short-term interest rate futures are quoted and calculate their gains and losses using the basis point value.
- Price = 100 - annualized rate; prices fall when rates rise.
- Long interest rate futures gains when rates fall; short gains when rates rise (opposite of a long FRA).
- BPV = notional x 0.0001 x period fraction = USD 25 for a USD 1 million three-month contract.
- Future borrowers sell futures to hedge; future lenders buy futures.
- Daily settlement causes a small convexity difference between futures and FRA rates.
Module at a glance
- Futures are marked to market daily; their value resets to zero after each settlement.
- Between settlements, long value = (current futures price - last settlement price) x size.
- Margin calls occur below maintenance margin and must restore the account to initial margin.
- Futures price > forward price when the underlying is positively correlated with rates; lower when negative.
- Interest rate futures: price = 100 - rate; BPV = USD 25 per USD 1 million three-month contract.
- Borrowers sell interest rate futures or buy FRAs to hedge rising rates.
- Futures prices converge to spot at expiration.
This free module has 4 lessons, 14 practice questions with full explanations.