How Daily Futures Settlement Supports Hedging and Limits Default Risk
Summary
The document explains why daily settlement does not erase the hedging purpose of a futures contract. A business can lock in a price for a future purchase or sale, while daily mark-to-market transfers gains and losses as prices change. For a buyer facing higher future commodity costs, gains on a long futures position can help fund the eventual spot purchase when the position is closed.
Daily margin requirements address the separate risk that one counterparty may fail to pay accumulated losses. The example describes initial and maintenance margin and a margin call after losses reduce the account balance. These mechanisms reduce the amount of unpaid exposure that can build up between counterparties. The explanation is conceptual and uses illustrative figures; it does not examine contract basis risk, the timing mismatch between hedge and purchase, or how margin calls can create liquidity pressure.
Key ideas
- Futures can set an agreed price for a commodity or financial asset at a future date.
- Daily mark-to-market realizes gains and losses throughout the contract rather than only at maturity.
- A hedger can use futures gains to help pay for a later spot-market purchase.
- Initial and maintenance margin requirements help limit counterparty exposure by requiring funds as losses accrue.
- Margin calls can create a near-term cash requirement even when the hedge serves its intended purpose.
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Full text
# What is the point of futures with daily settlement? # What is the point of futures with daily settlement? The way futures typically are taught, is that it's a way to hedge against volatility. Basically, as I understand it, the point of the future is, that we don't know the price of the commodity or currency some time in the future, but we're expecting to use it at that point, so we sign a contract such that we know exactly what our costs are in the future, when we need the commodity. This makes sense to me. What doesn't make sense then, is how does a futures contract fulfill this purpose, when we have to do daily settlement? In the end, you end up loosing or gaining the difference anyways. And in the end, you're affected by the volatility of the market just the same. So what is the purpose of a futures contract? ## Answer by João (score 4) https://quant.stackexchange.com/a/81896 The point of Futures contracts is to know the price of a commodity for a given date. Example: an Airline group needs to know the price of jet fuel (Platts) to be able to make a price offer to the consumer on flight tickets for 7th of January 2026 Daily settlements on Futures Contracts ensure that both counterparties ( buyer and seller ) are able to comply with the contract So, to diminish the risk of default, we have to mark-to-market, that essentially makes a extra account for both counterparties same as margin account based on the notional of the contract. A the end of every day if the amount exceeds the margin maintenance the other counterparty that exceed that margin is required to add funds (margin call) until the original value (its like an insurance) Example: -> DAX Index -> 11.500 spot -> spot x 25€ ( contract dimension ) -> Initial Margin = 20.500€ -> Maintenance Margin = 15.500€ -> 3 contracts So we make a deposit of 21.500€ * 3 contracts = 61.500 On the 4th day we have a daily loss of 30.000€, so we are margin called because 24.000 < 61.500 so we need to add the remaining 37.500€ This is to ensure that losses are covered before they accumulate to unmanageable levels, reducing counterparty risk. ## Answer by nbbo2 (score 4) https://quant.stackexchange.com/a/81897 If the price of the commodity goes up the cash you make from being long the future can be used to help you buy the commodity when the maturity approaches. You will close the futures position. You will still need to put up a predetermined amount of your own cash to cover the initally estimated cost, but the rest of the cash, corresponding to the price increase, will come for your futures account. So your purchase of the commodity in the spot market will be made easier by the futures cash P&L. In this situation the futures market is your friend, helping you to pay the bill.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.