Before we understand what futures are and their types, we need to learn about derivatives. So let us begin.
Like share trading in the cash segment (buying and selling shares), the derivative is a type of trading instrument. It consists of unique contracts that derive their worth from an underlying security.
Futures and options are two different types of derivatives that you can trade on Indian stock exchanges. In India, the futures market is quite popular and has much liquidity. The Securities and Exchange Board of India (SEBI) has 188 securities for which futures contracts are available.
You can trade these securities in the Exchange’s Capital Market category. These contracts have predetermined prices and expiration dates.
In futures trading, the trader buys or sells a contract for an index (e.g., NIFTY) or a company (e.g., Reliance). The trader makes a profit if the price moves in the trader’s favor throughout the contract life (rises in the case of a buy position or falls in the case of a sell position). The trader loses money if the price trend is negative.
Futures are standardized derivative financial contracts that bind the parties to trade an item at a defined future date and price. It specifies the quantity of the underlying asset and allows trading on a futures exchange.
You can utilize futures for hedging or trade speculation on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
The SEBI regulates the futures market in India. It aims to protect investors’ interest in putting tight measures in place to ensure that neither buyer nor seller fails on their agreement.
In a contract, the buyer or seller can withdraw from their commitment if the price goes in a negative trend. However, this backing out is not possible in a futures contract. The exchange ensures that both the buyer and the seller honor their contracts by acting as a counterparty.
As a result, the buyer buys from the exchange, and the seller sells to it. If a buyer fails to pay the required amount, the exchange will pay the seller instead of the buyer and retrieve the money. Therefore, there is no risk of counterparty default.
A futures contract is an agreement between two parties to acquire or sell an item at a certain price at a future period. A buyer with an option contract has the opportunity to purchase an item for a specified price. On the other hand, the buyer is not obligated to settle the purchase.
Buy/sell transactions in the margin segment must be squared off the same day. However, in the futures, they can be carried out until the contract’s expiration and squared off at any moment throughout the contract’s life.
You can convert your margin positions to spot delivery. But you must have the proper trading limits for purchase positions and the requisite number of shares in Demat for sale positions.
This exchange is not possible in futures because all futures transactions are cash-settled. Suppose you wish to convert your futures holdings into delivery positions. In that case, it must first square off transactions in the future market before acquiring a cash position in the cash market.
Let us look at the different types of futures.
These futures are based on particular stocks. You must deposit an initial margin with the broker before trading in stock futures. The bigger the volume of transactions, the higher the profit. However, the dangers are also greater.
Furthermore, you can only trade on stock exchanges such as the BSE and NSE for a limited number of equities.
Index futures are useful to bet on the future fluctuations of indexes such as the Sensex and Nifty. If stock prices fall, portfolio managers use these futures to hedge their equity investments.
This futures contract allows risk managers and speculators to trade a currency at a fixed rate against another currency at a predetermined date in the future. An importer in India, for example, may purchase USD futures to protect against a rupee depreciation.
Hedging against price fluctuations in the future of numerous items is possible with commodity futures, including gold, silver, and petroleum. Commodity futures are also used to bet on price movements.
Due to the low beginning margins in commodities, these futures traders can take large bets. Of course, the profit potential is enormous, but the risks tend to be high.
It is an agreement to trade a debt instrument at a certain price on a specific date. Government bonds or Treasury bills, which trade on the NSE and BSE, are the underlying assets.
When buying equity shares on the spot market, you must pay the whole contract value upfront. But in the futures, you can acquire positions by paying only the first margin, allowing traders to access significant holdings with less cash.
Investors can make bigger profits because of the considerable leverage. Investors might earn bigger returns than on the spot market, as they have access to higher holdings.
Hedgers frequently utilize futures to hedge their spot market bets.
Let us say an investor has 250 shares of any company in the spot market. However, they are concerned that the stock may drop soon. He can sell futures contracts to hedge their spot market position against this trend.
Short-selling in the spot market requires settling your position within the same trading day. Investors are required to square off even if they are losing money due to this aspect. In contrast, you can keep your futures contract until it expires. As a result, investors have plenty of time to cover their short holdings.
Futures contracts also have strand raised lot sizes to trade them.
It is the price at which you can purchase a share. The cost of a futures contract is often greater than the underlying asset’s price (in our example, stocks).
The contract value is the real worth of your position. By multiplying the lot size with the futures contract price, you can determine the contract value.
Every futures contract has a set expiration date. All futures contracts expire on the last Thursday of each month. The contract will terminate on Wednesday if last Thursday is a holiday.
It is the underlying asset’s price, which is the cash market share price in an ideal world. The futures prices would move in the same direction as underlying prices.
The buyer of the futures contract is an individual who has an optimistic opinion of the stock and expects the price to rise in the future. As a result, he is purchasing it at a lower price today. This strategy is known as a long position on a stock.
The individual who sells a futures contract with a pessimistic perspective on the stock is known as a seller of a futures contract. His goal is to lock in the selling price today so that a future decline will not give him a loss. Such a trick is referred to as a short position.
Most futures contracts in India are cash-settled before expiration. It implies that if you buy a futures contract, you must sell it before or on expiration, or vice versa.
The market displays several open contracts or positions on a particular day. A considerable open interest indicates a high level of liquidity.
This graph depicts the daily movement in the futures contract. A positive price movement indicates the addition of more contracts and that investors are going long on the futures contract (purchasing).
Square off means selling a future position. For example, if you buy 1 lot of NIFTY futures on 20th Aug 2014 and decide to sell it on 24th Aug 2014; you square off your future position.
Cover order is a type of order used to sell squares off an open futures position.
Indian investors can trade futures on the NSE and BSE. It is critical to choose one’s future trading strategy. You might select to invest in futures depending on your knowledge and research.
Futures in the stock agreement is a contract to exchange equity at a certain price in the future. It is a wager on how a stock’s price will fluctuate in the future. A futures buyer benefits from a price increase, whereas a selling benefits from a price decrease.
Step 1: Invest in an equity future.
If you wish to trade in the F&O segment and have a share broker account in India, the first step is to buy (or sell, in the case of short-selling futures) a future contract.
Step 2: Keep an eye on the stock market's future performance.
Futures contracts are often traded on an exchange. One side agrees to buy a specific number of securities or commodities and accept delivery on a specific date. The selling party to the contract consents to provide it.
Companies with significant liquidity and volume of trades on stock exchanges are qualified for F&O trading. The stock exchange determines which companies fulfill the criteria.
Yes, you can sell the contract (or close down the open position) before it expires. If you do not sell the contract before the expiration date, it will pass, and the profit or loss will be divided with you.
The types of settlements in the future are:
The gains and losses are calculated at the end of each day. MTM will continue until the available position has been closed (square off or sell).
When the futures contract expires, the exchange marks all open positions at the final settlement price. It then pays the profit or loss in cash.
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