Futures: What is it? Everything You Need to Know

In order to have a comprehensive understanding of futures trading, one must have a thorough knowledge of derivatives first. Derivatives essentially are financial contracts that derive their value from the price movement of some other financial instrument.

So, futures are nothing but a type of derivative contract for the purchase or sale of an asset on a future date at a predetermined price. That asset can be shares of a company of a commodity, life coffee, silver, gold, etc. In a futures contract, one party is a buyer (the one having a long position) and a seller (the one having a short position), where the buyer of Futures agrees to buy a certain quantity of a commodity or securities and the seller agrees to provide it. Usually, futures contracts trade on an Exchange. As time goes by, the contract’s price tends to change based on the price of the underlying asset. This frequent change in price of the contract also creates profit or loss for the trader.

How does Futures Trading work?

The futures market is thronged by multiple kinds of financial players. They could be investors, speculators or companies either wanting to physically accept the delivery of the commodity or supply it through the terms of futures contract.

Futures contract is used by Hedgers to fix the buy or sell price of the underlying commodity on a specific date.

To illustrate how futures trading works, let’s consider a jar of beans. In the event of the price of beans going up, a major food processor who is dependent on beans to run the business will have to pay the farmer or the dealer more. For protection against this sudden rise in the price of beans, the processor may want to “hedge” his risk by buying beans futures contracts to cover the risk of price changes. It will prove beneficial for the futures contract buyer in case the price of beans goes up.

Similarly, in stock market too people can hedge the stock prices through stock futures. It can be purchased now on stocks or on an index. The buyer of a futures contract does not have to pay the full amount of the contract beforehand. Only initial margin is to be paid.

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How Futures Trading Differs from Other Financial Instruments?

The key difference between Futures and other financial instruments is:

  • Futures contract does not have intrinsic value, its value is derived from that of the underlying asset
  • Futures contract is traded in stock market
  • Futures contract has an expiry date which is the last Thursday of the month
  • Futures contract is transacted in lots

Advantages of Futures Trading

One of the biggest advantages of Futures Trading is that there’s no risk of default. The clearing corporation on the stock exchange gives a counter-guarantee for every trade of futures in the stock market. This ensures that sufficient margin is maintained by the respective counterparties in the contract to avoid the risk of default. Trading in futures lets you take position in larger contract size by just paying the margin amount.

Disadvantages of Futures Trading

  • More complex than trading in stocks
  • Leveraged positions can lead to magnified losses as well
  • Daily Mark to Market adjustment requires the trader to have enough capital available to keep the position intact. So, it’s not possible to maintain a futures contract with smaller capital.

FEW THINGS TO KEEP IN MIND WHILE TRADING FUTURES

  • Clear concept of leverage – Understanding the working of leverage is very important while trading in futures. One of the biggest benefits of a futures market is that you needn’t pay the full price of futures contract’s value to take a long or short position. They just need to pay a portion of the price known as margin. Having said that, traders need to be very cautious in the usage of leverage. A slight deviation in the direction of prices can either bring them profits or result in major losses.
  • Use of stop Loss orders – Traders should operate skilfully and know when to get in and out of a trade. Proper planning is of utmost importance and that’s where stop Loss orders play a significant role. Stop Loss orders are orders to buy or sell at a definite price to limit losses in a trade.

Futures are used by traders and investors to form an opinion on the price movements of the underlying asset.

Futures trading FAQs

Yes, if your futures trading is activated with your Broker’s account, you can trade intraday in futures during the market hours.

A lot size in Futures trading is the minimum number of underlying asset that the futures contract represents. Futures contract is traded in lots.

You can view futures contract on the Bajaj Financial Securities platform (Trade online & BFSLTrade App). The Stock Exchange, NSE and BSE also provides the details of contracts that are traded in derivatives market on their websites.

In order to trade in futures, you need to open a trading account with a SEBI registered Stock Broker. You cannot trade in futures if you don’t have an activated trading account.

For Indian markets below are the timings-
Stock Futures & Index Futures – It is dependent on the segment you trade on. For NSE, BSE cash, and NSE F&0, the hours are 9:15 AM – 3:30 PM.
Commodity Futures – The commodity online trading markets are open from 9 AM – 11:55 PM (November to March) and 9 AM to 11:30 PM (March to November), Monday to Friday.

You need to open a free Demat and Trading account and activate Futures trading by sharing income proof at the time of account opening. If you already have an account, you can write to connect@bajajfinserv.in