Introduction To Future Trading

Do you know or have you ever heard the term ‘futures trading’ in the derivative market? To learn the concept of future trading one must be aware of derivatives in detail. Derivative refers to a financial contract whose value depends upon the price movement of another financial instrument.

Thus, futures are derivatives contracts to purchase or sell underlying assets at a fixed price at some definite date in the future. Derivatives are financial contracts that derive their value from the price movement of some other financial instrument.

Thus, futures are the derivative contract to buy and sell the asset at a pre-agreed price on a specific date in the future.

Meaning Of Futures Trading

Futures or futures contracts refer to a type of financial contract obligating buyers to buy a certain asset, or for the seller to sell a certain asset at a future date and price.

These range from stocks of companies, commodities like coffee, silver, and gold, to many others. A future contract involves a buyer, taking the long position, and a seller, taking a short position. The former agrees to buy a particular amount of commodity or securities, which the latter agrees to provide. Futures contracts are traded on the Exchanges.

As time passes, the price of the contract also continually changes as per the price movement of the underlying asset, resulting in profit or loss to the trader.

Futures trading is a legal contract between buyer and seller to buy or sell derivatives based on the terms on or before the contract’s expiration date. In the case of futures trading, the buyers and the sellers must execute the contract terms.

How Futures Trading Work in India?

Futures are a complex and dissimilar investment to others, such as stocks and mutual funds. A person who is a complete beginner in stock trading will find it tough to jump into futures. If you try to trade futures, it is vital to learn the working mechanism along with associated risks and related costs involved with them. The steps to be considered while trading in futures contracts:

1. Know your risk tolerance:

Though we all want to make a profit in the market, most of the people participating in future trading face possible losses. It is very important that, before venturing into future investments, one needs to test his or her risk tolerance by knowing how much money you can afford to lose and how such a loss would change your way of living.

2. Select a trading strategy:

Futures trading requires the adoption of a certain strategy. You may directly invest in futures based on your knowledge and study, or you may hire an expert for this purpose.

3. Utilise a fake trading account:

You will have more freedom to practice after you understand the concept of futures trading. You can find simulated trading accounts online, which can be utilised to experience exactly how futures markets work so that you can develop your skills without using any real money.

4. Open a Trading Account:

To further trading in futures, you have to open a trading account. Do a good background check before opening one, and ask queries about associated fees with the firm. When investing in futures, ensure to get the type of trading account that will serve your own interests best.

5. Arrange the margin money required:

In future contracts, one is required to deposit a certain amount of margin money to cover the purchase as security, generally a percentage of between 5% to 10% for the size of the contract. Once you know how to buy futures, arranging the required margin money becomes necessary. If you are buying futures in the cash segment, then the full value of the shares purchased needs to be paid unless one is a day trader.

6. Depositing the margin money:

You pay the margin money to your broker and he deposits it with the Exchange. The Exchange keeps the money during the whole contract duration. If the margin increases in that duration, then you are required to deposit additional margin money.

7. Market buy/sell orders through the broker:

Later, you can market your order through your broker. Marketing your order through a broker is similar to purchasing a stock. You must provide a broker with details of the trade such as the size of the contract, number of contracts you intend to purchase, strike price and expiration date. Brokers will provide you with the countless contracts available, and through that, you can select one.

8. Establish futures contracts:

Finally, you will need to close out the forward contracts. This could be done on the date of expiration or it could also be settled before the expiration of the contract. Settlement refers to the fulfillment of the delivery at which a futures contract is made. There is a consideration in certain cases are the actual physical delivery of the product such as in the case of the agricultural products. But in the case of the equity index as well as the interest rate futures, settlement is by way of cash.

Types of Futures-trading in India

In India, there are four types of Futures, which are Commodity Futures, Stock Futures, Interest Rate Futures, and Currency Futures.

1) Commodity Futures

Under this kind of contract, a commodity futures contract is signed and involves an obligation to sell or purchase a fixed amount of the commodity at a particular price set on a specific future date.

Commodity futures are derivative contracts. The buyer agrees to purchase or sell an agreed quantity of an actual commodity at a given price at a future stipulated date. Derivatives, as financial instruments, derive their value from the value of another asset, commonly known as the underlying asset.

2) Stock Futures

Stock derivatives contracts are those that take a single stock as the underlying asset. A stock futures contract implies an agreement to purchase or sell a certain amount of an underlying stock at a specified date, sometime in the future, at a pre-determined price by both the buyer and seller. The contracts, in this regard, are standardised on the market lot, expiry date, price unit, tick size, and method of settlement.

3) Interest Rate Futures

Interest rate futures are a contract to buy or sell an interest-paying asset for an agreed-upon price at the future date. Such instruments are offered to the public by the NSE and the Bombay Stock Exchange through India. Underlying government bonds or T-Bills form the main basis of these futures, and they are cash-settled. Settlement between a buyer and seller can be at a future date when fixing the price of an interest-bearing asset. You can carry out the transaction using your demat account.

4) Currency Futures

Currency futures are a type of contract that includes an assurance to submit currencies at a selected rate at some moment in future. Currency Futures contracts are introduced on the Metropolitan Stock Exchange. Currency Futures are available in India on USD-INR, EUR-INR, GBP-INR, and JPY-INR at the Metropolitan Stock Exchange in India. In India, Currency Futures are also available in the BSE, NSE, MCX-SX and, USE. They assist investors to safeguard themselves from fluctuating levels of foreign exchange. The quoted price of a currency futures contract is based upon INR per unit of the other currency.

Advantages of Futures Trading in India

There are several benefits which make futures more lucrative to anyone wishing to enter the trading. The futures trading have a variety of benefits, and these include:

1) Easy Access:

New investors can easily access futures’ contracts with only a reliable internet connection, some capital, and an internet broker to get them set for business.

2) Leverage:

Trading in futures allows investors to control a large contract value by only paying a small fraction, known as margin. This increased leverage can lead to higher potential profits if market conditions are favorable.

3) Hedging and Diversification:

Indeed, the investor is offered a sufficiently broad exchange in Futures trade to trade any type of assets so that stocks, currencies, and commodities can be traded for Portfolio diversification leading to reduced risk.

4) Low Cost:

A Smaller amount of fees with a minimum commission rate in Futures trading compared to other tradings; the trader maximises profit.

5) High Liquidity:

Because of a huge amount of trading every day, the futures markets are highly liquid. That is, with an ongoing stream of buyers and sellers, it is fairly easy to enter and exit orders efficiently.

Frequently Asked Questions (FAQs)

What is the difference between Futures and Options?

Futures represent agreements to purchase or sell an underlying stock or other assets at a pre-determined price on a specific date. Conversely, an options contract grants the investor the choice, but not the obligation, to purchase or sell the assets at a specific price on a particular date, referred to as the expiry date.

How does Futures trading help farmers in the agriculture sector?

Farmers use futures contracts to lock in prices and hedge against price uncertainty. Profits or losses in the cash markets resulting from price fluctuations will be offset by corresponding gains or losses in future markets, allowing farmers to manage risks associated with price fluctuations during the growing season.

What is an underlying asset?

The interest-bearing security on which the contract is founded is the underlying asset. The underlying asset for an interest rate futures contract can be a Government bond or a T-Bill.

What is the margin rate in NSE for the interest rate futures in India?

It is 1.5% of the contract’s value, which can go maximum to 2.8% on the first day of futures trading.

Is there any Securities Transaction Tax (STT) to be paid on Futures contracts?

No, the investors do not need to pay any STT on the transaction of Futures contracts.

Are Futures contracts done in real time?

Yes, the trading in the futures contracts is done in real-time.

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