The Indian secondary market which is commonly referred to as the stock market, allows you to trade in stocks and derivatives. Derivatives are amongst the most preferred choice of traders and investors due to a number of advantages over conventional stocks.
Futures contracts are contracts between two or more parties for buying or selling a particular asset on a future date at a pre-decided price. The futures contracts are widely used for speculation and hedging. Futures contracts or futures are very similar in nature to Forward Contracts. The point which differentiates forwards from futures is that unlike forwards, futures are traded on the exchange. Future is an obligation which means that both the buyer and seller will have to buy and sell the asset at the set price, irrespective of the current valuation on the expiry date.
Let us now discuss in detail about futures contracts.
So, without further ado let us discuss about futures contracts in detail. Futures contracts are standardized contacts and are traded on stock exchanges.
1. What are Future Contracts
Future contracts or simply futures are derivative instruments which obligate the involved parties to buy or sell an underlying asset at a predetermined price and date. Future is an obligation which means that both the buyer and seller will have to buy and sell the asset at the set price, irrespective of the current valuation on the expiry date.
These underlying assets can be stocks, commodities and even indices. Future contracts are standardized contracts and are therefore traded on the exchanges. They are widely used for trade speculation and hedging purposes.
Future contracts have a fixed expiry date and set prices which are known up front. These contracts are usually identified on the basis of expiry. For example, a December Crude Futures will expire in December. The futures market is very wide and there are various different types of futures available like commodity futures, stock index futures or currency futures.
2. Trading in Futures Contracts
Trading in futures is usually done using high leverage. It means that the trader or investor does not requires to deposit the 100 per cent of the contract value amount with the broker. But the broker would only require an initial margin amount which is usually a fraction of the total value of the contract. This amount can vary depending on a number of factors including the size of the contract, the creditworthiness of the trader and the terms and conditions of the broker.
Futures contracts can be cash settled or may require physical delivery depending on the contract and the exchange. Mostly future contracts are from those traders who speculate on trade. These contracts are closed out and netted, which means that the difference between the original trade and closing trade price is calculated and the contracts are cash settled.
3. Advantages of Futures Contracts
As we discussed, you can use futures for trade speculation and hedging. You can use these contracts for speculating on the direction in the price of the underlying asset. Future contracts are also used by institutional investors and investors for hedging. Companies hedge the price of their products or raw materials which they require to safeguard them from any sudden or adverse price movements. Futures Contracts also require you to deposit a fraction of the total contract amount with your broker to be eligible for trading.
4. Disadvantages of Futures Contracts
Apart from all the advantages discussed above, it is important for you to understand about the disadvantages of futures as well before you trade in them. Futures are instrument which use leverage, therefore investors have a risk that they may loose more than the initial margin amount. Hedging using futures can cause you to miss out on a favorable price movement which may end up in considerable amount of losses. Also, the margins can prove out to be a double-edged sword, which means that the gains can be surely amplified, but so are the losses.
Conclusion
Futures contracts make use of leverage and therefore they are considered a high-risk instrument. You can take the help of Equity Derivative Pack for getting research based recommendations for all your derivative trading needs. If you want to use swing trading strategies in your derivatives trading, you can use Delta Derivative Plus. Also, you should get your risk profile evaluated from a SEBI registered investment advisor before investing in any of the investment instruments to have an idea about your risk bearing capacity.
