Futures Trading - Indian Economy
Introduction
When a buyer and a seller enter into a futures trading agreement, the former commits to purchase from the latter a specified number of shares or an index at a predetermined price at a later date. These terms are agreed upon when the transaction occurs. Since futures contracts' expiration dates and contract sizes are specified, they can be freely traded on exchanges. The identity of the vendor may not be known to the buyer and vice versa.
Futures Trading: An Overview
• When trading futures, the buyer and seller have a responsibility to carry out their agreement and complete the transaction by the specified date and price. Delivery date and futures price are the terms used to describe the predetermined time in futures trading. Consider the following to get a better idea of future meaning:
• The underlying asset's value has an effect on future contract value. Futures contracts increase in value together with the value of the underlying assets.
• Futures contracts can be traded and transferred. The seller may sell the property to a third party in order to terminate the agreement. The purchaser is also covered by this.
• Future contracts must be properly managed to prevent default because both parties must fulfil their responsibilities. India's futures market is governed by SEBI to ensure its smooth operation.
• The terms of future contracts will not be negotiable and will be governed by a consistent system that prevents any individual from customizing them.
• Settlements for futures trades are made in cash. The difference in monetary values is paid by one party to the other.
How Should A Futures Contract Be Traded?
Futures trading is based on price fluctuations rather than purchasing or selling stocks. Hedgers and Speculators are the two main sorts of participants in futures trading.
Through futures trading, speculators take risks in order to profit from price changes. Hedgers try to avoid risk in order to guard against price fluctuations.
The following terms are some of the key ones in the futures industry:
Long call
• At a later time, the buyer purchases the transaction for the price that was originally agreed upon.
Short call
• When the seller later sells the deal for a specific price.
Short put
• Although the buyer has the choice to exercise the option contract, the seller is required to sell in this manner. The buyer typically does this after the stock's value has increased beyond the predetermined price.
Long put
• The seller must agree to the buyer's fixed price in order for the transaction to be purchased.
Bull put Spread
• When one of two contracts that a party sells and buys has a higher predetermined price than the other.
Bear call spread
• Similar to the last method, this one also uses two option contracts. The contract bought should have a higher strike price than the contract sold. These are a few illustrations of futures trading strategies.
The Benefits Of Futures Trading
• Futures trading is honest and open. SEBI is in charge of it, making sure that the deals are equitable for all parties.
• It helps traders become accustomed to the idea of a stock's future price.
• Based on the present future price, it helps the trader predict future demand and supply for the shares.
• Since a futures contract only carries a little brokerage fee, trading in futures is less expensive.
The Drawbacks of Trading Futures
• The trader may be exposed to large financial losses if market circumstances fall short of expectations.
• Due to the time-sensitivity of future contracts, the parties are required to complete transactions often, necessitating the maintenance of adequate capital.
• You must be knowledgeable with futures trading. You need to be aware of how trading functions on both the buying and selling sides.
Difference Between Futures And Options
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Basis For Comparison |
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Futures |
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Options |
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Meaning |
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A futures contract is a legally binding agreement that allows you to purchase and sell a financial asset at a predetermined price on a future date. |
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Options are contracts in which the investor is given the right but not the obligation to purchase or sell a financial instrument at a predetermined price on or before a specific date. |
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Obligation of buyer |
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Yes, in order to execute the contract. |
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No, you are not obligated to do so. |
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Execution of contract |
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On-time, as agreed. |
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Before the agreed-upon date expires, at any moment. |
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Risk |
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High |
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Limited |
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Advance payment |
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There is no need to pay in advance. |
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Premiums are the method of payment. |
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Degree of profit/loss |
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Unlimited |
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Unlimited profit and limited loss. |
Conclusion
Futures are financial derivative contracts where the buyer and seller agree to buy and sell an asset, respectively, at a specified future time and price. A futures contract allows an investor to make predictions about the course of an asset, commodity, or financial instrument. Futures are used to hedge the price movement of the underlying asset and protect against losses brought on by unfavorable price changes.