What Is a Futures Contract?
A futures contract is a standardised, legally binding agreement between two parties to buy or sell a specified underlying asset (such as a stock, index, commodity, or currency) at a predetermined price on a specific future date (expiry date). Unlike forward contracts (bilateral agreements), futures contracts are traded on organised exchanges (NSE in India), are standardised in terms of lot size and expiry, and are guaranteed by the clearing corporation (NSCCL for NSE), which eliminates counterparty risk.
Key Features of Futures Contracts
- Standardisation: Lot size, expiry date, and contract specifications are fixed by NSE. No customisation is possible.
- Exchange-traded: Futures are bought and sold on NSE's derivatives segment, providing transparency and liquidity.
- Clearing corporation guarantee: NSCCL (NSE's clearing corporation) guarantees all trades, eliminating the risk of the other party defaulting.
- Leverage: Requires only margin (10-15% of contract value) rather than full payment.
- Daily MTM settlement: Daily profit and loss is settled to your trading account every evening.
Parties in a Futures Contract
| Party | Position | Obligation |
|---|---|---|
| Futures buyer (long) | Agrees to buy at futures price | Must buy at contracted price if held to expiry |
| Futures seller (short) | Agrees to sell at futures price | Must sell at contracted price if held to expiry |
Futures vs. Spot Market
In the spot (cash) market, you buy/sell the asset immediately and pay full price (e.g., buy Reliance shares at Rs 2,800). In futures, you agree on a price today but transact at expiry (typically one month away). The futures price is usually slightly above the spot price (due to cost-of-carry: financing cost and expected dividends), a relationship called "contango." If futures price is below spot, it is called "backwardation," common when high dividends are expected.
Uses of Futures Contracts in India
- Speculation: Taking leveraged directional bets on Nifty, Bank Nifty, or individual stocks.
- Hedging: Protecting equity portfolios from market decline using short futures.
- Arbitrage: Exploiting price differences between cash and futures segments.
- Pair trading: Long futures on one stock, short on a correlated stock simultaneously.
Key Takeaway
Futures contracts provide standardised, leveraged exposure to underlying assets with the safety of exchange-guaranteed settlement. Understanding the mechanics of futures, including leverage, MTM settlements, and expiry obligations, is essential before trading. Use the Lemonn app to monitor futures prices, track basis (futures vs. spot price), and build a strong foundation for derivatives trading in Indian markets.
