A futures contract is an agreement between two parties to buy or sell an asset at a set price on a future date.
The asset can be a stock, an index, a commodity, or a currency. Futures contracts are standardised, which means their contract specifications are fixed by the exchange and are the same for all traders.
Futures are a type of derivative contract because their value is derived from the price of another asset, known as the underlying asset. Traders and investors use futures either to hedge against unfavourable price movements in their existing positions or to speculate on the future direction of the market. Since futures are traded on margin, they also allow participants to gain larger market exposure with a relatively small initial investment.
How do futures contracts work?
When traders buy or sell a futures contract, they are taking a position based on where they think the price of the underlying asset will move.
Unlike buying stocks in the cash market, traders do not have to pay the full contract value. They only need to deposit a margin, which is a small percentage of the total contract value. The profit or loss on the position is calculated and settled daily through a process called mark-to-market (MTM).
Example: buying a Nifty futures contract
Suppose Nifty is trading at 24,000. A trader believes the market is likely to move higher over the next few weeks. Instead of buying all the stocks that make up the index, the trader can buy a Nifty futures contract.
| If Nifty | Value of the futures contract | Result |
| Rises to 24,500 | Increases | The trader can close the position and book a profit |
| Falls to 23,500 | Decreases | Loss |
What is the underlying asset?
An underlying asset is the asset from which a futures contract derives its value.
Common underlying assets include:
| Type | Examples |
| Stocks | Reliance Industries and Infosys |
| Indices | Nifty 50 and Sensex |
| Commodities | Gold and crude oil |
| Currencies | USD/INR |
The price of a futures contract generally moves in line with the price of its underlying asset.
Example: buying a Reliance Industries futures contract
Suppose Reliance Industries is trading at ₹1,500, and its July futures contract is trading at ₹1,510. If a trader expects the stock price to rise, they may buy the futures contract at ₹1,510.
| If the futures price | Result |
| Increases to ₹1,560 | The trader can exit the position and earn a profit of ₹50 per share |
| Falls to ₹1,460 | The trader would incur a loss of ₹50 per share |
Since futures are traded using margin, traders only need to deposit a fraction of the contract value to take a position rather than paying the entire amount upfront.
What is expiry?
Every futures contract has a fixed expiry date, which marks the last day it can be traded. Once the contract reaches its expiry date, it is settled according to the exchange's rules, and trading in that contract ceases.
As the expiry date approaches, traders who wish to maintain their positions often roll them over to a contract with a later expiry. Those who do not close or roll over their positions before expiry are subject to the settlement process specified by the exchange.
When do futures contracts expire in India?
In India, futures contracts expire on different days depending on the exchange.
| Exchange | Expiry day |
| National Stock Exchange (NSE) | Last Tuesday of the expiry month |
| Bombay Stock Exchange (BSE) | Last Thursday of the expiry month |
If the expiry day falls on a trading holiday, the contract expires on the previous trading day.
What happens after expiry?
If you buy a July futures contract, you can trade it until its expiry date. After expiry, the contract is settled, and you must take a fresh position in a later-expiry contract if you wish to continue your exposure to the underlying asset.
What are the advantages of trading futures?
Some advantages of futures trading are:
- Exposure to stocks, indices, commodities, and currencies.
- The ability to take positions when prices are expected to rise or fall.
- Lower upfront capital requirement because trading is done using margin.
- A useful tool for hedging investment portfolios.
What are the risks of trading futures?
Futures trading carries a higher level of risk than investing in the underlying asset directly.
Some of the risks include:
- Losses can accumulate quickly if the market moves against the position.
- Volatile market conditions can lead to sharp price swings.
- Traders may be required to add more funds if the available margin falls below the required level.
Because futures involve leverage, both profits and losses can be significantly larger than the initial margin deposited. To learn more about Futures, visit the Futures Trading Module on Varsity.