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Tutorial: Indian Futures..!!

Are you interested in business but don’t want to have a typical house of CAs, attorneys and bookkeepers? Well, you can be a businessman (or businesswoman) without having to handle all these people! Are you wondering how? Futures Trading is the answer. All you need is a personal computer! No warehousing, no fear of competition, no dealing with customers. You can operate from anywhere in the world with very little capital and can be 99% sure of unlimited earnings and real wealth – 99 because markets are synonymous with risk.

Now if you are pondering over what is Futures Trading, it is a means of speculating security’s price going up or down in the future. A security here could imply stock (RIL, TISCO etc.), stock index (NSE), asset (gold etc.), currency (dollar, pound, sterling, euro etc.) etc. Also while trading futures, you do not purchase or sell anything. You merely bet on the way the stock would go in the future – you buy a futures contract if you think the price would increase in future and sell if you sense the price would decrease. There is always a buyer and seller in every trade but neither owns anything. All that the future trader has to do is deposit enough money with her/his brokerage firm in order to pay up if their trade loses money.

So what exactly are futures?

You buy a futures contract, but what is this futures contract? No need to get boggled by the terminology used. A futures contract is a usual contract, the difference being that you buy or sell at a certain date in the future and at a specified price. Please remember the following terms while agreeing to a futures contract:

·          Futures date – Delivery date or final settlement date

·          Futures price – Pre-set price

·          Settlement price – Price of the instrument on the delivery date 

Also remember that if you are entering into a futures contract, then unlike the options contract, both the prospective ‘buyer’ and ‘seller’ are bound by the contract and HAVE to buy/sell the underlying instrument, as the case is.

We are sure you would have understood that in a futures contract, the seller delivers her/his asset to the buyer. In case the futures contract is made on stocks, then cash is transferred from the traders who sustained a loss to the trader who enjoyed profit. Like all other contracts, you can egress from a futures contract also. All that the holder of the futures position has to do is, prior to the settlement date, either sell a long position or buy back a short position thus offsetting his position.

A typical futures contract would have the following features:

1.      Underlying asset or instrument – this can be anything from gold and crude oil to a specific stock or share.

2.      Type of settlement – settlement can either be monetary (common in India) or physical.

3.      Unit of underlying asset per contract – this can be a barrel of crude oil, two kilos of gold, etc.

4.      Currency in which the futures contract is quoted.

5.      Grade of deliverable – this specifies which bonds can be delivered in case of bonds, while in case of physical commodities this also mentions the manner and location of delivery.

6.      Delivery month.

7.      Last trading date. 

Please note that the Securities and Exchange Board of India (SEBI) regulates futures trading.
 

We now proceed to the next level – How does futures trading work?

Categorically speaking there are two participants in futures trading – hedgers and speculators. Hedgers, as the name suggests, comprises of those who protect themselves from losses. Using futures as a medium, the raison d’etre is based upon the predisposition of cash prices and futures value to move in tandem.

For easier understanding, let’s take the example of a food processor canning barley. If the price of barley increases, the processor has to pay more to the farmer or dealer. In order to “save money” and keep the price constant, the processor may buy barley futures contract covering the barley amount she/he is to buy. Since cash and futures prices move hand-in-hand, the futures position will profit if barley prices rise enough to balance barley cash losses. Speculators on the other hand, unlike hedgers, can gain and enjoy huge profits if they can read the market well. This is because capital in futures market rises quicker than real estate or stock. Similarly, wrong speculation can cause heavy losses. In futures, unlike stocks, traders put up only a margin, say 10%, since the money thus put up is only a performance bond and not a down payment. The actual value of the contract is exchanged when delivery takes place and this is rare. In addition, the futures investor does not have to pay any interest on the difference between the margin and full contract value. Futures contract is, relatively speaking, a new term in India. A typical contract is settled when the agreement has been abided by. But how are futures contract settled? Buying or selling offsetting position settles futures contract allowing the participant to realise profit/losses. The margin balance along with any additional gains is returned to the holder, or credited towards the holder’s loss. Cash is brought into play only where delivery is impossible.

The option of delivery has been kept open in futures contract so as to ensure that the futures price and cash price of the good congregate at the expiration date. If this does not happen then the trader could purchase at a lower price, sell in the futures market at a higher price and make a handsome profit. Traders can make huge profits from a very meagre difference! 
 

To highlight some advantages of engaging with futures trading:

·         High leverage – Futures trading guarantees excellent profits IF you are a good reader of the market. As stated before, futures trading require only a portion of the contract as ‘margin’. Thus if the investor has deposited 10%, the profit earned will be ten-fold provided, of course, the market prediction is correct. This is better than buying and taking physical delivery of stocks.

·          Profit irrespective of market condition – Futures trading also promises profits irrespective of whether the market is at a high or suffering from lows IF chosen correctly.

·          Lower transaction cost – Commission for trading a futures contract is one-tenth of a percent while it is as much as one percent for trading stocks!

·         High liquidity – Contracts are traded very frequently in most markets on a daily basis ensuring quick market orders’ placement. 

Futures trading is today being addressed as the perfect business and there are lots of reasons for this. For one, you only need a computer (your start up cost). You work from your home, no permits or licences required, no employees to handle, no need for advertising, no set hours, no selling, no inventory, no restrictions on markets to trade, no need to worry about which way the market is going as profits are guaranteed, no interest charges, no transaction fees – all these factors, combined with many more, are why futures trading is being talked of as ‘perfect business’. 

With dedication and discipline and little help from our newsletter services, we assure constant cash flow for you. Please remember, while all the information will help you to trade better, you will become a better trader only if you are able to read the market well.

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Disclaimer: The purpose of this tutorial is limited to provide knowledge about futures only. We do not guarantee the correctness and authenticity of the material written and the final decision of trading derivatives is totally yours.