Different Types of Futures Contracts

Different Types of Futures Contracts

In the financial market, futures contracts are the most popular tool as they offer agreements to buy or sell assets at a future price and time. These contracts provide important hedging against price instability, so traders and investors actively use them. Futures offer a variety of opportunities for market participation and risk management because a variety of assets are covered by futures, including currencies, equities, indices, and commodities. This blog will review the different types of future contracts and futures trading strategies.

What are Futures?

Futures act as binding contracts to purchase or sell a specific commodity, asset, or security at a predetermined price on a predetermined future date. These contracts are secured to regulated standards for quality and quantity, thereby supporting the futures exchange trading process. The buyer agrees to acquire and receive the underlying asset upon contract expiration. Contrary to what the seller promises, the asset must be delivered and provided after the contract.

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Table of Content

  1. What are Futures?
  2. Types of Futures
  3. Types of Futures Traders
  4. How are Stock Futures traded?
  5. How are Index Futures traded?
  6. What are Commodity Futures all About?
  7. Pros and Cons of Futures Trading

Types of Futures

Here are the types of futures contracts for your understanding: 

Commodity Futures

Food grains, metals, oil, and natural gas are examples of tangible goods that investors may purchase and sell. Futures contracts are essential for minimising price risk since they protect these transactions, particularly for farmers. Farmers who wish to sell their produce at a fixed price but don't want to worry about losing money if the price declines can do so by entering into futures contracts.

Currency Futures

Contracts based on currency exchange rates are known as currency futures. The contractual parties agree upon an exchange rate for the future exchange of two currencies. These contracts can help remove the potential currency rate risk associated with extended international trade. To satisfy their demands, the parties usually close these contracts before the expiration date.

Interest Rate Futures

One way to protect yourself from the possibility of future fluctuations in the interest rate of a financial instrument is to purchase interest-rate futures. Uncertain interest rates might put firms under further financial strain and cause large losses. Usually, money market or bond market instruments like government bonds, bills, and the like are utilised with interest rate futures. These types of futures contracts are based on these assets.

Stock Futures

Investors utilise stock futures as financial derivatives to speculate, trade, and manage risk. They represent sentiments and investor confidence in the market. While stock market index futures follow the movement of an index, single stock futures serve as a hedge against the stock's future price. Because they hedge against prospective stock price declines, these derivatives are advantageous for investors who own a sizable investment in one or a small number of equities.

Different Types of Futures Contracts

 

Types of Futures Traders

Here are the different types of Futures Traders: 

Hedgers

Commodity producers, such as farmers or mining companies, are known as hedgers. Corporations use futures contracts to safeguard against potential price volatility.

For instance, a coffee bean planter could think that the commodity's price would have decreased at the time of harvest. To hedge against potential losses, he might sell a futures contract at current pricing. When harvest season approached, he could get out of the arrangement by purchasing coffee beans at a discount. Simply put, he profited from the gap between the selling and buying prices by selling the cocoa at a higher price before actually acquiring it at a lower cost when it was created. Banks, insurance providers, and pension fund organisations are examples of additional hedgers. 

Speculators

This group consists of private investors and independent floor traders. These businesses mainly want to profit from the purchase of contracts that are projected to increase in value and the sale of contracts that are anticipated to decrease in value.

How are Stock Futures traded?

Stock futures are contracts based on individual stocks that have been used for hedging risk and speculating for many years. Currently, stock futures trading is allowed in 192 different stocks, and the complete list of these stocks can be found on the NSE website.

Here are key facts about stock futures on the Indian stock exchanges:

  • The symbol identifies stock futures – FUTSTK and trades on the futures and options segment of the stock market.
  • Futures contracts are available on 192 securities stipulated by SEBI, with lot sizes defined for each stock, such as a minimum notional value of Rs. 5 lakhs.
  • Stock futures contracts have a maximum 3-month trading cycle, including the near-month, mid-month, and far-month contracts. New contracts are introduced on the trading day following the expiry of the near-month contracts, so at any point in time, there will be 3 contracts available for trading in each stock futures. Liquidity is an individual stock-specific issue.
  • Stock futures contracts expire on the last Thursday of the expiry month. If last Thursday is a trading holiday, the contracts expire on the previous day.

How are Index Futures traded?

If the trader does not want to take a view of specific stocks, then index futures can come in handy. In India, on the NSE, index futures are available on 4 indices: the Nifty 50, Bank Nifty, Nifty Financial Services Index and the Nifty Midcap Select Index. Index futures trading is less risky than stock futures since they tend to be less volatile than individual stocks. Secondly, in the case of a portfolio with some F&O stocks and some non-F&O stocks, using stock futures to hedge may not work. In such cases, Beta hedging can come in handy using index futures.

Here are essential points to know about index futures trading in India:

  • Out of the 4 index futures available on the NSE, the Nifty 50 Index Futures, Nifty Bank Index Futures, and Nifty Financial Services Index have three consecutive months of trading cycle: near-month, Mid-Month, and Far-Month.
  • The Nifty Midcap Select Index Futures will have 4 serial weekly cycles excluding the monthly expiries plus three consecutive months of trading cycle, i.e. Near-Month, Mid-Month and Far-Month.
  • For F&O expiry, the last Thursday of the expiry period will be the expiry date for Nifty 50 and Nifty Bank Index. If last Thursday is a trading holiday, the contract expires on the previous working day.
  • For the Nifty Financial Services Index and the Nifty Midcap Select Index, the monthly contract expires on the last Tuesday of the expiry month. If last Tuesday is a trading holiday, then the expiry day is the previous trading day.

What are Commodity Futures all About?

In India, commodity futures are used to hedge the risk of commodities. Positions in the commodity futures can be taken for speculation or specifically for physical delivery, done by the exchange through the designated warehouses. The largest commodity futures trading exchange in India by volume is the MCX, which dominates all futures types of products other than agricultural futures. NCDEX dominates the agricultural futures. Apart from these two principal commodity exchanges, NSE and BSE also offer commodity futures types, but the volumes are just about picking up now. Broadly there are 4 categories of commodity futures trading available on the MCX and the NCDEX:

  • Precious metals futures cover gold and silver
  • Base metals futures cover copper, zinc, aluminium and other industrial metals
  • Energy futures include trading in crude oil and natural gas
  • Agricultural futures offer a host of cash crops for futures trading
  • Normally commodity futures on agricultural products tend to be more politically sensitive than others.

Pros and Cons of Futures Trading

Here’s a table to show the pros and cons of Future Trading: 

ProsCons
Working with futures prices linked to the market's actual asset cost is one of the incomparable advantages of futures contracts for investors.Futures contracts include a number of advantages, but they also carry a number of hazards. Therefore, if there is a price swing in the opposite direction, speculators may also lose their original margins.
These kinds of contracts are used by traders as hedging against future market price declines.When entering a futures contract, investors may often miss out on favorable price benefits.
By using leveraged margin, investors can also considerably save themselves from making payments in advance.Using margin involves potential damages for investors as well.

Conclusion 
Futures are a sort of financial contract in which the buyer is obligated to buy an asset, or the seller is obligated to sell an asset, such as a physical commodity or a financial instrument, at a defined future date and price. There are different types of future contracts. They are classified based on the type of asset being traded, the date the item can be delivered, the date the asset contract may be exchanged, and whether the contract is standardised or bespoke. Futures are classified into three types: cash or spot, forward, and futures. Remember to choose a reliable stock market app for a better experience. 

FAQs on Different Types of Future Contracts

Futures contracts allow traders to bet on market direction while also providing benefits such as quick pricing, high liquidity, and risk hedging. With margin investing, these highly leveraged securities improve profit possibilities. Unlike options, the futures market is linear, with a well-defined margin needed based on the cost of carrying the spot price.

Single-stock futures contracts are futures contracts where the underlying asset is a single stock, allowing traders to speculate on the future price movements of individual companies.

Futures contracts serve as risk management tools, allowing participants to hedge against price volatility, thereby managing exposure to various market fluctuations.

Interest rate futures contracts are based on the future interest rates of financial instruments, allowing investors to hedge against interest rate fluctuations.

Futures contracts have standardized terms, including quantity, quality, expiration date, and delivery methods, enabling liquidity and easy trading on regulated exchanges.

The Securities & Exchange Board of India( SEBI) has issued 182 future contracts on securities. The Exchange's Capital Markets division trades these securities.