What is Futures Trading in Derivatives?

What is Futures Trading in Derivatives?

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Futures trading in India is a popular derivative instrument that occurs in the equity market, specifically in the F&O segment. It involves buying or selling an asset at a future date at a price determined today. Futures contracts, also known as futures market investing, are contracts that do not create assets. They are symmetric products, meaning the rights and obligations of buyers and sellers are symmetrical to each other. Future trading is a short-term trading strategy, with stock index futures and individual stock futures available on four indices. Futures trading is not a form of investment, as these contracts do not create assets. Understanding futures trading as a product and how to execute it in the real live market is crucial for successful futures trading. Let’s explore what is futures trading in this article.

How to Start Future Trading?

To start your futures trading in India, you need to follow some of the below steps.

  1. Acquire knowledge: Gain an understanding of the future derivative concepts, the mechanics of futures contracts, various trading strategies, as well as the technical and fundamental analysis related to these contracts. You can read books, and enrol in training courses to acquire the knowledge before trading.
  2. Choose a broker: You should open an account with a well-known and regulated broker for purposes of executing futures trade. Important factors to consider are the commissions and margin rates charged, available trading platforms, and tools provided. Most of the brokers offer demo accounts for practising various approaches.
  3. Choose the markets for trading: Identify futures markets by evaluating your analysis of trading prospects, risk tolerance, and available capital. Typical selections include equity index, commodity, currency, and bond futures. It is essential to comprehend the seasonality and events that influence each market.
  4. Develop a trading plan:  Outline your risk tolerance, capital allocation, strategies (long/short/spread), position sizing, and entry and exit rules. Define trading guidelines to maintain discipline.
  5. Start with small position sizes: Trade only a few contracts when starting. Gain experience before increasing position sizes.
  6. Review performance: Analyse results periodically to improve trading plans. Track detailed trading records, performance metrics, and mistakes to refine strategy.
  7. Manage risks:  Control overall portfolio risks through prudent position sizing, diversification, and managing market exposure. Use defensive strategies if required.

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Table of Content

  1. How to Start Future Trading?
  2. What are Futures Markets and Types of Futures?
  3. Types of Future Traders
  4. What is Futures Trading?
  5. Advantages & Disadvantages of Futures Trading 
  6. How does Futures Trading differ from other financial instruments?
  7. Contract Specifications for Exchange Traded Futures

What are Futures Markets and Types of Futures?

Futures Markets act as platforms where people can trade future contracts which are agreements to buy or sell an asset at a determined future date and a specified price. The instruments can be used to hedge or to speculate the anticipated direction of the asset price. There is a wide range of future contracts available, right from the derivatives over to the agricultural commodities. On this note, let’s take on what most active futures look like.

  • Financial Futures: Financial futures include index and interest rate contracts. Index futures provide exposure to the value of specific market indices, while interest rate futures offer exposure to the interest rates of certain debt instruments. 
  • Currency Futures: Traders can use this to predict the future exchange rates among several real or virtual currencies.  
  • Energy Futures: These are contracts for crude oil, natural gas, and gasoline. These contracts provide traders the opportunity to speculate on the prices of energy resources that are widely used in manufacturing, production, transportation, and personal consumption.
  • Metal Futures: Metal futures cover contracts for precious and industrial metals, such as gold, silver, and steel. These contracts are commonly used by businesses involved in manufacturing and construction, allowing them to hedge against price fluctuations in raw materials.
  • Livestock Futures: Livestock futures involve contracts for live animals like cattle and hogs. These contracts allow traders to speculate on the price changes in the livestock market, which is crucial for meat production and distribution. 
  • Grain Futures: Grain futures include contracts for raw grains such as wheat, corn, and soybeans. These contracts are essential for farmers and businesses involved in animal feed production and commercial processing into products like ethanol and corn syrup. 
  • Food and Fibre Futures: These futures contracts provide exposure to the prices of agricultural products, often referred to as "softs," such as coffee, cotton, and dairy. They cover products that are cultivated, like fruits and vegetables, and offer a way to hedge against price volatility in the agriculture sector.

Types of Future Traders

Hedgers and Speculators are the two categories of futures trading.

  • Hedgers: Investors who buy derivative products to hedge against losses on their money are known as hedgers. For instance, a commodity producer may sell a futures derivative at the present price and purchase it back when the price drops if they believe that the value of their crop will decline in the future.
  • Speculators: Independent floor traders and investors who make money off of the rise and fall of derivative contracts are known as speculators. They purchase and sell futures and options based on the state of the market and the derivative's supply and demand dynamics. In actuality, the parameters of supply and demand control futures prices. A speculator is similar to an intraday share trader who makes purchases at a discount to the asset's value and sells it at a premium.

What is Futures Trading?

Futures trading meaning refers to entering into a purchase or sale of futures. A futures contract is an arrangement that obliges a contracting party to undertake the future sale of an asset at a specified price on an agreed future date. Underlying assets can also be on a computer. For future trading example, a commodity like oil, a financial one, like a government bond or a stock index, and others or a currency pair. Also, the trade in such a contract is characterised by certain requirements concerning the volume and quality of assets, the place of delivery, and the time of fulfilment of obligations. It helps to comprehend the sense of novelty and features of trading in futures markets.

Advantages & Disadvantages of Futures Trading 

Now that you understand what is futures trading, let’s take a look at the benefits and drawbacks of this strategy. Here are the advantages and disadvantages of futures trading.

Advantages of Futures Trading

Disadvantages of Futures Trading

No risk of default due to the clearing corporation guarantee.Trading complexity surpasses stock trading.
Counter-guarantee by the clearing corporation minimizes default.Leveraged positions can amplify losses.
Allows larger contract positions with minimal initial margins.Daily mark-to-market adjustments require substantial capital, limiting smaller capital usage.

How does Futures Trading differ from other financial instruments?

The primary distinction between other financial products and futures is:

  • The value of a futures contract is derived from the underlying asset; it does not have an inherent worth.
  • In stock markets, futures contracts are exchanged.
  • The last Thursday of each month is when futures contracts expire.
  • Lots of transactions include futures contracts.

Contract Specifications for Exchange Traded Futures

Under the SEBI approval list, there are currently 4 indices and a total of 194 stocks where trading in futures and options is permitted. Here are the contract highlights.

  • Out of the 4 index futures; Nifty 50 Index Futures, Nifty Bank Index Futures and Nifty Financial Services Index will have 3 consecutive months trading cycle i.e. Near-Month, Mid-Month and Far-Month.
  • The Nifty Midcap Select Index Futures will have 4 serial weekly cycles excluding the monthly expiries plus 3 consecutive months trading cycle i.e. Near-Month, Mid-Month and Far-Month.
  • In terms of F&O expiry, for Nifty 50 and Nifty Bank Index; the last Thursday of the expiry period will be the expiry. If last Thursday is a trading holiday, then the contract will expire on the previous working day.
  • For the Nifty Financial Services Index and the Nifty Midcap Select Index, the expiry of the monthly contract will be on the last Tuesday of the expiry month. If last Tuesday is a trading holiday, then the expiry day will be the previous trading day.
  • For the 194 individual securities in F&O, the last Thursday of the expiry month will be the default expiry date for the contract.   

Conclusion
For futures trading in derivatives, traders and investors can undertake risk management activities or seek profit from variations in the value of the various underlying assets including commodities, financial instruments, and currencies. For a trader to appreciate this market, knowledge of the construction of futures contracts, behaviour of the market, plus the types of traders like hedgers and speculators is paramount. No matter if you are a newcomer or a skilled trader, due to the nature of futures trading, it is possible to extend your investment portfolio. Engage in this dynamic market with strategic approaches and informed decisions with a strong stock market app

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FAQs on Futures Trading in Derivatives

You can trade Intraday in futures during market hours if your broker's account is linked to your Futures trading activity.

The smallest quantity of underlying assets that a futures contract represents in futures trading is known as the lot size.

Hedgers use futures contracts to mitigate the risk of adverse price movements in the underlying asset, securing future prices. Speculators, on the other hand, aim to profit from price fluctuations by buying or selling futures contracts based on market expectations.

Futures contracts obligate both parties to fulfil the contract's terms upon expiration, involving buying or selling the underlying asset. Options contracts, however, provide the holder with the right but not the obligation to buy or sell the asset.

Futures trading carries risks such as market volatility, leveraged positions leading to magnified losses, and potential margin calls requiring additional funds. It's crucial to understand these risks and employ risk management strategies while engaging in futures trading.

A futures trade refers to purchasing or selling a uniform contract to accept delivery of an item at a fixed price on a specific future date. There are two uses for this trade: hedge against potential market risks or speculate on price fluctuations.

There are certain benefits to trading futures compared to stock trading, regardless of the risks involved. Among the advantages are more leverage, lower trading costs, and extended trading hours.