What Is a Future Contract?
A Future Contract is an agreement between two parties to buy or sell an asset at a fixed price at a specified date in the future . They are traded on regulated stock exchanges, and often used for commodities, stocks, indices and currencies.
In layman’s terms, a future contract lets traders and investors set the price of an asset today for a transaction that will happen later.
For instance, suppose you believe that the Nifty 50 is going to move up in the coming weeks. You can buy a Nifty futures contract. If you are right you profit from the price change .
Futures contracts are one of the most sought-after instruments in the Futures and Options (F&O) market as they provide leverage, liquidity and opportunities for profits in both rising and falling markets.
What is a future contract?
Let’s illustrate this with a simple example.
Assume ABC Ltd. is presently trading at ₹1,000 in the cash market.
ABC Ltd.’s one-month futures contract is being traded at ₹1,010.
You believe that the stock price will rise in the next month and you purchase one futures contract at ₹1,010.
Scenario 1 – Price Going Up
ABC Ltd. is trading at ₹1,080 at the time of expiry.
Your gain:
₹1,080 – ₹1,010 = ₹70/share.
If 1 lot = 500 shares:
Profit = 500 × Rs.70 = Rs.35,000
Scenario 2: Price Declines
If the stock drops to ₹980, your loss becomes:
₹1,010 – ₹980 = ₹30/share
Total loss:
₹30 × 500 = ₹15,000
This example illustrates that the profits and losses on futures are dependent on price changes.
Main Features of Forward Contracts
1. Contracts standardised
Future contracts have pre-defined specifications like:
- Size of the lot
- Expiration date
- tick step
- Trading times
These are fixed by Stock Exchange.
2. Traded on Exchange
Future contracts are traded on regulated exchanges, unlike private agreements, which makes them transparent and secure.
3. Trading on Margin
You do not need to pay the full value of the contract.
Instead, you just pay an initial margin, and give traders control of a much larger position with less capital.
4. Use Leverage
Leverage improves your purchasing power.
For example, if you have ₹2 lakh, you can control a futures position of ₹10 lakh.
Leverage can magnify gains, but it can also magnify losses.
5. Daily mark to market (MTM)
Profits and losses are settled at the end of each trading day.
This is called Mark-to-Market (MTM) settlement.
Types of Future Contracts
In the financial market you can find different kinds of future contracts.
Stock Futures
Individual company shares contracts for Reliance, TCS or Infosys.
Futures Index –
Based on market indices like Nifty 50 or Bank Nifty.
Futures on Commodities
Traded in commodities such as gold, silver, crude oil and natural gas.
Futures on Currency
Contracts on currency pairs like USD/INR.
Futures on interest rates
These contracts are linked to government securities and interest rates.
Advantages of Futures Contracts
Protect Against Risk
Futures are used by businesses and investors to hedge against the risk of price changes.
High Liquidation
Contracts for popular futures tend to have high volume, which makes them easier to buy and sell.
Use
Traders are able to trade large positions with less capital.
Make Money in Any Market Direction
You can make money if prices go up or down by going long or short.
Clear Pricing
Futures are traded on exchanges so prices are public and transparent.
Risks of futures contracts
Futures are full of opportunities but they also come with huge risks.
High Leverage Risk
Markets can move very fast and small moves can mean big profits or big losses.
Margin Calls
Deposit of additional funds is needed if losses are more than the margin available.
Volatility in the Market
Price swings can happen on news or events that catch you off guard.
Unlimited Loss Possibility
Unlike buying options, futures positions can theoretically lead to unlimited losses if the market moves sharply against your position.
Proper risk management is necessary in futures trading.
Who Should Trade Futures Contracts?
Future contracts are good for:
- Professional traders
- “Professional investors
- Hedging
- Institutional Players”
- Swing traders … actively
Futures trading is not for the faint of heart. Before trading futures, beginners should learn about market behaviour, leverage, margin requirements and risk management.
Cash Market and Future Contract
| Feature | Forward Contract | Cash Market |
|---|---|---|
| Ownership | No ownership for now | Legal title to shares |
| Profit margin | Needed | Total paid |
| Use | For Sale | Unavailable |
| Expiration | Yes. | No due date |
| Short Selling | Simple | Constrained by market rules |
| Danger | Higher | Less |
Tips Before Trading Futures
- Get a handle on futures trading.
- Always use stop-loss orders.
- Don’t let your positions get too leveraged.
- Only trade liquid contracts.
- Keep track of economic events and market news.
- Maintain good risk management.
- Never trade on tips or feelings alone.
Summary
A Future Contract is a strong financial instrument that allows traders to buy or sell an asset at a fixed price on a fixed future date. It is commonly used for speculation, hedging and portfolio management. Futures are also leveraged, meaning they can multiply profits and losses.
If you are new to futures trading, you should know how margin, leverage, lot sizes and risk management work before you make your first trade. Discipline and education are the foundations for long term success in the futures market.