Updated: Apr 8, 2021
Welcome to one of the brand new article in the mastery articles of futures and options. In this article, we will discuss the futures contract. In our previous article, we had discussed the options. What are the Options? How they perform? I had introduced you to options. If you have not read the previous article, you can read it first. So in this article, I am going to just briefly touch upon the futures contract and why the future exists, and how we can use it in the stock market.
The Futures agreement is an ad-lib of the Forwards Agreement. The Futures Contract is planned so it holds the core conditional structure of a Forwards Market. Simultaneously, it wipes out the dangers related to the forward's agreement. A Forward Agreement would give you a monetary advantage as long as you have an exact directional perspective on a resource's value; this is the thing that I mean when I say 'core conditional structure'.
As we probably are aware, a future contract is organized somewhat better contrasted with a forward contract. This is for the most part to defeat the dangers engaged with the forward market. Allow us to take a glimpse at every one of these focuses that separate the futures from the forward's arrangement.
Note that you may in any case not be clear about futures; that is okay; keep the accompanying focuses in context. We will right away think about a futures model, and with that, you ought to be clear about how the Futures understanding functions.
The future contract is effectively tradable. On the small chance that I get into an agreement with a counter-part, in contrast to a forward agreement, I need not honor the agreement until the end (likewise called the expiry day). Anytime, if my view transforms or changes, I can move the agreement to another person and escape from the agreement.
Suppose a farmer wants to have a minimum support price. He can go to a trader and he can ask the delivery person: okay, my crop is almost ready. It will be ready to deliver within one month but I want a promise from you that you will buy my crop let’s say at 10 rupees per kg and then both will get into a kind of agreement where the farmer will sell in 10 rupees and the trader will buy in 10 rupees per kg that were called forwards.
So there was no third party involved generally buyer and seller was involved but there was lots of problem with that, especially the reliability legal enforce ability and standardization price. So because there was lots of problem with forwards, then something comes which is standard and which is regulated and which is taking care of by some third party that the contract should be enforced and the commitment should be completed and that's why the forwards came to stock exchange-listed traded on the stock exchange. It becomes the future. So for futures are also like the options they also have the number of underlying assets.
Underlying assets can be gold, it can be commodities, it can be crude oil, and it can be you can say stocks about which we are going to talk about. Therefore, you can buy futures contracts. So as you understand, the forwards were ancestors of futures and futures are opposite of spring of ancestors means forwards.
When the futures become slightly more sophisticated, these become options. So you understand options as I told you that it's kind of insurance and for taking insurance, you have to pay the premium but everybody will not be ready to pay a premium and everybody doesn't have you can say the capacity to pay the premium.
For example: - if you buy one lot of future for Reliance shares, you will have all the rights of Reliance shares for one month. It means you are going to buy a contract for one month. So, what is the future? These are the standardized contracts of forwards which are listed on the stock exchange and which are traded so by trading it becomes more standardized, more legal, and more enforceable.
If I want to buy a future for two days, I can do it. I can buy it today and after two days, I can sell it. Same way suppose a trader has taken a promise on behalf of the farmer but he's not interested after 15 days for whatever reason he doesn't want to buy the paddies then what he can do he can simply transfer the contract to some other trader.
That's what happens when the future is listed on the stock exchange. Anybody can transfer to somebody else. Futures have seemed like an underlying asset like a stock. So if the stock goes up, you make a profit. If it goes down, you make losses. Here also if future goes up, we make a profit and if future goes down, it makes losses. So I think this brief introduction about the future has cleared a lot more doubts.
The Futures Market is profoundly controlled – An administrative authority exceptionally manages the Futures markets (or, besides, the whole monetary subsidiaries market). In India, the administrative authority is "Securities and Exchange Board of India (SEBI)". This implies there is consistently somebody looks out the stock market and ensuring things run easily. This likewise implies default on a futures arrangement is not a chance.
The vast majority of the futures contracts are money settled. This implies just the money differential is paid out. There is no concern about moving the actual resource starting with one spot then onto the next. The money repayment is managed by the administrative authority guaranteeing absolute transparency in the money repayment measure.
Future is a normalized contract where everything identified with the understanding is pre-decided. The lot size is one such boundary. Lot size indicates the base amount that you should execute in a future contract. The part size differs starting with one resource then onto the next.
The benefit of a future contract is to stop loss. So mostly we are going to talk about future options strategy as a stop loss in emergency cases otherwise we don't use future because for future, you have to give a very high margin.
So if you're going to put the stop loss, you're going to pay margin but sometimes what happens you put some strategy in option and strategy goes out of your hand and the stop-loss that you're going to buy or if you're going to buy, the stop-loss in options is going to be very costly because premiums are very high.
So at that time, buying a premium option by paying a high premium is not feasible. So how you will protect your portfolio? How you protect your losses? The answer is that you can protect through these future contracts. We will discuss this in the later chapters.