What is Futures Trading?

In this article, we will discuss

• What are Futures?
• What is Futures Trading?
• The Different Types of Underlying Assets for Futures Contracts
• Decoding How Futures Trading Works in India
• Understanding Margins in Futures Trading
• Advantages of Trading in Futures
• Disadvantages of Trading in Futures
• Conclusion

Stock trading and options trading are both quite popular among traders — no matter what their level of expertise is. However, there is another market segment that also presents various trading opportunities for retail participants. We’re talking about the futures market, which is a part of the larger derivatives trading segment in India. Samco Securities offers a wide range of tools and features in the Samco trading app — all designed to make futures trading easy, even for beginners without prior experience in this market segment.

To make the most of what the Samco trading app offers, you must be clear about the basics of trading in the futures market. Here’s where this article can help. Let us delve into the finer details of futures trading and discover all there is to know about the futures market in India.

What are Futures?

Futures are derivative contracts that involve an agreement to sell or buy the underlying asset on a predetermined future date at a set specific price. The buyer of the futures contract is obligated to purchase the underlying asset, while the seller of the contract is duty-bound to sell it. The transaction occurs at the specific price mentioned in the contract, no matter what the market price on expiry is.

The key components or features of futures contracts include:

• Contract Size: Each futures contract has a standard size. The size may vary from one underlying asset to another. For instance, the lot size of Nifty 50 futures is 25 contracts.
• Contract Value: This is the notional value of the contract, which is the product of the current price and the lot size.
• Tick Size: This is the smallest amount by which the price of a futures contract can increase or decrease.
• Expiry: This is the date after which a futures contract is invalid. Each type of contract has a different expiry. For instance, Nifty 50 futures expire on the last Thursday of each month.

What is Futures Trading?

Futures trading is the process of buying or selling futures contracts to potentially profit from the price movement of the underlying asset. These contracts are typically traded online via specific exchanges like the National Stock Exchange (NSE), Multi Commodity Exchange of India Limited (MCX), Bombay Stock Exchange (BSE) and National Commodity & Derivatives Exchange Limited (NCDEX).

You can open a position in the futures market by placing buy or sell orders through the app or platform offered by your stock broker. Depending on your market outlook, you can sell or buy futures to potentially gain from any downward or upward price movement in the underlying asset.

The Different Types of Underlying Assets for Futures Contracts

An important part of futures online trading is understanding the different types of underlying assets that exist in this derivatives market. In India, the following types of underlying assets are included in the futures market segment.

• Indexes: Futures can be derived from market indexes like Nifty 50 and Sensex, among others. These indexes are not specific assets. Rather, they represent a statistical measure of a group of equity shares or other securities.
• Equity Stocks: Equity stocks can also be underlying assets for futures contracts in India. These futures contracts derive their value from the stocks of different companies that are listed in the market.
• Currencies:Currencies, or more specifically, currency pairs like USD-INR, can also be the underlying assets from which futures contracts are derived. This is quite a volatile segment of the derivatives market as currency values can fluctuate greatly.
• Commodities:Commodities are physical goods like rice, wheat, gold, aluminium, natural gas and other such items. They are traded in the commodities market — either in the form of physical goods or through derivatives like futures (and options).
• Interest Rates: Interest rates, interest rate indexes and interest rate instruments can also be used as the underlying assets from which futures derive their values. These futures are currently available only on the securities issued by the Indian government.

Decoding How Futures Trading Works in India

Now that you have seen the types of underlying assets for which you can sell or buy futures, let us get to know how futures online trading works in India. Primarily, traders can choose to adopt any one of the two kinds of futures trading — namely, hedging and speculation.

• Hedging

Hedging involves minimizing potential losses by taking futures positions that offset trades in the underlying asset’s market. You can use this futures trading strategy to protect your capital from any adverse price movements in the underlying asset. For instance, say you hold 1,000 shares of a company at Rs. 500 each. You are fairly certain that the share price will increase, but you also want to protect your capital if the stock price falls. So, you also sell 10 futures contracts (each with a lot size of 100 shares) at Rs. 510.

Now, if the share price rises as planned, your cash market position gains in value and these profits can offset the losses in the futures market. However, say the stock price falls to Rs. 450, resulting in a loss of Rs. 50,000 in your shareholdings. In that case, your futures trading position gains Rs. 60,000, thereby setting off that loss.

This is how hedging works. While it limits the potential loss you may incur, it also caps your potential gains. So, ensure that you weigh both sides of the trade before you hedge your position using futures.

• Speculation

Speculation is a riskier futures trading strategy. Your primary goal in speculative futures trading is profiting from potential price movements rather than protecting an existing position. Since there is no way to predict future price movements with 100% accuracy, speculative trading carries a higher level of risk, especially if it does not involve inherent or additional hedging. When you open a speculative position, you sell or buy futures based on how you expect the underlying asset’s price to move by expiry.

If you expect a bullish price movement, you may buy its futures contracts. Conversely, if you expect the price of the underlying asset to decline, you may sell its futures contracts instead. Leverage can help you amplify your potential returns from speculative trading. However, it also magnifies the risk involved.

Due to the high levels of risk involved in speculation, it is mostly practised by institutional traders with vast amounts of smart money at their disposal. Retail traders, especially those with limited capital, must ideally opt to hedge futures positions to prevent massive losses.

Understanding Margins in Futures Trading

Margins play a crucial role in futures trading. They help safeguard both traders and exchanges from the risks of adverse price changes. In simple terms, margin money deposits (or margins) are a type of collateral that you need to offer to open and maintain a position in the futures market. The amount of margin money required depends on the asset you are trading in, the current market scenario and the broad risk involved.

We have two main types of margins in futures trading, as outlined below:

• Initial Margin

This is the amount required to open a new futures position. It is typically calculated as a percentage of the total contract value, and it varies based on the underlying asset's volatility and market conditions. Exchanges calculate this amount using complex risk management models. You can use a margin calculator to get a fair idea of the deposit amount required.

• Maintenance Margin

The maintenance margin is the minimum amount that you must retain in your trading account to keep your futures trading position open. If the account balance falls below this level, your stock broker will issue a margin call. You must then deposit the additional funds required to bring the account balance back to the required margin level.

Exchanges also employ additional margin requirements during periods of high volatility or significant events. These may include special margins, volatility margins, or exposure margins. Understanding and managing these margin requirements is crucial for successful futures trading in India, as it directly impacts a trader's capital efficiency and risk management strategies.

Advantages of Trading in Futures

Trading in futures comes with many benefits. The top advantages of futures online trading include the following pros:

• The Advantage of Leverage

Futures trading helps you control significant quantities of assets with a relatively small initial investment. This amplifies potential returns and helps you maximise your capital efficiency. However, it's important to note that leverage also increases risk.

• Opportunities for Hedging

Futures contracts provide an effective tool for hedging against price fluctuations in the underlying asset. This allows you to protect your positions in the spot market and reduce exposure to unfavourable price movements.

• Improved Market Accessibility

Futures markets also offer easy access to a wide range of assets — including commodities, currencies and stock indices. This makes it easier for you to diversify your portfolio and take positions in markets that might otherwise be difficult or costly to access directly.

• Liquidity

Futures markets are generally highly liquid, meaning you can enter and exit positions quickly and easily. This high liquidity results in tighter bid-ask spreads that reduce transaction costs and allow for more efficient trading strategies, especially for large-volume trades.

Disadvantages of Trading in Futures

Futures trading also has a few limitations that you must be aware of before you sell or buy futures.

• High Levels of Risk

The leverage that makes futures attractive also significantly increases risk. Small price movements can lead to substantial losses that could even exceed your initial investment. This high-risk market may not be suitable for you if you have a low tolerance for risk.

• Complexity

Futures trading also involves complex strategies, terminology and market dynamics. Understanding contract specifications, margin requirements and the impact of various economic factors can be challenging for new traders.

• Time Commitment

Successful futures trading often requires constant market monitoring and quick decision-making. The fast-paced nature of these markets, coupled with their sensitivity to global events, demands significant time and attention.

Conclusion

Futures trading is, ultimately, an excellent way to potentially profit from the price movements in the underlying asset. When used smartly, futures trading strategies can also help you hedge your positions in other market segments, thus limiting your risk significantly. To get better at trading in futures, you need access to the best trading tools available today.

Samco Securities can help you here, with the many state-of-the-art features integrated into the Samco trading app. With advanced TradingView charts, up-to-date market depth data and a user-friendly interface that makes it easy to sell and buy futures, the trading app from Samco Securities is just what you need to become a better futures trader.

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