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Futures Contracts

It is an agreement between a seller and a buyer, wherein the seller (called the short) has to deliver to the buyer (called the long) a specified quantity of security, commodity or forex at an agreed time in the future, at a price that is agreed to at the time of entering into the contract. In futures contracts, both buyers & sellers of futures are required to fulfill their part of the contract; unlike in case of options wherein the investors have a choice whether to exercise their option or not. The contracts are traded on the futures exchange. The price is determined by the forces of demand and supply among competing buy and sell orders on the exchange at the time if the purchase or sale of the contract. The underlying asset can be in the form of currencies, securities, financial instruments, commodities, stock indexes, interest rates etc. The futures date is called the delivery date or final settlement date. Futures contracts are exchange-traded derivatives where the underlying has standardized terms. These standardized terms include the following; Quality of the underlying Quantity of the underlying Date & month of delivery Location of settlement etc.

Features of Futures Contract


1. They are standard contracts that provide for the settlement of the contract either through delivery of asset or by a final cash settlement. 2. They trade on organized futures exchanges with clearing associations that act as intermediaries between the contracting parties. 3. In the contract, the seller is called a short & the buyer a long. 4. Both the parties pay a margin to the clearing house. 5. The margin price is generally marked to the market price every day.
6. Every futures contract represents a specific standardized quantity and is not at

all negotiated by the two parties.

Difference between Futures & Forwards


1. Standardisation: A forward contract is a tailor-made contract between the buyer and the seller where the terms are settled mutually by the two parties whereas a futures contract is standardized in regard to the quality, quantity, place of delivery of the asset etc. but only price is negotiated. 2. Price of Contract: In a forward contract the price of the contract remains fixed till maturity, whereas in a futures contract the price of the contract changes every day.

3. Nature of Market: In a forward market it is Over the counter whereas in futures contract it is Exchange traded.

4. Margin: In a forward contract there are only two parties involved i.e. the seller & buyer and there is no margin required. However in a futures contract, a third party called Clearing Corporation is also involved with which margin is required to be kept by both the parties. 5. No. of Contracts in a Year: In a forwards contract, there can be any number of contracts in a year. However in a futures contract, there can be only 4-12 contracts in a year. 6. Liquidity: Forward contracts have no liquidity unless a third party agrees to buy it, but in a futures contract there is high liquidity as they are traded on organized exchanges. 7. Counterparty Risk: It is present in forward contracts and not present in futures contracts. 8. Mode of Delivery:

In forward contracts the mode of delivery is decided by the two parties & most of the contracts result in delivery whereas in futures contracts the mode of delivery is standardized & most of the contract are cash settled. 9. Profit/Loss Settlement: The settlement of a forward contract takes place on the date of maturity so that the profit/loss is booked on maturity only. On the other hand, the futures contracts are marked to market daily so that the profits or losses are settled daily.

Settlement Mechanism of Futures Contracts


Daily Mark-to-Market Settlement The positions in the futures contracts for each member is marked-to-market to the daily settlement price of the futures contracts at the end of each trade day. The profits/losses calculated as the difference between the trade price or the previous days settlement price, as the case may be, and the current days settlement price. The Clearing Members who have suffered a loss are required to pay the mark-to-market loss amount to NSCCL which is passed on to the members who have made a profit. This is known as daily mark-to-market settlement. Option to settle Daily MTM on T+0 day Clearing members may opt to pay daily mark to market settlement on a T+0 basis. The option can be exercised once in a quarter (Jan-March, Apr-June, Jul-Sept & Oct-

Dec). The option once exercised shall remain irrevocable during the quarter. Clearing members who wish to opt to pay daily mark to market settlement on T+0 basis shall intimate the Clearing Corporation as per the format specified in specified format. Clearing members who opt for payment of daily mark to market settlement amount on a T+0 basis shall not be levied the scaled up margins. The pay-out of MTM settlement shall continue to be done on T+1 day basis. Final Settlement On the expiry of the futures contracts, NSCCL marks all positions of a Clearing Member to the final settlement price and the resulting profit/loss is settled in cash. The final settlement of the futures contracts to the daily settlement process except for the method of calculation of final settlement price. The final settlement profit/loss is computed as the difference between the trade price or the previous days settlement price as the case may be, and the final settlement price of the relevant futures contract. Final settlement loss/profit amount is debited/credited to the relevant Clearing Members clearing bank account on T+1 day.

Settlement Procedure of Futures Contracts


Daily MTM settlement on T+0 day Clearing members to opt to pay the Daily MTM settlement on a T+0 basis would compute such settlement amounts on a daily basis and make the amount of funds available in their clearing account before the end of the day on T+0 day. Failure to do so would be as good as nonpayment of daily MTM settlement on a T+0 basis. Further,

partial payment of daily MTM settlement would also be considered as nonpayment of daily MTM settlement on a T+0 basis. These would be considered as non compliance and penalties applicable for fund shortages from time to time would be levied. A penalty of 0.07% of the margin amount at the end of day on T+0 would be levied on the clearing members. Further, the benefit of scaled down margins shall not be available in case of nonpayment of daily MTM settlement on a Y+0 basis from the day of such default to the end of the relevant quarter.

CURRENCY FUTURES
A currency future is also known as Foreign Exchange Future or FX Future. It is a futures contract to exchange one currency for another at a specified date in the future at a price (also called as exchange rate) that is fixed on the purchase date. Currency futures are futures markets where the underlying commodity is a currency exchange rate, such as the Euro to US Dollar exchange rate, or the British Pound to US Dollar exchange rate. Currency futures are essentially the same as all other futures markets, and are traded exactly in the same way. Normally one of the currencies is the US Dollar. In that case the price of a future is in terms of US dollars per unit of the other currency. Most contracts have physical delivery, so for those held at the end of the last trading day, actual payments are made

in each currency. However, most contracts are closed out before that. Investors can also close out the contract at any time prior to the contracts delivery date. Futures based upon currencies are similar to the actual currency markets (Forex), but there are some significant differences. For example, currency futures are traded via exchanges, such as the Chicago Mercantile Exchange, but the currency markets are traded via currency brokers, and are therefore not as controlled as the currency futures. Advantages of Currency Futures 1. Easy Accessibility: Currency futures are being offered on the recognized exchanges in India. Small investors would get an easy access to currency futures trading on the popular exchanges. It is as easy as trading in a blue chip stock on any chosen exchange. 2. Low Transaction Costs: When you trade in INT currency futures on NSE in India, a small amount of brokerage fees and statutory duties and taxes are to be paid. However in Forex trading, one has to pay commissions to the back or foreign exchange agents in the form of spreads. Spreads is the difference in the buy/sell price over the reference date, which can be very high. 3. Easy Affordability: Margins are very low and the contract size is also very small.

4. Transperancy: It is possible for an investor to verify details on the stock exchange if he has doubt that the broker has tried to cheat. 5. Counter-party Default Risks:
6. Efficient Price Discovery:

EFFICIENT PRICE DISCOVERY: Internationally it has been established that currency future is a better and efficient mechanism for price discovery. With its state of the art automated electronic trading system where the orders are executed on the basis of price-time priority, NSE is well poised to offer efficient price discovery.

COUNTER-PARTY DEFAULT RISKS: All the trades done on the recognized exchanges are guaranteed by the clearing corporations and hence it eliminates the risks associated with counter party default. NSCCL (National Securities Clearing Corporation Limited) carries out all the novation, clearing and settlement process of currency futures trading.

STANDARDIZED CONTRACTS: Exchange Traded currency futures are standarizsed in respect of lot size (1000$) and maturity (12 monthly contracts). Retail investors with their limited resources would find it tremendously beneficial to take positions in standardised USD INR futures contracts.

Advantages of Currency Future Trading in India


For a common-man in India, question of handling forex rarely arose in the past until as late as early 21st Century. Indian economy has grown rapidly during the last few years. India is one of the top global economies.

Nowadays it is common to find Indian residents often looking out for hedging currency risks. Unlike in the past, a large population of India (common-man) earns huge amount of foreign exchange from overseas.

INR has seen huge fluctuations of around 10% in its price against USD in a span of less than one year. Indian financial markets offered very few options such as currency forwards, swaps and options (traded on OTC over the counter market) to Indian investors for hedging their currency risks. Besides, cash Forex or OTC Forex trading is not easily accessible to small investors. Even more, it was suitable to only large participants due to various factors that acted as the deterrent to retail investors.

Recently Indian government has permitted trading in exchange traded currency futures. NSE (National Stock Exchange of India) was the first recognised exchange to launch currency futures trading in India. Currency futures offer unique advantages over overseas forex trading to retail investors and small traders.

Carry on reading further to know the advantage of exchange traded forex futures trading India:

1.

EASY ACCESSIBILITY: Currency future is being offered on the recognised exchanges in India. NSE (National

Stock Exchange) has already commenced currency futures trading. Two more leading exchanges BSE (Bombay Stock Exchange) and MCX (Multi-Commodity Exchange) Stock Exchange would very soon commence currency futures trading. Small investors would get an easy access to currency futures trading on the popular exchanges. It is as easy as trading in a blue chip stock on any of your favorite exhange.

2.

EASY AFFORDABILITY: Margins are very low and the contract size is very small. As per the specification of

NSE USD-INR currency future contract, the lot size is 1000$. Margin is 1.75%. Dont you think that it was never so easy and affordable for any retail investor to take a call on Indian Rupee by taking position in currency futures?

3.

LOW TRANSACTION COSTS: When you trade in INT currency futures on NSE in India, you have to pay a small

amount of brokerage fees and statutory duties and taxes. In overseas forex trading you have to pay commissions to the banks or foreign exchange agents in the form of spread. Spread is the difference in the buy/sell price over the reference rate, which can be very high.

4. 5.

TRANSPERANCY: It is possible for you to verify trade details on NSE if you have a doubt that the broker has

tried to cheat you. EFFICIENT PRICE DISCOVERY: Internationally it has been established that currency future is a better and

efficient mechanism for price discovery. With its state of the art automated electronic trading system where the orders are executed on the basis of price-time priority, NSE is well poised to offer efficient price discovery.

6.

COUNTER-PARTY DEFAULT RISKS: All the trades done on the recognized exchanges are guaranteed by the

clearing corporations and hence it eliminates the risks associated with counter party default. NSCCL (National Securities Clearing Corporation Limited) carries out all the novation, clearing and settlement process of currency futures trading.

7.

STANDARDIZED CONTRACTS: Exchange Traded currency futures are standarizsed in respect of lot size

(1000$) and maturity (12 monthly contracts). Retail investors with their limited resources would find it tremendously beneficial to take positions in standardised USD INR futures contracts.