FUTURES CONTRACTS

WHAT ARE FUTURES CONTRACTS?

 A futures contract is a legal agreement to buy or sell a

particular commodity or asset at a predetermined price at a
specified time in the future.
 Futures contracts are standardized for quality and quantity to
facilitate trading on a futures exchange.
 The buyer of a futures contract is taking on the obligation to
buy the underlying asset when the futures contract expires. The
seller of the futures contract is taking on the obligation to
provide the underlying asset at the expiration date.
 Two purposes- Hedging and Speculation.
CLASSIFICATION

FUTURES CONTRACTS CAN BE BROADLY CLASSIFIED INTO:

 FINANCIAL FUTURES: Single stock, index, currency, bonds etc.

 COMMODITIES FUTURES : Metals, Energy, Grains and Oil seeds,

Livestock, Food and Fiber etc.
STEPS IN FUTURES TRADING

 An investor should choose a suitable contract based upon

exposure and maturity date.
 Place a margin to buy a contract.
 Brokerage and Transaction Fee will be charged
 On a daily basis, Mark to Market will take place.
 Contract is squared off when margin balance is
exhausted.
 Contract expires on the maturity date,
MARK TO MARKET

 Purchase price of the contract is the base

 Everyday, difference between previous closing price
and current closing price is debited/credited to the
account.
 This debiting/crediting is called MTM.
 MTM happens everyday.
 MTM loss will reduce margin and MTM gain will increase
margin.
 How Stock Futures are Priced?

The theoretical price of a future contract is sum of the current spot price and cost of carry.
However, the actual price of futures contract very much depends upon the demand and
supply of the underlying stock. Generally, the futures prices are higher than the spot prices of
the underlying stocks.

Futures Price = Spot Price + Cost of Carry

Cost of carry is the interest cost of a similar position in cash market and carried to maturity of
the futures contract less any dividend expected till the expiry of the contract.

Example:

Spot Price of Infosys = 1600, Interest Rate = 7% p.a. Futures Price of 1 month contract=1600 +
1600*0.07*30/365 = 1600 + 11.51 = 1611.51
Settlement, Closing and Square up

 Presently, stock futures are settled in cash. The final settlement price
is the closing price of the underlying stock.

 The investor can square up his position at any time till the expiry.
The investor can first buy and then sell stock futures to square up or
can first sell and then buy stock futures to square up his position.
E.g. a long (buy) position in March Infosys futures, can be squared
up by selling March Infosys futures.