Know the types of Future Contracts: We all want to create profit and become financially independent; there are a number of ways to do so, one of which is to invest in stocks. Operating in the stock market has shown to be profitable.
Investing and trading have a lot of potential for growing our wealth and generating a steady income. Bonds, stocks, and derivatives are all dynamic instruments in the financial sector. In this article, we’ll discuss the different types of future contracts.
What is a Derivative?
A derivative is a type of security that derives (gets) its value from another asset or security. There are different types of derivatives: forwards, futures, options, and swaps.
What are Futures?
Futures are contracts where one party agrees to buy and another party agrees to sell an asset for a particular price and quantity on a specific date in the future. Futures are standardized and traded within the exchange.
Futures are generally used as a hedging instrument for their investments, but the biggest use of futures is for trading and building trade hedging strategies.
The buyer of a futures contract is said to have gone long or taken a long position, while the seller of a futures contract is said to have gone short or taken a short position. Futures are traded in specific quantities called “lots.”
Understand The Types of Future Contracts
There are 4 different types of Future Contracts that exist. Let’s dive into to understand them:
Types Of Future Contracts #1 – Stock Futures
Here, the underlying asset is the stock, and the value of the future is determined by the stock prices. Stock futures were introduced in India on November 9, 2001. Stock futures are a very good hedging tool for investors and traders. Trading futures gives investors and traders the advantage of leverage.
For example, if the stock price of Reliance is Rs. 1000 and we want to buy one lot of future Reliance, the lot size is 250 shares, meaning to buy one lot of Reliance we need Rs. 1000×250 = Rs. 250,000.
But that’s not the case with the option of leverage. We only need a fraction of the amount.
Let’s say the margin requirement is (the amount to deposit) is 10% of the future price, you can buy one lot of reliance future for Rs 25,000.
As a result of leverage, our profits can rise while our dangers rise. As a result, futures are thought to be riskier than other derivatives.
We can trade these stock futures on both the NSE and the BSE. They are available for 173 stocks currently, and the list keeps changing.
Types Of Future Contracts #2 – Index Futures
India introduced index futures on June 12th, 2000, and the value of the future is determined by movement in the index. The first index future was NIFTY 50.
Among traders, index futures are very popular since they can be used to speculate and hedge. The principle is the same as with stock futures, and leverage is available on index futures too.
Index futures in India include the NIFTY, BANK NIFTY, FIN NIFTY, and NIFTY MIDCAP Commodity futures
In commodity futures, the underlying asset is the specific commodity. It can be gold, silver, energy, petrol, etc. Commodity futures were introduced in India a very long time ago.
Commodity futures are very powerful instruments, and India is one of the top 5 producers of major commodities. It is used as a hedging instrument to protect against price fluctuation.
The initial margin on commodities is low, making it accessible to everyone, but the risks associated with trading commodity futures in India are quite high.
Commodity futures in India. These futures are traded on commodity exchanges like the Multi Commodity Exchange (MCX) and the National Commodity and Derivatives Exchange.
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Types Of Future Contracts #3 – Currency Futures
In currency futures, the underlying asset is the currency, such as the rupee, yen, dollar, etc. Currency futures allow us to buy and sell currency at a specific time and date in the future. The use of currency futures is very beneficial for firms that operate in the import and export
business or for companies whose subsidiaries are in foreign countries. They are used to hedge against currency risks.
Currency futures are always traded against another currency, like INR vs USD. This is because each currency is relative to the other currency while trading in the future.
Example: An importer of phones in India has to pay his supplier in the USA in dollars after 3 months, so the importer would buy dollar futures against the rupee (USD/INR) if the price of the dollar rises.
Types Of Future Contracts #4 – Interest Rate Futures
Interest rate futures are customized financial instruments based on bonds and other debt instruments. Interest rate futures work in a very different way. There is no buying or selling of any financial asset.
Instead, the parties are involved in an exchange of the interest income which is generated by a bond or other financial instrument. Interest rate futures are mostly traded by banks or big investors. Interest rate futures in India are very rare.
In Closing
Futures are a type of derivative which is mainly used for hedging against price fluctuations, but it is also used for trading and speculation purposes. Futures reflect the price of underlying assets like stocks, indices, and commodities.
Futures as an instrument are quite risky, and understanding the instrument’s quality and the broad market will yield the most benefit. That is all for the article on types of future contracts.
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