Trading in Futures

Futures is a contract between two parties traded through an exchange to buy or sell a specified quantity of an asset at a future date at a pre-determined price. The asset can be a commodity like Gold,oil,wheat etc or financial instruments like stocks or currency. Underlying asset can also be intangible assets like Index or Interest Rates.Futures trade started in the modern era in 1864 when Chicago board of Trades (CBOT) listed standardized forward contracts which were called forward contracts. This was offered for grains and started a trend which saw various other commodities and financial instruments being offered by various exchanges across the world over a period of time.How does it workWhen you buy a Futures contract,you have an obligation to buy the underlying asset at a pre-determined price on the day when the contract matures (also called the Expiry date) Futures are exchange traded instruments. In India,where trading is electronic,Exchange does the matching of bids and ask prices placed by the buyers and sellers and ensures transactions take place. Clearing and settlement of the trades is guaranteed by the Exchange.Futures traded in India are cash settled which means on the date of expiry you just pay or receive the difference between the spot price and the contract price. For example,if you bought RIL futures at Rs 1,100 and on the day of expiry spot is Rs 1,050,you will pay Rs 50 (Rs 1,100-1050=50) to the Exchange. Exchange will pay this amount to the seller. Where and how do you trade in FuturesFutures are offered by NSE (National Stock Exchange) for financial Instruments like Index,stocks,currency and interest rates. While commodities futures and currency futures are traded through exchanges like MCX and NCDEX. You will need to open a trading account with brokers who are members of these exchanges.When you buy or sell futures you will first need to provide a margin to the broker called initial margin. This can be in the form of cash or can be stocks as collaterals. On stocks,brokers apply a haircut,which means if you transfer lets say 100 shares of RIL with current market value of Rs 1,000,the broker will give you a margin of anything between 80-85 per cent of the value of the stock. For less liquid stocks the haircut may be more. Typically 50 per cent of your margin needs to be in the form of cash. Once you have the margin in place you are ready to buy or sell futures.Futures contracts on NSE is available for 3 maturity dates at any point in time – current month,near month and far month. Each of these contracts expire on the last Thursday of the respective months.When you buy a contract you need to choose the month of expiry. Like any other security,the price at which the future contract is available is determined by market forces and keeps changing constantly.But is it for me?Futures because of high leverage comes with some associated risks. You can lose money very rapidly and it can erode your capital in no time if the market moves sharply.However,if you take care of a few basics you can benefit from Futures.Keep a Stop Loss on positions. Which means you should know and give clear instructions to your broker to square off your positions when your losses hit a certain level. For example,in our previous example,you may decide that you will exit your contract if BHEL drops by more than 5 per cent from the contracted price of Rs 2,375. This will ensure you will limit your losses when your directional calls go wrong. You can use Futures to hedge your portfolio. If you feel markets may go down and erode the value of your portfolio,you can go short on Index Futures which will hedge your portfolio to a large extent.Use only a part of your investible surplus for investment in Futures. Depending on your risk appetite you should allocate a percentage. It can give a boost to your portfolio’s earnings but do keen in mind that it comes with some risks.Stay involved. When you take a Futures position,you must keep track of it.

The author is Executive Vice President,Fullerton Securities and Wealth Advisors