EQUITY DERIVATIVES FUTURES
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Equity Derivatives Futures
Futures are derivative financial contracts obligating the buyer to purchase a stock or the seller to sell a stock at a predetermined future date and set price. A future is a contract where an investor participates in the trading activity at an agreed rate on a future date.
These contracts have expiration dates and set prices that are known upfront. Futures are identified by their expiration month. For example, a December Stock’s futures contract expires in December
Basic Terms in Futures:
- Contract Size/Lot size – Contracts represent a specific number of underlying shares that a trader may be looking to buy. Lot size in Future&Options represents the minimum units of the underlying asset in a futures or options contract. For example, A stock has a lot size of 250, enabling the trade of 250 shares in a single contract.
- Expiry date – The date on which Future and Options contract expires,usually the last Thursday of a calendar month.
Process:
A futures contract allows a trader to speculate on the direction of a stock’s price. If a trader bought a futures contract and the price of the stock rose and was trading above the original contract price at expiration, then they would have a profit. Before expiration, the futures contract—the long position—would be sold at the current price, closing the long position. However, the trader could also lose if the stock’s price was lower than the purchase price specified in the futures contract.
The difference between the prices would be cash-settled in the investor’s Demat account.
Benefits:
- A futures contract allows an investor to speculate on the price of a stock.
- Futures are used to hedge the price movement of a stock to help prevent losses from unfavorable price changes.
- When you engage in hedging, you take a position opposite to the one you hold with the stock; if you lose money on the stock, the money you make on the futures contract can mitigate that loss.
- In futures markets the trader does not need to put up 100% of the contract’s value amount when entering into a trade. Instead, the trader would require an initial margin amount, which consists of a fraction of the total contract value. (The amount required by the trader for a margin amount can vary depending on the size of the futures contract, the creditworthiness of the trader, and the broker’s terms and conditions.)
Drawbacks:
- Investors risk losing more than the initial margin amount since futures use leverage.
- Margin can be a double-edged sword, meaning gains are amplified but so too are losses.