Futures are the way to go for a trader, a very simple yet complex way of trading and predicting the future prices of the commodities that you believe in. In this article, we will be talking about futures trading in India. For a beginner, the basics of futures trading will be explained and you will also learn the things you need to know to be a successful futures trader.
The Indian stock market is the second largest in the world, with more than 1.5 lakh listed stocks. It is one of the 21 stock exchanges in the world to be a part of BSE (Bombay Stock Exchange) and a constituent of the NSE (National Stock Exchange). There are a number of ways one can trade in the Indian stock market, one of which is trading on a futures exchange.
A Beginners Guide to Trading Futures: Knowing where to start, the basic ideas behind trading futures, different types of futures and the key differences between cash and futures markets can be daunting. This guide will help you understand futures, including what traders do in the cash market and what is the difference between futures and options..
Read more about what are futures in stocks and let us know what you think.
A beginner’s guide to futures trading in India: In essence, trading is nothing more than the art of anticipating the future. There is joy (gain) when we foresee things correctly, and a sense of sadness (loss) when our views and beliefs are wrong. In simple terms, a trader is a person or entity who buys or sells financial instruments such as stocks, bonds, derivatives, etc. to make a profit or hedge an existing position.
In this article we will explain how to trade futures in India. But before we delve into the world of futures trading, we should try to understand the cash and futures market mechanism that forms the fundamental basis of futures trading. Here we will try to find out their importance for the futures market. Then we will move on to the main topic of this article – the fundamentals of futures trading in India. Let’s get started.
What is the cash market?
The cash market is a securities market where the listed shares of a company are bought and sold. In cash market trading, a buyer of a company’s stock is essentially a co-owner of the company. He takes delivery of the company’s shares when he buys them on the cash market. They are regulated by the stock exchanges.
In any case, we can only buy as many shares here as our margin/capital in the trading account will allow. There is no concept of leverage when trading the cash market. The main aspects of the cash market are the delivery of shares, the ownership of the company and the absence of leverage in the delivery of shares.
What is the futures market?
The futures market concept was created to protect the interests of farmers. Under this method, farmers’ agricultural products were reserved in advance at a certain price for delivery in a certain quantity and on a certain date in the future.
Thus, the futures market is essentially a contract between two parties to buy an underlying asset at a specific price, in a specific quantity, and at a fixed price in the future. These instruments have lost popularity due to some obvious limitations, but are still used by banks and other financial institutions.
Some of the limitations of futures contracts are :
- There is no third party (exchange or legal authority) that regulates futures contracts. This makes legality a disadvantage when negotiating forward contracts.
- Lack of liquidity is another major constraint on futures trading. It can sometimes be difficult to find an opposing party who is willing to take opposing positions.
What is the futures market?
A futures market is a financial derivative that derives its value from an underlying asset. The underlying asset can be stocks, bonds, commodities, etc.
A futures market is a standardized contract that has a certain fixed number of shares (in the case of the stock market) per lot, and it has a fixed expiration date (three different contracts with expiration dates run concurrently). They are similar to buying shares on the stock market, but with the fundamental difference that futures contracts do not involve delivery of shares.
Another important difference between the two is the leverage you get when trading futures. In the case of the cash market, the leverage is equal to the margin size of the securities account. But in futures trading, the amount of margin required ranges from 20% to 60% of the total value of the contract in the case of stocks and from about 10% to 12% of the total value of the contract in the case of index futures. So financial leverage is an important factor for the futures trader.
One of the great advantages of futures trading is also that these contracts are regulated by an exchange (SEBI in India) and legality is never a factor in futures trading. And futures contracts are inherently highly liquid, meaning that it is very easy to find a counterparty willing to take offsetting positions.
Now that we have understood the basics of futures trading, we can try to understand how futures are traded in India.
How to trade futures in India
In India, futures are traded mainly in two forms: equity futures and index futures. All futures contracts in India have three simultaneous contracts – for the near, mid and far month.
Each time the near month expires, a new contract is added for the far month. Monthly contracts expire on the last working day of the month. And if the last working day is a holiday, it will expire the day before.
– Forward stock transactions
An equity futures contract is a derivative financial instrument whose value depends on the value of the underlying instrument (company shares). The contracts have a fixed scope, a fixed price and a fixed date. Once an agreement is reached, it must be respected. The following are some of the characteristics of equity futures contracts:
- Contract size: All stocks traded on the futures market have a different number of shares in each lot. Negotiation on partial lots is not allowed. There must be at least one lot. For example, a batch of futures of Reliance Industries has 250 shares, a batch of Maruti has 100 shares, a batch of ICICI Bank has 1375 shares, etc.
- Shelf life: All equity futures have a predetermined fixed maturity. They expire on the last trading day of the month. And if the last Thursday is a holiday, they expire the previous trading day. The promotion has three expiration contracts – near month (1 month contract), mid month (2 month contract) and far month (3 month contract).
- Border area: The margin required to trade equity futures is very high to cover market value losses (M2M). This is primarily to protect the interests of brokers and the securities market. The use of margin in futures trading in India eliminates the possibility of default in futures trading. The margin consists of two elements: the exposure margin and the SPAN margin. The SPAN margin is the minimum margin required under the Exchange’s mandate and the exposure margin is the margin required on top of SPAN to account for any loss of SSR.
– Index futures
An index is a representation of a broader sector of the economy. In India, two major indices are actively traded in the futures market: the Nifty Index and the Bank Nifty Index. On the 12th. In January 2021, SEBI also allowed Nifty Financial to trade in the derivatives segment.
If someone wants to express their opinion on the economy, they should do so by trading index futures, as they reflect general market sentiment. Trading futures on the Nifty is expressing your opinion on the economy as a whole, as the Nifty 50 is a composite of the 50 largest companies listed on the NSE.
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Some key facts about index futures
– NiftyForward transactions
- Basic installation : Nifty 50 Index
- The total number of shares in the Nifty index is 50 : 50
- Total number of active contracts at any time: 3 (near month, middle month, far month)
- Shares in 1 batch of futures contracts : 75
- Duration: Last Thursday of each month (previous day if Thursday is a holiday)
For example, if the present value of a lot of Nifty futures maturing next month is 14476, then the total contract value – contract value = 14476 * 75 = Rs. 10,85,700
The required margin is the same:
– NiftyBank Futures
- Basic installation : Beautiful bank
- The total number of shares in the Bank Nifty index : 12
- Total number of active contracts at any time: 3 (near month, middle month, far month)
- Shares in 1 batch of futures contracts : 25
- Duration: Last Thursday of each month (previous day if Thursday is a holiday)
For example, if the present value of a batch of Bank Nifty futures maturing next month is 331628.05, then the total contract value – contract value = 31628.05 * 25 = Rs. 790701.25
Here the required margin will be the same:
– Nifty Financial Services Forward Market
- Basic installation : Nifty Financial Services
- Total Nifty Index Shares for financial services: 20
- Total number of ongoing contracts at a given time : 4
- Shares in 1 batch of futures contracts : 40
- Duration: Last Thursday of each month (previous day if Thursday is a holiday)
For example, if the present value of a batch of Bank Nifty futures maturing next month is 15308.30, then the total contract value – contract value = 15308.30*40 = Rs. 612332
Here the required margin will be the same:
How are futures contracts valued?
The value of a futures contract depends on the value of the underlying asset. There is always a spread/difference between the prices of the cash segment and those of the derivative segment. There are essentially two methods of determining the price of a futures contract: Freight cost method and expectation method.
– Wear model
This method assumes that the market is fully efficient. So the profits from trading the spot segment or the futures segment are the same, because the price movements are the same. The process for calculating prices under the cost of carry model is described below.
Forward price = locomotive price + transport costs
The deferred value here is the cost of holding the futures contract until maturity.
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– Standby method
Under this method, forward rates represent the expected future cash price of the underlying asset. Thus, if the market is positive/favorable for the underlying asset, the futures price will be higher than the spot price. If the market sentiment for the underlying asset is low, the futures price will be lower than the price of the underlying asset.
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Why trade futures?
Here are some of the benefits of trading futures:
- Contracts are well regulated: Because the futures market is well regulated, there is no risk of legality and all contracts are settled at maturity.
- Lever: Leverage is perhaps one of the main reasons why futures trading is one of the most popular derivative instruments.
- High liquid: Liquidity is never a factor in futures trading, as there are a large number of players willing to trade futures or hedge their existing position in the market.
Final thoughts
In this article, we have discussed how to trade futures in India for beginners. Here are some important points to remember from this article:
- The value of a futures contract depends on the value of the underlying asset.
- Futures trading is popular with traders because of its low margin requirements.
- Futures contracts are regulated by the exchange, so traders never have a confidence problem.
- It is possible at any time to leave an existing futures position by entering into an opposite position on the futures market.
- Index futures are settled in cash
- There are two methods of calculating the value of a futures contract: the cost of carry method or the expectation method.
So much for today’s article on futures trading in India. We hope this was helpful to you. We’ll be back tomorrow with more interesting news and market analysis. Until then, good luck and have fun investing!
Frequently Asked Questions
How do I start trading futures?
To start trading futures, you’ll need to open a futures trading account.
How can I trade futures in India?
If you are a resident of India, you may trade futures in India.
How do you trade futures examples?
If you want to buy a futures contract, you would buy a futures contract on the underlying asset. For example, if you wanted to buy a futures contract on gold, you would buy a futures contract on the gold futures contract.
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