The different types of Future Contracts are:
- Commodity futures: For physical goods like oil or wheat.
- Financial futures: For assets like currencies or government bonds.
- Index futures: Tied to stock indices such as the S&P 500.
Content:
- What Is a Futures Contract?
- Types Of Futures Contract
- Futures Vs Forward Contract
- Types Of Futures Contract – Quick Summary
- Types Of Futures Contract In India – FAQs
What Is a Futures Contract?
A futures contract is an agreement traded on financial markets, obligating the buyer to purchase, or the seller to sell, a specific asset at a predetermined future date and price. It’s commonly used for hedging risks or speculating on price movements of various assets.
The underlying asset in a futures contract can be a commodity, financial instrument, or market index. Traders use futures to lock in prices and mitigate risk against price fluctuations. These contracts are traded on futures exchanges and are standardized in quality, quantity, and delivery time.
Futures contracts require a margin deposit and involve daily settlement of gains and losses. They offer high leverage, meaning a small change in the asset’s price can result in significant gains or losses. However, this also increases the risk, making futures trading more suitable for experienced investors.
For example: Suppose a farmer expects to harvest 1000 kg of wheat in three months. To hedge against price drops, he enters a futures contract to sell it at Rs. 20/kg. If market prices fall, he’s protected; if they rise, he misses extra profit.
Types Of Futures Contracts
The main types of futures contracts include commodity futures for physical goods like oil or wheat, financial futures for assets like currencies or government bonds, and index futures tied to stock indices such as the S&P 500, catering to different investment strategies and needs.
- Commodity Futures
These involve contracts for physical goods like oil, wheat, or gold. Traders use them to hedge against price fluctuations in the commodities market, with prices influenced by factors like supply and demand, geopolitical events, and weather conditions.
- Financial Futures
These contracts are tied to financial assets such as government bonds, interest rates, or currencies. They are essential tools for managing financial risk and capitalizing on movements in the financial markets, influenced by economic indicators, policy changes, and global events.
- Index Futures
Linked to stock indices like the S&P 500 or Dow Jones, these futures allow traders to speculate on the overall movement of the stock market. They offer a way to gain exposure to broad market trends without having to trade individual stocks, influenced by market sentiment and economic data.
Future Vs Forward Contract
The main difference between futures and forward contracts is that futures are traded on exchanges with standardized terms. In contrast, forwards are private agreements between parties, customized to their needs, typically traded over the counter, without the same level of regulation or standardization.
| Aspect | Futures Contract | Forward Contract |
| Trading Venue | Traded on organized exchanges. | Traded over-the-counter (OTC), not on exchanges. |
| Standardization | Standardized terms for quantity, quality, and delivery. | Customized to the needs of the contracting parties. |
| Regulation | Highly regulated with clearinghouses guaranteeing transactions. | Less regulated, relying on the creditworthiness of parties. |
| Liquidity | Generally, it is more liquid due to exchange trading. | Less liquid due to the customized nature of contracts. |
| Counterparty Risk | Lower, as the exchange acts as an intermediary. | Higher, as the contract depends on the counterparties’ ability to fulfill terms. |
| Margin Requirement | Requires margin deposits and daily settlement of gains and losses. | No margin requirements; terms are set by the parties involved. |
Types Of Futures Contract – Quick Summary
- The main types of futures contracts – commodity futures for goods like oil or wheat, financial futures for currencies or bonds, and index futures linked to stock indices – cater to diverse investment strategies and needs.
- A futures contract, traded on financial markets, obligates a party to buy or sell an asset at a set price and date. It’s a key tool for hedging risks or speculating on asset price movements.
- The main distinction between futures and forward contracts is that futures are exchange-traded with set standards, whereas forwards are privately negotiated, customized, and traded over the counter, lacking similar regulation and uniformity.
Types Of Futures Contract In India – FAQs
- Commodity futures: Agricultural products, metals, and energy.
- Financial futures: Currency pairs and interest rates.
- Stock index futures: Based on indices like Nifty and Sensex.
A futures contract is a financial agreement to buy or sell a specified asset at a predetermined price at a future date, commonly used for hedging risk or speculating in various markets.
Futures contracts are used by investors, traders, and corporations to hedge against price volatility, speculate on market movements, manage risks, and secure prices for commodities, currencies, and also financial instruments.
In India, futures contracts are regulated by the Securities and Exchange Board of India (SEBI). SEBI oversees the derivatives markets, ensuring fair practices and protecting investor interests in futures trading.
The basic formula for a futures contract’s price is Futures Price = Spot Price + Cost of Carry. The cost of carry includes storage costs, interest, and dividends lost or gained due to holding the contract.
The main advantages of futures contracts are hedging against price volatility, leverage, and high liquidity. Disadvantages include significant risk due to leverage, price limit moves, and the potential for substantial losses, especially for inexperienced traders.
Nifty futures primarily include the standard Nifty 50 futures, which track the Nifty 50 index, and Bank Nifty futures, focused on the banking sector. Both offer ways to speculate on the broader Indian market trends.
We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, commodity and hence we bring you the important topics and areas that you should know:
