Futures trading is a key segment of the derivatives market that allows participants to buy or sell an underlying asset at a predetermined price on a future date. It is widely used for hedging, price discovery, and market participation across equities, currencies, and commodities. Understanding how futures contracts work is important before considering this market segment.
What is futures trading?
Futures trading involves buying or selling standardised contracts that create an obligation to transact an underlying asset at a predetermined price on a specified future date.
Futures contracts are used for purposes such as hedging, price discovery, and speculation. However, because they involve leverage, they may amplify both potential gains and potential losses.
A futures contract may be linked to an underlying asset such as a stock, index, currency, commodity, interest rate instrument, or other financial asset.
How does futures trading work?
A futures contract works through a standardised agreement between a buyer and a seller. The contract clearly mentions the underlying asset, lot size, expiry date and price at which the trade will take place.
In futures trading, investors do not usually pay the full contract value upfront. Instead, they deposit a margin with the broker. This margin allows them to take a larger market position than the amount deposited.
Futures positions are also marked to market on a daily basis. This means profits and losses are calculated each trading day based on the settlement price. If the market moves against the position, the investor may need to add more margin.
A futures position can be squared off before expiry or settled on the expiry date, depending on the contract and exchange rules.
How to start futures trading?
To begin futures trading, investors may follow these steps:
1. Open a trading account with a SEBI-registered broker.
2. Complete the applicable Know Your Customer (KYC) requirements.
3. Enable the Futures and Options (F&O) segment on the trading platform.
4. Understand margin requirements, contract specifications, and settlement mechanisms.
5. Review the underlying asset and prevailing market conditions.
6. Place futures orders through the trading platform.
Things to consider
Before starting futures trading, investors should also assess whether this segment suits their risk profile. Futures involve leverage, daily mark-to-market settlement and margin requirements, which can make them more complex than regular stock investing.
It is also important to compare brokerage charges, understand the contract size, check liquidity in the contract and review how expiry works. New investors may consider observing the market or using simulated trades before taking actual positions.
Example of futures trading
Consider an Indian importer who expects to pay USD 100,000 to an overseas supplier three months from now. Assume the current USD-INR exchange rate is ₹84 per US dollar.
If the importer is concerned that the rupee may depreciate, the importer may purchase 100 USD-INR futures contracts on the NSE, assuming each contract represents USD 1,000, at ₹84 per US dollar.
If the exchange rate rises to ₹86 per US dollar at contract expiry, the gain on the futures position may help offset the higher cost of purchasing US dollars in the spot market. This is a common example of using currency futures to hedge foreign exchange exposure.
Similarly, a market participant anticipating such a currency movement may take a futures position with the expectation of benefiting from the price change. However, if the market moves in the opposite direction, losses may occur.
The figures shown are for illustrative purpose only.
Uses of futures trading
Futures trading is used by different market participants for different purposes. Some use it to reduce risk, while others use it to take a view on future price movements.
- Hedging: Businesses and investors may use futures to manage the risk of price changes in currencies, commodities, stocks or indices.
- Speculation: Traders may use futures to benefit from expected price movements. However, losses can also occur if prices move in the opposite direction.
- Price discovery: Futures markets can help reflect market expectations about the future price of an asset.
- Arbitrage: Market participants may use futures to benefit from price differences between the futures market and the spot market.
Futures vs forward contracts
Futures and forwards are both agreements to buy or sell an asset at a future date. However, they are not the same.
| Futures contracts | Forward contracts |
| Standardised contracts traded on exchanges. | Customised contracts agreed between two parties. |
| Usually regulated and traded through recognised exchanges. | Usually traded over the counter. |
| Require margin and daily mark-to-market settlement. | Settlement terms are decided between the parties. |
| Easier to enter and exit because they are exchange-traded. | May be harder to exit before maturity. |
| Counterparty risk is generally reduced due to exchange clearing mechanisms. | Counterparty risk may be higher because the contract depends on both parties honouring the agreement. |
What are futures markets and different types of futures?
Futures markets are organised exchanges where standardised futures contracts are traded. In India, futures trading is facilitated through exchanges such as the National Stock Exchange (NSE), BSE, Multi Commodity Exchange (MCX), and National Commodity & Derivatives Exchange (NCDEX).
Different categories of futures are used by various market participants depending on their objectives and underlying assets. Major types of futures include:
- Financial futures
- Currency futures
- Energy futures
- Metal futures
- Livestock futures
- Grain futures
- Food and fibre futures
Financial futures
Financial futures derive their value from financial assets such as stocks, stock indices, interest rates, or government securities. Examples include Nifty 50 Futures, Bank Nifty Futures, and Single Stock Futures.
Currency futures
Currency futures are contracts that provide exposure to exchange rate movements between two currencies at a future date and a predetermined price. Investors and businesses may use currency futures to manage foreign exchange exposure arising from international transactions. Examples include USD-INR Futures, EUR-INR Futures, and GBP-INR Futures.
Energy futures
Energy futures are commodity contracts linked to products such as crude oil, natural gas, and refined petroleum products. In India, these contracts are primarily traded on MCX. They are commonly used by producers, refiners, distributors, and traders to manage price-related risks. Examples include Crude Oil Futures and Natural Gas Futures.
Metal futures
Metal futures are contracts linked to physical metals such as gold, silver, copper, zinc, aluminium, and lead. These contracts are actively traded on MCX. Gold futures, in particular, are commonly used by jewellers, importers, and other market participants to manage fluctuations in gold prices.
Livestock futures
Livestock futures are contracts linked to animals raised for agricultural production, such as cattle. These contracts are more common in certain international markets and currently have limited relevance in the Indian derivatives market.
Grain futures
Grain futures are linked to agricultural commodities such as wheat, maize, rice, and soybeans. Where available, these contracts may be used by producers, processors, and traders to manage agricultural commodity price risks.
Food and fibre futures
Food and fibre futures cover agricultural commodities including sugar, cotton, edible oils, spices, and pulses. In India, these are traded primarily on NCDEX. Cotton futures, for example, are used by textile manufacturers and exporters to hedge against raw material price volatility, while sugar futures are used by mills and traders in the domestic sugar industry.
Futures trading vs options trading: Key differences
Under the Securities Contracts (Regulation) Act, 1956, options and futures are both derivative contracts. However, they differ in terms of obligations, costs, and risk characteristics.
| Futures | Options |
| Both buyer and seller are obligated to fulfil the contract terms. | The buyer has a right, but not an obligation, to exercise the contract. |
| Margin requirements generally apply. | Buyers pay a premium upfront, while sellers are generally subject to margin requirements. |
| Potential losses may be substantial depending on price movements. | Buyer losses are generally limited to the premium paid, while seller risk may be substantial. |
| Gains and losses are settled through daily mark-to-market adjustments. | Option buyers generally do not face daily mark-to-market adjustments on the premium paid. |
| Commonly used for hedging, speculation, and arbitrage. | Commonly used for hedging, income-oriented strategies, and directional market views. |
How is futures trading different from other financial instruments?
Futures contracts differ from several traditional financial instruments in the following ways:
- Unlike stocks, futures contracts use leverage, allowing larger market exposure with a relatively smaller initial margin.
- Unlike mutual funds, futures contracts have fixed expiry dates and are actively traded derivative instruments.
- Unlike bonds or fixed deposits, futures contracts do not provide regular income or fixed payouts.
- Futures contracts are subject to daily mark-to-market settlement and margin requirements.
Because of leverage and daily settlement obligations, futures trading generally involves a higher level of risk than many traditional investment products.
Risks of futures trading
Futures trading can be useful for hedging and market participation, but it also carries important risks. Investors should understand these risks before taking positions.
- Leverage risk: Futures allow larger exposure with a smaller margin amount. This can amplify both gains and losses.
- Margin call risk: If the market moves against the position, the investor may need to add more funds to maintain the trade.
- Mark-to-market risk: Futures positions are settled daily, so losses may need to be paid even before the contract expires.
- Volatility risk: Sudden price movements can lead to sharp gains or losses.
- Liquidity risk: Some contracts may not have enough trading volume, making it difficult to enter or exit positions at desired prices.
- Expiry and rollover risk: Futures contracts have fixed expiry dates. Investors may need to close or roll over positions before expiry.
Because of these risks, futures trading may not be suitable for every investor. It requires a clear understanding of the product, margin rules, market movements and possible loss scenarios.
Conclusion
Futures trading plays an important role in financial and commodity markets by facilitating hedging, price discovery, and speculation. Futures contracts are available across multiple asset classes, including equities, currencies, and commodities. Before participating in futures trading, investors may consider understanding contract specifications, margin requirements, settlement mechanisms, leverage, and the associated risks.
FAQs
What is mark-to-market (MTM) in futures trading and how often is it calculated?
Mark-to-market (MTM) refers to the daily adjustment of profits and losses in futures positions based on the exchange-determined settlement price. Indian exchanges generally calculate MTM adjustments on a daily basis.
Are futures better than stocks?
Futures contracts and stocks serve different purposes and have different risk characteristics. Stocks represent ownership in a company, whereas futures are derivative contracts linked to an underlying asset. Futures also involve leverage and contract expiry dates.
How can I buy futures?
Investors may access futures contracts through a SEBI-registered broker after completing KYC requirements, enabling the F&O segment, and meeting the applicable margin requirements.
How profitable is futures trading?
Futures trading does not offer assured profits. It can be profitable if the market moves in the direction of the trader’s view, but it can also lead to substantial losses if the market moves against the position. Since futures involve leverage, both gains and losses can be magnified. Profitability depends on market movement, risk management, margin discipline and the trader’s understanding of the contract.
Is futures good for beginners?
Futures trading may not be suitable for many beginners because it involves leverage, margin requirements, daily mark-to-market settlement and the possibility of substantial losses. New investors should first understand how futures contracts work, how margin is calculated and what can happen if the market moves against their position.
Is future trading legal?
Yes, futures trading is legal in India when it is carried out through recognised exchanges and registered intermediaries, subject to applicable regulations. Investors can trade futures contracts through a SEBI-registered broker after completing KYC requirements, enabling the F&O segment and meeting the required margin obligations.
