What is a Futures Contract?
A futures contract is a standardized legal agreement to buy or sell an asset at a predetermined price on a specific future date. These contracts are traded on exchanges and are commonly used for hedging and speculation in financial markets.
Key Features of Futures Contracts
- Standardized Agreement – Each contract has a fixed quantity, quality, and expiration date set by the exchange.
- Underlying Assets – Futures can be based on commodities (gold, oil, wheat), stocks, indices, currencies, or interest rates.
- Leverage – Traders can control large positions with a small margin deposit, increasing both potential gains and risks.
- Mark-to-Market (MTM) Settlement – Profits and losses are settled daily based on market price fluctuations.
- Expiry Date – Every contract has a fixed maturity date when it must be settled.
- Two Types of Settlement
- Physical Delivery – The actual asset is delivered upon contract expiration.
- Cash Settlement – The contract is settled in cash based on the asset’s price difference.
How Futures Contracts Work
- Example: Suppose an investor agrees to buy 100 barrels of crude oil at ₹6,000 per barrel in a 3-month futures contract. If the market price rises to ₹6,500 per barrel before expiry, the investor profits ₹50,000 (₹500 × 100 barrels).
Uses of Futures Contracts
✅ Hedging – Businesses use futures to protect against price fluctuations (e.g., farmers securing wheat prices).
✅ Speculation – Traders bet on price movements to earn profits.
✅ Arbitrage – Investors exploit price differences between spot and futures markets.
Risks of Futures Contracts
⚠ High Leverage Risk – Small price movements can cause significant gains or losses.
⚠ Liquidity Risk – Some contracts may have low trading volume, making them hard to exit.
⚠ Market Volatility – Unpredictable price swings can lead to unexpected losses.
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