Hi, In this video, we will be talking about some key things to be kept in mind while placing a futures order.

Hi, In this video, we will be talking about some key things to be kept in mind while placing a futures order.

A futures contract is a standard forward contract which is traded on an exchange. It enables a buyer or a seller, to buy or sell a commodity or a stock, at a certain predetermined price, on a certain date in future. A futures contract is an obligation, and the investor is bound to fulfill it, even if the asset price on the settlement date is not favorable for him. So, one needs to understand the mechanism and risks involved before entering the futures market. Here are some of the key terms you should know before trading futures contracts.

First is Spot Price. Spot price is a price at which an asset trades in the cash market. It is also known as the current Market price.

Next is the Futures Price. Futures price is the price of the futures contract in the futures market. The price of a futures contract is determined by the spot price of the underlying asset, adjusted for time and dividend accrued till the expiry of the contract.

Next is Contract Cycle. A contract cycle is a period over which a contract trades. The maximum number of index futures contracts are of 3-month contract cycles – One Month (Near month), Two months (Next month) and three months (Far Month).

Next is the Contract Size. This is also known as the lot size and it is the minimum quantity of an asset (stocks, indices and commodity) that one needs to buy or sell to trade in futures. You have to multiply the price with the lot size to get the contract value.

Next is the Expiry Date. It is the last date on which the futures contract trades on the exchange. At the end of the expiry date, the futures contract is no longer valid and it ceases to exist. All traders are compulsorily required to settle their positions on the expiry date. Generally, In India, equity derivative contracts expire on the last Thursday of every month.

Next is the Initial Margin. The Initial margin is the amount one needs to deposit in the margin account at the time of entering a futures contract. Margins are levied by the exchange to ensure that counterparties fulfil their obligations.

Next is the Cost of Carry. Cost of carry is the cost to be incurred by the trader for holding certain positions in the underlying market, till the futures contract expires. In the commodity market, Cost of carry is the storage cost plus the interest that is paid to finance, or carry the asset till delivery, less the income earned on the asset during the holding period.

For equity derivatives, carrying cost is the interest paid to finance the purchase, less dividend earned. Lastly, we have the Mark to market (MTM). In a futures contract, gains or losses are settled on a continuous basis at the end of each trading day. This exercise is called the MTM settlement. The exchange, with the help of a broker and a clearing house, collects this MTM margin from the loss bearing party, and pays the same to the gaining, eligible party.

A futures contract is very risky and volatile. As it moves due to every news flow, your margin-paying capacity should be high. This means, since it has to be settled within the month, liquidity is the biggest concern. One has to be very well informed and educated before taking a futures contract, else one may end up losing even their capital due to little or no knowledge.

Thank you for watching the video.