Basics of Futures Derivatives
Futures derivatives trading
Future trading can be done on stocks as well as on Indices like IT index, Auto index, Pharma index etc.
Stock future trading -
Let’s first understand what the meaning of futures trading is. In simple language one future contract is group of stocks (one lot) which has to be bought with certain expiry period and has to be sold (squared off) within that expiry period.
Suppose if you buy futures of Wipro of one month expiry then you have to sell it within that one month period.
Important - Future contract get expires at every last Thursday of every month.
If you buy October month expiry future contract then you have to sell it within last Thursday of October month. Likewise you can buy two months and three months expiry period future contract.
You can buy maximum of three month expiry period.
For example - suppose this is month of October then you have to buy till maximum month of December expiry and you have to sell it within last Thursday of December month. You can sell anytime between these periods.
Indices future trading
As you can do future trading on stocks likewise you can do trading on different indices like Nifty index, IT index, Auto index, Pharma index etc.
Successful trading in futures
Future or derivative trading is the process of buying or selling stock future or index future for a certain period of time and squaring off before the expiry date.
Expiry period can be of one month, two month and three month and not more then of three month.
Its not compulsion that you have to square off your positions on the expiry date or wait till the expiry period but in fact you can square off at any time even, at the same day, or you can hold as long as you want but remember to square off before expiry date.
Most of the times on 3rd month expiry future you may see very less trading volumes.
Generally most of the traders/investors trade or invest on current month future or second month future contract and you may see very low volumes on last month means third month expiry .
Lot size (group of stocks in one future contract) varies from future to future contract.
For example Reliance Industries future lot size has 150 quantities of shares while a Tata Consultancy service has 250 shares.
In the same manner all futures have different lot sizes decided by SEBI (Securities Exchange Board of India).
The margin (in other words price of one lot size) varies on daily basis based on its stocks closing price.
Future trading can be done on selected stocks listed under Nifty and Jr. Nifty and not on all stocks.
The price of future contract is determined by its underlying stock.
Important - You can’t buy future contract of expiry period of not more than 3 months.
But on Nifty index contract or on other index contract you may see good trading volumes even on 3rd month expiry future also.
You can also buy and sell or sell and buy future contract on the same day of any expiry month. This is called as day trading or intraday in futures.
Selling future contract before buying is called short selling. Short selling is allowed in futures trading.
Major Advantages of Futures Trading over Stock Trading
Margin is available
In future trading you get margin to buy (but can hold only up to maximum of 3 months), while in stock trading you must have that much of amount in your account to buy.
For example - If you plan to buy stock XYZ at Rs. 100 and quantity 1000 shares then you have to pay 1 lakh rupees (RS 100 x1000 qty). But if you plan to buy XYZ future contract and that contract
lot size has 1000 quantity of shares then instead of paying 1 lakh rupees you have to pay just 20% to 30% of whole amount which comes to 20 thousand to 30 thousand rupees.
In short in future trading you have to pay just 20% to 30% of the whole amount what you pay if you buy stock of that price. But limitation for this is your expiry period. Means if you bought future of one month expiry then you have to square off within that one month likewise you can buy maximum of three months expiry.
Possible to do short selling
You can short sell futures- You can sell futures without buying them which is called short selling and later buy within your expiry period, to cover up your positions.
This is not possible in stocks. You can’t sell stocks before buying them in delivery (you can do in
intraday). You can short sell futures and can cover off within your expiry period.
For example - If expiry period of your future contract is of 1 month then you have time frame of one month to cover off your order like wise if your future expiry period is of two months then you have
time frame of two months and this continues till three months and not more then three months.
In short selling of futures also you get margin as you get in buying of futures.
Brokerages are low
Brokerages offered for future trading are less as compared to stock delivery trading.
Disadvantages of Future Trading over Stock Trading
1) Limitation on holding
If you buy or sell a future contract then you have limitation of time frame to square off your position before expiry date.
For example - If you buy or sell future contract of one month expiry period then you have to square off your position
before your expiry date of that month, so in this example you got one month period. So likewise if you go for two
month expiry period then you get 2 months and if you go for three month expiry then you will get 3 month expiry
period to square off your position.
2) Level of Risk
Due to margin facility in future trading you may earn huge profit by investing fewer amounts but at the contrary side if your
trade goes wrong then you may have to suffer huge loss.
3) Limitation on stocks
You can’t do future trading on all stocks. You can only do on listed stocks on Nifty and Jr. Nifty.
Important points to Remember while doing future trading
1) First up all you have to decide whether you want to buy stock derivatives or index derivative. After this you have to select the expiry period. Once you buy certain expiry period then you have to sell (cover off) your order before that period.
Its no need to wait till the expiry period, you can even square off on the same day (if you are getting profit) or anytime whenever you feel to book profit, no compulsion to cover off your order on the last day of expiry.
2) Check out for Futures current market price.
3) Futures Lot Size (number of shares in that particular Lot).
4) Futures Lot price (this is the amount you must have in your account to buy one lot of future) also called as margin amount.
5) Selection of expiry period - you want to trade on expiry of one month, two month or last 3rd month.
6) No need to wait till expiry period can book profit wherever applicable.
Method of Short Selling
Short selling (selling before buying in future trading)
In future trading you can do short selling and buy (cover) later when price comes down from your selling price you can short sell stock future as well as index future. But again same restriction will apply and that is of expiry period.
If you are new and do not know about Nifty future trading but interested to learn then please visit below link
Go here. It is free of cost.
More points will be added very shortly. Tips on futures trading will be added to our tips page very soon…………………Keep Watching
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