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Understanding Futures Contracts Basics

Sep 13, 2024

Futures Contracts Overview

Introduction

  • Previous topic: Forwards market
  • Focus of this session: Understanding futures contracts

Key Features of Futures Contracts

  • Buyer and Seller: Two parties involved in the contract.
  • Standardization: Futures contracts are standardized products.
  • Regulator Presence: Ensures compliance of duties by buyers, sellers, and intermediaries.

Differences Between Futures and Forwards Contracts

  • Standardization: Futures are standardized, while forwards are customizable.
  • Regulatory Oversight: Futures have regulatory bodies overseeing transactions.

Components of Futures Contracts

  1. Underlying Asset

    • Definition: The asset being traded (e.g., gold, equity, currency, or indices like Nifty/Sensex).
    • Example: Gold was the underlying in the previous example.

  2. Lot Size

    • Definition: Minimum amount of shares/contracts that can be traded.
    • Examples: 50 shares of a company in equities or specified grams/kgs for commodities like gold.

  3. Contract Size

    • Definition: Total value of the futures contract.
    • Calculation: Lot Size x Price of the underlying asset.
    • Example: For Tata Steel, multiply the number of shares by the price to get the contract size.

  4. Expiry

    • Definition: The date when the contract expires.
    • Monthly Expiry: Last Thursday of each month.
    • Weekly Expiry: Thursday of the current week.
    • Importance: All obligations must be fulfilled by the expiry date.

  5. Margin

    • Definition: Percentage of the total contract size required to enter a futures contract.
    • Example Calculation: If contract size is 10 lakh rupees and margin is 10%, the margin to be paid is 1 lakh rupees.

Practical Example: Infosys Futures Contract

  • Current Spot Price: 1,702.05
  • Futures Contract Details:
    • Expiry Date: 30th September 2021 (last Thursday of September).
    • Market Lot Size: 600 shares.
    • Contract Size: Lot Size x Spot Price = 600 x 1,702.
    • Margin: Assuming 18% margin, calculate based on contract size.

Key Takeaways

  • Futures involve standardized contracts regulated by authorities.
  • Understand the components: underlying asset, lot size, contract size, expiry, and margin.
  • Real-life example illustrated the principles of futures contracts using Infosys.

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