Types of Futures Contract

There are primarily two categories of people who enter into any of the above contracts.

Hedgers

The first category is of those people who use it as a tool for hedging their risk of unfavorable price movement of an asset in the future. They enter into the futures contract to fix a price for their trade. This minimizes any uncertainty as well as the risk of prices going up or down in the future.

Speculators

The second category is those of speculators. They have no intention of taking the physical delivery of the asset. They look to make quick profits at the expiry of the contract by differences in the price of the asset at that date.

Futures contracts may seem similar to options as both can be settled in the near future. But there is a major difference between the two. Options just give a right to trade in the asset at the time of expiry of the contract or even before. They do not create an obligation to do the same. But futures contracts generate an obligation to settle the contract at the expiry of the time period.

Commodities Futures

Commodities are tangible assets that investors can physically buy and sell. The most common commodities in which investors buy futures contracts are oil, metals, natural gas, food grains, etc. The security behind such contracts is the assets themselves.

Commodities futures are very important for managing price risk, especially to people like farmers. The primary producer of crops or the farmer can enter into a futures contract to sell his produce at a particular price at a particular date in the future. This way, he gets an assurance of the price he will get for his efforts. He can be free from the tension of losses because of the price going down in the future. Similarly, the purchaser of food grains from the farmer will also know in advance the price which he has to pay for the food grains. He can accordingly plan his production if the product is a raw material for his further production. Or he may sell the produce at a higher rate and ensure that he makes a profit from the trade. Oil and gold are other important commodities in which futures contracts play a major role globally.

Stock Futures

Index futures first appeared in India in the year 2000. These were followed by individual stock futures a couple of years later. There are several advantages of trading in stock futures. The biggest one is leverage. Before trading in stock futures, you need to deposit an initial margin with the broker. If the initial margin is, say, 10 per cent, you can trade in Rs 50 lakh worth of futures by paying just Rs 5 lakh to the broker. The larger the volume of transactions, the higher your profit. But the risks are also more significant. You can trade stock futures on stock exchanges like the BSE and NSE. However, they are available only for a specified list of stocks.

Index Futures

Index futures can be used to speculate on the movements of indices, like the Sensex or Nifty, in the future. Let’s say you buy BSE Sensex futures at Rs 40,000 with an expiry date of the month. If the Sensex rises to 45,000, you stand to make a profit of Rs 5,000. If it goes down to Rs 30,000, your losses, in that case, would be Rs 5,000. Index futures are used by portfolio managers to hedge their equity positions should share prices fall. Some of the index futures in India include Sensex, Nifty 50, Nifty Bank, Nifty IT etc.

Currency Futures

Currency futures are contracts on the exchange price of currencies. The parties to the contract fix an exchange rate for the exchange of two currencies on a specific date in the future. Such contracts help nullify the exchange rate risk that may arise in the case of international trade over a period of time. Usually, the parties close these contracts before the date of expiry as per their need.

For example, suppose Mr.X has an investment in India that is due to mature in November this year. One USD is equal to 75 INR at the current exchange rate. He can buy currency futures and lock the current exchange rate of USD to INR. Thus, he will be sure of what investment amount he will receive at this currency exchange rate, no matter what the currency exchange rate is at that time.

Interest rate futures

An interest rate future is one of the different types of futures. It’s a contract to buy or sell a debt instrument at a specified price on a predetermined date. The underlying assets are government bonds or treasury bills. You can trade these on the NSE and the BSE.