Futures trading is a part of future and option trading in the derivatives segment of the stock market. Investors trading in futures speculates the price of a stock, currency, commodity, or benchmark in future. Futures trading is a subtype of derivative trading. A derivative is a financial contract that gets its value from an underlying asset’s price movement. Simply put, a derivative tracks another asset’s price. And, through futures and options trading, an investor tries to profit from the price movement of a derivative.
What is a Futures Contract?
A futures contract is a legal, financial instrument that ties a buyer and a seller. While the buyer takes a long position in the derivative, hoping that the price of the underlying asset will increase, the seller sells, hoping that the underlying asset’s price will decrease. Futures contracts come with a fixed expiry date.
Through the futures agreement, the buyer expresses their desire to purchase the derivative on or before the expiry of the contract. As the contract nears its expiration date, the underlying asset’s price determines the value of the futures contract. If the asset price crosses the strike price of the derivative, it is considered in the money, and the buyer wins the trade. But, if the asset price remains much lower than the derivative’s strike price, the seller wins the trade.
The Two Types of Futures Traders
Futures traders are of two types - Hedgers and Speculators.
Hedgers are investors who purchase derivative instruments to protect their capital from losses. For example, if the producer of a commodity feels that the price of their harvest will decrease in the future, they can sell a futures derivative at the current price and buy it back when the price tumbles.
Speculators are independent floor traders and investors who profit from the rise and fall of derivative contracts. They buy or sell futures and options depending on the market condition and the demand-supply scenario of the derivative. In fact, the demand-supply conditions govern futures pricing. You can compare a speculator with an intraday share trader who buys when the asset value is low and sells when the asset value increases.
What is Futures Trading?
Futures trading refers to an obligatory agreement between a buyer and a seller to trade derivatives according to the agreement. Unlike options trading, both buyers and sellers are obligated to honour the contract in futures trading. The time is known as the delivery or contract expiry date in a futures contract, and the strike price is the futures price. Since a futures contract is obligatory and legal in nature, The Securities and Exchange Board of India (SEBI) oversees the process to maintain the market’s sanctity.
The Benefits of Futures Trading
All futures contracts are monitored by SEBI, making them fair for all parties. Moreover, you can improve your understanding of the stock, currency, or commodity markets by trading in futures. Also, you can predict the demand-supply scenario in the capital market better and make informed investment decisions.
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