1) Introduction To Futures Market
• A Futures Market is an auction market in which participants buy and sell commodity and futures contracts for delivery on a specified future date.
• Futures are exchange-traded derivatives contracts that lock in future delivery of a commodity or security at a price set today.
• Today, the majority of trading of futures markets occurs electronically.
2) The Basics of a Futures Market
• Futures contracts are made in an attempt by producers and suppliers of commodities to avoid market volatility. These producers and suppliers negotiate contracts with an investor who agrees to take on both the risk and reward of a volatile market.
• Futures markets or futures exchanges are where these financial products are bought and sold for delivery at some agreed-upon date in the future with a price fixed at the time of the deal.
• Futures contracts can be made or "created" as long as open interest is increased, unlike other securities that are issued.
3) Characteristics Of Futures Contracts
Lot/Contract size
• In the derivatives market, contracts cannot be traded for a single share.
• Instead, every stock futures contract consists of a fixed lot of the underlying share.
Expiry
• All three maturities are traded simultaneously on the exchange and expire on the last Thursday of their respective contract months.
• If the last Thursday of the month is a holiday, they expire on the previous business day.
Duration
• Contract is an agreement for a transaction in the future.
• How far in the future is decided by the contract duration.
• Futures contracts are available in durations of 1 month, 2 months and 3 months.
4) Advantages of Futures Market
• It allows hedgers to shift risks to speculators.
• It gives traders an efficient idea of what the futures price of a stock or value of an index is likely to be.
• Based on the current future price, it helps in determining the future demand and supply of the shares.
• It allows small speculators to participate and trade in the futures market by paying a small margin instead of the entire value of physical holdings.
5) Disadvantages of Futures Market
• The Main Risk stems from the temptation to speculate excessively due to a high leverage factor, which could amplify losses in the same way as it multiplies profits.
• Further, as derivative products are slightly more complicated than stocks or tracking an index, lack of knowledge among market participants could lead to losses.