Introduction to Futures
Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered,(or which can be used for reference purposes in settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 99% of futures transactions are offset this way.
The standardized items in a futures contract are:
• Quantity of underlying
• Quality of the underlying
• The date and the month of the delivery
• The units of price quotation
and minimum price change
• Location of settlement
Futures terminology
• Spot price: The price at which an asset trades in the spot market.
• Futures price: The price at which the futures contract trades in the futures market.
• Contract cycle: The period over which a contract trades. The index futures contracts on the NSE have one month, two months, and three months expiry cycles which expire on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three month expiry is introduced for trading.
• Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist.
• Contract size: The amount of…
