As the name suggests a Futures Contract is a Derivative tool that is an agreement between 2 parties, (A buyer and a Seller) who agree to exchange the underlying securities of the contract on a Future date at a Pre-determined price. The buyer & Seller of a Futures contract pay a token amount which is known as the Margin Money, and they have an obligation to pay to full money at the time of exercising the contract. There is no compulsion to hold a contract till expiry. One can exit their positions anytime provided there is sufficient liquidity in the underlying asset. Future contracts are used for investment as well as to Hedge the existing position or other Option contracts.
Futures Contract-
A futures contract is a legal contract between the buyer and the seller to buy or sell the underlying asset at a pre-determined price on the expiry of the contract. A futures contract is a derivative segment that has an obligation on the buyer to Buy the underlying securities on the Date of Expiry and the Seller has the obligation to sell the securities to the buyer at a pre-determined price on the date of Expiry.
How does Futures Contract work-
Future is a part of derivatives that involves 2 parties, A Buyer & a Seller.
The buyer of a futures contract buys the futures of an underlying stock in order to buy that Particular security on a Future date at the pre-determined price. To buy the Future contract the Buyer has to pay a certain amount as the Margin money that ranges from 20 to 35% depending on the stocks.
Example-
To buy A future of Reliance Industries, one will have to pay Rs 1,22,000 which contains 250 shares of Reliance Industries. The settlement will take place on the expiry day when the remaining amount for the 250 shares has to be paid while taking delivery of the shares. On the other hand if one has the buy 250 shares of Reliance Industries from the Cash market then one will have to pay 5,20,500 upfront. This is an advantage to buy a Future as one will enjoy the same amount of Profits & Losses for 250 shares by paying only a fraction of the total value.
How it is Used-
Futures contracts are used by both Investors as well as traders. Investors buy and hold the Futures of Stocks in order to save the extra money that would have used to buy the stocks in the cash market, Futures are also used to Hedge the long-term holdings from the short-term volatility of the market without selling the positions. On the other hand, traders buy and sell Futures for Speculative activities to generate some profits, and also as a hedge to the Option positions.
Conclusion-
A futures contract is an agreement between the buyer and the seller to buy or sell the underlying security on the expiry date at the pre-determined price. Futures are used as a Hedging instrument by investors and an as a speculative tool by traders. The buyer need not wait till expiry to sell the contract. He can exit the position any time providing there is sufficient liquidity in the particular Asset.