A Beginner’s Guide on How to Trade Futures in India: Essentially, trading is nothing but an art to be able to foresee the future. There is joy (of profits) if we can foresee it right, and a sense of grief (losses) if our views and conviction go wrong. In simple terms, a trader is an individual or entity who buys or sells financial instruments like shares, bonds, derivatives, etc intending to make profits or to hedge the existing position.

In this post, we are going to discuss how to trade futures in India. However, before we dwell deeper into the world of futures trading, let us try and understand the mechanism of the Cash market and Forwards market, which builds the basic foundation of futures trading.  Here, we try and draw their relevance to the futures market. Then, we’ll dig into the main topic of this article on the basics of how to trade futures in India. Let’s get started.

What is the cash market?

The cash market is an equity market where the buying and selling of the shares of the company listed on the exchange takes place. While trading via the cash market, the buyer of the shares of the company is essentially the part-owner of the company. He/she takes delivery of the shares of the company when they buy it from the cash market. These are regulated by exchanges.

Anyways, here, we can only buy that number of shares that our margin/capital in the trading account allows. There is no concept of leverage while trading via the cash market. The most import aspects of the cash market are delivery of the shares, ownership of the company, and no leverage allowed for delivery of the shares.

What are Forwards Market?

The concept of the forward market essentially came into the picture to protect the interest of farmers. Under this method, the agricultural produce of the farmers was pre-booked at a specified price to be delivered for a specified quantity and on a fixed date in the future.

Therefore, the forwards market is essentially a contract between two parties to buy the underlying asset at a specified price, in the specified quantity, and at a fixed price in the future. These instruments have lost their popularity because of certain glaring limitations, but are still used by banks and other financial institutions.

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Some of the limitations of the Forward contracts include:

  • There is no third party (exchange or legal body) governing the forward contracts. So legality becomes a drawback while trading forward contracts.
  • Lack of liquidity is another major limitation that is plaguing the forward contracts. It can sometimes become difficult to find a counterparty willing to take opposite positions.

What are Futures Market?

The futures market are financial derivatives that derive their value from the underlying asset. The underlying asset here could be Shares, bonds, commodities, etc.

The futures market are a standardized contract that has a certain fixed quantity of shares (in the case of the equity market) per lot and they have a fixed expiry (three different expiry contracts run simultaneously) period. They are just like buying shares in the equity market but with a fundamental difference that in the case of futures contracts there is no delivery of the shares.

Another major difference between them is the leverage that one receives while trading futures contracts. In the case of the cash market, the leverage is to the tune of the amount of margin the trading account. But while trading futures, the amount of margin required varies between 20-60% of the total contract value in the case of shares and about 10-12% of the total contract value while trading index futures. So financial leverage becomes a major consideration for a futures trader.

In addition, one major advantage of trading via futures contracts is that these contracts are regulated via exchange (SEBI in India) and legality is never a factor with futures contracts. And the futures contracts are very liquid by nature i.e., it is very easy to find a counterparty willing to take opposite positions.

Now, having understood the basic premise of futures trading, let us try and understand how are futures contracts traded in India.

How to Trade Futures in India?

Futures trading in India is mainly in two forms – Stock futures and Index futures. All the futures contracts in India have three contracts running simultaneously – the near month, middle month, and the far month.

Whenever the near month expires, a new far month contract is added. The monthly contracts expire on the last working Thursday of the month. And if the last working Thursday is a holiday, then it expires the preceding day. 

— Stock Futures

Stock futures are a financial derivative instrument that derives their value from the value of the underlying asset (shares of the company). The contracts have a specific size, fixed price, and specified date. Once the contract is entered, it will have to be honored. Following are some of the characteristics of Stock futures:

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  • The size of the contract: All the stocks trading in the futures market, have a different number of shares in each lot. Partial lot trading is not permitted. A minimum of one lot has to be traded. For example, one lot of futures contract of Reliance industries has 250 shares, one lot of Maruti has 100 shares, one lot of ICICI bank has 1375 shares etc.
  • Expiry: All the stock futures contract has pre-decided fixed maturity. They expire on the last trading Thursday of the month. And if the last Thursday is a holiday, then they expire on the previous trading day. The stocks have three expiring contracts – near month (1-month), middle month (2-month), and far month (3-month).
  • Margin: The margin required to trade stock futures contract is very high to cover for Mark to Market (M2M) losses. This is basically done to protect the interest brokers and the exchange. And with the prevalence of margin, while trading futures in India, there is no chance of default in trading via futures contracts. Margin has two components – Exposure margin and SPAN margin. SPAN Margin is the minimum requisite margins required as per the exchange’s mandate and ‘Exposure Margin’ is the margin required over and above the SPAN to account for any MTM losses

— Index Futures

An index is a representation of the broader sector of the economy. In India, there are two major index which are actively traded in the futures market – Nifty Index and Bank Nifty Index. On Jan 12, 2021, SEBI also allowed trading of Nifty Financial services in the derivatives segment.

If one were to express their view on the economy then one should express their view views by trading Index futures as it shows the overall sentiment of the market. Trading Nifty futures would mean that one is expressing his views on the overall economy as Nifty 50 is a composition of the top 50 companies listed on NSE. 

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A few KEY Factsheets for Index Futures

— Nifty Futures Trading

  • Underlying Asset: Nifty 50 Index
  • Total Stocks in the Nifty 50 Index: 50
  • Total Active Contracts anytime : 3 (Near Month, Mid Month, Far Month)
  • Shares in 1 futures lot: 75
  • Expiry: Last Thursday of Every Month (Previous day if Thursday is a holiday)

For example,  if the present value of one lot of Nifty futures for near month expiry is 14476, then the total value of the contract will be – Contract value = 14476 * 75 = Rs. 10,85,700

The margin required will be equal to:

How to Trade Futures in India - margin required

— Bank Nifty Futures Trading

  • Underlying Asset: Bank Nifty
  • Total Stocks in the Bank Nifty Index: 12
  • Total Active Contracts anytime : 3 (Near Month, Mid Month, Far Month)
  • Shares in 1 futures lot: 25
  • Expiry: Last Thursday of Every Month (Previous day if Thursday is a holiday)

For example, if the present value of one lot of Bank Nifty futures for near month expiry is 331628.05, then the total value of the contract will be – Contract value = 31628.05 * 25 = Rs. 790701.25

Here, the margin required will be equal to:

How to Trade Futures in India - bank nifty margin

— Nifty Financial Services Future Trading

  • Underlying Asset: Nifty Financial Services
  • Total Stocks in the Nifty Financial Services Index: 20
  • Total Active Contracts anytime: 4
  • Shares in 1 futures lot: 40
  • Expiry: Last Thursday of Every Month (Previous day if Thursday is a holiday)

For example, if the present value of one lot of Bank Nifty futures for near month expiry is 15308.30, then the total value of the contract will be – Contract value = 15308.30*40 = Rs. 612332

Here, the Margin required will be equal to:

How to Trade Futures in India - Nifty financial services futures trading

How are Futures contracts Priced?

Futures contract derive their value from the value of the underlying assets. There is always a variation/difference in the prices of the cash segment and derivatives segment. There are basically two methods of pricing the futures contract: The Cost of Carry Method & The Expectancy Method.

— The Cost Of Carry Model

Under this method, the market is assumed to be perfectly efficient. So, the profit made by trading the cash segment or futures segment is the same, as the movement in the prices are aligned. Following is the process of calculating the prices under the Cost of Carry model

Futures Price = Cash Price + Cost of Carry

The cost of carry here refers to the cost of holding the futures contract till maturity.

— The Expectancy Method

Under this method, the futures prices are the expected cash price of the underlying asset in the Future. So, if the market is positive/conducive for the underlying asset, then the futures price will be higher than the cash price. If the market has a weak sentiment towards the underlying asset, then the futures price will be lower than the underlying asset.

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Why Trade Futures?

The following are some of the benefits of futures trading:

  • The contracts are well regulated: As the futures market are well regulated, there is no risk of legality and all the contracts are settled at the time of expiry
  • Leverage: Leverage is perhaps one of the most important reasons for which futures trading is one of the most popular derivative instruments. 
  • Highly liquid: Liquidity is never a factor while trading via futures as there are hordes of players who are willing to trade futures or hedge their existing position in the market. 

Closing Thoughts

In this article, we discussed How to Trade Futures in India for beginners. Here are a few key takeaways from this post:

  • Futures contract derive their value from the value of the underlying assets.
  • Because of the low margin requirement, futures trading is very popular amongst traders
  • The futures contract are exchange regulated, there is never the question of trust amongst the traders
  • One can exit their existing futures contract position anytime from the market by taking an opposite position in the futures market.
  • The Index futures are cash-settled
  • There are two methods of calculating the futures contract value – The cost of carry method or the Expectancy method

That’s all for today’s article on How to Trade Futures in India. We hope it was useful for you. We’ll be back tomorrow with another interesting market news and analysis. Till then, Take care and Happy investing!