A futures trade allows a trader to buy or sell an asset at a prearranged price on a future date. The asset can be stock, index, currency or raw commodity . Its value is derived from that asset, hence it is derivative.
Apart from this, F&O trading also involves futures. “F” is the futures symbol. The “O” is for options. Both trade on exchanges. But the rules are different. The deal binds both parties to a futures contract. An option gives the holder the right, not the obligation, to buy or sell.
Introduction to Futures Trading Concepts
Underlying asset: The stock, index or asset that the contract is based on.
Contract price: The futures price agreed upon.
Lot size: Futures are traded in lots which are fixed units.
Expiry date: The date on which the contract is due to expire.
Long position: A trader buys a long position when he/she thinks the price is going up.
Short position: When a trader believes the price will fall, they take a short position
Margin: The portion of the contract value that a trader pays to open a position.
Mark-to-market: Open trades are priced to the daily closing price. The trading balance is increased or decreased by profit or loss.
A Simple Example
Say a stock futures contract is trading at ₹ 500. 1 lot = 100 shares Contract value Rs 50,000 The trader goes long one lot expecting the price to move higher.
If the price hits ₹510, profit is Rs.1,000 (excluding cost). That’s a difference of ₹10 x 100 shares. If the price falls to ₹ 490, the loss would be ₹ 1,000;
The trader might only need a margin to get in. But profit and loss are based on the total contract value. This is the support. It can amplify profits and losses.
How Futures Are Used by Traders
Futures have three functions. They are used by hedgers to cap adverse price movements. Price traders have a view on direction of price . Not purchasing the underlying asset . Arbitrage traders look for differences between the cash and futures prices.
Each use should be well planned out. Do not trade simply because the margin is small.
Risks in F&O Trading
Margin leverage: A small price change can result in a large gain. It can be a big loss on the margin paid.
Margin call risk: If the losses reduce the balance, the broker may ask for more funds. If you don’t pay, your position may be closed.
Market risk: Prices can change quickly, based on news, rates, policy action or world events.
Liquidity risk: Hard to exit a thin contract at a fair price.
Expiry risk: Prices, close rules or margin requirements can alter as the expiry date approaches.
Risk of trading costs: Money lost to brokerage, taxes, fees, bid ask spreads.
Nine out of ten individual traders in the equity F&O segment incurred net losses in its cited study periods, says SEBI. So risk control is the fundamental element of the futures trading.
Getting started
- Know the rules: Check asset, lot size, expiry, settlement type, margin, price move.
- Create the right accounts: Demat and trading account with SEBI registered broker is a must. F&O segment is expected to be active.
- Verify the capital requirements: Have money for margin, daily losses, fees and margin calls. Don’t do it for easy wins and bills.
- Start with a liquid contract: Check its cash price and futures price, Volume and Open interest and expiry.
- Define the trade first: Record entry, exit, stop loss, target, size of trade and reason.
- Cleanliness: Choose contract, expiry, amount, order type and price. Be sure to check each field before sending.
- Follow the position: Watch Margin and Daily Mark-to-Market Entries When you have reached the set level or when the plan fails, you should leave.
- Keep a trade log of all your trades: Result, setup, cost, error, lesson. Record. Please review this carefully before the next trade.
Bajaj Broking also provides trading in Equity and F&O. It also includes guides on futures, margin, risk and contract terms. Please read the charges, margin rules, product terms and risk disclosures prior to trading.
Conclusion
Futures trading is the trading of fixed exchange contracts to take a long or short view, hedge risk or study price gaps. The critical factors are lot size, expiry, margin, leverage and daily settlement. A beginner should learn the contract, the trade size limit, set an exit rule and review every result. Trading F&O requires discipline as leverage can multiply losses quickly when it is against the position.