Now what the heck futures trading is all about? Never heard before this thing in my life. If it is so, then trust me professional traders love trading in derivative segment and futures trading is one of the derivatives. You’ll be amazed by knowing the power of futures trading that act like a money-making machine.
Derivatives are none other than a security that derives its value from another financial instrument. Pro-traders referred this financial instrument as an ‘Underlying Asset’. You can do futures trading in stock futures, index futures, commodity futures, or currency futures.
It is not a new concept and is exist for more than centuries. In fact, we are doing lots of transaction that involves future trading in our day to day activities.
In a future contract trading, both buyer and seller enter into an agreement digitally through an exchange. Transaction happens at a specific price, quantity, and a specific future date that regulated by SEBI itself.
To understand futures trading in a simple way, just consider there are two parties involved in buying and selling of a particular company’s share. Both the parties are expected to gain profit while entering into a futures trading irrespective of their views on the stock.
For instance, let say buyer name is Tukaram who intends to buy the shares and seller of the shares is Atmaram. Suppose today on 25th May 2018 is a trading day and HPCL – Hindustan Petroleum Corporation is trading at around 280. As HPCL main business is oil marketing and is heavily dependent on crude oil.
So a 1$ rise in crude oil price may impact HPCL profit margin. Rumour is that crude oil price likely to go up and may touch 100$ per barrel. However, it is just a rumor and not a fact. It may go up or come down from the current level. Traders from across the world make their own views and some assume crude oil price will shoot up and others have negative sentiments.
Tukaram is bullish on HPCL as he thinks that crude oil price may correct and go down in the near future. On contrary, Atmaram has a bearish view on HPCL as he believes that crude oil may shoot up and touch 100$ soon. So, same stock but Tukaram and Atmaram have a different view on the stocks.
Now instead of buying HPCL shares, Tukaram decided to trade and buy in HPCL Futures. At the same time, Atmaram also decided to take a short position in HPCL futures. HPCL futures is the derivatives of HPCL which is the underlying asset. So, if HPCL moves up or down, HPCL futures also follow the same path as HPCL spot price.
Key things to know before you trade in futures.
Instrument Type – Underlying asset is a stock of a company and so the instrument type is stock futures.
Expiry Date – Futures contract nearest expiry date is 31st May 2018.
Underlying Value – Underlying asset value price is the spot price. Here, the underlying value of HPCL is 296.50
Lot Size – It is the minimum number of shares that you need to buy or sell if you wish to trade in a futures contract. HPCL futures lot size is 1575, that means you need to buy at least 1575 shares or a multiple of 1575 shares.
Contract Value – To get the HPCL contract value, you need to multiply its lot size by its Futures Price. So, the contract value will be 467,932.50 (1575 x 297.1).
Do remember that the futures price always moves in line with the spot price or the underlying asset. Here, the underlying asset is the stock of HPCL and its derivatives is HPCL futures. You can get all these information in the NSE or BSE site and also in your trading terminal.
3 possible outcomes in futures trading.
Once a transaction happens between Tukaram and Atmaram, they can expect 3 possible outcomes by 31st May 2018.
HPCL stock price move up by May 31, 2018
Assume HPCL stock price move up and eventually, HPCL futures price also increases from 297.10 to 325. So, Tukaram’s profit will be 27.90 per share and his per lot profit earning will be 43942.50(27.90 x 1575). On contrary, Atmaram will be sitting on a loss by the expiry date.
HPCL stock price moves down by May 31, 2018
Suppose HPCL stock price gone down and so HPCL futures price also decrease from 297.10 to 270. So, here, Atmaram’s profit will be 27.10 per share and per lot profit earned will be 42682.50(27.10 x 1575). On the other hand, Tukaram will be sitting on a loss.
HPCL stock price remains same by May 31, 2018
Since the HPCL stock price remain unchanged by the expiry date and so there will be no profit or loss between Tukaram and Atmaram
So, keeping in mind the above 3 scenarios, you can start trading in a futures contract. As you may be heard about the famous stock market jargon “Trend is your friend”. So, before you, trade start gathering real-time information as you need to find out the trend.
You don’t have to pay the full contract value as an only certain percentage of contract value is required to trade in a futures contract. It is like paying advance and called as margin money that will be adjusted as per your profit and loss.
The moment you entered into a futures contract, you are obligated to honor the contract irrespective of profit and loss. However, you may exit from the trade at any point in time.
In futures trading, margin plays a very crucial role and because of that, you may find it more attractive as compared to spot market trading.
I have covered the basic concept of futures trading in this post. However, I will cover some other key aspects of a future contract like margin money, M2M settlements, Open Interest, and Leverage in my upcoming post. In my next post, I will unfold options trading that lets you make money online insanely
For the time being, just read this post again if you don’t understand any part of it. You can ask any query or express your views on futures trading in the comment section as well.
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Published on: May 28, 2018