What Are Futures (In Derivatives)? Basics of Futures
There's a lot more you can trade in the share market beyond just company shares — F&O (Futures & Options), Commodities, and Currencies are all traded too. Today, we're focusing on the basics of Futures.
What Is a Derivative?
A Future is, at its core, a type of Derivative — so it helps to understand that term first.
A Derivative is a financial instrument that derives its value from an underlying asset.
Here's a simple way to picture it: imagine an empty treasure box. The key to that box, on its own, is worth nothing. But if that same box now holds a million dollars in cash, the key to it suddenly has real value — a million dollars' worth, in fact.
The key is the financial instrument. The cash inside the box is the underlying asset. The key's value comes entirely from what it unlocks — that's the essence of a derivative.
There are four types of derivatives:
- Forwards
- Futures
- Options
- Swaps
We'll focus on Futures.
What Is a Future Contract?
A Future is a financial instrument that derives its value from an underlying asset — most commonly a company's shares, though Commodity Futures (derived from commodities) and Currency Futures (derived from currencies) exist too. This article focuses on Financial Futures — those tied to shares, bonds, and similar instruments.
A Future Contract is an agreement between a buyer and seller, designed to protect both sides from losses caused by day-to-day price fluctuations.
A simple example: Say a bakery buys flour from a supplier, Mr. X, once every 3–4 months, paying whatever the market price happens to be at delivery time. Flour prices fluctuate — so if the price is $4/kg today, there's no telling what it'll be in two months when the next delivery is due. Last time, the price dropped to $2/kg, and Mr. X took a loss.
To avoid repeating that, Mr. X and the bakery sign a Future Contract, locking in a price of $4/kg regardless of what the market price actually is at delivery time. If the price rises to $6/kg, the bakery benefits from having locked in the lower rate. If it falls, Mr. X benefits from having locked in the higher one. Either way, both sides are protected from the downside — which is exactly why both parties are willing to enter into it.
Of course, in a simple two-party handshake deal, either side might be tempted to walk away if the market moves sharply in their favor. In reality, this risk is handled by a regulated system: the Regulator of the Capital Market (SEBI in India, the SEC in the U.S.) and the stock exchanges oversee the process, ensuring both the buyer pays what they owe and the seller delivers what they agreed to, at the agreed price and time.
How Futures Actually Work in Practice
Real Financial Futures aren't traded in flour — they're traded in lots of company shares. A "lot" is a fixed number of a company's shares that a future contract represents, and the lot size is set by the stock exchange.
Example: Say company XYZ's future has a lot size of 10 shares, and each share is priced at $500. The total value of that future is $5,000 (10 × $500). In practice, the future's listed price is usually set slightly below this full value, giving buyers a built-in discount/profit margin — but we'll keep it at $5,000 here to keep the example simple.
As with any derivative, the future's price moves in step with the underlying share price. If XYZ shares rise to $510, the future's value rises to $5,100. (Note: not every company has futures available to trade — only a limited number do.)
Why Trade Futures Instead of Just Buying Shares?
This is a fair question — since a future of 10 shares costs roughly the same as buying 10 shares outright, why bother with a future at all?
The answer is leverage (also called margin). Rather than paying the full $5,000 up front, an investor is typically only required to put up a fraction of that — commonly in the 10–20% range, depending on the exchange's margin requirements for that particular contract. The remainder isn't a personal loan from the broker in the traditional sense; it's collateral-backed exposure, with the exchange requiring a minimum margin to cover potential losses.
Continuing the example: if an investor puts up $500 (10% of $5,000) as margin and the share price rises to $600, the future is now worth $6,000 — a $1,000 gain on a $500 outlay. That's the appeal of leverage: amplified gains relative to the capital you put in.
Did you know? Futures can be significantly more profitable than shares — and significantly riskier, for the exact same reason.
The downside works the same way, in reverse. If the share price falls to $400 instead of rising, the future drops to $4,000 — a $1,000 loss, even though you only put up $500. That shortfall doesn't just vanish: you're required to cover it, typically through your linked bank account or by having other holdings in your portfolio liquidated to make up the difference. In effect, you're now carrying a form of debt until it's settled.
Where does the margin requirement actually come from? It isn't a broker charging interest on a loan the way the original explanation might suggest — it's the exchange's way of ensuring you can cover potential losses. Positions are settled daily through a process called mark-to-market: gains and losses are calculated and applied to your account at the end of every trading session, not just at expiry. Brokers do earn revenue from futures trading, but primarily through brokerage fees charged per order — not ongoing interest on your leveraged exposure, which is a common misconception. (Separately, brokers do offer interest-bearing margin trading facilities for regular share purchases — but that's a distinct product from exchange-traded futures.)
Because of this daily settlement, it's essential to maintain sufficient funds in your account to cover potential margin calls — otherwise you risk having positions forcibly closed out.
Types of Future Contracts
Futures are categorized by how far out they expire:
- Near Month — expires the following month
- Next Month — expires two months out
- Far Month — expires three months out
Note on expiry dates: For years, most Indian index and stock futures/options expired on the last Thursday of the month. As of September 2025, NSE shifted this to the last Tuesday of the expiry month (BSE's Sensex contracts moved to Thursday around the same time). If the scheduled expiry day falls on a market holiday, expiry shifts to the previous trading day. It's worth double-checking the current rule for your specific exchange and contract, since these schedules have changed more than once in recent years.
Can You Trade a Future Before It Expires?
Yes — futures can be bought and sold at any point before expiry, not just held until the end. If a future's value rises sharply shortly after you buy it, you can sell it early to lock in the gain, rather than waiting out the full contract term and risking a reversal. Whoever buys it from you can, in turn, trade it further, right up until expiry.
Once a future reaches expiry without being sold, the underlying shares are automatically transferred into the holder's demat account at whatever the settlement price is at that time — whether that results in a profit or a loss for them.
Did you know? A large share of futures contracts are closed out or rolled over before reaching their expiry date, rather than being held all the way through to settlement.
Recap
- A Future is a type of Derivative — a financial instrument that derives its value from an underlying asset (most commonly, a company's shares)
- A Future Contract locks in a price between buyer and seller to protect both sides from market fluctuations
- Futures are traded in lots, with lot size set by the exchange
- Leverage/margin lets investors control a much larger position with a smaller upfront outlay — amplifying both potential gains and potential losses
- Futures settle daily via mark-to-market, not just at expiry
- Contracts are categorized as Near Month, Next Month, or Far Month, and can be traded any time before expiry
A note of caution: futures carry meaningfully more risk than buying shares outright, given the leverage involved. This article is meant to introduce the concept — not as a recommendation to trade futures. Any decision to do so, and its outcome, is entirely your own responsibility.
Would you ever consider trading futures? Let us know in the comments.
Comments
Post a Comment