Every futures has two parties namely the buyer, who takes delivery of the product and the seller, who delivers the product.
Futures are an essential part of the trading mechanism of markets.
The mechanism for future trading in the stock market:
- The primary requirement for a futures contract in the stock market is a trading account.
- The investor has to put affront the margin money, i.e., a percentage of the total contract amount. This amount has to be paid by the investor to the exchange or the clearing house.
- The margin amount can also be paid to the broker, who will forward it to the clearing house.
- Place an order with the broker to buy a futures contract.
Commodity futures contract is an agreement that requires making or taking delivery of a particular commodity at a future date. The contract is raised based on the speculation of the price rise or fall. If the price rises above the agreed amount, the purchaser will take delivery of the commodity against the agreed price. This helps the purchaser to gain a profit.
In case the price goes lower than the contract price, the seller will have the advantage as he gains profit because the contract to pay the price binds the purchaser.
Settlement of the futures contract:
When trading in a futures contract, the settlement is completed once there is the delivery of the commodities or securities. This scenario can be divided into two types:
- On expiry of the contract
- Before expiry of the contract
The futures contract is settled on the agreed price on the set date. If there is a loss or gain, the purchaser’s account is duly debited or credited for stock market traders. The commodity traders have to take delivery of the commodity and pay the agreed price for the contract to expire.
Before expiry of the contract:
When using a futures contract, there is no need to wait until the completion period. In practice, many traders exit the contract before the stipulated date. Any loss or gain is adjusted against the margin deposited by the trader to the clearing house before purchasing the futures contract.
Futures also have their share of advantages:
- It allows hedging and risk shifting.
- It gives the future rate of a particular commodity or security.
- The current price and trend help in calculating the future rate.
- The system of margin payment is beneficial to small-time traders as they need not pay the whole amount.