A futures contract is a standardised agreement to buy or sell an underlying asset (a stock, an index like the Nifty 50, or a commodity) at a price fixed today, on a fixed future date called the expiry. It is one half of the derivatives segment, which we cover in What is F&O (Futures and Options)?.
What does the sabzi mandi have to do with futures?
Start with a deal that has nothing to do with the stock market.
Ramesh runs a small hotel and buys 100 kg of tomatoes every month. Prices swing wildly, ₹20 per kg one month, ₹60 the next. So he strikes a deal with a farmer: "Next month, I will buy 100 kg from you at ₹35 per kg, whatever the mandi price is that day."
Both sides have locked in a price today for a transaction that happens later. If tomatoes shoot up to ₹60, Ramesh is relieved. He still pays ₹35. If they crash to ₹20, the farmer is relieved. He still receives ₹35. This is a forward agreement, and farmers and traders have used them for centuries.
A futures contract is the same idea moved onto a stock exchange, with three big upgrades:
- Standardised terms. The quantity (called the lot size), expiry date and quality of the underlying are set by the exchange, not negotiated privately.
- No counterparty worry. The exchange's clearing corporation stands between buyer and seller, so you don't have to trust a stranger to honour the deal.
- Easy exit. Ramesh is stuck with his farmer until delivery day. A futures trader can exit any time before expiry by taking the opposite trade. This is called squaring off.
How does a futures trade actually work?
Suppose Kaveri Motors shares trade at ₹500, and its one-lot futures contract (say, 500 shares) trades at ₹504. Sunita expects the price to rise, so she buys one lot of Kaveri Motors futures.
She does not pay the full contract value of about ₹2,52,000. Instead, her broker collects a fraction of it upfront as margin, a security deposit against losses. Each day, her position is marked to the day's price: if the futures price rises to ₹514, roughly ₹5,000 (₹10 × 500) is credited to her; if it falls, the loss is debited, and she may need to top up margin.
Sunita can square off whenever she likes. If she is still holding the position at expiry, it is settled as per the contract's rules. Index futures settle in cash, while stock futures can involve giving or taking delivery of the actual shares.
You can browse the futures contracts available for a stock or index in What is the Futures Chain and how do I use it?
Why do futures prices differ from the share price?
The futures price usually sits slightly above or below the underlying's current (spot) price. The gap mainly reflects the cost of holding money until expiry and the market's demand for that contract. As expiry approaches, the futures price converges towards the spot price, because on expiry day the two must effectively meet.
Things to keep in mind
- Futures are obligations, not choices. Unlike an option buyer, a futures trader cannot walk away. Gains and losses are settled daily whether the move is in your favour or not.
- Margin makes futures a leveraged product: a small price move creates a large percentage gain or loss on the money you put up, and losses can exceed your initial margin. Read What are the risks of trading Futures and Options (F&O)? before your first trade.
- Lot sizes and expiry dates are set by the exchange and can be revised. Always check the contract details before trading.
- The prices in this article are illustrative, not live market data.
Read next
What are lot size and contract value in F&O? — Futures trade in fixed lots — this is how big a position really is.