A future is a derivative contract in which two parties agree to buy or sell to each other at a particular price at a FUTURE date.
It clearly means that the delivery is not immediate and is at a much later date. More importantly, payment is also not immediate, it is at a later date. This kind of contract is also called a forward contract.
It has the feature of short selling. One can sell shares without owning it and then buy it later. Yes, this is certainly possible. So if one believes that the price of a share is going down, one can sell it. Since the concerned person doesn’t have to deliver it right now, the buyer does not care if you already have it or not. On the later date, just buy from the market and give it to the buyer, pocketing (or losing) the difference.
Let us understand it with the help of an illustration of a Godrej Future contract.
What does the statement mean – “I have bought 250 shares of Godrej December Future @ Rs. 700” mean in theory? It means that the person has agreed to buy 250 shares of Godrej Industries on 17th December 2018 (the expiration date) at Rs. 700 per share. So, the current scene is as follows:
- The underlying is the shares of Godrej.
- The quantity is 250 shares.
- The expiry date is 17th December 2018.
- The pre-determined price is Rs. 700. If the price of Godrej increases to Rs. 800 on the settlement day on 17th December 2018, the person buys 250 shares at the contracted price of Rs. 700 and can sell it at the prevailing market price of Rs. 800 thereby gaining Rs. 100 per share.
On similar lines, if the price falls to 650, he/she loses Rs. 50 per share as one has to buy at Rs. 700 but the prevailing market price is Rs. 650.
Also read: What Is Short Selling?
Futures Contracts has also the added feature of Hedging
Suppose, I’m a dealer in rice. Currently, the price of one kilo of price is Rs. 100 but in future as per my knowledge, it might decrease to Rs. 50 due to high competition. I can make a sell futures contract which basically means that the buyer has to buy the concerned kilo of rice at Rs. 100 only irrespective of the then prevailing market price. The buyers in such cases are usually consumers who do not have much idea about the concerned market or are anticipating an opposite result.
We will also be discussing Options Contracts in further articles. As of now, one should understand that futures Contract is one of the key components in the share market.
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