What Is a Futures Contract? Locking In a Price for Later

A futures contract is a standardized agreement to buy or sell an underlying asset — a stock, index, commodity, or currency — at a predetermined price on a specified future date, obligating both the buyer and seller to complete the transaction regardless of the asset's actual market price at that future date.

How a Futures Contract Works

Unlike simply buying a stock outright, a futures contract involves an agreement about a future transaction. If an investor buys a futures contract on a stock currently trading at ₹500, agreeing to a future price of ₹510 for a contract expiring in a month, the outcome depends on where the actual market price lands by expiry — if the stock is at ₹540 at expiry, the futures buyer profits from the ₹30 difference; if it's at ₹480, they face a corresponding loss.

Futures contracts in India trade on regulated exchanges and are typically settled either through actual delivery of the underlying asset or, more commonly for financial futures, through cash settlement based on the price difference.

Why Futures Contracts Are Used

Hedging is a primary use — a business or investor with exposure to a particular asset's price can use futures to lock in a price in advance, protecting against unfavorable price movements. A jewelry business, for instance, might use gold futures to lock in a purchase price for future inventory, protecting against a potential price increase.

Speculation is another common use — traders use futures to bet on the future direction of an asset's price, often using leverage, since futures contracts typically require only a margin deposit rather than the full contract value upfront.

The Leverage and Risk Involved

Because futures contracts require only a margin deposit rather than full payment of the contract's value, they offer significant leverage — meaning both potential gains and losses are amplified relative to the capital actually put up, similar in concept to margin trading. This leverage makes futures considerably riskier than simply buying the underlying asset outright.

FAQ

Do all futures contracts require taking physical delivery? No, most financial futures in India, including stock and index futures, are typically cash-settled rather than requiring physical delivery of the underlying asset.

Are futures contracts suitable for beginner investors? Given the leverage involved and the complexity of managing an obligation (rather than a simple right, as with options), futures are generally considered more appropriate for experienced traders with a solid understanding of derivatives and risk management.

Futures contracts serve important hedging and speculative purposes in financial markets, but the leverage involved means gains and losses are significantly amplified compared to trading the underlying asset directly. This is general information, not personalized investment advice.

Sources

• Securities and Exchange Board of India — sebi.gov.in
• National Stock Exchange of India — nseindia.com