Futures

Futures:

A futures contract is an agreement between two parties to buy or sell a number of shares at a pre-determined price in the future (expiry date).

Contract size:

Every stock futures or index futures consist of a fixed lot of underlying shares as determined by the exchange and it differs between each shares or indices. For eg each lot of reliance futures contract has 600 shares. You can buy or sell only in lots.

Duration of Contracts:

The life of each Futures contract is limited for 3 months only. At any point of time, three types of futures contracts will be traded for any given shares depending on the life or duration of the contract before it gets expired. They are near month contract which expires on the current month, middle month contract which expires the next month or the second month and the far month contract which expires on the third month. All futures expire on the last Thursday of the expiry month. If the last Thursday happens to be a holiday, then they expire on the working day before that. After the expiry of the current month contract, the second month contract will become current month contract and the third month contract will become second month contract and the fresh third month contracts will be issued on the next working day after the expiry of current month futures contracts.

Index Futures:

As stock futures derive their value from the underlying stock, the index futures derive their value from the underlying stock index, which itself is derived from the mathematical formula that is used to measure the changes in stock prices of appropriate sample of stocks that represent a certain segment. Each point in index is converted to certain number of rupees. For example, each point in S&P CNX Nifty is equivalent to Rs 100 as S&P CNX is traded in lots of 100. Duration of index futures contract is similar to that of stock futures.

Price variations between futures and their underlying stock or index:

You can always find that there will be some variations between the actual price of the underlying stock or index  and their future prices. This difference is called the Basis. The basis will usually remain positive in bullish market and turn negative when the market is bearish. The price variations between stock or index and their future prices is due to the cost of carry model that represent all the costs (that one has to bear if he is to hold similar stocks in the cash market which include financing charges at the current rate of interest) and benefits of holding such stocks in cash market and the expectancy model that represent the expected spot price in the future.

Spot price:

 The price of the stock or index in the cash market is called the Spot price.

Strike Price:

The price of the stock future or the index future is called the Strike price.

Both spot price and the strike price converge on the date of expiry of the contract.