Trading in Futures
Trading in futures is similar to trading in stocks except that you do not take delivery of the stocks. In cash market, you can only hold stocks in the long position for a longer period, whereas in the futures market, you can also hold short positions open for many number of days depending on the contract duration.
You do not have to pay the actual value of the lots while buying futures. Instead you will have to deposit only a percentage of the value of the open position which is called margin money which covers the initial and the exposure margin. This margin amount for each stock futures and index futures is prescribed by the exchange depending on the volatility of the stock or index. In addition to maintaining margin, one has to maintain mark-to-market margins (MTM) which covers the daily difference between the cost of the contract and the closing price of the contract for the day.
Settlement of Futures
In Indian stock market, buying stock futures does not result in delivery of shares. So the futures contract has to be settled on or before the date of expiry of the contract by squaring off the position (i.e., taking position opposite to the existing open position of a futures contract). Based on the profit or loss made by the movement of futures prices, the account of the position holder will either be credited or debited. You can square off your position at any point before the expiry date to book profit or loss. Or you can leave your position open till expiry date on which your profit or loss will be calculated based on the closing price on the expiry date and then your account will be credited or debited accordingly.
Trading Strategies in Futures
Let’s see how speculators, arbitrageurs and hedges take advantage of the futures market.
Speculators speculate the market direction and thereby buy or sell futures according to their predictions. Since they have to invest only a percentage of the open position, they take advantage of this to hold a huge position and reap huge profit with lesser investment. The downside of this is they will suffer huge loss if their speculation goes wrong.
Arbitrageurs look out for the large difference in spot and futures price and buy the stock in cash market at the spot price and sell the corresponding futures at the current higher price and wait till the expiry date when both spot prices and futures price converge to book the riskless profit by selling the physical shares and buying back the futures.
If the investor expects the downfall in the market, he can protect his open position in the cash market by selling the futures equal to the value of their open position in the cash market. The downside of this is he will not make profit if the market moves up.