Beginners often hear the term future trading or options trading or future and options trading or in short FNO trading. In this article, we will discuss what is future trading in share market. Future trading is also called as derivative trading.
What are derivatives?
Derivatives are something that derives value from something else. A stock’s derivative derives value from that stock only. We will discuss derivatives in simple terms. Ravi wants to buy a property, so he goes to the owner Ramu and tells him that he wants to buy the property at Rs. 10 lacs because he liked it. Ramu also agrees and the deal is final. Now Ravi tells Ramu that he will pay the amount of Rs. 10 lacs after 3 months. So the Rs. 10 lacs deal is fixed that to be paid after three months. Ravi pays Ramu Rs. 2 lacs as advance and the papers of the property are prepared accordingly.
Once, Ravi pays the advance, the liability of the property goes to him. If the value of the property becomes 15 lacs he can make a profit by selling it instead of taking the possession. He can thus earn Rs. 5 lacs profit out of his advance of Rs. 2 Lacs. And similarly if the price of the property moves down to Rs. 5 lacs, Ravi can either take the possession of the property by paying Rs. 8 lacs more or he can sell it and book a loss of Rs. 5 lacs on his advance.
Now if you ask me what is future trading in share market, the same way the stock futures market works. Here no stock or share is changing hands. Neither you are buying a stock from someone, nor someone is giving you delivery of a stock. Simply an unwritten contract is happening between the buyer and seller of the stock and a margin money is fixed between the buyer and seller to buy or sell X number of shares, that is called derivative. It’s called derivative because it derives its value from the underlying stock. The final deal must be completed within a prefixed future date. Thus this is also called future contract.
Once a trader pays the margin money he is bound to take the liability of the derivative. If a trader buys a stock future at Rs. 300, he needs to take the liability of the same, be the price becomes Rs. 280 or be it Rs. 340.
The future can be bought and sold in the market and it needs to square off on or before a prefixed date. The stock exchange only charges a margin money for buying or selling the stock future. Every stock or index future has a fixed lot size. That means you can not buy 1 share or 2 shares or 10 shares in a future contract. You need to buy it in a fixed quantity and that is known as lot size. The exchange decides the lot size. The lot sizes get reviewed every 3 or 6 months.
So, we already understood what is future trading in share market. Like stocks futures also can be bought for either intraday trading or for delivery trading. It’s time to understand the margin money deeply. Suppose a trader buys a future contract or 300 rupees per share with a lot size of 1000. That means the total contract value is Rs. 300 x 1000 lot size = Rs. 3,00,000. The exchange like NSE only charges a margin money of 25%-30% from the trader that will automatically be deducted from his trading account. So, the trader becomes owner of Rs. 3,00,000 value of the stock by only paying 25%-30% margin. Now, whatever profit or loss will be accrued on the futures contract as per the daily movement of the stock, that profit or loss will be adjusted day by day in the trader’s trading account. This is called Mark To Market or MTM.
The contracts have a specific expiry day after which the contracts expire. The same as Ravi asked for a date when he approached Ramu to buy the property. Generally, the contracts are a 1-month contract with the expiry date at the last Thursday of the month. After the expiry of a month’s contract, the next month contract starts. So if you want to renew the contract you need to square off this month’s contract and take the position on the next month’s contract. If you don’t want to renew the contract you can simply square off this month’s contract on or before the expiry date and you need to bear whatever loss or profit is incurred.
This discussion on what is future trading in share market is to give newcomers an idea of future contracts and derivatives. We suggest newcomers stay away from future trading as here lot size it fixed and quantity is big. So newcomers will not be able to handle big quantities.
How to add futures to your broker’s terminal? You can add a stock like Reliance Industries by just writing RELIANCE to the market watch. You can add Nifty index by writing NIFTY INDEX in the terminal. But to add Nifty December series contract, you need to write NIFTY DEC FUT in Zerodha Kite MarketWatch.
Concluding statement on the topic what is future trading in share market: Future is a contract that is done between the buyer and seller where the lot size is fixed and decided by the stock exchange. There is a margin money also decided by the exchange to take a position in a future contract. Once a trader pays the margin money be becomes the owner of the future contract and if the stock or index moves in his direction he makes a profit on his position. The future trading has an expiry date that generally is on the last Thursday of every month where this month’s contracts are expired and next month’s contracts are in force. Future contracts can be on stocks, indices, commodities or even currencies. Future trading is a high-risk high gain business. So far, we advise that only veteran and experienced traders to trade in futures and beginners to stay away.
Indrajit is a professional blogger and trading system developer. Amibroker expert, Wordpress expert, SEO expert and stock market analyst.Trading since 2002, he has started the journey of StockManiacs.net on 2008. He follows Indian and world stock markets closely.