Futures Contracts
Introducing Futures Contracts​
Futures contracts are an essential part of financial markets, offering traders a way to buy or sell an asset at a predetermined price on a future date. These contracts are standardised, meaning they are traded on regulated exchanges like the National Stock Exchange (NSE), making them accessible and secure for both retail and institutional traders.
For AlgoTest users, understanding futures contracts is key to managing risk, leveraging market exposure, and speculating on price movements. Futures allow traders to benefit from both upward and downward price movements of the underlying asset, such as stocks, commodities, or indices like Nifty 50 and BankNifty. At AlgoTest, our Strategy Builder and Simulator enable traders to experiment with different futures trading strategies and run backtests using historical data.
How Futures Work​
A futures contract is essentially an agreement between two parties to buy or sell an asset at a predetermined price on a specific future date. Unlike forward contracts, which are customised and traded privately, futures are standardised and traded on exchanges. This standardisation includes details like contract size, expiration date, and settlement procedures.
Let’s break down a typical futures contract scenario: Suppose you’re bullish on Infosys and expect the stock price to rise. Instead of buying the stock outright, you enter into an Infosys futures contract at a price of ₹1,400 per share. Each futures contract represents a specific quantity of shares, typically 100. If Infosys stock rises to ₹1,450 by the contract’s expiration date, your futures position will increase by ₹50 per share, translating to a profit of ₹5,000 (₹50 x 100 shares).
Here’s a chart to visualise the price movements:
| Price (in ₹) | Profit/Loss per Share |
|---|---|
| 1,450 | +₹50 |
| 1,400 (Entry) | ₹0 |
| 1,350 | -₹50 |
Why Use Futures?​
- Leverage: Futures allow you to control a large position with a relatively small margin, amplifying your potential returns. However, leverage can also magnify losses, making risk management critical. AlgoTest’s Simulator can help you understand how leverage impacts your strategy, especially during volatile market conditions.
- Hedging: Futures are an excellent tool for hedging against adverse price movements. For example, if you’re holding Infosys shares and fear a market downturn, you can enter into a short futures position to offset potential losses.
- Speculation: Many traders use futures to speculate on the price direction of an asset. Whether you’re bullish or bearish, you can take advantage of futures contracts to profit from price movements without owning the underlying asset.
Futures vs. Forwards​
Although similar, forwards and futures have key differences. Forwards are private contracts and can be customised, while futures are standardised and traded on exchanges. This makes futures more liquid and secure, as they are backed by clearinghouses, reducing the risk of default. Additionally, futures are subject to mark-to-market (M2M), meaning gains and losses are settled daily, rather than at the end of the contract as with forwards.
Using AlgoTest for Futures Trading​
With AlgoTest’s Strategy Builder, you can create complex strategies involving futures and options. For example, you can combine futures contracts with put or call options to build a comprehensive risk management strategy. The Simulator allows you to test these strategies using real historical data, ensuring you understand their performance before deploying capital in live markets.
Example Strategy​
Suppose you believe the market is heading for a correction. You could enter into a short position on Nifty futures while simultaneously buying a call option as insurance in case the market rebounds. This strategy helps you hedge against significant losses while giving you a profit opportunity if the market falls.
Futures contracts offer AlgoTest users the ability to enhance their trading strategies with leveraged exposure, risk management tools, and the potential to profit in both rising and falling markets. By combining futures with options in the Strategy Builder, traders can create versatile approaches suited to their risk tolerance and market outlook.