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Futures Trade

The Futures Trade​

Futures trading offers a powerful way for traders to speculate on the price movement of assets like stocks, indices, or commodities. A futures contract is a standardised agreement to buy or sell an asset at a specific price on a future date, making it a highly liquid and regulated financial instrument. In this chapter, we’ll explore the practical aspects of executing a futures trade and how traders at AlgoTest can leverage these contracts.

How Does a Futures Trade Work?​

Let’s break it down with an example. Imagine it’s December 15th, 2014, and Tata Consultancy Services (TCS) announces cautious revenue growth, causing the stock price to drop by 3.6%. As a trader, you believe the market overreacted and the price will bounce back. Instead of buying TCS shares in the spot market, you decide to enter into a futures contract. You purchase 1 lot of TCS futures (125 shares) at ₹2,374.9 per share.

The minimum number of shares you must buy in a futures contract is known as a lot size, and in this case, it’s 125. The value of your futures contract is the lot size multiplied by the price, which equals ₹296,862.5 (₹2,374.9 x 125).

The Trade Process​

  1. Margin Requirement: To buy a futures contract, you don’t pay the entire contract value upfront. Instead, you deposit a margin, a percentage of the total value, as a sort of token advance. At AlgoTest, you can calculate the margin using our margin calculator in the Strategy Builder.
  2. Counterparty Match: Once you’ve placed the order, the exchange’s system finds a seller who has the opposite view, i.e., someone who believes TCS’s price will fall further. The contract is digitally signed, binding both parties to the agreement.
  3. Daily Settlement (M2M): Futures contracts are marked-to-market, meaning your profit or loss is settled daily based on the change in the futures price. If TCS futures rise to â‚ą2,450 the next day, you gain â‚ą75.1 per share, resulting in an overall profit of â‚ą9,387.5 (â‚ą75.1 x 125).

Example Scenarios​

Scenario 1 – Price Increase:
Suppose by the contract’s expiry (December 24th, 2014), TCS futures rise to ₹2,450. Your profit would be ₹75.1 per share or ₹9,387.5 in total.

Scenario 2 – Price Decrease:
If TCS futures drop to â‚ą2,300, you would incur a loss of â‚ą74.9 per share or â‚ą9,375 in total.

Scenario 3 – Price Remains Unchanged:
If the price stays the same, neither party benefits, and the contract closes without profit or loss.

Exiting a Futures Trade​

You’re not required to hold a futures contract until the expiry date. You can exit (or “square off”) your position by selling your futures contract at any time before expiration. For example, if you bought 1 lot of TCS futures at ₹2,374.9 and sold it at ₹2,460 the next day, you lock in a profit of ₹10,637.5. This is known as risk transfer—passing the price risk to another trader.

Conclusion​

Futures trading offers AlgoTest users flexibility and leverage, but it also requires careful risk management. By utilising our Strategy Builder and Simulator, you can test your futures trading strategies with real historical data before risking your capital.