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2. How Does a Futures Contract Work?

A futures contract is a standardized legal agreement between two parties to buy or sell an asset at a predetermined price on a specified future date.
Unlike spot trading where the transaction happens immediately, in futures trading, the contract locks in the price today, but the actual exchange of money and (if applicable) the asset happens on the contract's expiry date.

These contracts are traded on regulated exchanges (like NSE or MCX in India) and are governed by the clearing corporation that guarantees the trade.

Why Is It Called a “Futures” Contract?

Because you agree to transact in the future—but you’re fixing the price today.
Whether the price moves up or down, both parties are legally obligated to settle the contract on or before expiry.

Who Participates in the Contract?

Role	Belief/Intention	Outcome if Price Rises	Outcome if Price Falls
Buyer	Expects prices to go up (bullish)	Gains	Loses
Seller	Expects prices to go down (bearish) or hedges	Loses	Gains

Both parties agree on:

The asset to be traded
The price
The contract size (lot size)
The expiry date

Standard Features of a Futures Contract

Term	Explanation
Underlying Asset	The instrument the contract is based on—e.g., Nifty, Reliance stock, Crude Oil
Lot Size	The quantity in one contract (e.g., 50 shares of Nifty, 250 of Reliance)
Expiry Date	The future date on which the contract expires—typically the last Thursday of the month
Futures Price	The agreed price at which the trade will be executed at expiry
Margins	Traders don’t pay the full value upfront. They post a percentage as a margin (collateral)
Settlement	At expiry, the difference between the contract price and the final price is settled—either in cash or delivery

Step-by-Step Example

Reliance stock is trading at ₹2,400 today
Trader A expects the price to go up
Trader B expects the price to go down
They enter into a futures contract at ₹2,400
Lot size = 250 shares

Scenario 1: Price at Expiry = ₹2,500

Trader A (Buyer): Profit = (2,500 – 2,400) × 250 = ₹25,000
Trader B (Seller): Loss = ₹25,000

Scenario 2: Price at Expiry = ₹2,300

Trader A: Loss = (2,400 – 2,300) × 250 = ₹25,000
Trader B: Profit = ₹25,000

The profit/loss depends entirely on the difference between the agreed price and the market price at expiry.

How a Future Contract Works

What Happens Before Expiry?

Traders can exit the position before expiry by entering an opposite trade (squaring off).
Or they can roll over to the next month’s contract.

Key Advantages of Futures Contracts

Leverage: Small capital can control a large position.
Flexibility: Can profit in both rising and falling markets.
Hedging: Helps protect portfolios or business revenues from adverse price moves.
Transparency: Exchange-traded contracts reduce counterparty risk.

Key Takeaways

A futures contract is a legal obligation to buy/sell an asset at a fixed price on a future date.
These contracts are ideal for both speculators and hedgers.
They are standardized, transparent, and require only margin to trade.
Profit or loss is settled based on the price difference at expiry or whenever the position is exited.