future contracts in share market

 

Understanding Future Contracts in the Share Market

If you're interested in investing in the share market, you might have come across the term "future contracts." Future contracts are a way to speculate on the future price of an asset. It's like making a bet on the future value of a stock, commodity, or index. But how do future contracts work, and what do you need to know before getting involved?

What are Future Contracts?

Future contracts are agreements to buy or sell an asset at a predetermined price on a future date. These are standardized agreements traded on exchanges, and they specify the quantity and quality of the underlying asset. For example, if you buy a future contract for 100 shares of Company X at $50 per share with an expiration date of three months, you are agreeing to buy those shares at that price, regardless of the stock's actual market price in three months.

How Do Future Contracts Work?

When you enter into a future contract, you're making a commitment to buy or sell the underlying asset at the agreed-upon price when the contract expires. If you buy a future contract and the price of the asset rises above the contract price, you make a profit. Conversely, if the price falls below the contract price, you incur a loss. The same applies if you sell a future contract - you profit if the price goes down and incur a loss if it goes up.

Why Trade Future Contracts?

Future contracts can be used for hedging and speculation. Hedging involves using future contracts to offset potential losses in the cash market. For example, a farmer can use future contracts to lock in a price for their crops, securing a guaranteed income regardless of fluctuations in market prices. On the other hand, speculators trade future contracts to profit from price movements without owning the actual asset.

Risks Associated with Future Contracts

Like any investment, trading future contracts carries risks. The leverage involved can magnify both gains and losses. If the market moves against your position, you could lose more than the initial margin amount you put up. Additionally, future contracts are time-bound, so if the market doesn't move in the anticipated direction before the contract expires, you could lose money.

Regulations and Oversight

Future contracts are traded on regulated exchanges such as the Chicago Mercantile Exchange (CME) and are subject to oversight by regulatory bodies like the Commodity Futures Trading Commission (CFTC) in the United States. This oversight is designed to ensure fair and orderly trading and to mitigate the risks associated with future contracts.

Conclusion

Future contracts are complex financial instruments that offer opportunities for both hedging and speculation. Understanding the mechanics and risks associated with future contracts is crucial before getting involved in this type of trading. It's essential to do thorough research, consider seeking advice from financial professionals, and only trade future contracts with money you can afford to lose.

Remember, it's never wise to jump into any investment without fully understanding how it works. Just like with any form of investment, future contracts carry risks, and it's essential to be well-informed before dipping your toes into this area of the share market.