Chapter 4: Types of Futures
You’ve more or less understood what are futures and how they work. Let’s see the various types of futures contracts that are traded.
3.1 Commodity Futures
Commodity futures contracts are standardised contracts in which buyers and sellers agree to buy/sell physical assets like wheat, rice, crude oil, gold silver, and more at a predetermined date.
These futures are either settled in cash or physical delivery has to be given to the buyer of the contract on expiry.
Commodity futures are traded on an exchange (NSE, MCX, NCDEX) that guarantees the settlement of the underlying commodity and ensures both parties honor their commitments. Commodity futures are generally known to provide a hedge for the price risk.
3.2 Currency Futures
Currency futures are a contractual obligation to exchange one currency for another at a specified date in the future at a price. The price at which the buying and selling is done is called the exchange rate. The most commonly traded currencies are USD, EUR, JPY, and GBP.
Currency futures can also be used to speculate and profit from rising or falling exchange rates or to hedge against any potential exchange rate volatility by someone who is expecting a payment from a foreign buyer.
In India, currency futures are cash-settled. This means that foreign currency is not delivered to your demat account when the contract expires.
3.3 Interest Rate Futures
An interest rate future (IRF) is a financial derivative that allows exposure to changes in interest rates. Investors can use IRFs to either speculate on the direction of interest rates with futures or use them to hedge against changes in rates.
In most countries, government backed securities/treasury bills are used as the underlying asset. The IRF contract allows the buyer and seller to fix the price of the interest-bearing asset for a future date. Hence, they hedge themselves from changing interest rates.
3.4 Stock & Index Futures
Stock futures are derivative financial instruments wherein traders agree to buy/sell a particular stock which is the underlying asset. Stock futures are used by speculators and arbitrageurs to speculate their views on a particular stock.
Unlike the stocks traded in the cash markets, where even one share is traded, stock futures are traded in lot sizes and the number of shares in 1 lot is determined by the exchange.
In India, there are currently close to 198 stocks which are traded on the NSE which is the most liquid exchange. Similar to the stock futures, there are index futures which are available to trade in the F&O markets.
An Index future is a derivatives contract wherein the underlying financial instrument is the stock index and it replicates the movement similar to that of the underlying index.
An index is an indicator of the performance of the overall market or a particular sector. Examples of some of the popular which are traded in the futures market in India are the Nifty Futures, Bank Nifty Futures, FinNifty futures etc.