• Shares (equities)

• Share market indices (e.g., NIFTY, SENSEX)

• Interest rates (e.g., bond yields)

• Commodities (e.g., gold, oil, agricultural products)

• Currencies (e.g., USD, EUR, INR)

The value of the derivative contract is derived from the price of the underlying asset, making it an essential component of the contract.

Lot size 

A lot size is a fixed quantity of a derivative contract that is set by the exchange, and it cannot be divided into smaller quantities. This means that when trading futures, investors must buy or sell the specified lot size, which can vary depending on the underlying asset.

For example, as you mentioned, one lot of Reliance futures is equal to 505 shares, so if the share price is Rs. 2000, the total value of the lot would be Rs. 10,10,000 (Rs. 2000 x 505).

It's important to note that not all stocks or commodities have futures contracts available for trading, and only those specified by SEBI (Securities and Exchange Board of India) are eligible for futures trading on the exchange.

• A lot size is fixed for each derivative by the exchange.

• Futures are bought and sold in ‘lots’.

• A lot size fixed by the exchange cannot be divided into smaller numbers. For example, one lot of Reliance futures is 505 shares. So, if the shares are trading at Rs.2000, then the total value of the lot is Rs.10,10,000 (Rs. 2000*505)

• Each stock or commodity will have a different lot size.

• Only those stocks specified by SEBI have a futures contract and are traded on the exchange.

Value of a Lot

The value of one lot is calculated by multiplying the price of the underlying share by the lot size. This typically ranges from approximately ₹2-3 lakhs per lot, depending on the share price and lot size.

For example, if the share price is ₹2000 and the lot size is 505 shares (as in the case of Reliance futures), the value of one lot would be:

₹2000 (share price) x 505 (lot size) = ₹10,10,000 (value of one lot)

This is significantly higher than the typical range of ₹2-3 lakhs per lot, but it illustrates the calculation.

Margin Money

When entering into a futures contract, investors don't need to pay the full value of the contract. Instead, they need to deposit a fraction of the contract value, known as margin money, which acts as a security deposit.

The margin percentage varies based on the underlying asset's volatility, typically ranging from 10% to 40%. In the case of Reliance shares, a 30% margin would be approximately Rs. 3,03,000, as you mentioned.

It's important to note that the National Stock Exchange (NSE) determines the margin percentage, which can change daily based on market conditions. This means investors must maintain the required margin amount in their accounts to avoid any penalties or losses.

Life of a Contract

The life of a futures contract is typically three months, and at any given time, there are three contracts available for trading with different expiry dates:

1. Near Month (1 month) contract: Expires in the current month

2. Next Month (2 months) contract: Expires in the following month

3. Far Month (3 months) contract: Expires in the month after the next month

This means that traders can choose to trade in contracts with different expiry dates, depending on their market outlook and strategy. As the near-month contract expires, a new far-month contract is introduced, maintaining a three-month cycle.

Different types of Futures

The different types of futures contracts traded on various exchanges in India:

1. Stock Futures: Traded on the National Stock Exchange (NSE), these contracts are based on individual stocks, such as Reliance or Infosys.

2. Stock Index Futures: Also traded on the NSE, these contracts are based on stock market indices, such as the NIFTY or SENSEX.

3. Commodity Futures: Traded on the Multi Commodity Exchange (MCX) and National Commodity and Derivatives Exchange (NCDEX), these contracts are based on commodities like gold, silver, oil, and agricultural products.

4. Interest Rate Futures: Traded on the NSE, these contracts are based on interest rates, such as government bond yields.

Each type of futures contract allows investors to manage risk or speculate on price movements in different markets.

Open Interest

What open interest represents in the futures market:

• Open interest refers to the number of outstanding contracts that have not been settled or closed.

• It represents a matched buy-and-sell pair, where every buyer has a corresponding seller.

• The example you provided illustrates how open interest increases when a new buy-and-sell pair is formed (e.g., Mr. Mohan and Mr. Rajesh).

• Open interest is calculated by multiplying the number of open contracts by the lot size.

• You also correctly noted that open interest cannot exceed the total number of shares outstanding in the underlying company.

• Finally, an increase in open interest suggests that more money is flowing into the market, indicating higher trading activity.

Marked to Market

"marked to market" in the futures market:

• Authorities regularly monitor futures contracts and update their values daily to reflect changes in the market price.

• The value of a futures contract is adjusted daily to reflect gains or losses, known as marking to market.

• If the contract value increases, the gain is credited to the trader's account.

• Conversely, if the contract value decreases, the loss is debited from the trader's account.

• This process continues daily until the contract expires or is settled.

Marking to market ensures that traders' accounts reflect the current market value of their positions, making it essential for risk management and fair trading practices.

Trading screen for the futures contract 

how futures contracts are displayed on a trading screen:

• Futures contracts are coded and listed on the trading screen, similar to equities.

• Contracts are organized in alphabetical order, making it easy to find a specific contract.

• Three contracts with different expiry dates are available for trading at any given time:

  • Near Month (1 month)

  • Next Month (2 months)

  • Far Month (3 months)

• The trading screen displays essential information for each contract, including:

  • Open price

  • High price

  • Low price

  • Traded quantity (volume)

  • And other relevant details

This screen provides traders with a convenient and informative way to monitor and trade futures contracts.

Long and Short Positions

• A long position refers to a buy position that is still open and hasn't been settled or closed. The trader has bought a futures contract and hasn't sold it yet, expecting the price to rise.

• A short position refers to a sell position that is still open and hasn't been settled or closed. The trader has sold a futures contract they didn't own (usually through short selling) and hasn't bought it back yet, expecting the price to fall.

These terms are used to describe the trader's exposure in the market, and it's essential to understand them to manage risk and profit from futures trading.

Spot and Spread

the concepts of spot, futures, and spread in the context of financial markets:

• Spot price: The current market price of an asset in the cash market, where immediate delivery occurs.

• Futures price: The price of a futures contract, which is a derivatives product that settles on a specific date in the future.

• Spread: The difference between two prices, which can refer to:

  • The difference between the prices of two futures contracts with different expiry dates (e.g., October and December contracts).

  • The difference between the bid and ask prices of a single asset or contract.

It's important to understand the context in which the term "spread" is used, as you've highlighted. Typically, futures prices are higher than spot prices due to factors like interest rates, storage costs, and expected price movements.

The expiry date of a contract

The expiry date rules for futures contracts:

• All futures contracts expire on the last Thursday of every month.

• On expiry, all obligations and rights associated with the contract are settled, and the contract ceases to exist.

• The near-month contract (e.g., October) expires on the last Thursday of the current month.

• If the last Thursday falls on a holiday, the expiry date moves to the previous trading day.

• All contracts are settled automatically on the day of expiry.

• A new series of contracts is introduced into the system on the day following the expiry.

This process ensures a smooth transition between contract cycles, allowing traders to roll over their positions or realize their profits/losses

Settlement

The settlement process for futures contracts:

• Futures contracts are typically cash-settled, meaning the actual underlying asset is not delivered.

• Traders use futures contracts for hedging or speculation, and they usually don't intend to take physical delivery of the underlying asset.

• In the example you provided:

  • The trader bought an M&M futures contract at Rs. 617.

  • At expiry, the price rose to Rs. 627.

  • The trader receives the price difference (Rs. 10) as a profit, plus their initial margin back from the exchange as settlement.

• This cash settlement process allows traders to realize their profits or losses without the need for physical delivery of the underlying asset.