Futures Contracts Explained: Why They Exist and How They Work in India

A futures contract is an agreement to buy or sell something at a fixed price on a fixed future date. Unlike buying a share, which makes you a part-owner of a company immediately, a futures contract is a commitment about a transaction that has not happened yet. In India, the most widely traded futures are on stock indices such as the NIFTY 50 and on individual large-company shares, listed on NSE and BSE. Commodity futures trade separately on exchanges such as MCX.

Where the idea came from

Futures began as a tool for producers and buyers of physical goods. A wheat farmer worried that prices might fall before harvest, and a flour mill worried they might rise, could agree a price in advance. Each gave up the chance of a better price in exchange for certainty. Financial futures apply the same logic to shares, indices, currencies, and interest rates. The hedging motive still exists — a mutual fund might use index futures to adjust its market exposure quickly — but in modern markets a large share of futures trading is speculation on short-term price moves.

Standardisation: lots, months, and the exchange in the middle

Exchange-traded futures are standardised so they can be bought and sold easily. The exchange fixes the underlying asset, the contract size (the 'lot'), the expiry dates, and the settlement method. You cannot buy one NIFTY unit through a futures contract; you trade in multiples of the lot size the exchange sets. Lot sizes are revised from time to time, partly so that one contract stays within a value range set by the regulator. Following SEBI's October 2024 measures for index derivatives, minimum contract values were raised, which means lot sizes and the money needed to trade one contract went up. Because these numbers change, always check the exchange's current contract specifications rather than a figure from an article.

The exchange's clearing corporation stands between buyer and seller. Each side's contract is effectively with the clearing corporation, not with an unknown counterparty, which removes the risk that the other side simply refuses to pay. In return, the clearing corporation demands margin from both sides.

Margin and daily settlement

To open a futures position you do not pay the full value of the contract. You deposit an initial margin — a fraction of the contract's value set by the clearing corporation based on the asset's volatility. Then, every trading day, your position is marked to market: if the futures price moved in your favour, the gain is credited to your account; if it moved against you, the loss is debited. If losses eat into your margin below the required level, your broker will ask you to add money, and may close your position if you do not.

Here is an illustration with round numbers (not current contract specifications). Suppose one contract represents index exposure worth ₹15 lakh and requires margin of around ₹2 lakh. If the index rises 2%, the contract gains about ₹30,000 — 15% of the margin. If it falls 2%, the contract loses about ₹30,000 and the trader must cover that loss in cash that day. A 10% move against the position would wipe out roughly ₹1.5 lakh, most of the margin. This leverage is why futures can multiply both gains and losses.

Cash settlement and physical settlement

There is no way to deliver 'the NIFTY 50' itself, so index futures are cash-settled. At expiry, any open position is closed at a final settlement price based on the index, and the difference is paid in cash. Stock futures in India are different: since SEBI moved stock derivatives to physical settlement in phases from 2018, a stock futures position held through expiry results in actual delivery of shares, which means the buyer must pay the full value and the seller must deliver the shares. Many traders close or roll positions before expiry for exactly this reason.

Expiry and rollover

Every futures contract has an expiry date. On NSE, monthly contracts for several months are available at the same time — commonly referred to as the near, next, and far month. The weekday on which contracts expire has been changed more than once by the exchanges and the regulator, so check NSE's current expiry calendar.

A trader who wants to keep exposure beyond expiry must 'roll' the position: close the expiring contract and open the same position in the next month's contract. The two contracts usually trade at slightly different prices, so rolling has a cost (or occasionally a benefit), in addition to transaction charges on both legs.

Why the futures price differs from the spot price

The futures price is usually a little different from the current market price of the underlying, called the spot price. The difference is called the basis. In simple terms, buying a futures contract instead of the shares lets you keep your cash invested elsewhere until expiry, while giving up any dividends paid in the meantime. The futures price reflects this 'cost of carry', so it often sits slightly above spot when interest rates are higher than the expected dividend yield. As expiry approaches, the futures price converges toward the spot price, and on the expiry day they meet.

Who uses futures, and for what

• Hedgers: a portfolio manager who holds many large-company shares can sell index futures to reduce exposure to a market fall without selling the shares themselves.
• Arbitrageurs: traders who buy in the cash market and sell in the futures market (or the reverse) when the basis is out of line, locking in the gap. Some arbitrage mutual funds use this strategy.
• Speculators: traders who take a view on price direction and use the leverage of futures to magnify the outcome.

What the data says about individual traders

SEBI has studied the results of individual traders in the equity futures and options segment. An updated study released in September 2024 found that 93% of individual traders incurred losses in equity F&O between FY22 and FY24, with aggregate losses exceeding ₹1.8 lakh crore over the three years. Brokers are required to show risk disclosures based on SEBI's findings before clients trade in this segment. In October 2024, SEBI also announced a set of measures to strengthen the index derivatives framework, including higher minimum contract sizes and changes around expiry-day margins.

These findings do not mean futures are 'bad'. They are an important tool for hedging and price discovery. They do mean that the leverage which makes futures efficient for professionals makes them unforgiving for anyone without a clear plan for risk.

Key terms

• Lot size: the fixed quantity of the underlying in one contract.
• Initial margin: the deposit required to open a position.
• Mark to market: daily settlement of gains and losses in cash.
• Basis: the difference between the futures price and the spot price.
• Rollover: closing an expiring contract and opening the next month's.
• Cash settlement: final profit or loss paid in cash rather than by delivery.