A futures contract is a standardised agreement made between two parties. It stipulates buying or selling an asset – be it Stocks, Indices, Currencies or Commodities – at a predetermined future date and price. Since the two contracting parties may not know each other, exchanges ensure a guarantee mechanism for the contract's fulfilment.
To illustrate using a hypothetical stock example, imagine a futures contract involving shares of a company called 'Tech Innovations', which is currently trading at ₹1,000 per share. An investor enters into a futures contract to buy 100 shares of 'Tech Innovations' at ₹1,050 per share in three months, anticipating the price will go up. This makes the total value of the futures contract ₹105,000.
Fast forward three months, if the price of 'Tech Innovations' rises to ₹1,200 per share, the investor profits by purchasing at the lower contracted price of ₹1,050 per share, and then potentially selling the shares at the current market price. This would result in a gain of ₹15,000 (minus any transaction costs), since they're acquiring the shares for ₹15 less per share than the market rate.
Conversely, if the share price dips to ₹900, the investor would face a loss, since they are contractually obliged to purchase at the higher price of ₹1,050 per share. The exchange's guarantee mechanism ensures the seller delivers the shares at the agreed price and the buyer fulfills their payment obligation at the contract's maturity.
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