Futures: a deal today for a trade later

The futures contract, in one sentence

A futures contract is an agreement, made on an exchange, to buy or sell a fixed quantity of something on a fixed future date at a price agreed today. The buyer is long; the seller is short. Both are bound - neither can walk away.

Unlike the tea handshake, every term is standardised by the exchange, so millions of people can trade the same contract:

All NEPSE contract terms in this course are made up for learning - NEPSE has no futures yet. In other markets, exchanges set lot sizes so that one contract is worth a meaningful sum; India's index contracts, for example, are worth several lakh rupees each.

Going long: you think NABIL will rise

You buy one NABIL future at Rs 552. You haven't paid Rs 2,76,000 - you've agreed to "buy" at 552 on expiry. On expiry day NABIL closes at Rs 580:

Going short: you think NABIL will fall

Here is something you can't do with shares on NEPSE today: profit from a fall without owning the stock. Selling a future means you've agreed to "sell" at 552 on expiry. If NABIL closes at 520, you gain (552 − 520) × 500 = Rs 16,000. If it closes at 580, you lose Rs 14,000. The short side is the exact mirror of the long side.

How a futures position ends

• Close it before expiry - most traders do. You simply sell the future you bought (or buy back the one you sold). Your profit is the difference between the two prices.
• Let it expire, cash-settled - the exchange takes the final price of NABIL and pays the difference. No shares change hands. Almost all stock and index futures in the world are cash-settled, or at least can be closed before any delivery.
• Physical settlement - some contracts (oil, wheat, gold, and stock futures in a few markets) end with real delivery. That detail mattered a lot in April 2020, when oil futures went below zero - lesson 10.
• Roll it over - close this month's contract and open next month's, to keep the position going.

Index futures: betting on the whole market

The most traded futures in most countries aren't on single stocks - they're on the index. An illustrative NEPSE index future might be worth Rs 100 per index point. With NEPSE at 2,690, one contract would be worth 2,690 × 100 = Rs 2,69,000, and a 30-point move would be Rs 3,000 of profit or loss. Index futures are how big investors hedge a whole portfolio in one trade (lesson 8).

What's different from buying the shares

• No ownership. A future gives no dividends, no bonus shares, no AGM vote.
• An expiry date. Shares can be held forever; a future ends, and you must roll or close it.
• Two-way. You can be short as easily as long.
• You don't pay the full value - you put down margin. That's where the real danger is, and it's the next lesson.