Futures Compare

Additional Useful Information

• Suitable for speculators and hedgers. Speculators are market participants that have a market view about the underlying asset and want exposure to it without actually holding the asset. Hedgers wish to mitigate the risk of price fluctuations in the underlying commodity by locking in a price for future delivery. For example, farmers who grow wheat may use futures contracts to lock in a price for their crop at a future date, thereby reducing the risk of price fluctuations that could affect their profitability.

• These underlying assets include stocks, commodities, indexes, etc.

Returns *

• Futures trading is a zero-sum game. This means that whenever a participant makes a profit, there will be an opposite participant who will make the exact same loss. This would mean that futures returns vary from individual to individual and it depends heavily on the skill of the market participants to speculate the future trend of the underlying asset.

• There are potentially 3 components of returns in futures -
• Price Return - A change in the spot price (current price) from the previous spot price is called the price return. This is like capital gains.
• Roll Return – Investors roll ahead futures contracts when they want a longer-term exposure to the underlying asset as compared to a shorter-term exposure. The roll return is achieved by merging the futures price with a higher spot price.
• Collateral Return – If any collateral is posted, returns can be earned on the collateral as well.

Risk Level

• Futures trading is generally high risk.

• The main risk is the price risk, that is, price of underlying asset changing unfavourably due to market conditions.

• Futures trading involves a lot of leverage. This can magnify losses or gains which makes futures high risk investments.

• Another risk is counterparty risk. This is when the party taking the opposite position fails to honour the terms of the contract. This is where the clearinghouse comes into play. A clearinghouse makes sure that the counterparty obligates their contract by making them deposit collateral, etc. However, a clearinghouse is available only on organized exchanges (NSE, BSE). If an investor trades in an unorganized, ‘over the counter’ market, there is no clearinghouse available so, that is an additional risk.

• It is always worth doing thorough due diligence on an individual level on every futures contract under consideration.

Liquidity

• Futures trading/investing is very liquid.

• This is because futures are derivatives which have an expiry date. This means that no investors will be forced to hold on to the investment for an indefinite period. Investors can either sell the futures contract or wait till the expiry date.  

Interesting Facts

• Since futures contracts are highly leveraged, less upfront capital is required to purchase them.

• The buyer of the futures contract is said to be long the futures contract while the seller is said to be short the contract.

• Commodity manufacturing companies often hedge commodity prices using futures contracts to safeguard their position from future unexpected price fluctuations.

• Derivatives have a less than perfect correlation with other asset classes, which allows them to improve diversification benefits from an overall portfolio perspective.

• Forwards are traded in over the counter markets. They are similar to futures, except that they are not standardized contracts, they are customized contracts. In contrast to forwards, futures are traded in organized exchanges.

Tax Implications

• Profits from futures trading is treated as non-speculative business income. It is taxed as per the tax slab of the person or entity.

• Losses can be carried forward for 8 years and can be set off with any future profits of similar non speculative business income.

• The government of India levies a Security Transaction Tax (STT) on futures contracts trading. This is in addition to Goods and Services Tax (GST).

Where To Invest

• https://www.icicidirect.com/futures-and-options