Derivatives and advanced market conceptsModule 1, lesson 2 of 21
Forwards and futures
Forward contracts, standardised futures, lot sizes and contract value, and the payoffs of long and short futures, with losses shown as clearly as gains.
In this lesson
- Explain a forward contract and why futures standardise it.
- Calculate the contract value of a futures position from its price and lot size.
- Calculate the profit or loss on long and short futures positions.
- Explain why buying a future is not the same as buying the shares.
Builds on
- What derivatives areFutures are the simplest derivative described there.
On this page
In simple terms
A forward contract is an agreement between two parties to buy or sell something at a price fixed today, for delivery on a future date. A wheat farmer and a flour mill might agree in sowing season on a price for wheat to be delivered after harvest. Both gain certainty: the farmer about income, the mill about costs.
A futures contract is a forward with standard terms, traded on an exchange: a fixed quantity, a fixed expiry date and a clearing corporation that guarantees both sides. Standardisation lets contracts be bought and sold easily before expiry.
Lots and contract value
Futures trade in lots, a fixed number of units of the underlying. Lot sizes and expiries are set by the exchange under SEBI's rules and change from time to time, so the figures here are made up.
Worked example: A made-up share futures contract
| Item | Value |
|---|---|
| Futures price | ₹1,000 |
| Lot size (made up) | 500 shares |
| Contract value: 1,000 × 500 | ₹5,00,000 |
One contract controls ₹5 lakh of shares, though the trader puts up only a fraction of that as margin, as the margin lesson explains.
Long and short positions
- Long futures: you agree to buy. You gain if the price rises and lose if it falls.
- Short futures: you agree to sell. You gain if the price falls and lose if it rises.
Worked example: Payoffs on one made-up contract of 500 shares at ₹1,000
| Price at expiry | Long position | Short position |
|---|---|---|
| ₹900 | −₹50,000 | +₹50,000 |
| ₹940 | −₹30,000 | +₹30,000 |
| ₹1,000 | ₹0 | ₹0 |
| ₹1,050 | +₹25,000 | −₹25,000 |
| ₹1,100 | +₹50,000 | −₹50,000 |
| Long result at ₹940: (940 − 1,000) × 500 | −₹30,000 |
|---|---|
| Short result at ₹1,050: (1,000 − 1,050) × 500 | −₹25,000 |
Each side's gain is exactly the other's loss, before costs.
A futures payoff is a straight line: every ₹1 move in the price changes the result by ₹500 for this contract. There is no floor on the loss for a long position until the price reaches zero, and no ceiling on the loss for a short position, as the short selling lesson explains.
Futures are not the same as shares
| Owning shares | Long futures | |
|---|---|---|
| Expiry | None; hold as long as you like | Contract expires; must be closed or rolled over |
| Money needed | Full price | Margin, a fraction of contract value |
| Daily settlement | No | Gains and losses settled daily |
| Dividends and votes | Yes | No |
| Maximum loss | The amount invested | Can exceed the margin paid |
Rolling over means closing an expiring contract and opening a later one, which costs brokerage and the price difference between the two contracts, as the basis lesson explains.
Who uses futures
Futures serve different users. A company that will need a commodity later can buy futures to fix its cost; an investor can sell index futures to reduce market risk for a while; a trader can use them to take a leveraged view on prices. The contract is the same; the purpose differs. For speculators, the leverage that makes futures attractive is also what makes losses so fast, as the leverage lesson explains.
Why it matters
Futures are the building block of derivatives markets, and their straight-line payoff makes them the easiest place to see leverage at work. Understanding contract value, rather than just margin, is the first defence against taking positions far larger than intended.
Limitations
Real contracts have details not covered here, such as settlement method, price limits and specific expiry rules, which are set by the exchange and change over time. Costs and taxes reduce every result shown.
Common mistakes
- Looking at margin instead of contract value when judging position size.
- Treating futures as shares that can be held forever.
- Forgetting that losses are not capped at the margin paid.
- Ignoring rollover costs.
Try it yourself
- For a made-up contract with a lot size of 250 and a price of ₹2,000, calculate the contract value.
- Calculate the long and short results if the price ends at ₹1,850 and at ₹2,120.
- Compare the contract value with your total savings, and note how large a position one contract would be for you.
Key takeaways
- A forward is a private agreement to buy or sell something at a fixed price on a future date. A future is a standardised forward traded on an exchange.
- Futures trade in lots. Contract value is the futures price multiplied by the lot size, and it is usually many times the money put up as margin.
- A long futures position gains when the price rises and loses when it falls; a short position does the opposite. Gains and losses grow in step with the price move.
- Unlike shares, futures expire, carry no dividends or votes, are marked to market daily, and must be rolled over to keep a position.
- The losses on a futures position are not limited to the margin paid.
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Terms used in this lesson
- Futures contract
- A standardised, exchange-traded agreement to buy or sell an underlying at a fixed price on a set expiry date.
- Forward contract
- A private agreement to buy or sell something at a price fixed today, for delivery on a future date.
- Lot size
- The fixed number of units of the underlying in one derivative contract.
- Underlying asset
- The share, index, currency, commodity or other asset whose price a derivative's value depends on.
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This lesson is general education, not investment advice. Examples use made-up or clearly dated figures to explain ideas; they are not recommendations. Read the disclaimer.