Give me a Simple Example of Futures

Let's say, for example, that you take a personal loan from a bank. You enter into an agreement with the bank to return the loan in 5 years by paying a specific number of EMIs, calculated on the basis of a certain interest rate, every month for the next five years. This contract made with the bank is similar to a futures contract, in that you have agreed to return the loan at a future date, with the price and terms for the loan already set. You have secured your EMI for now and the next five years - even if the interest rates increase/decrease during that time. By entering into this agreement with the bank, you have reduced your risk of higher interest rates.

That's how the futures market works. Except, instead of a bank, there is Mr. X trying to secure a selling price for Reliance for the end of the month, while you are trying to secure a buying price to determine that if the markets moves along your expected lines, how much profit you would earn. So Mr. X and you may enter into a futures contract requiring the delivery of, say, 100 shares of Reliance to you at the end of the month at a price of Rs.2040/- per share. By entering into this futures contract, Mr. X and you secure a price that both parties believe will be a fair price at the end of the month.

So, a futures contract is an agreement between two parties: a short position - the party who agrees to deliver the shares/commodity - and a long position - the party who agrees to receive the shares/commodity. In the above scenario, Mr.X would be the holder of the short position (agreeing to sell) while you would be the holder of the long (agreeing to buy). So, it's important to know that every contract involves both positions.

In every futures contract, everything is specified: the quantity and quality of the shares/commodity, the specific price per unit, and the date and method of delivery. The “price” of a futures contract is represented by the agreed-upon price of the underlying commodity or financial instrument that will be delivered in the future. For example, in the above scenario, the terms of the contract are 100 shares of Reliance at a price of Rs.2040/- per share.