FUTURES TERMINOLOGY

Meaning of Futures

Futures contract is standardised and exchange-traded Futures contract is an agreement between buyer and seller to buy or sell a an asset at a certain time in future at a certain price. These are traded on recognised exchanges like NCDEX National Commodity and Derivative Exchanges Limited, MCX Multi Commodity Exchange of India Limited, Mumbai, NSE, BSE etc. Asset is delivered at a future date at the price fixed today. The future date is called the delivery date or final settlement date. The agreed price is called the ‘futures price’.
Thus, futures contract provides both a right and an obligation to buy or sell a standard asset or security or currency on a specified future date at a price agreed when the contract is entered into Futures contracts are commonly known as futures.
Futures are standardised with regard to the contract size and also the maturity period of the contract. Futures contracts require deposits of margins. Hence, default risk is avoided. Although the price of thee futures is negotiable between the parties, it is regulated by the futures exchange.

Futures Terminology

Futures contracts are highly standardised. Standardization of the contract relates to the asset, size, time, place and procedure of delivery, quality of underlying asset, etc. Some of the specifications of the terms used in the futures contracts may be explained below:

1. Underlying asset : The underlying asset may be a commodity or a financial asset. Futures contracts are normally specified by the name of the underlying asset and month and year of the expiry of the contract. For example, a futures contract in rice at Multi Commodity Exchange (MCX) denoted as RICE MAR19 implies that the contract in rice is due for delivery in March 2019.
2. Contract size : Contract size or trading unit refers to the standard contract size that will be traded on the exchange. In other words, this is the amount of asset that has to be delivered under one contract Each futures contract for gold on NMCE is for 100 gm.
3. Price quotation : Quotation is the basis of price. It is not the value of futures contract. For example, the price quotation for futures contract on rice is rupees per quintal.
4. Tick size : This is the minimum change that will be rcognised in the price quotation. It is the minimum difference between two quotes of a similar nature.
5. Price limit : These are the limits on the maximum price variation permitted in a day’s trading. The exchange sets a daily price movement limit of the underlying asset, which normally matched the initial margin money collected against the futures contract. When the price increases by an amount equal to the daily price limit, it is called ‘limit up’ and decreases by the amount equal to the daily price limit, it is called ‘limit down’.
6. Position limits : These are the limits upon the maximum number of contracts an individual client or a member broker may hold. This is specified by the futures exchange. The purpose is to avoid any concentration of business in the market place.
7. Spot price : This is the price at which an asset trades in the spot or current market. It is also called cash price or current price.
8. Futures price : This is the price at which the futures contracts trades in the futures market.
9. Expiry date : This is the date specified in the futures contract. This is the last day on which the contract will be traded. At the end of this, it will expire.
10. Basis : fhis is the futures price minus the spot price) In a normal market, basis will be positive. This means that futures prices normally exceed spot prices.
11. Cost of carry : This measures storage cost plus the interest that is paid to finance the asset less income earned on the asset.
12. Open interest : Open interest is the number of futures contracts outstanding. It is the number of open contracts or contracts remaining to be settled (unsettled).
13. Long and short positions : There are two parties to every futures contract – a buyer and a seller. The buyer is said to have a long position and the seller is said to have a short position.
14. Open position : A long (buy) or short (sell) position that is outstanding or unsettled in various derivative contracts is called an open position. For example, if X sells 5 contracts on Infosys futures and buys 3 contracts on TCS futures, he would be termed as having an open position. This is equivalent to short on 5 contracts on infosys and long on 3 contracts of TCS. If he then buys 2 infosys contracts with the same maturity, his open position would be short on 3 infosys contracts and long on 3 TCS contracts.