What are Futures in the stock market? And what are Currency Futures?

If you thought that your currency notes were useless to deal with financial risks, you are wrong. Currency Futures are one of the most interesting hedging tools that investors use to cap their losses. By using the price movements in the physical market and the stock market together, investors make profits using Currency Futures, even when actual prices for goods are increasing.   

First, what are Futures? Say you are a businessman and want to buy an antique copper coin set that costs Rs 50,000 today. You know today that based on the current world events, the price of this antique copper coin set will rise up to about Rs 80,000 in a year. You only want to pay Rs 50,000 for the antique copper coin set and lock the price today but you cannot pay the entire price today. So what do you do?    

Here's where the concept of Futures comes in: Futures are basically contracts or paper agreements that are signed by a buyer and a seller. This contract allows you to buy or sell a particular asset on a future date based on a price that you fix today. Since you are an antique copper coin collector, you will trade in copper coin Futures. Similarly, if you were an oil trader, you would deal in oil Futures. If you were into the business of cotton, you would deal in cotton Futures. 

So on the stock exchange, these paper contracts are traded and their value changes depending on the situation. 

How does this paper (or copper Future as it's called) help a copper collector? 

Say that when you go into the antique shop today, you know that you won't be able to buy and pay in cash for the actual antique set. 

• Say each Futures contract costs Rs 50 and you buy 1000 contracts so that the total value of the contracts is Rs 50,000 (equivalent to the cost of antique coin set). Even though you buy 1000 ''1-year Futures contracts of Copper'', you don't have to pay the entire Rs 50,000. You have to pay a small amount (a few thousand bucks) to buy a contract of Rs 50,000. 
• Remember, the value of Future contracts depends on the asset it represents. So as the value of copper increases, the value of copper contracts increases too. Say by the end of 1 year, the Futures contract of copper rises to Rs 80 per contract and the actual copper set costs Rs 80,000.   

Here's how it will benefit you: One year later, you will sell the 1000 'futures contracts' (that you bought a year ago) on the stock exchange for Rs 80,000 (80*1000 contracts). On this day, you will actually receive a profit of Rs 30,000 in your bank account because that was the profit you made in the Futures contract.

Now you will go to the antique shop, give your own Rs 50,000 and add the profit of Rs 30,000 from the contract and finally pay a total of Rs 80,000 to the antique shop owner.   

Second, what are Currency Futures? Currency Futures are basically when buyers and sellers enter into agreements to trade in a particular ''currency'' (instead of antique copper coin sets). Currency Futures usually talk about buying or selling a particular currency at a certain fixed price, in the future, where the price is fixed today. So for eg: traders can deal in future contracts of USD, euro, pound, yen, and many other currencies and use the profits from these trades to set off their actual losses from dealing in foreign currency.

Just like businessmen buy copper contracts to receive profits when they expect copper prices to go up eventually, currency traders buy a futures contract of a particular currency today if they expect the value of the currency to go up later. 

There are two ways of dealing in Currency Futures: Delivery or Net Settlement. 

If you enter into a Delivery Contract: If you buy a 1-year Pound futures contract on the stock exchange at Rs 90, this means that you are agreeing to buy Pounds at Rs 90 a year later. One year later, you will have to pay Rs 90 per Pound, irrespective of what the actual price of the Pound is (for eg: Rs 97). 

If you enter into a Net Settlement contract: Say you buy 1 year Pound Futures for Rs 90. You can settle this contract by selling an equivalent Future Contract at a certain higher price. Thus you will make a net profit, without actually having to receive ''currency notes''.