Introduction to Forwards and Futures carries 20 marks in NISM Series VIII — level with Options as the largest chapter. It is also foundational: the trading mechanism, clearing and strategy chapters all assume you understand it.
Forwards versus futures
| Forward | Futures | |
|---|---|---|
| Where it trades | Privately, OTC | On an exchange |
| Terms | Customised | Standardised |
| Counterparty risk | Present | Removed by the clearing corporation |
| Settlement | At maturity | Marked to market daily |
The exchange does not remove market risk — the holder is still exposed to price movement. What it removes is counterparty risk, through novation: the clearing corporation becomes the buyer to every seller and the seller to every buyer.
The cost of carry model
Fair futures price = Spot price + net cost of carry
The net carry is the cost of financing the underlying until expiry, less any income received while holding it. So:
- A higher financing rate → higher fair futures price
- An expected dividend → lower fair futures price, because the dividend is income to the holder and reduces the net carry
That dividend point is a favourite exam question, and candidates get it backwards.
Basis, contango and backwardation
Basis = Spot − Futures
In a normal market futures trade above spot, so the basis is negative. That condition is contango. The reverse — futures below spot — is backwardation.
At expiry the basis goes to zero. There is no carrying period left, so the cost of carry vanishes and the two prices converge.
Arbitrage keeps it honest
If the futures price runs above fair value, an arbitrageur sells the future and buys the spot, carrying it to expiry. The profit is locked at the moment of trade because the two legs must converge — it does not depend on which way the market then moves.
That cash-and-carry trade is what pulls the futures price back to fair value.
Practise all 70 questions on this chapter free on ScoreSetu.
Mark to market
Futures are settled daily, not at expiry. Each day's gain or loss against the settlement price is credited to or debited from the margin account. If the balance falls below the maintenance level, a margin call follows.
The consequence: your total profit is still (exit − entry) × lot size × contracts. Daily settlement simply pays it out in instalments rather than in one lump at the end.
The arithmetic that decides your result
A large share of the chapter is P&L calculation, and almost every mark lost here is a direction error, not an arithmetic one.
A trader sells one futures contract at Rs 745 and buys it back at Rs 754. Lot size 1,500.
Work it in order:
- Which way is the position? Short.
- Which way did the price go? Up, by Rs 9.
- Short and price up = loss. 9 × 1,500 = Rs 13,500 loss.
Candidates compute the Rs 13,500 correctly and then mark it positive. Build the habit of naming the direction before touching the numbers.
And remember to multiply by the number of contracts, not just the lot size.
Hedging with futures
An investor holding shares who fears a fall sells index futures — a short hedge. Someone planning to buy later who fears a rise buys futures — a long hedge.
Scale the hedge by beta: a Rs 50 lakh portfolio with a beta of 1.2 needs 50 × 1.2 = Rs 60 lakh of index futures.
Remember for exam day
Series VIII carries 25% negative marking. On a payoff question you cannot crack, eliminate what you can before committing — and if you truly have no idea, a blank costs nothing while a wrong answer costs 0.25.
Practise futures free, then take a full-length timed mock.