How Does A Futures Trade Work?
Suppose for example there is a big blue chip company and the management of the company announces that they are now being very cautious about the growth of revenue of the company. The market does not like such statements coming from the management itself and thus as soon as the announcement is out the share price of the company drops by a huge percentage.
However, you could be someone who would feel that the blue-chip company is a promising company and that the statement that the management has made is an exaggeration. It could be something that is cyclic and that the company is sure to perform in the future. Thus you believe that the price fall in the stock is something that is not justified and that you believe that the share prices will eventually go high up. Thus you want to be a buyer in the stocks of the blue-chip company.
Based on what you feel about the blue-chip stock you take a directional view on the stock. You feel that the underlying asset which is the stock will eventually rise in value in the future. Thus you are bullish about the company and you think that its market price will rise above what its current market price is.
What do you do in such a scenario?
You could buy the stocks of the blue-chip company on its current market price. But you plan to not do that and instead, you buy the company futures. You will first have to see the price of the futures of the company. The futures price will mimic the price of the spot price of the stock. Thus if the spot price of the stock has gone down so will be its futures price.
So since the spot price of the stock went down its futures price will also down today. You look at the stock futures whose underlying is the stock.
You will also have to consider two important parameters which are the underlying value and the market lot size of the futures contract.
The underlying value is the price at which the spot price of the stock is trading in the market. The market lot size is the lot size of the standardized futures contract. This is the minimum shares that you will have to buy or sell if you want to enter into a futures contract.
So If you think that the stock prices are about to go up you can buy the futures contract of the stock instead of buying the stocks of the company.