NISM Series VIII, Chapter 3. Updated Jun 2026, 10-minute read.
Futures Contracts — Pricing, Hedging and Margins
Futures contracts are the backbone of the derivatives market. Chapter 3 of NISM Series VIII covers how futures are priced (cost of carry model), how they're used for hedging, and the margin mechanism that keeps the market safe.
Key takeaways
- Futures price = Spot × (1 + r − d)^T — the cost of carry model
- Basis = Spot price − Futures price; converges to zero at expiry
- Initial Margin is collected upfront from both buyer and seller (typically SPAN margin)
- Mark-to-Market (MTM) settlement occurs daily; losses are debited, gains are credited
- Contango = Futures > Spot (normal market); Backwardation = Futures < Spot (dividends or high demand for spot)
- Hedging with futures locks in a price; imperfect hedge due to basis risk
Futures Pricing — Cost of Carry Model
The theoretical fair price of a futures contract is derived from the cost of carry model:
F = S × e(r+q-d)×T (continuous compounding)
or simplified: F = S × (1 + r − d) × T
Where:
- F = Fair futures price
- S = Current spot price
- r = Risk-free rate (e.g., T-bill rate)
- d = Dividend yield of underlying
- T = Time to expiry (in years)
Example: Nifty 50 = 23,000. Risk-free rate = 7% p.a. No dividends. Time to expiry = 1 month (1/12 year). Fair futures price = 23,000 × (1 + 0.07/12) = 23,134.
Basis and Convergence
Basis = Spot Price − Futures Price
At the start of a contract, basis is usually negative (futures > spot = contango) because of the cost of carry. As expiry approaches, the basis narrows and converges to zero at expiry — this is called convergence.
Basis risk arises when the change in spot and futures prices is not perfectly correlated — creating imperfect hedges.
Margin System
Initial Margin (SPAN Margin)
Both buyer and seller must deposit an Initial Margin upfront with the clearing corporation (NSCCL). This is calculated using the SPAN (Standard Portfolio Analysis of Risk) methodology based on worst-case scenario loss over a single day.
Maintenance Margin
The minimum margin level. If MTM losses bring the account below maintenance margin, a Margin Call is issued. The trader must top up to the Initial Margin level within a specified time, or the broker squares off the position.
Mark-to-Market (MTM)
At end of day, all positions are revalued at the Daily Settlement Price:
- Gains → credited to margin account
- Losses → debited from margin account
Hedging with Futures
A short hedge involves selling futures to protect against a price fall (used by investors holding the underlying).
A long hedge involves buying futures to lock in a purchase price (used by those planning to buy the underlying in the future).
Hedge Ratio: Number of contracts needed = Portfolio Value / (Futures Price × Lot Size)
Frequently asked questions
What is contango and backwardation?
Contango is when futures price > spot price (the normal situation due to cost of carry). Backwardation is when futures price < spot price, which can occur when large dividends are expected or when there is very high immediate demand for the spot asset.
What is the lot size for Nifty futures?
As of 2024, the Nifty 50 futures lot size is 25 units per contract. Contract value = 25 × index level. For Nifty at 23,000, one contract is worth ₹5,75,000.
What happens if you don't square off a futures position before expiry?
If you hold an equity futures position to expiry, it is compulsorily settled in cash at the Final Settlement Price (FSP), which is based on the RBI reference rate or the closing spot price on expiry day.
Written by Arpan Das.
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