One advantage of investing in futures is it could give you a higher return on investment as you have to shell out only an initial margin and also save you costs related to insurance, storage and security. It is, however, riskier if prices do not move in tandem with your view; you may also lose out on the entire capital. Therefore, futures are definitely for high-risk, well-informed investors with a speculative bent of mind.
How does gold futures work?
If you were to buy a futures contact, you agree to buy the quantum of gold specified in the contract at a prevailing fixed price on expiration of the contract. If you sell a futures contract, you agree to sell the underlying commodity at a fixed sale price at the expiration of the contract.
Now you can take actual delivery or square off (put a contra order; that is, if you have put a buy order, put a sell order to close the transaction) anytime before the expiration of the contract. You can buy futures if you think gold prices will go up or sell futures if you think they will fall. The futures price moves in tandem with the price of gold in the spot market. This leads to profits or losses as your contract is at a fixed price.
The advantage of futures is that it is leveraged and, hence, the return on investment is much higher. If you were to buy 1 kg of gold in the physical market at a price of Rs 7000 per 10 gm, you will have to shell out Rs 7 lakh. In the futures market, however, you just pay an initial margin of 3.5 per cent (as per MCX contract specifications), that is, Rs 24,500 for the same exposure. If your futures price goes up from say Rs 7,000 to Rs 7,200 in a month, you gain Rs 20,000. That is an 82 per cent return on your investment.
You can also take physical delivery of the contract at the place specified. In this case, you have to express your intention to the broker. You also have to bear the sales tax and storage costs.
If you were to start trading in gold futures, you have to incur brokerage, transaction or turnover charges imposed by the exchanges; the initial margin money; and government levies such as sales tax, service tax and cess. The brokerage depends on whether the trade is squared off on the same day or rolled over or if you intend to take physical delivery. Brokerage is higher if you intend to take physical delivery. Some brokerage houses charge brokerage depending on the volumes. The brokerage is lower if the client is regular and deals in large volumes. Some firms also charge an account-opening fee.