View From The Gangway
Let us look at the intimidating, chaotic world of Futures and Options through the lens of a “Deck Cadet” on their very first contract.
Picture this: You have just climbed the gangway of a ULCC (Ultra Large Crude Carrier) for the first time. You are wearing a boiler suit that is two sizes too big and a helmet that smells like the previous cadet. You step onto the main deck and stare at the labyrinth of pipes, valves, manifolds, and towering cranes. It is awe-inspiring, but mostly, it is terrifying. You have no idea which valve does what, but you know that turning the wrong one results in a very loud noise followed by an uncomfortable meeting with the Chief Officer.
The stock market’s derivatives segment—Futures and Options—is exactly like that main deck. To the uninitiated, it looks like a dangerous tangle of numbers, Greeks, and red candles designed to blow up your bank account. But, just like that ship, once you understand the flow of the cargo, it isn’t magic; it’s just plumbing.
So, forget the Black-Scholes models and the complex calculus for a moment. Let’s sit in the mess room and listen to a story about our Captain.
The Forward Contract: A Gentleman’s Agreement
Let us introduce our protagonist, Captain Smart. He is currently serving a six-month contract on a massive tanker, hauling crude across the Atlantic. Captain Smart is a man of many talents: he can navigate a 300-meter ship in a storm, he can smell a change in barometric pressure, and—most importantly—he makes a cooks delicious Biryani and other Mughlai dishes.
His retirement dream is to open a restaurant. There is a beautiful piece of farmland just outside his hometown that would be perfect for this venture. The current price of the farm is ₹50 Lakhs.
The Captain wants it desperately. However, there is a snag. His liquidity is currently tied up—perhaps in his son’s overseas education, . He doesn’t have ₹50 Lakhs right now.
But, as the old maritime saying goes: ” The Captain is always right, and if he is wrong, refer to rule number one.” Captain Smart does not take “no” for an answer.
He calls up the Farmer, a grumpy old soul who trusts soil more than sailors.
“Hello,” says Captain Smart. “I want your farm. I know you want ₹50 Lakhs for it.”
“Yes,” says the Farmer. “Cash on the barrel.”
“Here is the problem,” says the Captain. “I am at sea. I don’t have the cash today. But, I promise to buy it from you exactly one year from today.”
The Farmer scoffs. “And why should I wait? If I sell it to someone else today for ₹50 Lakhs and put that money in the bank, I’d earn interest. Waiting for you costs me money.”
“Fair point,” says the Captain, smooth as silk. “So, let’s make a deal. I won’t pay you ₹50 Lakhs. I will pay you ₹53 Lakhs one year from now. That covers the price of the land plus the ₹3 Lakhs interest you would have earned.”
The Farmer does the mental math. He gets his price, and he gets his interest. “Now you are talking, Captain.”
They shake hands (metaphorically, over the satellite phone).
The Breakdown:
Captain Smart has just entered into a Forward Contract.
- Maturity Date: One year from today.
- Forward Price: ₹53 Lakhs (Spot Price + Cost of Carry/Interest).
- The obligation is binding. The Captain must buy, and the Farmer must sell.
From Farm to Fuel: Enter the Futures Contract
Now, a Forward Contract is great, but it has a flaw: it relies on trust. What if the Captain disappears in the Bermuda Triangle? What if the Farmer sells the land to a developer behind the Captain’s back?
This is where “Futures” come in.
Imagine the ship owner back in the head office. He needs thousands of tons of Heavy Fuel Oil (HFO) to run his fleet. He knows he needs fuel three months from now, but he is terrified the price of oil will spike. He wants to lock in a price today, just like the Captain did with the farm.
But he doesn’t call a random guy with a barrel of oil. He goes to an Exchange (like the National Stock Exchange or the Bombay Stock Exchange or Multi Commodity Exchange ).
When a Forward Contract is traded on an organised exchange, it is called a Future Contract. The Exchange acts like the strict Bosun on deck. They specify the quantity (Lot Size), the quality (Grade), and the date (Expiry). Most importantly, the Exchange guarantees the trade. If the buyer runs away, the Exchange covers it.
The underlying asset can be anything: Stocks, Gold, Crude Oil, or even US Dollars. It is the same “buy now, pay/deliver later” logic, just standardized, regulated, and stripped of the risk that the other guy might ghost you.
The Call Option: Buying a Ticket to the Show
Let’s return to Captain Smart. His dilemma is evolving.
While scrubbing through maritime news, he hears a rumor from a reliable source—perhaps the Chief Engineer, who knows everything. The rumor is that the National Highways Authority of India (NHAI) might build a new super-highway that passes right next to that specific farmland.
If the highway is built, that ₹50 Lakh farm will instantly be worth ₹1 Crore. A restaurant right on the highway? That is a goldmine.
But, if the rumor is false and the highway isn’t built, the land might actually drop in value, or just remain a quiet, dusty field where no one comes to eat Biryani.
The Captain is stuck.
- If he commits to buying it for ₹53 Lakhs (the Forward contract) and the highway doesn’t come, he is stuck overpaying for a farm he might not want anymore.
- If he waits, and the highway does come, the Farmer will jack up the price to ₹1 Crore.
Captain Smart needs a way to secure the opportunity without the obligation. He calls the Farmer again.
“Change of plan,” says the Captain.
The Farmer groans. “What now?”
“I am still willing to pay you ₹53 Lakhs after one year,” says the Captain. “But, I want the right to say ‘No’ later. I want one year to decide. If the highway comes, I buy. If it doesn’t, I walk away.”
The Farmer laughs. “You want me to hold the land for you for a year, and you can just walk away? What’s in it for me? I’m not running a charity.”
“I know,” says the Captain. “For this privilege, I will pay you a non-refundable token amount of ₹1 Lakh right now. You keep this ₹1 Lakh no matter what happens. Even if I don’t buy the land, the money is yours. It’s the price of my hesitation.”
The Farmer thinks again. He gets ₹1 Lakh cash in hand immediately. If the Captain buys, great. If the Captain walks away, the Farmer keeps the land and the ₹1 Lakh. “Deal.”
The Breakdown:
Captain Smart has just bought a Call Option.
- Premium: ₹1 Lakh (The price to buy the “right”).
- Strike Price: ₹53 Lakhs.
- The Buyer (Captain): Has the right to buy, but not the obligation. His max loss is just the ₹1 Lakh premium.
- The Seller (Farmer): Has the obligation to sell if the Captain wants to buy. He keeps the premium as compensation for taking the risk.
The Put Option: The Insurance Policy
The sea is a cruel mistress, and Captain Smart’s troubles aren’t over. Just as he settles the farm deal, he gets an email from his family doctor. The medical report suggests he might need to skip the next contract due to high blood pressure (probably caused by all this trading).
If he can’t sail, he has no income. He needs a backup plan.
He owns a large ancestral house in the city. He doesn’t want to sell it, but if the real estate market crashes next year just when he needs money, he will be in big trouble. He fears the house price, currently ₹80 Lakhs, might crash to ₹60 Lakhs due to a recession.
He finds a wealthy investor who loves old houses.
“I might sell you my house next year,” Captain Smart tells the investor. ” I want you to promise to buy it from me at ₹80 Lakhs next year, regardless of the market price.”
The investor raises an eyebrow. “Why would I agree to buy it for ₹80 Lakhs if the market price drops to ₹60 Lakhs? I’d be losing money.”
“Because,” says the Captain, “I will pay you ₹1 Lakh right now as a premium. You keep that money if I opt out of selling the house.But if I choose to sell then you will have to buy it”
The investor, betting that the market won’t crash, agrees to take the free cash.
The Breakdown:
The Captain has just bought a Put Option.
- Put Option: The right to sell at a fixed price.
- Purpose: Protection (Hedging).
- If the market booms, the Captain is safe; he can sell his house at the high price of ₹80 Lakhs.
- If the market crashes, he lets the option expire, loses only his small premium, and keeps his valuable house.
- The Buyer (Investor): Has the obligation to buy if the Captain wants to sell. He keeps the premium as compensation for taking the risk.
The Evening Whiskey: A Review of the Logbook
That evening, Captain Smart sits calmly. He pours a generous peg of whiskey(non alcoholic, of course)—purely for medicinal purposes—and reviews his position. He smiles. He has navigated the stormy waters of finance using strategy, not just hope.
Let’s look at his Master Plan:
Scenario A: The Government builds the Highway & Real Estate Booms.
- The Farm (Call Option): The land price zooms to ₹1 Crore. The Captain exercises his right to buy it at the agreed ₹53 Lakhs. He makes a massive profit and his dream of opening a restaurant comes true.
- The Ancestral House (Put Option): He chooses the right to sell this house for 80 Lakh to fund the Farm land
- Result: Captain is rich.
Scenario B: The Highway is cancelled & The Market Crashes.
- The Farm (Call Option): The land is worthless. The Captain walks away. He loses only the ₹1 Lakh premium. He is saved from buying a bad asset.
- The Ancestral House (Put Option): The market price crashes to ₹60 Lakhs. But the Captain exercises his right! The investor must buy the house for ₹80 Lakhs.
- Result: Captain survives the storm with his capital intact.
And that, dear deck cadet, is the essence of Futures and Options. It isn’t about gambling; it is about managing risk. It is about paying a small price today to sleep soundly tomorrow, regardless of which way the financial winds blow.
Now, finish your tea and get back on deck. The manifold isn’t going to check itself.
The Phantom Value: Notional Value of a Forward Contract
Now that Captain Smart has struck his deals and set his sails, it’s time to talk about the notional value—the phantom number lurking behind every forward contract.
When Captain Smart signs a forward contract with the Farmer, no money actually changes hands at the start. Think of it like agreeing to buy a fancy Golf set next Diwali, but neither of you cracks open your wallet today.
Does that mean the contract is worthless? Not at all!
The notional value is simply the imaginary total worth of that agreement—the big number you’d use if you wanted to imagine the full size of the trade. For instance, if Captain Smart’s contract is to buy 1,000 sacks of rice at ₹75 per sack one year from now, the notional value is ₹75 × 1,000 = ₹75,000. Easy, right?
But what if the contract is one of those trickier creatures—like a stock index, which can’t be packed into sacks? Suppose the index is at 26000 points, and the exchange assigns a lot of 75. The notional value here is 26000 X 75 = ₹19,50000.
Exchanges carefully set these lot sizes—not too high to scare traders off, and not too low to flood markets with paperwork. They aim to find the sweet spot, a bit like a captain selecting the perfect wind and tide for his voyage.
So even if Captain Smart doesn’t pay the full notional amount upfront, this phantom figure shows his true exposure—the size of the ship he’s captaining through the choppy trading waters.
Practical Examples of Settlement on NSE
Stock Example: Docking a Cargo Ship
Captain Smart decides to buy 500 shares (one FnO Lot) of Reliance Reliance Industries Limited at ₹1,500 each. That’s ₹7,50,000 paid upfront. Within two business days (T+2 settlement), those shares safely berth in his demat account, and the payment reaches the seller. He now owns those shares and can sell them anytime—turning any “paper” profits into cash. Simple and direct.
Futures Example: Daily Cargo Check on the Tanker
Next, Captain Smart takes on a futures contract to buy 1,00 barrels of crude oil at ₹5,000 per barrel three months from now. Instead of paying the full ₹5 lakh now, he deposits a margin—a security deposit to keep his ship afloat. Each day, MCX (or NSE) updates his account based on the oil’s price. If it rises to ₹5,500, profit flows into his account; if it falls, he must add funds. This daily balancing act keeps the trade fair, like checking a tanker’s cargo every day until delivery. The opposite occurs if he sells a future contract.
Options Example: Ticket for a Special Voyage
Captain Smart buys an option giving him the right to buy Reliance shares at ₹1,500 within the next month. He pays a premium upfront —think of it as a ticket price for this special voyage. If the share price surges past ₹2,000 at expiry, he can exercise his right and profit; if not, the option expires worthless and he walks out of the contract.
Sellers of options must hold margins as security against risk, with the premium cushioning this margin requirement—like an upfront payment for reserving space on a ship, just in case.
Docking the Ship: How Settlements Actually Work
Picture Captain Smart coming ashore after a long voyage, his logbook full of trades: stocks, futures, options. Before he pours his celebratory whiskey, he must settle accounts. But unloading each type of trade is like handeling a different kind of ship—each with unique rules at the NSE, BSE or MCX.
Stock Settlement: Simple Harbour Maneuver
Trading stocks on NSE is like tossing a mooring line and stepping off the boat. Buy 100 shares of Reliance at ₹2,500, pay ₹2,50,000, and the exchange acts as a middleman—routing money and shares. This happens neatly within two working days (T+2 settlement). The reward: real shares in your account and real profits once you sell them.
Futures Settlement: Mark-to-Market and Margin Jitters
Step onto a bigger vessel: futures contracts. Captain Smart enters a deal for 1,000 barrels of oil at ₹6,500 each. Instead of full upfront payment, he posts a margin specified by the exchange—security in case the winds change. Every evening, the exchange recalculates the contract’s value. Rising prices mean immediate “credits” to his account; falling prices mean debits. This daily “mark-to-market,” or variation settlement, keeps things honest. Captain Smart can close positions anytime or hold until expiry, settling physically (stock futures, commodity futures) or in cash (index futures).
Options Settlement: Choose-Your-Adventure Ending
Options contracts are trickier—small sailboats with secret compartments. Captain Smart pays a premium upfront for the right, not obligation, to trade at a set price on expiry.
At Indian Exchanges (MSE, BSE, MCX etc), options settle in two ways:
- Stock Options (Physical): If “in the money” at expiry, shares exchange hands. The Captain delivers or receives shares—a barrel rolled from ship to ship.
- Index Options (Cash): No physical shares change hands; only differences in money settle the deal.
All options contracts in Indian exchanges are European style, exercised only on expiry. Profitable positions auto-settle; worthless ones expire like forgotten cargo.
Margins and Risk: Keep Wind in Your Sails
For both futures and option sellers, NSE requires margins—a safety net ensuring no one jumps ship mid-trade. Fail to top-up margins during storms (adverse price moves), and the exchange or brokers close positions—sometimes quicker than a monsoon squall.
Whether you’re a calm harbour trader holding stocks or a daring sailor on futures and options seas, knowing how settlements work keeps your cargo safe and your logbook tidy—guiding you safely from the open ocean to the home port of NSE.
Sources
[2] What Is Options Trading? A Beginner’s Overview
[3] Call option and put option understanding types of options
[4] Call and Put Options: Meaning, Types, Difference & …
[5] Forward vs Futures Contracts: Key Differences and Examples