Futures contract is a derivative contract which is legal in nature and allows to buy or sell an underlying asset at a future date at an agreed price. Futures involve a minimum order size (market lot) and are traded on the exchanges just like any other security. The exchange is the legal intermediary and both the parties i.e. the buyer and the seller are required to pay a margin to the exchange in order to ensure that they honour the contract. The changes in prices take place daily in futures based on the securities price and thus they are settled on a daily basis, known as mark-to-market.
The futures are usually used by traders to hedge their risks and also by speculators who aim to earn by betting on the future price of the underlying asset.
Example: A trader agrees to buy 1 lot (500 shares) of SBI at Rs.300 at expiry.
Now suppose the price of SBI moves to Rs. 310 on expiry the trader will benefit from the trade as he can now buy each share of SBI at Rs.300 instead of Rs.310. Thus his total profit would be Rs.5,000 [(310-300)*500].
If suppose the price of SBI falls to Rs.280 at expiry. In this case, the buyer will suffer a loss, as he has agreed to buy the shares at Rs. 300. His loss would be Rs. 10,000 [(300-280)*500].