Futures

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Features of Futures Markets

FUTURES CONTRACTS

»Available on a wide range of underlyings »Exchange traded »Settled daily

MARGINS
» A margin in cash or marketable securities deposited by an investor with the broker » The balance in the margin account is adjusted to reflect daily settlement » Margins minimize the possibility of a loss through a default on a contract

Settlement methods
» “Delivery”
» Buyer takes possession of the goods

» Cash
» difference between the cash market price and the future price

Settlement methods
» “Delivery”
» Buyer takes possession of the goods

» Cash
» difference between the cash market price and the future price

Futures in India
» Futures exists in various forms
» Commodities (MCX, NCDEX) » Interest rate futures (NSE) » Stock and Index Futures (NSE)

» NSE Stock/Index Futures
» 1 month, 2 month and 3 month contracts » Near, Mid and Far month

Settlement
» Trading settlement on NSE
» Cash: Rolling » Futures – settled once a month on NSE

» Expiry Date in India
» Last Thursday of month » If holiday, like Dec 25 is, then previous day » In unexpected circumstances, may be moved to next day

» Cash settled, daily marked to market
» you don’t have to provide “delivery” of stock if you sell a future » Differential of cash price and stock is charged to you (or paid to you) daily

» Futures prices are DIFFERENT from underlying
» Cost of carry

Lot Size
» Futures don’t trade in quantities of 1 » A minimum lot size is used
» Nifty futures = 50 Nifty » Reliance futures = 75 reliance shares

» For each stock futures have different lot sizes
» Listed on the NSE web site

» Not all stocks have futures
» And not all futures that exist are liquid!

Margin
» To buy or sell a future NSE requires a margin
» A percentage of each contract size (lot size x price per share) » The actual margin per contract will change every day, calculated by NSE » Broker will take this margin money from you » Around 15-30% for index futures and 25-60% for stock futures
» Eg. Two lots i.e. 100 Nifty at 3000 price, is a contract size of 3 lakhs. Margin will be between 40K to 1L (depending on broker, volatility)

Let us trade an example
» Buy two lots of Reliance Future (December) on December 1, 2008

Test order screen

» Underlying has a unique code » Choose “Futures” and Contract Expiry Date » Qty – multiples of 75 » Limit order (buy at 1106 or lesser)

Marked to Market: Futures
» At the end of each day, you are expected to pay or receive a mark to market price from/to your account
» Difference of last price and current price » If price rose today and you are long a future
» You receive money (credit)

» If price fell today and you are long
» You have to pay out the difference (debit)

» Reverse if you are short » Online brokerages deduct this automatically
» Offline route, you may have to pay a cheque

Marking to market: Example
» Let’s assume a 50% margin » On day 1 you will have 1106x150 x 50% taken from you as margin
» Rs. 82,950

» Dec 1: RIL future closed at 1106 » Dec 2: RIL future closed at 1075
» So Rs. 31 loss is taken from you as Marked to market loss » For 150 RIL this is Rs. 4650 that you have to pay

» Dec 3: RIL future closed at 1071
» What happens?

Covering your future
» December 4: RIL reaches 1150
» You “square off” your order. » you have already paid out mark-to-market margin upto 1071. » you will get back 1150-1071 = Rs. 79 as profit (along with your initial margin)
» That’s a credit for Dec 4 of 11,850, plus the initial margin of 82,950 » Your real profit is (1150 – 1106) per share, 150 shares » Rs. 6600 » Investment = Rs. 90000 (approx) » RISK!

Shorting a future
» If you believe RIL will go down in price, you can choose to “Sell” instead of buy » That will create an open “sell” position for you

Waiting for settlement
» At the end of expiry day all futures are “automatically” settled » Price is assumed to be closing price of the underlying stock (in this case, RIL) » If RIL closes at
» 1200 –net profit, over all days added up will be (12001106) » 1100 –net payout of Rs. 6 » marked to market every day

Open Interest
» Each buy/sell pair is a contract » Someone buys, someone else sells » Total number of open contracts x lot size = Open interest » Open interest has limits
» cannot exceed the number of shares that the company has

» NSE announces if certain stocks reach close to this limit

Other Points About Futures
»They are settled daily »Closing out a futures position involves entering into an offsetting trade »Most contracts are closed out before maturity

Some Terminology
» Open interest: the total number of contracts outstanding. This equals to number of long positions or number of short positions » Settlement price: the price just before the final bell each day. This is used for the daily settlement process » Volume of trading: the number of trades in 1 day

Convergence of Futures to Spot

Futures Price Spot Price
Time

Spot Price Futures Price
Time

(a)

(b)

Forward Contracts
» A forward contract is an OTC agreement to buy or sell an asset at a certain time in the future for a certain price » There is no daily settlement . At the end of the life of the contract one party buys the asset for the agreed price from the other party

Profit from a Long Forward or Futures Position

Profit

Price of Underlying at Maturity

Profit from a Short Forward or Futures Position

Profit

Price of Underlying at Maturity

Forward Contracts vs Futures Contracts

Forward Private contract between two parties Not standardized Usually one specified delivery date Settled at end of contract Delivery or final settlement usual Some credit risk

Futures Traded on an exchange Standardized Range of delivery dates Settled daily Usually closed out prior to maturity Virtually no credit risk

BACK UP SLIDES

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» How do I place a futures buy/sell order? » In the "Place Order" page, you need to define the stock code and opt for "Futures" in the "Product" drop down box. » On clicking on "Select the contract", the whole list of contracts available in the given stock code expiring in different months would be displayed. » Depending on your interest, you can select one of the contracts by clicking on buy / sell link. »
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» It will take you to the buy / sell page. Values like, your E-Invest account no., exchange, contract details would be auto-populated. » You need to define the order type i.e. market or limit, order validity period i.e. day of GTD, limit price and stop loss trigger price if any.

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» Can I short sell the shares in futures segment (i.e. sell shares which I do not hold in DP)? » Yes, you can short sell the shares in futures segment. There is no block on your holdings in the demat account » How much margin would be blocked on placing the futures order? » Initially, margin is blocked at the applicable margin percentage of the order value.
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» For market orders, margin is blocked considering the order price as the last traded price of the contract. » On execution of the order, the same is suitably adjusted as per the actual execution price of the market order. » The initial margin percentage can be checked from the " Stock List" link on the FNO trading page for all underlying securities. You can check the Margin obligations on your position from the "Know Your Margin" link on FNO trading page
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» Is the margin % uniform for all stocks? » it may not be so. Margin percentage may differ from stock to stock based on the risk involved in the stock, which depends upon the liquidity and volatility of the respective stock besides the general market conditions. Normally index futures would attract less margin than the stock futures due to comparatively less volatile in nature. But all contracts within the same underlying would attract same margin %.
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» Can margin be changed during the life of contract? » Yes, margin % can be changed during the life of the contract depending on the volatility in the market. » It may so happen that you have taken your position and 25% margin is taken for the same. But later on due to the increased volatility in the prices, the margin % is increased to 30%.

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» In that scenario, you will have to allocate additional funds to continue with open position. Otherwise it may come in MTM loop and squared off because of insufficient margin. It is advisable to keep higher allocation to safeguard the open position from such events. » What is meant by 'squaring off ' a position? What is a cover order? » Squaring off a position means closing out a futures position
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» For example, if you have futures buy position of 500 Reliance expiring on 27th Feb 2002, squaring off this position would mean taking sell position in 500 Reliance expiring on 27th Feb 2002 on or prior to 27th Feb 2002. » The order placed for squaring off an open position is called a cover order. » Is margin blocked on all future orders? » No. Margin is blocked only on future orders, which results into increased risk exposure.
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» For calculating the margin at order level, value of all buy orders and sell orders (in the same underlying-group) is arrived at . » Margin is levied on the higher of two i.e. if buy orders value is higher than sell order value, only buy orders will be margined and vice versa. » In other words, margin is levied at the maximum marginable order value in the same underlying.

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For example, you have placed the following buy and sell orders.
Contract Details Qty Fut - ACC27 Feb 2002 Fut - ACC26 Mar 2002 Fut - ACC29 Apr 2002 Total 200 25500 100 100 Buy Orders Rate 100 155 Order Value 10000 15500 200 100 300 160 16 32000 16300 48300 Qty Sell Orders Rate Order Value

As mentions above, the higher of buy and sell order value is margined. In the above given example, sell order value is greater than buy order value. Hence margin would be levied at specified margin % on Rs. 48300.
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» If I have purchased a share, do I have to take delivery?
» No you can choose to sell the share before the end of settlement cycle. However once the settlement cycle is over you have to take delivery by paying for it.

» If I have sold, do I have to give delivery of shares?
» No you can choose to buy the share before the end of settlement cycle. However once the settlement cycle is over you have to give the delivery of shares from your Demat account.
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What is a Stop Loss order ?
» A Stop loss order allows the client to place an order which gets activated only when the market price of the relevant security reaches or crosses a threshold price specified by the investor in the form of 'Stop Loss Trigger Price'. » When a stop loss trigger price (SLTP) is specified in a limit order, the order becomes one which is conditional on the market price of the stock crossing the specified SLTP

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» The order remains passive (i.e. not eligible for execution) till the condition is satisfied. Once the last traded price of the stock reaches or surpasses the SLTP, the order becomes activated (i.e. eligible for execution by being taken up in the matching process of the exchange) and then on behaves like a normal limit order. It is used as a tool to limit the maximum loss on a position.

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Examples- Stop Loss Buy Order :
» 'A' short sells Reliance shares at Rs 325 in expectation that the price will fall. However, in the event the price rises above his buy price 'A' would like to limit his losses. 'A' may place a limit buy order specifying a Stop loss trigger price of Rs 345 and a limit price of Rs 350. The stop loss trigger price (SLTP) has to be between the last traded price and the buy limit price. Once the market price of Reliance breaches the SLTP i.e. Rs 345, the order gets converted to a limit buy order at Rs 350.
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» Stop Loss Sell Order 'A' buys Reliance at Rs 325 in expectation that the price will rise. However, in the event the price falls, 'A' would like to limit his his losses. 'A' may place a limit sell order specifying a Stop loss trigger price of Rs 305 and a limit price of Rs 300. The stop loss trigger price has to be between the limit price and the last traded price at the time of placing the stop loss order. Once the last traded price touches or crosses Rs. 305, the order gets converted into a limit sell order at Rs. 300
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What is Margin Trading
» In margin trading, you take buy/sell positions in stock(s) with the intention of squaring off the position within the same settlement cycle. » If, during the course of the settlement cycle, the price moves in your favour (rises in case you have a buy position or falls in case you have a sell position), you make a profit. » In case the price movement is adverse, you incur a loss. However, you also have the option to take/give delivery of buy/sell position respectively if you have sufficient cash/securities to do so.
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» Normally to buy shares, you have to place 100% of the order value, while to sell shares, you need to have shares in your demat account. » However, margins are blocked only to safeguard against any adverse price movement. » At present, you have to place 33.33% of the order value as margin. » With margin trading, you can leverage on your trading limit by taking buy/sell positions much more than what you could have taken in cash segment. However, the risk profile of your transactions goes up.

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» While buy/sell transactions in Cash Segment are settled by delivery unless squared off within the same settlement, buy/sell transacions in the Margin Segment are squared off unless converted into delivery (cash segment). » Time of End Of Settlement process would be specified in the Open Margin Position screen every Tuesday. »

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» For example, when you place an order to buy 100 shares of Reliance in the cash segment, your intention is to pay for and receive the shares in your Demat Account. » However, if the same order were to be placed in the margin segment, your intention would be to sell those shares subsequently in the same settlement at a higher price and thereby make a profit on the same. However, if the price falls subsequently, there may be a loss.
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» Since a cash position is meant to be settled by delivery, the required cash or securities are blocked in full. For example, if you place an order to buy 100 shares of Reliance, 100% of the order value is blocked from your limit and if you place an order to sell 100 shares of Reliance, 100 securities of Reliance are blocked in your Demat Account. On the other hand, in a margin order, only a specified % of the order value is blocked from your limit. A sell order in the margin segment can be placed even without having any stock in demat account.
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» However, unlike the sell order in the cash segment which can be placed without having any limit, a sell order in margin can be placed only if sufficient limit is available. The most important thing to understand is that though you can leverage on your trading limit with margin trading, the risk profile of your transactions goes up substantially

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» Execution price of cover order is compared against the weighted average price at which the position was built up (as shown in the "margin Position" table) and profit/loss is calculated therefrom. For example, say you have a margin position - 'Buy 100 Reliance Shares' at an average price of Rs. 100 per share created through the execution of 2 orders - 'Buy 50 Reliance Shares @ Rs. 110 per share' and 'Buy 50 Reliance Shares @ Rs. 90 per share'. If you square off a part of the position by selling 60 Reliance Shares @ Rs. 105 per share, the profit on such square off would be calculated as : Quantity squared off * (Square off trade price - Average price of the position) 60 * (105 - 100) = 300 »

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What is meant by 'squaring off a position'? What is a cover order?
» Squaring off a position means closing out a margin position. » For example, if you have a margin buy position of 100 Reliance Shares', squaring off this position would mean selling 100 Reliance shares in the same settlement. » The order placed for squaring off an open position is called a cover order. » In the example, the order placed to sell 100 Reliance shares is a cover order against the open position - 'Bought 100 Reliance Shares'.

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Is margin blocked on all margin orders
» No. Margin is blocked only on margin orders, which are in the nature of building up fresh positions. Margin orders which are placed to square up existing open buy/sell position (called 'cover orders') shall not attract margin. For example, if you have a buy position (executed trade) of 100 shares in Reliance in margin and now place a sell order for 100 shares in Reliance in margin, the sell order would not attract any margin as it is in the nature of a cover order. However, if you place a sell order for 150 shares, the fresh component of the order i.e. 50 shares would attract margin at the applicable margin rate. Such orders can be called 'partial cover order'.
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