Introduction To Futures on National Stock Exchange
Glossary of Terms
Contract – The futures security that is being traded
Lot Size / Contract Size – The volume covered by 1 contract
Underlying Instrument – The security basis which the Contract Value is determined
Margin – The amount of money to be secured for the contract [10% of Contract Price x Lot Size]
Long Contract – Buying a Contract [In the hope that the underlying price will increase in value]
Short Contract – Selling a contract [In the hope that the underlying price will decrease in value]
Expiration Month – The month for which a contract is valid
MTM – Mark To Market
EOD – End of Day
Out of the numerous stocks listed on National Stock Exchange, around 200 stocks are allowed to be traded in the derivatives section of Futures Contracts. Any person holding a demat account and authorized by the exchange to trade on Futures and Options can conduct transactions for such derivatives.
The futures are divided into 2 main divisions i.e. Index Futures and Stock Futures. It is a globally accepted norm that trading on futures and options is completely ‘speculation’ in layman’s terms.
Example of Index Future: Nifty Futures
The underlying instrument in this case is nothing but the value of the index itself. The contract size is 50 units. So if a trader thinks that the markets will go up, he can buy a contract of Nifty futures. He is required to place a margin of 10% of the total contract value. Since the contract size is 50 and suppose the Nifty index value at the time of buying the contract is 5000, the value of the contract becomes 5000 x 50 = INR 250,000. If the value of Nifty goes up as expected, for each point increase on Nifty, the trader starts gaining 50 rupees and if the Nifty starts falling against his expectation of a rise, for each point fall in Nifty, he loses 50 rupees.
At the end of the day, the exchange [and in turn the broker] sends out a statement showing the Profit/Loss of a particular trade. Should the trade actually go in favor of the trader’s position and he has not squared off his position, the statement will reflect the MTM [Mark To Market] Profit and the onus is on the trader to follow up on that contract and square it off.
Conversely, if the market has moved against the trader, the risk management team assesses the cash margin in the account of the trader. To the extent that the loss on a contract is offset by the additional cash in the demat account of the trader and the trader does not square off the position, the trade will be untouched and the loss on the trade will be adjusted against the cash [thereby decreasing that much amount to trade further]. The moment the loss on a position exceeds the cash balance and the trader does not square off the position, the broker automatically cancels the position, marks down the loss and any cash salvaged from the deposited margin [when taking a position, a deposit was made] will be deposited back in the trading account as Cash.
Most common Index Futures on NSE are Nifty, Mininifty, Banknifty, CNXIT and now DJIA / SnP 500 as well. [FTSE Futures are due to come soon]
Stock Futures: In this case, the underlying instrument is the price of the stock and again, the contract price is determined by Stock Price times the Contract Size. Stock Futures tend to have higher lot sizes ranging anywhere between 125 per contract to 4000. The concept of Long [Buy in anticipation of rise]/ Short [Sell in anticipation of fall] remains the same but the margin and profit / loss calculation changes.
Margin principle is 10% of total contract value but the stakes get much higher in Stock Futures. The rewards while lucrative also entail huge risks and a 4 rupee difference in the stock price going against your actual position can wipe out all the margin put at stake.
To give a better understanding of the concept, below are listed 2 wins and 2 loses covering both index and stock futures. For practical purposes, the assumption is that this is the September series contract and the trader has started with a margin cash of INR 50,000/-
Simulation 1: Long Nifty Futures – Winner (Index Future Winner)
Assumption: Nifty will go UP
Cash = 50,000/-
Trader took a Long position in Nifty futures at Nifty Index value = 5000 and assumed that at least 50 points upside is remaining within the next 2 to 3 trading sessions.
Initiates a Buy Order on Monday at 11 am for Nifty Futures 1 contract
Contract Value =5000 [Banknifty Spot Value] x 50 [Lot Size] = 250,000/-
Margin Deducted = 10% of Contract Value [In case of high demand, there might be a small premium taken as well of about 1% additional]
Debit Cash = 25,000/-
Spare Cash = 25,000/-
At the end of the day, Nifty did not gain those 50 points but closed at 4980
Contract Value at End of Monday = 4980x 50 = 249,000/-
Since the trader had placed the deposit of 50,000, the loss of 1,000 is marked as MTM Loss at the end of Monday.
The EOD statement on Monday will be as follows
Long Nifty September Futures – Debit 25,000/-
MTM Loss – Debit 1,000/-
Cash Balance – 24,000/-
Total Portfolio Value = 49,000/-
On Tuesday, market opens on a positive note and the gains of 50 points over 5000 are realized and the trader squares off his position. All the deposited margin is freed up and the gains are added to the cash account.
The EOD statement on Tuesday will be as follows
Long Nifty September Futures Squared – Credit 25,000/-
MTM Profit – Credit 1,000/-
Cash Balance – 25,000/-
Total Portfolio Value = 51,000/- [This is the 1,000 profit made on the transaction added to trading margin account]
Simulation 2: Long Banknifty Futures – Loser (Index Future Loser)
Cash = 50,000/-
Trader took a Long position in Banknifty futures at Banknifty Index value =9500 and assumed that at least 75 points upside is remaining within the next 2 to 3 trading sessions.
Initiates a Buy Order on Monday at 11 am for Nifty Futures 1 contract
Contract Value = 9500 [Nifty Spot Value] x 25 [Lot Size] = 237,500
Margin Deducted = 10% of Contract Value [In case of high demand, there might be a small premium taken as well of about 1% additional]
Debit Cash = 23,750/-
Spare Cash = 26,250/-
At the end of the day, Banknifty did not gain those 50 points but closed at 9465
Contract Value at End of Monday = 9465 x 25 = 236,625/-
Since the trader had placed the deposit of 50,000, the loss of 875 is marked as MTM Loss at the end of Monday.
The EOD statement on Monday will be as follows
Long Banknifty September Futures – Debit 23,750/-
MTM Loss – Debit 875/-
Cash Balance – 25,375/-
Total Portfolio Value = 49,125/-
On Tuesday, market continues to remain negative Banknifty continues to drop further and finally at 9425 on Banknifty spot, the trader squares off his position. 75 points are lost in total. This results in a net loss of 75*25 = 1875/- The same is deducted from the deposited margin.
The EOD statement on Tuesday will be as follows
Long BankNifty September Futures Squared – Credit 23,750/-
MTM Loss – Debit 1,875/- [This is the 1,875/- loss incurred on the transaction]
Cash Balance – 25,000/-
Total Portfolio Value = 48,125/-
Simulation 3: Long ONGC Futures – (Stock Future Winner)
Assumption: ONGC will go UP
Cash = 50,000/-
Trader took a Long position in ONGC futures at ONGC stock value = 250 and assumed that at least 10 points upside is remaining within the next 2 to 3 trading sessions.
Initiates a Buy Order on Monday at 11 am for ONGC Futures 1 contract
Contract Value =250 [ONGC Spot Value] x 1000 [Lot Size] = 250,000/-
Margin Deducted = 10% of Contract Value [In case of high demand, there might be a small premium taken as well of about 1% additional]
Debit Cash = 25,000/-
Spare Cash = 25,000/-
At the end of the day, ONGC did not gain those 10 points but closed at 248
Contract Value at End of Monday = 248 x 1000 = 248,000/-
Since the trader had placed the deposit of 50,000, the loss of 2,000 is marked as MTM Loss at the end of Monday.
The EOD statement on Monday will be as follows
Long ONGC September Futures – Debit 25,000/-
MTM Loss – Debit 2,000/-
Cash Balance – 23,000/-
Total Portfolio Value = 48,000/-
On Tuesday, market opens on a positive note and ONGC gains 10 points over 248 and at this point it is showing signs of dropping back. The trader decides to square off the position. All the deposited margin is freed up and the gains are added to the cash account.
The EOD statement on Tuesday will be as follows
Long ONGC September Futures Squared – Credit 25,000/-
MTM Profit – Credit 8,000/-
Cash Balance – 25,000/-
Total Portfolio Value = 58,000/- [This is the 8,000 profit made on the transaction added to equity]
Simulation 4: Long LnT Futures – (Stock Future Loser)
Assumption: LnT will go UP
Cash = 50,000/-
Trader took a Long position in LnT futures at LnT stock value = 1650 and assumed that at least 25 points upside is remaining within the next 2 to 3 trading sessions.
Initiates a Buy Order on Monday at 11 am for LnT Futures 1 contract
Contract Value =1650 [LnT Spot Value] x 150 [Lot Size] = 247,500/-
Margin Deducted = 10% of Contract Value [In case of high demand, there might be a small premium taken as well of about 1% additional]
Debit Cash = 24,750/-
Spare Cash = 25,250/-
At the end of the day, LnT did not gain those 10 points but closed at 1645
Contract Value at End of Monday = 1645 x 150 = 246,750/-
Since the trader had placed the deposit of 50,000, the loss of 750 is marked as MTM Loss at the end of Monday.
The EOD statement on Monday will be as follows
Long LnT September Futures – Debit 24,750/-
MTM Loss – Debit 750/-
Cash Balance – 24,500/-
Total Portfolio Value = 49,250/-
On Tuesday, market opens on a bad note and LnT loses another 5 points and quotes 1640 and at this point it, the trader decides to square off the position. All the deposited margin is freed up and the loss is adjusted to the cash account and entire balance reflects in trader’s equity.
The EOD statement on Tuesday will be as follows
Long LnT September Futures Squared – Credit 24,750/-
MTM Loss – Debit 1,500/-
Cash Balance – 23,500/-
Myths and Realities
Myth1: Futures contracts are very risky compared to reward possibilities and high margins need to be tabled with the broker.
Fact: Yes a high level of margin needs to be tabled with the broker. Risk is an inherent part of trading anyways but the advantage with futures is that your margin burn rate is much lower. The risk reward ratio is primarily dependent on 2 points
1] Liquidity of the futures contract i.e. is the contract actively traded with volumes from a volume perspective. If yes, then your odds of winning basis correct judgement are high and getting out with stop loss is easy.
2] The contract size amplitude: This is very very critical to study and understand. For Nifty futures a 1 point rise will yield 50 rupees while a 1 point fall will yield a loss of 50 rupees. However with ONGC, a 1 point rise will yield 1000 rupees but if the bet goes wrong, it will straightaway erode 1000 rupees from your margin. So on a bad market day, if your directional bet on ONGC goes wrong and it goes in the opposite direction of your trade more than 10 points, you have almost lost 50% of your trading margin.
My personal observation so far has been that a lot of traders don't understand the dynamics of the trade [the very basic parameters as outlined in the initial part of this post]. Second, a proper study of the charts and support/resistance levels is lacking be it for Index futures or Stock futures. Third, a unidirectional bet is taken and money is burnt very badly.
Even the best of traders cannot determine whether the anticipated price action will go through or no during a trade. Regardless of how confident one, is a hedged position is always better i.e. Go Long via a current series future and Short via the next series future until the clear trend emerges. Do a thorough study of your margin at stake, your breakeven point and the stage where one leg has to be dropped and the winning leg must continue.
For starters, it is always easy and best to play with Nifty futures. The margin requirements are relatively lower and these are the most liquid futures contracts. Also for analysing potential moves of Nifty, it is critical to understand the components of the Nifty 50 index and how convergence or divergence on movements of Nifty 50 stocks affect the index. [Banknifty, RIL, LnT impact the value of Nifty index tremendously]
Stock Futures are meant only for very advanced and seasoned players in the market who have high margins and can take positions on both sides and monitor the same. There is enough evidence in the historical studies of futures contracts on all major bourses that the maximum number of contracts an average trader can trade with is 3 contracts! Yes - studying and analysing thoroughly movement of contracts and taking positions is restricted to just 3 contracts be it index or stock futures. Despite all technlogical advances in software and screening facilities, it is almost impossible to track more than 3 counters in futures for regular trading.
Of course one can take up certain high probable contracts with the help of screeners but that would not really be a trader's edge for long term success. As long as one studies 2 or 3 liquid contracts thoroughly and allocates trading margins across these 3 contracts, s/he is on a set path to success provided the Effort+Discipline is followed well as indicated by WWji in the Trader's Paradox a few days ago.
Next in this series will be an introduction to Options and then harshalji will take over to conclude this series for the benefit of all fellow boarders.
Recommended Books For Technical Analysis of Futures and Options
Futures and Options by John Hull. It is an investment for life and comes along with a CD with software called Derivagem.
The book is an exhaustive resource on various derivative securities. One should only look at the chapters pertaining to Binomial Options [both European and American; one can conveniently ignore the Black Scholes Model which is very much out-dated now IMHO] This book actually forms a major text book for students studying advanced financial engineering at Masters Levels so selective reading will be helpful. Self help is the best help and the aim of this series is to educate our fellow boarders and encourage them to do their own homework with a better understanding of the dynamics of futures and options trades.
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