faq on futures

8/4/2019 FAQ on Futures

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FAQs on FUTURES

What are Futures?

Futures are financial derivatives which derive their value from the price of underlying

asset. A Future contract is an agreement to buy or sell a specified quantity of underlyingasset for a future date at a price agreed upon between the buyer and seller. The contract istraded on an exchange and contract specifications like market lot, expiry day, unit of price

quotation, tick size and method of settlement are standardized. Futures give investors

increased capabilities to leverage themselves within the market.

What are the benefits of Futures?

Futures offer a variety of usage to the investors. Some of the key usages are mentioned below:

Price Discovery - The prices in an organized derivatives market reflect the perception of

market participants about the future and lead the prices of the underlying to the perceived

future level. The prices of futures normally converge with the prices of the underlyingstock at the expiration of the contract. Thus futures help in discovery of future as well as

current prices. Investors can take long term view on the underlying stock using futures.

Leverage - Futures offer high leverage. This means that one can take a large position withless capital. As the investor will have to pay only the margin (which forms a fraction of

the notional value of contract), his return on investment will be higher than on an

equivalent purchase of shares.Arbitrage - Single futures offer arbitrage opportunity between futures and the underlying

cash market. Such opportunities to earn risk-less profit arise as the futures may look

overpriced or under priced compared to the spot.Hedging - An investor with position in cash segment can minimize either market risk or

price risk of the underlying stock by taking reverse position in an appropriate futurescontract. This hedging facility offered by single-futures makes them an effective risk

management tool.Increase in Trading Volumes - Transfer of risk enables market participants to expand their

volume of activity. With the introduction of single futures, the market of the underlying

stock also witnesses higher trading volumes because of participation by more players whowould not otherwise participate for lack of arrangement to transfer risk. Speculative

trades also shift to a more controlled environment of futures market.

What are risks and returns in investing in futures?

The payoff for a person who buys a futures contract is similar to the payoff for a person

holding the stock in the cash market, with a potentially unlimited upside as well as a potentially unlimited downside. The exact profits and losses would depend upon the

difference between the price at which the position is opened and the price at which it is

closed. Say for an example Mr. “A” has a long position of one “Reliance” Futures lot

sized 200 @ Rs.100. If he squares up his position by selling the futures @ Rs.110, his profit will be Rs.10 per share. In case “A” squares up his position by selling the futures @

Rs.95, his loss will be Rs.5 per share. On the other hand, let us assume that “A” has short

position in “Reliance” futures @ Rs110. If he squares up his position by buying futures @



Rs.100, his profit will be Rs.10 per share. In case A squares up his position by buying

futures @ Rs.115, his loss will be Rs.5 per share.

How can I start trading in Futures?

To start trading in Futures, all you need to do is open an account with us.You can start your trading immediately by depositing the margin for the contracts youwant to trade in.

How can I use futures when I anticipate a short-term fall in stock price?

The holder of the physical stock can sell a future to avoid making a loss without having to

sell the share. Any loss caused by the fall in the price of the stock is offset by gains made

on the stock future position.

What are the different contract months available for trading?

Currently there are 3 contracts of current month, next month and far month available for

trading in Futures.

What are margins in future?

Margins are the money to be paid to create an open position in futures. Margins are like asecurity deposit or insurance against a possible future loss of value of an outstanding

future position. The aim of margin money is to minimize the risk of default by either

counter-party. The payment of margin ensures the risk arising out of price movement oneach outstanding position.

What is SPAN Margin?

SPAN is short for Standardized Portfolio Analysis of Risk. This is a leading margin

system, which has been adopted by most options and futures exchanges around the world.SPAN is based on a sophisticated set of algorithms that determine margin according to a

global (total portfolio) assessment of the one-day risk for a trader's account. This risk iscalculated on the basis of worst possible one-day move.

What are the different types of Margins levied on Derivative Contracts?

There are two types of margin levied on Derivatives Contracts. One is Initial Margin and

the other is Mark-to-Market (MTM) Margin. Initial Margin is collected upfront and MTM

Margin on T+1 basis.

What is Initial Margin? Why is it charged?

The Initial Margin is the percentage of the purchase price of futures contract that theinvesting client needs to pay to the broker on an up-front basis before taking the position.Both buyer and seller have to deposit this margin. The Trading Members will buy and/or

sell derivatives contracts on behalf of the clients only on the receipt of initial margin,

unless the client already has an equivalent credit with the Trading Member. For futurescontracts, initial margin requirements are set by the exchange. The basic aim of Initial

margin is to cover the largest potential loss in one day. This margin is calculated by

SPAN by considering the worst case scenario.



When does the client need to pay Initial Margin to the broker?

The client needs to pay initial margin to the broker on an up-front basis before taking

either buy or sell position in a futures contract.

What is Mark-to-Market (MTM) Margin?In the Daily Settlement cycle, all open futures positions are marked to market at the dailysettlement price. This means that the difference between the Net Traded Value of the

futures position in any contract and the value of the open position in the same contract at

the futures closing price (Mark to Market Value) is calculated. Any profit arising out of this difference is paid out to the client on T+1 day, while losses arising on the open

position are required to be paid to the exchange on T+1 day. Thus MTM Margin can be

defined as the daily profit or loss obtained by marking the members outstanding positionto the market (closing price of the day.)

Say for an example Mr. X bought one stock future lot of 1000 shares @ Rs.100 and the

future closed at Rs105 on that day. His MTM profit will be 1000 X 5 = Rs.5000 which

will be paid to client. If the future closes at Rs.95 then his MTM loss will be 1000 X 5 =Rs.5000 which is to be paid by client on T+1 basis.

Is it compulsory for the client to pay Mark to Market margin?

Trading members are required to pay mark to market margin to the exchange for the open

positions of all their clients in futures contracts. It is compulsory for clients to meet their

mark–to–market obligations towards the Trading member for any losses arising on their open positions. Similarly, profit on the same will be credited to the account of the client

by the Trading member.

What steps can be taken by the Trading member in case of non-payment of margin

by the client?In case of non-payment of daily settlement by the client within the next trading day, the

Trading Member has the liberty to square up the client’s position by selling or buying thederivatives contracts, as the case may be, unless the constituent already has an equivalent

credit with the Trading Member. The loss incurred in this regard, if any, shall be met from

the margin money of the client.

Can the investor square up his position any time before expiry?

The investor can square up his position at any time till the expiry. The investor can first buy and then sell futures to square up or can first sell and then buy futures to square up

his position.

What are Daily Settlement and Final Settlement?

Daily Settlement: At the end of each trading session, Daily Settlement takes place. The

outstanding positions are marked to market at the daily settlement price. This means that

the difference between the Net Traded Value of the futures position in any contract andthe value of the open position in the same contract at the futures closing price (Mark to

Market Value) is calculated. Any profit arising out of this difference is paid out to the

client on T+1 day, while losses arising on the open position are required to be paid to theexchange on T+1 day.



Final Settlement: The Final Settlement of the current month contract takes place on the

last trading which is the last Thursday of Contract Expiry Month. In case the last

Thursday is a public holiday, the Final settlement is done on the previous working day. Incase of final settlement, the outstanding positions are closed out at the Final Settlement

Price, which is the closing price of the underlying (stock or index) in the cash market. Thenet difference is credited or debited, as the case may be, on the T+1 day. This completesthe entire settlement process for that contract.

Are Futures settled in cash or by giving / taking delivery of underlying stock?

Futures are settled in cash and there is no delivery settlement.

How is the Final Settlement Price determined?

The closing value of underlying Index / stock in the cash market is taken as the final

settlement price of the index / futures contract on the last trading day of the contract for

settlement purpose.

faq on futures

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