EQUITY RESEARCH LAB: STOCK FUTURES

STOCK FUTURE TIPS 

Future contract is the standardized transaction taking place on the futures exchange. Futures market was designed to solve the problems that are exist in forward market. A futures contract is an agreement between two parties, to buy or sell an asset at the certain time in the future at the certain price, but unlike forward contracts, futures contracts are the standardized and exchange traded To facilitate liquidity in the futures contracts, the exchange specifies the certain standard quantity and quality of the underlying instrument that can be delivered, and a standard time for such a settlement. Futures’ exchange has the division or subsidiary called a clearing house that performs the specific responsibilities of the paying and collecting daily gains and losses as well as guaranteeing performance of one party to the other. The future's contract can be offset prior to the maturity by entering into an equal and opposite transaction. More than 99% of the futures transactions are offset this way. Yet the another feature is that in the futures contrat gains and losses on the each party’s position is credited or charged on the daily basis, this process is called daily settlement or marking to market. Any person who entering into the futures contract assumes  long or short position, by a small amount to clearing house are called the margin money

The standardized items in the futures contract are:

•     Quantity of the underlying

•     Quality of the underlying

•     The dates and months of delivery

•     The units of price quotation and minimum price change

•     Location of settlement

 

FUTURES TERMINOLOGY

1. SPOT PRICE: The price at which an asset trades in the spot market.
2. FUTURES PRICE: The price at which the futures contract trades in the futures market.
3. CONTRACT CYCLE: The period over which a contract trades. The index futures contracts on the NSE have one month, two months and three months expiry cycles that expires on the last Thursday of the month. Thus a contract which is to expire in January will expire on the last Thursday of January.
4. EXPIRY DATE: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist.
5. CONTRACT SIZE: It is the quantity of asset that has to be delivered under one contract. For instance, the contract size on NSE’s futures market is 200 Nifties.
6. BASIS: In the context of financial futures, basis can be defined as the futures price minus the spot price. There will be different basis for each delivery month, for each contract. In a normal market, basis will be positive; this reflects that the futures price exceeds the spot prices.
7. COST OF CARRY: The relationship between futures price and spot price can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest paid to finance the asset less the income earned on the asset.
8. INITIAL MARGIN: The amount that must be deposited in the margin account at the time when a futures contract is first entered into is known as initial margin.
9. MARK TO MARKET: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor’s gain or loss depending upon the futures closing price. This is called Marking-to-market.
10. MAINTENANCE MARGIN: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day.

Stock futures contract
It is the contractual agreement to trade in stock/ shares of the company on a future date. Some of the basic things in the futures trade as specified by the exchange are:

• Contract size
• Expiration cycle
• Trading hours
• Last trading day
• Margin requirement

Advantages of stock futures trading

• Investing in futures is less costly as there is only initial margin money to be deposited
• A large array of strategies can be used to hedge and speculate, with smaller cash outlay there is greater liquidity

Disadvantages of stock futures trading

• The risk of losses is greater than the initial investment of margin money
• The futures contract does not give ownership or voting rights in the equity in which it is trading
• There is greater vigilance required because futures trades are marked to market daily

INDEX DERIVATIVES
Index derivatives are the derivative contracts that has the index as the underlying. The most popular index derivatives contract are the index futures and index options. NSE’s market index - the S&P CNX Nifty are the examples of exchange traded index futures. An index is the broad-based weighted average of the prices of selected constituents that form the part of the index. The rules for construction of the index are defined by the body that creates the index. The Trading in stock index futures was first introduced by the Kansas City Board of Trade in 1982.

Advantages of investing in stock index futures

•  Diversification of the risks as the investor is not investing in a particular stock
• Flexibility of changing the portfolio and adjusting the exposures to particular stock index, market or industry

 OPTIONS

An option is a contract, or a provision of the contract, that gives one party (the option holder) the right, but not the obligation, that perform the specified transaction with another party (the option issuer or option writer) according to the specified terms. The owner of the property might sell another party an option to purchase the property any time during the next three months at the specified price. For every buyer of an option there must be a seller. The seller is then often referred to as the writer. As with futures, options are brought into existence by being traded, if none is traded, none exists; conversely, that there is no limit to the number of option contracts that can be in existence at any time. As with the futures, the process of closing out options positions will cause contracts to the cease to exist, diminishing the total number. Thus an option is the right to buy or sell a specified amount of a financial instrument at the pre-arranged price on or before a particular date. There are two options which can be exercised:

• Call option, the right to buy is referred to as a call option.
• Put option, the right to sell is referred as a put option.

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