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Stock Futures


1. What are Stock Futures ?

Stock Futures are financial contracts where the underlying asset is an individual stock. Stock Future contract is an agreement to buy or sell a specified quantity of underlying equity share for a future date at a price agreed upon between the buyer and seller. The contracts have standardized specifications like market lot, expiry day, unit of price quotation, tick size and method of settlement.


2. How are Stock Futures priced?

The theoretical price of a future contract is sum of the current spot price and cost of carry. However, the actual price of futures contract very much depends upon the demand and supply of the underlying stock. Generally, the futures prices are higher than the spot prices of the underlying stocks.

Futures Price = Spot Price + Cost of Carry

Cost of carry is the interest cost of a similar position in cash market and carried to maturity of the futures contract less any dividend expected till the expiry of the contract.

Example:

Spot Price of Infosys = 1600, Interest Rate = 7% p.a. Futures Price of 1 month contract=1600 + 1600*0.07*30/365 = 1600 + 11.51 = 1611.51


3. How are Stock Futures different from Stock Options?

In stock options, the option buyer has the right and not the obligation, to buy or sell the underlying share. In case of stock futures, both the buyer and seller are obliged to buy/sell the underlying share.

Risk-return profile is symmetric in case of single stock futures whereas in case of stock options payoff is asymmetric.

Also, the price of stock futures is affected mainly by the prices of the underlying stock whereas in case of stock options, volatility of the underlying stock affect the price along with the prices of the underlying stock.



4. What are the opportunities offered by Stock Futures?

Stock futures offer a variety of usages to the investors. Some of the key usages are mentioned below:
  • Investors can take long term view on the underlying stock using stock futures.
Stock futures offer high leverage. This means that one can take large position with less capital. For example, paying 20% initial margin one can take position for 100 i.e. 5 times the cash outflow.

Futures may look overpriced or underpriced compared to the spot and can offer opportunities to arbitrage or earn risk-less profit. Single stock futures offer arbitrage opportunity between stock futures and the underlying cash market. It also provides arbitrage opportunity between synthetic futures (created through options) and single stock futures.

When used efficiently, single-stock futures can be an effective risk management tool. For instance, 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 futures contract.


5 How are Stock Futures settled ?

Presently, stock futures are settled in physical . The final settlement price is the closing price of the underlying stock.



6. Can I square up my position ?

The investor can square up his position at any time till the expiry. The investor can first buy and then sell stock futures to square up or can first sell and then buy stock futures to square up his position. E.g. a long (buy) position in December ACC futures, can be squared up by selling December ACC futures.


7. When am I required to pay initial margin to my broker ?

The initial margin needs to be paid to the broker on an up-front basis before taking the position.


8. Do I have to pay mark-to-market margin ?

Yes. The outstanding positions in stock futures are marked-to-market daily. The closing price of the respective futures contract is considered for marking to market. The notional loss / profit arising out of mark to market is paid / received on T+1 basis.


9. What are the profits and losses in case of a Stock Futures position ?

The 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. Let an investor have a long position of one November Stock "A" Futures @ 430. If the investor square up his position by selling November Stock "A" futures @ 450, the profit would be Rs. 20 per share. In case, the investor squares up his position by selling November Stock "A" futures @ 400, the loss would be Rs. 30 per share.


10. What is the market lot for Stock Futures ?
For market lot ands other details of the various stock futures available on BSE, please visit the F&O List Section



11. Why are the market lots different for different stocks ?

According to L.C.Gupta Committee Report on Derivatives, at the time of introduction of Derivatives Contracts on any underlying the value of the contract should be at least Rs. 2 lakhs. This value of Rs. 2 lakhs is divided by the market price of the individual stock to arrive at the initial 'market lot' for it. It may be mentioned here that the only exception to this rule is the 'mini' contract on the S&P BSE SENSEX (both futures and Options).

Similarly, you can enter an order for Sell Nov Dec stating the difference you want to receive. This would mean that you are selling a December Contract and buying a November Contract and receiving the difference.


12. What are the different contract months available for trading ?

1, 2 and 3 months contracts are presently available for trading. However, in case of S&P BSE SENSEX Options, SEBI has allowed the introduction of Long Dated Options or options with maturities of up to 3 years.


13. What is spread trading on BSE ?

One can trade in spread contracts on the Derivative Segment of BSE. Spreads are the contracts for differential price. This means that in case you want to buy a December contract and sell November contract, you can enter an order for Buy Nov Dec stating the difference you want to pay. This would mean that you are buying a December Contract and selling a November contract.
Deposit upfront the initial margin

Similarly, you can enter an order for Sell Nov Dec stating the difference you want to receive. This would mean that you are selling a December Contract and buying a November Contract and receiving the difference.


14. As an investor, how do I start trading in Stock Futures ?

You need to first register yourself as a client with a Registered Broker by fulfilling all the KYC or Know Your Client rules. Then, sign up the client agreement form and risk disclosure document provided to you by your broker.

Deposit upfront the initial margin

Now start trading!!


15. What securities can I submit to the broker as collateral ?

You can pay initial margin in non-cash (bank guarantee, securities) form also. This is an arrangement between you and your broker, as to which securities he/she is willing to accept. However, the mark-to-market loss incurred on a daily basis has to be settled in cash, only.


16. How does an investor, who has the underlying stock, use Stock Futures when he anticipates 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.


17. How can an investor benefit from a predicted rise or predicted fall in the price of a stock ?

An investor can benefit from a predicted rise in the price of a stock by buying futures. As the price of the futures rises, the investor will make a positive return. 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.

An investor can benefit from a predicted fall in the price of stock by selling futures. As the price of the future falls in line with the underlying stock, the investor will make a positive return.


18. What is pair trading ?

This trading strategy involves taking a position on the relative performance of two stocks. It is achieved by buying futures on the stock expected to perform well and selling futures on the stock anticipated to perform poorly. The overall gain or loss depends on the relative performance of the two stocks.

Similarly it is possible to take a position in the relative performance of a stock versus a market index. For example, traders who would like to take only company specific risk could buy/sell the relative index future.