Future and option

1. FUTURE AND OPTIONS
PART 1
Parvesh Aghi

2. Question 1
» You are mildly bullish on the market & want to go long .
» You entered into following contracts
» Required :
(1) What is the total cost ?
(2) What the maximum profit ?
(3) What is the maximum loss?
(4) At what is the breakeven level of Nifty
(5) What is this strategy called ?
2
Contract Act Strike At premium
OPT-NIFTY-28-May-2020-CE Buy 9150 at 235
OPT-NIFTY-28-May-2020-CE Sell 9200 at 205.15

3. BULL CALL SPREAD
3
75X 50 = 3750- 2238.75= 1511.25
9150 +( 235-205.15 ) = 9179.85
Break even level
Total cost & maximum loss 235-205.15 X75 = 2238.75

4. Answer
4

5. 5

6. Buy Nifty at 9125 with stop loss 9063.6 ( SLTP 9100)
6

7. BULL CALL SPREAD
7
75X 50 = 3750- 2238.75= 1511.25
9150 +( 235-205.15 ) = 9179.85

8. TYPES OF DERIVATIVES
FORWARDS
FUTURES
OPTIONS
SWAPS
Forward contract is a non-standardized contract between two parties to buy or
to sell an asset at a specified future time at a price agreed upon today.
Similar to Forwards . Standardized , regulated and traded on stock/commodity exchanges
A contract giving the right ,but not the obligation , to buy or sell a security
for e.g cinema ticket
A contract to exchange stream of cash flows based on certain events -Interest rates
,Currencies , Commodities prices, CDS

9. FORWARD CONTRACT ( FC)
9
FC is a direct agreement between a buyer and a seller
obligating the Seller to deliver a specified asset of
specified quality and quantity to the Buyer on a
Specified date at a specified place
The buyer in turn is obligated to pay the seller a
pre-negotiated price in exchange for the delivery
Forwards are not marketable once a firm enters into
a forward contract there is no convenient way to
trade out of it .

10. FUTURES CONTRACTS
10
By contrast in a spot contract there is an agreement
to buy or sell the asset immediately (or within a very
short period of time)
A futures contract is a standardized contract between
two parties to buy or sell a specified asset of
standardized quantity and quality for a price agreed
upon today (the futures price ) with delivery and
payment occurring at a specified future date, the
delivery date.
The contracts are negotiated at a futures exchange,
which acts as an intermediary between the two
parties

11. Introduction
NSE commenced
trading in
derivatives June
12, 2000.
Index futures
Futures contracts
are based on the
Nifty 50 Index.
Lot size 75
11

12. Introduction
Futures on
shares.
Index options
based on
NIFTY .
Options on
shares
12

13. Introduction
F &O on individual
securities are
available on 147
securities
F & O contracts
based on Nifty IT,
Nifty Bank, and
Nifty Midcap 50,
Nifty Infrastructure,
Nifty PSE, Nifty
CPSE indices.
13

14. IMPORTANT CONCEPTS
14

15. FUTURES
CASH MARKET
FUTURES
MARKET
F= Spot + *Cost
of carry
Hindustan lever
Spot = Rs1968
7/05/2020
Hindustan lever
Futures =
Rs 1973 ( May)
15
*Cost of carry = interest cost
- dividend earned

16. Positions in Futures market
Long position
( buy futures )
BULLISH
If you are
bullish on a
stock you buy
futures
16

17. Positions in futures market
Short position
( Sell futures )
BEARISH
If you are
bearish on a
stock you sell
futures
17

18. You pay span and exposure margin
Exposure
Margin
SPAN
Margin
Not the full
amount as in
the cash
market
18

19. Example : Stock HUL lot size 300
»300 x 1968 = 5,90,400 : 1,52,546/ 5,90,400= 25.83%
19

20. Contract Cycle
Futures contracts have a maximum of three-month trading
cycle - the near month (one), the next month (two) and the
far month (three).
New contracts are introduced on the trading day following the
expiry of the near month contracts.
The new contracts are introduced for three month duration.
At any point in time, there will be three contracts available for
trading in the market i.e., one near month, one mid month
and one far month duration respectively.
20

21. Example:
Contract month Expiry/settlement
May 2020 May 28
June 2020 June 25
July 2020 July 30
21
Futures contracts in Nifty in May 2020

22. Trading window
22

23. How are the futures contracts settled in India?
Square
off
Physical
Delivery
23
From October 2019, all stocks in the derivatives segment
will be physically settled, if you fails to square-off your
position before the expiry date.
.

24. How are the futures contracts settled in India?
» The futures contracts can be settled on daily mark to
market basis and final settlement basis (expiry).
» Before expiry, the settlement is done on cash basis,
where the difference in the closing price are looked into
for calculating the gains or losses on any position.
» In case of MTM settlement, the difference between
previous day price and settlement day price is determined
and the same is credited to and debited from the account.
» In case of final settlement before expiry, the gains and
losses are calculated in similar manner where the
difference between previous day settlement price and
final settlement price offer gains or losses.
» 24

25. How are the futures contracts settled in India?
»From October 2019, all stocks in the derivatives
segment will be physically settled, if you fails to
square-off your position before the expiry date.
»If you don’t square off your derivatives positions
in the stocks before the close of trading hours on
the expiry day, you will either have to take
delivery (for long futures, long calls, short
puts) or give delivery of the underlying stock
(for short futures, long puts, short calls) for the
contract.
25

26. Squaring off
This means closing a
futures contract by
taking a position which
is opposite to the
position taken originally.
26

27. Example of squaring off
» You are a day trader or derivative trader
» 10 am you entered in a long position (BUY) of DISHTV LTD at
Rs 100 for 5000 shares
» Now let's say at 1pm DISHTV Is trading at 101
» Now you can simply book profit by entering in short position
(SELL) At Rs 101 By selling your shares at Rs 101 means
squaring off position
» SO it simply means entering into opposite position
» If u are already long, you can short in order to square off
» OR If you are already short then you can enter into long
position to square off
27

28. Another example
»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
28

29. What Is Physical Settlement?
So far, trading in futures and
options in India was cash-
settled. That means upon
expiry of the contract, buyers
or sellers settle their position
in cash without taking delivery
of the underlying.
29

30. Example
To explain it better, consider this example of Reliance
Industries Ltd., one of the most liquid stocks in the
futures and options segment. As of now, buying RIL
futures or options don’t mean owning its shares in a
demat account.
But with physical settlement, if traders don’t close or
rollover their position till expiry date, they will be
required to pay the remaining amount upon delivery of
shares to their demat account as part of the settlement.
30

31. So, if a trader buys one lot of RIL, which is 500
shares, he’s required to pay margin .The
margin ranges between 15 percent and 35
percent depending on the volatility of the stock.
The trade is leveraged as the trader is not
immediately required to pay the entire contract
value which can be around Rs 6
31

32. How Physical Settlement Happens Stock Futures:
If traders initiate a long trade on a security
and the contract is not closed till expiry,
they will have to compulsorily take
delivery of shares against the derivative
position and pay the full contract value—
from above example total Rs 6.5 lakh—
and pay securities transaction tax
applicable in cash market.
32

33. If traders sell stock futures and the position is not
covered or rolled over till expiry, they will have to give
delivery of shares—a trader will have to deliver 500
shares of RIL.
If a trader doesn’t own 500 shares, he will have to pay
the penalty by participating in the auction where he’ll
have to purchase the shares from the market at a price
higher than the current market price.
33

34. Precautions
If the trader is holding short positions, then he/she
should remain watchful and make sure to square off.
Alternatively, one should make sure he has equivalent
amount of shares lying in his Demat account for a back-
up and avoid any shortfall of delivery, as it may lead to
the broker making purchases from the auction market,
thus slapping him with the price difference.
If a trader wants to avoid either of these situations, he
should make an early rollover on or before Monday of
the expiry.
34

35. Settlement Mechanism : Futures
Daily Mark-
to-Market
Settlement
Final
Settlement
35

36. Daily Mark-to-Market Settlement
Value of the contract is marked to its
current market value
Gains and losses are settled on each
trading day
36

37. For example
If an investor buys 1 lot (200 shares) of Futures on Stock A
on 10th September 2019, when the price was Rs 2500, he
was suppose to give a margin of 15% of the lot value i.e.
15%*200*2500 = Rs 75,000.
On 11th September, next trading day, the Futures prices
closes on Rs 2530, then the investor has made a gain of Rs
6000(Rs 30*200).
This gain would be credited in his account and debited from
the account of the seller on account of mark to market
settlement. The position would start from Rs 2530 from the
next day.
37

38. Daily Mark-to-Market Settlement
Daily settlement is the process where the closing market price is
determined at the end of each trading day in order to settle the
profit or loss between the long and the short
The profits/ losses are computed as the difference between the
trade price or the previous day's settlement price, as the case
may be, and the current day's settlement price.
Closing price of the futures contracts on Individual security /
Index on the trading day :
closing price for a futures contract shall be calculated on the
basis of the last half an hour weighted average price across
exchanges of such contract
38

39. Final Settlement
» On the expiry of the futures contracts, NSE Clearing marks all
positions to the final settlement price and the resulting profit / loss is
settled in cash.
» The final settlement of the futures contracts is similar to the daily
settlement process except for the method of computation of final
settlement price.
» The final settlement profit / loss is computed as the difference
between trade price or the previous day's settlement price, as the
case may be, and the final settlement price of the relevant futures
contract.
» Final settlement loss/ profit amount is debited/ credited to the relevant
CMs clearing bank account on T+1 day (T= expiry day).
» Open positions in futures contracts cease to exist after their expiration
day
39

40. Final settlement price
» Index - Closing price of the relevant underlying
index in the Capital Market segment of NSE, on
the last trading day of the futures contract.
»Individual securities - Closing price of the relevant
underlying security in the Capital Market segment
across exchanges, on the last trading day of the
futures contract.
40

41. Introduction
The National Stock Exchange of India Limited (NSE)
commenced trading in derivatives with the launch of index
futures on June 12, 2000.
The futures contracts are based on the popular benchmark
Nifty 50 Index.
The Exchange introduced trading in Index Options (also
based on Nifty 50) on June 4, 2001. NSE also became the
first exchange to launch trading in options on individual
securities from July 2, 2001.
41

42. Introduction
Futures on individual securities were
introduced on November 9, 2001. Futures and
Options on individual securities are available
on 147 securities stipulated by SEBI.
The Exchange has also introduced trading in
Futures and Options contracts based on Nifty
IT, Nifty Bank, and Nifty Midcap 50, Nifty
Infrastructure, Nifty PSE, Nifty CPSE indices.
42
Central public sector enterprises (CPSEs)

43. Products
Since the launch of the Index Derivatives on the
popular benchmark Nifty 50 Index in 2000, the
National Stock Exchange of India Limited (NSE)
today have moved ahead with a varied product
offering in equity derivatives.
The Exchange currently provides trading in
Futures and Options contracts on 9 major
indices and more than 100 securities.
43

44. What is a derivative?.
»F
44
Derivatives have risen from the need to
manage the risk arising from movements
in markets beyond our control, which
may severely impact the revenues and
costs of the firm.
Derivatives are used to shift risk and
act as a form of insurance

45. Derivatives : A risk reduction tool
45
Firms are exposed to several risks in the
ordinary course of operations and
borrowing funds
For some risks, management can obtain
protection from an insurance company
(fire, loss of profit , loss of stock, marine
insurance)

46. 46
Similarly, there are capital market products
available to protect against certain risks.
Such risks include :
- Risks associated with a rise in the price of
commodity purchased as an input
- A decline in a commodity price of a product
the firm sells
- A rise in the cost of borrowing funds
- An adverse exchange rate movement.
The instruments that can be used to provide such
protection are called derivative instruments

47. 47
Derivatives are generally used as an instrument
to hedge risk, but can also be used for
speculative purposes.
For example, a American investor purchasing
shares of an Indian company off of an Indian
exchange (using Rupee to do so) would be
exposed to exchange-rate risk while holding
that stock. To hedge this risk, the investor
could purchase currency futures to lock in a
specified exchange rate for the future stock
sale and currency conversion back into dollars

48. 48
For example, if an Indian company expects
payment for a shipment of goods in Dollars
, it may enter into a forward contract with
another party to reduce the risk that the
exchange rate with the rupee will be more
unfavorable at the time the bill is due and paid.
Derivatives are risk-shifting devices. Initially,
they were used to reduce exposure to
changes in such factors as foreign exchange
rates, interest rates, or stock indexes.

49. 49
Under the derivative instrument, the other
party is obligated to pay the company the
amount due at the exchange rate in effect
when the derivative contract was executed.
By using a derivative product, the company
has shifted the risk of exchange rate
movement to another party.

50. Derivatives : Definition
50
A derivative is a financial instrument or
a financial contract, whose value is
derived from one or more underlying
assets.
The most common underlying assets
include stocks, bonds, commodities,
currencies, interest rates and market
indexes.

51. WHAT IS A DERIVATIVE ?
A Derivatives is any security whose
price is determined by the value of
another asset.
--- This asset is called the underlying security , or
simply , the “Underlying”
UNDERLIYING
PRICE
CHANGE
DERIVATIVE
PRICE
CHANGE

52. WHY DO DERIVATIVES EXIST ?
TWO PURPOSES
HEDGING SPECULATION

53. TYPES OF DERIVATIVES
FORWARDS
FUTURES
OPTIONS
SWAPS
Forward contract is a non-standardized contract between two parties to buy or
to sell an asset at a specified future time at a price agreed upon today.
Similar to Forwards . Standardized , regulated and traded on stock/commodity exchanges
A contract giving the right ,but not the obligation , to buy or sell a security
for e.g cinema ticket
A contract to exchange stream of cash flows based on certain events -Interest rates
,Currencies , Commodities prices, CDS

54. FORWARD CONTRACT ( FC)
54
FC is a direct agreement between a buyer and a seller
obligating the Seller to deliver a specified asset of
specified quality and quantity to the Buyer on a
Specified date at a specified place
The buyer in turn is obligated to pay the seller a
pre-negotiated price in exchange for the delivery
Forwards are not marketable once a firm enters into
a forward contract there is no convenient way to
trade out of it .

55. FUTURES CONTRACTS
55
By contrast in a spot contract there is an agreement
to buy or sell the asset immediately (or within a very
short period of time)
A futures contract is a standardized contract between
two parties to buy or sell a specified asset of
standardized quantity and quality for a price agreed
upon today (the futures price ) with delivery and
payment occurring at a specified future date, the
delivery date.
The contracts are negotiated at a futures exchange,
which acts as an intermediary between the two
parties

56. Forward Contracts vs Futures Contracts
Forward Futures
Private contract between two
parties
Traded on an exchange
Not standardized Standardized
Usually one specified delivery
date
Range of delivery dates
Settled at end of contract Settled daily
Delivery or final settlement
usual
Usually closed out prior to
maturity
Some credit risk Virtually no credit risk

57. 57
How Future contract is different from the underlying
stock :
• When you buy a stock you pay full value of the
transaction ( i.e. the number of shares multiplied by
market price of each share).
•There is no time component , you own the stock for
all times to come.
•You make a loss or profit only when you sell the
shares you own.
•There is no way of taking a position on the index
through cash market .
•The cash market has a market lot of one. i.e. you can
buy any stock in the multiples of one unit.

58. When you trade futures
58
Long is the equivalent of initiating a futures
position by buying a future contract and
squaring up by selling it.
Short is the equivalent of initiating the position
by first selling a future contract and then
squaring up by buying it back.
You pay only margin which is a fractional
portion of the total transaction value, generally
about 15% in case of index futures, and up to
50% in the case of individual stock futures

59. 59
All the future contracts are dated . For example
, Indian futures and option settlement takes
place on last Thursday of every month. So
the current month futures expire on the
month’s last Thursday. If the trader has to
carry his position to the next month ,he has to
shift his position to the next month future.
Futures are generally traded using technical
analysis because product facilitates speculation.
You can go long or short on futures depending upon
the short term view of the market and or a stock

60. On expiry date, all the contracts are
compulsorily settled. If a contract is to
be continued then it must be rolled to
the near future contract. For a long
position, this means selling the
expiring contract and buying the next
contract. Both the sides of a roll over
should be executed at the same time.
60

61. Basis
Basis: The difference between the spot
price and the futures price is called basis.
If the futures price is greater than spot
price, basis for the asset is negative.
Similarly, if the spot price is greater than
futures price, basis for the asset is
positive. On December 9, 2019, spot
price > future price thus basis for nifty
futures is positive i.e. (11899.15 -
11897.65 = Rs 1.50).
61

62. Basis
It is also important to understand that
the basis difference between say one
month and two months futures contract
should essentially be equal to the cost
of carrying the underlying asset
between first and second month.
Indeed, this is the fundamental of
linking various futures and underlying
cash market prices together.
62

63. Basis
During the life of the contract, the basis may become
negative or positive, as there is a movement in the futures
price and spot price.
Further, whatever the basis is, positive or negative, it turns to
zero at maturity of the futures contract i.e. there should not
be any difference between futures price and spot price at the
time of maturity/ expiry of contract.
This happens because final settlement of futures contracts
on last trading day takes place at the closing price of the
underlying asset.
63

64. Futures Price
64
The futures prices for a particular contract is
the price at which you agree to buy or sell
It is determined by supply and demand in the
same way as a spot price

65. 65
How Stock Futures are 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
Fair price = Spot price + Cost of carry - Inflows

66. In mathematical terms, F = S (1+r-q)T
Where F is fair price of the futures contract, S is the
Spot price of the underlying asset, q is expected return
during holding period T (in years) and r is cost of carry.
If we use the continuous compounding, we may rewrite
the formula as: F= Se(r-q)*T
66

67. Let us apply the above formula to the index futures
market to find the synthetic futures price/ future fair
price of an index. Suppose , you buy an index in cash
market at 5000 level i.e. purchase of all the stocks
constituting the index in the same proportion as they
are in the index, cost of financing is 12% and the
return on index is 4% per annum (spread uniformly
across the year). Given this statistics, fair price of
index three months down the line should be:
= Spot price (1+cost of financing – holding period return)
^ (time to expiration/365)
67

68. = 5000 (1+0.12-0.04)^(90/365)
= Rs. 5095.79
• [Alternatively, we could use exponential form for
calculating the futures value as spot price * e(r-q)T.
Value in that case would have been 5000 * e((0.12-
0.04)*90/365) = Rs. 5099.61].
• If index futures is trading above 5099, we can buy index
stocks in cash market and simultaneously sell index
futures to lock the gains equivalent to the difference
between futures price and future fair price (the cost of
transaction, taxes, margins etc. are not considered
while calculating the future fair value).
68

69. Cost of Carry
Cost of Carry is the relationship between futures prices and
spot prices.
It measures the storage cost (in commodity markets) plus the
interest that is paid to finance or ‘carry’ the asset till delivery
less the income earned on the asset during the holding
period.
For equity derivatives, carrying cost is the interest paid to
finance the purchase less (minus) dividend earned.
69

70. Cost of Carry
For example, assume the share of ABC Ltd is trading at Rs.
100 in the cash market. A person wishes to buy the share,
but does not have money.
In that case he would have to borrow Rs. 100 at the rate of,
say, 6% per annum. Suppose that he holds this share for one
year and in that year he expects the company to give 200%
dividend on its face value of Rs. 1 i.e. dividend of Rs. 2.
Thus his net cost of carry = Interest paid – dividend received
= 6 – 2 = Rs. 4. Therefore, break even futures price for him
should be Rs.104.
70

71. 71
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 Stock “X" = 4000, Interest Rate = 12% p.a.
Futures Price of 1 month contract = 4000 + 4000*0.12*30/365
= 4000 + 40
= 4040

72. Futures
» A future contract is a standardized forward contact
between two parties where one of the parties commits
to sell and other to buy a stipulated quantity of a
security or an index at an agreed price on or before a
given date in the future
Seller Buyer
A B
Future price = spot price +carry cost
CLEARING
HOUSE
A future contract is a standardized forward contact
between two parties where one of the parties commits
to sell and other to buy a stipulated quantity of a
security or an index at an agreed price on or before
a given date in the future

73. Futures in India
73
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
MCX=Multi Commodity Exchange of India ,NCDX=National commodity & derivative exchange

74. FUTURES
FUTURES
Individual stock
future
Index futures
Underlying asset is
the individual stock
Underlying asset is the
stock
Index
Bombay Sensex future Nifty Future

75. 75
Let us take an example of a simple derivative
contract:
Shayam buys a futures contract.
He will make a profit of Rs 800 if the price of
TCS rises by Rs 800.
If the price is unchanged Shayam will receive
nothing.
If the stock price of TCS falls by Rs 600
he will lose Rs 600.

76. 76
As we can see, the above contract depends
upon the price of the TCS scrip, which is
the underlying security.
Similarly, futures trading has already started
in Sensex futures and Nifty futures.
The underlying security in this case is the
BSE Sensex and NSE Nifty

77. What is span and exposure margin?
SPAN Margin is the minimum requisite margins
blocked for futures and option writing positions as per
the exchange’s mandate and ‘Exposure Margin’ is the
margin blocked over and above the SPAN to cushion
for any MTM losses.
Do note both SPAN and Exposure margin are
specified by the exchange. So at the time of initiating
a futures trade, the client has to adhere to the initial
margin requirement. The entire initial margin (SPAN +
Exposure) is blocked by the exchange.
77

78. 78

79. Example A.
79
On 01January an investor feels the market
will rise
– Buys 1 contract of December TATA STEEL .
Futures at Rs. 460 (market lot : 1500)
(Total margin to be deposited : 17.7% Rs 122130)
09 January
– TATA STEEL Futures price has risen to Rs. 470
– Sells off the position at Rs. 470.
Makes a profit of Rs.15,000
(1500*10) .

80. Example B.
80
On 01 January an investor feels the
market will fall
– Sells 1 contract of April TATA STEEL .
Futures at Rs. 460 (market lot : 1500)
12 January
– TATA STEEL . Futures price has fallen
to Rs. 455
– Squares off the position at Rs. 455
– Makes a profit of Rs.7500 (1,500*5) .

81. Example C.
81
An investor purchased 225 Nifty Futures @
Rs. 11200 on July 11.
Expiry date is July 27.
Total Investment : Rs. 25 ,20,000.
Initial Margin paid : Rs.2,52,000
On July 27, suppose, Nifty index closes at
10,080
Loss to the investor (11200 – 10080) X 225
= Rs. 2,52,000
The entire initial investment (i.e. Rs.2,52,000)
is lost by the investor

82. Example C.
82
An investor purchased 200 Nifty Futures @
Rs. 5200 on July 11.
Expiry date is July 27.
Total Investment : Rs. 10 ,40,000.
Initial Margin paid : Rs.1,04,000
On July 27, suppose, Nifty index closes at
4,680 Loss to the investor (5200 – 4680) X 200
= Rs. 1,04,000
The entire initial investment (i.e. Rs. 104,000)
is lost by the investor

83. »The market regulator Sebi permitted stock
exchanges to introduce Index options contracts on
the Sensex and the Nifty for a longer tenure of five
years.
Initially, on January 11, 2008, Sebi had set the tenure
for Index options trading for three years. Investors
who operate in Index options bet on the overall
movement of the stock market, constituting a basket
of stocks. Broadly, they enable investors to gain
access to the market as a whole or to its specific
segments/sectors ..
83

84. Contract Specifications
NSE’s Nifty Index Futures Contracts
Underlying index CNX Nifty
Contract Multiplier (Lot size) 75
Tick size
difference
or minimum price 0.05 index point (i.e., Re 0.05 or 5 paise)
Last trading day/ Expiration day Last Thursday of the expiration month. If it happens to be a holiday, the
contract will expire on the previous business day.
Contract months 3 contracts of 1, 2 and 3 month’s maturity. At the expiry of the nearest
month contract, a new contract with 3 months maturity will start. Thus, at
any point of time, there will be 3 contracts available for trading.
Daily settlement price Settlement
contract.
price of the respective futures
Final settlement price Settlement price of the cash index on the expiry
date of the futures contract.
84
Contract specifications include the salient features of a derivative contract
like contract maturity, contract multiplier also referred to as lot size, contract
size, tick size etc. An example contract specification is given below:

85. Price band
»Price Band is essentially the price range within
which a contract is permitted to trade during a
day.
»The band is calculated with regard to previous
day closing price of a specific contract. For
example, previous day closing price of a contract
is Rs.100 and price band for the contract is 10%
then the contract can trade between Rs.90 and
Rs.110 for next trading day
85

86. »On the first trading day of the contract, the price
band is decided based on the closing price of the
underlying asset in cash market.
»For example, Today is first trading day of a
futures contract for an underlying asset i.e.
company A. The price band for the contract is
decided on the previous day’s closing price of
company ‘A’ stock in cash market. Price band is
clearly defined in the contract specifications so
that all market participants are aware of the same
in advance.
86

87. Positions in derivatives market
Long position : Outstanding/ unsettled buy
position in a contract is called “Long Position”.
For instance, if Mr. X buys 5 contracts on
Sensex futures then he would be long on 5
contracts on Sensex futures. If Mr. Y buys 4
contracts on Pepper futures then he would be
long on 4 contracts on pepper.
87

88. Short Position :Outstanding/ unsettled sell
position in a contract is called “Short Position”.
For instance, if Mr. X sells 5 contracts on
Sensex futures then he would be short on 5
contracts on Sensex futures. If Mr. Y sells 4
contracts on Pepper futures then he would be
short on 4 contracts on pepper.
88

89. Open position
Outstanding/ unsettled either long (buy) or short (sell)
position in various derivative contracts is called “Open
Position”.
For instance, if Mr. X shorts say 5 contracts on Infosys
futures and longs say 3 contracts on Reliance futures, he is
said to be having open position, which is equal to short on 5
contracts on Infosys and long on 3 contracts of Reliance.
If next day, he buys 2 Infosys contracts of same maturity, his
open position would be – short on 3 Infosys contracts and
long on 3 Reliance contracts
89

90. Naked and calendar spread positions
Naked position in futures market simply means a long or
short position in any futures contract without having any
position in the underlying asset.
Calendar spread position is a combination of two positions
in futures on the same underlying - long on one maturity
contract and short on a different maturity contract.
For instance, a short position in near month contract
coupled with a long position in far month contract is a
calendar spread position.
90

91. »Calendar spread position is computed with
respect to the near month series and becomes an
open position once the near month contract
expires or either of the offsetting positions is
closed.
»A calendar spread is always defined with regard
to the relevant months i.e. spread between
August contract and September contract, August
contract and October contract and September
contract and October contract etc.
91

92. Future & Option daily turnover
92

93. 93

94. Contract specifications
94

95. 95

96. 96

97. What does compulsory physical delivery mean?
From October 2019 expiry, all stock
F&O contracts will be compulsorily
physically settled.
If you hold a position in any Stock
F&O contract, at expiry, you will be
required to give/take delivery of stocks
97

98. Physical settlement
»The deliverable quantity is computed as under
Unexpired Futures
Long futures shall result in a buy (security receivable) position
Short futures shall result in a sell (security deliverable) position
In-the-money call options
Long call exercised shall result in a buy (security receivable) position
Short call assigned shall result in a sell (security deliverable) position
In-the-money put options
Long put exercised shall result in a sell (security deliverable) position
Short put assigned shall result in a buy (security receivable) position
98

99. Physical settlement
» The quantity to be delivered/received shall be equivalent
to the market lot * the number of contracts that result in a
delivery settlement.
» This is a significant change to how these contracts were
settled earlier – by cash.
» Also, since most people trading F&O usually have just a
small portion of the overall contract value blocked as
margins (Futures and Short Options) or premium (Long
calls & puts), the actual obligation of taking or giving
delivery can be exponentially higher.
»
99

100. » This increases the risk for us as a brokerage firm significantly. Below is our
new policy on physically settled derivative contracts which is part of our
broader RMS (Risk Management) policy.
» Our policy
» Futures and Short Option (Calls & Puts) positions
» The margin requirement for all Stock F&O contracts will be increased 2 days
prior to expiry (Wednesday and Thursday of the expiry week) to twice of the
exchange mandated SPAN + Exposure margin required.
» These margins will be debited on your trading ledger. The increase in
exposure margin is to cover for the additional obligation that will arise if these
contracts are held until expiry and result in physical settlement.
» For example, if the margin required for Allahabad Bank futures is normally
25% as SPAN+Exposure of the contract value, it will be 50% of the contract
value on Wednesday and Thursday of the expiry week.
100

101. » You can check for the increased margin requirement on
our SPAN margin calculator.
» Long/Buy option (Calls & Puts) positions
» There will be a physical delivery margin charged for all In-
the-money(ITM) long options. This will be twice the
exchange mandated SPAN + Exposure margin charged
for the respective futures contract for the same expiry.
» Exchanges have defined Close to money (CTM) contracts
which are a subset of ‘in the money (ITM)’ or contracts
that expire with some intrinsic value.
101

102. For Call Options – 3 ITM options strikes immediately
below the final settlement price shall be considered as
‘CTM’. For example, if Wipro contract settles at 243 on
expiry day, call options with strike 230, 235, and 240 will
be marked as CTM contracts
For Put Options – 3 ITM options strikes
immediately above the final settlement price shall
be considered as ‘CTM’. For example, if Wipro
contract settles at 243 on expiry day, put options
with strike 245, 250, and 255 will be marked as
CTM contracts
102

103. »For example – in case of cash settlement, if
trader bought future for XYZ Ltd (lot size – 5000)
at Rs 100, then contract value is Rs 5,00,000 and
generally on an average he pays a margin of
20% (about Rs 100000).
» Suppose expiry day closing is Rs 102, then
contract had been settle on cash basis and he
will get a profit of Rs 10,000 and their margin has
been released (Note: margin could be in security
or cash basis).
103

104. »In case of physical settlement (considering above
example), if contract is open for exercise, then he
has to take delivery of 5000 shares and need to
pay contract value i.e. Rs 500000. And on this, he
has to bear cash segment STT, transaction cost,
brokerage.
104

105. »With this blast, traders have to face new
challenges and problems, some of them are in
line:-
»1. Delivery margin shall be applicable on all
potential In The Money long option positions 4
days prior to expiry of derivative contracts. It
should be likewise 20% on expiry – 4EOD, 40%
on expiry – 3EOD, 60% on expiry – 2EOD, 80%
on expiry – 1EOD.
105

106. »For example: If you have a long in the money call
option contract that is going to be expired on
Thursday, then the delivery margin shall be
applicable from previous Friday i.e. 20% on Friday,
40% on Monday, 60% on Tuesday & 80% on
Wednesday.
»2. If the trader has short position and contract is open
for exercise, then he has to give delivery of shares
and if they don’t have delivery of shares, then Broker
has to cover from Auction Market to settle in
exchange. Hence, short position consist higher risk in
physical settlement.
106

107. »Only short future, Only in the money short call
option, Only in the money long put option are the
some examples of short position contracts.
»3. Price Risk at the time of auction – After the
expiry on Thursday, auction for all undelivered
short position will be held on Tuesday. Normally,
Pay-in will be on Monday & in case of shortage,
auction will be conducted on Tuesday. Hence,
there is a rate difference risk in between
Thursday’s closing to Tuesday’s auction Price.
107

108. » For example- If the expiry day closing price of script is Rs
106 with a lot size of 5000 and contract is open for
exercise. And due to shortage of delivery, auction will be
held on Tuesday at Rs 112, so loss of Rs 30000 (6*5000)
has to be bear by Short Seller, which was not done in
cash settlement earlier.
» On the flipside, every challenge has some opportunity. As
a result, on next Tuesday after Thursday’s expiry,
Auctioneers would get better rate difference in F&O
segment companies for Arbitraging. For Example: In cash
– If Script is trading at Rs 110 then auctioneer is getting 1-
2% arbitrage benefit on that day which is much higher
than normal days.
108

109. »In gist, physical settlement increases the load of
STT, transaction charge, brokerage, higher funds
and even required higher margins. Hence,
everyone would get benefit except traders.
»Now the question arises, how trader would
protect himself from Exercise??? They require
“Do Not Exercise” by netting all potential open
future positions with In The Money option
contracts and vice-versa. But do not forget the
rule of CTM (Close to the Money).
109

110. Understanding index futures
110
A futures contract is an agreement between
two parties to buy or sell an asset at a certain
time in the future at a certain price.
Index futures are all futures contracts where
the underlying is the stock index
(Nifty or Sensex) and helps a trader to take a
view on the market as a whole
Index futures permits speculation and if a trader
anticipates a major rally in the market he can simply
buy a futures contract and hope for a price rise on
the futures contract when the rally occurs

111. 111
Each contract expires on the last Thursday
of the expiry month and simultaneously a new
contract is introduced for trading after expiry
of a contract

112. Example:
Contract month Expiry/settlement
Jan 2020 Jan 30
Feb 2020 Feb 27
March 2020 March 26
112
Futures contracts in Nifty in Jan 2020

113. Contract month Expiry/settlement
October 2013 October 31
November 2013 November 28
December 2013 December 26
113
On Sept 27
The permitted lot size is 50 or multiples thereof for the Nifty.
That is you buy one Nifty contract the total deal value
will be 50*5500 (Nifty value)= Rs 2,75,000.
In the case of BSE Sensex the market lot is 15. That is you buy
one Sensex futures the total value will be 15*18000 (Sensex
value)= Rs 2,70,000

114. Types of Traders in a Derivatives Market
114
HEDGERS- Protect themselves from the
risk associated with the price of an asset by using
derivatives
SPECULATORS- They actually bet on the future
movement in the price of an asset. never interested
in actual owing the commodity/security
ARBITRAGEURS- Arbitrators are the person who
take the advantage of a discrepancy between prices
in two different markets

115. Hedging
115
Stocks carry two types of risk – company specific
and market risk.
While company risk can be minimized by diversifying
your portfolio .Market risk cannot be diversified but
has to be hedged.
So how does one measure the market risk? Market risk
can be known from Beta

116. 116
Beta measures the relationship between movement
of the index to the movement of the stock.
The beta measures the percentage impact on the stock
prices for 1% change in the index. Therefore, for a
portfolio whose value goes down by 12% when the
index goes down by 10%, the beta would be 1.2.
When the index increases by 10%, the value of the
portfolio increases 12%.

117. 117
The idea is to make beta of your portfolio zero to
eliminate your losses.
Hedging involves protecting an existing asset position
from future negative price movements
In order to hedge a position, a investor needs to
take an equal and opposite position in the futures
market to the one held in the cash market.

118. 118
Assuming you have a portfolio of Rs 1 million, which
has a beta of 1.3, you can factor a complete hedge by
Selling Rs 1.3 mn of S&P CNX Nifty futures.
Steps:
Determine the beta of the portfolio.
Short sell the index in such a quantum that
the gain on a unit decrease in the index would
offset the losses on the rest of his portfolio

119. 119
This is achieved by multiplying the relative volatility of
the portfolio by the market value of his holdings
Therefore in the above scenario we have to
shortsell 1.3 * 1 million = 1.3 million worth of Nifty
Now let us study the impact on the overall
gain/loss that accrues:

120. Index up 10%
Index down 10%
Gain/(Loss) in
Portfolio
Rs 130,000 (Rs 130,000)
Gain/(Loss) in
Futures
(Rs 130,000) Rs 130,000
Net Effect Nil Nil
120
Now let us study the impact on the overall gain/loss that accrues

121. 121
As we see, that portfolio is completely insulated from
any losses arising out of a fall in market sentiment.
But as a cost, one has to forego any gains that arise
out of improvement in the overall sentiment
Then why does one invest in equities if all the gains will
be offset by losses in futures market.
The same methodology can be applied to a single
stock by deriving the beta of the scrip and taking
a reverse position in the futures market

122. HEDGING EXAMPLE
122
X’ holds HDFC bank worth Rs 7.4 lakh at
Rs1,234 per share on January 01, 2020.
Assuming that the beta of HDFC bank is 1.13.
How much Nifty futures does ‘X’ have to sell
If the index futures is ruling at 11,150 ?
To hedge he needs to sell 7.4 lakh * 1.13 =
Rs 8,36,200
lakh on the index futures i.e. 8,36,200/11,150
= 75 Nifty futures.

123. 123
On January 19, 2020, the Nifty futures is at
10600 and HDFC Bank is at 1207.
‘X’ closes both positions earning
Rs 25,050, i.e. his position on HDFC bank
drops by Rs 16,200 and his short
position on Nifty gains Rs 41250 (75*550).
Therefore, the net gain
is 41250-16200 = Rs 25,050

124. HEDGING EXAMPLE
124
X’ holds HDFC worth Rs 9 lakh at Rs 600 per
share on July 01, 2012. Assuming that the
beta of HDFC is 1.13. How much Nifty futures
does ‘X’ have to sell if the index futures is
ruling at 5085 ?
To hedge he needs to sell 9 lakh * 1.13 =
Rs 1017000
lakh on the index futures i.e. 1017000/5085
= 200 Nifty futures.

125. 125
On July 19, 2012, the Nifty futures is at
4700 and HDFC is at 570.
‘X’ closes both positions earning
Rs 32000, i.e. his position on HDFC
drops by Rs 45,000 and his short
position on Nifty gains Rs 77000 (200*385).
Therefore, the net gain
is 77000-45000 = Rs 32000.

126. EXAMPLE
126
Suppose you have a portfolio of Rs 1 crore.
The beta of the portfolio is 1.15 . The portfolio is to be
hedged by using Nifty futures contracts. Suppose the
current level of Nifty future is 5227. ( Market lot=50)
Find out the number of contracts in futures market to
neutralise risk
If the index is at 5227 * 50 (market lot) = Rs 2,61,350
The number of contracts to be sold is:
1.15*1 crore = 1.15 crores /2,61,350= 44 contracts
If you sell more than 44 contracts you are over
hedged and sell less than 44 contracts you are under
hedged. Thus, we have seen how one can hedge their
portfolio against market risk.

127. EXAMPLE
127
Suppose you have a portfolio of Rs 1 crore.
The beta of the portfolio is 1.15 . The portfolio is to be
hedged by using Nifty futures contracts. Suppose the
current level of Nifty future is 11200. ( Market lot=75)
Find out the number of contracts in futures market to
neutralise risk
If the index is at 11200 * 75 (market lot) = Rs 8,40,000
The number of contracts to be sold is:
1.15*1 crore = 1.15 crores /8,40,000= 13.7 contracts
If you sell more than 14 contracts you are over
hedged and sell less than 14contracts you are under
hedged. Thus, we have seen how one can hedge their
portfolio against market risk.

128. HEDGE RATIO
128
Hedge Ratio: The Hedge Ratio is defined as the number
of Futures contracts required to buy or sell so as to
Provide the maximum offset of risk.
This depends on
the
Value of a Futures contract;
Value of the portfolio to be Hedged; and
Sensitivity of the movement of the portfolio price to that
of the Index (Called Beta).
The Hedge Ratio is closely linked to the correlation
between the asset (portfolio of shares) to be hedged
and underlying (index) from which Future is derived.

129. Speculation
129
Speculators are those who do not have any position on
which they enter in futures and options market.
They only have a particular view on the market, stock,
commodity , currency etc.
In short, speculators put their money at risk in the hope
of profiting from an anticipated price change.
They consider various factors such as demand ,supply,
market positions, open interests, economic
fundamentals and other data to take their positions.

130. 130
Harish is a trader but has no time to track and analyze
stocks. However, he fancies his chances in predicting
the market trend. So instead of buying different stocks
he buys Index Futures.
On January 1, 2020, he buys 25 Sensex futures @ 41200
on expectations that the index will rise in future.
On January 24 , 2013, the Sensex rises to 41700 and at
that time he sells an equal number of contracts to
close out his position.
Selling Price : 41700*25 = Rs 10,42,500
Less: Purchase Cost: 41200*25 = Rs 10,30,000
Net gain = Rs 12,500

131. 131
Harish has made a profit of Rs 12,500 by taking a call
on the future value of the Sensex.
However, if the Sensex had fallen he would have
made a loss.
Similarly, if would have been bearish he could have
sold Sensex futures and made a profit from a falling
profit.
In index futures players can have a long-term view of
the market up to at least 3 months.

132. 132
Harish is a trader but has no time to track and analyze
stocks. However, he fancies his chances in predicting
the market trend. So instead of buying different stocks
he buys Index Futures.
On April 1, 2013, he buys 100 Sensex futures @ 18700
on expectations that the index will rise in future.
On April 24 , 2013, the Sensex rises to 19500 and at
that time he sells an equal number of contracts to
close out his position.
Selling Price : 19500*100 = Rs 19,50,000
Less: Purchase Cost: 18700*100 = Rs 18,70,000
Net gain = Rs 80,000

133. 133
Harish has made a profit of Rs 80,000 by taking a call
on the future value of the Sensex.
However, if the Sensex had fallen he would have
made a loss.
Similarly, if would have been bearish he could have
sold Sensex futures and made a profit from a falling
profit.
In index futures players can have a long-term view of
the market up to at least 3 months.

134. Arbitrage
134
An arbitrageur is basically risk averse. He
enters into those contracts were he can earn
riskless profits.
When markets are imperfect, buying in one
market and simultaneously selling in other
market gives riskless profit.
Arbitrageurs are always in the look out for
such imperfections.

135. 135
In the futures market one can take advantages
of arbitrage opportunities by buying from
lower priced market and selling at the higher
priced market.
In index futures arbitrage is possible between
the spot market and the futures market
(NSE has provided a special software
for buying all 50 Nifty stocks in the spot
market. )

136. 136
Take the case of the NSE Nifty.
Assume that Nifty is at 11200 and 3
month’s Nifty futures is at 11750.
The futures price of Nifty futures can
be worked out by taking the interest
cost of 3 months into account.
If there is a difference then arbitrage
opportunity exists.

137. 137
Let us take the example of single stock to
Understand the concept better.
If HCL is quoted at Rs 800 per share and
the 3 months futures of HCL is Rs 870 then
one can purchase HCL at Rs 800 in spot
by borrowing @ 12% annum for 3 months
and sell HCL futures for 3 months at Rs 870.
Sale = 870
Cost= 800+24 = 824
Arbitrage profit = 46

138. 138
These kind of imperfections continue to
exist in the markets but one has to be
alert to the opportunities as they tend to
get exhausted very fast.

139. Risk Containment mechanism
» NSE Clearing has developed a comprehensive risk
containment mechanism for the Futures & Options
segment.
» The most critical component of a risk containment
mechanism for NSE Clearing is the online position
monitoring and margining system.
» The actual margining and position monitoring is done on-
line, on an intra-day basis. NSE Clearing uses the
SPAN® (Standard Portfolio Analysis of Risk) system for
the purpose of margining, which is a portfolio based
system.
139

140. What is span and exposure margin?
SPAN Margin is the minimum requisite margins
blocked for futures and option writing positions as per
the exchange’s mandate and ‘Exposure Margin’ is the
margin blocked over and above the SPAN to cushion
for any MTM losses.
Do note both SPAN and Exposure margin are
specified by the exchange. So at the time of initiating
a futures trade, the client has to adhere to the initial
margin requirement. The entire initial margin (SPAN +
Exposure) is blocked by the exchange.
140

141. 141

142. MARGINS
142
Margins are financial guarantees required of
both buyers and sellers of futures contracts
to ensure that they fulfill their futures
contract obligations.
Daily margining is of two types:
1. Initial margin (span margin)
2. Exposure Margin

143. Initial margin
Before a futures position can be opened, there must be
enough available balance in the futures trader's margin
account to meet the initial margin requirement.
Upon opening the futures position, an amount equal to
the initial margin requirement will be deducted from the
trader's margin account and transferred to the
exchange's clearing firm. This money is held by the
exchange clearinghouse as long as the futures position
remains open.
143

144. Initial Margin
144
Before a futures position can be opened, there must
be enough available balance in the futures trader's
margin account to meet the initial margin requirement.
Upon opening the futures position, an amount
equal to the initial margin requirement will be
deducted from the trader's margin account and
transferred to the exchange's clearing firm.
This money is held by the exchange clearinghouse
as long as the futures position remains open.

145. Initial Margin
145
Margin is money deposited by both the buyer and
seller at the The time of taking a buy or sell call to
assure integrity of the contract
Minimum margins are set by the exchange are usually
About 10% of the total value of the contract , though
it can be more For highly volatile stock
The computation of initial margin on the futures
market is done using the concept of Value-at-Risk
(VaR).

146. 146
The initial margin amount is large enough
to cover a one-day loss that can be
Encountered on 99% of the days.
Several popular methods are deployed to
compute the initial margins. The margin
calculation is carried out using a software
called - SPAN® (Standard Portfolio Analysis
of Risk).

147. 147
VaR methodology seeks to measure the
amount of value that a portfolio may
stand to lose within a certain horizon
time period (one day for the clearing
corporation) due to potential changes in the
underlying asset market price.
Initial margin amount computed using
VaR is collected up-front.

148. Maintenance Margin
The maintenance margin is the minimum
amount a futures trader is required to maintain
in his margin account in order to hold a futures
position. The maintenance margin level is
usually slightly below the initial margin.
If the balance in the futures trader's margin
account falls below the maintenance margin
level, he or she will receive a margin call to top
up his margin account so as to meet the initial
margin requirement.
148

149. Exposure Margin : Futures
»The exposure margins for futures contracts on
index is 3% of the notional value of a futures
contracts.
»Futures Contract on individual Securities:
The higher of 5% or 1.5 standard deviation of the
notional value of gross open position in futures on
individual securities
»The standard deviation of daily logarithmic returns
of prices in the underlying stock in the cash market
in the last six months is computed on a rolling and
monthly basis at the end of each month.
149

150. Mark- to Market
150
The daily settlement process called
"mark-to-market"
provides for collection of losses that have
already occurred (historic losses) whereas
initial margin seeks to safeguard against
potential losses on outstanding positions.
The mark-to-market settlement is done
in cash.

151. 151
To cover for the risk of default by the counterparty for
the clearing corporation, the futures contracts are
marked-to-market on a daily basis by the exchange.
Mark to market settlement is the process of adjusting
the margin balance in a futures account each day for
the change in the value of the contract from the
previous day, based on the daily settlement price
of the future contracts

152. 152
This process helps the clearing corporation in
managing the counterparty risk of the future contracts
by requiring the party incurring a loss due to adverse
price movements to part with the loss amount on a
daily basis
Simply put, the party in the loss position pays the
clearing corporation the margin money to cover for
the shortfall in cash.
In extraordinary times, the Exchange can require a
mark to market more frequently (than daily).

153. 153

154. 154

155. 155

156. 156
Let us say, Initial Futures Price = Rs. 1000; Initial
Margin requirement = Rs. 500;
Maintenance Margin Requirement = Rs. 300;
Contract size = 10 (that is, one futures contract has
10 shares of XYZ.
How the end of day margin balance of the holder of
(i) a long position of a contract and (ii) a short position
(ii) of a contract, varies with the changes in
(iii) settlement price from day to day is given below.

157. »Let us say, Initial Futures Price = Rs. 1000; Initial
Margin requirement = Rs. 500; Maintenance
Margin Requirement = Rs. 300;
» Contract size = 10 (that is, one futures contract
has 10 shares of XYZ.
»How the end of day margin balance of the holder
of (i) a long position of a contract and (ii) a short
position of a contract, varies with the changes in
settlement price from day to day is given below.
157

158. Mark to market margin of a long position
Day Beginning
balance
Funds
deposited
Settlement
price
Future
price
change
Gain
/Loss
Ending
balance
0 0 500 1000 0 -
1 500 0 992 -8 -80 420
2 420 0 960 -32 -320 100
3 100 400 1010 50 500 1000
4 1000 0 1035 25 250 1250
5 1250 0 1030 -5 -50 1200
6 1200 0 1040 10 100 1300
158

159. Mark to market margin of a short position
Day Beginning
balance
Funds
deposited
Settlement
price
Future
price
change
Gain
/Loss
Ending
balance
0 0 500 1000 0 -
1 500 0 992 -8 80 580
2 580 0 960 -32 320 900
3 900 0 1010 50 -500 400
4 400 0 1035 25 -250 150
5 150 350 1030 -5 50 550
6 550 0 1040 10 -100 450
159

160. Settlements
160
All trades in the futures market are cash
settled on a T+1 basis and all positions
(buy/sell) which are not closed out will
be marked-to-market.
The closing price of the index futures will be
the daily settlement price and the position
will be carried to the next day at the
settlement price.
The most common way of liquidating an open position
is to execute an offsetting futures transaction by
which the initial transaction is squared up.

161. Settlements
161
The initial buyer liquidates his long position
by selling identical futures contract
In index /stock futures the other way of
settlement is cash settled at the final
settlement.
At the end of the contract period the
difference between the contract value and
closing stock/ index value is paid.

162. OPEN INTEREST
162
A futures contract is formed when a buyer
and a seller take opposite positions
in a transaction.
This means that the buyer goes long and
the seller goes short.
Open interest is calculated by looking at either
the total number of outstanding long or short
positions – not both.

163. OPEN INTEREST
163
Open interest is therefore a measure of
contracts that have not been matched
and closed out.
The number of open long contracts must
equal exactly the number of open short
contracts.

164. 164
Open interest refers to the number of outstanding
contracts that remain open.
For example, if a position was taken in a contract,
and at the expiry of that contract, instead of closing
Out the position, the trader decided to roll the
contract over (ie open a similar position in the next
expiry month), their open interest in that contract
would continue.
If however the trader decided to close out their position,
the open interest for that contract would decrease.

165. Action Resulting open interest
New buyer (long) and new seller (short)
Trade to form a new contract.
Rise
Existing buyer sells and existing seller
buys –The old contract is closed.
Fall
New buyer buys from existing buyer.
The Existing buyer closes his position
by selling to new buyer.
No change – there is no increase in
long contracts being held
Existing seller buys from new seller. The
Existing seller closes his position by
buying from new seller.
No change – there is no increase in
short contracts being held
165

166. Price Open interest Market
Strong
Warning signal
Weak
Warning signal
166
Open interest is also used in conjunction with other technical analysis
chart patterns and indicators to gauge market signals.
The following chart may help with these signals.
The warning sign indicates that the Open interest is not
supporting the price direction.

167. THANK YOU
167

168. MCQ SECTION
168

169. FUTURES MCQ
Choices:
A. One month
B. Two months
C. Three months
D. All of the above
169
1. In India, futures contracts have an expiry
period of

170. FUTURES MCQ
Choices:
A. One month
B. Two months
C. Three months
D. All of the above
170
1. In India, futures contracts have an expiry
period of

171. »
Choices:
A. F= S-C
B. F= S+C
C. F=S+C-D
D. None of the above
171
2. The cost of carry is represented by following
formula

172. »
Choices:
A. Tuesday
B. Thursday
C. Wednesday
D. Friday
172
3. In the case of index futures the contract expires on
the last ______ of the month

173. Choices:
A. True
B. False
173
4. In the case of stock futures all positions are daily
marked-to-market

174. »
Choices:
A. On the day of the expiry of the contract
B. On daily settlement .
C. At the end of every month .
D. On a fortnightly settlement basis
174
5. In stock index futures trading, profits are received or
losses are paid

175. Choices:
A. Currency
B. Equity
C. Commodity
D. All of the above
175
6.The underlying Security for a derivatives
Instrument can be

176. Choices:
A. Sell 1,00,000 of Nifty
B. Buy 1,00,000 of Nifty
C. Buy 90,000 of Nifty
D. Sell 90,000 of Nifty
176
7.The beta of TATA STEEL is 0.9. Assuming you have
a position of Rs 1,00,000 of TATA STEEL which of the
following gives a complete hedge?

177. Choices:
A. He is over hedged
B. He is under hedged
C. He is completely hedged
D. None of the above
177
8. Abha expects that the rupee will depreciate
and hence profits of TCS will increase. He goes long
on TCS to the tune of Rs 5 lakh. The beta of TCS is
1.20 In order to remove his Nifty exposure he does
SHORT NIFTY to the tune of Rs 6.5 lakh. Which is true:

178. »
»
Choices:
A. 3,00,000
B. 90,000
C. 15,000
D. 1,50,000
178
9.You are bearish on the market and hope that the
market will go down so you sell 20 market lots of
Nifty Jul Futures at 5500. Your forecast comes true
and you close out the position at maturity at 5200.
How much profit do you make? ( Nifty lot =50)

179. »
Choices:
A. Bullish
B. Bearish
C. Neutral
D. None of the above
179
10. An decrease in the open interest of a contract
denotes a ____ trend

180. Choices :
A. taking a futures position opposite to one’s
cash market position.
B. taking a futures position identical to one's
cash market position.
C. holding only a futures market position.
D. holding only a cash market position.
E. none of the above
180
11. Hedging involves:

181. 12 Which of the following does the most to
reduce default risk for futures contracts?
A. Marking to market.
B. High liquidity.
C. Credit checks for both buyers and sellers.
D. Flexible delivery arrangements.
181

182. 13 . In futures trading initial margin is paid by :
A. buyer only
B. clearing member
C. seller only
D. buyer and seller
182

183. 14. All Stock Options are American in nature.
A. TRUE
B. FALSE
» SEBI circular no. CIR/DNPD/6/2010 dated October 27, 2010
» (Stock Options Go European from Jan 2011)
183

184. 15. Nifty is at 5420. What should be the fair
price of Nifty futures expiring 30 days from
today. Risk free rate is 8% p.a.
A. 5467
B. 5577
C. 5456
D. 5452
184

185. ANSWER KEY
185
1. D.
2. B.
3. B.
4. A.
5. B.
6. D.
7. D.
8. A
9. A.
10 B
11 A
12 A
13 D
14 B
15 C

186. CA FINAL JUNE 2009
186
The share of X ltd is currently selling for
Rs 300 . Risk free rate is .8% per month .
A three month futures contract is selling for
Rs 312.
Develop a arbitrage strategy and show what
your risk less profit Will be 3 months hence
assuming that X ltd will not pay any dividend
In the next three months

187. The fair price of X ltd 3 months futures = S+ C –D = 300+ 300 X 3 X
.008+0 = 307.2. the market price is Rs 312
Therefore today the arbitrageur would buy the stock in cash market
and sell the 3 month futures . By doing so he would make a
riskless profit of Rs 4.8 today. After 3 months he will square up the
future contract by buying X ltd
Rupees
ACTIVTY
TODAY
Activity at
Expiry
Sell Futures 312 Buy Futures
Buy Stock 300 Sell stock
187

188. MAY 2011
»
188
A mutual fund is holding the following
assets in Rs crore : The beta of the portfolio is 1.1
The index future is selling at 4300 Level .
The fund manager apprehends that the index
will fall at most by 10% . How much index futures he
should short so that the Beta is reduced to 1.0 .
one index future consist of 50 units Substantiate your
answer assuming the fund manager’s
apprehension will materialize
Investment in diversified equity shares 90
Cash and Bank balances 10
Total 100

189. The beta of the portfolio is 1.1
Desired beta of the portfolio 1
Portfolio value = 100 crore . He needs to short the index futures so that
his loss is limited to the extent fall equal to index
1.1-1 X value of the portfolio
.1 X 100 crore= 10 crore
Value of each contract = 50 X 4300= Rs 215000
No of Index future contracts to be sold = 10 crore / 215000= 465 contracts
Now let us study the impact on the overall gain/loss that accrues
INDEX IS DOWN 10%
Gain/(Loss) in
Portfolio
( 11 crore)
Gain/(Loss) in
Futures
1 crore
Net Effect (10 crore)
189

190. 190

191. The weekly options contracts on the Nifty index will
be made available for trading in the F&O segment
with effect from February 11, 2019, the NSE
The first series will expire on February 14 and the
second series will expire on February 21.
Last month, the National Stock Exchange of India
had said that it had secured permission from the
Securities and Exchange Board of India to launch
weekly options on the Nifty index. The weekly
options of ..
191

192. »Some important details include:
»Contracts expire each Thursday at the market
close; if this is a holiday, then the trading day
prior to the holiday is selected as the expiry day
»There are seven weekly contracts at any point in
time, excluding the week of the monthly expiry
»Strike intervals between weeklies are the same
as monthlies
»Live trading commenced on 11th February 2019
192

193. »Product introductions by exchanges can be tricky
to maneuver around but should not be entirely
avoided. As a quantitative trader, it’s a good idea
to explore new markets cautiously with
conservative position sizing strategies, but at the
same time, exploit market inefficiencies and
discover new ideas. In this two-part series, we will
attempt to predict the future success of the Nifty
Weekly Options product introduction and
speculate on trading strategy ideas based on
what we know so far.
193

194. »Weekly Options Contracts Versus Monthly
Options Contracts: How They Differ
»Let’s take a quick look at the NSE Bhavcopy file
for 14th Feb 2019 for all FnO activity, which was
the first ever weekly expiry day. (Bhavcopy refers
to the files released by the NSE which include
authentic price/volume data for NSE listed
securities).
»The contracts have been sorted in descending
order in terms of traded turnover, with BankNifty
contracts highlighted in red and Nifty contracts
highlighted in green. 194

195. What is a derivative?.
Derivatives are a useful financial instrument.
By using different types of derivatives, you can remove the
need to invest a large amount of capital upfront.
A derivative allows you to benefit from market movements. If
you are good at anticipating market movements, derivatives
are a good friend since they allow you to earn returns quickly.
195

196. What is a derivative?.
»They also double up as an effective tool to hedge
risks.
» The classical derivative definition is - A
derivative is a contract between two or more
parties whose value is based on an agreed-upon
underlying financial asset or set of assets. This is
how many define derivative.
196

197. What are the key benefits of derivative trading
»There are 4 main benefits of derivative trading.
» 1. Gain leverage - Derivative trading enables you to get higher trading
exposure with a low margin amount.
» 2. Do hedging - Derivative trading allows you to de-risk yourself by
hedging your positions. You can buy in the cash segment and agree
to sell in the derivative market or vice versa.
» 3. Opt for risk as per choice - Derivative trading allows you to choose
between conservative or high-risk strategies, These could be based
on the expected rise and fall of stock prices/indices.
» 4. Access higher returns - With derivative trading, you have a
possibility to get returns irrespective of market moving up, down or
sideways.
197

198. » Nifty 50 options contracts have 3 consecutive monthly
contracts. Plus, they have 3 quarterly months of the cycle
March / June / September / December and 5 following semi-
annual months of the cycle June / December would be
available. At any point in time, there would be options contracts
with at least 3-year tenure available. On the expiry of the near
month contract, new contracts are introduced at new strike
prices for both call and put options, on the trading day following
the expiry of the near month contract.
» Nifty 50 options contracts expire on the last Thursday of the
expiry month. Like the Nifty 50 Futures, if the last Thursday is a
trading holiday, the Nifty 50 Options contracts expire on the
previous trading day.
198

199. Settlement Mechanism
»Settlement of futures contracts on index and
individual securities
»Daily Mark-to-Market Settlement
»Final Settlement
199

200. Daily Mark-to-Market Settlement
» The positions in the futures contracts for each member is
marked-to-market to the daily settlement price of the
futures contracts at the end of each trade day.
» The profits/ losses are computed as the difference
between the trade price or the previous day's settlement
price, as the case may be, and the current day's
settlement price.
» The CMs who have suffered a loss are required to pay the
mark-to-market loss amount to NSE Clearing which is
passed on to the members who have made a profit.
» This is known as daily mark-to-market settlement.
200

201. Settlement Price
Product Settlement Schedule
Futures
Contracts
on Index
or
Individual
Security
Daily
Settlemen
t
a.Index - Closing price of the futures contracts on
Index on the trading day. (closing price for a futures
contract shall be calculated on the basis of the last
half an hour weighted average price on NSE of
such contract)
b.Individual Security - Closing price of the futures
contracts on Individual security on the trading day.
(closing price for a futures contract shall be
calculated on the basis of the last half an hour
weighted average price across exchanges of such
contract)
201

202. Settlement Price
Product Settlement Schedule
Futures
Contracts
on Index
or
Individual
Security
Final
Settlemen
t
a. Index - Closing price of the relevant underlying
index in the Capital Market segment of NSE, on
the last trading day of the futures contract.
b. Individual securities - Closing price of the
relevant underlying security in the Capital Market
segment across exchanges, on the last trading day
of the futures contract.
202

203. Final Settlement
» On the expiry of the futures contracts, NSE Clearing marks all
positions of a CM to the final settlement price and the resulting profit /
loss is settled in cash.
» The final settlement of the futures contracts is similar to the daily
settlement process except for the method of computation of final
settlement price.
» The final settlement profit / loss is computed as the difference
between trade price or the previous day's settlement price, as the
case may be, and the final settlement price of the relevant futures
contract.
» Final settlement loss/ profit amount is debited/ credited to the relevant
CMs clearing bank account on T+1 day (T= expiry day).
» Open positions in futures contracts cease to exist after their expiration
day
203

204. Settlement Procedure
» Daily MTM settlement on T+0 day
» Clearing members who opt to pay the Daily MTM
settlement on a T+0 basis would compute such settlement
amounts on a daily basis and make the amount of funds
available in their clearing account before the end of day
on T+0 day. Failure to do so would tantamount to non
payment of daily MTM settlement on a T+0 basis. Further,
partial payment of daily MTM settlement would also be
considered as non payment of daily MTM settlement on a
T+0 basis. These would be construed as non compliance
and penalties applicable for fund shortages from time to
time would be levied.
204

205. »A penalty of 0.07 % of the margin amount at end
of day on T+0 would be levied on the clearing
members. Further, the benefit of scaled down
margins shall not be available in case of non
payment of daily MTM settlement on a T+0 basis
from the day of such default to the end of the
relevant quarter.
205

206. »From this series (October 2019), all
stocks in the derivative segment will
be physically settled.
»This means delivery of shares is a
must, if one fails to square-off his or
her position ahead of the expiry date.
206

207. »According to SEBI, the move is to check
excessive speculation and volatility in share
prices, especially during the settlement
weeks.
»Earlier, any open position in the F&O
segment would automatically squared off
by the exchanges at the close of the
session with the final closing price as the
settlement price.
207

208. »The difference between one’s position and
the settlement price either gets debited or
credited as the case may be into the
client’s ledger.
»To avoid booking losses, some traders roll
over their positions on the expiry date
leading to excessive volatility.
208

209. »So, will the ‘physically settled’ system make
any difference?
»If one goes by the current trend in the F&O
segment on the stocks that are already in
the physical settlement mode, there is
hardly any change. Traders still roll over
their positions well ahead of expiry or
square off their positions on the advice of
brokers.
209

210. »However, things could change in the
coming days, as the stocks that have been
moved into physical delivery are highly
liquid, large-caps with active trading
interest.
» So, the traders have to be doubly cautious
while trading in the F&O segment from now
on, as they may end up paying the full
contract value besides the margin money.
210

211. »If you don’t square off your positions in the
identified stocks before the close of trading hours
on the expiry day, you will either have to take
delivery (for long futures, long calls, short puts) or
give delivery of the underlying stock (short
futures, long puts, short calls) for the contract.
»Currently 149 stocks are available for trading in
the F&O segment on the NSE. The market lot
varies for individual stocks from as high as
45,000 shares (GMR Infrastucture) to as low as
10 shares (MRF).
211

212. » Assuming you are long on GMR Infrastructure futures,
as the stock is quoting around ₹17, you need to
have ₹7.65 lakh in your account on the expiry day to
take delivery, if you do not square off your position
explicitly.
» Similarly, the GMR Infrastructure 17 call is quoting at a
premium of ₹1. Though it will cost you ₹45,000 to buy
the option, you will need to shell out ₹7.65 lakh to take
delivery of those shares when your positions is not
closed by you ahead of the expiry. However, if the
premium of the option rises at the time of expiry, your
burden will be less to that extent.
212

213. »For positions of short futures, long puts or short
calls of GMR infrastructure, you need to own
45,000 shares in your account as you are liable
to give delivery of shares to the counter-party
when he/she exercises his/her right.
»However, if you do not have enough shares in
your account, then the settlement will go to
auction, where you may be forced to buy those
shares at an astronomical price.
»In the case of MRF, where the market lot is 10,
you need to have about ₹6.3 lakh, as the
underlying share is quoting around ₹63,000. 213

214. »Need for clear strategy
»So, traders wishing to benefit from the leverage
of F&O market should have a clear strategy
before entering into any position. Besides, proper
communication with your broker is also a must,
especially during the expiry week
214

215. NEW SYSTEM
» highly liquid and most traded in the F&O segment—will also be delivered
physically at the end of expiry unless squared off or rolled over.
What Is Physical Settlement? So far, trading in futures and options in India
was cash-settled. That means upon expiry of the contract, buyers or sellers
settle their position in cash without taking delivery of the underlying. To
explain it better, consider this example of Reliance Industries Ltd., one of the
most liquid stocks in the futures and options segment. As of now, buying RIL
futures or
As of now, buying RIL futures or options don’t mean owning its shares in a
demat account. But with physical settlement, if traders don’t close or rollover
their position till expiry date, they will be required to pay the remaining
amount upon delivery of shares to their demat account as part of the
settlement.
215

216. » So, if a trader buys one lot of RIL, which is 500 shares, he’s required
to pay value at risk margin—margin intended to cover the largest loss
that can be encountered—to the exchanges. The margin ranges
between 15 percent and 35 percent depending on the volatility of the
stock. The trade is leveraged as the trader is not immediately required
to pay the entire contract value which can be around Rs 6
How Physical Settlement Happens Stock Futures: If traders initiate a
long trade on a security and the contract is not closed till expiry, they
will have to compulsorily take delivery of shares against the derivative
position and pay the full contract value—from above example total Rs
6.5 lakh—and pay securities transaction tax applicable in cash
market. If traders sell stock futures and the posit
216

217. » Stock Options: Only in the money positions go in for physical settlement. Traders can take option position either by
buying or writing an option strike. Buying Options If traders buy 1,300 call strike of RIL, and the stock on the expiry
day closes at 1,305, it means the option is expiring in the money. Hence, traders will have to take physical delivery of
shares assuming the position is not close
If traders buy 1,300 call strike of RIL, and the stock on the expiry day closes at 1,305, it means the option is expiring
in the money. Hence, traders will have to take physical delivery of shares assuming the position is not closed till
expiry. A call is an option to buy shares or assets at an agreed price. If the contract expires below 1,300, then it
doesn’t go for physical settlement. Similarl
»
» Similarly, if traders buy a put contract and the stock closes at 1,290 and the position is not closed till expiry, then
they will have to give delivery of shares. A put is an option to sell security or an asset at an agreed price.
Writing An Option If traders write 1,300 call of RIL and if the underlying closes at 1,310 and the position is still open
on the expiry day, they will have to give delivery of shares. Similarly, if traders write 1,300 put strike betting that RIL
will expire above 1,300 and if the stock closes at 1,290 on expiry day, then they will have to take physical delivery of
shares. Several institutional investors are likely to move to the F&O market if they intend to take delivery of stock.
Institutional investors who seek to buy or sell large block of shares, face impact cost—incurred while executing a
transaction due to the prevailing liquidity condition on the counter—in the cash market.
» With physical settlement in all stocks, especially Nifty stocks, institutional volumes in derivatives can increase as
traders and asset managers can start to take directional view, said Tushar Mahajan, head (derivatives) at Centrum
Broking. Trade can be executed through the futures market first rather than buying in cash due to better liquidity and
lower impact cost, but retail activity could see
217

218. » One, due to short-selling where traders sell stocks without owning them and then have to deliver at
the time of settlement. They, however, have to a penalty by buying shares at higher price from an
auction while their position remains on the short side. An alternative is the securities lending and
borrowing mechanism—introduced in 2008—where traders can borrow shares for a fee. Typically,
large i
An alternative is the securities lending and borrowing mechanism—introduced in 2008—where
traders can borrow shares for a fee. Typically, large investors or institutions—mutual funds and
insurers—are involved in lending of shares. But in India, this mechanism hasn’t evolved despite the
market regulator’s emphasis. While India has the most active trading volume for single stock
futures, securities
While India has the most active trading volume for single stock futures, securities lending and
borrowing is yet to develop. Globally, short positions in individual stocks are usually done through
securities lending and borrowing, while derivative products are mostly used for indices. Two, not just
availability of shares on the day of expiry, but liquidity can also be a concern. Even if traders
Two, not just availability of shares on the day of expiry, but liquidity can also be a concern. Even if
traders are in the money, not all stock options are liquid all the time. There are instances when
traders take the position in stock options when there is momentum but to square off there isn’t
adequate counterparty. In such cases, traders will be forced to go in for physical settlement. Stockb
Stockbrokers BloombergQuint spoke to on the condition of anonymity said they aren’t allowing retail
clients to take any position in stock derivatives in the expiry week to avoid any default as onus of
settlement lies with the broker. While physical settlement will curb any wild swings on the expiry day
and activity in the derivatives market could be spread through the series instead of the expiry 218