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Stock futures: An introduction - Views on News from Equitymaster
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  • Nov 27, 2001

    Stock futures: An introduction

    In a swift move, Indian Stock exchanges introduced stock futures just before Diwali on November 9, 2001. In June last year Index futures had been introduced. Subsequently, in July 2001 stock options were introduced. With the introduction of stock futures, the futures and options family is now complete.

    Stock futures have been introduced for 31 scrips on which there are options contracts available. The list of the stocks is given below. The stock futures are currently available for a time frame of 3 months. Therefore, at any given point of time there will be a series available for the current month and two months into the future. The system is similar to that available for other derivative contracts. Thus, a contract will be available for trading for a maximum time period of three months. The contracts that would exist on the 26th of November are November futures, December futures and January futures. The contracts expire on the last Thursday of every month.

    Sno Name Symbol Market lot
    1 Associated Cement Company ACC 1,500
    2 Bajaj Auto Limited BAJAJAUTO 800
    3 Bharat Petroleum corporation BPCL 1,100
    4 Bharat Heavy Electrical Limited BHEL 1,200
    5 BSES Ltd BSES 1,100
    6 Cipla Limited CIPLA 200
    7 Digital Equipments (I) Limited DIGITALEQP 400
    8 Dr.Reddy Laboratories DRREDDY 400
    9 Grasim Industries Ltd GRASIM 700
    10 Gujrat Ambuja Cements Ltd. GUJAMBCEM 1,100
    11 Hindustan lever Limited HINDLEVER 1,000
    12 Hindustan Petroleum corporation HINDPETRO 1,300
    13 Hindalco Industries Ltd HINDALC0 300
    14 HDFC Ltd HDFC 300
    15 ICICI Ltd ICICI 2,800
    16 Infosys Technologies Ltd INFOSYSTCH 100
    17 ITC Ltd ITC 300
    18 Larsen & Toubro Ltd L&T 1,000
    19 Mahindra & Mahindra Ltd. M&M 2,500
    20 Mahanagar Telephone Ltd MTNL 1,600
    21 Ranbaxy Labs Ltd RANBAXY 500
    22 Reliance Petroleum Ltd RELPETRO 4,300
    23 Reliance Industries Ltd RELIANCE 600
    24 Satyam Computer Services Ltd. SATYAMCOMP 1,200
    25 State Bank of India SBIN 1,000
    26 Sterlite Optical Technologies STROPTICAL 600
    27 Telco Ltd TELCO 3,300
    28 Tata Power Co. Ltd TATAPOWER 1,600
    29 Tata Iron & Steel Co.Limited TISCO 1,800
    30 Tata Tea Limited TATATEA 1,100
    31 Videsh Sanchar Nigam Limited VSNL 700
    The workings
    To take a position, an initial margin (IM) payment is required to be paid out. The IM is calculated as a percentage of the contract value. The floor is specified by the exchange daily. However, brokers might keep the figures higher as per their comfort level with a particular client and the possibility of default. The figure may be as high 25% of the contract size. However, the floor for the initial margin will be 7.5%.

    The contract value is calculated by multiplying the price at which the stock futures are bought/sold with the market lot. Market lot is the minimum number of stock futures a participant has to buy/sell for particular scrip. Thus, it is not possible to take position in one Infosys future. A tradable contract on the exchange will constitute of a minimum of 100 futures. This brings the contract value to around Rs 200,000 on an average. An initial margin of 15% would mean Rs 30,000, large enough to keep many retail investors out of the market. The minimum price movement has been kept as Rs 0.05.

    Theoretically, Stock futures are exactly similar to index futures, with the main difference being that the underlying is a stock, instead of being a stock market index. Thus, there is a possibility of physical delivery. However, currently all contracts are cash settled for the time being. Once players have sufficient experience with the products, the exchanges plan to introduce physical settlement.

    Long position
    Suppose Mr. X is bullish on HLL for the day and therefore, he takes a long position on HLL November futures at Rs 216. HLL has a market lot of 1,000 stocks. This implies that Mr. X will have to take a minimum position in 1,000 stock futures. The value of contract or contract size adds up to Rs 216,000. But he will not be required pay such a big amount. He can take the position just by paying the initial margin amount to the broker. If the IM is kept at 15%, Mr. X will have to pay Rs 32,400 to the broker. At close, the future is quoting Rs 215, therefore had Mr. X closed his position he would have realized Rs 215,000. This would have meant a loss of Rs 1,000 to him. He will have to pay this amount to the clearing corporation as his mark to market margin.

    Stock HLL
    Market lot 1,000
    Buy price (Rs) 216
    Contract value (Rs) 216,000
    IM @ 15% 32,400
    Settlement price (Rs) 215
    Contract value (Rs) 215,000
    Gain/(loss) (Rs) (1,000)
    Brokerage 216
    Net gain/(loss) (1,216)
    % Gain/(loss) -3.8%

    Short position
    Alternatively, Mr. Y is bearish on ACC and he sells the futures at open. The futures are quoting Rs 160. The market lot for the scrip is specified to be 1,500 contracts. The means the contract size works to be Rs 240,000. He has to pay Rs 36,000 as initial margin requirements. At close, assuming he has to square off his position he will have to buy back the futures. The settlement price for the futures is Rs 156. He will therefore be able to buy back the same contract for Rs 234,000. This translates to a gain of Rs 6,000. The clearing corporation will credit the amount to his account

    Stock ACC
    Market lot 1,500
    Sell price (Rs) 160
    Contract value (Rs) 240,000
    IM @ 15% 36,000
    Settlement price (Rs) 156
    Contract value (Rs) 234,000
    Gain/(loss) (Rs) 6,000
    Brokerage 240
    Net gain/(loss) 5,760
    % Gain/(loss) 16.0%

    A point to be noted here is that a futures transaction is also two sided like a stock transaction. Thus, if Mr. X has bought the futures someone has sold them. Mr. Xs loss is the counter partys gain, which is realized through the MTM margin. Similarly, if Mr. Y has sold ACC futures, someone has bought these contracts. He will have to pay Rs 6,000 to the clearing corporation as MTM, which is turn is credit to Mr. Ys account.

    The brokerage is charged as 0.1% of contract value. Thus, if the contract size is Rs 240,000 brokerage will be Rs 240.

    Calendar spreads
    If there are opposite positions (long and short) for the same stock future for different months then the IM requirement is relaxed. For example, if there is a long position on HLL for November and there is a short position on HLL for December, then the margins requirement for IM will be lower. For example, if there is a long position on HLL November series for Rs 240, then the IM requirement will be Rs 36,000. Now if the same participant creates a short position in December for Rs 250, the IM requirement will not be Rs 73,500 (for both the contracts). The position will be considered as an open position with a value of 1/3 the value of both the contracts. This means the value of the position will be Rs 163,333. Thus the IM payable would be based on this figure.

    Stock Options Vs Stock Futures

    However, retail investors need to be very careful with futures, as they are riskier instruments as compared to buying options. However, writing options is as risky as entering into a futures position. A long position in a stock option has limited risk and unlimited returns; a short position has limited returns and unlimited risk. However, a future has unlimited risk and unlimited returns. This is theoretically speaking. There is day minimum/maximum price range applicable for the futures contract. However, in order to prevent erroneous order entry the operating ranges for futures contract shall be kept at 20% of the previous days closing.

    If a player buys Infosys calls of strike price for Rs 3,600 at Rs 316 it gives him the right to buy the stock at Rs 3,600 irrespective of what the current market price is. Thus, the down side is limited. If the price goes below Rs 3,600 the option wont be exercised and there will be a loss of Rs 316. But for the counter party the gain is just Rs 316. However, theoretically there is no limit to what price above Rs 3,600 the stock can move to. Thus, the downside for the writer or seller of the call option is unlimited.

    Also margining requirements are different for the options and futures. For a long position on a call or a put there is not risk of default therefore no margins are collected. However, for short positions on stock options margins have to be paid out.

    Stock HLL
    Market lot 1,000
    Buy price (Rs) 216
    Contract value (Rs) 216,000
    IM @ 15% 32,400
    Settlement price (Rs) 173
    Contract value (Rs) 172,800
    Gain/(loss) (Rs) (43,200)
    Brokerage 216
    Net gain/(loss) (43,416)
    % Gain/(loss) -134.0%

    To conclude we would like to point out that the downside is unlimited. The above example shows the possibility of a loss of Rs 43,200 on a single contract. However, others may see this example from the other side i.e. that a gain of Rs 43,200 is possible. Therefore, one has to be very careful in the futures market.

    In the next article we will talk about how to use stock futures to lend, borrow, leverage, switch positions and also to take a view on the market.



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