final project on futures

7/27/2019 Final Project on Futures

1/26

An AssignmentSubmitted by

Siddhi .D .Pednekar (23-2008)

InC04A2: Derivatives Market

Department Of Commerce

Goa University2009-20010


2/26

INDEX

Sr.no Title1 Definition of futures2 Distinction between forward and futures3 Settlement procedure of futures4 Trading futures , Trading volumes5 What are the futures contracts in Indian markets?6 Currency futures

Definition of futures


3/26

A futures contract is a standardized contract between two parties were one of the

parties commits to sell and the other to buy , a stipulated quantity and quality , were

applicable of a commodity ,currency, security, index or some other specified item

at an agreed price on a given date in the future.

Future may be used either to hedge or to speculate on the price movements of an

underlying asset.

Example:

Futures contract for the S&P 500 index represents ownership interest in the S&P

500 index at a specified price for delivery on a specified date on a particular exchange.

Futures contracts are exchange-traded derivatives where the underlying has

standardized terms. These standardized terms include the following;

Quality of the underlying

Quantity of the underlying

Date & month of delivery

Location of settlement etc.

Features of Futures Contract

1. The margin price is generally noticeable to the market price every day.

2. Every futures contract represents a specific uniform quantity and is not at all

negotiated by the two parties.


4/26

3. Futures are trade on organized futures exchanges with clearing associations that act

as intermediaries between the contracting parties.

4. In the futures contract, the seller is known as a short & the buyer is known as a

long.

5. The buyer and seller pay a margin to the clearing house.

6. The settlement of the contract either through delivery of asset or by a final cash

settlement.

Benefits of future contract to buyer and seller

One of the most important benefits gained from trading in the futures market is that

traders can assume any of a wide range of commodities or other assets with a

relatively small initial investment. The initial investment includes a commission of

approximate of 50$ per contract and a margin

A margin is a good faith deposit. When a trader assumes a future position he locks

in a price for future delivery for the underlying commodity.

The fixed price is the future price at which the contract is brought and sold. As the

price of the actual commodity rises or falls, the future price follows suit, making or

losing money.

A benefit from selling futures contracts is that it enables the trader to establish. In

advance, an approximate price for crops he intends to harvest and market at some

future time. This provides protection against dangerous price swing, and enables

speculators to earn profit from market fluctions.


5/26

Distinction between futures and forwards

1. Standardization

A forward contract is a tailor-made contract between the buyer and the seller where the terms are

settled mutually by the two parties whereas a futures contract is standardized in regard to the

quality, quantity, place of delivery of the asset etc. but only price is negotiated.

2. Liquidity

Forward contracts have no liquidity unless a third party agrees to buy it, but in a futures contract

there is high liquidity as they are traded on organized exchanges.

3. conclusion of contract

Forward contract is normally concluded with a delivery of asset were as futures contracts are settled

sometimes with delivery of the asset and generally with the payment of price difference

4. Margin

In a forward contract there are only two parties involved i.e. the seller & buyer and there is zero

margin required. Futures contract, a third party called Clearing Corporation is also involved with

which margin is required to be kept by both the parties.

5. Profit/Loss Settlement

The settlement of a forward contract takes place on the date of maturity so that the profit/loss is

booked on maturity only. On the other hand, the futures contracts are marked to market daily so that

the profits or losses are settled daily.

6. Counterparty Risk

It is present in forward contracts and not present in futures contracts.


6/26

7. Mode of Delivery

In forward contracts the mode of delivery is decided by the two parties & most of the contracts result

in delivery whereas in futures contracts the mode of delivery is standardized & most of the contract

are cash settled.

8. Price of Contract:

In a forward contract the price of the contract remains fixed till maturity, whereas in a futures

contract the price of the contract changes every day.

9. Nature of Market:

In a forward market it is Over the counter whereas in futures contract it is Exchange traded.


7/26

Settlement procedure of futures

Daily market-to-market settlement

The settlement in the futures contract for the members is marked-to-market.

Under this the profit or loss are computed as the difference between the trading

price or last days settlement price and the current days settlement price, depending

upon the case.

It the clearing member suffers a loss it is required to pay the mark-to-market loss

amount to the NSCCL, were in the NSCCL will pass it to the respective members

who have made a profit. This process is known as daily mark-to market settlement.

Option to settle daily MTM on T+0 day

The clearing member may choose to pay daily mark to market settlement on a T+0

bases. The option can be exercised once in a quarter that is Jan to march, April to

June, July to September and October to December. The option once it is exercised

remains irrecoverable during that quarter. Clearing members who opt to pay daily

market settlement on T+0 basis shall inform the clearing corporation as per the

format given by them.


8/26

The clearing members who opt for payment of daily MTM settlement amount on a

T+0 basis shall not be levied the scaled up margins.

The pay-out of MTM settlement shall continue to be done on T+1 day.

Final settlement

On the expiry of the futures contract, NSCCL marks all the positions of a clearing

member to the final settlement price and the remaining profit or loss is settled on

cash basis.

The final settlement is similar to as daily settlement process but the only difference

is that in the case of final settlement the profit or loss is computed as the difference

between the trade and the previous days settlement price as the case may be and

the final settlement price of the relevant futures contract.

Final settlement profit or loss amount is debited or credited to the relevant clearing

members clearing bank account on T+1 day were T day is the expiry day.

Settlement procedure

Daily MTM settlement on T+0 day

Clearing members who opt to pay the MTM settlement on a T+0 basis would

compute such settlement amount on a daily basis and mark the amount of funds

available in their clearing account before the end of the day on T+0 day. Any

failure in doing so would be as equal to non payment of daily MTM settlement on a

T+0 bases.


9/26

Partial payment of daily MTM settlement would be considered as a non payment of

daily MTM settlement on T+0 bases. These would be considered as non

compliance and penalties applicable for fund shortages from time to time would be

imposed.

A penalty of 0.077%of the margin amount at the end of the day on T+0 would be

levied on the clearing members. 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 such default to the end o the relevant quarter.

Futures marginFutures margin is the amount of money you have to put up to control a futures

contract.

Futures margin rate are set by future exchange and some brokerages will add an

extra premium to the exchange minimum rate in order to lower their risk exposure.

Margin is set based on risk .the larger dollar volume that a futures market makes

you can expect high margin rates.

If an investor who is well versed with the trading stock on margin, this might be

easier for him to pick up. An investor can trade tocks on up to 50%margin.

Therefore he can buy up to Rs.100000 worth of stock for Rs.50000.

With futures contracts, it works in a similar fashion but the margin rate is much

low. Normally you put up about 5-15% of the contract value in margin.

Example:

If an investor wants to buy a contract of rice futures, the margin is about Rs 1700..

the total contract is worth about Rs32500.that is Rs6.50x 5000 bags of rice. Thus

the futures margin is about 5% of contract value.


10/26

Margin maintenance

It is the amount of money where a loss on the investors futures position requires

the investor to allocate more funds to bring the margin back to the initial margin

level.

Example:

If the margin of a wheat futures contract is Rs1000 and the maintenance margin is

Rs 700. If the investor buys a wheat futures contract he will need to have Rs1000

set aside for the initial margin. If the price of wheat drops by Rs 7 or Rs350 he has

violated the maintenance level and need to add an additional Rs350 in margin in

order to bring it back to the initial margin level.

How to calculate futures margin

Futures margin rates are typically calculated using a program called SPAN. This

programme measures many variables to come up with a final figure for initial and

maintenance margin in each futures market. The main variable is based on the

volatility of each future market. The exchanges do adjust the margin requirements

occasionally based on the market conditions.


11/26

Trading in futures

Till the 1980s, futures trading comprised of only a few farm products. The

popularity of futures market subsequently rose in the 21 st century.

The futures contracts are traded on recognized stock exchanges which are similar to

stock exchanges. Trading is done in the same way as other securities like shares.

Contracts with different delivery months are traded at any given time.

Once the investor decides to buy a certain contract he calls his broker and instructs

to buy for him the contract that the investor wants. The broker then sends the

message to his representative who is on the exchange, this is only in case of an

open out c ry system and would look for such contract at the screen if it is screen if

it is screen based trading.

Once the deal is struck, the information of confirmation of the conclusion of the

order shall reach the investor via the broker.

A future trading is a form of investment involved speculation of the price of a

commodity in the future. Futures are derivatives. Trading futures are not for new

investors since it involves high risk.


12/26

The majority of futures trading is specialised and involves cash settlement also

known as paper investing rather than for the actual physical delivery of the

commodity. Online futures trading is not as popular as online stock trading since

the former is substantially more risky. futures trading involves variety of

commodities like metals, livestock, energy, foodstuffs, currencies, indices like S&P

500 etc.

Trading future contracts

For the purpose of trading in futures you open an account with a future brokerage

firm known as a futures commission merchant (FCM) ,who will execute and record

the trade, and monitor and advice the investor regarding the investor margin

account obligations. One can also deal with the FCM directly or through an

introduction broker (IB) or commodity trading advisor (CTA). As with stock and

bonds we pay commissions and fees to trade futures.

Investors can give their broker an order to buy or sell a futures contract, either to

open a new position or to offset and cancel an existing position. The broker in tum

transmits the order to the appropriate exchange floor or electronic trading system.

In investor can also invest in futures through a commodity pool which resembles a

mutual fund. Investment is pooled with assets from other investors, and the

commodity pool operator (CPO) trades futures contracts using those funds. Or may

work with a commodity trading adviser (CTA) to whom you give an authority to

trade in your account.

Futures trading related to the Indian Stocks & Indices?


13/26

Futures trading are a form of investment which involves speculating on the price of a security going

up or down in the future. A security could be a stock (TATA), stock index (BSE), commodity (Gold, Silver,

etc), currency, etc.

Unlike type of investments, such as stocks and bonds, when you trade futures, you do not actually buy

anything or own anything. You are speculating on the future direction of the price in the security you are

trading. This is like a gamble on future price direction. The terms buy and sell merely indicate the

direction you expect future prices will take.

Example:

You were speculating on the NIFTY , you would buy a futures contract if you thought the price would be

going up in the future. You would sell a futures contract if you thought the price would go down. For every

trade, there is always a buyer and a seller. Neither person has to own anything to participate. He must only

deposit sufficient capital with a brokerage firm to insure that he will be able to pay the losses if his trades

lose money.

Benefits of trading futures

easy to own underlying commodity or stock

no need for holding the underlying commodity or equity.

Standardized contracts guaranteed the quality and quantity of underlying

product.

Reasonable market liquidity available for all major futures types.

Instant execution of market order.

Futures trading usually includes simple and reasonable low commission fees

and plans.

Traders can maximise profit or limit risk on tradind other funds,equity or

commodity.


14/26

Dangers of trading futures

The major risk involved in trading futures is that it is a highly

speculative market.

Trading volumeThe number of shares or contracts traded in a security or an entire market during

given period of time. It is simply the amount of shares that trade from seller to

buyer as a measure of activity. If a buyer of stock purchase 500 shares from the

seller then the trading volume for that period increases by 500 shares based on that

transaction.

Trading volume is an important indicator in technical analysis. If the market moves

up or down the real strength of that move depends on the trading volume for that

period. The higher the volumes during the price move the more significant is the

move.


15/26

What are the futures contracts in India?

There are two types of futures contracts in India those are

Commodity futures

Financial futures

Commodity futures

Commodity future aims to transfer risk associated with the ownership of a

commodity. Commodities futures contract involves a wide range of agricultural and

other commodities including precious metals, it also includes foreign currency.

The list of commodities on which futures contracts are traded in the major

American futures exchange like Chicago Board of trade, Kansas City board of

trade, Chicago Mercantile exchange, New York Mercantile exchange, New York

cotton exchange, Middle American commodity Exchange etc. , includes wheat ,

corn , oats, soybeans , cotton , orange juice, crude oil , unleaded gasoline, natural

gas, platinum, silver , lumber, feeder cattle and so on.


16/26

Commodity futures trading is done in an organized futures market, unlike other

investments such as stock and bonds trading in futures, the actual commodity does

not change hands. This contract is legally binding for the transfer of commodities at

a future date, which is specified at the time of entering into the contract. At the

same time the price at which the delivery would take place in the future is decided.

A well organized and efficient commodities futures market is acknowledged as

helpful for the price discovery of commodities that are traded in it. Such a market

facilitates the offsetting of transactions without actually impacting the physical

goods.Benefits

Through commodity futures trading it is possible for investors to make huge profits

with limited amount of investments.

Commodity futures attract hedgers as they can minimise their risk.

Market encourages competition among those traders who have the market

information and price judgement.

Risk involved

Commodity futures are risky in the case if the market is speculative.

Financial futures

The financial futures involve financial assets/ tools as against commodities. In this

even the contracts are written over a wide range of the underlying assets. The first

futures came into existed in USA.

There exist a long list of financial futures that exist in USA, UK , Japan etc. they

include 10,5,2 years treasury notes, 30 days interest rate etc.


17/26

Financial futures are futures contract based on financial instruments such as

currency, treasury bonds etc. The underlying asset are contracted to be both at a

specified price on a specified rate on a specified date. They may also involve

contracts on short term interest rates.

Financial futures are highly standardised or uniform contracts that are traded in

organised futures exchanges in different parts of the world. The method of trading

is the open outcry system were in people shout the bid on the floor of the exchange.

Example is the international money market in Chicago and London.

Benefits

Financial futures are one of the best hedging instruments.

They help the investor to earn high profit with low risk.

They provide high liquidity.

It gives an opportunity to avoid actual transfer of financial instruments.

Demerits

It involves high risk if investors trade without having proper planning of

investments.

Conclusion

Financial future is good for investors who are risky and willing to take up risk with

an intention to earn high profit in the short run.

Stock Index Futures


18/26

Introduction

Stock index futures were introduced in USA in 1982 with the commoditise futures

trading commission approving the Kansas board of trade proposal.

The distinct characteristics of the stock index futures contract is the underlying

asset. The stock index that trades promise to buy and deliver. A stock index is a

mathematical formula used for measuring stock price changes.

Stock index prices are statistically combined groups of stocks that represent a

certain asset class of investment. Stock index futures track the stock index. Stock

index futures are not convertible into the individual stock on the index nor do they pay dividends on the individual stocks. If the stock goes into bankruptcy or is no

longer eligible to be part of the index for any other reason such as a takeover, the

trustee of the index may substitute any other stock in its place. Stock futures are

traded at premium, meaning that because of the leverage of the index traded will

pay a slight premium to hold the more volatile futures contract and avoid owning

each stock individually.

Stock index futures represents a claim on assets similar to popular stock indexes.

There is no physical entity unlike commodity indexes.

Stock indexes exist to make large scale trading operations efficient and cost

effective.

Stock indexes represents a claim on the value of certain stocks.

Stock index holders do not own underlying stock.

Stock index trading is an important global means for institutions both speculate and

hedge positions quickly with immediate diversification.

Trading allows good liquidity and lower transaction costs than buying the individual

stock represented in the index.


19/26

Each index is traded by rules established by the exchange on which the index

trades. Individual can trade stock index futures through certified brokers as full

contracts or mini contracts.

Currency futures

Introduction

The Chicago Mercantile Exchange (CME) first coneived the idea of a currency

futures exchange and it launched the same in 1972.the CME provides the most

popular currency futures.

Meaning

The transferable future contracts that specifies the price at which a specified

currency can be brought and sold at a future date.

Currency futures

Currency futures are traded in the same manner as any other form of future

contract. Currency futures instead of dealing in a tangible product like wheat the

exchange rate between two given currencies serves as the commodity for the

underlying contract .


20/26

A currency future is also known as Foreign Exchange Future or FX Future .

Currency futures allow investors to hedge against foreign exchange risk. These

contracts are mostly marked-to market daily, investors can by closing out their

position that is exit from their obligation to buy or sell the currency prior to the

contracts delivery date.

There are two ways to settle currency futures contract either you can hold currency

futures until maturity at which point you receive a cash settlement at the rate

specified in the contract, or an investor can buy and sell currency contracts prior to

maturity on an regognized exchange. There are a number of exchanges that

specialize in currency futures like the Tokyo financial exchange , ChicagoMercantile exchange etc.

It is a standardized foreign exchange derive contract that is traded on the

recognized stock exchange.

Currency futures may be permissible in US Dollar- Indian rupee or any other

currency pair providing this has to be approved by the reserve bank of India fro

time to time.

Only person residing in India can purchase or sell currency futures in order to

hedge an exposure to foreign exchange risk.

For currency futures the underlying financial instrument is a standard quantity of

one currency exchangeable for a second currency usually the dollar. Only a limited

number of currencies are traded on any exchange and they are the most commonly

traded of the worlds currency.

The market price at which currency futures are traded is expressed in terms of

exchange rate. A price movement up or down in the futures markets represents a

change in the exchange rate for the currencies in the foreign exchange markets.


21/26

Pricing currency futures contracts

Contract prices for currency futures are determined by the interest rate for the

country of origin for the currencies listed in the futures contract as well as the spot

rates for each currency. By incorporating the spot rate in the contract price

calculation, the ability to profit solely on arbitrage differences is eliminated as the

contract price moves along with the fluctuations in the spot rate of either currency.

Features

Only US Dollar and Indian rupee contracts are allowed to be traded

The size of the contract has to be 1000 USD

The contract is settled and quoted in Indian rupee

The maturity of contact should not exceed 12 months

Settlement price will be the Reserve banks reference rate on the last tradingday.

Benefit

Easy Affordability:

Margins are very low and the contract size is also very small.

Low Transaction Costs:

When you trade in INT currency futures on NSE in India, a small amount of

brokerage fees and statutory duties and taxes are to be paid. However in Forex

trading, one has to pay commissions to the back or foreign exchange agents in the


22/26

form of spreads. Spreads is the difference in the buy/sell price over the reference

date, which can be very high.

Transparency:

It is possible for an investor to verify details on the stock exchange if he has

doubt that the broker has tried to cheat.

Counter-party Default Risks:

All trade done on the recognized exchange are guaranteed by the clearing

corporation and hence it eliminates the risk associated with counter party default.

Easy Accessibility:

Currency futures are being offered on the recognized exchanges in India. Small

investors would get an easy access to currency futures trading on the popular

exchanges. It is as easy as trading in a blue chip stock on any chosen exchange.

Standardized contracts:

Exchange traded currency futures are standardized in respect of lot size and

maturity. Retail investors who have limited resources find it beneficial to take

position in standardized USD, INR future contracts.

Hedging using currency futures


23/26

Hedging in currency market can be done through two positions short hedge and

long hedge.

Short hedge

A short hedge involves taking a short position in futures market. In the

currency market short hedge is taken by someone who already has the base

currency or is expecting a future receipt of the basic currency.

Example: as to where this strategy can be used.

An exporter who is expecting a receipt of USD in the future will try to fix the conversion

rate by holding a short position in the USD INR contract

Long hedge

A long hedge involves holding a long position in the futures markets. A long position

holder agrees to buy the base currency at the expiry date by paying the agreed exchange

rate. This strategy is used by those who will need to acquire the basic currency to pay any

liability to pay in the feature.

Example:

An importer who has to make payment for his imports in USD will take a long position in

USD INR contracts and fix the rate he can buy USD in future by paying INR.

Speculators prefer taking position in the futures market to the spot market because

of the low investment required in case of futures market. In futures market the

parties are required to pay just the margin money upfront, but in case of spot


24/26

market the parties have to invest the full amount as they have to purchase the

foreign currency


25/26

Bibliography

References

Websites

www.investopedia.com

www.derivativesindia.com

www.nscindis.com

www.futurequotes.com

www.fxpedia.com

Books

Fundamentals of futures and options markets by john C Hull

International financial management by Sharma

Currency futures by Brian Coyle

Futures and option by vohra and Bagri

NCFM module
http://www.investopedia.com/http://www.derivativesindia.com/http://www.nscindis.com/http://www.futurequotes.com/http://www.fxpedia.com/http://www.investopedia.com/http://www.derivativesindia.com/http://www.nscindis.com/http://www.futurequotes.com/http://www.fxpedia.com/


26/26

final project on futures

Documents