The Hindu Business Line : Trading in index futures

Futures and options are forms of exchange-regulated forward trading in which you enter into a transaction today, the settlement of which is scheduled to take place at a future date.

The settlement date is called the expiry date of the contract. A Futures contract is an agreement between the buyer and a seller for the purchase and sale of a particular asset at a specific future date. The price at which the asset would change hands in the future is agreed upon at the time of entering into the contract. The actual purchase or sale of the underlying involving payment of cash and delivery of the instrument does not take place until the contracted date of delivery.

A futures contract involves an obligation on both the parties to fulfill the terms of the contract.

An option is a contract that goes a step further and provides the buyer of the option (also called the holder) the right, without the obligation, to buy (call) or sell (put) a specified asset at an agreed price on or upto a particular date. For acquiring this right, the buyer has to pay a premium to the seller. The seller on the other hand, has the obligation to buy or sell that specified asset at that agreed price. The premium is determined taking into account a number of factors such as the underlying's current market price, the number of days to expiration, the strike price of the option, the volatility of the underlying asset, and the risk-less rate of return. Specifications of the options contract like the strike price, the expiration

date and regular lot, are specified by the exchange.

An option contract may be of two kinds, viz., a Call option or a Put option. An option that provides the buyer the right to buy is a Call option. The buyer of the call option can call upon the seller of the option and buy from him, the underlying at any point on or before the expiry date by exercising his option at the agreed price.

The seller of the option has to fulfill the obligation on exercise of the option.

The right to sell is called a Put option. Here, the buyer of the option can exercise his right to sell the underlying to the seller of the option at the agreed price.

What are stock index futures and options?

A futures or options contract which is based on a set of underlying securities, i.e., the index, is called a `Stock index futures or options contract'. When trading takes place in stock index futures, it means that market participants are taking a view on the way the index will move. By trading in Index-based Futures and Options you buy or sell the 'entire stock market' as a single entity.

S&P CNX NIFTY

S&P CNX NIFTY is the most scientifically developed index. The top 50 blue chip companies have been selected to construct the index. This index covers more than 25 industry sectors and is professionally managed by India Index & Services Ltd. (IISL). IISL has a licensing and co-branding arrangement with Standard & Poor's (S&P), the World's leading provider of equity indices, for co-branding IISL's equity indices. Daily derivatives trading in U.S. based on S&P 500 index alone is over US $ 50 billion.

What are the advantages of trading in S&P CNX NIFTY Futures?

Trading in S&P CNX NIFTY futures have many advantages:

* You, as an investor, will be able to buy or sell the 'entire stock market' instead of individual securities when you have a general view of the direction in which the market may move in the next few months.

* Index based derivatives satisfy the hedging requirements of investors such as you having reasonable sized portfolio irrespective of the composition of the individual securities in your portfolio.

* Index based derivatives are settled in cash and therefore all problems related to bad delivery, forged, fake certificates, etc can be avoided.

* Since the index consists of many securities (50 securities) it is very difficult to manipulate the index. This adds to the attractiveness of index as a base for introducing derivatives trading.

* Investors are required to pay a small fraction of the value of the total contract as margins. This means that trading in Stock Index Futures is a leveraged activity since the investor is able to control the total value of the contract with a relatively small amount of margin.

How do I trade in S&P CNX NIFTY futures?

Trading on the Nifty futures is just like trading in any other security. You take a view on the way the market will move and buy or sell the index. On the expiration day, if the closing index value is higher than the value at which you had bought the index, then you make a profit. If the closing index is lower than the level at which you bought, you make a loss.

However, in this case, if you had anticipated a downswing in the market, and had sold initially, you make a profit. It is similar to buying low and selling high or conversely selling and then buying back when the market goes down.

What is Trading cycle for S&P CNX NIFTY futures?

NSE will permit trading in near 3 months contracts. The contracts will expire on the last Friday of the contract month. New contracts will be introduced on the next trading day.

(To be continued)

Source: www.nse-india.com

If you have any queries relating to the futures/options markets and strategies that can be used in these markets, please mail them to Futures & Options, Kasturi & sons, 859-860, Anna Salai, Chennai 600 002 or email them to vaidy@thehindu.co.in with a mention of futures/options in the subject line of the mail.

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