The Hindu Business Line : Using futures/options

On going through the quotes particularly in ONGC, I have noticed the following: Cash/spot price of ONGC is Rs 705; May futures price of ONGC is Rs 709; June futures price of ONGC is Rs 707. If I buy June futures and sell May futures (profit spread of Rs 2) what is my risk? — K. Sankar, T. Nagar Chennai 600017.

This is called a calendar spread. Since you will buying a farther month futures and selling the near month futures you would have constructed a long calendar spread.

Futures contract which expire in the near months usually trade at a discount to the futures price of the farther month. This is mainly due to the cost of carry.

Since the farther month contract is trading at a discount to the near month, there is mispricing. This mispricing can be exploited by constructing a calendar spread.

You will make money on the contract if the farther month futures price rises faster or falls slower than the near-month futures price. If the mispricing is, however, not corrected even on the date of expiry of the near-month contract, you will lose money. In addition, this trade will need to be reversed just before the May futures expires. Otherwise, you will be long June futures contract and will be exposed to price changes in the farther month contract.

The risk in constructing a calendar spread is that the profits from the strategy are not adequate to cover the costs. Costs may be higher in the case of calendar spreads since you have to pay commission on both legs of the trade. Margin requirements however will be lower.

In addition, exploiting the mispricing of futures contracts successfully will require you to trade in liquid contracts. If this kind of mispricing exists in top ten traded contracts, calendar spreads can be constructed. Otherwise, you may only be exposed to the risk of loss.

Calendar spread can also be constructed to take advantage of your longer-term views on the underlying.

For instance, the futures price of ONGC clearly suggests that investors are bearish on the future spot price movement of the stock.

If you are, however, not so bearish and think such concerns are overdone, then you can buy the June futures contract alone. That, however, would completely expose you to the risk of losses and margin requirements in the near-term in the month of May. Selling the near-month contract can moderate the risk of losses in the month of May.

I have some doubts and I request you to clarify it. — Aravaazhi F., Coimbatore.

Can one buy a future and sell a call? If yes should I state in my order as a covered buy at the time when I buy the future and state in sell order as covered sell at the time I sell the call?

Yes, you can. You do not have to specify that it is a covered buy and sell. However, in the case of trading in the futures and option segment of the NSE, you have the option of making combination order entry. Since buying a future and selling a call will be part of a single strategy, you can specify that both trades be simultaneously executed. That facility is available. When you want to reverse the trade then too you can enter a combination order entry.

Can I buy a Nifty call/put at particular strike price and sell a call/put of a different strike price?

You can trade such strategies. The risks involved in such strategies differ depending on whether you buy/sell options with higher or lower strike price. Buying/selling options with higher or lower strike price will also depend on whether you are bullish or bearish on the underlying stock.

Queries relating to futures/options may be sent to fno@thehindu.co.in or to Futures & Options, Kasturi & Sons, 859-860, Anna Salai, Chennai 600 002.