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Suresh Krishnamurthy

I have sold Tata Motors for Rs 407. I want to buy to cover up. Is it possible to cover up within this month? Can I buy Arvind Mills futures at the prevailing rate? Please advice. — Senthil Anand

If you have sold the November futures contract of Tata Motors at Rs 407, then it is possible to close your open short position by buying the November futures contract.

If you do not square the contract by the end of November 25, 2004, the clearing corporation will mark all open positions to the final settlement price.

The final settlement price is the closing price of the security in the spot market.

In this case, the relevant stock is Tata Motors and the last day of trading of the futures contracts is November 25.

The closing price is the average of the prices traded in the last half an hour on November 25.

The difference between the settlement price and the price at which you sold is settled in cash.

As you would also have paid mark-to-market margins on a daily basis that too would be reduced from the amount payable by you.

If any excess amount is due, it would have to paid in by you in the day following the expiration of the futures contract, which in this case is November 26.

If you have sold the December contract of Tata Motors, then, too, you can square your position. You, however, have a time until the end of December for the position to turn in your favour.

This column does not recommend any investment action. What can however be done is to provide a view on the pricing of the futures contract.

The Arvind Mills November 25 futures contract closed on Friday at a price that is below its spot price. Technically, this is called backwardation.

If you have decided to buy Arvind Mills with a short-term horizon, then buying into Arvind Mills November futures than in the spot market would be a better option.

The December contract of Arvind Mills is now priced at a cost of carry of about 6.7 per cent.

If the opportunity cost of funds (the interest rate your funds will earn when invested in a risk-free security) for you or the rate at which you borrow is more than 6.7 per cent, then you can consider the futures priced cheaper and buy into it rather than buy in the spot market.

In addition, buying futures provides you leverage, which can work in your favour if your bullish view materialises.

Based on the cost of carry, you can also consider arbitrage trades.

If the cost of borrowing is less than 6.7 per cent for you, then you can sell the futures and simultaneously buy in the spot market.

If the opportunity cost of funds is above 6.7 per cent for you then you can buy the futures contract and simultaneously sell in the spot market by taking the shares on loan.

These arbitrage trades are, however, not possible for retail investors.

This is because the opportunity cost of funds for retail investors is usually about 3 per cent and cost of borrowing is usually above 12 per cent.

Therefore, if the cost of carry is between 3 and 12 per cent retail investors generally cannot take advantage.

As cost of carry is highly likely to fall in such no arbitrage zones, investors can usually take advantage of only backwardation.

Alternatively, they can consider calendar spreads that involve simultaneous buying and selling of futures with different expiration dates depending on their view and the cost of carry.

Please inform me whether any simple book is available regarding futures and options. Has the NSE or the BSE published any frequently asked questions (FAQs) on futures and options? — B. Tarakaram

Both the NSE and the BSE have published FAQs that is informative and is a good starting point.

The NSE's Certification in Financial Markets module has a module on derivatives.

This module can be downloaded from NSE's Web site. This module is quite useful and should provide you with the knowledge necessary to start trading in derivatives. After digesting the NCFM module, you can graduate to a more complex book on derivatives.

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.

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