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1<div id="oneTap" style="position:absolute;top:50;right:0"></div><main role="main"><section class="mt-0"><div class="container-fluid"><div class="row"><div class="col-lg-12"><nav area-label="breadcrumb" class="custom-breadcrumb"><ol class="breadcrumb" itemScope="" itemType="https://schema.org/BreadcrumbList"><li class="breadcrumb-item" itemScope="" itemType="https://schema.org/ListItem" itemProp="itemListElement"><a itemProp="item" href="/"><span itemProp="name">Home</span></a><meta itemProp="position" content="1"/></li><li class="breadcrumb-item" itemScope="" itemType="https://schema.org/ListItem" itemProp="itemListElement"><a itemProp="item" href="/school"><span itemProp="name">ELM School</span></a><meta itemProp="position" content="1"/></li><li class="breadcrumb-item" itemScope="" itemType="https://schema.org/ListItem" itemProp="itemListElement"><a itemProp="item" href="/school/categories/derivatives"><span itemProp="name">Derivatives</span></a><meta itemProp="position" content="2"/></li><li class="breadcrumb-item" itemScope="" itemType="https://schema.org/ListItem" itemProp="itemListElement"><a itemProp="item" href="/school/units/derivatives-demystified"><span itemProp="name">Basics of Derivatives</span></a><meta itemProp="position" content="3"/></li></ol></nav></div></div></div><div class="container-fluid p-0"><div class="custom_container pb-5"><div class="row"><div class="col-lg-12"><div class="page-module__4R5MOG__top_header_text_section"><div class="row"><div class="col-lg-8"><h1 class="page-module__4R5MOG__top_banner_top_text">Basics of Derivatives</h1></div></div></div></div><div class="col-lg-12"><div class="row"><div class="col-lg-3 "><div class="page-module__4R5MOG__expert_left_menu_box"><div class="page-module__4R5MOG__expert_left_menu_inner_box"><div class="page-module__4R5MOG__left_menu_list_box p-0 m-0"><p class="page-module__4R5MOG__module_unit">Module Units</p><ul class="page-module__4R5MOG__left_menu_list"><li><a class="undefined" href="/school/units/derivatives-demystified#introduction-5">1<!-- -->.<!-- --> <!-- -->Introduction to Derivatives<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#derivatives-in-financial-markets">2<!-- -->.<!-- --> <!-- -->Derivatives in Financial Markets<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#types-of-derivative-markets">3<!-- -->.<!-- --> <!-- -->Types of Derivative Markets<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#forwards-markets">4<!-- -->.<!-- --> <!-- -->Forwards Markets<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#futures-markets">5<!-- -->.<!-- --> <!-- -->Futures Markets<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#features-of-a-futures-contract">6<!-- -->.<!-- --> <!-- -->
1Features of Futures Contract<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#payoff-from-futures">7<!-- -->.<!-- --> <!-- -->Payoff from Futures<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#leverage">8<!-- -->.<!-- --> <!-- -->Leverage<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#pricing-of-futures">9<!-- -->.<!-- --> <!-- -->Pricing of Futures Contracts<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#hedger">10<!-- -->.<!-- --> <!-- -->Hedger<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#speculator">11<!-- -->.<!-- --> <!-- -->Speculator<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#arbitrageur">12<!-- -->.<!-- --> <!-- -->Arbitrageur<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#options">13<!-- -->.<!-- --> <!-- -->Options<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#call-options">14<!-- -->.<!-- --> <!-- -->Call options<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#put-options">15<!-- -->.<!-- --> <!-- -->Put Options<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#option-terminologies">16<!-- -->.<!-- --> <!-- -->Option Terminologies<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#open-interest">17<!-- -->.<!-- --> <!-- -->
1Open Interest<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#rollover">18<!-- -->.<!-- --> <!-- -->Rollover<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#margins">19<!-- -->.<!-- --> <!-- -->Margins<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li><li><a class="undefined" href="/school/units/derivatives-demystified#conclusion-22">20<!-- -->.<!-- --> <!-- -->Conclusion<span><svg width="8" height="14" viewBox="0 0 8 14" fill="none" xmlns="http://www.w3.org/2000/svg"><path d="M7.2627 7.12292C7.2627 7.34301 7.17866 7.56307 7.01095 7.73086L1.73073 13.011C1.39484 13.3469 0.85026 13.3469 0.514509 13.011C0.178757 12.6753 0.178757 12.1308 0.514509 11.7949L5.18674 7.12293L0.514672 2.45094C0.17892 2.11505 0.17892 1.57063 0.514672 1.23491C0.850423 0.898858 1.39501 0.898858 1.73089 1.23491L7.01111 6.51499C7.17885 6.68287 7.2627 6.90292 7.2627 7.12292Z" fill="#1D458A"></path></svg></span></a></li></ul></div><!--$?--><template id="B:0"></template>Loading glossary sections...<!--/$--></div></div></div><div class="col-lg-9" id="scrollArea"><section data-observe="true" id="introduction-5" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Introduction to Derivatives</h2><p><iframe allow="accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture" allowFullScreen="" frameBorder="0" height="315" src="https://www.youtube.com/embed/FeBEsejgd9g" title="YouTube video player" width="560"></iframe></p>
2
3<p> <br/></p>
4
5<h3>What are derivatives?</h3><p><span style="color:var(--bs-body-color);font-weight:var(--bs-body-font-weight);text-align:var(--bs-body-text-align)">The term &quot;</span><strong style="color:var(--bs-body-color);text-align:var(--bs-body-text-align)">Derivatives</strong><span style="color:var(--bs-body-color);font-weight:var(--bs-body-font-weight);text-align:var(--bs-body-text-align)">&quot; originates from the term &quot;</span><strong style="color:var(--bs-body-color);text-align:var(--bs-body-text-align)">Derive</strong><span style="color:var(--bs-body-color);font-weight:var(--bs-body-font-weight);text-align:var(--bs-body-text-align)">&quot; of the English language, which, as per the Oxford dictionary, means to obtain something from (a specified source).</span></p>
6
7<p> <br/></p>
8
9<p>Let us take a very simple example to understand what Derivatives are:</p>
10
11<p> <br/></p>
12
13<p>Let us assume that there is a farmer who works throughout the year on his farm and produces wheat. Currently, it is the month of March, and the price of wheat in the spot market where the farmer sells his produce is ₹10/kg. The total cost of production of wheat for the farmer, including fertilizer, seed, and his effort, is ₹6/kg.</p>
14
15<p> <br/></p>
16
17<p>However, the wheat on the farmer&#x27;s land will mature in the month of June, 3 months from today. Thus, he is worried that if there is good rainfall leading up to June, wheat from all the farmers will simultaneously hit the market, and because of this, the price of wheat might go down to ₹8/kg, and this will lead to a profit of only ₹2/kg for the farmer.</p>
18
19<p> <br/></p>
20
21<p>He is also aware that, leading up to June, the overall rainfall might not be that good, and the overall supply of wheat hitting the market could be less, and this can lead to the price of wheat going up to ₹12/kg. Now, since his farm is well irrigated, he will produce the desired quantity of wheat and sell it at the price of  ₹12/kg to generate significant profits.</p>
22
23<p> <br/></p>
24
25<p>In both scenarios, what the farmer faces is the price volatility risk, even though in the latter case, the price variability is favourable to the farmer, but he is more worried about the first case, where his profitability will shrink due to a fall in price.</p>
26
27<p> <br/></p>
28
29<p>On the other hand, let us assume that there is a company, ITC Ltd., which uses wheat throughout the year and produces flour under the brand name &#x27;Ashirwad&#x27;, as you all know.  </p>
30
31<p> <br/></p>
32
33<p>Currently, it&#x27;s the month of March, and the price of wheat in the spot market from which ITC buys is ₹10/kg. The overall cost for ITC to process the wheat into Flour (including packaging and marketing) is ₹4/kg. ITC has already tagged the packets in which it sells the flour at ₹16/kg, thus realizing a profit of  ₹2/kg.</p>
34
35<p> <br/></p>
36
37<p>However, what ITC is aware of is that, in the month of June, if the overall rainfall is not that good, then the supply of wheat hitting the market could be less, and this can lead to the price of wheat going up to ₹12/kg. This will lead to an increase in cost for ITC and shrink its profitability to zero. </p>
38
39<p> <br/></p>
40
41<p>ITC cannot simply raise the price of the flour. The reason behind this is that Ashirwad flour is a branded product. There is a huge cost involved in even raising the price, and it is a consumer-centric product. If ITC raises the price frequently, consumers will shift to a different brand or non-branded flour.</p>
42
43<p> <br/></p>
44
45<p>ITC also knows that if there is good rainfall, wheat from all the farmers will simultaneously hit the market, and because of this, the price of wheat might go down to ₹8/kg. In this case, it would lead to a profit of  ₹4/kg.</p>
46
47<p> <br/></p>
48
49<p>
49In both scenarios, ITC faces price risk, even though in the latter case, the price fluctuation is favourable to ITC. However, it is more worried about the first case, where its profitability will shrink due to a fall in price.</p>
50
51<p> <br/></p>
52
53<p>Now, the important thing to note is: The farmer faces the risk of losing money if the price of wheat goes down, and ITC faces the risk of losing money if the price of wheat goes up. Thus, both of them (farmer and lTC), to avoid this risk and to reduce the price uncertainty, enter into a contract, which says that:</p>
54
55<p> <br/></p>
56
57<p><img alt="derivative contract for ITC" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/XucmKITlpT.png"/></p>
58
59<p> <br/></p>
60
61<p>This contract between a farmer and ITC to buy and sell a fixed quantity of wheat at a specific price and on a specific date is called a<strong> DERIVATIVE CONTRACT.</strong> </p>
62
63<p> <br/></p>
64
65<p>According to the contract, the farmer in June is entitled to sell wheat at  ₹11/kg, no matter what the price of wheat is in the spot market, and ITC has to buy the wheat at ₹11/kg, whatever the price of wheat is in the spot market.</p>
66
67<p> <br/></p>
68
69<p>Thus, by virtue of this contract, both the farmer and ITC have eliminated the price risk. This is precisely what the use of derivatives is, or that is what derivatives are.</p>
70
71<p> <br/></p>
72
73<p>Derivatives are contracts in which two parties enter into a contract in order to eliminate or hedge their risk. It could be price risk or the risk of any kind of uncertainty.</p>
74
75<p> <br/></p>
76
77<p>In the Indian context, the <strong>Securities Contracts (Regulation) Act, 1956 (SCRA)</strong> defines &quot;<strong>derivative</strong>&quot; as-</p>
78
79<p> <br/></p>
80
81<p>1.   A security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument, contract for differences or any other form of security.</p>
82
83<p> <br/></p>
84
85<p>2.   A contract that derives its value from the prices, or index of prices, of underlying securities.</p>
86
87<p> <br/></p>
88
89<p>The first definition says that the derivative contract for wheat between a farmer and ITC is derived from the underlying asset, which is 1000 Kgs of wheat.</p>
90
91<p> <br/></p>
92
93<p>The second definition says that the value of the wheat contract depends on the value or price of the wheat, which is the underlying asset in the spot market.</p>
94
95<p> <br/></p>
96
97<p>This means that in the spot market, say in April, even if the price of wheat goes up to ₹13/kg, the person holding this contract still has the right to buy wheat only at  ₹11/kg. Thus, the value of this contract, which previously was only ₹11,000, has now increased to ₹13,000.</p>
98
99<p> <br/></p>
100
101<p>A derivative is a financial contract with a value that is derived from an underlying asset. Derivatives have no direct value of themselves - their value is based on the expected future price movements of their underlying asset. </p>
102
103<p> <br/></p>
104
105<p>The underlying instruments can be anything, such as bonds, commodities, currencies, interest rates, market indexes, and stocks. So, there are different types of financial derivatives available in the market. Let us discuss them in the next section. </p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->138</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 
10513.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.5986C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->5</span></a></span></div></section><section data-observe="true" id="derivatives-in-financial-markets" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Derivatives in Financial Markets</h2><style type="text/css">.right_content_section ul li {
106    margin-bottom: 5px; 
107}
108</style>
109<p>We can have derivative contracts on any assets. There are various types of derivative contracts, such as:</p>
110
111<ul>
112	<li>Commodity Derivatives</li>
113	<li>Currency Derivatives</li>
114	<li>Equity Derivatives</li>
115	<li>Interest Rate Derivatives, etc</li>
116</ul>
117
118<p>Let us discuss some of the markets with respect to the above derivatives and the way they help in the reduction of risk or uncertainty.</p>
119
120<p> <br/></p>
121
122<h3>Commodity</h3>
123
124<p>Tata Steel produces and sells steel. It has a huge inventory of steel and is worried that two months later, if the price of steel drops in the spot market, then it will have to suffer losses when it sells its steel.</p>
125
126<p> <br/></p>
127
128<p>On the other hand, there is a company like Maruti, which uses steel to produce cars. Maruti is seeing a huge increase in demand for cars in the next two months and plans to increase its production, for which it needs steel. However, they are worried that two months later, if the price of steel in the spot market increases, then they will have to spend more money.</p>
129
130<p> <br/></p>
131
132<p>Thus, Tata Steel and Maruti enter into a contract in the derivative market to sell and buy steel, respectively, two months later at a pre-fixed price, thus locking the price uncertainty.</p>
133
134<p> <br/></p>
135
136<h3>Currency</h3>
137
138<p>An exporter produces shirts and exports them to the United States. It is expected to receive a payment for the shirts it has supplied in a month&#x27;s time. The current USD-INR exchange rate is ₹72, and he is expected to receive a payment of $1,000. Thus, at the current rate, he expects to get ₹72,000 a month later.</p>
139
140<p> <br/></p>
141
142<p>However, he is worried that a month later, when his dollar payment comes, the Indian rupee might strengthen, and the USD-INR exchange rate might become ₹70, and thus he would only receive a payment of ₹70,000 instead of ₹72,000, which he had thought earlier.</p>
143
144<p> <br/></p>
145
146<p>On the other hand, an importer plans to import machinery for $1000 a month later and, as per the current exchange rate, plans to save ₹72,000 by the end so as to pay for the machine. However, he is worried that a month later, when he has to pay $1000 for the machinery, the USD-INR exchange rate might go up to ₹74 and he will have to spend ₹74,000 instead of  ₹72,000 to get the machine.</p>
147
148<p> <br/></p>
149
150<p>Thus, the importer and the exporter enter into a contract in the currency derivatives market to buy and sell dollars, respectively, one month later at a pre-defined exchange rate, locking the price uncertainty. </p>
151
152<p> <br/></p>
153
154<h3>Equity</h3>
155
156<p>An investor has held around 500 shares of Reliance for the last 2-3 years, which he does not want to sell at the moment. However, he is worried that the next day, when the verdict of the Reliance and RNRL case will be out in the public domain, and if Reliance loses the case, then the stock price of Reliance might go down significantly, and his wealth will shrink for the time being.</p>
157
158<p> <br/></p>
159
160<p>On the other hand, there is a speculator who already has some insider information that Reliance will win the court case and its stock price will increase.</p>
161
162<p> <br/></p>
163
164<p>However, he does not want to buy Reliance shares in the spot market as he does not want to hold the same for a long period.</p>
165
166<p> <br/></p>
167
168<p>Thus, the investor and the speculator in the equity derivatives market enter into a contract to sell and buy Reliance, respectively, one month later at a pre-defined price, locking the price uncertainty.</p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 
16812.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->74</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
1686C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="types-of-derivative-markets" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Types of Derivative Markets</h2><style type="text/css">.right_content_section ul li {
169    margin-bottom: 5px; 
170}
171</style>
172<p>We have learned about the different types of derivative contracts, but these are traded at different marketplaces. Let us discuss what they are.</p>
173
174<p> <br/></p>
175
176<p>There are 2 types of Derivative Markets. </p>
177
178<ul>
179	<li>Over-the-counter trades (OTC)</li>
180	<li>Exchange-traded contracts.</li>
181</ul>
182
183<h3>Over-the-Counter Market </h3>
184
185<p>The OTC is a market where financial instruments such as currencies, stocks, and commodities are traded directly between two parties through a dealer network. Agreements on what, how many, for what price, and under what conditions are all made based on mutual consent. The contracts between two parties are tailor made and customized. They meet specific requirements for dealing with counterparties. OTCs are mostly traded by smaller companies that do not meet the criteria for a listing on the stock exchanges. </p>
186
187<p> <br/></p>
188
189<p>In an OTC trade, there are no formal rules or mechanisms for risk management to ensure market stability and integrity. Management of counterparty risk is decentralized and located within individual institutions. Hence, OTC trades have high Counterparty risk, due to which the volume in these markets is quite low. </p>
190
191<p> <br/></p>
192
193<h3>Exchange Traded Contracts </h3>
194
195<p>Exchange-traded contracts are those derivative contracts which takes place between two parties via a recognized exchange. Simply put, these are derivatives that are traded in a regulated fashion. Exchange-traded derivatives have become increasingly popular because of the advantages they have over over-the-counter derivatives, such as standardization and elimination of default risk. </p>
196
197<p> <br/></p>
198
199<p>Let us understand what standardization is.</p>
200
201<p> <br/></p>
202
203<p>The exchange has standardized terms and specifications for each derivative contract, with respect to quantity and quality, making it easy for the investor to determine how many contracts can be bought or sold. </p>
204
205<p> <br/></p>
206
207<p>Suppose a person wants to trade in Gold futures at the MCX exchange. So, the exchange specifies that the contract of 1 unit of gold is of 1kg and the purity factor of Gold is 995. Any other quantity or quality variation is not allowed at the exchange. </p>
208
209<p> <br/></p>
210
211<p>Talking of Default risk, let&#x27;s know how it is eliminated in exchange-traded contracts. </p>
212
213<p> <br/></p>
214
215<p>The derivatives exchange itself acts as the counterparty for each transaction involving an exchange-traded derivative, effectively becoming the seller for every buyer and the buyer for every seller. This eliminates the risk that the counterparty to the derivative transaction may default on its obligations. </p>
216
217<p> <br/></p>
218
219<p>Exchange-traded derivatives have a mark-to-market feature. The gains and losses on every derivative contract are calculated daily. If the client has incurred losses, he or she will have to replenish the required capital in a timely manner, or else the exchange will square up the position. </p>
220
221<p> <br/></p>
222
223<p>Because of the standardization feature and sound risk management policies, the exchange-traded contracts have high liquidity, which makes it easier for traders to trade, hence attracting more volume. There are various types of derivative contracts: Forwards, Futures, Options, and Swaps.</p>
224
225<p> <br/></p>
226
227<p>Futures and Options are exchange-traded contracts, whereas forwards and 
227Swaps are OTC contracts. </p>
228
229<p><span><span>Take your trading skills to the next level with our </span><span><strong><a href="https://www.elearnmarkets.com/courses/display/commodity-and-currency" target="_blank">Masterclass on Advanced Commodity &amp; Currency</a></strong></span><span>: Forex Trading Course! Enroll now!</span></span></p>
230
231<p><img alt="Over-the-counter trades vs Exchange-traded contracts" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/DPebPeOfIa.png"/></p>
232
233<p> <br/></p>
234
235<p>We will discuss more about the Forwards and Futures market in our upcoming units. </p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->53</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
2356C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="forwards-markets" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Forwards Markets</h2><style type="text/css">.right_content_section ul li {
236    margin-bottom: 5px; 
237}
238</style>
239<p>First, let us understand the concept of  &#x27;<strong>Forwards</strong>.&#x27; </p>
240
241<p> <br/></p>
242
243<h3>What is a forward contract?</h3>
244
245<p>A forward contract is an agreement to buy or sell a particular asset at a pre-decided price in the future.</p>
246
247<p> <br/></p>
248
249<p>Remember, the contract between the farmer and the ITC to buy and sell a specified quantity of wheat at a specific date and at a specific price is known as a forward contract.</p>
250
251<p> <br/></p>
252
253<p>In this case, one of the parties entering into a forward contract assumes a long position to buy the underlying asset at a certain specified price, and the other party assumes a short position to sell the asset on the same date for the same price. A forward contract is a type of customized contract that can be between any two or more parties, and is not traded on stock exchanges, and thus there is no middleman in the contract. Owing to this nature of the contract, there is a high probability of default by any of the parties, which is known as the &quot;<strong>Counterparty risk</strong>&quot;.</p>
254
255<p> <br/></p>
256
257<h3>Features of a forward contract</h3>
258
259<ul>
260	<li>Each contract is custom-designed and hence is unique in terms of contract size, expiration date, and asset type and quality.</li>
261	<li>This is a bilateral contract and hence exposed to counterparty risk.</li>
262	<li>On the expiration date, the contract has to be settled by delivery of the asset.</li>
263	<li>The contract price is not available in the public domain.</li>
264</ul><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->51</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 
26413.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.5986C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="futures-markets" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Futures Markets</h2><style type="text/css">.right_content_section ul li {
265    margin-bottom: 5px; 
266}
267</style>
268<p>Next, let us discuss the concept of the &#x27;<strong>Futures</strong>&#x27; contract and how it differs from Forwards.</p>
269
270<p> <br/></p>
271
272<h3>What is a futures contract?</h3>
273
274<p>A future contract is similar to the forward contract in terms of its basics; however, the key difference is that a future contract is standardized in nature and is traded on stock exchanges. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract.</p>
275
276<p> <br/></p>
277
278<p>So, futures can be summarised as -</p>
279
280<ul>
281	<li>A standardized contract with a standard underlying instrument,</li>
282	<li>A standard quantity and quality of the underlying instrument that can be delivered,</li>
283	<li>A standard timing of such a settlement</li>
284</ul>
285
286<p>The futures market came into existence to overcome the shortcomings of the forward market. The futures market is more pronounced among the trader and investor community across the world because of the fact that the counterparty or default risk is virtually zero. Every futures contract carries a guarantee from the exchange where it is traded, and hence, in case of any default by the counterparty, it becomes the obligation of the exchange to pay off the other party.</p>
287
288<p> <br/></p>
289
290<p><img alt="differences between future market and forward market" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/zTeoeEutvG.png"/></p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->49</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 
29013.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.5986C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="features-of-a-futures-contract" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Features of Futures Contract</h2><p>Now that we are clear with the concept and features of the Forward contract, let us discuss the features of Future contracts. </p>
291
292<p> <br/></p>
293
294<p><strong>Features</strong>:</p>
295
296<p> <br/></p>
297
298<h3>1. Contract size</h3>
299
300<p>The size of the contract depends on the contract we are trading in. The futures transaction can be entered in accordance with the prescribed lot size, and the participants can only trade in multiples of the lot size while dealing in the futures market</p>
301
302<p>The quantity of wheat or rice in the case of a contract for agricultural commodity futures, or the value of currency in the case of currency futures, or the number of shares in the case of equity futures, is already predefined in terms of basic size.</p>
303
304<p> <br/></p>
305
306<h3>2. Trading Cycle</h3>
307
308<p>Equity Futures are traded in cycles of 3 months. At any point in time, one can take a position to buy or sell the underlying equity share or an index for the current month and the coming two months. For example, if currently it is the month of October, then an individual can choose to enter into a contract to buy or sell the underlying asset in the month of October, November, or December.</p>
309
310<p> <br/></p>
311
312<p>A trader can take either the near-month, the next-month, or the far-month position while trading in futures contracts on the stock exchanges.</p>
313
314<p> <br/></p>
315
316<p>Similarly, in the currency futures segment, the contracts are traded in cycles of 12 months. At any point in time, one can take the position to buy or sell the underlying currency for the current month and the coming eleven months.</p><p>                                              <br/></p>
317
318<p>                           <a href="https://www.elearnmarkets.com/courses/display/futures-trading-made-easy" target="_blank" style="color:rgb(255, 0, 0)"><strong>             <span>Shape your financial journey - Enroll in our Future &amp; Options Trading Course</span></strong></a></p>
319
320<h3>3. Expiry Date</h3>
321
322<p>Futures are traded with a specific time frame in mind, such that there is an expiry or settlement date for each future contract. All the outstanding positions (long or short) are settled on this expiry date. In the equity futures segment, the expiry date is the last Thursday of the expiry month.</p>
323
324<p> <br/></p>
325
326<p>*Note: If that Thursday is a holiday, then the previous trading day is taken into consideration. Similarly, in the Currency futures segment, the expiry date is the last business day of the month. If 27th September 2018 is a Thursday, then the contract expiry date will be 27th September and if it is a Friday, then the expiry will be on Thursday.</p>
327
328<p> <br/></p>
329
330<h3>4. Settlement Date</h3>
331
332<p>In India, Equity and Equity index futures contracts are cash-settled and physically settled. So, on the settlement date, the net payoff is determined, and settlement is made accordingly through cash or physical delivery of assets.</p>
333
334<p> <br/></p>
335
336<p>Also, in the commodity futures segment on MCX, the settlement nature of various commodities varies.</p>
337
338<p> <br/></p>
339
340<p>For example, the gold mini contracts on MCX are deliverables, so in case any of the counterparties does not square off his/her position 5 days before the settlement day, then he/she may be entitled to give or take delivery of the underlying asset. Copper Futures contracts are cash-settled.</p>
341
342<p> <br/></p>
343
344<p>
344<img alt="settlement dates of different companies" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/TwTIZllzFa.png"/></p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->52</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
3446C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->2</span></a></span></div></section><section data-observe="true" id="payoff-from-futures" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Payoff from Futures</h2><p>In this section, we will discuss &#x27;<strong>Payoff</strong>,&#x27; i.e., the likely profit or loss that would occur with a change in the underlying asset&#x27;s price. We will specifically learn the payoff structure for futures contracts for both long and short positions. </p>
345
346<p> <br/></p>
347
348<h3>Long Position</h3>
349
350<p> <br/></p>
351
352<p>A trader/ investor is said to be in a long position when he has entered into a contract to buy the underlying asset on the specified date at a specified price. Thus, the trader or investor will only benefit if the price of the underlying in the spot market increases.</p>
353
354<p> <br/></p>
355
356<p>For example, a trader goes long on the Nifty futures. He has a bullish view of the market and decides to buy 10 lots of Nifty futures contracts at 17200. However, if on expiry, the Nifty turns out to be 17800, then the trader would gain (17800-17200)*50* 10, i.e., ₹3,00,000</p>
357
358<p> <br/></p>
359
360<h3>Payoff diagram for Long positions</h3>
361
362<p> <br/></p>
363
364<p><img alt="Payoff diagram for Long positions" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/KuaGNDDAaa.png"/></p>
365
366<h3>Short Position</h3>
367
368<p> <br/></p>
369
370<p>A trader is said to be in a short position when he has entered into a contract to sell the underlying asset on a specified date at a specified price. The trader or investor will only benefit if the price of the underlying asset in the spot market decreases. </p>
371
372<p> <br/></p>
373
374<p>For example, if a trader holds a bearish view on the market and decides to sell 10 lots of Nifty at 17200. Suppose the value of Nifty happens to turn out to be 17100 on the expiry. The trader will make a profit of (17100 -17200)*50*10 = ₹50,000.</p>
375
376<p> <br/></p>
377
378<p>If on expiry, Nifty turns out to be 17300, then instead of the profit, the trader would incur a loss of (17200 -17300)*50*10 = - ₹50,000.</p>
379
380<p> <br/></p>
381
382<h3>Payoff diagram for Short positions</h3>
383
384<p><strong><img alt="Payoff diagram for Short positions" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/KgnjOLvezA.png"/></strong></p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->57</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 
38413.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.5986C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="leverage" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Leverage</h2><p>Dealing in futures contracts requires a large capital; here comes the usefulness of &#x27;<strong>Leverage &#x27;,</strong> which is basically the use of borrowed capital to undertake an investment. In this section, we will understand the use of Leverage in futures trading. </p>
385
386<p> <br/></p>
387
388<p>The fact that one can take full exposure to the price movement of the underlying asset by just providing a certain percentage of money as margin, if the price movement is in one&#x27;s favour, the return on investment is very high compared to the return on investment in case the investor takes direct exposure in the underlying asset.</p>
389
390<p> <br/></p>
391
392<p>Thus, taking exposure to a higher value of an asset by just providing margin or a smaller amount of sum is known as Leveraging. &quot;<em>Financial Leverage is a two-sided sword</em>.&quot; Let’s understand it with an example.</p><p><span><strong><a href="https://www.elearnmarkets.com/courses/display/commodity-and-currency" target="_blank">Unlock the Power of Leverage in our Masterclass on Advanced Commodity &amp; Currency Trading. Enroll Now for Forex Mastery!</a></strong></span></p>
393
394<p> <br/></p>
395
396<p><strong>Example</strong></p>
397
398<p> <br/></p>
399
400<p>Let us assume that individual A buys 250 shares of Reliance Industries in the cash/spot market @ ₹1000/share. For this transaction, he has to pay a total of ₹250,000 as initial outlay/investment.</p>
401
402<p> <br/></p>
403
404<p>On the other hand, an individual B buys 1 lot of Reliance Industries shares in the futures market, which is equivalent to 250 shares at the price of  ₹1000/share.</p>
405
406<p> <br/></p>
407
408<p>However, for this he has to pay only an initial margin of say 30% of the total contract value of  ₹250,000, i.e., ₹75,000.</p>
409
410<p> <br/></p>
411
412<p>Now, from here, if Reliance goes up by ₹100, then both individual A and individual B make a profit of ₹(250 x 100), i.e., ₹25,000.</p>
413
414<p> <br/></p>
415
416<p>However, the Return on Investment (ROI) for individuals A and B is different: </p>
417
418<p> <br/></p>
419
420<p>ROI (A) = 25,000/2,50,000 = 10%</p>
421
422<p>ROI (B) = 25,000/75,000 = 33.33%</p>
423
424<p> <br/></p>
425
426<p>Thus, we see that since futures allow one to invest a lesser amount of capital to take an exposure for an asset, the return on investment is comparatively higher.</p>
427
428<p> <br/></p>
429
430<p>However, if the price movement is against expectations and Reliance, instead of going up by ₹100, falls by the same amount, then, in that case, the loss for both the individuals is ₹25000 only, but the loss in percentage terms for B (-33%) is much higher than A (-10%).</p>
431
432<p> <br/></p>
433
434<p>Thus, the way in which futures trading provides higher returns if the movement is in favour, similarly, it leads to higher losses when the price movement is unfavourable.</p>
435
436<p> <br/></p>
437
438<p>Moreover, if one buys in the spot/cash market, one becomes a shareholder of the company and remains one even at the fallen price, then they do not need to pay any additional amount of money. Thus, if the price recovers in the future, he can still benefit from the transaction.</p>
439
440<p> <br/></p>
441
442<p>However, if one buys in the futures market, one does not become a shareholder, and if the price falls, he/she has to provide additional margin money for the adverse price movement, or else the broker cancels his trade, and he has to suffer the losses. After this, even if the prices increase in the future, one may not realize any gains or benef
442its. This is the inherent risk of trading in futures. </p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->46</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
4426C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="pricing-of-futures" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Pricing of Futures Contracts</h2><style type="text/css">.right_content_section ul li {
443    margin-bottom: 5px; 
444}
445</style>
446<p>In this unit, we will learn to determine the future price of an asset. </p>
447
448<p> <br/></p>
449
450<p>We know the futures instrument derives its value from its respective underlying. We also know that the futures instrument moves in sync with its underlying. If the underlying price falls, so would the futures price and vice versa. However, the underlying price and the futures price differ, and they are not really the same. Say, for example, Nifty Spot is at 17586, whereas the corresponding current month contract is trading at 17597. This difference in price between the futures price and the spot price is called the “<strong>basis</strong>” or spread. The basis is 9 points in our example. </p>
451
452<p> <br/></p>
453
454<p>The pricing of a futures contract depends on the characteristics of the underlying asset. There is no single way to price futures contracts because different assets have different demand and supply patterns, different characteristics, and cash flow patterns. Market participants use different models for pricing futures. The two popular models of futures pricing:</p>
455
456<p> <br/></p>
457
458<ul>
459	<li>Cash and Carry model</li>
460	<li>Expectancy model</li>
461</ul>
462
463<h3>Cash and Carry Model</h3>
464
465<p>Let us understand this concept with an example.</p>
466
467<p> <br/></p>
468
469<p>There are two people - Ram &amp; Arjun. Ram decides to buy a particular stock, TCS, in the spot market, paying the total amount and taking delivery of the shares. On the other hand, Arjun decides to buy TCS in futures, paying just the margin. </p>
470
471<p><em>What happens with Ram’s Position?</em></p>
472
473<p> <br/></p>
474
475<p>TCS shares are credited to his demat account. Now, if TCS announces a dividend, Ram is entitled to that dividend, but simultaneously, he loses out on the opportunity cost of the funds involved in buying those TCS shares in the spot market. He is basically forgoing the interest on those funds.</p>
476
477<p> <br/></p>
478
479<p>On the other hand, Arjun, deploying just a small margin, is holding a similar position in TCS. When a dividend is announced, Arjun is not entitled to this dividend as his demat account doesn’t have TCS shares.</p>
480
481<p> <br/></p>
482
483<p>We see that both Ram and Arjun are long on TCS, but still, their situation has a few differences on account of the opportunity cost of funds involved as well as dividends received. This is known as the <strong>cost of carry</strong>! </p>
484
485<p> <br/></p>
486
487<p>The <strong><a href="https://blog.elearnmarkets.com/cash-and-carry-arbitrage/">Cash &amp; Carry Model</a></strong>
487 assumes that markets are perfectly efficient. This means there are no differences in the cash and futures prices. No opportunity for arbitrage exists, and investors are indifferent to the spot and futures market prices while they trade in the underlying asset. </p>
488
489<p> <br/></p>
490
491<p>The model also assumes that the contract is held till maturity. The price of a futures contract will be equal to the spot price plus the net cost incurred in carrying the asset till the maturity date of the futures contract.</p>
492
493<p> <br/></p>
494
495<p><strong>Futures Price = Spot Price + (Carry Cost – Carry Return)</strong></p>
496
497<p> <br/></p>
498
499<p>Here, Carry Cost refers to the cost of holding the asset till the futures contract matures. This could include storage costs, in the case of commodities, interest paid to acquire and hold the asset, financing costs, etc. </p>
500
501<p> <br/></p>
502
503<p>Carry Return refers to any income derived from the asset while holding it, like dividends, bonuses, etc. The net of these two is called the net cost of carry.</p>
504
505<p> <br/></p>
506
507<p>The cost of carry model used for pricing futures is given by:</p>
508
509<p> <br/></p>
510
511<p><img alt="futures price formula" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/TOkbxzuUCw.png"/></p>
512
513<p> <br/></p>
514
515<p>Where,</p>
516
517<p> <br/></p>
518
519<p><strong>S- Spot price</strong></p>
520
521<p> <br/></p>
522
523<p><strong>r- cost of financing </strong>(using continuously compounded interest rate)</p>
524
525<p> <br/></p>
526
527<p><strong>T- Time to expiry</strong></p>
528
529<p> <br/></p>
530
531<p><strong>e- 2.71828</strong></p>
532
533<p> <br/></p>
534
535<h3>Expectancy Model</h3>
536
537
538
539<p>According to the expectancy model, it is not the relationship between spot and futures prices but that of expected spot and futures prices that moves the market. This is why market participants would enter into a futures contract and price the futures based upon their estimates of the future spot prices of the underlying assets. </p>
540
541<p> <br/></p>
542
543<p>According to this model, </p>
544
545<ul>
546	<li>Futures can trade at a premium or discount to the spot price of the underlying asset. </li>
547	<li>Futures prices give market participants an indication of the expected direction of movement of the spot price in the future.</li>
548</ul>
549
550<p>For instance, if the futures price is higher than the spot price of an underlying asset, market participants may expect the spot price to go up in the near future. This expectedly rising market is called the “<strong>Contango market</strong>”. </p>
551
552<p> <br/></p>
553
554<p>Similarly, if the futures price is lower than the spot price of an asset, market participants may expect the spot price to come down in the future. This expectedly falling market is called a “<strong>Backwardation market</strong>”</p>
555
556<p> <br/></p>
557
558<p>The difference between the spot and the futures price is known as the <strong>basis</strong>.</p>
559
560<p> <br/></p>
561
562<p>So, now that we have understood how futures contracts are priced. Next, let us discuss the different market participants in this futures market. </p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->29</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 
56213.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.5986C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->1</span></a></span></div></section><section data-observe="true" id="hedger" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Hedger</h2><style type="text/css">.right_content_section ul li {
563    margin-bottom: 5px; 
564}
565</style>
566<h3>What are the different participants in the derivatives market?</h3>
567
568<p> <br/></p>
569
570<p>There are three main types of participants in the derivatives market whose individual actions lead to market formation and rise or fall in the price of individual securities or the overall market.</p>
571
572<ul>
573	<li>Hedger</li>
574	<li>Speculator</li>
575	<li>Arbitrageur</li>
576</ul>
577
578<p>First, let us start with ‘<strong>Hedger</strong>’. We will discuss the other two &#x27;<strong>Speculator</strong>&#x27; and &#x27;<strong>Arbitrageur</strong>&#x27; in the subsequent sections. </p>
579
580<p> <br/></p>
581
582<p>Hedging means making an investment or taking a position to reduce the risk of adverse price movements in an asset. It enables an individual to reduce the risk arising from future price uncertainty.</p>
583
584<p> <br/></p>
585
586<p>In our introductory section, the example of ITC and the farmer, which we discussed, both counterparties, by virtue of entering into the futures contract, were acting as hedgers.</p>
587
588<p> <br/></p>
589
590<h3>Hedging Through Futures</h3>
591
592<p> <br/></p>
593
594<p>Hedging in the equity market or any other market could be possible by using various types of derivative products. Hedging via the use of a futures contract is one of the simplest forms of hedging possible, and it could be executed under two scenarios:</p>
595
596<ul>
597	<li>Long Security or underlying asset, Sell Futures</li>
598	<li>Short Security or underlying asset, Long Futures</li>
599</ul>
600
601<p><strong>Long Security or underlying asset, Sell Futures</strong></p>
602
603<p>A trader buys a security at ₹800, and he or she might be worried about the share price going down, so to hedge the position, he or she can short the futures of that particular security.</p>
604
605<p> <br/></p>
606
607<p>Assume that the spot price of the security he holds is ₹800 and the 2 months&#x27; future contract he was holding cost him ₹804. For this, he pays an initial margin. Now, if the price of the security falls any further, he will suffer losses on the security he holds. However, the losses he suffers on the security will be offset by the profits he makes on his short futures position. </p>
608
609<p> <br/></p>
610
611<p>Take, for instance, that the price of his security falls to ₹720. The fall in the price of the security will result in a fall in the price of futures, and the same will now trade at a price lower than the price at which he entered into a short futures position.</p>
612
613<p> <br/></p>
614
615<p>Hence, his short futures position will start making a profit. The loss of  ₹80 incurred on the security he holds will be made up by the profits made on his short futures position. However, in case the security price goes up instead of falling, then the profit he makes from his position in the underlying security is also wiped out by the loss he makes from his futures position.</p>
616
617<p> <br/></p>
618
619<p>Thus, it is not necessary that hedging always benefits an individual. The best that can be achieved using hedging is the removal of unwanted exposure, i.e., unnecessary risk, and all that can come out of hedging is reduced risk.</p>
620
621<p> <br/></p>
622
623<p>Hedging locks in the price of the security at which the hedge is entered, and even if the price rises or falls, the investor will realize the same value from the underlying asset.</p>
624
625<p> <br/></p>
626
627<p><strong>Short Security or underlying asset, Long Futures</strong></p>
628
629<p>An investor sells a security, say Reliance Industries at ₹1000, and he might always be worried about the share price going up, so in order to hedge himself, he can go long in futures.</p>
630
631<p> <br/></p>
632
633<p>Assume that the spot price of the security he holds is ₹1000 and the 2 months&#x27; future contract he was holding cost him ₹1004. For this, he pays an initial margin. Now, if the price of the security goes up further, he will suffer losses on the security he holds. However, the losses he suffers on the security will be offset by the profits he makes on his long futures position.</p>
634
635<p> <br/></p>
636
637<p>Take, for instance, that the price of his security rose to ₹1050. The rise in the price of the security will result in a rise in the price of futures also. Futures will now trade at a price higher than the price at which he entered into a long futures position. Hence, his long futures position will start making profits. The loss of  ₹50 per share incurred on the security he holds will be made up by the profits made on his long futures position. </p>
638
639<p> <br/></p>
640
641<p>
641Thus, what he has done is lock in the price of the shares in his portfolio at ₹1000, and even if the price goes up or comes down, he would still realize the same ₹1000 from selling the shares and coming out of the futures position.</p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->35</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
6416C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="speculator" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Speculator</h2><style type="text/css">.right_content_section ul li {
642    margin-bottom: 5px; 
643}
644</style>
645<p>We will discuss the next type of market participant, known as the ‘<strong>Speculator</strong>.’</p>
646
647<p> <br/></p>
648
649<p>Speculators are individuals who take large risks, especially with respect to anticipating future price movements, in the hope of making quick, large gains. Speculators can achieve these profits by buying low and selling high, and vice versa.</p>
650
651<p> <br/></p>
652
653<p>Their investment horizon is very short-term in nature, and hence they use futures markets where they also have to spend less (only margin money required) as against the full amount in the spot market.</p>
654
655<p> <br/></p>
656
657<h3>Speculating Through Futures</h3>
658
659<p> <br/></p>
660
661<p>Speculating in the equity market or any other market could be possible by using various types of derivative products. Speculating via uses of futures contracts is one of the simplest and yet highly rewarding forms if one&#x27;s expectation of future price movement is correct.</p>
662
663<p> <br/></p>
664
665<ul>
666	<li>Bullish on security, buy futures</li>
667	<li>Bearish on security, sell futures</li>
668</ul>
669
670<p><strong>Bullish on security, buy futures</strong></p>
671
672<p> <br/></p>
673
674<p>An investor holds a view that a particular security that trades at ₹1000 is undervalued and expects its price to go up in the next two to three days. So, he buys 100 shares, which cost him one lakh rupees. His hunch proves correct, and three days later the security closes at ₹1010, and he makes a profit of ₹1000 on an investment of  ₹1,00,000 for a period of three days. This works out to a return of one percent.</p>
675
676<p> <br/></p>
677
678<p>Today, a speculator can take the same position on the security by using futures contracts.</p>
679
680<p> <br/></p>
681
682<p>The security trades at ₹1000, and the one-month futures trade at ₹1002. Just for the sake of comparison, assume that the minimum contract value is ₹1,00,000 and he buys 100 security futures for which he pays a margin of ₹20,000.</p>
683
684<p> <br/></p>
685
686<p>Two days later, the security closes at ₹1012. He makes the same profit of  ₹1000 on an investment of  ₹20,000. This works out to a return of five percent.</p>
687
688<p> <br/></p>
689
690<p>Thus, using futures, the speculator has made a ROI of around 5% in a short period, as against 1% if he had used the cash market.</p>
691
692<p> <span>Explore the Masterclass: Gain Key Insights on Navigating as a Speculator. Elevate your skills in <strong><a href="https://www.elearnmarkets.com/courses/display/commodity-and-currency" target="_blank">Advanced Commodity &amp; Forex Trading!</a></strong></span></p><p><span><br/></span></p><p><span><br/></span></p>
693
694<p><strong>Bearish on security, Sell futures</strong></p>
695
696
697
698<p>Stock futures can also be used by a speculator who believes that a particular security is over- valued and is likely to see a fall in price. To trade based on his opinion, all he needs to do is sell stock futures. Futures on an individual security move correspondingly with the underlying security, as long as there is sufficient liquidity in the market for the security. </p>
699
700<p> <br/></p>
701
702<p>If the security price rises, so will the futures price. If the security price falls, so will the futures price.</p>
703
704<p> <br/></p>
705
706<p>Now, take the case of the trader who expects to see a fall in the price of ABC Ltd. He sells one two-month contract of futures of ABC Ltd. at ₹240 (each contract for 100 underlying shares). He pays a small margin on the same.</p>
707
708<p> <br/></p>
709
710<p>Two months later, when the futures contract expires, ABC closes at ₹220. On the day of expiration, the spot and the futures price converge. He has made a clean profit of  ₹20 per share. </p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 
71012.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->28</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
7106C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="arbitrageur" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Arbitrageur</h2><p>Lastly comes the ‘<strong>Arbitrageur</strong>.’</p>
711
712<p> <br/></p>
713
714<p>An arbitrageur is a type of individual who attempts to profit from price inefficiencies in the market by making simultaneous trades that offset each other and capture risk-free profits.</p>
715
716<p> <br/></p>
717
718<p>An arbitrageur would, for example, look for price differences between stocks listed on more than one exchange, and then buy the undervalued shares on one exchange while short selling the same number of overvalued shares on another exchange, thus capturing risk-free profits as the prices on the two exchanges converge.</p>
719
720<p> <br/></p>
721
722<p>Arbitrageurs also play a pivotal role in the operation of capital markets. They are also known as market makers, as their efforts in exploiting price inefficiencies keep prices more accurate than they otherwise would be.</p>
723
724<p> <br/></p>
725
726<h3>Arbitraging Through Futures</h3>
727
728<p> <br/></p>
729
730<p>Arbitraging in the equity market or any other market could be possible by using various types of derivative products. Arbitraging via the use of futures contracts is one of the most widely used methodologies of arbitrage in the Indian markets. </p>
731
732<p> <br/></p>
733
734<p>Even though over the last couple of years the systems have taken over a lot of roles from human individuals in the job market for arbitrageurs, still individuals with good quantitative skills and a bent for adoption of technology have fared quite well, and their requirement would always exist.</p>
735
736<p> <br/></p>
737
738<ul>
739	<li>If futures are overpriced: Buy spot, sell futures</li>
740	<li>If futures are underpriced: Sell Spot, Buy futures</li>
741</ul>
742
743<p><strong>Futures are overpriced: Buy spot, Sell futures</strong></p>
744
745<p> <br/></p>
746
747<p>Say, a stock, ABC Ltd. trades at ₹1000 in the cash market or spot market and one-month ABC futures contract&#x27;s theoretical price should be ₹1010 based on the futures pricing mechanism discussed earlier.</p>
748
749<p> <br/></p>
750
751<p>However, it trades at ₹1020 and seems overpriced. As an arbitrageur, you can make a riskless profit by entering into the following set of transactions.</p>
752
753<p> <br/></p>
754
755<p>On day 1, buy the security in the cash/spot market at ₹1000. And simultaneously, sell the futures of the security in the futures market at ₹1020. Through a series of similar actions by many arbitrageurs, the price in the spot market will start to increase as a lot of buying is taking place in the spot market, and the price in the futures market will start falling since a lot of selling is taking place in the futures market.</p>
756
757<p> <br/></p>
758
759<p>This process of buying in the spot market and selling in the futures market will continue till the spot price and the futures price come to a level at which the spot futures price difference comes back to the theoretically justified levels.</p>
760
761<p>Let’s assume the spot price rises to a level of  ₹1005 and the futures price falls to a level of  ₹1015, and now the basis is only ₹10, which is justified.</p>
762
763<p> <br/></p>
764
765<p>Thus, the arbitrageur will now sell his holding in the cash market at ₹1005, which he had bought at ₹1000, and cover his short position in the futures market at ₹1015, where he had initiated a short contract at ₹1020, making an overall profit of Rs.10 (₹5 in cash and ₹5 in futures)</p>
766
767<p> <br/></p>
768
769<p>This profit of  ₹10 is actually the amount by which the futures price was overpriced compared to its theoretical price when the arbitrageur initiated the trade. This overpricing was because of the inefficiency of markets, which the arbitrageur capitalized on.</p>
770
771<p> <br/></p>
772
773<p><strong>Future is under-priced: Sell spot, Buy futures</strong></p>
774
775<p> <br/></p>
776
777<p>A stock, say, ABC Ltd. trades at ₹1000 in the cash market, or spot market and one-month ABC futures contract&#x27;s theoretical price should be ₹1010 based on the futures pricing mechanism we discussed earlier. However, it trades at ₹990 and seems under-priced. As an arbitrageur, you can make a riskless profit by entering into the following set of transactions.</p>
778
779<p> <br/></p>
780
781<p>On day 1, sell the security in the cash/spot market at ₹1000 (if you already own it, or else borrow and sell) and simultaneously, buy the futures of the security in the futures market at ₹990.</p>
782
783<p> <br/></p>
784
785<p>Through a series of similar actions by many arbitrageurs, the price in the spot market will start to fall as a lot of selling is taking place in the spot market, and the price in the futures market will start rising as a lot of buying is taking place in the futures market.</p>
786
787<p> <br/></p>
788
789<p>This process of selling in the spot market and buying in the futures market will c
789ontinue till the spot price and the futures price come to a level at which the spot futures price difference comes back to the theoretically justified levels.</p>
790
791<p> <br/></p>
792
793<p>Let’s assume the spot price falls to a level of ₹990 and the futures price rises to a level of ₹1000, and now the basis is only ₹10, which is justified.</p>
794
795<p> <br/></p>
796
797<p>Thus, the arbitrageur will now buy or cover the number of shares he had sold in the cash market at ₹990, which he had sold at ₹1000, and sell in the futures market at ₹1000, where he had initiated a buy at ₹990, making an overall profit of Rs.20 (₹10 in cash and ₹10 in futures).</p>
798
799<p> <br/></p>
800
801<p>This profit of  ₹20 is actually the amount by which the futures price was under-priced compared to its theoretical price when the arbitrageur initiated the trade. This under-pricing was because of the inefficiency of markets, which the arbitrageur capitalized on.</p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->29</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
8016C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="options" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Options</h2><style type="text/css">.right_content_section ul li {
802    margin-bottom: 5px; 
803}
804</style>
805<p>Till now, we have completed our discussion on ‘<strong>Futures</strong>.’ Starting from this section, we will learn about a new derivative instrument called ‘<strong>Options</strong>’.</p>
806
807<p> <br/></p>
808
809<p>Options are very interesting and versatile derivative instruments. So far, we have learned about forwards and futures. We learned that futures overcome the limitations of forwards. However, in futures, theoretically, there is a possibility of unlimited profit as well as loss. In a future contract, the trader has an obligation to bear that loss or enjoy profits, as the case may be, on expiry.</p>
810
811<p> <br/></p>
812
813<p>Now, what happens if the trader has a choice? If a derivative contract can give the trader a choice to enter into the contract or simply back out at a later stage. Suppose the trader doesn&#x27;t want to enter into an obligation to fulfil the contract. If so, then the trader can exercise choice as per the situation. If the situation is in his/her favour, he/she can exercise the right and go ahead with the contract and take the risk as per his/her risk appetite. Else can back out and let the contract be!</p>
814
815<p> <br/></p>
816
817<p>Do you think this kind of choice is available? yes </p>
818
819<p> <br/></p>
820
821<p>This choice is called an<strong> OPTION</strong>, a type of derivative contract that gives you a CHOICE.</p>
822
823<p> <br/></p>
824
825<p>Choice of the right to buy or sell the asset, at a pre-determined price and time. </p>
826
827<p> <br/></p>
828
829<p>Now think about it - if in a contract, 1 party has a choice or right to enter or not enter the contract as per the situation, the other party has to take on an obligation. </p>
830
831<p> <br/></p>
832
833<p>There are a few important features of an option contract. </p>
834
835<p> <br/></p>
836
837<ul>
838	<li>When you choose to take up the right, you are the buyer of that choice or option.</li>
839	<li>When you choose to take an obligation, you are the seller of that choice or option. So, this choice can be bought or sold.</li>
840	<li>Now choose what to do.</li>
841	<li>When your choice is to buy the asset, it’s called a &#x27;<strong>Call</strong>&#x27; option.</li>
842	<li>When your choice is to sell the asset, it is called a &#x27;<strong>Put</strong>&#x27; option.</li>
843</ul>
844
845<p>We will learn more about <strong>Call</strong> and <strong>Put</strong> options in the subsequent sections of this module. </p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->34</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 
84513.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.5986C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="call-options" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Call options</h2><h3>What is a Call Option?</h3>
846
847<p> <br/></p>
848
849<p>A call option is an options contract in which the buyer has the right to buy a specified quantity of the underlying stock at a predetermined price without any obligation.</p>
850
851<p> <br/></p>
852
853<p>Now, let us understand this with an example:</p>
854
855<p> <br/></p>
856
857<p>Let us assume that a stock is trading at ₹100 today.</p>
858
859<p> <br/></p>
860
861<p>And today, you are getting the option that gives the right to buy the same stock one month later, at the same ₹100, even if the shares trade at more than or less than ₹100. </p>
862
863<p> <br/></p>
864
865<p>So, should you buy it?</p>
866
867<p> <br/></p>
868
869<p>The answer is yes, as this means that even after one month, if the share is trading at ₹120, you can still buy it at ₹100.</p>
870
871<p> <br/></p>
872
873<p>To get this right, you need to pay a small amount today, say ₹5, which is called the premium amount.</p>
874
875<p> <br/></p>
876
877<p>Now, if the share price goes above ₹100, then you can exercise your right and buy the shares at ₹100. If the share price stays at or below ₹100, then you do not need to buy the shares. You just lose ₹5, which you had paid for the right to buy in this example.</p>
878
879<p> <br/></p>
880
881<p>This type of options contract is known as the <strong><a href="https://blog.elearnmarkets.com/call-option-meaning-types-price/">Call Option</a></strong>.</p>
882
883<p> <br/></p>
884
885<h3>What are Long Call Options?</h3>
886
887<p> <br/></p>
888
889<p>When the traders expect that the price can move up, or when they are bullish, then they can take a long position in the call option.</p>
890
891<p> <br/></p>
892
893<p>Traders need to pay a premium to buy a call option. They buy these options due to the expectation that the underlying price will increase.</p>
894
895<p> <br/></p>
896
897<p>But if the price drops below the strike price, then the option holders lose the amount paid for the premium. This happens because the contract will not be exercised by the buyer, and hence it will lapse.</p>
898
899<p> <br/></p>
900
901<p>For example, let us assume that you are bullish on a stock. You buy a call option with a strike price of the stock is ₹5000, and the premium which you pay is ₹70.</p>
902
903<p> <br/></p>
904
905<p>Premium is the maximum amount that a buyer will agree to suffer as a loss. If the price of a share increases, the buyer exercises his option. </p>
906
907<p> <br/></p>
908
909<p>If the share’s price does not increase beyond the strike price of  ₹5000, then the option expires on the maturity date. The buyer thus incurs a loss of  ₹70 on the premium.</p>
910
911<p> <br/></p>
912
913<p><img alt="call option graph" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/lhVVHOQwDa.png"/></p>
914
915<p> <br/></p>
916
917<p>From the above diagram, you can see that your profits will be unlimited if the price moves up, and losses will be limited to the premium.</p>
918
919<p> <br/></p>
920
921<h3>What are Short Call Options?</h3>
922
923<p> <br/></p>
924
925<p>The short call options involve selling an option of a given underlying asset at a predetermined price.</p>
926
927<p> <br/></p>
928
929<p>This strategy leads to limited profit if shares are traded below the strike price, and it attracts substantial risk if it is traded at a value more than their strike price.</p>
930
931<p> <br/></p>
932
933<p><img alt="option transaction graph" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/hfMUfqrjtY.png"/></p>
934
935<p> <br/></p>
936
937<p>From the above diagram, you can see that when shorting a call option, the profit is limited to its premium amount, which is ₹70, and the loss is unlimited.</p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 
93712.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->35</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
9376C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="put-options" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Put Options</h2><h3>What is a Put Option?</h3>
938
939<p> <br/></p>
940
941<p>A put option is an option contract that gives the buyer the right, but no obligation, to sell the underlying asset at a specific price, also known as the strike price.</p>
942
943<p><br/>
944Put options can be traded on many underlying assets like stocks, currencies, and commodities.</p>
945
946<p> <br/></p>
947
948<p>They help us to protect our trades against the decline in the price of the above assets below a specific price.</p>
949
950<p> <br/></p>
951
952<p>The trader does not have to own the underlying asset to buy or sell puts.</p>
953
954<p> <br/></p>
955
956<p>The put buyer has the right, but not the obligation, to sell the asset at a particular price, within a specified period.</p>
957
958<p> <br/></p>
959
960<p>Whereas, the seller has the obligation to buy the asset at the strike price if the option owner exercises their put option.</p>
961
962<p> <br/></p>
963
964<h3>What is meant by Buying Put Options?</h3>
965
966<p> <br/></p>
967
968<p>It is one of the simplest ways to trade <a href="https://blog.elearnmarkets.com/put-options-buying-selling-trading/"><strong>Put Options</strong></a>.</p>
969
970<p> <br/></p>
971
972<p>When the options trader has a bearish view on a particular stock, then he can purchase put options to profit from a decline in the asset price.</p>
973
974<p> <br/></p>
975
976<p><strong>Example:</strong></p>
977
978<p> <br/></p>
979
980<p>Suppose the stock is trading at ₹4900 and a put option contract with a 4900 strike price is trading at ₹70, expiring in a month.</p>
981
982<p> <br/></p>
983
984<p>You are expecting that the price of the stock will drop sharply in the coming weeks.</p>
985
986<p> <br/></p>
987
988<p>The payoff diagram of the examples will look as follows:</p>
989
990<p> <br/></p>
991
992<p><img alt="put options transactions" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/eDvQnSAhLT.png"/></p>
993
994<p> <br/></p>
995
996<p>If the prices fall as expected, then we earn profits.</p>
997
998<p> <br/></p>
999
1000<p>But if our trade does not go according to our expectations, then our loss will be limited only to the premium price that we had paid.</p>
1001
1002<p> <br/></p>
1003
1004<h3>What is meant by Selling Put Options?</h3>
1005
1006<p> <br/></p>
1007
1008<p>Put sellers sell options with the expectation of gaining the premium amount when the underlying asset either goes up or remains in the existing range without seeing a negative bias. </p>
1009
1010<p> <br/></p>
1011
1012<p>Once a put has been sold to a buyer, the seller has the obligation to buy the underlying asset at the strike price if the option is exercised.</p>
1013
1014<p> <br/></p>
1015
1016<p>The stock price must increase above the strike price or remain in the strike price zone to make a profit.</p>
1017
1018<p> <br/></p>
1019
1020<p>If the underlying stock’s price falls below the strike price before the expiration date, then the buyer exercises his right, resulting in a loss for a put option seller. </p>
1021
1022<p> <br/></p>
1023
1024<p><img alt="put options graphs" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/kIiVgULLas.jpg"/></p>
1025
1026<p> <br/></p>
1027
1028<p>From the above diagram, we can see that the profit is limited to the premium, whereas if the prices move against our expectation, then we may suffer unlimited losses.</p>
1029
1030<p> <br/></p>
1031
1032<h3>Difference between Call Options and Put Options:</h3>
1033
1034<p> <br/></p>
1035
1036<p>An investor buys a put option when he expects the price of an underlying asset to fall within a specific time period, whereas an investor buys a call option when he expects the price of an underlying asset to rise within a specific time period.</p>
1037
1038<p> <br/></p>
1039
1040<p><img alt="differences between call options and put options" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/SQXqoswdNC.png"/></p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 
104012.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->30</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
10406C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->1</span></a></span></div></section><section data-observe="true" id="option-terminologies" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Option Terminologies</h2><style type="text/css">.right_content_section ul li {
1041    margin-bottom: 5px; 
1042}
1043</style>
1044<p>Previously, we have learned about buying and selling Call or Put options. But before we start options trading, it is essential to get used to the specific terminologies related to Options. </p>
1045
1046<p> <br/></p>
1047
1048<h3>What are the various terms used in Options? </h3>
1049
1050<p> <br/></p>
1051
1052<p>Different terms need to be understood with clarity regarding options. Let us understand this with the help of an example.</p>
1053
1054<p> <br/></p>
1055
1056<p>Let us assume that we are bullish on a stock, which is trading at ₹670/-. We buy a call option at a strike price of ₹750. By paying a premium of ₹50 per share. The contract would mature after one month. </p>
1057
1058<p> <br/></p>
1059
1060<p>It looks simple, but there are a lot of terms associated with it that need to be understood. </p>
1061
1062<p> <br/></p>
1063
1064<p>The right to buy a stock at a specified price on a certain specific predetermined date is known as a call option contract, and the person who has this right is known as a call option buyer or holder.</p>
1065
1066<p> <br/></p>
1067
1068<p>The person who has the obligation to sell the stock at the specified price on the predetermined date is known as a call option seller or writer.</p>
1069
1070<p> <br/></p>
1071
1072<p>The predefined specified price is known as the strike price or the exercise price, whereas the price at which the stock price is trading in the market at different points in time is known as the Spot price.</p>
1073
1074<p> <br/></p>
1075
1076<p>In our example, ₹670 is the spot price and ₹750 is the exercise price.</p>
1077
1078<p> <br/></p>
1079
1080<p>To enjoy the right to buy the stock, the option buyer pays a small amount to the option seller at the time of entering into the contract. This is known as the premium. </p>
1081
1082<p> <br/></p>
1083
1084<p>The time (i.e., one month in our example) when the contract would lapse is known as the time to maturity.</p>
1085
1086<p> <br/></p>
1087
1088<p>Similarly, a Put option is the right to sell the asset at a predefined price on a predefined date.</p>
1089
1090<p> <br/></p>
1091
1092<p>A seller of a put option has the obligation to buy the asset at the strike price, and he also receives a premium to do so. </p>
1093
1094<p> <br/></p>
1095
1096<p><strong>We must remember that all option buyers pay a premium and option sellers receive a premium. </strong></p>
1097
1098
1099
1100<p>One more concept with respect to options is their moneyness and intrinsic value. It basically tells us about the relationship of an options contract with respect to its spot price and exercise price. </p>
1101
1102<p> <br/></p>
1103
1104<p>It is a classification criterion which classifies each option strike based on how much money a trader will earn would exercise his option contract at this particular moment.</p>
1105
1106<p> <br/></p>
1107
1108<p>It basically tells us about the intrinsic value of an option. The intrinsic value of an option is the money the option buyer will make from the contract, assuming he has the right to exercise that option now. Intrinsic Value is always a positive value and can never go below zero. There are three broad classifications on the basis of moneyness. They are:</p>
1109
1110<p> <br/></p>
1111
1112<ul>
1113	<li>In the Money (ITM)</li>
1114	<li>At the Money (ATM)</li>
1115	<li>Out of the Money (OTM)</li>
1116</ul>
1117
1118<p>All in the money options are those options which have a positive intrinsic value. For call options, a contract is ITM when the spot price is greater than the exercise price, and for a put option, a contract is ITM when the spot price is lower than the exercise price. </p>
1119
1120<p> <br/></p>
1121
1122<p>OTM options are those whose intrinsic value is always 0. For call options, a contract is OTM when the spot price is lower than the exercise price. And for a put option, a contract is OTM when the spot price is higher than the exercise price. </p>
1123
1124<p> <br/></p>
1125
1126<p>ATM options are those where the spot price equals the exercise price, and intrinsic value is also zero.</p>
1127
1128<p> <br/></p>
1129
1130<p><img alt="intrinsic value of put and call options" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/hHlGzLzZtA.png"/></p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 
113012.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->28</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
11306C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="open-interest" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Open Interest</h2><p>Now that we are familiar with different option terminologies, we will learn about an important term called the <strong><a href="https://www.elearnmarkets.com/face2face/details/trading-strategy-using-options-open-interest-2">Open Interest</a></strong> that is useful to both futures and options trading.</p>
1131
1132<p> <br/></p>
1133
1134<h3>What is open interest and why is it important?</h3>
1135
1136<p> <br/></p>
1137
1138<p>Open Interest defines the total number of open or outstanding contracts presently held by the market participants at a given time. It helps in the identification of stock market trends.</p>
1139
1140<p> <br/></p>
1141
1142<p>In simple language, open interest analysis helps a trader to understand the market scenario by only showing the number of futures contracts that have changed hands during market hours. This concept applies to futures and options contract traders. Open Interest or OI data changes day by day depending on the outstanding contracts.</p>
1143
1144<p> <br/></p>
1145
1146<p>Let’s take an example to understand the whole picture.</p>
1147
1148<p> <br/></p>
1149
1150<p>There are five participants in the market: A, B, C, D, and E.</p>
1151
1152<p> <br/></p>
1153
1154<p>On 1st July, A buys 10 contracts from B =&gt; OI 10</p>
1155
1156<p> <br/></p>
1157
1158<p>2nd July, C buys 20 contracts from D =&gt; OI 30</p>
1159
1160<p> <br/></p>
1161
1162<p>3rd July, A sells his 10 contracts to D =&gt; OI 20</p>
1163
1164<p> <br/></p>
1165
1166<p>4th July, E buys 20 contracts from C =&gt; OI 20</p>
1167
1168<p> <br/></p>
1169
1170<p>So, we can understand how OI changes depending on the change in the number of contracts.</p>
1171
1172<p> <br/></p>
1173
1174<p>When a new entrant trades with a new entrant in the F&amp;O market, the Open Interest goes up.</p>
1175
1176<p> <br/></p>
1177
1178<p>When an existing position holder squares off with the entry of a new entrant, open interest remains unchanged.</p>
1179
1180<p> <br/></p>
1181
1182<p>When two existing position holders square off their positions, we see open interest go down.</p>
1183
1184<p> <br/></p>
1185
1186<h3>How to analyse open interest data to identify trends?</h3>
1187
1188<p> <br/></p>
1189
1190<p>A trend can be defined by its upward and downward direction, but the sustainability of that trend is questionable. There are some important factors which backs up the price to take a certain direction. OI is one of the factors and a reason for a sustainable trend, as well as a trend reversal.</p>
1191
1192<p> <br/></p>
1193
1194<p>When the price is going up or down, and the future open interest increases alongside the price at a certain level, then we can expect that the price movement is going to sustain.</p>
1195
1196<p> <br/></p>
1197
1198<p>On the other hand, when a trend is present in the market, and a sudden fall in futures open interest is visible, then we should be doubtful about the trend. There might be a chance of a trend reversal.</p>
1199
1200<p> <br/></p>
1201
1202<p>An increase in open interest means fresh money is flowing into the market, and a decrease in open interest suggests money outflow from the market. </p>
1203
1204<p> <br/></p>
1205
1206<p>Buyers move the market up by investing fresh cash into the market, while sellers do the opposite. </p>
1207
1208<p> <br/></p>
1209
1210<p>A trend depends on how many fresh contracts are exchanging hands with the new price move. If the fresh cash does not flow into the market and the fresh contract does not exchange hands, then we should be doubtful about the trend. </p>
1211
1212<p> <br/></p>
1213
1214<p><img alt="open interest  terminologies" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/KorjAfUqcg.png"/></p>
1215
1216<p><strong><a href="https://web.stockedge.com/scan/high-increase-in-future-open-interest/4001" target="_blank"> <br/></a></strong></p>
1217
1218<p><strong><a href="https://web.stockedge.com/scan/high-increase-in-future-open-interest/4001" target="_blank">Click here to know which stocks have seen a sudden increase in Open Interest. </a></strong></p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 
121812.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->28</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
12186C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="rollover" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Rollover</h2><style type="text/css">.right_content_section ul li {
1219    margin-bottom: 5px; 
1220}
1221</style>
1222<p>Here in this section, let us learn another common term called ‘<strong>Rollover</strong>,’ which is popularly used in the case of <a href="https://www.elearnmarkets.com/webinars/trade-futures-options-using-data-reading">F&amp;O trading</a>. </p>
1223
1224<p> <br/></p>
1225
1226<h3>What is rollover? </h3>
1227
1228<p> <br/></p>
1229
1230<p>Rollover is carrying forward a particular month’s futures positions to the next month. This is done by closing the existing futures position of the current month and simultaneously taking a similar position in the subsequent series. </p>
1231
1232<p> <br/></p>
1233
1234<p>Ideally, traders roll their positions in the last week of the expiry series, typically on the expiry day. </p>
1235
1236<p> <br/></p>
1237
1238<p>On the expiry day, traders have an option: they can either let their position lapse or enter into a similar contract expiring at a future date. </p>
1239
1240<p> <br/></p>
1241
1242<p>For example, if you are bullish on Nifty, you can rollover or carry forward the Nifty futures position by closing your original position, which is due to expire, and simultaneously initiating a buying position for the subsequent month’s contract. This involves a cost, i.e., the difference between the current series and the next series prices. </p>
1243
1244<p> <br/></p>
1245
1246<h3>Why do traders Rollover in the futures market?</h3>
1247
1248<p> <br/></p>
1249
1250<p>Rollover is an important action for most of the derivative market participants. </p>
1251
1252<p> <br/></p>
1253
1254<ul>
1255	<li>When they expect the current trend to continue in the near future</li>
1256	<li>They are not willing to book losses and are expecting the trend to reverse from the current situation.</li>
1257	<li>Cash and carry and reverse cash and carry Arbitrageurs tend to rollover their positions to take advantage of the price differentials.</li>
1258</ul>
1259
1260<h3>What is the cost associated with a Rollover? </h3>
1261
1262<p>A rollover can give both positive and negative yield. </p>
1263
1264<p> <br/></p>
1265
1266<p><strong>Positive Rollover yield: </strong>A short seller in a contango market, where the future price is quoted above the spot price, will have a positive rollover cost as the next series contract will trade at a premium. The contract will be available to get rolled at a higher price vis-à-vis the current series contract, yielding an incremental positive spread.</p>
1267
1268<p> <br/></p>
1269
1270<p>A trader with long positions in a backwardation market where the future price is quoted below the spot price will also have a positive rollover cost, as the next series contract will trade at a discount. The contract will be available to get rolled at a lower price vis-a-vis the current series contract, yielding an incremental positive spread.</p>
1271
1272<p> <br/></p>
1273
1274<p><strong>Negative Rollover yield:</strong> A trader with a long position in a contango market, where the future price is quoted above the spot price, will have a negative rollover cost as the next series contract will trade at a premium. The contract will be available to get rolled at a higher price vis-à-vis the current series contract, yielding a negative spread.</p>
1275
1276<p> <br/></p>
1277
1278<p>A short seller in a backwardation market, where the future price is quoted below the spot price, will also have a negative rollover cost as the next series contract will trade at a discount. The contract will be available to get rolled at a lower price vis-a-vis the current series contract, yielding a negative spread.</p>
1279
1280<p> <br/></p>
1281
1282<h3>How do we calculate the Rollover?</h3>
1283
1284<p> <br/></p>
1285
1286<p>Rollover is often expressed in percentage terms.</p>
1287
1288<p> <br/></p>
1289
1290<p>Nifty futures June rollover statistics can be calculated as:</p>
1291
1292<p> <br/></p>
1293
1294<p><img alt="options trading rollover formula" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/mQsCFTMUba.png"/></p>
1295
1296<p><img alt="options trading rollover formula" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/LnxkkanLNS.png"/></p>
1297
1298<p> <br/></p>
1299
1300<h3>How to interpret Rollover?  </h3>
1301
1302
1303
1304<p>Rollover is an indicator of traders&#x27; willingness to carry forward their existing bets on the market. But the standalone figures will not tell us in which direction traders have placed their bets. </p>
1305
1306<p> <br/></p>
1307
1308<p>On most occasions, lower-than-average rollovers signal uncertainty as well as unwinding of the current trend, while higher rollovers signal conviction of the current view, which can lead to a continuation of the current trend. </p>
1309
1310<p> <br/></p>
1311
1312<p>Hypothetically, if Rollover in Nifty futures from the March series to April is at 70% and its past three-month average Rollover is 64%, it means that traders are more convinced of the current market trend by building more positions. </p>
1313
1314<p> <br/></p>
1315
1316<p>However, at times, tracking Rollover trends based on just percentage terms can be misleading;
1316 it is always better to see it in terms of total contracts/shares getting rolled over. </p>
1317
1318<p> <br/></p>
1319
1320<p>For instance, a 70% Rollover may have taken place at a lower base of open interest number of outstanding positions, while an average of 64% rolls would have happened at a relatively higher open interest base.</p>
1321
1322<p> <br/></p>
1323
1324<p>Therefore, analysing Rollovers purely on the basis of percentage terms can lead to faulty analysis, and hence trades should also track Rollovers in terms of total contracts rolled and also analyse Rollover trends on the basis of Rollover cost. Usually, high Rollover cost signals that the mood is upbeat in the market.</p>
1325
1326<p> <br/></p>
1327
1328<p><img alt="open interest and price action rollover data" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/REEJQyzLvx.png"/></p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->21</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
13286C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->1</span></a></span></div></section><section data-observe="true" id="margins" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Margins</h2><p>Lastly, let us talk about ‘<strong>Margins</strong>,’ which simply means taking leverage on trading positions. </p>
1329
1330<p> <br/></p>
1331
1332<h3>Why are margins important?</h3>
1333
1334<p> <br/></p>
1335
1336<p>Margins play a very important role in derivative trading as it enables us to leverage our positions. In fact, margins are the one that gives a Derivative Contract the required financial twist. For this reason, understanding the margins in detail is extremely important.</p>
1337
1338<p> <br/></p>
1339
1340<p>Margin is a kind of collateral that the parties having the long and the short side of the futures contract need to deposit with his/her broker or exchange before taking any position. The reason the broker or the exchange takes this collateral is in order to protect itself from any kind of credit default by any of the parties involved.</p>
1341
1342<p> <br/></p>
1343
1344<p>For example, if one goes long in the Nifty futures contract and if the Nifty falls, then the long party has to pay for the losses, but if he defaults, the loss has to be borne by the exchange/broker. Thus, to protect itself from this potential default, the exchange/broker requires initial collateral from the trader investor before he can take any (long or short) position.</p>
1345
1346<p> <br/></p>
1347
1348<p>Margins allow us to deposit a small amount of money and take exposure to a large-value transaction, thereby leveraging the transaction. </p>
1349
1350<p> <br/></p>
1351
1352<p>Let us discuss this with an example to understand it better.</p>
1353
1354<p> <br/></p>
1355
1356<p>Kalyan Jewellers agrees to buy 15 kg of Gold at ₹3000/- per gram from Prabhudas Gold Dealers, three months from now.</p>
1357
1358<p> <br/></p>
1359
1360<p>Any variation in the price of gold will either affect Kalyan Jewellers or Prabhudas Gold Dealers negatively. If the price of gold increases, then Prabhudas Gold Dealers suffers a loss and Kalyan Jewellers makes a profit. </p>
1361
1362<p> <br/></p>
1363
1364<p>Likewise, if the price of gold decreases, Kalyan Jewellers suffers a loss, and Prabhudas Gold Dealers makes a profit. </p>
1365
1366<p> <br/></p>
1367
1368<p>We know that this kind of agreement, which is a typical example of a forward contract, works on a gentleman’s word. Consider a situation where the price of gold has drastically gone up, placing Prabhudas Gold Dealers in a difficult spot.</p>
1369
1370<p> <br/></p>
1371
1372<p>Clearly, Prabhudas Gold Dealers can say they cannot make the necessary delivery and thereby default on the deal. Obviously, what follows will be a long and legal chase, but that is outside our focus area. The point to be noted here is that, in a forward agreement, the scope for default is very high.</p>
1373
1374<p> <br/></p>
1375
1376<p>Since the futures and options markets are an improvisation of the over-the-counter market trades, the issue of default is carefully and intelligently dealt with. This is where the margins play a role.</p>
1377
1378<p> <br/></p>
1379
1380<h3>What are the different types of margins?</h3>
1381
1382<p> <br/></p>
1383
1384<p>Now, how does the exchange make sure that trade works seamlessly and no default takes place?  Well, they make this happen by means of –</p>
1385
1386<p> <br/></p>
1387
1388<p style="margin-left:40px">1. Collecting the margins<br/>
13892. Marking the daily profits or losses to the market, which is known as the mark-to-market (MTM). </p>
1390
1391<p style="margin-left:40px"> <br/></p>
1392
1393<p>Now, we know that at the time of initiating the futures position, margins are blocked in your trading account. The margins that get blocked are also called the “<strong>Initial Margin</strong>”</p>
1394
1395<p> <br/></p>
1396
1397<p>Initial Margin will be blocked in our trading account for as many days as we choose to hold the futures trade. The value of initial margin varies daily as it depends on the futures price.</p>
1398
1399<p> <br/></p>
1400
1401<p><strong>Initial Margin = % of Contract Value. </strong></p>
1402
1403<p> <br/></p>
1404
1405<p>Contract value = Futures Price * Lot Size</p>
1406
1407<p> <br/></p>
1408
1409<p>Lot size is fixed, but the futures price varies every day. </p>
1410
1411<p> <br/></p>
1412
1413<h3>Initial Margin</h3>
1414
1415<p> <br/></p>
1416
1417<p>This is the initial amount that must be deposited in the margin account at the time a future contract is entered into.</p>
1418
1419<p> <br/></p>
1420
1421<p>The amount of initial margin is calculated by National Securities Clearing Corporation Ltd (NSCCL) based on the Standard Portfolio Analysis of Risk <strong>(SPAN)</strong> methodology (commonly known as <strong>NSE SPAN</strong>). The objective of this methodology is to estimate the risk element in the portfolio of all the derivative contracts of each member.</p>
1422
1423<p> <br/></p>
1424
1425<p><strong>NSE SPAN</strong> determines the largest amount of loss that an open position can incur on 99% of days. It is also known as the 99% Value at Risk<strong> (VaR)</strong> approach. For liquid stocks, the margin covers one-day losses, whereas for illiquid stocks, it covers three-day losses to allow the exchange to liquidate the position over three days. This amount is collected by <strong>NSCCL</strong> from clearing members, who in turn collect the same from their trading members and clients.</p>
1426
1427<p> <br/></p>
1428
1429<h3>Mark to Mark Margin</h3>
1430
1431<p> <br/></p>
1432
1433<p>As we know, the futures price fluctuates on a daily basis, because of which we either stand to make a profit or a loss. Marking to market, or mark to market (MTM), is a simple accounting procedure that involves adjusting the profit or loss we have made for the day and entitling us to the same.</p>
1434
1435<p> <br/></p>
1436
1437<p>As long as we hold the futures contract, MTM is applicable.</p>
1438
1439<p> <br/></p>
1440
1441<p>Let us take up a simple example to understand this.</p>
1442
1443<p> <br/></p>
1444
1445<p>Assume on 1st April at around 9:30 AM, you decide to buy ABC Ltd Futures at ₹165/-. The Lot size is 3000. 4 days later, on 4th April, you decide to square off the position at 2:15 PM at ₹170.
144510/-. So it is a profitable trade –</p>
1446
1447<p> <br/></p>
1448
1449<p>Buy Price = ₹165</p>
1450
1451<p> <br/></p>
1452
1453<p>Sell Price = ₹170.1</p>
1454
1455<p> <br/></p>
1456
1457<p>Profit per share = (170.1 – 165) = ₹5.1/-</p>
1458
1459<p> <br/></p>
1460
1461<p>Total Profit = 3000 * 5.1 = ₹15300/-</p>
1462
1463<p> <br/></p>
1464
1465<p>However, the trade was held for 4 working days. Each day the futures contract is held, the profits or losses are marked to market. While marking to market, the previous day&#x27;s closing price is taken as the reference rate to calculate the profits or losses.</p>
1466
1467<p> <br/></p>
1468
1469<p>The table shows the futures price movement over the 4 days the contract was held. </p>
1470
1471<p> <br/></p>
1472
1473<p><img alt="" src="https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/vHXODHMfoI.png"/></p>
1474
1475<p> <br/></p>
1476
1477<p>Let us look at what happens on a day-to-day basis to understand how MTM works –</p>
1478
1479<p> <br/></p>
1480
1481<p>On Day 1 at 11:30 AM, the futures contract was purchased at ₹165/-, clearly, after the contract was purchased, the price went up further to close at ₹168.3/-. Hence, profit for the day is 168.3 minus 165 = ₹3.3/- per share. Since the lot size is 3000, the net profit for the day is 3.3*3000 = ₹9900/-.</p>
1482
1483<p> <br/></p>
1484
1485<p>Hence, the exchange ensures (via the broker) that ₹9900/- is credited to your trading account at the end of the day.</p>
1486
1487<p> <br/></p>
1488
1489<p>But the question is, where is this money coming from?</p>
1490
1491<p> <br/></p>
1492
1493<p>Obviously, it is coming from the counterparty. This means the exchange is also ensuring that the counterparty is paying up ₹9900/- towards his loss.</p>
1494
1495<p> <br/></p>
1496
1497<p>But how does the exchange ensure they get this money from the party who is supposed to pay up? – They do it through the margins that are deposited at the time of initiating the trade. </p>
1498
1499<p> <br/></p>
1500
1501<p>Now here is another important aspect we need to note – from an accounting perspective, the futures buy price is no longer treated as ₹165, but instead it will be considered as ₹168.3/- (closing price of day 1). </p>
1502
1503<p> <br/></p>
1504
1505<p><em>Why is this happening?</em></p>
1506
1507<p> <br/></p>
1508
1509<p>Well, the profit that was earned for the day has been given to you already by means of crediting the trading account. So the next day is considered a fresh start. Hence, the buy price is now considered at ₹168.3, which is the closing price of day 1. </p>
1510
1511<p> <br/></p>
1512
1513<p>On day 2, the futures closed at ₹172.4/-, clearly another day of profit. The profit earned for the day would be ₹172.4/ – minus ₹168.3/-, i.e., ₹4.1/- per share or ₹12300/- net profit.</p>
1514
1515<p> <br/></p>
1516
1517<p>The profits that you are entitled to receive are credited to your trading account, and the buy price is reset to the day’s closing price i.e., ₹172.4/-. Likewise, it&#x27;s done for Day 3.</p>
1518
1519<p> <br/></p>
1520
1521<p>Now, on day 4, the trader did not continue to hold the position through the day, but rather decided to square off the position mid-day, at 2:15 PM, at ₹170.10/-. Hence, with respect to the previous day’s close, he again made a loss. That would be a loss of ₹171.6/- minus ₹170.1/- = ₹1.5/- per share and ₹4500/- (1.5 * 3000) net loss. </p>
1522
1523<p> <br/></p>
1524
1525<p>Needless to say, after the square off, it does not matter where the futures price goes as the trader has squared off his position. And ₹4500/- is debited from the trading account by the end of the day.</p>
1526
1527<p> <br/></p>
1528
1529<p>Well, if we add up all the MTM cash flow, we will end up with the same amount that we originally calculated, which is –</p>
1530
1531<p> <br/></p>
1532
1533<p>Buy Price = ₹165/-</p>
1534
1535<p> <br/></p>
1536
1537<p>Sell Price = ₹170.1/-</p>
1538
1539<p> <br/></p>
1540
1541<p>Profit per share = (170.1 – 165) = ₹5.1/-</p>
1542
1543<p> <br/></p>
1544
1545<p>Total Profit = 3000 * 5.1</p>
1546
1547<p> <br/></p>
1548
1549<p>= ₹15300/-</p>
1550
1551<p> <br/></p>
1552
1553<p>So, the mark-to-market is just a daily accounting adjustment where –</p>
1554
1555<p> <br/></p>
1556
1557<p style="margin-left:40px">1. Money is either credited or debited (also called daily obligation) based on how the futures price behaves<br/>
1557
15582. The previous day&#x27;s closing price is taken into consideration to calculate the present day&#x27;s MTM.</p>
1559
1560<p style="margin-left:40px"> <br/></p>
1561
1562<h3>Why do you think MTM is required?</h3>
1563
1564<p> <br/></p>
1565
1566<p>MTM is a daily cash adjustment by means of which the exchange drastically reduces the counterparty default risk. As long as a trader holds the contract, the exchange, by virtue of the MTM, ensures both parties are treated fairly and square daily.</p>
1567
1568<p> <br/></p>
1569
1570<p>Let us now relook at margins, keeping MTM in perspective. As mentioned earlier, the margin required at the time of initiating a futures trade is called “<strong>Initial Margin</strong>”.</p>
1571
1572<p> <br/></p>
1573
1574<p>Every time a trader initiates a futures trade (for that matter, any trade), there are a few financial intermediaries who work in the background, making sure that the trade is carried out smoothly. The two prominent financial intermediaries are the broker and the exchange.</p>
1575
1576<p> <br/></p>
1577
1578<p><strong>Clinet&lt;</strong>-------<strong>&gt;Broker&lt;</strong>-------<strong>&gt;Stock Exchnage</strong></p>
1579
1580<p> <br/></p>
1581
1582<p>Now, if the client defaults on an obligation, obviously it has a financial repercussion on both the broker and the exchange. Hence, if both the financial intermediaries have to be insulated against a possible client default, then both of them need to be covered adequately by means of a margin deposit.</p>
1583
1584<p> <br/></p>
1585
1586<p>In fact, this is exactly how it works. Initial margin is the minimum requisite margins blocked as per the exchange’s mandate, which acts as a cushion for any MTM losses. This is specified by the exchange, and this initial margin is blocked by the exchange. </p>
1587
1588<p> <br/></p>
1589
1590<h3>Maintenance Margin</h3>
1591
1592
1593
1594<p>Maintenance margin is the minimum amount of equity that must be maintained in a margin account. If due to MTM, the margin account falls below the stipulated level, a maintenance margin call is issued. It protects both investors and the broking house. The broker does not have to absorb excessive investor losses while the investor is in a situation to avoid being totally wiped out.</p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->23</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
15946C23.1581 7.17993 23.6133 7.6355 23.6133 8.19501V16.5367C23.6133 17.0962 23.1581 17.5514 22.5986 17.5514H19.2761V7.99784C19.37 7.53015 19.8025 7.17993 20.2911 7.17993Z" fill="white"></path></g><defs><clipPath id="clip0_333_45"><rect width="30" height="30" fill="white" transform="matrix(-1 0 0 1 30 0)"></rect></clipPath></defs></svg><span> <!-- -->0</span></a></span></div></section><section data-observe="true" id="conclusion-22" class="card custom-categories-card-last-page active_units_details page-module__4R5MOG__right_content_section" style="scroll-margin-top:100px"><h2 class="page-module__4R5MOG__top_header_artical mt-1">Conclusion</h2><p>So, now that we are at the end of this module. We have learned the basic concepts of derivative instruments. More importantly, we have discussed several types of derivative instruments available for trading, especially in the equity markets. Trading in the derivatives segment is considered risky for novice traders. However, we have learnt quite a few concepts related to the derivatives market. But there are a lot of other elements to learn before you dive into trading futures and options contracts. Therefore, we have prepared many other modules similar to this at ELM School that will unfold all the complexities related to derivatives and the financial markets as a whole. Be sure to check them out so that you gather knowledge and develop the necessary skills required to become successful in the markets. </p><div class="page-module__4R5MOG__do_you_like_btn"><p>Did you like this unit? </p><span><a id="upvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_41)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C23.2615 30 30 23.2615 30 15C30 6.73846 23.2615 0 15 0C6.73846 0 0 6.73846 0 15C0 23.2615 6.73846 30 15 30Z" fill="#2196F3"></path><path d="M7.40145 12.097H10.7239V21.6506C10.63 22.1183 10.1975 22.4685 9.70887 22.4685H7.40145C6.84193 22.4685 6.38672 22.0129 6.38672 21.4534V13.1117C6.38672 12.5523 6.84193 12.097 7.40145 12.097ZM23.2007 13.2089C22.6818 12.5437 21.7489 12.097 20.8794 12.097H15.9851C15.9072 12.097 15.8338 12.0604 15.7869 11.9984C15.7396 11.9365 15.7243 11.8557 15.7453 11.7806L16.3638 9.56211C16.9593 7.4273 16.1734 6.83146 14.3664 6.06271C14.1974 5.99082 14.0329 5.98976 13.8632 6.05914C13.6934 6.12816 13.577 6.24388 13.5065 6.41328L11.2222 11.8973V21.5093L13.524 22.4685H19.6195C21.4222 22.4685 22.097 20.554 22.3035 19.7311L23.5638 14.7126C23.7268 14.0631 23.4563 13.5363 23.2007 13.2089Z" fill="white"></path></g><defs><clipPath id="clip0_333_41"><rect width="30" height="30" fill="white"></rect></clipPath></defs></svg><span> <!-- -->16</span></a><a id="downvote" href="#"><svg width="30" height="30" viewBox="0 0 30 30" fill="none" xmlns="http://www.w3.org/2000/svg"><g clip-path="url(#clip0_333_45)"><path fill-rule="evenodd" clip-rule="evenodd" d="M15 30C6.73846 30 0 23.2615 0 15C0 6.73846 6.73846 0 15 0C23.2615 0 30 6.73846 30 15C30 23.2615 23.2615 30 15 30Z" fill="#F34235"></path><path d="M6.79928 16.4396C7.31818 17.1048 8.25106 17.5514 9.12059 17.5514H14.0149C14.0924 17.5514 14.1662 17.5881 14.2131 17.65C14.2604 17.712 14.2757 17.7928 14.2547 17.8679L13.6362 20.0864C13.0407 22.2208 13.827 22.8166 15.6347 23.5858C15.8037 23.6577 15.9679 23.6587 16.138 23.589C16.3066 23.5207 16.4231 23.4049 16.4935 23.2349L18.7778 17.7512V8.13911L16.476 7.17993H10.3805C8.57778 7.17993 7.90295 9.09442 7.69652 9.91731L6.43623 14.9355C6.27322 15.5853 6.54369 16.1121 6.79928 16.4396ZM20.2911 7.17993H22.598
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Currently, it is the month of March, and the price of wheat in the spot market where the farmer sells his produce is ₹10/kg. The total cost of production of wheat for the farmer, including fertilizer, seed, and his effort, is ₹6/kg.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHowever, the wheat on the farmer's land will mature in the month of June, 3 months from today. Thus, he is worried that if there is good rainfall leading up to June, wheat from all the farmers will simultaneously hit the market, and because of this, the price of wheat might go down to ₹8/kg, and this will lead to a profit of only ₹2/kg for the farmer.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHe is also aware that, leading up to June, the overall rainfall might not be that good, and the overall supply of wheat hitting the market could be less, and this can lead to the price of wheat going up to ₹12/kg. Now, since his farm is well irrigated, he will produce the desired quantity of wheat and sell it at the price of\u0026nbsp; ₹12/kg to generate significant profits.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIn both scenarios, what the farmer faces is the price volatility risk, even though in the latter case, the price variability is favourable to the farmer, but he is more worried about the first case, where his profitability will shrink due to a fall in price.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn the other hand, let us assume that there is a company, ITC Ltd., which uses wheat throughout the year and produces flour under the brand name 'Ashirwad', as you all know.\u0026nbsp;\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eCurrently, it's the month of March, and the price of wheat in the spot market from which ITC buys is ₹10/kg. The overall cost for ITC to process the wheat into Flour (including packaging and marketing) is ₹4/kg. ITC has already tagged the packets in which it sells the flour at ₹16/kg, thus realizing a profit of\u0026nbsp; ₹2/kg.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHowever, what ITC is aware of is that, in the month of June, if the overall rainfall is not that good, then the supply of wheat hitting the market could be less, and this can lead to the price of wheat going up to ₹12/kg. This will lead to an increase in cost for ITC and shrink its profitability to zero.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eITC cannot simply raise the price of the flour. The reason behind this is that Ashirwad flour is a branded product. There is a huge cost involved in even raising the price, and it is a consumer-centric product. If ITC raises the price frequently, consumers will shift to a different brand or non-branded flour.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eITC also knows that if there is good rainfall, wheat from all the farmers will simultaneously hit the market, and because of this, the price of wheat might go down to ₹8/kg. In this case, it would lead to a profit of\u0026nbsp; ₹4/kg.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIn both scenarios, ITC faces price r
1595isk, even though in the latter case, the price fluctuation is favourable to ITC. However, it is more worried about the first case, where its profitability will shrink due to a fall in price.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow, the important thing to note is: The farmer faces the risk of losing money if the price of wheat goes down, and ITC faces the risk of losing money if the price of wheat goes up. Thus, both of them (farmer and lTC), to avoid this risk and to reduce the price uncertainty, enter into a contract, which says that:\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"derivative contract for ITC\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/XucmKITlpT.png\"\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThis contract between a farmer and ITC to buy and sell a fixed quantity of wheat at a specific price and on a specific date is called a\u003cstrong\u003e\u0026nbsp;DERIVATIVE CONTRACT.\u003c/strong\u003e\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAccording to the contract, the farmer in June is entitled to sell wheat at\u0026nbsp; ₹11/kg, no matter what the price of wheat is in the spot market, and ITC has to buy the wheat at ₹11/kg, whatever the price of wheat is in the spot market.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, by virtue of this contract, both the farmer and ITC have eliminated the price risk. This is precisely what the use of derivatives is, or that is what derivatives are.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eDerivatives are contracts in which two parties enter into a contract in order to eliminate or hedge their risk. It could be price risk or the risk of any kind of uncertainty.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIn the Indian context, the \u003cstrong\u003eSecurities Contracts (Regulation) Act, 1956 (SCRA)\u003c/strong\u003e defines \"\u003cstrong\u003ederivative\u003c/strong\u003e\" as-\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e1.\u0026nbsp; \u0026nbsp;A security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument, contract for differences or any other form of security.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e2.\u0026nbsp; \u0026nbsp;A contract that derives its value from the prices, or index of prices, of underlying securities.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe first definition says that the derivative contract for wheat between a farmer and ITC is derived from the underlying asset, which is 1000 Kgs of wheat.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe second definition says that the value of the wheat contract depends on the value or price of the wheat, which is the underlying asset in the spot market.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThis means that in the spot market, say in April, even if the price of wheat goes up to ₹13/kg, the person holding this contract still has the right to buy wheat only at \u0026nbsp;₹11/kg. Thus, the value of this contract, which previously was only ₹11,000, has now increased to ₹13,000.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA derivative is a financial contract with a value that is derived from an underlying asset. Derivatives have no direct value of themselves -\u0026nbsp;their value is based on the expected future price movements of their underlying asset.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe underlying instruments can be anything, such as bonds, commodities, currencies, interest rates, market indexes, and stocks. So, there are different types of financial derivatives available in the market. Let us discuss them in the next section.\u0026nbsp;\u003c/p\u003e3c:Tec0,\u003cstyle type=\"text/css\"\u003e.right_content_section ul li {\r\n    margin-bottom: 5px; \r\n}\r\n\u003c/style\u003e\r\n\u003cp\u003eWe can have derivative contracts on any assets. There are various types of derivative contracts, such as:\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eCommodity Derivatives\u003c/li\u003e\r\n\t\u003cli\u003eCurrency Derivatives\u003c/li\u003e\r\n\t\u003cli\u003eEquity Derivatives\u003c/li\u003e\r\n\t\u003cli\u003eInterest Rate Derivatives, etc\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003cp\u003eLet us discuss some of the markets with respect to the above derivatives and the way they help in the reduction of risk or uncertainty.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eCommodity\u003c/h3\u003e\r\n\r\n\u003cp\u003eTata Steel produces and sells steel. It has a huge inventory of steel and is worried that two months later, if the price of steel drops in the spot market, then it will have\u0026nbsp;to suffer losses when it sells its steel.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn the other hand, there is a company like Maruti, which uses steel to produce cars. Maruti is seeing a huge increase in demand for cars in the next two months and plans to increase its production, for which it needs steel. However, they are\u0026nbsp;worried that two\u0026nbsp;months later, if the price of steel in the spot market increases, then they will have\u0026nbsp;to spend more money.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, Tata Steel and Maruti enter into a contract in the derivative market to sell and buy steel, respectively, two months later at a pre-fixed price, thus locking the price uncertainty.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eCurrency\u003c/h3\u003e\r\n\r\n\u003cp\u003eAn exporter produces shirts and exports them\u0026nbsp;to the United States. It is expected to receive a payment for the shirts it has supplied in a month's time. The current USD-INR exchange rate is ₹72, and he is expected to receive a payment of $1,000. Thus, at the current rate, he expects to get ₹72,000 a month later.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHowever, he is worried that a month later, when his dollar payment comes, the Indian rupee might strengthen, and the USD-INR exchange rate might become ₹70, and thus he would only receive a payment of ₹70,000 instead of ₹72,000, which he had thought earlier.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn the other hand, an importer plans to import machinery for $1000 a month later and, as per the current exch
1595ange rate, plans to save ₹72,000 by the end so as to pay for the machine. However, he is worried that a month later, when he has to pay $1000 for the machinery, the USD-INR exchange rate might go up to ₹74\u0026nbsp;and he will have to spend ₹74,000 instead of\u0026nbsp; ₹72,000 to get the machine.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, the importer and the exporter enter into a contract in the currency derivatives market to buy and sell dollars, respectively, one month later at a pre-defined exchange rate, locking the price uncertainty.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eEquity\u003c/h3\u003e\r\n\r\n\u003cp\u003eAn investor has held around 500 shares of Reliance for the last 2-3 years, which he does not want to sell at the moment. However, he is worried that the next day, when the verdict of the Reliance and RNRL case will be out in the public domain, and if Reliance loses the case, then the stock price of Reliance might go down significantly, and his wealth will shrink for the time being.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn the other hand, there is a speculator who already has some insider information that Reliance will win the court case and its stock price will increase.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHowever, he does not want to buy Reliance shares in the spot market as he does not want to hold the same for a long period.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, the investor and the speculator in the equity derivatives market enter into a contract to sell and buy Reliance, respectively, one month later at a pre-defined price, locking the price uncertainty.\u003c/p\u003e3d:T109c,\u003cstyle type=\"text/css\"\u003e.right_content_section ul li {\r\n    margin-bottom: 5px; \r\n}\r\n\u003c/style\u003e\r\n\u003cp\u003eWe have learned about the different types of derivative contracts, but these are traded at different marketplaces. Let us discuss what they are.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThere are 2 types of Derivative Markets.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eOver-the-counter trades (OTC)\u003c/li\u003e\r\n\t\u003cli\u003eExchange-traded contracts.\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003ch3\u003eOver-the-Counter Market\u0026nbsp;\u003c/h3\u003e\r\n\r\n\u003cp\u003eThe OTC is a market where financial instruments such as currencies, stocks, and commodities are traded directly between two parties through a dealer network. Agreements on what, how many, for what price, and under what conditions are all made based on mutual consent. The contracts between two parties are tailor made and customized. They meet specific requirements for dealing with counterparties. OTCs are mostly traded by smaller companies that do not meet the criteria for a listing on the stock exchanges.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIn an OTC trade, there are no formal rules or mechanisms for risk management to ensure market stability and integrity. Management of counterparty risk is decentralized and located within individual institutions. Hence, OTC trades have high Counterparty risk, due to which the volume in these markets is quite low.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eExchange Traded Contracts\u0026nbsp;\u003c/h3\u003e\r\n\r\n\u003cp\u003eExchange-traded contracts are those derivative contracts which takes place between two\u0026nbsp;parties via a recognized exchange. Simply put, these are derivatives that are traded in a regulated fashion. Exchange-traded derivatives have become increasingly popular because of the advantages they have over over-the-counter derivatives, such as standardization and elimination of default risk.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLet us understand what standardization is.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe exchange has standardized terms and specifications for each derivative contract, with respect to quantity and quality, making it easy for the investor to determine how many contracts can be bought or sold.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSuppose a person wants to trade in Gold futures at the MCX exchange. So, the exchange specifies that the contract of 1 unit of gold is of 1kg and the purity factor of Gold is 995. Any other quantity or quality variation is not allowed at the exchange.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTalking of Default risk, let's know how it is eliminated in exchange-traded contracts.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe derivatives exchange itself acts as the counterparty for each transaction involving an exchange-traded derivative, effectively becoming the seller for every buyer and the buyer for every seller. This eliminates the risk that the counterparty to the derivative transaction may default on its obligations.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eExchange-traded derivatives have a mark-to-market feature. The gains and losses on every derivative contract are calculated daily. If the client has incurred losses, he or she will have to replenish the required capital in a timely manner, or else the exchange will square up the position.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eBecause of the standardization feature and sound risk management policies, the exchange-traded contracts have high liquidity, which makes it easier for traders to trade, hence attracting more volume. There are various types of derivative contracts: Forwards, Futures, Options, and Swaps.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eFutures and Options are exchange-traded contracts, whereas forwards and 
1595Swaps are OTC contracts.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cspan\u003e\u003cspan\u003eTake your trading skills to the next level with our \u003c/span\u003e\u003cspan\u003e\u003cstrong\u003e\u003ca href=\"https://www.elearnmarkets.com/courses/display/commodity-and-currency\" target=\"_blank\"\u003eMasterclass on Advanced Commodity \u0026amp; Currency\u003c/a\u003e\u003c/strong\u003e\u003c/span\u003e\u003cspan\u003e: Forex Trading Course! Enroll now!\u003c/span\u003e\u003c/span\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"Over-the-counter trades vs Exchange-traded contracts\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/DPebPeOfIa.png\"\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWe will discuss more about the Forwards and Futures market in our upcoming units.\u0026nbsp;\u003c/p\u003e3e:T66b,\u003cstyle type=\"text/css\"\u003e.right_content_section ul li {\r\n    margin-bottom: 5px; \r\n}\r\n\u003c/style\u003e\r\n\u003cp\u003eFirst, let us understand the concept of\u0026nbsp; '\u003cstrong\u003eForwards\u003c/strong\u003e.'\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhat is a forward contract?\u003c/h3\u003e\r\n\r\n\u003cp\u003eA forward contract is an agreement to buy or sell a particular asset at a pre-decided price in the future.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eRemember, the contract between the farmer and the ITC to buy and sell a specified quantity of wheat at a specific date and at a specific price is known as a forward contract.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIn this case, one of the parties entering into a forward contract assumes a long position to buy the underlying asset at a certain specified price, and the other party assumes a short position to sell the asset on the same date for the same price. A forward contract is a type of customized contract that can be between any two or more parties, and is not traded on stock exchanges, and thus there is no middleman in the contract. Owing to this nature of the contract, there is a high probability of default by any of the parties, which is known as the \"\u003cstrong\u003eCounterparty risk\u003c/strong\u003e\".\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eFeatures of a forward contract\u003c/h3\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eEac
1595h contract is custom-designed and hence is unique in terms of contract size, expiration date, and asset type and quality.\u003c/li\u003e\r\n\t\u003cli\u003eThis is a bilateral contract and hence exposed to counterparty risk.\u003c/li\u003e\r\n\t\u003cli\u003eOn the expiration date, the contract has to be settled by delivery of the asset.\u003c/li\u003e\r\n\t\u003cli\u003eThe contract price is not available in the public domain.\u003c/li\u003e\r\n\u003c/ul\u003e3f:T609,\u003cstyle type=\"text/css\"\u003e.right_content_section ul li {\r\n    margin-bottom: 5px; \r\n}\r\n\u003c/style\u003e\r\n\u003cp\u003eNext, let us discuss the concept of the '\u003cstrong\u003eFutures\u003c/strong\u003e' contract and how it differs from Forwards.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhat is a futures contract?\u003c/h3\u003e\r\n\r\n\u003cp\u003eA future contract is similar to the forward contract in terms of its basics; however, the key difference is that a future contract is standardized in nature and is traded on stock exchanges. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSo, futures can be summarised as -\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eA standardized contract with a standard underlying instrument,\u003c/li\u003e\r\n\t\u003cli\u003eA standard quantity and quality of the underlying instrument that can be delivered,\u003c/li\u003e\r\n\t\u003cli\u003eA standard timing of such a settlement\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003cp\u003eThe futures market came into existence to overcome the shortcomings of the forward market. The futures market is more pronounced among the\u0026nbsp;trader and investor community across the world because of the fact that the counterparty or default risk is virtually zero. Every futures contract carries a guarantee from the exchange where it is traded, and hence, in case of any default by the counterparty, it becomes the obligation of the exchange to pay off the other party.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"differences between future market and forward market\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/zTeoeEutvG.png\"\u003e\u003c/p\u003e40:Tf0b,\u003cp\u003eNow that we are clear with the concept and features of the Forward contract, let us discuss the features of Future contracts.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eFeatures\u003c/strong\u003e:\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003e1. Contract size\u003c/h3\u003e\r\n\r\n\u003cp\u003eThe size of the contract depends on the contract we are trading in. The futures transaction can be entered in accordance with the prescribed lot size, and the participants can only trade in multiples of the lot size while dealing in the futures market\u003c/p\u003e\r\n\r\n\u003cp\u003eThe quantity of wheat or rice in the case of a contract for agricultural commodity futures, or the value of currency in the case of currency futures, or the number of shares in the case of equity futures, is already predefined in terms of basic size.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003e2. Trading Cycle\u003c/h3\u003e\r\n\r\n\u003cp\u003eEquity Futures are traded in cycles of 3 months. At any point in time, one can take a position to buy or sell the underlying equity share or an index for the current month and the coming two months. For example, if currently it is the month of October, then an individual can choose to enter into a contract to buy or sell the underlying asset in the month of October, November, or December.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA trader can take either the near-month, the next-month, or the far-month position while trading in futures contracts on the stock exchanges.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSimilarly, in the currency futures segment, the contracts are traded in cycles of 12 months. At any point in t
1595ime, one can take the position to buy or sell the underlying currency for the current month and the coming eleven months.\u003c/p\u003e\u003cp\u003e\u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp;\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp;\u003ca href=\"https://www.elearnmarkets.com/courses/display/futures-trading-made-easy\" target=\"_blank\" style=\"color: rgb(255, 0, 0);\"\u003e\u003cstrong\u003e \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp; \u0026nbsp;\u0026nbsp;\u003cspan\u003eShape your financial journey - Enroll in our Future \u0026amp; Options Trading Course\u003c/span\u003e\u003c/strong\u003e\u003c/a\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003e3. Expiry Date\u003c/h3\u003e\r\n\r\n\u003cp\u003eFutures are traded with a specific time frame in mind, such that there is an expiry or settlement date for each future contract. All the outstanding positions (long or short) are settled on this expiry date. In the equity futures segment, the expiry date is the last Thursday of the expiry month.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e*Note: If that Thursday is a holiday, then the previous trading day is taken into consideration. Similarly, in the Currency futures segment, the expiry date is the last business day of the month. If 27th September 2018 is a Thursday, then the contract expiry date will be 27th September and if it is a Friday, then the expiry will be on Thursday.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003e4. Settlement Date\u003c/h3\u003e\r\n\r\n\u003cp\u003eIn India, Equity and Equity index futures contracts are cash-settled and physically settled. So, on the settlement date, the net payoff is determined, and settlement is made accordingly through cash or physical delivery of assets.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAlso, in the commodity futures segment on MCX, the settlement nature of various commodities varies.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eFor example, the gold mini contracts on MCX are deliverables, so in case any of the counterparties does not square off his/her position 5 days before the settlement day, then he/she may be entitled to give or take delivery of the underlying asset. Copper Futures contracts are cash-settled.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"settlement dates of different companies\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/TwTIZllzFa.png\"\u003e\u003c/p\u003e41:T85b,\u003cp\u003eIn this section, we will discuss '\u003cstrong\u003ePayoff\u003c/strong\u003e,' i.e., the likely profit or loss that would occur with a change in the underlying asset's price. We will specifically learn the payoff structure for futures contracts for both long and short positions.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eLong Position\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA trader/ investor is said to be in a long position when he has entered into a contract to buy the underlying asset on the specified date at a specified price. Thus, the trader or investor will only benefit if the price of the underlying in the spot market increases.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eFor example, a trader goes long on the Nifty futures. He has a bullish view of the market and decides to buy 10 lots of Nifty futures contracts at 17200. However, if on expiry, the Nifty turns out to be 17800, then the trader would gain (17800-17200)*50* 10, i.e., ₹3,00,000\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003ePayoff diagram for Long positions\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"Payoff diagram for Long positions\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/KuaGNDDAaa.png\"\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eShort Position\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA trader is said to be in a short position when he has entered into a contract to sell the underlying asset on a specified date at a specified price. The trader or investor will only benefit if the price of the underlying asset in the spot market decreases.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eFor example, if a trader holds a bearish view on the market and decides to sell 10 lots of Nifty at 17200. Suppose the value of Nifty happens to turn out to be 17100 on the expiry. The trader will make a profit of (17100 -172
159500)*50*10 = ₹50,000.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIf on expiry, Nifty turns out to be 17300, then instead of the profit, the trader would incur a loss of (17200 -17300)*50*10 = - ₹50,000.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003ePayoff diagram for Short positions\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003e\u003cimg alt=\"Payoff diagram for Short positions\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/KgnjOLvezA.png\"\u003e\u003c/strong\u003e\u003c/p\u003e42:Te45,\u003cp\u003eDealing in futures contracts requires a large capital; here comes the usefulness of '\u003cstrong\u003eLeverage ',\u003c/strong\u003e\u0026nbsp;which is basically the use of borrowed capital to undertake an investment. In this section, we will understand the use of Leverage in futures trading.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe fact that one can take full exposure to the price movement of the underlying asset by just providing a certain percentage of money as margin, if the price movement is in one's favour, the return on investment is very high compared to the return on investment in case the investor takes direct exposure in the underlying asset.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, taking exposure to a higher value of an asset by just providing margin or a smaller amount of sum is known as Leveraging. \"\u003cem\u003eFinancial Leverage is a two-sided sword\u003c/em\u003e.\" Let’s understand it with an example.\u003c/p\u003e\u003cp\u003e\u003cspan\u003e\u003cstrong\u003e\u003ca href=\"https://www.elearnmarkets.com/courses/display/commodity-and-currency\" target=\"_blank\"\u003eUnlock the Power of Leverage in our Masterclass on Advanced Commodity \u0026amp; Currency Trading. Enroll Now for Forex Mastery!\u003c/a\u003e\u003c/strong\u003e\u003c/span\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eExample\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLet us assume that individual A buys 250 shares of Reliance Industries in the cash/spot market @ ₹1000/share. For this transaction, he has to pay a total of ₹250,000 as initial outlay/investment.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn the other hand, an individual B buys 1 lot of Reliance Industries shares in the futures market, which is equivalent to 250 shares at the price of\u0026nbsp; ₹1000/share.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHowever, for this he has to pay only an initial margin of say 30% of the total contract value of\u0026nbsp; ₹250,000, i.e., ₹75,000.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow, from here, if Reliance goes up by ₹100, then both individual A and individual B make a profit of ₹(250 x\u0026nbsp;100), i.e., ₹25,000.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHowever, the Return on Investment (ROI) for individuals A and B is different:\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eROI (A) = 25,000/2,50,000 = 10%\u003c/p\u003e\r\n\r\n\u003cp\u003eROI (B) = 25,000/75,000\u0026nbsp;= 33.33%\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, we see that since futures allow one to invest a lesser amount of capital to take an exposure for an asset, the return on investment is comparatively higher.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHowever, if the price movement is against expectations and Reliance, instead of going up by ₹100, falls by the same amount, then, in that case, the loss for both the individuals is ₹25000 only, but the loss in percentage terms for B (-33%) is much higher than A (-10%).\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, the way in which futures trading provides higher returns if the movement is in favour, similarly, it leads to higher losses when the price movement is unfavourable.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eMoreover, if one buys in the spot/cash market, one becomes a shareholder of the company and remains one even at the fallen price, then they do not need to pay any additional amount of money. Thus, if the price recovers in the future, he can still benef
1595it from the transaction.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHowever, if one buys in the futures market, one does not become a shareholder, and if the price falls, he/she has to provide additional margin money for the adverse price movement, or else the broker cancels his trade, and he has to suffer the losses. After this, even if the prices\u0026nbsp;increase in the future, one may not realize any gains or benefits. This is the inherent risk of trading in futures.\u0026nbsp;\u003c/p\u003e43:T174a,\u003cstyle type=\"text/css\"\u003e.right_content_section ul li {\r\n    margin-bottom: 5px; \r\n}\r\n\u003c/style\u003e\r\n\u003cp\u003eIn this unit, we will learn to determine the future price of an asset.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWe know the futures instrument derives its value from its respective underlying. We also know that the futures instrument moves in sync with its underlying. If the underlying price falls, so would the futures price and vice versa. However, the underlying price and the futures price differ, and they are not really the same. Say, for example, Nifty Spot is at 17586, whereas the corresponding current month contract is trading at 17597.\u0026nbsp;This difference in price between the futures price and the spot price is called the “\u003cstrong\u003ebasis\u003c/strong\u003e” or spread. The basis is 9 points in our example.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe pricing of a futures contract depends on the characteristics of the underlying asset. There is no single way to price futures contracts because different assets have different demand and supply patterns, different characteristics, and cash flow patterns. Market participants use different models for pricing futures. The two popular models of futures pricing:\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eCash and Carry model\u003c/li\u003e\r\n\t\u003cli\u003eExpectancy model\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003ch3\u003eCash and Carry Model\u003c/h3\u003e\r\n\r\n\u003cp\u003eLet us understand this concept with an example.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThere are two\u0026nbsp;people - Ram \u0026amp; Arjun. Ram decides to buy a particular stock, TCS, in the spot market, paying the total amount and taking delivery of the shares. On the other hand, Arjun decides to buy TCS in futures, paying just the margin.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cem\u003eWhat happens with Ram’s Position?\u003c/em\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTCS shares are credited to his demat account. Now, if TCS announces a dividend, Ram is entitled to that dividend, but simultaneously, he loses out on the opportunity cost of the funds involved in buying those TCS shares in the spot market. He is basically forgoing the interest on those funds.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn the other hand, Arjun, deploying just a small margin, is holding a similar\u0026nbsp;position in\u0026nbsp;TCS. When a dividend is announced, Arjun is not entitled to this dividend as his demat account doesn’t have TCS shares.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWe see that both Ram and Arjun are long on TCS, but still, their situation has a few differences on account of the opportunity cost of funds involved as well as dividends received. This is known as\u0026nbsp;the \u003cstrong\u003ecost of carry\u003c/strong\u003e!\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe \u003cstrong\u003e\u003ca href=\"https://blog.elearnmarkets.com/cash-and-carry-arbitrage/\"\u003eCash \u0026amp; Carry Model\u003c/a\u003e\u003c/strong\u003e assumes that markets\u0026nbsp;
1595are perfectly efficient. This means there are no differences in the cash and futures prices. No opportunity for arbitrage exists, and investors are indifferent to the spot and futures market prices while they trade in the underlying asset.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe model also assumes that the contract is held till maturity.\u0026nbsp;The price of a futures contract will be equal to the spot price plus the net cost incurred in carrying the asset till the maturity date of the futures contract.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eFutures Price = Spot Price + (Carry Cost – Carry Return)\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHere, Carry Cost refers to the cost of holding the asset till the futures contract matures. This could include storage costs, in the case of commodities, interest paid to acquire and hold the asset, financing costs, etc.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eCarry Return refers to any income derived from the asset while holding it, like dividends, bonuses, etc. The net of these two is called the net cost of carry.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe cost of carry model used for pricing futures is given by:\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"futures price formula\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/TOkbxzuUCw.png\"\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWhere,\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eS- Spot price\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003er- cost of financing\u0026nbsp;\u003c/strong\u003e(using continuously compounded interest rate)\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eT- Time to expiry\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003ee- 2.71828\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eExpectancy Model\u003c/h3\u003e\r\n\r\n\r\n\r\n\u003cp\u003eAccording to the expectancy model, it is not the relationship between spot and futures prices but that of expected spot and futures prices that moves the market. This is why market participants would enter into a futures contract and price the futures based upon their estimates of the future spot prices of the underlying assets.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAccording to this model,\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eFutures can trade at a premium or discount to the spot price of the underlying asset.\u0026nbsp;\u003c/li\u003e\r\n\t\u003cli\u003eFutures prices give market participants an indication of the expected direction of movement of the spot price in the future.\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003cp\u003eFor instance, if the futures price is higher than the spot price of an underlying asset, market participants may expect the spot price to go up in the near future. This expectedly rising market is called the “\u003cstrong\u003eContango market\u003c/strong\u003e”.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSimilarly, if the futures price is lower than the spot price of an asset, market participants may expect the spot price to come down in the future. This expectedly falling market is called a “\u003cstrong\u003eBackwardation market\u003c/strong\u003e”\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe difference between the spot and the futures price is known as the \u003cstrong\u003ebasis\u003c/strong\u003e.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSo, now that we have understood how futures contracts are priced. Next, let us discuss the different market participants in this futures market.\u0026nbsp;\u003c/p\u003e44:T1345,\u003cstyle type=\"text/css\"\u003e.right_content_section ul li {\r\n    margin-bottom: 5px; \r\n}\r\n\u003c/style\u003e\r\n\u003ch3\u003eWhat are the different participants in the derivatives market?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThere are three main types of participants in the derivatives market whose individual actions lead to market formation and rise or fall in the price of individual securities or the overall market.\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eHedger\u003c/li\u003e\r\n\t\u003cli\u003eSpeculator\u003c/li\u003e\r\n\t\u003cli\u003eArbitrageur\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003cp\u003eFirst, let us start with ‘\u003cstrong\u003eHedger\u003c/strong\u003e’. We will discuss the other two '\u003cstrong\u003eSpeculator\u003c/strong\u003e' and '\u003cstrong\u003eArbitrageur\u003c/strong\u003e' in the subsequent sections.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHedging means making an investment or taking a position to reduce the risk of adverse price movements in an asset. It enables an individual to reduce the risk arising from future price uncertainty.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIn our introductory section,\u0026nbsp;the example of ITC and the farmer, which we discussed, both counterparties, by virtue of entering into the futures contract, were acting as hedgers.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eHedging Through Futures\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHedging in the equity market or any other market could be possible by using various types of derivative products. Hedging via the use of a futures contract is one of the simplest forms of hedging possible, and it could be executed under two scenarios:\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eLong Security or underlying asset, Sell Futures\u003c/li\u003e\r\n\t\u003cli\u003eShort Security or underlying asset, Long Futures\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eLong Security or underlying asset, Sell Futures\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA trader buys a security at ₹800, and he or she might be worried about the share price going down, so to hedge the position, he or she can short the futures of that particular security.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAssume that the spot price of the security he holds is ₹800 and the 2 months' future contract he was holding cost him ₹804. For this, he pays an initial margin. Now, if the price of the security falls any further, he will suffer losses on the security he holds. However, the losses he suffers on the security will be offset by the profits he makes on his short futures position.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTake, for instance, that the price of his security falls to ₹720. The fall in the price of the security will result in a fall in the price of futures, and the same will now trade at a price lower than the price at which he entered into a short futures position.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHence, his short futures position will start making a profit. The loss of\u0026nbsp; ₹80 incurred on the security he holds will be made up by the profits made on his 
1595short futures position. However, in case the security price goes up instead of falling, then the profit he makes from his position in the underlying security is also wiped out by the loss he makes from his futures position.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, it is not necessary that hedging always benefits an individual. The best that can be achieved using hedging is the removal of unwanted exposure, i.e., unnecessary risk, and all that can come out of hedging is reduced risk.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHedging locks in the price of the security at which the hedge is entered, and even if the price rises or falls, the investor will realize the same value from the underlying asset.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eShort Security or underlying asset, Long Futures\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAn investor sells a security, say Reliance Industries at ₹1000, and he might always be worried about the share price going up, so in order to hedge himself, he can go long in futures.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAssume that the spot price of the security he holds is ₹1000 and the 2 months' future contract he was holding cost him ₹1004. For this, he pays an initial margin. Now, if the price of the security goes up further, he will suffer losses on the security he holds. However, the losses he suffers on the security will be offset by the profits he makes on his long futures position.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTake, for instance, that the price of his security rose\u0026nbsp;to ₹1050. The rise in the price of the security will result in a rise in the price of futures also. Futures will now trade at a price higher than the price at which he entered into a long futures position. Hence, his long futures position will start making profits. The loss of\u0026nbsp; ₹50 per share incurred on the security he holds will be made up by the profits made on his long futures position.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, what he has done is lock in the price of the shares in his portfolio at ₹1000, and even if the price goes up or comes down, he would still realize the same ₹1000 from selling the shares and coming out of the futures position.\u003c/p\u003e45:Tf40,\u003cstyle type=\"text/css\"\u003e.right_content_section ul li {\r\n    margin-bottom: 5px; \r\n}\r\n\u003c/style\u003e\r\n\u003cp\u003eWe will discuss the next type of market participant, known as the ‘\u003cstrong\u003eSpeculator\u003c/strong\u003e.’\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSpeculators are individuals who take large risks, especially with respect to anticipating future price movements, in the hope of making quick, large gains.\u0026nbsp;Speculators can achieve these profits by buying low and selling high, and vice versa.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTheir investment horizon is very short-term in nature, and hence they use futures markets where they also have to spend less (only margin money required) as against the full amount in the spot market.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eSpeculating Through Futures\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSpeculating in the equity market or any other market could be possible by using various types of derivative products. Speculating via uses of futures contracts is one of the simplest and yet highly rewarding forms if one's expectation of future price movement is correct.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eBullish on 
1595security, buy futures\u003c/li\u003e\r\n\t\u003cli\u003eBearish on security, sell futures\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eBullish on security, buy futures\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAn investor holds a view that a particular security that trades at ₹1000 is undervalued and expects its price to go up in the next two to three days. So, he buys 100 shares, which cost him one lakh rupees. His hunch proves correct, and three days later the security closes at ₹1010, and he makes a profit of ₹1000 on an investment of\u0026nbsp; ₹1,00,000 for a period of three\u0026nbsp;days. This works out to a return of one\u0026nbsp;percent.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eToday, a speculator can take the same position on the security by using futures contracts.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe security trades at ₹1000, and the one-month futures trade at ₹1002. Just for the sake of comparison, assume that the minimum contract value is ₹1,00,000 and he buys 100 security futures for which he pays a margin of ₹20,000.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTwo days later, the security closes at ₹1012. He makes the same profit of\u0026nbsp; ₹1000 on an investment of\u0026nbsp; ₹20,000. This works out to a return of five\u0026nbsp;percent.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, using futures, the speculator has made a ROI of around 5% in a short period, as against 1% if he had used the cash market.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cspan\u003eExplore the Masterclass: Gain Key Insights on Navigating as a Speculator. Elevate your skills in \u003cstrong\u003e\u003ca href=\"https://www.elearnmarkets.com/courses/display/commodity-and-currency\" target=\"_blank\"\u003eAdvanced Commodity \u0026amp; Forex Trading!\u003c/a\u003e\u003c/strong\u003e\u003c/span\u003e\u003c/p\u003e\u003cp\u003e\u003cspan\u003e\u003cbr\u003e\u003c/span\u003e\u003c/p\u003e\u003cp\u003e\u003cspan\u003e\u003cbr\u003e\u003c/span\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eBearish on security, Sell futures\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\r\n\r\n\u003cp\u003eStock futures can also be used by a speculator who believes that a particular security is over- valued and is likely to see a fall in price. To trade based on his opinion, all he needs to do is sell stock futures. Futures on an individual security move correspondingly with the underlying security, as long as there is sufficient liquidity in the market for the security.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIf the security price rises, so will the futures price. If the security price falls, so will the futures price.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow, take the case of the trader who expects to see a fall in the price of ABC Ltd. He sells one two-month contract of futures of ABC Ltd. at ₹240 (each contract for 100 underlying shares). He pays a small margin on the same.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTwo months later, when the futures contract expires, ABC closes at ₹220. On the day of expiration, the spot and the futures price converge. He has made a clean profit of\u0026nbsp; ₹20 per share.\u0026nbsp;\u003c/p\u003e46:T16f5,\u003cp\u003eLastly comes the ‘\u003cstrong\u003eArbitrageur\u003c/strong\u003e.’\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAn arbitrageur is a type of individual who attempts to profit from price inefficiencies in the market by making simultaneous trades that offset each other and capture risk-free profits.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAn arbitrageur would, for example, look for price differences between stocks listed on more than one exchange, and then buy the undervalued shares on one exchange while short selling the same number of overvalued shares on another exchange, thus capturing risk-free profits as the prices on the two exchanges converge.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eArbitrageurs also play a pivotal role in the operation of capital markets. They are also known as market makers, as their efforts in exploiting price inefficiencies keep prices more accurate than they otherwise would be.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eArbitraging Through Futures\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eArbitraging in the equity market or any other market could be possible by using various types of derivative products. Arbitraging via the use\u0026nbsp;of futures contracts is one of the most widely used methodologies of arbitrage in the Indian markets.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eEven though over the last couple of years the systems have taken over a lot of roles from human individuals in the job market for arbitrageurs, still individuals with good quantitative skills and a bent for adoption of technology have fared quite well, and their requirement would always exist.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eIf futures are overpriced: Buy spot, sell futures\u003c/li\u003e\r\n\t\u003cli\u003eIf futures are underpriced: Sell Spot, Buy futures\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eFutures are overpriced: Buy spot, Sell futures\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSay, a stock, ABC Ltd. trades at ₹1000 in the cash market or spot market and one-month ABC futures contract's theoretical price should be ₹1010 based on the futures pricing mechanism discussed earlier.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHowever, it trades at ₹1020 and seems overpriced. As an arbitrageur, you can make a riskless profit by entering into the following set of transactions.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn day 1, buy the security in the cash/spot market at ₹1000. And simultaneously, sell the futures of the security in the futures market at ₹1020. Through a series of similar actions by many arbitrageurs, the price in the spot market will start to increase as a lot of buying is taking place in the spot market, and the price in the futures market will start falling since a lot of selling is taking place in the futures market.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThis process of buying in the spot market and selling in the futures market will c
1595ontinue till the spot price and the futures price come to a level at which the spot futures price difference comes back to the theoretically justified levels.\u003c/p\u003e\r\n\r\n\u003cp\u003eLet’s assume the spot price rises to a level of\u0026nbsp; ₹1005 and the futures price falls to a level of\u0026nbsp; ₹1015, and now the basis is only ₹10, which is justified.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, the arbitrageur will now sell his holding in the cash market at ₹1005, which he had bought at ₹1000, and cover his short position in the futures market at ₹1015, where he had initiated a short contract at ₹1020, making an overall profit of Rs.10 (₹5 in cash and ₹5 in futures)\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThis profit of\u0026nbsp; ₹10 is actually the amount by which the futures price was overpriced compared to its theoretical price when the arbitrageur initiated the trade. This overpricing was because of the inefficiency of markets, which the arbitrageur capitalized on.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eFuture is under-priced: Sell spot, Buy futures\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA stock, say, ABC Ltd. trades at ₹1000 in the cash market, or spot market and one-month ABC futures contract's theoretical price should be ₹1010 based on the futures pricing mechanism we discussed earlier. However, it trades at\u0026nbsp;₹990 and seems under-priced. As an arbitrageur, you can make a riskless profit by entering into the following set of transactions.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn day 1, sell the security in the cash/spot market at ₹1000 (if you already own it, or else borrow and sell) and simultaneously, buy the futures of the security in the futures market at ₹990.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThrough a series of similar actions by many arbitrageurs, the price in the spot market will start to fall as a lot of selling is taking place in the spot market, and the price in the futures market will start rising as a lot of buying is taking place in the futures market.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThis process of selling in the spot market and buying in the futures market will continue till the spot price and the futures price come to a level at which the spot futures price difference comes back to the theoretically justified levels.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLet’s assume the spot price falls to a level of\u0026nbsp;₹990 and the futures price rises to a level of\u0026nbsp;₹1000, and now the basis is only ₹10, which is justified.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThus, the arbitrageur will now buy or cover the number of shares he had sold in the cash market at ₹990, which he had sold at ₹1000, and sell in the futures market at ₹1000, where he had initiated a buy at ₹990, making an overall profit of Rs.20 (₹10 in cash and ₹10 in futures).\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThis profit of\u0026nbsp; ₹20 is actually the amount by which the futures price was under-priced compared to its theoretical price when the arbitrageur initiated the trade. This under-pricing was because of the inefficiency of markets, which the arbitrageur capitalized on.\u003c/p\u003e47:T9ec,\u003cstyle type=\"text/css\"\u003e.right_content_section ul li {\r\n    margin-bottom: 5px; \r\n}\r\n\u003c/style\u003e\r\n\u003cp\u003eTill now, we have completed our discussion on ‘\u003cstrong\u003eFutures\u003c/strong\u003e.’ Starting from this section, we will learn about a new derivative instrument called ‘\u003cstrong\u003eOptions\u003c/strong\u003e’.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOptions are very interesting and versatile derivative instruments. So far, we have learned about forwards and futures. We learned that futures overcome the limitations of forwards. However, in futures, theoretically, there is a possibility of unlimited profit as well as loss. In a future contract, the trader has an obligation to bear that loss or enjoy profits, as the case may be, on expiry.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow, what happens if the trader has a choice? If a derivative contract can give the trader a choice to enter into the contract or simply back out at a later stage. Suppose the trader doesn't want to enter into an obligation to fulfil the contract. If so, then the trader can exercise choice as per the situation. If the situation is in his/her favour, he/she can exercise the right and go ahead with the contract and take the risk as per his/her risk appetite. Else can back out and let the contract be!\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eDo you think this kind of choice is available? yes\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThis choice is called an\u003cstrong\u003e OPTION\u003c/strong\u003e, a type of derivative contract that gives you a CHOICE.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eChoice of the right to buy or sell the asset, at a pre-determined price and time.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow think about it -\u0026nbsp;if in a contract, 1 party has a choice or right to enter or not enter the contract as per the situation, the other party has to take on an obligation.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThere are a few important features of an option contract.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eWhen you choose to take up the right, you are the buyer of that choice or option.\u003c/li\u003e\r\n\t\u003cli\u003eWhen you choose to take an obligation, you are the seller of that choice or option. So, this choice can be bought or sold.\u003c/li\u003e\r\n\t\u003cli\u003eNow choose what to do.\u003c/li\u003e\r\n\t\u003cli\u003eWhen your choice is to buy the asset, it’s called a '\u003cstrong\u003eCall\u003c/strong\u003e' option.\u003c/li\u003e\r\n\t\u003cli\u003eWhen your choice is to sell the asset, it is called a '\u003cstrong\u003ePut\u003c/strong\u003e' option.\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003cp\u003eWe will learn more about\u0026nbsp;\u003cstrong\u003eCall\u003c/strong\u003e and \u003cstrong\u003ePut\u003c/strong\u003e options in the subsequent sections of this module.\u0026nbsp;\u003c/p\u003e48:Te8a,\u003ch3\u003eWhat is a Call Option?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA call option is an options contract in which the buyer has the right to buy a specified quantity of the underlying stock at a predetermined price without any obligation.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow, let us understand this with an example:\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLet us assume that a stock is trading at ₹100 today.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAnd today, you are getting the option that gives the right to buy the same stock one month later, at the same ₹100, even if the shares trade at more than or less than ₹100.\u
15950026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSo, should you buy it?\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe answer is yes, as this means that even after one\u0026nbsp;month, if the share is trading at ₹120, you can still buy it at ₹100.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTo get this right, you need to pay a small amount today, say ₹5, which is called the premium amount.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow, if the share price goes above ₹100, then you can exercise your right and buy the shares at ₹100. If the share price stays at or below ₹100, then you do not need to buy the shares. You just lose ₹5, which you had paid for the right to buy in this example.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThis type of options contract is known as the\u0026nbsp;\u003cstrong\u003e\u003ca href=\"https://blog.elearnmarkets.com/call-option-meaning-types-price/\"\u003eCall Option\u003c/a\u003e\u003c/strong\u003e.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhat are Long Call Options?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWhen the traders expect that the price can move up, or when they are bullish, then they can take a long position in the call option.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTraders need to pay a premium to buy a call option. They buy these options due to the expectation that the underlying price will increase.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eBut if the price drops below the strike price, then the option holders lose the amount paid for the premium. This happens because the contract will not be exercised by the buyer, and hence it will lapse.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eFor example, let us assume that you are bullish on a stock. You buy a call option with a strike price of the stock is ₹5000, and the premium which you pay is ₹70.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003ePremium is the maximum amount that a buyer will agree to suffer as a loss. If the price of a share increases, the buyer exercises his option.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIf the share’s price does not increase beyond the strike price of\u0026nbsp; ₹5000, then the option expires on the maturity date. The buyer thus incurs a loss of\u0026nbsp; ₹70\u0026nbsp;on the premium.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"call option graph\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/lhVVHOQwDa.png\"\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eFrom the above diagram, you can see that your profits will be unlimited if the price moves up, and losses will be limited to the premium.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhat are Short Call Options?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe short call options involve selling an option of a given underlying asset at a predetermined price.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThis strategy leads to limited profit if shares are traded below the strike price, and it attracts substantial risk if it is traded at a value more than their strike price.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"option transaction graph\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/hfMUfqrjtY.png\"\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eFrom the above diagram, you can see that when shorting a call option, the profit is limited to its premium amount, which is ₹70, and the loss is unlimited.\u
1595003c/p\u003e49:Tef6,\u003ch3\u003eWhat is a Put Option?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA put option is an option contract that gives the buyer the right, but no obligation, to sell the underlying asset at a specific price, also known as the strike price.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cbr\u003e\r\nPut options can be traded on many underlying assets like stocks, currencies, and commodities.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThey help us to protect our trades against the decline in the price of the above assets below a specific price.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe trader does not have to own the underlying asset to buy or sell puts.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe put buyer has the right, but not the obligation, to sell the asset at a particular price, within a specified period.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWhereas, the seller has the obligation to buy the asset at the strike price if the option owner exercises their put option.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhat is\u0026nbsp;meant\u0026nbsp;by Buying Put Options?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIt is one of the simplest ways to trade \u003ca href=\"https://blog.elearnmarkets.com/put-options-buying-selling-trading/\"\u003e\u003cstrong\u003ePut Options\u003c/strong\u003e\u003c/a\u003e.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWhen the options trader has a bearish view on a particular stock, then he can purchase put options to profit from a decline in the asset price.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eExample:\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSuppose the stock is trading at ₹4900 and a put option contract with a 4900 strike price is trading at ₹70, expiring in a month.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eYou are expecting that the price of the stock will drop sharply in the coming weeks.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe payoff diagram of the examples will look as follows:\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"put options transactions\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/eDvQnSAhLT.png\"\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIf the prices fall as expected, then we earn profits.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eBut if our trade does not go according to our expectations, then our loss will be limited only to the premium price that we had paid.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhat is\u0026nbsp;meant by Selling Put Options?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003ePut sellers sell options with the expectation of gaining the premium amount when the underlying asset either goes up or remains in the existing range without seeing a negative bias.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOnce a put has been sold to a buyer, the seller has the obligation to buy the underlying asset at the strike price if the option is exercised.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe stock price must increase above the strike price or remain in the strike price zone to make a profit.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIf the underlying stock’s price falls below the strike price before the expiration date, then the buyer exercises his right, resulting in a loss for a put option seller.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"put options graphs\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/kIiVgULLas.jpg\"\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eFrom the above diagram, we can see that the profit is limited to the premium, whereas if the prices move against our expectation, then we may suffer unlimited losses.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eDifference between Call Options and Put Options:\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAn investor buys a put option when he expects the price of an underlying asset to fall within a specific time period, whereas an investor buys a call option when he expects the price of an underlying asset to rise within a specific time period.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"differences between call options and put options\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/SQXqoswdNC.png\"\u003e\u003c/p\u003e4a:T10aa,\u003cstyle type=\"text/css\"\u003e.right_content_section ul li {\r\n    margin-bottom: 5px; \r\n}\r\n\u003c/style\u003e\r\n\u003cp\u003ePreviously, we have learned about buying and selling Call or Put options. But before we start options trading, it is essential to get used to the specific terminologies related to Options.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhat are the various terms used in Options?\u0026nbsp;\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eDifferent terms need to be understood with clarity regarding options. Let us understand this with the help of an example.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLet us assume that we are bullish on a 
1595stock, which is trading at ₹670/-. We buy a call option at a strike price of\u0026nbsp;₹750. By paying a premium of ₹50 per share. The contract would mature after one\u0026nbsp;month.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIt looks simple, but there are a lot of terms associated with it that\u0026nbsp;need to be understood.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe right to buy a stock at a specified price on a certain specific predetermined date is known as a call option contract, and the person who has this right is known as a call option buyer or holder.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe person who has the obligation to sell the stock at the specified price on the predetermined date is known as a call option seller or writer.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe predefined specified price is known as the strike price or the exercise price, whereas the price at which the stock price is trading in the market at different points in time is known as the Spot price.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIn our example, ₹670 is the spot price and ₹750 is the exercise price.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTo enjoy the right to buy the stock, the option buyer pays a small amount to the option seller at the time of entering into the contract. This is known as the premium.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe time (i.e., one\u0026nbsp;month in our example) when the contract would lapse is known as the time to maturity.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSimilarly, a Put option is the right to sell the asset at a predefined price on a predefined date.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA seller of a put option has the obligation to buy the asset at the strike price, and he also receives a premium to do so.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eWe must remember that all option buyers pay a premium and option sellers receive a premium. \u003c/strong\u003e\u003c/p\u003e\r\n\r\n\r\n\r\n\u003cp\u003eOne more concept with respect to options is their moneyness and intrinsic value. It basically tells us about the relationship of an options contract with respect to its spot price and exercise price.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIt is a classification criterion which classifies each option strike based on how much money a trader will earn would exercise his option contract at this particular moment.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIt basically tells us about the intrinsic value of an option. The intrinsic value of an option is the money the option buyer will make from the contract, assuming he has the right to exercise that option now.\u0026nbsp;Intrinsic Value is always a positive value and can never go below zero. There are three\u0026nbsp;broad classifications on\u0026nbsp;the basis of moneyness. They are:\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eIn the Money (ITM)\u003c/li\u003e\r\n\t\u003cli\u003eAt the Money (ATM)\u003c/li\u003e\r\n\t\u003cli\u003eOut of the Money (OTM)\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003cp\u003eAll in the money options are those options which have a positive intrinsic value. For call options, a contract is ITM when the spot price is greater than the exercise price, and for a put option, a contract is ITM when the spot price is lower than the exercise price.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOTM options are those whose intrinsic value is always 0. For call options, a contract is OTM when the spot price is lower than the exercise price. And for a put option, a contract is OTM when the spot price is higher than the exercise price.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eATM options are those where the spot price equals the exercise price, and intrinsic value is also zero.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"intrinsic value of put and call options\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/hHlGzLzZtA.png\"\u003e\u003c/p\u003e4b:Tf72,\u003cp\u003eNow that we are familiar with different option terminologies, we will learn about an important term called the\u0026nbsp;\u003cstrong\u003e\u003ca href=\"https://www.elearnmarkets.com/face2face/detail
1595s/trading-strategy-using-options-open-interest-2\"\u003eOpen Interest\u003c/a\u003e\u003c/strong\u003e that is useful to both futures and options trading.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhat is open interest and why is it important?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOpen Interest defines the total number of open or outstanding contracts presently held by the market participants at a given time. It helps in the identification of stock market trends.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIn simple language, open interest analysis helps a trader to understand the market scenario by only showing the number of futures contracts that have changed hands during market hours. This concept applies to futures and options contract traders. Open Interest or OI data changes day by day depending on the outstanding contracts.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLet’s take an example to understand the whole picture.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThere are five participants in the market: A, B, C, D, and E.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn 1st July, A buys 10 contracts from B =\u0026gt; OI 10\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e2nd July, C buys 20 contracts from D =\u0026gt; OI 30\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e3rd July, A sells his 10 contracts to D =\u0026gt; OI 20\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e4th July, E buys 20 contracts from C =\u0026gt; OI 20\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSo, we can understand how OI changes depending on the change in the number of contracts.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWhen a new entrant trades with a new entrant in the F\u0026amp;O market, the\u0026nbsp;Open Interest goes up.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWhen an existing position holder squares off with the entry of a new entrant, open interest remains unchanged.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWhen two existing position holders square off their positions, we see open interest go down.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eHow to analyse open interest data to identify trends?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA trend can be defined by its upward and downward direction, but the sustainability of that trend is questionable. There are some important factors which backs up the price to take a certain direction. OI is one of the factors and a reason for a sustainable trend, as well as a trend reversal.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWhen the price is going up or down, and the future open interest increases alongside the price at a certain level, then we can expect that the price movement is going to sustain.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn the other hand, when a trend is present in the market, and a sudden fall in futures open interest is visible, then we should be doubtful about the trend. There might be a chance of a trend reversal.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAn increase in open interest means fresh money is flowing into the market, and a decrease in open interest suggests money outflow from the market.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eBuyers move the market up by investing fresh cash into the market, while sellers do the opposite.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;
1595\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA trend depends on how many\u0026nbsp;fresh contracts are\u0026nbsp;exchanging hands with the new price move. If the fresh cash does not flow into the market and the fresh contract does not exchange hands, then we should be doubtful about the trend.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"open interest  terminologies\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/KorjAfUqcg.png\"\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003e\u003ca href=\"https://web.stockedge.com/scan/high-increase-in-future-open-interest/4001\" target=\"_blank\"\u003e\u0026nbsp;\u003cbr\u003e\u003c/a\u003e\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003e\u003ca href=\"https://web.stockedge.com/scan/high-increase-in-future-open-interest/4001\" target=\"_blank\"\u003eClick here to know which stocks have seen a sudden increase in Open Interest.\u0026nbsp;\u003c/a\u003e\u003c/strong\u003e\u003c/p\u003e4c:T1736,\u003cstyle type=\"text/css\"\u003e.right_content_section ul li {\r\n    margin-bottom: 5px; \r\n}\r\n\u003c/style\u003e\r\n\u003cp\u003eHere in this section, let us learn another common term called ‘\u003cstrong\u003eRollover\u003c/strong\u003e,’ which is popularly used in the case of \u003ca href=\"https://www.elearnmarkets.com/webinars/trade-futures-options-using-data-reading\"\u003eF\u0026amp;O trading\u003c/a\u003e.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhat is rollover?\u0026nbsp;\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eRollover is carrying forward a particular month’s futures positions to the next month. This is done by closing the existing futures position of the current month and simultaneously taking a similar position in the subsequent series.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIdeally, traders roll their positions in the last week of the expiry series, typically on the expiry day.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn the expiry day, traders have an option: they can either let their position lapse or enter into a similar contract expiring at a future date.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eFor example, if you are bullish on Nifty, you can rollover or carry forward the Nifty futures position by closing your original position, which is due to expire, and simultaneously initiating a buying position for the subsequent month’s contract. This involves a cost, i.e., the difference between the current series and the next series prices.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhy do traders Rollover in the futures market?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eRollover is an important action for most of the derivative market participants.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cul\u003e\r\n\t\u003cli\u003eWhen they expect the current trend to continue in the near future\u003c/li\u003e\r\n\t\u003cli\u003eThey are not willing to book losses and are expecting the trend to reverse from the current situation.\u003c/li\u003e\r\n\t\u003cli\u003eCash and carry and reverse cash and carry Arbitrageurs tend to rollover their positions to take advantage of the price differentials.\u003c/li\u003e\r\n\u003c/ul\u003e\r\n\r\n\u003ch3\u003eWhat is the cost associated with a Rollover?\u0026nbsp;\u003c/h3\u003e\r\n\r\n\u003cp\u003eA rollover can give both positive and negative yield.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003ePositive Rollover yield: \u003c/strong\u003eA short seller in a contango market, where the future price is quoted above the spot price, will have a positive rollover cost as the next series contract will trade at a premium. The contract will be available to get rolled at a higher price vis-à-vis the current series contract, yielding an incremental positive spread.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA trader with long positions in a backwardation market where the future price is quoted below the spot price will also have a positive rollover cost, as the next series contract will trade at a discount. The contract will be available to get rolled at a lower price vis-a-vis the current series contract, yielding an incremental positive spread.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eNegative Rollover yield:\u003c/strong\u003e A trader with a long position in a contango market, where the future price is quoted above the spot price, will have a negative rollover cost as the next series contract will trade at a premium. The contract will be available to get rolled at a higher price vis-à-vis the current series contract, yielding a negative spread.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eA short seller in a backwardation market, where the future price is quoted below the spot price, will also have a negative rollover cost as the next series contract will trade at a discount. The contract will be available to get rolled at a lower price vis-a-vis the current series contract, yielding a negative spread.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eHow do we calculate the Rollover?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eRollover is often expressed in percentage terms.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNifty futures June rollover statistics can be calculated as:\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"options trading rollover formula\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/mQsCFTMUba.png\"\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"options trading rollover formula\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/LnxkkanLNS.png\"\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eHow to interpret Rollover?\u0026nbsp;\u0026nbsp;\u003c/h3\u003e\r\n\r\n\r\n\r\n\u003cp\u003eRollover is an indicator of traders' willingness to carry forward their existing bets on the market. But the standalone figures will not tell us in which direction traders have placed their bets.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn most occasions, lower-than-average rollovers\u0026nbsp;signal uncertainty as well as unwinding of the current trend, while higher rollovers signal conviction of the current view, which can lead to a continuation of the current trend.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHypothetically, if Rollover in Nifty futures from the March series to April is at 70% and its past three-month average Rollover is 64%, it means that traders are more convinced of the current market trend by building more positions.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHowever, at times, tracking Rollover trends based on just percentage terms can be misleading;
1595 it is always better to see it in terms of total contracts/shares getting rolled over.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eFor instance, a 70% Rollover may have taken place at a lower base of open interest number of outstanding positions, while an average of 64% rolls would have\u0026nbsp;happened at a relatively higher open interest base.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTherefore, analysing Rollovers purely on the basis of percentage terms can lead to faulty analysis, and hence trades should also track Rollovers in terms of total contracts rolled and also analyse Rollover trends on the basis of Rollover cost. Usually, high Rollover cost signals that the mood is upbeat in the market.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"open interest and price action rollover data\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/REEJQyzLvx.png\"\u003e\u003c/p\u003e4d:T3107,\u003cp\u003eLastly, let us talk about ‘\u003cstrong\u003eMargins\u003c/strong\u003e,’ which simply means taking leverage on trading positions.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhy are margins important?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eMargins play a very important role in derivative trading as it enables us to leverage our positions. In fact, margins are the one that gives a Derivative Contract the required financial twist. For this reason, understanding the margins in detail\u0026nbsp;is extremely important.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eMargin is a kind of collateral that the parties having the long and the short side of the futures contract need to deposit with his/her broker or exchange before taking any position. The reason the broker or the exchange takes this collateral is in order to protect itself from any kind of credit default by any of the parties involved.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eFor example, if one goes long in the Nifty futures contract and if the Nifty falls, then the long party has to pay for the losses, but if he defaults, the loss has to be borne by the exchange/broker. Thus, to protect itself from this potential default, the exchange/broker requires initial collateral from the trader investor before he can take any (long or short) position.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eMargins allow us to deposit a small amount of money and take exposure to a large-value transaction, thereby leveraging the transaction.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLet us discuss this with an example to understand it better.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eKalyan Jewellers agrees to buy 15 kg of Gold at ₹3000/- per gram from Prabhudas Gold Dealers, three\u0026nbsp;months from now.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAny variation in the price of gold will either affect Kalyan Jewellers or Prabhudas Gold Dealers negatively. If the price of gold increases, then Prabhudas Gold Dealers suffers a loss and Kalyan Jewellers makes a profit.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLikewise, if the price of gold decreases, Kalyan Jewellers suffers a loss, and Prabhudas Gold Dealers makes a profit.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWe know that this kind of agreement, which is a typical example of a forward contract, works on a gentleman’s word. Consider a situation where the price of gold has drastically gone up, placing Prabhudas Gold Dealers\u0026nbsp;in a difficult spot.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eClearly, Prabhudas Gold Dealers can say they cannot make the necessary delivery and thereby default on the deal. Obviously, what follows will be a long and legal chase, but that is outside our focus area. The point to be noted here is that, in a forward agreement, the scope for default is very high.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSince the futures and options markets are\u0026nbsp;an improvisation of the over-the-counter market trades, the issue of default is carefully and intelligently dealt with. This is where the margins play a role.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhat are the different types of margins?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow, how does the exchange make sure that trade works seamlessly and no default takes place?\u0026nbsp; Well, they make this happen by means of –\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp style=\"margin-left: 40px;\"\u003e1. Collecting the margins\u003cbr\u003e\r\n2. Marking the daily profits or losses to the market, which is known as the mark-to-market (MTM).\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp style=\"margin-left: 40px;\"\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow, we know that at the time of initiating the futures position, margins are blocked in your trading account. The margins that get blocked are also called the “\u003cstrong\u003eInitial Margin\u003c/strong\u003e”\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eInitial Margin will be blocked in our trading account for as many days as we choose to hold the futures trade. The value of initial margin varies daily as it depends on the futures price.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eInitial Margin = % of Contract Value.\u0026nbsp;\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eContract value = Futures Price * Lot Size\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLot size is fixed, but the futures price varies every day.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eInitial Margin\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThis is the initial amount that must be deposited in the margin account at the time a future contract is entered into.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe amount of initial margin is calculated by National Securities Clearing Corporation Ltd (NSCCL) based on the Standard Portfolio Analysis of Risk \u003cstrong\u003e
1595(SPAN)\u003c/strong\u003e methodology (commonly known as \u003cstrong\u003eNSE SPAN\u003c/strong\u003e). The objective of this methodology is to estimate the risk element in the portfolio of all the derivative contracts of each member.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eNSE SPAN\u003c/strong\u003e determines the largest amount of loss that an open position can incur on 99% of days. It is also known as the 99% Value at Risk\u003cstrong\u003e (VaR)\u003c/strong\u003e approach. For liquid stocks, the margin covers one-day losses, whereas for illiquid stocks, it covers three-day losses to allow the exchange to liquidate the position over three days. This amount is collected by \u003cstrong\u003eNSCCL\u003c/strong\u003e from clearing members, who in turn collect the same from their trading members and clients.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eMark to Mark Margin\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAs we know, the futures price fluctuates on a daily basis, because of which we either stand to make a profit or a loss. Marking to market, or mark to market (MTM), is a simple accounting procedure that involves adjusting the profit or loss we have made for the day and entitling us to the same.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAs long as we hold the futures contract, MTM is applicable.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLet us take up a simple example to understand this.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eAssume on 1st April at around 9:30 AM, you decide to buy ABC Ltd\u0026nbsp;Futures at ₹165/-. The Lot size is 3000. 4 days later, on 4th April, you decide to square off the position at 2:15 PM at ₹170.10/-. So it is a profitable trade –\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eBuy Price = ₹165\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSell Price = ₹170.1\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eProfit per share = (170.1 – 165) = ₹5.1/-\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTotal Profit = 3000 * 5.1 = ₹15300/-\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHowever, the trade was held for 4 working days. Each day the futures contract is held, the profits or losses are marked to market. While marking to market, the previous day's closing price is taken as the reference rate to calculate the profits or losses.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe table shows the futures price movement over the 4 days the contract was held.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cimg alt=\"\" src=\"https://d24uab5gycr2uz.cloudfront.net/uploads/other_pic/vHXODHMfoI.png\"\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLet us look at what happens on a day-to-day basis to understand how MTM works –\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn Day 1 at 11:30 AM, the futures contract was purchased at ₹165/-, clearly, after the contract was purchased, the price went up further to close at ₹168.3/-. Hence, profit for the day is 168.3 minus 165 = ₹3.3/- per share. Since the lot size is 3000, the net profit for the day is 3.3*3000 = ₹9900/-.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eHence, the exchange ensures (via the broker) that ₹9900/- is credited to your trading account at the end of the day.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eBut the question is, where is this money coming from?\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eObviously, it is coming from the counterparty. This means the exchange is also ensuring that the counterparty is paying up ₹9900/- towards his loss.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eBut how does the exchange ensure they get this money from the party who is supposed to pay up? – They do it through the margins that are deposited at the time of initiating the trade.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow here is another important aspect we need to note – from an accounting perspective, the futures buy price is no longer treated as ₹165, but instead it will be considered as ₹168.3/- (closing price of day 1).\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cem\u003eWhy is this happening?\u003c/em\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWell, the profit that was earned for the day has been given to you already by means of crediting the trading account. So the next day is considered a fresh start. Hence, the buy price is now considered at ₹168.3, which is the closing price of day 1.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eOn day 2, the futures closed at ₹172.4/-, clearly another day of profit. The profit earned for the day would be ₹172.4/ – minus ₹168.3/-, i.e., ₹4.1/- per share or ₹12300/- net profit.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eThe profits that you are entitled to receive are\u0026nbsp;credited to your trading account, and the buy price is reset to the day’s closing price i.e., ₹172.4/-. Likewise, it's done for Day 3.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow, on day 4, the trader did not continue to hold the position through the day, but rather decided to square off the position mid-day, at 2:15 PM, at ₹170.
159510/-. Hence, with respect to the previous day’s close, he again made a loss. That would be a loss of ₹171.6/- minus ₹170.1/- = ₹1.5/- per share and ₹4500/- (1.5 * 3000) net loss.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNeedless to say, after the square off, it does not matter where the futures price goes as the trader has squared off his position. And ₹4500/- is debited from the trading account by the end of the day.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eWell, if we add up all the MTM cash flow, we will end up with the same amount that we originally calculated, which is –\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eBuy Price = ₹165/-\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSell Price = ₹170.1/-\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eProfit per share = (170.1 – 165) = ₹5.1/-\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eTotal Profit = 3000 * 5.1\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e= ₹15300/-\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSo, the mark-to-market is just a daily accounting adjustment where –\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp style=\"margin-left: 40px;\"\u003e1. Money is either credited or debited (also called daily obligation) based on how the futures price behaves\u003cbr\u003e\r\n2. The previous day's closing price is taken into consideration to calculate the present day's MTM.\u003c/p\u003e\r\n\r\n\u003cp style=\"margin-left: 40px;\"\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eWhy do you think MTM is required?\u003c/h3\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eMTM is a daily cash adjustment by means of which the exchange drastically reduces the counterparty default risk. As long as a trader holds the contract, the exchange, by virtue of the MTM, ensures both parties are treated fairly and square daily.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eLet us now relook at margins, keeping MTM in perspective. As mentioned earlier, the margin required at the time of initiating a futures trade is called “\u003cstrong\u003eInitial Margin\u003c/strong\u003e”.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eEvery time a trader initiates a futures trade (for that matter, any trade), there are a few financial intermediaries who work in the background, making sure that the trade is carried out smoothly. The two prominent financial intermediaries are the broker and the exchange.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u003cstrong\u003eClinet\u0026lt;\u003c/strong\u003e-------\u003cstrong\u003e\u0026gt;Broker\u0026lt;\u003c/strong\u003e-------\u003cstrong\u003e\u0026gt;Stock Exchnage\u003c/strong\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eNow, if the client defaults on an obligation, obviously it has a financial repercussion on both the broker and the exchange. Hence, if both the financial intermediaries have to be insulated against a possible client default, then both of them need to be covered adequately by means of a margin deposit.\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eIn fact, this is exactly how it works. Initial margin is the minimum requisite margins blocked as per the exchange’s mandate, which acts as a cushion for any MTM losses. This is specified by the exchange, and this initial margin is blocked by the exchange.\u0026nbsp;\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003ch3\u003eMaintenance Margin\u003c/h3\u003e\r\n\r\n\r\n\r\n\u003cp\u003eMaintenance margin is the minimum amount of equity that must be maintained in a margin account. If due to MTM, the margin account falls below the stipulated level, a maintenance margin call is issued. It protects both investors and the broking\u0026nbsp;house. The broker does not have to absorb excessive investor losses while the investor is in a situation to avoid being totally wiped out.\u003c/p\u003e21:[\"$\",\"$L3a\",null,{\"styles\":{\"about_author_section\":\"page-module__4R5MOG__about_author_section\",\"about_the_author\":\"page-module__4R5MOG__about_the_author\",\"active\":\"page-module__4R5MOG__active\",\"active_unit\":\"page-module__4R5MOG__active_unit\",\"artticle_display\":\"page-module__4R5MOG__artticle_display\",\"author_name_school\":\"page-module__4R5MOG__author_name_school\",\"card_bottom_section\":\"page-module__4R5MOG__card_bottom_section\",\"catagory_name\":\"page-module__4R5MOG__catagory_name\",\"categories_description\":\"page-module__4R5MOG__categories_description\",\"custom_categories_card\":\"page-module__4R5MOG__custom_categories_card\",\"do_you_like_btn\":\"page-module__4R5MOG__do_you_like_btn\",\"download_pdf_btn\":\"page-module__4R5MOG__download_pdf_btn\",\"elm_btn_cir
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