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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 "</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)">" originates from the term "</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)">" 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 â¹10/kg. The total cost of production of wheat for the farmer, including fertilizer, seed, and his effort, is â¹6/kg.</p> 14 15<p> <br/></p> 16 17<p>However, 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 â¹8/kg, and this will lead to a profit of only â¹2/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 â¹12/kg. Now, since his farm is well irrigated, he will produce the desired quantity of wheat and sell it at the price of â¹12/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 'Ashirwad', as you all know.  </p> 30 31<p> <br/></p> 32 33<p>Currently, it's the month of March, and the price of wheat in the spot market from which ITC buys is â¹10/kg. The overall cost for ITC to process the wheat into Flour (including packaging and marketing) is â¹4/kg. ITC has already tagged the packets in which it sells the flour at â¹16/kg, thus realizing a profit of â¹2/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 â¹12/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 â¹8/kg. In this case, it would lead to a profit of â¹4/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 â¹11/kg, no matter what the price of wheat is in the spot market, and ITC has to buy the wheat at â¹11/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 "<strong>derivative</strong>" 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 â¹13/kg, the person holding this contract still has the right to buy wheat only at  â¹11/kg. Thus, the value of this contract, which previously was only â¹11,000, has now increased to â¹13,000.</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's time. The current USD-INR exchange rate is â¹72, and he is expected to receive a payment of $1,000. Thus, at the current rate, he expects to get â¹72,000 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 â¹70, and thus he would only receive a payment of â¹70,000 instead of â¹72,000, 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 â¹72,000 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 â¹74 and he will have to spend â¹74,000 instead of â¹72,000 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'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 & 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 '<strong>Forwards</strong>.' </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 "<strong>Counterparty risk</strong>".</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 '<strong>Futures</strong>' 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 & 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 '<strong>Payoff</strong>,' 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. </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., â¹3,00,000</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 = â¹50,000.</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 = - â¹50,000.</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 '<strong>Leverage ',</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'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. "<em>Financial Leverage is a two-sided sword</em>." Letâs 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 & 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 @ â¹1000/share. For this transaction, he has to pay a total of â¹250,000 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 â¹1000/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 â¹250,000, i.e., â¹75,000.</p> 409 410<p> <br/></p> 411 412<p>Now, from here, if Reliance goes up by â¹100, then both individual A and individual B make a profit of â¹(250 x 100), i.e., â¹25,000.</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 â¹100, falls by the same amount, then, in that case, the loss for both the individuals is â¹25000 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 â<strong>basis</strong>â 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 & 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 Ramâs 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 doesnât 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 & 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 â 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 â<strong>Contango market</strong>â. </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 â<strong>Backwardation market</strong>â</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 â<strong>Hedger</strong>â. We will discuss the other two '<strong>Speculator</strong>' and '<strong>Arbitrageur</strong>' 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 â¹800, 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 â¹800 and the 2 months' future contract he was holding cost him â¹804. 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 â¹720. 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 â¹80 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 â¹1000, 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 â¹1000 and the 2 months' future contract he was holding cost him â¹1004. 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 â¹1050. 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 â¹50 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 â¹1000, and even if the price goes up or comes down, he would still realize the same â¹1000 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 â<strong>Speculator</strong>.â</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'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 â¹1000 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 â¹1010, and he makes a profit of â¹1000 on an investment of â¹1,00,000 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 â¹1000, and the one-month futures trade at â¹1002. Just for the sake of comparison, assume that the minimum contract value is â¹1,00,000 and he buys 100 security futures for which he pays a margin of â¹20,000.</p> 683 684<p> <br/></p> 685 686<p>Two days later, the security closes at â¹1012. He makes the same profit of â¹1000 on an investment of â¹20,000. 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 & 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 â¹240 (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 â¹220. On the day of expiration, the spot and the futures price converge. He has made a clean profit of â¹20 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 â<strong>Arbitrageur</strong>.â</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 â¹1000 in the cash market or spot market and one-month ABC futures contract's theoretical price should be â¹1010 based on the futures pricing mechanism discussed earlier.</p> 748 749<p> <br/></p> 750 751<p>However, it trades at â¹1020 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 â¹1000. And simultaneously, sell the futures of the security in the futures market at â¹1020. 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>Letâs assume the spot price rises to a level of â¹1005 and the futures price falls to a level of â¹1015, and now the basis is only â¹10, 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 â¹1005, which he had bought at â¹1000, and cover his short position in the futures market at â¹1015, where he had initiated a short contract at â¹1020, making an overall profit of Rs.10 (â¹5 in cash and â¹5 in futures)</p> 766 767<p> <br/></p> 768 769<p>This profit of â¹10 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 â¹1000 in the cash market, or spot market and one-month ABC futures contract's theoretical price should be â¹1010 based on the futures pricing mechanism we discussed earlier. However, it trades at â¹990 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 â¹1000 (if you already own it, or else borrow and sell) and simultaneously, buy the futures of the security in the futures market at â¹990.</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>Letâs assume the spot price falls to a level of â¹990 and the futures price rises to a level of â¹1000, and now the basis is only â¹10, 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 â¹990, which he had sold at â¹1000, and sell in the futures market at â¹1000, where he had initiated a buy at â¹990, making an overall profit of Rs.20 (â¹10 in cash and â¹10 in futures).</p> 798 799<p> <br/></p> 800 801<p>This profit of â¹20 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 â<strong>Futures</strong>.â Starting from this section, we will learn about a new derivative instrument called â<strong>Options</strong>â.</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'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, itâs called a '<strong>Call</strong>' option.</li> 842 <li>When your choice is to sell the asset, it is called a '<strong>Put</strong>' 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 â¹100 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 â¹100, even if the shares trade at more than or less than â¹100. </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 â¹120, you can still buy it at â¹100.</p> 870 871<p> <br/></p> 872 873<p>To get this right, you need to pay a small amount today, say â¹5, which is called the premium amount.</p> 874 875<p> <br/></p> 876 877<p>Now, if the share price goes above â¹100, then you can exercise your right and buy the shares at â¹100. If the share price stays at or below â¹100, then you do not need to buy the shares. You just lose â¹5, 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 â¹5000, and the premium which you pay is â¹70.</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 shareâs price does not increase beyond the strike price of â¹5000, then the option expires on the maturity date. The buyer thus incurs a loss of â¹70 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 â¹70, 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 â¹4900 and a put option contract with a 4900 strike price is trading at â¹70, 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 stockâs 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 â¹670/-. We buy a call option at a strike price of â¹750. By paying a premium of â¹50 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, â¹670 is the spot price and â¹750 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>Letâs 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 => OI 10</p> 1155 1156<p> <br/></p> 1157 1158<p>2nd July, C buys 20 contracts from D => OI 30</p> 1159 1160<p> <br/></p> 1161 1162<p>3rd July, A sells his 10 contracts to D => OI 20</p> 1163 1164<p> <br/></p> 1165 1166<p>4th July, E buys 20 contracts from C => 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&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 â<strong>Rollover</strong>,â which is popularly used in the case of <a href="https://www.elearnmarkets.com/webinars/trade-futures-options-using-data-reading">F&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 monthâs 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 monthâs 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' 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 â<strong>Margins</strong>,â 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 â¹3000/- 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 gentlemanâs 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 â</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 â<strong>Initial Margin</strong>â</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 â¹165/-. The Lot size is 3000. 4 days later, on 4th April, you decide to square off the position at 2:15 PM at â¹170.
144510/-. So it is a profitable trade â</p> 1446 1447<p> <br/></p> 1448 1449<p>Buy Price = â¹165</p> 1450 1451<p> <br/></p> 1452 1453<p>Sell Price = â¹170.1</p> 1454 1455<p> <br/></p> 1456 1457<p>Profit per share = (170.1 â 165) = â¹5.1/-</p> 1458 1459<p> <br/></p> 1460 1461<p>Total Profit = 3000 * 5.1 = â¹15300/-</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'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 â</p> 1478 1479<p> <br/></p> 1480 1481<p>On Day 1 at 11:30 AM, the futures contract was purchased at â¹165/-, clearly, after the contract was purchased, the price went up further to close at â¹168.3/-. Hence, profit for the day is 168.3 minus 165 = â¹3.3/- per share. Since the lot size is 3000, the net profit for the day is 3.3*3000 = â¹9900/-.</p> 1482 1483<p> <br/></p> 1484 1485<p>Hence, the exchange ensures (via the broker) that â¹9900/- 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 â¹9900/- 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? â 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 â from an accounting perspective, the futures buy price is no longer treated as â¹165, but instead it will be considered as â¹168.3/- (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 â¹168.3, which is the closing price of day 1. </p> 1510 1511<p> <br/></p> 1512 1513<p>On day 2, the futures closed at â¹172.4/-, clearly another day of profit. The profit earned for the day would be â¹172.4/ â minus â¹168.3/-, i.e., â¹4.1/- per share or â¹12300/- 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 dayâs closing price i.e., â¹172.4/-. Likewise, it'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 â¹170.10/-. Hence, with respect to the previous dayâs close, he again made a loss. That would be a loss of â¹171.6/- minus â¹170.1/- = â¹1.5/- per share and â¹4500/- (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 â¹4500/- 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 â</p> 1530 1531<p> <br/></p> 1532 1533<p>Buy Price = â¹165/-</p> 1534 1535<p> <br/></p> 1536 1537<p>Sell Price = â¹170.1/-</p> 1538 1539<p> <br/></p> 1540 1541<p>Profit per share = (170.1 â 165) = â¹5.1/-</p> 1542 1543<p> <br/></p> 1544 1545<p>Total Profit = 3000 * 5.1</p> 1546 1547<p> <br/></p> 1548 1549<p>= â¹15300/-</p> 1550 1551<p> <br/></p> 1552 1553<p>So, the mark-to-market is just a daily accounting adjustment where â</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's closing price is taken into consideration to calculate the present day'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 â<strong>Initial Margin</strong>â.</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<</strong>-------<strong>>Broker<</strong>-------<strong>>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 exchangeâs 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 â¹10/kg. The total cost of production of wheat for the farmer, including fertilizer, seed, and his effort, is â¹6/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 â¹8/kg, and this will lead to a profit of only â¹2/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 â¹12/kg. Now, since his farm is well irrigated, he will produce the desired quantity of wheat and sell it at the price of\u0026nbsp; â¹12/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 â¹10/kg. The overall cost for ITC to process the wheat into Flour (including packaging and marketing) is â¹4/kg. ITC has already tagged the packets in which it sells the flour at â¹16/kg, thus realizing a profit of\u0026nbsp; â¹2/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 â¹12/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 â¹8/kg. In this case, it would lead to a profit of\u0026nbsp; â¹4/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; â¹11/kg, no matter what the price of wheat is in the spot market, and ITC has to buy the wheat at â¹11/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 â¹13/kg, the person holding this contract still has the right to buy wheat only at \u0026nbsp;â¹11/kg. Thus, the value of this contract, which previously was only â¹11,000, has now increased to â¹13,000.\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 â¹72, and he is expected to receive a payment of $1,000. Thus, at the current rate, he expects to get â¹72,000 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 â¹70, and thus he would only receive a payment of â¹70,000 instead of â¹72,000, 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 â¹72,000 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 â¹74\u0026nbsp;and he will have to spend â¹74,000 instead of\u0026nbsp; â¹72,000 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., â¹3,00,000\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 = â¹50,000.\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 = - â¹50,000.\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.\" Letâs 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 @ â¹1000/share. For this transaction, he has to pay a total of â¹250,000 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; â¹1000/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; â¹250,000, i.e., â¹75,000.\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 â¹100, then both individual A and individual B make a profit of â¹(250 x\u0026nbsp;100), i.e., â¹25,000.\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 â¹100, falls by the same amount, then, in that case, the loss for both the individuals is â¹25000 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 â\u003cstrong\u003ebasis\u003c/strong\u003eâ 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 Ramâs 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 doesnât 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 â 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 â\u003cstrong\u003eContango market\u003c/strong\u003eâ.\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 â\u003cstrong\u003eBackwardation market\u003c/strong\u003eâ\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 â\u003cstrong\u003eHedger\u003c/strong\u003eâ. 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 â¹800, 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 â¹800 and the 2 months' future contract he was holding cost him â¹804. 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 â¹720. 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; â¹80 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 â¹1000, 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 â¹1000 and the 2 months' future contract he was holding cost him â¹1004. 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 â¹1050. 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; â¹50 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 â¹1000, and even if the price goes up or comes down, he would still realize the same â¹1000 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 â\u003cstrong\u003eSpeculator\u003c/strong\u003e.â\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 â¹1000 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 â¹1010, and he makes a profit of â¹1000 on an investment of\u0026nbsp; â¹1,00,000 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 â¹1000, and the one-month futures trade at â¹1002. Just for the sake of comparison, assume that the minimum contract value is â¹1,00,000 and he buys 100 security futures for which he pays a margin of â¹20,000.\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 â¹1012. He makes the same profit of\u0026nbsp; â¹1000 on an investment of\u0026nbsp; â¹20,000. 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 â¹240 (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 â¹220. On the day of expiration, the spot and the futures price converge. He has made a clean profit of\u0026nbsp; â¹20 per share.\u0026nbsp;\u003c/p\u003e46:T16f5,\u003cp\u003eLastly comes the â\u003cstrong\u003eArbitrageur\u003c/strong\u003e.â\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 â¹1000 in the cash market or spot market and one-month ABC futures contract's theoretical price should be â¹1010 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 â¹1020 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 â¹1000. And simultaneously, sell the futures of the security in the futures market at â¹1020. 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\u003eLetâs assume the spot price rises to a level of\u0026nbsp; â¹1005 and the futures price falls to a level of\u0026nbsp; â¹1015, and now the basis is only â¹10, 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 â¹1005, which he had bought at â¹1000, and cover his short position in the futures market at â¹1015, where he had initiated a short contract at â¹1020, making an overall profit of Rs.10 (â¹5 in cash and â¹5 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; â¹10 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 â¹1000 in the cash market, or spot market and one-month ABC futures contract's theoretical price should be â¹1010 based on the futures pricing mechanism we discussed earlier. However, it trades at\u0026nbsp;â¹990 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 â¹1000 (if you already own it, or else borrow and sell) and simultaneously, buy the futures of the security in the futures market at â¹990.\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\u003eLetâs assume the spot price falls to a level of\u0026nbsp;â¹990 and the futures price rises to a level of\u0026nbsp;â¹1000, and now the basis is only â¹10, 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 â¹990, which he had sold at â¹1000, and sell in the futures market at â¹1000, where he had initiated a buy at â¹990, making an overall profit of Rs.20 (â¹10 in cash and â¹10 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; â¹20 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 â\u003cstrong\u003eFutures\u003c/strong\u003e.â Starting from this section, we will learn about a new derivative instrument called â\u003cstrong\u003eOptions\u003c/strong\u003eâ.\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, itâs 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 â¹100 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 â¹100, even if the shares trade at more than or less than â¹100.\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 â¹120, you can still buy it at â¹100.\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 â¹5, 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 â¹100, then you can exercise your right and buy the shares at â¹100. If the share price stays at or below â¹100, then you do not need to buy the shares. You just lose â¹5, 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 â¹5000, and the premium which you pay is â¹70.\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 shareâs price does not increase beyond the strike price of\u0026nbsp; â¹5000, then the option expires on the maturity date. The buyer thus incurs a loss of\u0026nbsp; â¹70\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 â¹70, 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 â¹4900 and a put option contract with a 4900 strike price is trading at â¹70, 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 stockâs 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 â¹670/-. We buy a call option at a strike price of\u0026nbsp;â¹750. By paying a premium of â¹50 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, â¹670 is the spot price and â¹750 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\u003eLetâs 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 â\u003cstrong\u003eRollover\u003c/strong\u003e,â 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 monthâs 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 monthâs 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-Ã -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-Ã -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 â\u003cstrong\u003eMargins\u003c/strong\u003e,â 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 â¹3000/- 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 gentlemanâs 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 â\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 â\u003cstrong\u003eInitial Margin\u003c/strong\u003eâ\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 â¹165/-. The Lot size is 3000. 4 days later, on 4th April, you decide to square off the position at 2:15 PM at â¹170.10/-. So it is a profitable trade â\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eBuy Price = â¹165\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSell Price = â¹170.1\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 â 165) = â¹5.1/-\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 = â¹15300/-\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 â\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 â¹165/-, clearly, after the contract was purchased, the price went up further to close at â¹168.3/-. Hence, profit for the day is 168.3 minus 165 = â¹3.3/- per share. Since the lot size is 3000, the net profit for the day is 3.3*3000 = â¹9900/-.\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 â¹9900/- 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 â¹9900/- 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? â 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 â from an accounting perspective, the futures buy price is no longer treated as â¹165, but instead it will be considered as â¹168.3/- (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 â¹168.3, 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 â¹172.4/-, clearly another day of profit. The profit earned for the day would be â¹172.4/ â minus â¹168.3/-, i.e., â¹4.1/- per share or â¹12300/- 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 dayâs closing price i.e., â¹172.4/-. 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 â¹170.
159510/-. Hence, with respect to the previous dayâs close, he again made a loss. That would be a loss of â¹171.6/- minus â¹170.1/- = â¹1.5/- per share and â¹4500/- (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 â¹4500/- 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 â\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eBuy Price = â¹165/-\u003c/p\u003e\r\n\r\n\u003cp\u003e\u0026nbsp;\u003cbr\u003e\u003c/p\u003e\r\n\r\n\u003cp\u003eSell Price = â¹170.1/-\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 â 165) = â¹5.1/-\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= â¹15300/-\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 â\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 â\u003cstrong\u003eInitial Margin\u003c/strong\u003eâ.\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 exchangeâs 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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