Future Contract

is a agreement between the two parties

>>to buy or sell
>>underlying asset
>>in a specified future period
>>at an agreed price
>>through recongnized stock exchange / exchange traded

A future contract is an exchange traded, standardized , forward like contract that is marked t

Have an expiration date, but they need not be held until that date.
>>cancellation is allowed at any time during the tenure

The exchange act as a mediator and facilitator between parties

A buyer or seller identity is not known to the parties

Future contracts are derivatives in nature because their value is determined by an undelying as
All contracts are standardized i.e quality, quantity, date & month of delivery, tick size etc.

Buyer = Long

Seller = Short

Organised Exchange
NIFTY50, NIFTY500, BANK NIFTY traded on NSE

Clearing house
Assurance of trade settlement

Margins
The exchange requires that a margin must be deposited with clearing house by a member whi e
The amount of margin is generally between 2.5% to 10% of value of contract but can vary.

Marking to Market
In the futures market parties to the contract are required to open their margin account
at the end of the each trading session, the difference in prices are settled on daily basis. It's MT

Actualy delivery is rare, less than 1% of the contracts traded get settled with actual delivery.
Futures are used as a device to hedge against price risk.

Types of Future Contract

>> Depending on the type of underlying assets, different types of futures contracts are available
> Stock Futures
These are derived contracts that give you a power to buy or sell a specific stocks at prefixed pr
The specified stock basically consists of the equity shares of specific company.
Once you enter into a contract you are obligated to uphold the terms of the agreement
Futures are available only on selected stocks
a future contract will generally trade at a higher price than the spot price for its underlying stoc

> Currency Futures

A standardised agreement between two parties
>> To exchange a specified amount of one currency for another currency
>> At a predetermined exchange rate and specific date in the future
>> underlying are currency exchange rate
>> used as hedging tool by business or investors to manage their foreign exchange risk.

> Commodity Futures

>> a contract is an agreement to buy or sell a particular commodity at a future date
>> the price and the amount of commodity are fixed at the time of the agreement.
>> underlying can be Crude oil, wheat, corn, silver. Aluminium etc. Basically there are three com
>> Multi Commodity Exchange (MCX) for metal and energy, National Commodity and Derivative

> Index Futures

>> Index futures are contract that allow a trader
To buy or sell a financial index today and
have it resolved at a future date
>> Cash settled
>> specifically used to hedge or speculate
>> S&P 500 Index, NIFTY50, BANKNIFTY, NIFTYIT, S&P BSE SENSEX etc
>> Profit/Loss = (Selling price - entry price) * lot size

> Interest Futures Contract

>> Contract based on interest bearing financial instrument
>> It is contract between a buyer and seller which agrees to buy and sell a debt instrument at a
at a price which is determined today.
>> The underlying assets can be any interest bearing instrument like T-bills, Govt bonds (Treasu
>> Contract can be cash-settled or it can involve the delivery of the underlying security.
>> used for hedging and speculative purpose.
>> pricing for these futures is derived by simple formula: 100 - Implied interest rate
So a futures price of 94 means that the implied interest rate for the security is 6%.
>> contracts are tradable on NSE based on 6-year, 10-year and 13-year Govt of India Security (N
91-day GOI treasury bills (91DTB)
>> Size refers to total amount of the contract. However, a minimum requirement of Rs 2 lakh o
hat is marked to market daily

an undelying asset
ck size etc.

a member whi enters into a futures contract.

ut can vary.

account
ily basis. It's MTM.

tual delivery.
acts are available for trading.

ks at prefixed price by a certain date.

reement

underlying stock.

nge risk.
 re are three components of commodity futures i.e. Metal, Food and Enery.
ty and Derivatives Exchange Ltd (NCDEX) for leading agreecultural commodity in India.

instrument at a future date when contract expires.

vt bonds (Treasury bonds), Eurodollars etc.

security.
India Security (NBF-II) and

nt of Rs 2 lakh or 2000 bonds if one wants to trade in these futures.

Margin Account Illustration

Investor 'A' has taken a long position and Investor 'B' has taken a short position in N
The lot size associated with the contract is 75 (lot size)
The Initial Margin is assumed to be 10% of one futures contract and the mainten
The futures settlement prices on the following 5 (five) days are as follows:

Day Closing Price Settlement Price

1 9950
2 9920
3 9750
4 9600
5 9680

Prepare a market to market margin settlement statement in the accounts of both th

if the contract is closed on the 5th day.

Solution
 Futures price of Nifty at the time of Long or Short Position : 9900 F0
Lot size :
No of Long or Short Contracts
Value of one futures contract :
(Futures Price at P0 * Lot size * No of contracts)

STEP 1 Initial Margin 10% of Value of futures * no of contracts

STEP 2 Maintenance Margin 75%* of Initial Margin

Margin statement Calculation

Margin
Mr A
Futures Change in Daily(long position)
Margin Ac Call @
Day Price Price Gain /Loss balance 55688 Day
0 9900 74,250.00 0
1 9950 50 3750 78,000.00 0 1
2 9920 -30 -2250 75,750.00 0 2
3 9750 -170 -12750 63,000.00 0 3
4 9600 -150 -11250 51,750.00 ### 4
 Closing
Balance
Closing -
5 9680 (initial
Balance - 80 Closing6000 80,250.00 0 5
margin
(initial + Balance 80,250.00
Net Margin
margin + call
gain
Net /loss amount
Margin call
for
gainMr A topped
/loss amountup) -16,500.00 Loss
for Mr B topped up) 16,500.00 Profit
hort position in Nifty Futures at 9900 (one contact)

nd the maintenance margin is 75% of initial margin.

follows:

ccounts of both the investors and find out the gain / loss
 9900
75
1
742,500.00 NOTIONAL VALUE

74,250.00 INITIAL MARGIN

55,687.5 MAINT. MARGIN

Daily Margin Margin

Closing day Mr B (Short position)
Change in Gain Ac Call @
Futures Price Price /Loss balance 55688
9900 ###
9950 -50 -3750 ### 0
9920 30 2250 ### 0
9750 170 12750 ### 0
9600 150 11250 ### 0
 9680 -80 -6000 ### 0
closing balance ###
> Financial Dervatives price depends largely on the value of the un

> A futures contact price is determined by the cost of its underlyin

moves in sync with it. i.e. the agreement's value will change with fl

> The cost of future will rise if the cost of its underlying in increase

> The spot price if an asset can be different from its future price

> The difference between Future price and Spot price is known as

> Basis = Spot price - Future price

> Basis can be Positive, Negative or Zero
Future > Spot = basis being negative >> This is Contango Market

Future < Spot = positive basis >> Backwardation market

Principle of Convergence = on the last day that a futures contract

and the price of the underlying asset will be

Futures Price = Spot price * [1+Rf*(days/365)]-d

Future price is known as fair value

If stock traded higher or below this price then there is Spread.

Example
XYZ spot 2000
Rf 7%
days to exp 23days
Dividend 2Rs

Fo 2007 Spot -future parity/fair value/ theoritical price

Lets say future contract is trading at 2015

means there are some more factors impacting the price
as the spread is = 2015-2007 8
that means future market price of the contract is expensive or spo

Thumb rule , buy cheap, sell expensive

Future pricing helps in decision making or what action to be taken

 Model of Future contract Pricing
a) Cost of Carry
CC model is mostly used to calculate future price
It defines relationship between the spot and future price
Model assumes that future price of a futures contract is-
>> the price of underlying asset in the spot market plus the co
>> Futures contrcat price = Spot price + Cost of carry
CC refers to the cost incurred by an investor for holding and r
This could include storage cost in case of commodities, intere
Asset's futures price is generally higher than its spot price (or
>> The seller would incur for buying and financing the commo
>> these costs are referred as Cost of carry.

>> Cost of carry = Futures contrcat price - Spot price

 OR
>> Cost of carry = Interest on loan/Interest on margin + storag
OR
>> FP = SP + (carry cost - Carry return) i.e. called net holding c

Calculated future price is called Theoretical minimum price or

Future price calculation in case is always continuous compoun

b) Expectancy Model
The expectancy Model of future pricing states that the future
>> basically what the spot price of the asset is expected to be
As per this model, it is not the relationship between spot and
>> that of expected spot and future price, which moves the m
According to this model,
>> Future can trade at a discount or premium to the spot pric
>> Future price gives market participants an indication of mov
>> In this model, an assets futures pricing depends on its futu
>> so this prediction can be bullish or bearish.
lue of the underlying assets.

its underlying assets and

hange with fluctuations in assets price

g in increases and vise a versa.

uture price

is known as Basis or Spread

ngo Market

ures contract, the price of the futures

asset will be equal

Spread.
tical price

ensive or spot is cheaper than futures

n to be taken in the market.

 re price
tract is-
et plus the cost of carrying the asset for the period of futures.

holding and retaining as asset or a financial position in the market

dities, interest paid to acquire or hold the asset, financing cost etc.
pot price (or cash price) because it incorporates costs that
g the commodity/ asset, financing, storage cost until the delivery date.
argin + storage cost +Insurance cost - Dividend income

net holding cost

mum price or arbitrage free price or fair price

ous compounding i.e F = Se^rt

at the futures price of an asset is

pected to be in the future.
een spot and future prices but
moves the market.
the spot price of underlying assets
ation of movement of the spot price in the future
ds on its futures spot price trends
arket
ost etc.

very date.
 Risk free
Cost of carry 5.00% p.a. compounded continuously
interest rate
Equity futures Spot price Expected price of
T ( days to
Sr no spot price (Rs) Dividend (Rs) Dividend days adjusted for future contract
settlement)
1 100.00 30 0.00 dividend
? (Rs) (Rs)
?
2 100.00 25 1.00 10.00 ? `
3 100.00 20 1.10 15.00 ? ?
4 100.00 40 0.00 ? ?
5 ? 30 0.00 ? 100.50
6 ? 30 1.00 10.00 ? 99.85
7 100.00 ? 0.00 ? 100.76
8 100.00 ? 1.00 20.00 ? 99.65

Commodity futures Expected price Actual price of

T ( days to Storage cost Expected cost of
Sr no spot price (Rs) of future future contract
settlement) (% p.a.) carry (% p.a.)
9 100.00 30 6.00% contract
? (Rs) (Rs)
100.85 ?
10 100.00 25 4.00% ? 100.84 ?

Currency futures/forward contracts

Expected price of Actual price of

T ( days to domestic risk overseas risk
Sr no spot price (Rs) future/forward future/forward
settlement) free (% p.a.) free (% p.a.)
contract (Rs) contract (Rs)

11 65.00 90 5.00% 1.50% ? 65.51

12 65.00 30 5.50% ? ? ?
ously
Actual price
Implied cost of carry
of future
(% p.a.)
contract
100.65(Rs) ?
99.80 ?
? 9.76%
? 10.00%

Implied cost
Convenience yield
of carry (%
(% p.a.)
p.a.)
? ?
? ?

Expected
Implied cost of carry
cost of carry
(% p.a.)
(% p.a.)

? ?
4.00% 4.10%
 market
price of
gainQ1 gainQ2
underlyin
110
g on exit 0 0
175 0 17500
220 0 -22000
280 0 -28000
110 0 0
0 -32500
margin gain%Q3
0
0
0
0
0
0 #DIV/0!
 Risk free interest
Basis,spread and cost of carry 5.00% p.a.
rate

1 Compute basis in case spot is 100, expiry after 15 days, no dividend and implied cost of car

2 Compute basis in case spot is 100, expiry after 15 days, dividend of 1 after 10 days and imp

3 Compute implied cost of carry (% p.a. compouded continuously) if basis is 2,spot is 100, ex

4 Compute implied cost of carry (% p.a. compouded continuously) if basis is 0.2,spot is 100,

5 Compute basis for a commodity with spot of 100, storage cost @ 3% p.a., expiry after 20 d

6 Spot is 100, basis ( expiry 12 days away) is 0.4, near month spread @ 1.3 ( expiry 42 days a
Calculate implied cost of carry in % p.a. compouded continuously for the current month, n

Actual price days Implied cost of

carry (% p.a.)
spot 100.0000
current ? 12 ?
near ? 42 ?
far ? 71 ?
 compounded continuously

end and implied cost of carry 9% p.a. compounded continuously

of 1 after 10 days and implied cost of carry 9% p.a. compounded continuously

if basis is 2,spot is 100, expiry after 25 days and dividend is nil

if basis is 0.2,spot is 100, expiry after 35 days and dividend is 1 after 12 days

@ 3% p.a., expiry after 20 days, convenience yield of 2.3% p.a. Risk free interest rate is @ 5% p.a.

ad @ 1.3 ( expiry 42 days away) and far month spread @ 2.4 ( expiry 71 days away).
y for the current month, near month as well as far month futures
te is @ 5% p.a.
net gain,margin

1 Entry
underlying entry Entry day count for Exit Price
Sr no # of units Price Exit Basis
security long/short Basis exit of expiry Futures
1 100 X L Futures
121 2 30
2 100 y L 165 3 30 1
3 100 Z S 201 4 30
4 100 A S 306 2 30 1
5 100 B L 103 30
Compute net gain in INR for Futures only

2 In case of the example in Q1 above, recompute net gain in INR for stocks X,Y,Z, A and B of 100 shares each

3 In case of example in Q1 above, compute % gain over expiry cycle if average margin for X, Y and B is 20% and that for A & Z is 25%
Assume that the surplus funds (if any) remain with the broker till expiry

4 The implied cost of carry is 9% p.a. (compounded continuously), time to expiry is 10 days and average margin 20% of entry notion
Compute % gain if underlying moves up by 5% during the 10 day period. Position held till expiry. No dividends expected
Spot Price today is INR 100. Compute % gain if you are buying futures on spot and holding till expiry

5 Entry is short position at 100. Initial margin is 20% and maintenance level is 12%. At what price would the margin call be made?

6 If 10 lots were sold at entry in the example in Q5 above i.e. at 100 and the price went to 109, but the customer did not respond to
How many lots would need to squared off? Lot size : 2500
 market price of
underlying on exit
110
175
220
280
110

% and that for A & Z is 25% of the notional entry value

margin 20% of entry notional value

idends expected

he margin call be made?

stomer did not respond to the margin call.

Mahesh, a cashew merchant, wants to buy five cashew contracts on March 5 at INR 5,600 each.
The initial margin for Mahesh is 5.5% of the contract value
The futures price is for each carton, and the contract size is 50 cartons
Mahesh closes out his position on March 16.
The futures prices from March 6 to March 16 are shown below.
The variation margin is INR 50,000
Prepare a margin account for Mahesh. March 5 is a Monday, and trading takes place only on weekdays.

Date Futures Price

Mar-05 5600
Mar-06 5650
Mar-07 5675
Mar-08 5610
Mar-09 5570
Mar-12 5520
Mar-13 5400
Mar-14 5480
Mar-15 5570
Mar-16 5650
Arbitrage and Hedging
Q1 Stock X is purchased at 100 by borrowing fully at 6% p.a. Future on X is simultaneously sold at 100.90
Expiry is 30 days away. Positions held till expiry
Compute the net gain on the expiry day
Assume transaction costs to be nil, ignore interest cost on the margin for the future
Compute interest using simple interest method

Q2 If in Q1 above, average margin deployed on the future contract was 25% and it was out of owned funds;
Compute % net gain on the owned funds invested
Assume transaction costs to be nil

Q3 If in Q2 above, the transaction costs are 0.2% for delivery based transactions and 0.03% for futures transacti
Compute the revised % net gain on the owned funds invested. Price of the stock went up by 10% during the e

Q4 With respect to Q1,2 and 3 above; what is the minimum value of the futures contract necessary to make arbi

Q5 Further to Q4, what is the minimum implied cost of carry in terms of % p.a. necessary for arbitrage profit?
Compute using simple interest method, discrete compounding as well as continuous compounding

Q6 Stock Y is purchased at 100 and simultaneously Future on Y is sold at 101. Expiry is 25 days away
Dividend of 0.3 is expected 15 days from now
Average margin of 25% for the futures contract
80% of the total investment funded through borrowing at 6% p.a.
Interest/gain computed using simple interest method
Dividend would reduce borrowing cost
Transaction costs 0.25% for delivery and 0.05% for futures (excluding expiry day)
Compute % net gain p.a. on the owned funds invested from this arbitrage transaction. Assume that the stock

Q7 Stock Z was borrowed from SLBM at borrowing cost of 0.7% p.a. (including SLBM transaction costs) for 30 da
Stock Z was sold at 100 and the future contract on Z was simultaneously purchased at 99.20
Expiry of the futures contract is 30 days way
No dividend expected
Transaction costs 0.25% for delivery and 0.05% for active futures
Fund received on selling the stock was first used in giving the margin for the futures contract and the balance
Compute net arbitrage gain on the expiry day. Stock price 105 at the time of expiry
Assume average margin of 25% on the entry future price

Q8 On day t=0, stock X was priced at 100 and its basis was at 1.2% of the stock price. On day t=0, stock Y was pri
Stock X went up by 3% from t=0 to t=15. Stock Y went up by 4% in the same period
On day 15, basis for X was 0.7% and that for Y was 0.9%
Max capital available is 200
Expiry on t=30
Compute optimum net arbitrage gain on expiry day based on the information given
Interest computed on simple interest basis and nil transaction costs
Assume average margin of 25% on the entry future price

Q9 An HNI investor is expecting inflow of INR 100 cr on 5th Feb, 2019. This would be invested in diversified large
The investor is bullish about the budget to be presented on 1st Feb,2019 and wishes to hedge once the large
The following are the prices of various futures contracts as on 28th Jan, 2019
Choose appropriate contract for hedging and compute the number of lots needed to be transacted.
Will the future contracts be sold or bought?
 Nifty31stjan2019 10937
Nifty28thFeb2019 10967
BankNifty31stJan2019 27560
BankNifty28thFeb2019 27674

Q10 A diversified fund with Beta of 1.2 and size of 12340 cr as on 19th Feb wishes to hedge its portfolio.
Using the futures contracts used in Q9 above, compute the number of lots to be transacted by the fund.
Will the future contracts be bought or sold?

Q11 A company borrows USD 100m@ 2.4% p.a., sells spot USD@ 70 and buys 1 year forward USD @73
The funds received by selling spot USD are invested at 7% p.a.
If spot USD after 1 year is 73.5; compute net arbitrage gain in INR and in USD
Assume simple interest method.

Q12 A company borrows USD 100m @ 3.5% p.a. for a period of 1 year and buys forward USD at a premium of 5%
With the proceeds from this loan, the company pays back an outstanding domestic loan which carried intere
If the spot at the beginning of the year was INR 70 per USD and at the end of one year was INR 73 per 1 USD;
Is this an example of arbitrage or hedging?

Q13 A commodity having storage cost of 1.5% p.a. is bought in spot @ 100. Future contract on that commodity (e
Average margin on the future contract is 25%
Assume that the commodity purchase was funded by borrowing at 6% p.a. and margin for the futures contra
Compute the net gain on the expiry day. Interest and storage cost computed using simple interest method. T

Q14 Compute % net gain p.a. in Q13 above

n X is simultaneously sold at 100.90

gin for the future

s 25% and it was out of owned funds;

ansactions and 0.03% for futures transactions (excl expiry day);

e of the stock went up by 10% during the expiry period

he futures contract necessary to make arbitrage profit?

of % p.a. necessary for arbitrage profit?

well as continuous compounding

at 101. Expiry is 25 days away

ng expiry day)
bitrage transaction. Assume that the stock price appreciates by 3% at expiry

ncluding SLBM transaction costs) for 30 days

eously purchased at 99.20

in for the futures contract and the balance was invested at 5% p.a. (simple interest method)
he time of expiry

he stock price. On day t=0, stock Y was priced at 150 and its basis was 0.7% of the stock price
the same period

nformation given

This would be invested in diversified large cap stocks.

b,2019 and wishes to hedge once the large lumpsum inflow is received.

of lots needed to be transacted.

 lot size : 75
lot size : 75
lot size : 40
lot size : 40

Feb wishes to hedge its portfolio.

r of lots to be transacted by the fund.

d buys 1 year forward USD @73

and buys forward USD at a premium of 5% on the spot to pay back this loan.
anding domestic loan which carried interest of 9.5% p.a.
the end of one year was INR 73 per 1 USD; compute the annual savings to the company.
Assume all rates are based on simple interest.

100. Future contract on that commodity (expiring 30 days later) is simultaneously sold at 100.80

t 6% p.a. and margin for the futures contract was paid from owned funds
computed using simple interest method. Transaction costs Nil.