Wednesday 21 September 2016

Demystifying Futures :- Margin and Mark To Market

What is Futures ?

This question comes in the mind of those trader who are either newcomer in stock market or want to come in stock market but do not know what it is actually Nifty Future or Reliance Future or Stock Future. But they have listen this word number of times.

So as we know there is National Stock Exchange, one of the main stock exchange of India. Most of the companies registered in this stock exchange and through this stock exchange we are able to do transaction in these companies stock . We are able to buy and sell the companies stock through our broker registered in stock exchange.

Index of National Stock Exchange is known as Nifty. And the derivative contract of Nifty 50 known as Nifty Future. Nifty is a portfolio of main 50 stocks and according to movement of these stock, we see the up and down movement in Nifty

As of now in India a minimum tradeable contract in future has to be of Rs 5 lakhs that is the reason Nifty Future lot size is 75 which means 75 X 8800 (Approximate) = Rs 660000




Must Read : How is Daily & Historical Volatility calculated for Stocks

Why Futures ?

Imagine a scenario that you are doubly sure that a scrip like Reliance Industries will move up in next few months due to Jio Launch or fundamentals or what not. 
But the idea is you are bullish on Reliance, now Reliance Industries trade at 1070, If you had to buy 500 shares then you will have to pay 535000 to broker for delivery. 
Futures market helps you buy 500 shares in a single go while paying a margin of around 7% which is equal to Rs 37450.
There is no Physical delivery of shares in your demat account but virtually you are holding 500 shares of reliance industries which is the lot size.

How is market to market calculated in futures ?

Assume you purchased 1 lot of Reliance at 1070 on 19/09/2016, closing price of Reliance Sep Futures on 19/09/16 was 1084.15 so your ledger account will be credited with Rs 7075 (closing price - purchase price * lot size) 

On 20/09/2016 your future position would be brought forward with Rs 1084.15 from 19/09/2016, since you did not sold your future on 20/09 and it would be carry forwarded with closing price of 20/09/16 to 21/09/06.
This cycle continues unless you square off the position or last Thursday of the month whichever is earlier 
MTM of 20/09/16 would be 1084.15 - 1078.95, now your ledger would be debited with Rs 2600 ( Today's Closing Price - Yesterday closing price * Lot Size) 

On 21/06/16 you squared off the position at the rate of 1087, now your ledger would be credited with Rs 4025 i.e 1087 (sold rate) - 1078.95 (yesterday closing price) * 500.

All in all you earned a total of Rs 1087 - Rs 1070 = Rs 8500

It can also be a loss if you reliance goes down . Futures trading is risky compared and at certain level it may erode your capital , it is always better to have stop loss while trading in futures. 

Must Read : What is POA in Demat & Online Trading

How is Margin Calculated in Futures ?

When you trade in futures market, Stock Broker collects upfront margin from you which includes Initial Margin (Span Margin) & Exposure Margin.
Everyday stock broker has to inform the exchange about margin collected from each and every client, in case of margin shortfall, penalty is levied to broker which in turns levy to you in case of shortfall.

You can adjust your stocks against your margin lying with the broker beneficiary account or in your POA account but only those scrips which are Liquid and approved by Stock Exchange after haircut i.e Var Margin

According to NSE, Exposure margin is not compulsory to collect in Equity Derivatives Segment but it is compulsory to collect in Equity Currency Segment.

As i mentioned earlier there are two types of margin in futures i.e Initial Margin & Exposure Margin 

Initial Margin is the span margin computed by exchange and it comes around to 7.1% of the overall value of the contract 
In our above example of Reliance Sep Future , If you had to buy or sell a future then you have to deposit an upfront margin of Rs 1070 X 500 = 37985 
Exposure Margin is published by NSE in circular section.

Must read : Types of Orders in Trading Engine

In our example we shall assume exposure margin of 5% for Reliance Sep Future i.e Rs 26750

In addition to Rs 37985 you will have to deposit Rs 26750 to buy or sell 1 lot of future. The whole purpose for margin is to collect enough money from you to absorb the capital loss in case if reliance has to go down by 10% 

Margin also work in the manner of MTM discussed earlier , A new margin is debited daily and previous margin is credit in your account resulting in difference of margin entry in your ledger 

I hope i am able to explain you in layman's term,In case if you have any doubt or want any kind of clarifications do let me know in comment section, i would be happy to assist you.

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