Thursday, 28 January 2016

Futures Trading Terminologies

What is Future? What is Nifty Futures ?

These questions 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. 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 and broker registered in stock exchange.

So Index of National Stock Exchange 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

Futures terminologies: Let us understand various terms in the futures market with the help of quotes on Nifty futures from NSE:

Quotes given on the NSE website for Nifty futures as on Jan 27, 2016

1. Instrument type: Future Index
2. Underlying asset: Nifty
3. Expiry date: Jan 28, 2016
4. Open price (in Rs.) : 7434
5. High price (in Rs.) : 7473
6. Low price (in Rs.) : 7415
7. Closing price (in Rs.) : 7433.40
8. Last Traded price (in Rs.) : 7433.40
9. No of contracts traded : 209277
10. Turnover in lakhs : 1167730.60
11. Underlying value (in Rs.) : 7,437.75
12. Open Interest: 12,215,625

Spot Price: The price at which an asset trades in the cash market. This is the underlying value of Nifty on Jan 27, 2016 which is 7,437.75

Futures Price: The price of the futures contract in the futures market. The closing price of Nifty in futures trading is Rs. 7433.40. Thus Rs. 7433.40 is the future price of Nifty, on a closing basis.

Contract Cycle: It is a period over which a contract trades. On Jan 27, 2016, the maximum number of index futures contracts is of 3 months contract cycle- the near month (Jan 2016), the next month (Feb 2016) and the far month (March 2016). Every futures contract expires on last Thursday of respective month (in this case Jan 28, 2016). And, a new contract (in this example - April 2016) is introduced on the trading day following the expiry day of the near month contract (in this example – on Jan 29, 2016).

Expiration Day: The day on which a derivative contract ceases to exist. It is last trading day of the contract. The expiry date in the quotes given is Jan 28, 2016. It is the last Thursday of the expiry month. If the last Thursday is a trading holiday, the contracts expire on the previous trading day. On expiry date, all the contracts are compulsorily settled. If a contract is to be continued then it must be rolled to the near future contract. For a long position, this means selling the expiring contract and buying the next contract. Both the sides of a roll over should be executed at the same time. Currently, all equity derivatives contracts (both on indices and individual stocks) on NSE are cash settled whereas on BSE, derivative contracts on indices are cash settled while the contracts on individual stocks are delivery settled.

Tick Size: It is minimum move allowed in the price quotations. Exchanges decide the tick sizes on traded contracts as part of contract specification. Tick size for Nifty futures is 5 paisa. Bid price is the price buyer is willing to pay and ask price is the price seller is willing to sell.

Contract Size and contract value: Futures contracts are traded in lots and to arrive at the contract value we have to multiply the price with contract multiplier or lot size or contract size. For Nifty 50, lot size is 75 . For individual stocks, it varies from one stock to another. The lot size changes from time to time. In the Nifty quotes given above, contract value would be equal to Nifty Futures Price * Lot Size = 7433.40 * 75 = Rs. 5,57,505. Recently NSE has introduced minimum contract size as Rs 5 Lakhs for any contracts

Basis: The difference between the spot price and the futures price is called basis. If the futures price is greater than spot price, basis for the asset is negative. Similarly, if the spot price is greater than futures price, basis for the asset is positive. On Jan 27, 2016, spot price > future price thus basis for nifty futures is positive i.e. (7,437.75-7433.40 = Rs. 4.35).

Importantly, basis for one-month contract would be different from the basis for two or three month contracts. Therefore, definition of basis is incomplete until we define the basis vis-a-vis a futures contract i.e. basis for one month contract, two months contract etc. It is also important to understand that the basis difference between say one month and two months futures contract should essentially be equal to the cost of carrying the underlying asset between first and second month. Indeed, this is the fundamental of linking various futures and underlying cash market prices together.

During the life of the contract, the basis may become negative or positive, as there is a movement in the futures price and spot price. Further, whatever the basis is, positive or negative, it turns to zero at maturity of the futures contract i.e. there should not be any difference between futures price and spot price at the time of maturity/ expiry of contract. This happens because final settlement of futures contracts on last trading day takes place at the closing price of the underlying asset.

Cost of Carry Cost of Carry is the relationship between futures prices and spot prices. It measures the storage cost (in commodity markets) plus the interest that is paid to finance or ‘carry’ the asset till delivery less the income earned on the asset during the holding period. For equity derivatives, carrying cost is the interest paid to finance the purchase less (minus) dividend earned.

For example, assume the share of ABC Ltd is trading at Rs. 100 in the cash market. A person wishes to buy the share, but does not have money. In that case he would have to borrow Rs. 100 at the rate of, say, 6% per annum. Suppose that he holds this share for one year and in that year he expects the company to give 200% dividend on its face value of Rs. 1 i.e. dividend of Rs. 2. Thus his net cost of carry = Interest paid – dividend received = 6 – 2 = Rs. 4. Therefore, break even futures price for him should be Rs.104.
It is important to note that cost of carry will be different for different participants.

Margin Account As exchange guarantees the settlement of all the trades, to protect itself against default by either counterparty, it charges various margins from brokers. Brokers in turn charge margins from their customers. Brief about margins is as follows:

 Initial Margin The amount one needs to deposit in the margin account at the time entering a futures contract is known as the initial margin.
Let us take an example - On Jan 27, 2016 a person decided to enter into a futures contract. He expects the market to go up so he takes a long Nifty Futures position for 25th Feb 2016 expiry. On Jan 27, 2016 Nifty closes at 7433.40.

The contract value = Nifty futures price * lot size = 7433.40 * 75 = Rs. 557,505.

Therefore, Rs 557,505 is the contract value of one Nifty Future contract expiring on Feb 2016.

Assuming according to the SPAN® calculation margin comes at around 5% of the contract value as initial margin, the person has to pay him Rs. 27,875.25 as initial margin. Both buyers and sellers pay initial margin, as there is an obligation on both the parties to honour the contract.

The initial margin is dependent on price movement of the underlying asset. As high volatility assets carry more risk, exchange would charge higher initial margin on them.

Exposure Margin: Time to Time basis exchange releases a circular for exposure margin levied on Futures Index & Futures Stock. For Index(s) exposure margin as on date 27 Jan 2016 is 3% which means, both buyers and sellers pay exposure margin over and above Initial margin. In our case it would be 557,505 *3% = 16,725.15

Mark to Market (MTM) In futures market, while contracts have maturity of several months, profits and losses are settled on day-to-day basis – called mark to market (MTM) settlement. The exchange collects these margins (MTM margins) from the loss making participants and pays to the gainers on day-to-day basis.

Let us understand MTM with the help of the example. Suppose a person bought a futures contract at the lowest price on Jan 27, 2016 at 7415. He paid an initial margin of Rs. 27,875.25 & Exposure Margin of Rs 16725.15 as calculated above. On the same day Nifty futures contract closes at 7433.40. This means that he benefits due to the 18.4 points gain on Nifty futures contract. Thus, his net gain is of Rs.  1,380 (18.4 * 75). This money will be credited to his account and next day the position will start from 7433.40.

Open Interest and Volumes Traded An open interest is the total number of contracts outstanding (yet to be settled) for an underlying asset. The quotes given above show us on Jan 27, 2016 Nifty futures have an open Interest of 12,215,625. It is important to understand that number of long futures as well as number of short futures is 12,215,625. This is because total number of long futures will always be equal to total number of short futures. Only one side of contracts is considered while calculating/ mentioning open interest. On Jan 25, 2016, the open interest in Nifty futures was 15,204,900. This means that there is a decrease of 2,989,275 in the open interest on Jan 27, 2016. The level of open interest indicates depth in the market.
Volumes traded give us an idea about the market activity with regards to specific contract over a given period – volume over a day, over a week or month or over entire life of the contract.

Contract Specifications Contract specifications include the salient features of a derivative contract like contract maturity, contract multiplier also referred to as lot size, contract size, tick size etc. An example contract specification is given below: NSE’s Nifty 50 Index Futures Contracts

Underlying index
Contract Multiplier (Lot size)
Tick size or minimum price difference
0.05 index point (i.e., Re 0.05 or 5 paise)
Last trading day/ Expiration day
Last Thursday of the expiration month. If it happens to be a holiday, the contract will expire on the previous business day.
Contract months
3 contracts of 1, 2 and 3 month’s maturity. At the expiry of the nearest month contract, a new contract with 3 months maturity will start. Thus, at any point of time, there will be 3 contracts available for trading.
Daily settlement price
Settlement price of the respective futures contract.
Final settlement price
Settlement price of the cash index on the expiry date of the futures contract.

Tuesday, 19 January 2016

Types of Orders in Stock Market

Market Order vs Limit Order vs Stop Loss Order 

Market Orders
A market order allows you buy or sell a stock at the prevailing market price. When you place an order during normal market hours (9:15 AM to 3.30 PM), a market order typically executes within seconds. There are certain brokers in India who allows After Market Order, When you place a aftermarket order during non-market hours, Trading System automatically moves the trade when market opens, so the order executes as soon as possible.

Market Order 

Limit Orders
A limit order allows you to specify the maximum amount you are willing to pay for a security (when you buy) or the minimum amount you are willing receive for a security (when you sell).

  • Buy Limit Orders: Let's say you want to buy NIFTY Jan Future for Rs 7420.00 or less and the current market price is Rs 7435. You can enter a limit price at Rs 7420, and trading system will only NIFTY Futures if it trades at Rs 7420 or less. If NIfty Futures trades above the limit price, the buy order will not execute. Typically, the limit price for a buy order is placed at or below the current Ask price

Buy-Limit-OrderSimply speaking you want to buy at a lower price than market price and only and if there is a seller at your price , order will get executed else it won’t

  • Sell Limit Orders: Let's say you want to sell NIFTY Futures at 7450 and Nifty is trading at 7435, in this case you can enter a limit price at Rs 7450, and trading engine will only sell the futures if it trades at 7450 or more. If the security trades below the limit price, the sell order will not execute. Typically, the limit price for a sell order is placed at or above the current Bid price.

Stop-Loss Orders

A stop-loss order can help you limit your losses. If the market price reaches or crosses through the Stop price, your order is sent to the exchange as a market order.
  • Sell Stop-Loss: When you place a Sell Stop-Loss order, you create a "floor" for your position. Let's say you have bought Nifty Futures 1 Lot at Rs 7500 and you'd like to sell i.e (Target Price) at Rs 7550 or book loss if the price reaches Rs 7450.00. You can place a Stop-Loss order and enter a Stop Price of Rs 7550 & Rs 7450 respectively for Target Price & Stop Loss. If NIFTY reaches Rs 7550 or 7450 , the order triggers and becomes a market order. You'll get the current price available for the security under the prevailing market conditions.           *Remember you have to manually remove other stop loss order if anyone of them is executed
Sell Stop Loss Order
To clarify further below image is an example for Nifty Futures 
  • Buy Stop-Loss: When you place a Buy Stop-Loss order, you create a "ceiling" for your position. Let's say you shorted a Nifty Futures 1 Lot at Rs 7500. You'd like to buy i.e (Target Price) at Rs 7450 or book loss if the price reaches Rs 7550.00. You can place a Stop-Loss order and enter a Stop Price of Rs 7540 & Rs 7550 respectively for Target Price & Stop Loss. If the contract price reaches 7450 or 7550, the order triggers and becomes a market order. You'll get the current price available for the security under the prevailing market conditions.
To clarify further below image is an example for Nifty Futures

Buy Stop Loss Order

  • Sell Orders: The Stop Price must be entered at least 0.05 below the current Bid Price in Indian Market 
  • Buy Orders: The Stop Price must be entered at least 0.05 above the current Ask Price in Indian Market 

Problem with Stop Loss Order , Please check the below example 

You Bought Nifty Futures at Rs 7500 – Margin Levied Rs 50000/-

You Put a Stop Loss Order for Profit booking at Rs 7550 – Margin Levied Rs 0, 

As the Nifty Futures at this point of time haven’t reached 7550 and to safe guard yourself you are entering a Stop Loss order at Rs 7450, in this case the RMS of Trading engine would ask for another Rs 50000/- as Margin Requirement because according to RMS there would anytime remain 1 pending order of 1 Lot of Naked Position of NIFTY
This problem is eradicated in bracket order which is mentioned below 

Bracket Order

Customer places a bracket order such that the parent order (LEG1) is placed with two cover order of the same quantity, ie Book Profit trigger Order (Exit at target)(LEG2) and Loss Exit Order (LEG3).

The parent order (LEG1) is immediately send to exchange, were in book Profit trigger order (LEG2) and Loss Exit Order (LEG3) remains in the trading system  

Once the parent order (LEG1) is executed, the book Profit trigger Order (LEG2) and Loss Exit Order (LEG3) are considered for viable condition, ie the condition to check LEG2 and LEG3 touching the market rate.

Once viable condition favours, either of the cover order, ie Leg1 or Leg2 is generated and placed to exchange for squaring off the position.

Here is an example which might help you to understand how stock market bracketed orders work. If you place a buy bracketed order for 1 Lot of Nifty Futures at Rs 7500 [LEG 1],  you can then set a sell stop order at Rs 7450 [LEG 3] and a sell limit of Rs 7550 [LEG 2] in a single order. This means that for a single order you can input 3 details , Buy or Sell Price, Target Price & Stop Loss Price. In this example Nifty Lot will be purchased at Rs 7500 [LEG 1] will be sold if they drop to 7450 [LEG3]  or rise to 7550 [LEG2] . And there won’t be any pending order in exchange resulting in faster execution of error free trades 

In case if you have any doubt or clarifications please let me know in comment section

Saturday, 16 January 2016

If's and but's of Options Pricing - 1

Options Pricing – 1

Option pricing is a very popular topic for any students studying finance: it can get extremely technical and sometimes divorced from reality. Over the next two articles my aim is to provide you with the tools to understand how options are priced and what are the risks involved. Before we begin, let’s briefly recap what options are and how they work.

A call (put) option gives the holds the right but not the obligation to buy (sell) an asset at a particular price on a particular date. An example should help clarify this.
NIFTY is currently trading at 7500, and an investor buys a 3 month put option on Nifty with a strike price of 7500. This means that the investor has bought the right to sell NIFTY at RS 7500 in three months’ time. After three months if NIFTY has fallen below RS 7500 the investor will exercise the option and make a profit equal to the difference between RS 7500 and the market price. The investor's net profit will be deducted by the initial premium paid for the option.

Options generally take one of two forms: they are either European or American.

A European option allows exercise of the option only on the expiry date and an American option allows exercise at any time up to and including the expiry date.

 (Note that European and American arc just names. they have no relevance to what these options originate from. In general, it is never optimal to exercise an option prior to expiry no European and American options will usually behave in the sonic way. I will explain why this is the cast later in this tutorial.

The value of an option can be divided into two components, the intrinsic value and the time value.

The intrinsic value is equal to the difference between the strike price and the current market price. Effectively it is equal to what you would make if you were to exercise the option now. If NIFTY is trading at RS 7600 and we have a call option with a strike price of 7500 the intrinsic value of the option is 100. This is because if we exercised the option, we could buy NIFTY at RS 7500 and immediately sell at the current market price of RS 7600, making a profit of RS 100

An option will always be in one of three states and they are In the Money (ITM), At the money (ATM) and Out of the money (OTM).

An ITM option has positive intrinsic value: it is an option that if one were to exercise now one would make an immediate profit (like in the example in the previous paragraph which had a positive intrinsic value of RS 100).

An ATM option has a strike price equal to the current market price and this has no intrinsic value.
An example would be a NIFTY call option with a strike price of 7500. When the current market price is also 7500. In general, ATM options arc the most liquid.

An OTM option is one which also has no intrinsic value and the strike price is not equal to the market price.
An example would be a NIFTY call option with a strike price of 7600 and a market price at 7500

Now lets us move on to time value. The time value of the option is equal to the difference between the current option price and the intrinsic value.

 For example a NIFTY call option with a strike price of RS 7500 is trading at 20. The current market price is RS 7525.
The intrinsic value is RS 25 (7525-7500) and the time value is RS 5 (RS 25-RS 20).

The time value represents the premium that we pay for the option. As the option approaches expiry the time value component will decrease and when the option expires it will have no time value.

As you'd expect, longer dated options have a higher time value. Going back to what I said earlier about European and American options the reason that it is usually not optimal to exercise an option prior to expiry is that the investor would be giving up the time value. Because an option prior to expiry has positive time value the market price will always be higher than the intrinsic value. Therefore an investor is always better off selling the option at the market price rather than exercising it and receiving the intrinsic value.

The determinants of time value can be quite complex. Time value will depend on time to expiry, volatility, interest rates and how far OTM or ITM the option is, the options Greeks (delta, gamma, theta, vega & rho).

Friday, 15 January 2016

What is POA in Demat & Online Trading

Do you read every line of the booklet the stock broker give you to sign before opening a trading or Demat account? A very few do full reading and understanding about what are the accurate rules and clauses. We simply do sign about 20 signatures moreover give him every necessary documents. However do you make out what power is been given to him by signing the documents blindly?

When opening a trading account should one compulsorily sign a power of attorney (PoA) in favour of the stock broker? No, not necessarily. But then, it has become a common exercise in this age of on-line Trading. With the Securities Exchange Board of India introducing a set of guidelines in 2010 standardizing the norms that brokers to need to follow when obtaining PoA, the risk of the broker misusing his power is almost zero
SEBI Circular dated April 23rd 2010 and aftermath clarification about few doubts on the said circular dated Dec 30th 2010 indicates that POA is mandatory only for online accounts but not to offline accounts.

POA is only an option available and no stock broker or depository participant can deny service to you simply because you refused to execute a PoA in his favour.

What is POA ?

POA is a legal document giving legal authority to another person to operate your account as per the instruction contained in the power of attorney

Different types of POA ?
There are 2 types of POA i.e. Specific POA or Limited POA and General POA

  • General Power Of Attorney-Here the POA holder can perform all activities on behalf of the original holder. Hence, before going for such generic POA you must do take care of the after effect also. It gives more power to POA holder.

  • Specific Power Of Attorney-  The guidelines here state that the broker can use his power under PoA to only transfer securities from the client's account to meet delivery obligations (and pledging of stock for margin requirements of the client) and transfer funds from the client's bank account to meet settlement obligations (and towards fees due to the broker for using his service).

What can brokers do with the Limited Power of Attorney or Specific Power of Attorney ?

1) Securities-

Transferring of the securities for stock exchange which happen due to trade execute by client on exchanges from the similar broker.

To oath the securities in support of share broker for limited time to meet the mere requirement of trade executed by the client.

To pertain for various stuffs like Mutual Funds, rights, Public Issues, etc. based upon the client directions which also include releases.

2) Funds-

Funds transfer from client’s account in the subsequent cases.

For meeting agreement obligations and margin necessities for the trade done by the client from the stock exchange by the same share broker.

For recovering exceptional dues rising out of the client trading activities on the exchange from the similar share broker.

For meeting any other obligations of client subscription to products like offer of shares, public issues, mutual funds, etc.

For dues awaiting as charges or a fee to maintain DP account and trading account.

What Brokers Cannot do with your POA ?

1) To transfer securities intended for off market trading but for other parties mentioned in the POA.

2) Transferring of funds from the client’s account for the trade done by client from another share broker.

3) To open a trading account along with any stock broker.

4) Execute trades without client consent.

5) Barring issue of release instruction slips to helpful owners.

6) Barring clients from the working account.

7) Merging balance from other accounts for nullifying debit in other account.

8) To create an email account in aid of the client for receiving statutory transactions.

9) To renouncing from liability rising out of directions provided by share broker to obstruct the client’s bank’s account.

Thus it is essential to keep an eye on the stock broker if one has given POA to the broker to operate Demat Account.

Wednesday, 13 January 2016

Pros and Cons of Futures Trading

Advantages and Disadvantages of Futures Trading

 Futures trading is amongst today's most highly leveraged, potentially profitable financial pursuits. It allows traders to build up their trading accounts fast with only a small amount of capital at their disposal. However, if you take futures trading lightly, you could also wipe out your trading account in a matter of days. Therefore, it's crucial to your trading success that you diligently educate yourself in futures trading, and trade only with a proven and solid trading strategy.
If you're new to futures trading, it can be especially difficult to decide WHICH contracts to actually trade. There are a lot of options! The best approach would probably be to start with the more popular commodities, until you have a better idea of which contracts most fit you and your trading.
The more you know about the basics of futures contracts and commodities like this, the better your chances of trading success. With any type of online trading, there are a number of factors that you should take into account. Here are four of those factors, along with an assessment of how futures trading measures up:

1.) The Capital Requirements
In order to trade a futures contract, you need to deposit an initial investment into your futures trading account. Currently, brokers require a minimum of Rs 50000 to trade in NIFTY Futures.

2.) The Leverage
The leverage depends on the futures contract you're trading and the contract value. Each contract requires an initial margin. Here are some examples for the most popular contracts (as of January 2016)
On an average indian brokers allow intraday limit of 5 times so if you have an deposit of Rs 50000/- as collateral then you may trade 5 lots of Nifty
Leverage plays an important part in speculation

3.) Liquidity
Again, the liquidity depends on the futures contract you are trading. Here are some numbers:
NIFTY : around 300,000 contracts/day
RELIANCE : around 37,000 contracts/day
USDINR : around 1160000 contract/ day
As you can see, the liquidity varies, and therefore you MUST check the volume of the futures market you are planning to trade.

4.) Volatility
You will find decent volatility in the futures markets. The high leverage will allow you to make decent profits, even if the markets move just a few points. Here are some average daily moves:
NIFTY : around 17% Annual Volatility
RELIANCE : between 30% and 33% annualized volatility
Keep in mind that these moves represent approximately 50-100 points per day for each contract traded.

Futures markets can be very liquid, and the capital requirements are as low as Rs 50000. The leverage is at least 1:5 and some brokers provide leverage of 1:10, and there's decent volatility.
Futures markets are regulated and the spread is typically 1 tick (minimum movement of the contract). Commissions are usually below .02% and now a days there are Discount brokers who allow you to trade Rs 15 per trade. It's no surprise that many day traders choose the futures market for their trading endeavours.