Module 03

Futures and
Options
 Introduction – Futures
 Indirect contracts
 Exchange traded contracts
 Highly standardized contracts
 Agreement to buy or sell a particular asset between
the parties in a specified future period at an agreed
price through stock exchange
 BSE “Futures are the exchange traded contracts to
sell or buy financial instruments or physical
commodities for future delivery at an agreed price.
There is an agreement to buy or sell a specified
quantity of financial instruments or commodities in a
designated future month at a price agreed upon by
the buyer and the seller. The contracts have certain
standardized specification”.
Features of Futures
 Indirect contracts
 Highly standardized contracts/rigid
 Deferred delivery or final cash settlement
 Contracts traded through organized stock exchanges with a
clearing house between parties
 Margin requirement - mandatory
 Margins- mark-to-market
 100% hedging is not possible
 Settlement – daily basis
 Regulated by Stock exchanges (Forwards and Futures commission)
 High liquidity
 No counter party risk
Standardization of Futures Contracts
The underlying
Type of settlement
The amount and unit of underlying asset per
contract
The currency in which the futures are quoted
The last trading date
Other details – tick size,
Participants in Futures Market
1. Hedger
2. Speculators
a) Fundamental Speculators/Fundamentalists
b) Technical Speculators/Technicians
c) Local Speculators – trades on his own name
 Scalpers – one who tries to make profit by holding positions for short
term period and bridges gap between outside orders by filling orders
that come from brokers in return for a slight price concessions
 Pit speculators – one who take bigger positions and hold them for long
term period
 Floor speculators – usually considers inter commodity price
relationships.
3.Arbitrageurs
Futures Terminology
a) Spot Price – price at which an asset trades in spot market
b) Futures Price – price at which an asset trades in futures
market
c) Contract cycle – the period in which an asset trades in futures
market (near month, next month, far month)
d) Expiry date – date at which futures contract expires
e) Contract size/ lot size – NSE – 200, BSE – 50 (Contract size =
Multiplier X Index value)
f) Long and Short Positions
g) Basis – Futures price – Spot price
h) Cost of carry – (Futures price = spot price + carry cost – carry
return)
i) Margin
j) Mark-to-market
k) Positions limit – maximum number of contracts that a
speculator may hold
Types of Futures
1. Stock Futures
 Underlying- stocks
 In India –Nov 2001
 99% cash payment – settlement
2. Currency Futures
 Exchange rate futures
 Underlying is exchange rates
 In India 2008
 Both cash settlement and physical delivery
3. Index Futures
 Underlying –indices
 Types – (stock index futures, bond index futures, cost of living
index futures)
4. Interest rate futures (short term and long term)
5. Commodity futures
Futures Contracts Specifications
Limitations of Forward Contracts
1) There is not a liquid market for forward
contracts, no secondary market. Might be hard to
match up the two parties to the transaction.
2) High default risk. No outside party
guaranteeing the transaction, like there is in the
futures market.
3) Requires actual delivery to complete the
contract.
4) No Liquidity
5) Lack of centralization of trading
 Difference between Forward and Futures
Points Forward Futures
Trading Through telephone/internet Stock exchange
Way of contract Direct Indirect

Size of contract Decided between parties Standardized by Stock exchange

Price of contract Remains fixed till maturity It changes everyday

Mark to market No Yes

Margin No Mandatory
requirement
Counter party Yes No
risks
No. of contracts No limit Fixed by exchange
in a year

Frequency of 90% of contracts are in actual 90% of contracts are in cash

delivery delivery settlement
Hedging Perfect for hedging Not perfect for hedging

Liquidity No liquidity There is liquidity

Nature of market OTC ET

Mode of delivery Decided by parties and physical Standardized by SE and cash

delivery settled

Transaction cost Based on bid-ask spread Brokering commissions

Settlement On the date of expiration Daily trading and settlement

Regulation By individual terms and conditions SE

Options