Project On Futures and Options
Project On Futures and Options
A financial contract obligating the buyer to purchase an asset (or the seller to sell an asset),
such as a physical commodity or a financial instrument, at a predetermined future date and
price. Futures contracts detail the quality and quantity of the underlying asset; they are
standardized to facilitate trading on a futures exchange. Some futures contracts may call for
physical delivery of the asset, while others are settled in cash. The futures markets are
characterized by the ability to use very high leverage relative to stock markets.
Futures can be used either to hedge or to speculate on the price movement of the underlying
asset. For example, a producer of corn could use futures to lock in a certain price and reduce
risk (hedge). On the other hand, anybody could speculate on the price movement of corn by
going long or short using futures.
Futures
An agreement to buy and sell an asset at a certain date at a certain price. For example,
Investor A may make a contract with Farmer B in which A agrees to buy a certain number of
bushels of B's corn at $15 per bushel. This contract must be honored whether the priceof corn
goes to $1 or $100 per bushel. Futures contracts can help reduce volatility in certain markets,
but they contain the risks inherent to all speculative investing. These contracts may be sold
on the secondary market, but the person holding the contract at its end must take delivery of
the underlying asset.
range of dates. Forward contracts, on the other hand, only possess one settlement date.
Lastly, because futures contracts are quite frequently employed by speculators, who bet
on the direction in which an asset's price will move, they are usually closed out prior to
maturity and delivery usually never happens. On the other hand, forward contracts are mostly
used by hedgers that want to eliminate the volatility of an asset's price, and delivery of the
asset or cash settlement will usually take place.
1.
a price for that particular commodity which fairly represents its value in light of the
news story which just broke. They may have a lot of information or very little
information to make this determination. They may be able to look at the spread
between different months or this may be of no use to them. Whatever the case, they
must determine a price which fairly represents the value of that contract(s) given the
new circumstances.
Currency Futures
What Does Currency Futures Mean?
A transferable futures contract that specifies the price at which a specified currency can be
bought or sold at a future date.
Rupee
The Indian economy has been expanding rapidly over the last twenty years,
and innovations in its capital markets and financial instruments have
accelerated at a similar pace. Now independent traders, large financial
institutions, trading companies, importers, exporters, and commercial hedgers
have a fully functioning system for buying and selling Indian Rupees all over
the world. Learn the steps that can be taken to successfully trade currency
futures in India.
Step 1
Understand the Indian currency futures market. The market is primarily
focused on the exchange rate relationship between the US Dollar and
Indian Rupee. Unlike spot foreign exchange, in which one currency is
bought against the sale of the other, Indian currency futures allow
traders to bet on the anticipated direction of one currency without short
selling the other. Indian currency futures are traded domestically on the
National Stock Exchange, in Mumbai, and internationally on Dubai
Gold and Commodities Exchange, based in Dubai.
Step 2
Open a brokerage account . You could either open an Indian futures
brokerage account, with an outfit like JV Capital Services, or open an
account with a US or international broker who offers you access to the
Indian marketplace. Interactive Brokers is one of the few US-based
brokers with an entire division devoted to Indian stock and futures
Step 3
Study and follow the fundamental factors that affect the price of the
Indian Rupee in relation to the US Dollar and other international
currencies. The primary drivers of price change are interest rate
fluctuations, and the factors that have the greatest impact on interest
rates, such as GDP growth, inflation, trade balances, and international
money flows. Keep track of factors that affect both the Rupee in
absolute terms, as well as relative to the US Dollar.
Step 4
Become acquainted with technical analysis, and use it to decide on
when to buy and sell Indian currency futures. Technical analysis is the
use of price charts and indicators to better predict what prices will be
doing in the future. It can help you better determine if the Rupee is
overvalued or undervalued relative to the Dollar, and at what price you
might consider entering a long or short position in the currency futures
market.
Step 5
Implement a comprehensive risk and money management plan. Indian
currency futures, like all futures contracts, are high risk, high reward
instruments, and if you trade without stop losses, there's a very good
chance you'll eventually get caught on the wrong side of a big move
and lose your entire account. When making a trade, always know
exactly how much you're willing to lose ahead of time, as well as at
what price you will be stopped out of the trade.
Definitions
(i) Currency Futures means a standardised foreign exchange derivative contract traded
on a recognized stock exchange to buy or sell one currency against another on a
specified future date, at a price specified on the date of contract, but does not include a
forward contract.
(ii) Currency Futures market means the market in which currency futures are traded.
Permission
(i) Currency futures are permitted in US Dollar - Indian Rupee or any other currency
pairs, as may be approved by the Reserve Bank from time to time.
(ii) Only persons resident in India may purchase or sell currency futures to hedge an
exposure to foreign exchange rate risk or otherwise.
Features of Currency Futures
Standardized currency futures shall have the following features:
a. Only USD-INR contracts are allowed to be traded.
b. The size of each contract shall be USD 1000.
c. The contracts shall be quoted and settled in Indian Rupees.
d. The maturity of the contracts shall not exceed 12 months.
e. The settlement price shall be the Reserve Banks Reference Rate on the last trading
day.
Participants
(i) No person other than 'a person resident in India' as defined in section 2(v) of the
Foreign Exchange Management Act, 1999 (Act 42 of 1999) shall participate in the
currency futures market.
(ii) Notwithstanding sub-paragraph (i), no scheduled bank or such other agency falling
under the regulatory purview of the Reserve Bank under the Reserve Bank of India Act,
1934, the Banking Regulation Act, 1949 or any other Act or instrument having the force of
law shall participate in the currency futures market without the permission from the
respective regulatory Departments of the Reserve Bank. Similarly, for participation by
other regulated entities, concurrence from their respective regulators should be
obtained.
Membership
i. The membership of the currency futures market of a recognised stock exchange shall
be separate from the membership of the equity derivative segment or the cash segment.
Membership for both trading and clearing, in the currency futures market shall be subject
to the guidelines issued by the SEBI.
ii. Banks authorized by the Reserve Bank of India under section 10 of the Foreign
Exchange Management Act, 1999 as AD Category - I bank are permitted to become
trading and clearing members of the currency futures market of the recognized stock
exchanges, on their own account and on behalf of their clients, subject to fulfilling the
following minimum prudential requirements:
a) Minimum net worth of Rs. 500 crores.
b) Minimum CRAR of 10 per cent.
c) Net NPA should not exceed 3 per cent.
d) Made net profit for last 3 years.
The AD Category - I banks which fulfill the prudential requirements should lay down
detailed guidelines with the approval of their Boards for trading and clearing of currency
futures contracts and management of risks.
(iii) AD Category - I banks which do not meet the above minimum prudential
requirements and AD Category - I banks which are Urban Co-operative banks or State
Co-operative banks can participate in the currency futures market only as clients, subject
to approval therefor from the respective regulatory Departments of the Reserve Bank.
Position Limits
i. The position limits for various classes of participants in the currency futures market
shall be subject to the guidelines issued by the SEBI.
ii. The AD Category - I banks, shall operate within prudential limits, such as Net Open
Position (NOP) and Aggregate Gap (AG) limits. The exposure of the banks, on their own
account, in the currency futures market shall form part of their NOP and AG limits.
Risk Management Measures
The trading of currency futures shall be subject to maintaining initial, extreme loss and
calendar spread margins and the Clearing Corporations / Clearing Houses of the
exchanges should ensure maintenance of such margins by the participants on the basis
of the guidelines issued by the SEBI from time to time.
Surveillance and Disclosures
The surveillance and disclosures of transactions in the currency futures market shall be
carried out in accordance with the guidelines issued by the SEBI.
Authorisation to Currency Futures Exchanges / Clearing Corporations
Recognized stock exchanges and their respective Clearing Corporations / Clearing
Houses shall not deal in or otherwise undertake the business relating to currency futures
unless they hold an authorization issued by the Reserve Bank under section 10 (1) of the
Foreign Exchange Management Act, 1999.
Powers of Reserve Bank
The Reserve Bank may from time to time modify the eligibility criteria for the participants,
modify participant-wise position limits, prescribe margins and / or impose specific
margins for identified participants, fix or modify any other prudential limits, or take such
other actions as deemed necessary in public interest, in the interest of financial stability
and orderly development and maintenance of foreign exchange market in India.
trading volume
Definition
The number of shares, bonds or contracts traded during a given period, for a security or an
entire exchange. also called volume.
Volume
What Does Volume Mean?
The number of shares or contracts traded in a security or an entire market during a given
period of time. It is simply the amount of shares that trade hands from sellers to buyers as a
measure of activity. If a buyer of a stock purchases 100 shares from a seller, then the volume
for that period increases by 100 shares based on that transaction.
A futures contract has a specified lot size. So, there could be a futures contract of 100
shares of IBM or 50 shares of Cisco Systems. You could also opt for an index. For instance,
one could opt for purchasing the E-mini S&P 500 futures contract. This gives you exposure to
all the stocks in this index.
You can trade with margin payment. This means that when you purchase a futures
contract, you do not have to pay the entire amount of the contract. You only need to pay a
specified margin amount. For instance, you could purchase a futures contract for
100 shares of IBM worth $102 per share at a 20% margin. This means that
instead of paying $10,200 (100 x $102), you need to pay only $2040 (20% of $10,200). This
offers substantial leverage to the investor.
High leverage
High liquidity
Low brokerage fees
Marking to market
Over their term and even throughout a typical trading day, futures
contracts change value. At the end of each trading day, the
exchange's clearinghouse will either credit your account with profits
or require you to add more money to bring your margin account up to
the appropriate level. This process is called daily cash settlement, or
marking to market.
Leverage magnifies
The ability to buy a futures contract with a good faith deposit or initial
margin of 10% or less of the underlying commodity's value appears
to give an investor a lot of buying power. The initial amount required
to open a futures position seems relatively small. For example, you
might buy a gold contract with the following terms:
Quantity 100 troy ounces
Delivery month February
Price in dollars per ounce $350
Minimum tick 10 cents per troy ounce, $10 per contract
For only a $3,500 initial margin, you would control a $35,000
investment in a futures contract for gold. If the price went up $50 to
$400 per ounce, the value of the futures contract would increase by
$5,000 to $40,000.
That increase represents a $1,500 paper gain on the initial margin of
$3,500. On the other hand, if the price dropped $50, the value of the
futures contract would drop $5,000 to $30,000, and you would have
to add $1,500 to your margin account to cover the loss in the
contract's value.
In a volatile market, leveraged investing magnifies the effect of price
changes.
Trading positions
There are two sides to every futures contract an investor who has a long position and an investor
with a short position. And investors in the futures market virtually always take both long and short
positions, as they buy or sell contracts to offset existing positions. So a typical investor will be a long in
some contracts and a short in others.
That's not the case in the stock market. A typical stock market investor takes a long position buying
stock to sell at a higher price at some future date. Selling short is a higher risk strategy that only a
percentage of stock investors employ, hoping to make money on stocks that are losing value. To sell
short, investors borrow shares they don't own and sell them. Then they wait for the price of the stock to
drop so they can buy the shares at the lower price to replace the borrowed shares (plus interest and
commission). The longer the price takes to drop, the higher the interest charges owed to the broker, and
the less profit possible.
In a futures contract, the short may buy an offsetting contract at any time before the expiration of the
contract term. Because the futures contract is a future obligation, nothing is borrowed and interest
penalties do not accrue.
the order. So you won't know the price you paid until the order fulfillment is reported back to you.
Contingent orders
To solve the inherent uncertainty of a market order, you may also place restrictions on how an order is to
be filled. The most common contingent order is the limit order. A limit order places a restriction on the
price at which a contract may be bought or sold sell orders will be authorized only at or above the
limit price and buy orders will be authorized only at or below the limit price. Unless otherwise
indicated, a limit order is also a day order, so that if it has not been filled by the end of the trading day, it
expires. Good-til-canceled (GTC) or open orders, on the other hand, do not expire until they are filled
or cancelled.
There is a range of other contingent orders possible. Market-if-touched (MIT) or stop orders trigger
buying or selling if substantial market volatility sends prices in a certain direction. Market-on-close
(MOC) and market-on-open (MOO) orders stipulate buying or selling at the market's open or close.
etc. These futures are also known as currency futures and are often traded just like
commodity futures though electronic platforms.
High liquidity.
An opportunity to avoid the actual transfer of financial instruments.
Investors with a high risk appetite tend to like financial futures and their potential for
short term profits.
Through commodity futures trading, it is possible for investors to make huge profits
with limited capital. Sometimes it happens even in a short period of time.
Due to its features, the commodity futures market attracts hedgers since they can
minimize their risks. The market also encourages competition among the traders who have
the market information and price judgment.
For example, if the value of the Euro were to rise in the spot currency
market but the increase was not reflected in the futures market, an
arbitrage opportunity would result as the futures price would still be
based on the weaker Euro valuation. Traders could use this information
to buy futures contracts that, in effect, were priced on stale data. By
updating futures prices with changes in the spot market, the ability to
exploit market arbitrage is greatly reduced.
The following formula is used to set the price for a contract for a given currency pair:
F = S (1 + RQ x T) (1 + RB x T)
Where:
Because contract prices are determined i.e. derived from the underlying
currencies, currency futures are considered a derivatives product. Currency futures
contracts are similar to forward rate agreements (FRAs) and can also be used for
hedging and speculation purposes. However, unlike FRAs which are agreements
between two parties with terms as agreed to by both parties, currency futures have
standard maturity dates and are offered in fixed amounts only.
MARGIN
There are two types of margin you need to know about prior to trading currency
futures. The first is initial margin this is the money you deposit in your trading
account to establish an account with your broker. If you incur losses and the amount
in your account falls below a certain threshold amount as mandated by the exchange
and your broker, you will then be required to deposit additional money this
threshold is known as maintenance or variation margin. If the balance in your account
falls below the required maintenance margin levels, your broker will notify you
through a margin call that you must bring your maintenance margin back to
compliance levels; failure to do so will result in your broker liquidating your holdings.
Buying on margin or leveraged buying allows you to submit trades for values
considerably more than the amount you have available in your account. To illustrate
the power of leveraged buying, consider a margin ratio of just 20:1 coupled with a
trading account containing $10,000. This means that you could trade amounts up to
$200,000 ($10,000 x 20) thus enabling you to secure greater profits on even small
price movements.
Of course, this can work against you as well. If you have committed all your available
cash to a trade and the value of the trade falls below your maintenance margin level,
you will receive a margin call requiring you to deposit additional margin to your
account.
For example, consider the following scenario where an investor intends to buy a
single USD / CAD currency futures contract:
USD / CAD currency futures contracts are listed in $100,000 CAD lots
One contract is currently valued at $0.9500 CAD per U.S. dollar, or
$95,000 USD
Initial margin required is 10% - therefore, you need at least $9,500
USD margin available in your account (lets assume that you have
exactly this amount available in your account)
Maintenance margin required by your broker is 7.5% - assuming that
you have no other transactions in your account, you need to maintain at
least $7,125 USD in your account in either cash or marked-to-market
value
Based on this information, if the single dollar price moves up to 0.9550 CAD per U.S.
dollar a gain of fifty pips the value of the single contract is now worth $500 more
than you paid. You can calculate this in one of two ways:
1. A single CAD pip is equal to $10 CAD per contract therefore, 50 pips x
$10 = $500, or
2. 0.0050 (fifty pips) x $100,000 CAD = $500 CAD
How about if instead of gaining fifty pips, you lose 300 pips? again, we are
assuming that you have only one order in your account:
1. 300 pips x $10 CAD = ($3,000 CAD) remember this is a loss. You can
also calculate in this manner 2. 0.0300 (300 pips) x $100,000 = ($3,000 CAD)
When your broker performs the mark-to-market evaluation and takes into account this
loss, your available margin will fall from $9,500 to $6,500 CAD. This is obviously
below the $7,125 USD threshold you are required to maintain so this will trigger a
margin call from your broker requesting you to deposit sufficient funds to bring your
account back to compliance.
Advantages
Disadvantages
The leverage effect works in both directions and, therefore, makes trading in
futures contracts highly risky.
Daily settlement of gains and losses provides for regular realization of losses,
for which reason an investor must have a sufficient reserve so that his or her
position will not be closed involuntarily.
Futures contracts involve the same risks as may be potentially involved in
other investment instruments, such as market and currency risks.