Search 


 

What are Index Futures?

  • Index futures are the future contracts for which underlying is the cash market index.
  • For example: BSE may launch a future contract on "BSE Sensitive Index" and NSE may launch a future contract on "S&P CNX NIFTY".

Frequently used terms in Index Futures market

  • Contract Size - The value of the contract at a specific level of Index. It is Index level * Multiplier.
  • Multiplier - It is a pre-determined value, used to arrive at the contract size. It is the price per index point.
  • Tick Size - It is the minimum price difference between two quotes of similar nature.
  • Contract Month - The month in which the contract will expire.
  • Expiry Day - The last day on which the contract is available for trading.
  • Open interest - Total outstanding long or short positions in the market at any specific point in time. As total long positions for market would be equal to total short positions, for calculation of open Interest, only one side of the contracts is counted.
  • Volume - No. of contracts traded during a specific period of time. During a day, during a week or during a month.
  • Long position- Outstanding/unsettled purchase position at any point of time.
  • Short position - Outstanding/ unsettled sales position at any point of time.
  • Open position - Outstanding/unsettled long or short position at any point of time.
  • Physical delivery - Open position at the expiry of the contract is settled through delivery of the underlying. In futures market, delivery is low.
  • Cash settlement - Open position at the expiry of the contract is settled in cash. These contracts are designated as cash settled contracts. Index Futures fall in this category.
  • Alternative Delivery Procedure (ADP) - Open position at the expiry of the contract is settled by two parties - one buyer and one seller, at the terms other than defined by the exchange. World wide a significant portion of the energy and energy related contracts (crude oil, heating and gasoline oil) are settled through Alternative Delivery Procedure.

Concept of basis in futures market

  • Basis is defined as the difference between cash and futures prices:
    Basis = Cash prices - Future prices.
  • Basis can be either positive or negative (in Index futures, basis generally is negative).
  • Basis may change its sign several times during the life of the contract.
  • Basis turns to zero at maturity of the futures contract i.e. both cash and future prices converge at maturity

         
Life of the contract

Operators in the derivatives market

  • Hedgers - Operators, who want to transfer a risk component of their portfolio.
  • Speculators - Operators, who intentionally take the risk from hedgers in pursuit of profit.
  • Arbitrageurs - Operators who operate in the different markets simultaneously, in pursuit of profit and eliminate mis-pricing.

Pricing Futures

Cost and carry model of Futures pricing

  • Fair price = Spot price + Cost of carry - Inflows
  • FPtT = CPt + CPt * (RtT - DtT) * (T-t)/365
  • FPtT - Fair price of the asset at time t for time T.
  • CPt - Cash price of the asset.
  • RtT - Interest rate at time t for the period up to T.
  • DtT - Inflows in terms of dividend or interest between t and T.
  • Cost of carry = Financing cost, Storage cost and insurance cost.
  • If Futures price > Fair price; Buy in the cash market and simultaneously sell in the futures market.
  • If Futures price < Fair price; Sell in the cash market and simultaneously buy in the futures market.
    This arbitrage between Cash and Future markets will remain till prices in the Cash and Future markets get aligned.

Set of assumptions

  • No seasonal demand and supply in the underlying asset.
  • Storability of the underlying asset is not a problem.
  • The underlying asset can be sold short.
  • No transaction cost; No taxes.
  • No margin requirements, and so the analysis relates to a forward contract, rather than a futures contract.

    
1  2  3  4  5