FUTURES CONTRACT AND MARGIN MANAGEMENT IN DERIVATIVES MARKET
This topic completely a knowledge sharing on Future contracts and Margin Management in the derivatives market.
We had already discussed the basics of derivatives, most people have a lot of confusion about future terminologies and different type of margin levied by an exchange. Let us simplify one by one.
No need to get into the complex definition of all terminologies related to future market but we need to understand the basic terms before getting into the trading.
Let us understand the various terms in the future market with the help of quotes on Nifty Futures from NSE.
Quotes are given on the NSE website for Nifty futures as on August 14, 2020
It is an underlying value of Nifty, simply cash market price.
The price of the futures contract traded in the future market.
The closing price of nifty future is 11,186 on a closing basis.
It is a period over which a contract trade.
The maximum number of index futures contracts is three-month contract cycle- the near month, the next month and the far month contracts.
Once the previous contracts expired, a new contract introduced on the next trading day of the monthly expiry.
The day on which derivative contracts cease to exist which is the last trading day of the contract.
Every future contract expires last Thursday of the respective month.
Note: On the expiry date all contracts must be settled. If someone wants to continue the contract then it must be rolled to the near future contract.
For example, assume that we hold current month nifty future contract long positions.
In this case, you must sell the current month contract and buy the next month’s contract.
Both the sides of rollover should be executed at the same time.
The minimumprice movement of the underlying asset mentioned by exchange from time to time.
The tick size for the nifty future contract is 5 paisa. Let us understand the two more terminologies
l Bid Price Buyers willing to pay
l Ask price Sellers willing to sell
CONTRACT SIZE AND CONTRACT VALUE:
Future contracts are traded in multiples of lots. An example nifty lot size is 75 and the contract value will be lot size (75) * future price (11,186)
Contract value = 8, 38, 950.
Most of us get shocked here if we want to trade in nifty future, we must have more than eight lakh cash balance in your account.
It is not possible for retail traders to take a position in future markets, always at this high price.
That’s why exchange introduces the margin system for a future contract.
Let us have a brief discussion about the margin system.
As exchange guarantees the settlement of all trades, to protect the counterparty risk, it imposes various margin from trading members. Let us have a quick view on this.
The amount one needs to deposit in the margin account at the time of entering a futures contract is known as the initial margin.
Let us take an example, on August 17, 2020 a person decided to enter a nifty future short contract.
They expect the market will fall this month. Assume that end of this month nifty close at 10800.
At the time of entering the contract, the contract value is 838950. Assuming that your brokerage charges 12% of the contract value as an initial margin.
They should pay 100674 as a margin to enter the contract.
The initial margin is dependent on the price movement of the underlying asset, in case of high volatility in the market, exchange impose additional margin.
If we don’t have an enough margin in your account broker will square off your position.
Marking to Market (MTM):
In the futures market, while contracts have different maturity.
Profit and loss of the position are settled on a daily basis called mark to market settlement.
The exchange collects MTM margins from loss-making traders and pays to the gainers on daily basis.
Open interest and Volume Traded:
Open interest is the total number of outstanding contracts traded in the particular underlying asset.
It is important to understand, long futures contracts will always equal to a short futures contracts.
The level of open interest shows market depth.
Volume traded indicates overall market activity with regards to specific contracts over a period of time.
· After reading this content, most of us excited about the future market, you may think about if nifty future move one rupee.
· I will make 75 Rs as profit, always remember if market reverse you end up with huge losses.
· It’s a high risk high reward market.
· In a volatile market, margins are heavily imposed by the exchange to control the volatility.
· If you want to trade in future market you have to maintain the excess cash in your account to manage the extreme situation.
· Futures are traded in multiple of lots, before taking a trade to understand these terminologies very carefully.