While we are discussing the Future Contracts, it is important to understand that the Future Contracts as the name suggests – are for future date and time. However, the futures price mimics the cash price of the stock, commonly known as the spot price. Before we get into those details, let’s first get into the few of the important aspects related to the Futures.
Lot Size – as we had mentioned earlier, the Futures Contracts are standardised and hence there is a lot size pre-decided for all shares. Lot size means, when you purchase a particular Futures contract, there is a minimum quantity you have to transact. Lot size varies from one company to another. Even in the case of other asset classes like commodities and precious metals, there is a predetermined lot size. Like For Index Futures the lot size of Nifty-50 is 50 units and for Bank Nifty it is 25 units.
Contract Value – Contract Value in Simple words is the Current Market Price (CMP) of the sock multiplied by the lot size. Like for Nifty 50 the CMP is 18400 and as the lot size is 50 the contract value would be Rs 9,20,000 (18400*50 units). However, we need not pay the amount in full as the buyers only need to pay the premium part for the trade.
Expiry – As in the table showing the lot size for the companies, there are three months shown in the List viz October, November and December. The months are expiry months for different contracts. Future Contracts expire every month and in Equity markets – it is the Last Thursday (trading Day) of every month. If last Thursday is a Holiday, the expiry happens one day before. At one time three months contracts are available – Current month, Near Month, and Far Month. As of current we are in October 2021, hence October 2021 is the Current Month, November 2021 is the Near Month and December 2021 is the far month.
We only need to pay a margin amount which would be around 15-20 percent of the contract value. Like at current levels the Normal Margin rate 18.50 percent and hence one only needs to pay the 18.50 percent of the contract value.
One needs to understand that the Spot Price of the stock would differ from the Future Price of the stock. The reason being, with expiry occurring after few weeks, there is interest Cost Added and even the time value of money. Like If the Spot Price of Reliance is trading at Rs 2710, the October Future would be Trading at Rs 2720, and November Future would trade at Rs 2730 approximately. The difference between the spot price and Future price is called Premium or discount.
If the Future price is higher than Spot price it is called a premium and when the future price is lower than the Spot price, it is considered to be trading at discount. Discount may happen on various reasons like Dividend amount payable in Future, any other corporate announcement like bonus or rights etc.
Understanding the Future Contracts in Detail
As we mentioned that the Futures Contracts are open for next three months, naturally it is executed in future and hence as per expectations of Cash price (Spot price) or underlying in the Future one would take exposure to an Index or a stock Future. Like, some one expects that (based on the research and analysis) expects the share price of Reliance Industries to move upwards in coming months. Now he has got two choices, for the same. Like first is to buy cash Shares of Reliance Industries or he can buy a Futures Contract of the same for the Current month contract or near month contract.
Now at current levels, Reliance Industries is trading at Rs 2710 and the lot size of the future contract for Reliance is 250 units. (Rs 2710*250 units)
Now if he wants to buy 250 shares of Reliance in the Cash market he needs to pay Rs 2710 * 250 units. He would have to pay Rs 6.78 lakh for the same. However, if purchases one Lot for the current Month (October 2021), he can purchase the same for Rs 1.52 lakh. As only margin is paid, one can get leverage by buying Futures contracts. However, as Future Contract is expiring after a few days the value of Future is marginally higher than the spot price of the underlying. With the interest cost or the time value of money added to it, October 28, 2021, Expiry Future would be trading in between Rs 2715-2720.
Now, what would be the outcome of the above position taken in the market by you?
Again there are going to be three outcomes (payouts) when the Future Contract comes to expiry.
Scenario 1 – Price Moves Up As Expected
First is, as per expectations the share price of RIL increases to and moves to Rs 2750. Let’s check what would be the outcome for the Buyer of the Future Contact.
Here we have purchased the October 28, 2021 Contract of Reliance Industries at Rs 2715 and we paid the margin amount of Rs 1.52 lakh. Now the Price of stock has moved up and is trading at Rs 2750. Our profit would be Rs 35 (Rs 2750-Rs 2715) per Share. As we book profit on the date of expiry, the profit would be Rs 35*250 units. Rs 8750 will be the profit made here. The amount would be cash-settled and the buyer would make a profit of Rs 8750 on the invested amount of Rs 1.52 lakh.
Scenario 2- Price Moves Downward
As we have purchased the Future at Rs 2715, now contrary to our research and expectations the Stock price moves down to Rs 2680. In this case the buyer would be making losses and it would be calculated as follows.
Purchase Price – Rs 2175 and Expiry Price – Rs 2680. Here the loss per unit is Rs 35 and hence with a lot size of 250 units the total loss would be Rs 8750.
Scenario 3 – No Change in Price
If the price remains the same on the expiry date, it would be no profit no loss for the investment.