How To Trade In Futures by Clifton DeSilva (Edit 3 Oct 2007)

The futures and options market has been a very vibrant market and the daily turnover on the futures and options market is substantially higher than that of the cash market. Since the futures and options markets became operational in India about 6-7 years back, not many people are conversant with the ways these markets operate. The scope of this article is to explain in simple terms the difference between the cash market and the futures market.

On the National Stock Exchange there are two market segments- the spot or the cash markets and the futures and options market.

The difference between the two markets is as follows. The spot or cash market is a market where you purchase shares, make full payment for the purchase and take delivery of the shares. The trading or market lot in the spot market is one share. In simple terms – the price of Indian Hotels is quoting at Rs. 125 and you are positive about the outlook of the company. You could purchase one share of Indian Hotels by paying Rs.125 and take delivery of the share. Since the shares are in demat form they will be transferred to your demat account.

On the other hand the futures market is a market where the underlying asset is the stock. In the case of Indian Hotels futures, the underlying is the stock of Indian Hotels. Unlike the spot market you do not take delivery of the shares and do not pay the full purchase price, but a small amount of 20% by way of initial margin money. In the futures market each stock has a different market lot. For e.g. the market lot for Indian Hotels is 1750 shares In the futures market every contract commences on the last Friday of the month and ends on the last Thursday of the month. You can carry forward of roll over the contract to the ensuing months till your price objective is met. For e.g. The October contract began on Friday 28th September and will end on Thursday 25th October. The November contract begins on Friday 26th October and will expire on 29h Nov. The current price of Indian Hotels is Rs. 125 and by 29th November, the expiry date of the November futures contract you expect the price to touch Rs 150. You by a November futures contract on Indian Hotels. at the current price of Rs 125. The total investment would amount to Rs. 2,18,750. (1750x125). You pay an initial margin of 20% ie Rs. 43,750. On 29th November, the price of Indian Hotels as per expectations

quotes at Rs. 150 The net result is a profit of Rs 43750 (150-125=25x1750) on an investment of Rs 43,750 in a span of a month. The return works out to 100% per month or 1200% on an annualised basis.. In case the same deal was done on the cash market, the returns would be as follows: Purchase of 1750 Indian Hotels at Rs. 125 would involve an investment of Rs. 2,18,750. The sale of 1750 Indian Hotels a month later at Rs 150 would generate sales proceeds of Rs. 2, 62,500, resulting in a profit of Rs. 43,750 but on higher investment of Rs. 218,750 as against Rs. 43,750 in the futures market. The return works out to 20% or 240% on an annualised basis. The futures market provides you with the power of leveraging. Clifton DeSilva is the Chairman & Managing Director, Altina Securities Pvt. Ltd. Member National Stock Exchange of India