MGT-411: Lecture-III

Dr. Mohinder Singh

 Future Contract

• A future contract is a standardised agreement between the seller (short

position) of the contract and the buyer (long position), traded on a futures
exchange, to buy or sell a certain underlying instrument at a certain date in
future, at a pre-set price. The future date is called the delivery date or final
settlement date. The pre-set price is called the futures price.
• A futures contract gives the holder the right and the obligation to buy or sell.
Contrast
• Futures contracts or simply futures are exchange-traded derivatives. The
exchange acts as counterparty on all contracts, sets margin requirements, etc.
 Future Contract

• Futures are highly standardised contracts that provide for performance of

contracts through either deferred delivery of asset or final cash settlement;
– The type of settlement, either cash settlement or physical settlement

– The amount and units of the underlying asset per contract (not negotiated by the party)
– The currency in which the futures contract is quoted

– The grade of the deliverable

– The delivery month;

– The last trading date;

– Other details such as commodity tick, the minimum permissible price fluctuation
– Both buyers and sellers are required to post a performance bond called ‘margin

• Margins paid are generally marked to market-price everyday;

• Categories of Futures: Contracts Financial and Commodity
Forward vs Future
 Type of Future Contract

• Index Future
• Stock Future
• Currency Futures
• Commodity Futures
– Agricultural futures contracts

– Metallurgical futures contract

 Future Terminology
• Position (Long vs Short) – Short pay off (F -St )
• Price • Closing a Future
– Spot price (S), – Physical Delivery
– Future Spot price (St) – Offsetting or Reversing Trades
– Delivery Price (K) – Cash-Settled Trades
– Futures or Forward price (F) • Cost –of-carry
• Contract cycle – Financing cost –dividend (+storage
– T= term cost)
– t = Expiry date
• Future Price Quotations
• Contract size or lot size (Q) – Open, high, low, settlement, change,
• Margin Highest and lowest, open interest, no.
– Initial, Maintenance Margin of contract, total open interest
– Daily Settlement & Marking-to-market
– Clearing Margin
• Basis (futures minus the spot price)
• Fungibility
• Pay –off
– Long pay off (St –F)
Delivery Period & F and St Price
The typical pattern of open interest over time
(Start with zero and end up with zero)
Understanding Future Leverage
Particular Spot Market Futures Markets
Capital Available Rs.100,000/- Rs.100,000/-
By Date 15th Dec 2020 15th Dec 2020
Buy Price Rs.2362 per share Rs.2362 per share
Qty 100,000 / 2362 = 42 shares Depends on Lot size
Lot Size Not Applicable 125
Margin Not Applicable 14%
Contract value per lot Not Applicable 125 * 2362 = 295,250/-
Margin Deposit per lot Not Applicable 14% * 295,250 = 41,335/-
How many lots can be bought Not Applicable 100,000/41,335= 2.4 or 2 Lots
Margin Deposit Not Applicable 41,335 * 2 = 82,670/-
No of shares bought 42 (as calculated above) 125 * 2 = 250
Buy Value (Contract Value) 42 * 2362 = 100,000/- 2 * 125 * 2362 = 590,500/-
Sell Date 23rd Dec 2020 23rd Dec 2020
No of days trade was live 9 days 9 days
Sell Price Rs.2519/- per share Rs.2519/- per share
Sell Value 42 * 2519 = 105,798 250 * 2519 = 629,750/-
Profit earned 105798 – 100000 = Rs.5798/- 629750 – 590500 = Rs.39,250/-
Absolute Return for 9 days 5798 / 100,000 = 5.79 % 39250 / 82670 = 47%
% Return annualized 235% 1925%
 Pricing Future Contract

• Cost-of-Carry Model (rests on the idea of arbitrage) or Carrying charge

theory of futures prices
– Futures prices depend on the cash price of a commodity and the expected cost of storing the
underlying good from the present to the delivery date of the futures contract.
– Carrying charges fall into four basic categories: storage costs, insurance costs, transportation
costs, and financing costs.