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The futures opportunity

India is the world’s largest single stock futures market, according to an article in FT. Meaning, nowhere else in the world do people trade stock futures than in India. This is confirmed by Andy Mukherjee in an article:

Indians, more than anyone else in the world, are crazy about single-stock futures. In January, the National Stock Exchange of India traded six times as many of these derivatives as Euronext.liffe, the world’s No.2 market for contracts that oblige people to buy or sell a stock on a specified future date and price.

Single stock futures means futures on a stock, like Infosys or Reliance. Not all stocks have futures; Around 191 securities, out of the 1000 odd scrips traded daily, have futures and options that are tradeable.

What about the US? Well, options are traded there and there aren’t any stock futures listed on the Nasdaq or NYSE. In stock options they beat the living daylights out of us – they trade about 100x our volume. Index futures wise, they again are about 15x our size.

Stock futures allow you to sell a stock without having to own it. In the US, you can do that in the spot market by “borrowing” shares. In India futures is the only real way to do it. Given that futures also gives you leverage – you can buy Rs. 100 worth of futures for Rs. 10 paid today as margin – there is a good reason to buy futures (or sell them) when the odds are on your side.

It’s not an expensive trade, really. You can buy a Nifty future – lot size of 50 or multiples of it – for a margin of about Rs. 25,000 per lot. Each lot is equivalent to Rs. 200,000 or so (since the Nifty is at 4300), so effectively you get a position worth 10x your investment. You have to specify an “expiry date” – the date the future expires

That means that when the Nifty goes up 1% (40 points) you gain Rs. 2,000 – nearly 10% of your original margin. But if it goes down 1%, you lose 10% – that’s the downside of leverage. You can “cover” this by taking the opposite position in the cash market – say by buying the stock and selling the future. The differnce is usually not large enough to make huge profits, but a reasonable 1% arbitrage is possible.

Once you buy (or sell) you can square off your transaction anytime before the expiry date by doing the reverse transaction in the futures market. Or, you can wait till expiry and reap the benefit (or loss) when the exchange squares it off at the closing price on the expiry day. If you have notional losses against the current market value of your position you may be required to place the loss as additional margin money.

One thing about stock futures though – they earn no dividends so none of that upside comes to you.

  • Guruprasad says:

    In India,Stock options are not trading good. Prices of options are not reasonable and I think our exchanges need to come up with innovative way to make people to trade in options. I think best hedging for futures is to buy options thatz exactly opposite to what you’ve done in futures. As for as I’m concerned I believe that Cash won’t give perfect cushion for hedge against my action in futures market.

  • Deepak Shenoy says:

    >Guru: Someoptions are liquid but most options are illiquid. The Nifty options are fairly liquid and a lot of trading happens there.

    Second, if you buy an option you still lose money. You should sell the reverse position to effectivley hedge, which gives you a small cushion on the downside.

  • Madhab says:

    >Hi Deepak,
    I have a small doubt here..
    When you said a Nifty lot size of 50. What exactly are we buying when we buy a Nifty future lot ?
    Because when we buy futures of a single stock, if you take delivery you get the stocks.


  • Deepak Shenoy says:

    >Madhab: You don’t get delivery of stocks when you buy futures. The futures are settled in cash only (that means you get or pay the difference between your position and the market value on the expiry day)

    Nifty works exactly like stocks.