Capitalmind
Capitalmind
Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
Concepts & Tutorials

Q&A: Futures Versus Cash

Suhail Kazi writes in on the derivatives post with a few questions that I thought belong in a separate post.

a) Is there a T+2 (or other) settlement period for futures similar to stocks?

No; when you buy a future you own it. The “settlement” is only at expiry, and it’s in cash – that is positions are netted out and resulting cash paid.

b) If I buy a one-month future position, then at the end of expiry (24/11) with no further action on my part, will my demat a/c increase to 500? Will I be charged the usual broking/STT charges same as if I’d bought add’l 250 shares at my strike price?

Indian stock futures are cash settled, so there is no conversion of a futures position into shares. You just get charged the difference between your buy price and the market price every day till expiry.

c) If I don’t want (b) to happen, and I don’t want to square off by selling it, how to continue (‘roll-over’ -is that the term used by traders?) the long position into the next month? I don’t see any rollover button/link anywhere on my screen.

Rollover is a process of doing two trades – exiting current month position and entering a new position for the next month. In NSE NOW (one of the software pieces that some brokers use), you can create a “spread” order which tells the exchange to take on both trades simultaneously if the difference between the prices ever comes closer than a number you specify. (Say a spread of 5, and the exchange will try to get both trades with less than 5 rupees paid as the net difference per share)

d) If I sell one lot, and I don’t sq.off, on expiry will my existing 250 shares be deducted? ~ Similarly how to avoid it if I want to continue this short position to next month without affecting my demat holding.

Again, cash settled, so your demat holding is not touched.

e) And if the answer to (d) is Yes, then: In the chart above, at several points (say peak of 2008) the difference between futures and stock pricing is so much that if I simultaneously sell a future lot and buy eqvlnt stocks I stand a guaranteed gain, no matter how the price moves after that. Essentially an arbitrage? Is that correct?

There isn’t much of an arb nowadays between cash and futures unless it’s on the other side (that is, cash is higher than futures, and you can’t take advantage because you can’t have a short position on the stock)

f) Can you add a bit about the brokerage/STT etc behind it? Is it charged daily on M2M basis or lumpsum on initial transaction, squareoff, expiry settlement or some combination? Will help if you continue with yr 1-lot ICICI example to explain it.

There is no brokerage on a daily basis, but M2M is done and cash taken out or added in. STT is one time – on the sell side. There’s a futures tutorial you can look at as well. Hope that helps!

(Thanks Suhail for writing in!)

  • Rudra Chowdhury says:

    Hi Deepak,
    I guess you can emphasize a few more aspects which will help willing investors wanting to enter F&O for the first time.
    a) Effect of leverage: Since one pays only a margin and not the whole amount, the leverage goes up and can wreck havoc on the downside as MTMs will wipe out huge chunks of money more than intended.
    b) Most first time investors do not understand the implied premium on futures price
    (T, T+1, T+2)months based on time to maturity and risk free rate. They try to do an arbitrage at the price gap when none actually exists.
    c) Lot size is a major hindrance specially for single stock futures as the liquidity remains pretty low outside of Nifty fifty. Many times the liquidity is the major reason of futures trading a premium/discount to their fair price.

  • Suhail says:

    Yo Deepak! Thx a ton mate for the answers.
    After asking, I googled around. So it seems this SEBI nod to physical settlement was never taken up by exchanges. Hmm..
    About rollovers, Duh me #facepalm! I used to think it was some fancy-schmancy xaction not for plebeians like me using online discount brokers. Proves once again to me, things are not complicated as they appear to be 🙂
    Two final Qs (sorry, can’t resist – hope you don’t mind) :
    a) Same cash-settlement holds true for options too?
    b) If I don’t square-off and allow it to expire, which price is considered to settle? Closing price of expiry day, avg of last n days, or some other auction-type price?
    c) Thx for the fish. But can you teach me fishing? Any book(s) you recommend that explains these basic transactions for Indian stk mkts? Something that includes details of SEBI/NSDL/CDSL/NSE/BSE and the relation governing them, lifeline of a stock-purchase(T+2), after-hours/pre-market, constitution and calculations of benchmark/other indices, closing prices, ticker prices, record dates, figuring out stock’s cum/ex-dividend status, how to gather these things from which websites, etcetc.
    Thanks again – that’d be all.

    • a) yes, cash settlement holds for options too.
      b) It’s always closing price of expiry day.
      c) There’s no real book for the Indian market other than Ashwani Gujral’s trading derivatives. But I’m writing one 🙂
      Cheers!

      • Suhail says:

        Hey you know, believe me, I was just thinking that if I don’t find any, this might as well be a good topic even for a moderate amateur like me to take up, research and with all kinds of self/mass-mkt-publishing (Rupa et al MRP 95) option available nowadays, make for a good foray into my own first book targeted at total newbies. At-least, I’ll have my spelling/grammar pat down for sure. Only hitch is the creeping self-doubt in ability to differentiate these dead-serious profound thoughts from day-dreaming – which usually happens only in hindsight ;-p
        I’m glad you are already taking it up. If I can be of any assistance in either researching, going through drafts, cleaning/polishing, making sure it’s accessible to a lay-reader etc- feel free to ping me. I’d love to be part of such an effort.
        ps: Did you create that Indian VC list and any update on that webinar?

  • Praveen says:

    Thanks for the post Deepak, even I had the same ques in my mind which were asked by Suhail

  • Abhijit says:

    Physical settlement does exist, BSE stock futures and options are Physically settled and not cash settled.