Transcript Basis - PSG INSTITUTE OF MANAGEMENT

Basis
• Short hedge-Spot 1 : Rs 100
Spot 2: 85 Futures 1: Rs102 Futures 2:Rs87
When basis strengthens –Gain ?
When basis weakens –Loss?
• Long hedge –Spot 1:Rs.200 Futures 1Rs.203 Spot 2:Rs.240 Futures2:Rs243
• Why spot price= future price @ expiry?
Arbitrage opportunity
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Contract specifications –stock
futures
• -Nov,2001
• Contract-underlying securities /S&P CNX
Nifty
• Exchange-NSE
• Security descriptor –N FUTSTK
• Contract size-as specified by exchangeRs.2 lakh
• Price steps-.05* respective lot size
• Trading cycle-three month trading cycle
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Contract specifications –stock futures
• Near month(one); next month(two); far
month(three)-New contract will be introduced
on next trading day following the expiry of
near month contract
• Expiry day-last Thursday of the expiry
month/previous trading day if the last
Thursday is a trading holiday
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Open interest and Settlement price
• Open interest:-Outstanding positions in the
contract at that point of time and Liquidity of
the contract . Next video
Closing out position –easier at when open interest
is high and vice versa
Settlement price:-average of the prices at which
the contract is traded-NSE: average price of Last
half an hour and when trade is not taking place
–theoretical price will be taken to consideration
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Price
Volume
Rising
Open Interest
Open
Interest
Market
Change in market
Up
Up
Strong BullishStrong
New money
entering into the
market
Rising
Down
Down
Bearish-Weak
Money leaving
the market
Declining
Up
Up
Weak Bearish
Aggressive new
short selling
Declining
Down
Down
Bullish-Strong
Seller will
liquidate his
positions causing
an end to
downward trend
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key advantages &Major types
• Key advantages
• Highly liquid market-easy to open and close
position
• Gearing-buying large exposure with the help
of 10% of the total exposure
• Long futures –buying futures –Bullish
• Short futures –selling futures –Bearish
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Features Geared instruments
• Facilitates to buy the large exposure with
small outlay is known gearing process
• Futures to trade without owning stocks
• Futures are used as hedging instruments
• Futures for portfolio adjustments
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Gearing process –example
• Share A is currently priced Rs.100 and the
December future on that share is priced at
Rs.102
• A few days later the share price has risen to
Rs.110 and the future has risen to Rs.112
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Futures-Features
Futures to trade without stocks
• Moving out of the existing
futures by entering into
counter positions
Futures-Pairs(Spread) trading
• To take position on relative
performance of two shares
–pairs trading
• Studying the movement of
prices of two stocks –
entering into the futures
Determiining the net gains
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Futures –Pairs Trading
Share A
Rs
Share B Rs
Share
price
600
400
Future
price
675
450
Price
after
Share A
Rs
Share B
Rs
Share
price
540
340
Future
price
546
344
• Investor thinks that A will outperform the B
stock over the next few months . He buys 2
futures of A and sells 3 futures of B (1000
shares)
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Port folio adjustments
• Assume investor
holds 10,000 shares
of A . B is considered
as outperforming
stock over the A
stock. (futures-1000)
• He sells 10 futures of
A and buys 13
futures B
price
A
B
Share 320
250
future 325
254
Price
B
A
2months
Share 336
275
Futur 338
e
277
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Maintenance margin
• Maintenance Margin – to support the daily settlement
process “mark to market”-losses already are collected
• Initial margin- to safeguard against potential losses on
outstanding positions.
• Maintenance margin-75-80% of initial margin – adequate
cash resources should be deposited –transactions will be with
held- to maintain the margin shorting is done and profits are
realised and set the balances in the margin deposit and the
remaining are withdrawn by the investor
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Marking to market
• - to evade credit risk – margin is maintained by
the exchange- from the players- to overcome
counterparty risk.
• -Contract is marked to its present market value.
• On every day- contract is marked to market
• Trader vs Exchange
• If trader earns profit- exchange is liable-profit
will be credited
• Unless otherwise vice versa
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Variation margin
• To restore the initial margin- through margin call from
the exchange
Exercise
On November 15, the spot price for Telco is Rs.473 per
share , Mr. X buys 15 contracts of Jan Telco futures of
Rs.491.Assume that initial margin is Rs.800 per contract
and the maintenance margin is Rs.600 per contract
.Given the each contract 50 shares .Daily settlement of
prices are given
Nove15 Rs.496;Nove16 Rs.503; Nove 17 Rs.488; Nove 18
Rs.485; Nov19 Rs.491
November16th Mr.X withdraws the profit from the
maximum allowed on Nov16 and half the maximum
amount allowed
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Arbitrage – Pricing of futures
Borrow money to buy• Borrowing Rs 100
shares
• Buying of shares
Buy shares
Rs.100
Sell futures contract =Interest rate Rs.6
to the shares bought Dividends Rs.2
Hold shares and receive
dividends
Deliver shares in
fulfillment of futures
contract
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Arbitrage – Pricing of futures-cash and
carry
Borrow money to buy shares
+ Rs100
Buy shares
- Rs.100
Payment of Interest
-Rs.6
Receipt of Dividends
+Rs.2
Sell futures
+Rs 104
Repayment of loan
-Rs100
Pay off
Zero
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Pricing of futures
•
•
•
•
•
•
Cost of carry=?????
Fair value=?????
When will be the risk less profit –sell futures ?
Premium=?
Components of premium=?
Early future contract slides…
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Pricing of futures-Reverse cash and
carry
1
Sellsharees
Sell shares
+Rs100
2
lend proceeds from
sale and receive
interest
Deposit of funds
-Rs.100
Receive interest (net)
+Rs.4
Buy futures equivalent
to the shares sold
Surrender dividends
-Rs.2
Return of loan/Deposit
+Rs.100
Buy futures
-Rs102
Profit/Loss
Zero
3
4
5
Wait until the delivery
date
Receive shares through
transaction
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Currency futures –Introduction to
currency market
• Type of currencies –Base and counter
currencies
• USD-INR
• GBP-INR
• Japanese yen –USD
• First currency – Base currency
• Second currency – Counter /terms /qoute
currency
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Exchange rate regimes
Exchange
Rate
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Fixed
Floating
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Fixed and Floating exchange rates
• Govt action towards
buying and selling of
domestic currency-in
open market
• Buying at value is
coming down
• Selling at value is going
up
• Self correcting
mechanism
• Demand and supply of
the currency
• Demand for currency is
low-import is costlier
and export is cheaper
• When exportspayment leads to
appreciation of
domestic currency
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Factors –Exchange rates
• Fundamental factors : inflation, BOP,
unemployment , capacity utilisation ,
trends in import and exports-BOP surplusFavourable exchange rate and vice versa
• Technical factors : Interest rates ,Inflation
rate and Exchange rate policy
• Political factors
• Speculation-over valuation
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Important reasons for Rupee
Depreciation
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Quotes
• Direct quote : in the expression of USD ;1USD
=INR 45.000
• Indirect quote : in the expression of terms
currency ; 1INR=.021 USD
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Tick size
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NSE tick size :.0025
Value of one on each contract =Rs 2.5
Example 4 ticks improvement and 5 contracts
Bid price – willing of the buyer to pay
Ask price- willing of the price to sell
Spread
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Highlight –Forex Futures Contract
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Currency Future-Contract cycle
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Contract specification
• Last trading day :Two working days prior to
final settelment
• Settlement :Cash settlement
• Final settlement price: The reference rate
fixed by RBI two working days prior to the final
settlement date will be used for final
settlement .
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RBI Reference rate
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Currency futures contract trading
process
Trader
Buyer
Trader
seller
Member
Member
Broker
Broker
Clearing house
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Pricing of futures contract-interest rate
parity
• A theory in which the interest rate differential between two
countries is equal to the differential between the forward
exchange rate and the spot exchange rate. Interest rate parity
plays an essential role in foreign exchange markets,
connecting interest rates, spot exchange rates and foreign
exchange
rates.
F/S= (1+Rh)/(1+Rf)
• F=S *e(rh-rf)*r
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Example problems
• Assume on March10,2002 annual interest
rate was 10% p.a on indian rupees and US
dollar was 7% per annum . The spot Re/$
exchange rate was 44 using the above futures
,calculate the theoretical futures price on one
year forward exchange rate
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