A future Contract is an agreement between two parties to BUY or SELL an underlying asset, including stocks, indices,commoditities or currency, at a certain time in the future at a certain price. Futures contracts are standardized and are traded on the exchange. To facilitate liquidity in futures contracts, the exchange defines certain standard specifications for a particular contract, including a standard underlying instrument, a standard quantity and quality of that underlying asses ( to be delivered or cash settled), and a standard timing for such a settlement. If you have taken position in equity futures, whether long or short, you have to close the position by entering in an equal and opposite transaction anytime prior to expiry of the contract as there is no delivery of the underlying assest.
The Relationship between Futures Prices and Spot Prices can be summarised in terms of what is commonly known as the COST-OF-CARRY. Typacilly, the cost-of-carry meassures the storage cost plus the interest paid to finance the asest less the income earned on the assest. However, in equity futures,there is no incidence of storage costs as in commodity futures. Moreover, equity has a dividend stream, which is a negative cost if one is long on the futures of the underlying and positive if one is short.
The Pricing of a futures contract is a simple pricess. Using the cost-of-carry logic mentioned above. one can calculate the fair value of a futures contract, The cost-of -carry model used for pricing futures is given below:
F=Se(rT) Here rT is Power
Where,F is the theoretical Futures prices,
S is the spot Price
e is 2.71828
T is the time to expiration in years and r is the cost of financial ( continuously compounded interest rate)
Suppose ABC Ltd trades in the spot market @ 1150 .the money can be invested @11% p.a. The fair value of a one-month futures cintract in ABC is calculated as follow:-
F=1150x2.718280.11x(1/12)
=1160
The above example show how to calculate the futures price when no dividend is expected.
Now we shall see how the futures price is calculated when divindends are expected. Suppose the Interest rate is 10% and the market price of ABC Ltd is Rs.140. The company will be declaring a dividend of Rs.10 after 15 Days of purchassing a two-month contract. then the Rs.10 dividend will be compounded for the remaining 45 days of the Contract.
Therefore,
F=140x2.718280.1x(60/362)-10x2.718280.1x(45/365)
=132.20
Although cost-of-carry is a critical indicator to judge the movement in the futures market, cost-of-carry in conjunction with open interest is a good indicators of the prevaoling market Sentiments.
Open-Interest is the number if contracts that are not squared off or closed(Futures) or exercised (Option-Buyers) on a particular day. For example, says Mr. R buys a futures contract, and at the end of the day, he does not squre-off his position, then the contract is considered open and the open interest is said to be one.
1. An Increase in Open-Interest with an Increase in cost-of-carry indicates accumulation of long -position, which means that the price of the underlying is likely to go up in the next few trading sessions.
2. An Increase inopen-interest witha decrease in cost-of-carry indicates addition of short positions,which means that the price of the underlying is likely to go down in the next few trading sessions.
3. Similarly, a fall in open-Interest accompanied by a rise in cost-of-carry indicates closure of short positions, which occurs when the market moves against a trader's exisiting short positon, thereby triggering his stop-loss. This means that the stock is not likely to fall and may witness upside in the next few trading sessions.
4. Likewise, a fall in both the open interest and cost-of-carry indictes closures of long positions,whcih occures when the market moves against a trader's existing long possition, thereby triggering his stop-loss.This means that the stock is not likely to observe further upsides and is likely to witness a fall in the next few trading session.
12 years ago
