Futures - Backlog of Finance/Stock Market (Practical Approach)

Greetings of  the day to all  the  members of  CCI  Family.

Friends my last Article was on “FUTURES – BACKLOG OF FINANCE/STOCK MARKET”

Futures - Backlog of Finance/Stock Market 

The Article covered theoretical knowledge of the various concepts used in Futures. There is a request to all the members to read my previous article before proceeding for this one.

FUTURES – BACKLOG OF FINANCE/STOCK MARKET (PRACTICAL APPROACH)

Objective –

-  The objective of this Article is to help the Students to clear the Concepts of Futures from Exam Point of View

-  To help them to solve the questions relating to Futures

Scope of Article –

- Example of Long & Short Position

-  Fair Future Price

-  Arbitrage Profit/Loss

-  Hedging

So let’s start with it :

Long & Short Position (Gain/Loss) :

EXPLANATION :

· Suppose Mr. x an Investor decides to take long Position in the market i.e. he plans to buy 100 Shares @ Rs.100 after 1 month.

· The Price of the share after 1 month turns out to be Rs.120, so in this it will be a profit for Mr. X, because the share will cost to him Rs.100 instead of Rs.120.

· So it means that he has safeguard his position I month before by entering into a Future Contract.

· But if the price turns out to be Rs.80 after I month, in this case Mr. x will suffer a loss of Rs.20, because now Mr. x will have to purchase the share @ 100 instead of Rs.80.

EXPLANATION :

· Suppose Mr. X an Investor decides to take Short Position in the market i.e. he plans to sell 100 Shares @ Rs.100 after 1 month.

· The Price of the share after 1 month turns out to be Rs.120, so in this it will be a loss for Mr. X, because now he will get Rs.100 instead of Rs.120.

· So it means that even by taking short position, Mr. x  Suffered a loss of Rs.20

· If the price of the share after I month turns out to be Rs.80, so in such case it will result in profit of Rs.20 for Mr. X, because by taking short position I month before Mr. x will get now Rs.100 instead of Rs.80.

ARBITRAGE PROFIT/LOSS :

Terms to be used in the Table:

· FAIR FUTURE PRICE (FFP) :

- It is the future price of security which can be called as “Optimum“  

- Fair means it will be equal to Break Even Point i.e. No Profit No Loss situation

- By point of View of Investors it is called as “ What the amount of security Should be in Future i.e. Fair Price of Security

· ACTUAL FUTURE PRICE (AFP) :

- It is the Actual Price of the Security as on date of settlement

- In other words it means Suppose Mr. x an Investor decides to take long Position in the market i.e. he plans to buy 100 Shares @ Rs.100 after 1 month. But the Actual Price turns out to be Rs.120 so in such case AFP = Rs.120.

EXPLANATION :

CASE-1 (AFP MORE THAN FFP)

Example :

-  FFP of a security 190 (Calculated through Formula) CMP is 180 & AFP is 195 (ROI is 12 %)

-  So it means that it is the Case-1 according to First Table

-  So in this case we will proceed accordingly  -

-  In the given case we thought that the Price of the Security (FFP) after 6 months would be 190,but in actual It turned out to be 195, So we will take short position in the Future Market i.e. we will sell the share @ 195 (Revenue for us)

-  Now in the Cash Market we will take Long Position or buy the security @ 180

-  So to buy the Security we need some money, so we will borrow from Bank Rs.180 @ 12% Rate of Interest

So Arbitrage Profit can be taken out in the following way –

CASE-2 (AFP LESS THAN FFP)

Example-

- FFP of a security Rs.7760 (Calculated through Formula) CMP is 75 & AFP is Rs.7400 (ROI is 12 %) Lot Size - 100

- So it means that it is the Case-2 according to First Table

- So in this case we will proceed accordingly  -

- In the given case we thought that the Price of the Security (FFP) after 6 months would be 7760,but in actual It turned out to be 7400, So we will take Long position in the Future Market i.e. we will buy the share @ 7400 (Cost for us)

- Now in the Cash Market we will take Short Position or sell the security @ 7500 (Assuming we already hold Share)

- So now by selling the share we have Received Rs.7500 which we will invest for 6 Months & get return @12%

HEDGING –]

· It is the process of taking an opposite position in the market in order to reduce loss caused by price difference

·  In other words we can say that the purpose of hedging is to reduce loss.

NOTE: Don’t link the concept of Arbitrator with Hedging

So it brings to the end of my Article.

Hope it would be helpful to all of you.

Thanks & Regards

Sanyam Arora