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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) :

SITUATION

FUTURE PRICE

GAIN/LOSS

LONG POSITION

INCREASE

PROFIT

DECREASE

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.

SITUATION

FUTURE PRICE

GAIN/LOSS

SHORT POSITION

INCREASE

LOSS

DECREASE

GAIN

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.

    SITUATION

        VALUE

FUTURE PRICE

CASH MARKET

BORROW/INVEST

AFP MORE THAN FFP

OVERVALUED

SHORT POSITION OR SELL

LONG POSITION OR BUY

BORROW

AFP LESS THAN FFP

UNDERVALUED

LONG POSITION OR BUY

SHORT POSITION OR SELL

INVEST

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 –

Sell share as per Future Contract

Rs.195

Payment to Bank with Interest ( 180 * e .12 * 6/12 )

Rs.191.312

ARBITRAGE PROFIT

3.8688

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%

Buy share as per Future Contract

Rs.7400

Amount Received from Bank with Interest (7500*e .12*6/12 )

Rs.7963.80

ARBITRAGE PROFIT

359.76

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

ARBITRATOR

Works for Profit

HEDGOR

To Reduce Loss

So it brings to the end of my Article.

Hope it would be helpful to all of you.

Thanks & Regards

Sanyam Arora




Category Students, Other Articles by - SANYAM ARORA  



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