FUTURES TERMINOLOGY

Presented byAvinish Agrawal

2833

FUTURES TERMINOLOGY

SPOT PRICE

Thespot priceis the current marketpriceat which an asset is

bought or sold for immediate payment and delivery. It is
differentiated from the forwardpriceor the futuresprice, which
arepricesat which an asset can be bought or sold for delivery in
the future.
The price at which an underlying asset trades in the spot market.

FUTURES PRICE

Thepriceat which the twoparticipantsin afutures contractagree

to transact at on thesettlement date.
The price that is agreed upon at the time of the contract for the
delivery of an asset at a specific future date.

 CONTRACT CYCLE
It is the period over which a contract trades. The index
futures contracts on the NSE have one-month, two-month
and three-month expiry cycles which expire on the last
Thursday of the month. Thus a January expiration contract
expires on the last Thursday of January and a February
expiration contract ceases trading on the last Thursday of
February. On the Friday following the last Thursday, a new
contract having a three-month expiry is introduced for
trading.
EXPIRY DATE
It is the date on which the final settlement of the contract
takes place.
COST OF CARRY
Measures the storage cost plus the interest that is paid to
finance the asset less the income earned on the asset.

INITIAL MARGIN
The amount that must be deposited in the margin account
at the time a futures contract is first entered into is known
as initial margin.

MARKING TO MARKET
In the futures market, at the end of each trading day, the
margin account is adjusted to reflect the investors gain or
loss depending upon the futures closing price. This is called
marking-to-market.

MAINTENANCE MARGIN
Investors are required to place margins with their trading
members before they are allowed to trade. If the balance in
the margin account falls below the maintenance margin,
the investor receives a margin call and is expected to top
up the margin account to the initial margin level before
trading commences on the next day.

 OPEN INTEREST
Definition:Open interest is the total number of
outstanding contracts that are held by market
participants at the end of each day. Open interest
measures the total level of activity into the futures
market.
Example:-
If both parties to the trade are initiating a new
position (one new buyer and one new seller), open
interest will increase by one contract.
If both traders are closing an existing or old
position
(one old buyer and one old seller), open
interest will decline by one contract.
If one old trader passes off his position to a new
trader (one old buyer sells to one new buyer), open
interest will not change.

 FUTURES PAYOFF
Futures contracts have linear or symmetrical
payoffs. It implies that the losses as well as
profits for the buyer and the seller of a futures
contract are unlimited. These linear payoffs are
fascinating as they can be combined with options
and the underlying to generate various complex
payoffs.

VALUATION OF FUTURES CONTRACT

Afutures contractismarked to marketon a daily
basis. The value of a futures contract at the trade
date (when it is originally transacted) is zero.
In order to value this contract, it is crucial to
distinguish
between
two
methods:
valuation during the trading day before marking t
he contract to market
and
valuation during the trading day after marking it
to market
.
Assuming the mark to market process doesn't
impact its current price, the price of a generic
futures contract is equal to the price of a generic
forward contract.

 In this case, the futures price is:

p(T) = S0(1+r)T

Where:
p(T) is the futures price at time T
S0is the spot price of the underlying asset

T is a given point in time during the life of the

contract
r is interest rate during the life of the contract
The value of a futures contract will revert to zero
as soon as it is marked to market.

THANK YOU