Index Futures Pricing

RAVI -IBA

Index Futures
Index Futures is a contract whose
underlying asset is a stock market
index.
It is an agreement to buy or sell the
portfolio of stocks in the stock
market index with in a specified
future period at a pre-determined
rate.
The rate, thus agreed upon for the
future transaction is referred to as

 In any futures contract, the future price

depends upon the spot price, also known
as , as the cash price, of the underlying
asset and varies with changes in cash
price of the underlying asset.
In Index futures, the cash price of the
underlying asset is the value of the
underlying stock market index or the
monetary value of the stock market index.

 What is the relationship between the

futures price of an index future and the
value of the stock market index ?
F0,t = S0 (1+ C)
Where F0,t = futures price at t = 0 for
delivery at time t
S0 = spot price at t =0
C = the percentage cost of carrying the
asset from t=0 to time t

 The cost of carry model by modified as below

F0,t = S0 (1+C) = i=1,N Dt (1+ ri)
Where F0,t = index futures price at t =0 for the contract
expiring at time t
S0 = Spot price at t= 0 (stock index value at t =0)
C = percentage cost of carrying the portfolio of stocks from t
= 0 to time t
Di= the ith dividend
ri = the interest rate on investment of dividend from its time
of receipt till time t
It may be noted that Di (1+ri) represents the sum of
dividends received from stocks with interest earned on
investment of such dividends till contract maturity.

 The excess of the financing cost over

the dividend income constitutes the
net cost-of-carry.
The futures price is expected to be
equal to the spot index value plus
the net cost-of-carry.
In other words, the futures prices is
expected to be at premium to the
spot price, the premium being equal
to the net cost-of-carry.

 Futures premium may be calculated by using

the following formula.
FP = I x { (r y)/100 } * {d /365}
FP = futures premium
I = Spot price
r = annual percentage interest rate (financing
cost)
y= annual % dividend yield on the index
portfolio
d= no. of days in the funding period

Example
The current level of Nifty is 4200. There are 30 days to
maturity of the Nifty futures contract. The int. rate on
borrowings is 11.5% pa. The estimate rate of dividend
yield on the Nifty portfolio is 7.5% pa. Calculate Nifty
Futures Premium.
Solution : FP = I * { (r-y)/100}* (d/365)
=4200 * {0.1155 -0.0750)(30/365)}
= 4200 (0.04* 0.082)
=4200* 0.00328
=13.776
The Nifty futures rounded to 14. Hence Nifty futures
price should be 4214 (4200 + 14).

Example contd.
Alternatively, futures price can be calculated by
directly modifying the above formula as follows;
F0,t = S0 { 1+ (r-y) * (d/365)}
Where F0,t = Futures price at t =0 for contract
expiring at t
S0 = Spot price at t =0 (stock index value at t =0)
Applying this formula in the above example, we get
F0,t = 4200 * { 1+ (0. 0.1150 0.0750) (30/365)}
= 4200 * 1.00328 = 4213.776 rounded off to 4214

Valuation of Stock Index

Futures
A stock index traces the changes in the value of a
hypothetical portfolio of stocks. The value of a
futures contract on a stock, index may be obtained
by using the cost of carry model.
For such contracts, the spot price is the spot index
value, the carry cost represents the interest on the
value of stock underlying index, while carry return is
the value of dividends receivable between the day
of valuation and the delivery date.
Accordingly the indices are thought of as securities
that pay dividends, and the futures contract valued
accordingly.

Stock Index Futures Case 1

(example)
When the securities included in the index are not
expected to pay any dividends during the life of the
contract. Here we have,
F = S0 * ert
Where F is the value futures contract, S0 is the spot
value index, r is the continuously compounded risk-free
rate of return, and t is the time to maturity (in years).
Example: Calculate the value of a futures contract
using the following data:
Spot value of Index = 3090; Time to expiration = 76
days ; Contract multiplier = 100; Risk free return = 8%
pa;

Case 1 contd.
Spot S0 = 3090 time to expiration : 76/365
Continuously compounded rate of return =
ln(1.08) = 0.077
Accordingly , F = S0 ert
= 3090 * e(76/365) * 0.077
= 3090 * e 0.208219178 * 0.077
= 3090 * e 0.016032877
= 3090 * 1.01615 = 3139.92
The value of contract = 3139.92 * 100 =
3,13,992

Case 2

When dividend is expected to be paid

by one or more of the securities
included in index during the life of
the contract. In the event of
dividends expected to be paid on
some securities, the dividend is
discounted amount is discounted to
present value terms and then the
rule of pricing securities with known
income is applied. Thus F = (S0 I)ert

Case 2 contd.
Assume that a market capitalization weighted index
contains only three stocks A. B, C as shown below. The
current value of the index is 1056.

Calculate the price of futures contract with expiration

in 60 days on this index if it is known that 25 days
from today, Company A would pay a dividend of Rs 8
per share. Take the risk free rate of int. to be 15% pa.
Assume the lot size to be 200 shares

Case 3 Example 3

Open Interest

Open Interest