Future terminology By Rosemary David July 31 2009
· Spot price: The price at which an asset trades in the spot market.
· Futures price: The price at which the futures contract trades in the futures market.
· Contract cycle: The period over which a contract trades. The index futures contracts on the NSE have one-month, two-months and three-months 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 in capital market.
· Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist.
· Contract size: The amount of asset that has to be delivered under one contract. For instance, the contract size on NSE's futures market is 50 Nifties.
· 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. In the futures market, margin refers to the initial deposit of "good faith" made into an account in order to enter into a futures contract. This margin is referred to as good faith because it is this money that is used to debit any day-to-day losses. When you open a futures contract, the futures exchange will state a minimum amount of money that you must deposit into your account. This original deposit of money is called the initial margin. When your contract is liquidated, you will be refunded the initial margin plus or minus any gains or losses that occur over the span of the futures contract.
· Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called marking–to–market.
· Maintenance margin: This is somewhat lower than the initial margin. The initial margin is the minimum amount required to enter into a new futures contract, but the maintenance margin is the lowest amount an account can reach before needing to be replenished. For example, if your margin account drops to a certain level because of a series of daily losses, brokers are required to make a margin call and request that you make an additional deposit into your account to bring the margin back up to the initial amount. This is set to ensure that the balance in the margin account never becomes negative. 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.
Futures positions are highly leveraged because the initial margins that are set by the exchanges are relatively small compared to the cash value of the contracts in question (which is part of the reason why the futures market is useful but also very risky). The smaller the margin in relation to the cash value of the futures contract, the higher the leverage.
Example on long position: Table given below explains the mark to market margins to be paid by a member who buys one lot of December RNRL future contract at Rs. 180 per stock (Lot size = 7150) on December 10. For taking position in RNRL future contract, Member submit initial margin of 3,86,000 (23% of the contract value) and maintenance margin of 1,28,700 (10% of the contract value). The member closes the position on December 16. The mark to market profit/ loss per contract shows at he makes a total loss of Rs. 20 per stock for trading. So upon closing his position, he makes a total of Rs. 1,43,000, (i.e. 20 X 7150) on the long (purchase) position taken by him. The profit/loss made by him however gets added/ deducted from his initial margin on a daily basis.
| Particulars | Date | Price | Lot size | Contract value | Initial Margin (23%) | Maintenance Margin (10%) | Mark to market loss/ profit |
| RNRL | 10-12-2007 | 180 | 7150 | 12,87,000 | 3,86,000 | 1,28,700 | |
| RNRL | 11-12-2007 | 182 | 7150 | 13,01,300 | 3,86,000 | 1,43,000 | +14,300 |
| RNRL | 12-12-2007 | 177 | 7150 | 12,65,550 | 3,86,000 | 1,07,250 | -21,450 |
| RNRL | 13-12-2007 | 175 | 7150 | 12,51,250 | 3,86,000 | 92,950 | -14,300 |
| RNRL | 14-12-2007 | 170 | 7150 | 12,15,500 | 3,86,000 | 57,200 | -35,750 |
| RNRL | 15-12-2007 | 165 | 7150 | 11,79,750 | 3,86,000 | 21,450 | -35,750 |
| RNRL | 16-12-2007 | 160 | 7150 | 11,44,000 | 3,71,700 | -14,300 | |
The member submitted the total margin of Rs. 5,14,700 (3,86,000+1, 28,700) against the exposure of contract value of Rs. 180 X 7150 = 12,87,000 and closed his open position on 16-12-2007 with the loss of Rs. 20X7150 = 1,43,000. On 16-12-2007 he gets his initial margin minus loss back from the clearing corporation (5,14,700 – 1,43,000 = 3,71,700).
OPTIONS TERMINOLOGY
· Types of options: There are two basic types of options, call options and put options:
Ø Call options: A call options gives the holder the right but not the obligation to buy an asset by a certain date for a certain price.
Ø Put options: A put options gives the holder the right but not the obligation to sell an asset by a certain date for a certain price.
· Index options: These options have the index as the underlying. Like index futures contracts, index options contracts are also cash settled. Examples of Index options contract are Nifty option contract, Bank Nifty option contract or Sensex option contract.
· Stock options: Stocks options are options on individual stocks. Options currently trade on over 500 stocks in the United States and 226 stocks in the NSE. A contract gives the holder to buy or sell shares at the specified price. Like stock futures contract, stock options contracts are also cash settled. Examples of Stock options contract are Reliance option contract, Tata steel option contract and Sail option contract.
· Buyer of an option: The buyer of a call/put option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/ writer.
· Writer of an option: The writer of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.
· Option premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium.
· Expiration date: The date specified in the option contract is known as the expiration date, the exercise date, the strike date or the maturity.
· Strike price: The price specified in the option contract is known as the strike price or the exercise price.
· American options: American options are options that can be exercised at any time upto the expiration date. All stocks options contracts are American style options.
· European options: European options are options that can be exercised only on the expiration date itself. All index options are European style options.
· In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cash flow to the holder if it were exercised immediately. A call option on the index is said to be in-the-money when the current index stands at a level higher than the strike price (i.e. spot price > strike price). If the index is much higher than the strike price, the call is said to be deep ITM. In the
case of a put, the put is ITM if the index is below the strike price.
· At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cash flow if it were exercised immediately. An option on the index is at-the-money when the current index equals the strike price (i.e. spot price = strike price).
· Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative cash flow if it were exercised immediately. A call option on the index is out-of-the-money when the current index stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is much lower than the strike price, the call is said to be deep OTM. In the case
of a put, the put is OTM if the index is above the strike price.
| | Call options | Put options |
| In the money | Spot (S) >Strike price (K) | Spot (S) < Strike price (K) |
| Out of the money | Spot (S) < Strike price (K) | Spot price > Strike price (K) |
| At the money | Spot (S) = Strike price (K) | Spot (S) = Strike price (K) |
