Characteristics of future market

1. In terms of the spot market, the futures price imitate the primary price. In fact, the futures price and spot prices are completely different. 

2. All futures contract are the standard contract with pre-set agreements. These are in terms of lot size and expiry date. The minimum quantity specified in the futures contract is exactly the lot size.

                   Contract value = Futures Price * Lot Size

3. You can hold the futures agreement up to a certain time. The last day on which you can hold is the expiry date,

4. To begin with futures agreement, the investors will have to deposit margin money. Your broker calculates it at a certain percentage of the contract value. Therefore, the margin money allows investors to deposit a small amount. Then they can take wider exposure to value transaction, thereby leveraging on the transaction.

5. Before you operate in a futures contract, you have to digitally sign the agreement with the counterparty. This constrains you to honour the contract upon expiry.

6. The agreement in futures is tradable. This indicates that you do not need to hold on to the agreement until the expiry. If the movement of the price is in your favour then you can hold and can get financial gains. For example, let's assume an investor who buys Infosys Futures at 9:15 AM at a price of 1951 and sell it by 9:17 AM in 1953. Since Infosys lot size at the time was 250, our investor would stand to make INR 500 (2 * 250) within a matter of 2 minutes. Our investors further have a choice of holding it overnight for a few days or even can hold it till expiry. 

7. In futures, there is a term called “Zero Sum Game” which means this Instrument allows the investor to transfer money from one pocket to another. The higher the leverage, maximum is the risk. The payoff structure of a futures instrument is linear.

Difference between future and forward contracts

What is the margin money?

Why your broker collects margin money?

" The exchange make sure this works seamlessly by -

Collecting the margin money

Marking the daily profits or losses to market (also called M2M) " 

Explain the concept of initial margin, span margin, and exposure margin

The concept of Margin and Mark to Margin is something that the traders need to know in corresponding to thoroughly acknowledge the dynamics of futures trading. Although, it is a bit complicated to understand both the concepts at the same time. So, here I would like to pause a bit on margin money and proceed to Mark to Margin. We will understand Mark to Margin completely and come back again to margins. We will then relook at margins keeping Mark to Margin in perspective. But before we move to Mark to Margin, I would like you to keep the following points in the back of your mind.

Step-by-step working of margin money- 

1. The broker blocks the margins in the trader’s trading account when it comes up to initiate the futures position.
2. The term that can be used in terms of blocking the margins is the “Initial Margin”
3. The initial margin has two sub-parts i.e., SPAN margin and the Exposure Margin
4. Initial Margin = SPAN Margin + Exposure Margin
5. Your broker will block Initial Margin in your trading account for the days one chooses to hold on to the futures trade. There will always be a variation in the value of the initial margin on a daily basis as it has a dependency on the futures price.

"Remember, Initial Margin = % of Contract Value

Contract Value = Futures Price * Lot Size"

6. The lot size does not change whereas there is a variation in futures price on a daily basis. This means the margins also vary every day

What are mark-to-margin? 

Buy Price = INR. 749.90

Sell Price = INR. 751.60

Profit per share = INR (751.60 - 749.90) = INR 1.7

Total Profit = 1200 * 1.7 = INR 2040

Can you explain M2M with an example?

Buy Price = INR 749.90

Sell Price = INR 750.90

Profit per share = INR (750.90 - 749.90 ) = INR 1.00

Total profit per lot = 1200 * 1.00 = INR 1200

" Therefore, the mark-to-market refers to a daily adjustment of accounting wherein –

1. There will be either credit or debit from your account.   

2. The previous day close price acts as the base to calculate the present day M2M "

Discuss the importance of margin in trading from the retail investor perspective

Initial margin is a certain percentage of the contract value. We also know –

Initial Margin (IM) = SPAN Margin + Exposure Margin

The number of times a trader initiates futures, there are intermediaries to make trading moves smoothly. The two foremost financial intermediaries in the trading process are the broker and the exchange.

Considering a situation wherein, the client defaults on an obligation, then it has a financial fall out on both the broker and the exchange. Hence margin money insulates both the financial intermediaries against any possible client default.

In fact, this is exactly how it works. ‘SPAN Margin’ is the mandatory margins. The exchanges block it as per the exchange’s mandate. Your broker blocks amount for exposure margin over and above the span margin to cushion for any MTM losses. The exchange identifies both the span and exposure margin. So at the time of initiating a futures trade, the client has to adhere to the initial margin requirement. The exchange block the complete initial margin (SPAN + Exposure).

Amongst the two margins, SPAN Margin is more important. As it is that it does not have a penalty from the exchange in the account. As long as you wish to carry your position, your broker will strictly maintain the span margin. It is therefore also called maintenance margin.

The variation of the contract value is in between 4% - 5% for exposure margin that is usually an additional margin.