A Note On Currency And Index Futures

TRADING USING INDEX FUTURES Contd..

Example:

On January 01, 2003, an investor feels that the budget to be presented on February 28, 2003, will be investor-friendly and expects the index to rise thereafter. He therefore buys a three-month index futures contract expiring on March 27, 2003, currently trading at Rs. 1020. So his initial position is long Index futures worth Rs. 204000 (200 X 1020). On March 12, 2003, the index rises to 1335 and the March futures contract rises to Rs. 1352. The investor unwinds his position by selling at Rs. 1352. His total profit = 66400 (200 X (1352 – 1020)).

•Expecting Bearish Phase, Go Short on Index Futures

At times, investors feel that market is in for a bear phase for several reasons such as a series of bad corporate results, a minority government and a forecast of a bad weather. To benefit from such a scenario, investors have the following alternatives:

a) To sell securities which move in tandem with the index and buy at a time when investor feels he has realized the profit.
b) To sell the index portfolio and buy at a later date.
c) To take a short position on index futures.
The third alternative is effortless and involves initial outlay only in terms of margin money.

Example:

On April 01, 2002, an investor feels that the year's monsoon will be bad and expects the index to fall thereafter. He therefore sells a three-month index futures contract expiring on June 27, 2002, currently trading at Rs. 920. So his initial position is short in index futures worth Rs. 1,84,000 (200 X 920). On June 09, 2002, the index falls to Rs.835 and the June futures contract falls to Rs. 852. Investor unwinds his position by buying at Rs. 852. His total profit = 13600 (200 X (920 – 852)).

ARBITRAGE

•Arbitraging when lending money to the market

Index futures market provides an opportunity to investors to lend money into the market without being exposed to the (a) price risk and (b) default risk of the counter party. The investor creates a portfolio, which buys all the securities that comprise an index (say Nifty).

The proportion of securities should be a representation of their market capitalization. A moment later, the investor sells the contracts in the futures market. Now the investor is completely hedged against fluctuations in the index and the credit risk is also eliminated since the counterparty is the clearing house. The investor loans the money to the market at the point of delivery of securities. A few days later the investor will unwind the position; the investor will send sell orders to sell off all the securities of the portfolio, and a moment later will reverse the future position. The point when the investor makes the delivery of the shares is when he receives his money back.

The return that investor earns when he unwinds the transaction at the expiration date of the futures is equal to the futures price minus cash market price of the Index. There are two other intricacies, which affect the return earned (1) dividends earned on shares during the period of holding and, (2) brokerage and other transaction costs. Suppose on 1 January 2003, the spot price of the index is Rs. 954.52, and the index January futures are at Rs. 965.3, then the return earned by the lender is [(965.3 – 954.52)/954.52 X 100] 1.13% for 30 days.Speculation