A speculative product, stock index futures will attract the retail investor.
There has been a lot of hype created about the imminent advent of derivative trading in India accompanied by a lot of individual concern. But then trading in derivatives has always existed at some point of time or the other. For that matter, the BSE and NSE are classic examples of futures markets in operation in India. The NSE equity market is a weekly futures market with Tuesday expiration. This, because when a person goes long on Wednesday, he is not obliged to give delivery and payment right away; this long position can be reversed on Friday thus leaving no obligation with the clearing house. In a true cash market, when a trade takes place on a particular day, delivery and payment would also take place on the same day. Settlement procedures like T+3 would qualify as cash markets. Considering this, only the OTCEI is a cash market by definition.
So, for the investor the procedure would be similar. He can trade in the index in the same way as he trades in the equity market. Initially, there will be three contracts namely a one-month, two-month and a three-month contract. The contracts would have to be settled by the end of the stipulated month. While the BSE would trade on the Sensex, which comprises 30 scrips, the NSE would trade on the Nifty, which comprises 50 scrips. After testing the success in these indices they could move on to other broad-based indices.
Says ANS Securities' Suraj Bajaj, "Initial margins on the S&P 500 is a mere 6.5 per cent, which means an investor can leverage himself by 15 times." However, the minimum contract size abroad is $2,50,000. In India, the minimum contract size stipulated by Sebi is Rs 2 lakh. Even if the initial margins in India are higher than that mentioned above, the very fact that one can leverage himself by 10 times, is likely to experience a lot of speculative activity. For an investor who has decided that futures fit properly into his portfolio, has chosen to take trading decisions for himself and, has decided to trade on the Nifty, could trade as follows:
Choose a broker. A futures broker specifically who may or may not be a stock broker.
Enter into an agreement with the broker and set up an account.To trade futures, one has to deposit what is known as an initial margin. The initial margin is the amount of money a customer must deposit for each futures contract to be traded. Exchanges set minimum margin requirements for futures contracts, while individual brokerage firms may require higher margin deposits from their customers.
Note that in a futures market, margins have a different meaning and purpose than they have in stocks. In futures, the margin money is the earnest money made solely as a deposit of good faith. A trader's brokerage firm could draw upon the money to cover losses that may be incurred in the course of the futures trading.
Once the margin money is deposited and a futures contract is bought or sold, profits on the open futures position is added to the margin account and losses deducted. If and when the funds in a margin account are reduced by losses to below a level known as the maintenance margin, a broker will require additional funds to be deposited in the account to restore it back to the initial margin level. This is known as a margin call. Therefore, before trading it is important to understand a brokerage firm's margin agreement and how and when the firm expects the margin calls to be met. Onlythen go ahead with your first trade.
Let's assume you have decided to hedge. You have a substantial diversified portfolio in the stockmarket, but are concerned that the Indian economy could be headed towards a recession and that the bourses may be headed downwards in the near term. Therefore, you don't want to sell because of the bad times and expenses involved in commissions. You would later possibly rebuild your portfolio even as you want to be protected against potential near-term losses. Through futures, you can protect yourself against the near-term losses without liquidating your stock portfolio, with one transaction and one brokerage commission.
Then call your broker and place an order to sellsay one Nifty futures contract at the market. You fill the order at a stock index level of 1500.00 points, representing Rs 1,50,000. Subsequently, the Indian economy does indeed go on a downturn and the stock market falls too. Your stock portfolio suffers losses. Later, when you decide to buyback at the Nifty the index is trading at 1400.00. Thus, you make a profit of Rs 10,000 minus the broker's commission.
But, if the market had risen when you decided to buyback your contract, let's say to 1600.00, you would have lost Rs 10,000. However, properly hedged, gains in your portfolio offset the futures losses.
Regarding comfort levels, indiainfoline.com has initiated a mock real-time game, in which investors were allocated an initial corpus of Rs 10 lakh on June 24, 1999 and allowed to trade stock index futures. At that time the Sensex was at 3,500 levels. Around 20,000 individuals participated.
Since then, the Sensex has risen and with most people tending to go long, around 75 per cent are making money while the rest are losing. But then, this game is not even a year old. Tracking an entire bull-and-bear cycle would give a more accurate inference.