10.1 – The Pricing Formula
If you were to take a conventional course on Futures trading, you would probably be introduced to the futures pricing formula right at the very beginning of the course. However we have deliberately opted to talk about it now, at a much later stage. The reason is simple – if you are trading futures based on technical analysis (I assume a vast majority of you are doing this) then you would not really need to know how the futures are priced, although a good working knowledge would help. However if you aspire to trade futures by employing quantitative strategies such as Calendar Spreads or Index Arbitrage then you certainly need to know this. In fact we will have a module dedicated to ‘Trading Strategies’ where we would discuss some of these strategies, hence the discussion in this chapter will lay down a foundation for the forthcoming modules.
If you recall, in some of the earlier chapters occasionally we discussed the ‘Futures Pricing Formula’ as the prime reason for the difference between the spot price and the futures price. Well, I guess it is time now to lift the veil and introduce the ‘Future Pricing Formula’.
We know the futures instrument derives its value from its respective underlying. We also know that the futures instrument moves in sync with its underlying. If the underlying price falls, so would the futures price and vice versa. However, the underlying price and the futures price differs and they are not really the same. To give you a perspective as I write this, Nifty Spot is at 8,845.5 whereas the corresponding current month contract is trading at 8,854.7, please refer to the snap shot below. This difference in price between the futures price and the spot price is called the “basis or spread”. In case of the Nifty example below, the spread is 9.2 points (8854.7 – 8845.5).
The difference in price is attributable to the ‘Spot – Future Parity’. The spot future parity the difference between the spot and futures price that arises due to variables such as interest rates, dividends, time to expiry etc. In a very loose sense it is simply is a mathematical expression to equate the underlying price and its corresponding futures price. This is also known as the futures pricing formula.
The futures pricing formula simply states –
Futures Price = Spot price *(1+ rf )– d
Where,
rf = Risk-free rate
d – Dividend
Note, ‘rf’ is the risk-free rate that you can earn for the entire year (365 days); considering the expiry is at 1, 2, and 3 months one may want to scale it proportionately for time periods other than the exact 365 days. Therefore a more generic formula would be –
Futures Price = Spot price * [1+ rf*(x/365)]– d
Where,
x = number of days to expiry.
One can take the RBI’s 91 day Treasury bill as a proxy for the short term risk-free rate. You can find the same on the RBI’s home page, as shown in the snapshot below –
As we can see from the image above, the current rate is 8.3528%. Keeping this in perspective let us work on a pricing example. Assume Infosys spot is trading at 2,280.5 with 7 more days to expiry, what should Infosys’s current month futures contract be priced at?
Futures Price = 2280.5 * [1+8.3528 %( 7/365)] – 0
Do note, Infosys is not expected to pay any dividend over the next 7 days, hence I have assumed dividend as 0. Solving the above equation, the future price turns out to be 2283. This is called the ‘Fair value’ of futures. However the actual futures price as you can see from the image below is 2284. The actual price at which the futures contract trades is called the ‘Market Price’.
The difference between the fair value and market price mainly occurs due to market costs such as transaction charges, taxes, margins etc. However by and large the fair value reflects where the futures should be trading at a given risk free rate and number of days to expiry. Let us take this further, and figure out the futures price for mid month and far month contracts.
Mid month calculation
Number of days to expiry = 34 (as the contract expires on 26th March 2015)
Futures Price = 2280.5 * [1+8.3528 %( 34/365)] – 0
= 2299
Far month calculation
Number of days to expiry = 80 (as the contract expires on 30th April 2015)
Futures Price = 2280.5 * [1+8.3528 %( 80/365)] – 0
= 2322
From NSE website let us take a look at the actual market prices –
Snapshot of Infosys’s mid month contract
Snapshot of Infosys’s mid month contract
Clearly there is a difference between the calculated fair value and the market price. I would attribute this to the applicable costs. Besides, the market could be factoring in some financial yearend dividends as well. However the key point to note is as the number of days to expiry increases, the difference between the fair value and market value widens.
In fact this leads us to another important commonly used market terminology – the discount and the premium.
If the futures is trading higher than the spot, which mathematically speaking is the natural order of things, then the futures market is said to be at ‘premium’. While ‘Premium’ is a term used in the Equity derivatives markets, the commodity derivatives market prefer to refer to the same phenomenon as ‘Contango’. However, both contango and premium refer to the same fact – The Futures are trading higher than the Spot.
Here is a plot of Nifty spot and its corresponding futures for the January 2015 series. As you can see the Nifty futures is trading above the spot during the entire series.
I specifically want to draw your attention to the following few points –
- At the start of the series (highlighted by a black arrow) the spread between the spot and futures is quite high. This is because the number of days to expiry is high hence the x/365 factor in the futures pricing formula is also high.
- The futures remained at premium to the spot throughout the series
- At the end of the series (highlighted by a blue arrow) the futures and the spot have converged. In fact this always happens. Irrespective of whether the future is at a premium or a discount, on the day of the expiry, the futures and spot will always converge.
- If you have a futures position and if you fail to square off the position by expiry, then the exchange will square off the position automatically and it will be settled at the spot price as both futures and spot converges on the day of the expiry
Not always does the futures trade richer than the spot. There could be instances – mainly owing to short term demand and supply imbalances where the futures would trade cheaper than its corresponding spot. This situation is when the futures is said to be trading at a discount to the spot. In the commodities world, the same situation is referred to as the “backwardation”.
10.2 – Practical Application
Before we conclude this chapter, let us put the futures pricing formula to some practical use. Like I had mentioned earlier, futures pricing formula comes very handy when you aspire to trade employing quantitative trading techniques. Please note, the following discussion is only a preview window into the world of trading strategies. We will discuss all these things plus more in greater detail when we take up the module on “Trading Strategies”. Consider this situation –
Wipro Spot = 653
Rf – 8.35%
x = 30
d = 0
Given this, the futures should be trading at –
Futures Price = 653*(1+8.35 %( 30/365)) – 0
= 658
Accommodate for market charges, the futures should be trading in and around 658. Now what if instead the futures contract is trading at a drastically different price? Let’s say 700? Clearly there is a trade here. The difference between the spot and futures should ideally be just 5 points, but due to market imbalances the difference has shot up to 47 points. This is a spread that we can capture by deploying a trade.
Here is how one can do this – since the future contract is trading above its fair value, we term the futures market price as expensive relative to its fair value. Alternatively we can say, the spot is trading cheaper with respect to the futures.
The thumb rule in any sort of ‘spread trade’ is to buy the cheaper asset and sell the expensive one. Hence going by this, we can sell Wipro Futures on one hand and simultaneously buy Wipro in the spot market. Let us plug in the numbers and see how this goes –
Buy Wipro in Spot @ 653
Sell Wipro in Futures @ 700
Now we know that on the expiry day, both the spot and the futures converge into one single price (refer to the Nifty graph posted above). Let us assume a few random values at which the futures and the spot converge – 675, 645, 715 and identify what happens to the trade –
| Expiry Value | Spot Trade P&L (Long) | Futures Trade P&L (Short) | Net P&L |
|---|---|---|---|
| 675 | 675 – 653 = +22 | 700 – 675 = +25 | +22 + 25 = +47 |
| 645 | 645 – 653 = -08 | 700 – 645 = +55 | -08 + 55 = +47 |
| 715 | 715 – 653 = +62 | 700 – 715 = -15 | +62 – 15 = +47 |
As you can notice, once you have executed the trade at the expected price you have essentially locked in the spread. So irrespective of where the market goes by expiry, the profits are guaranteed! Of course, it goes without saying that it makes sense to square off the positions just before the expiry of the futures contract. This would require you to sell Wipro in spot market and buy back Wipro in Futures market.
This kind of trade between the futures and the spot to extract and profit from the spread is also called the ‘Cash & Carry Arbitrage’.
10.3 – Calendar Spreads
The calendar spread is a simple extension of the cash & carry arbitrage. In a calendar spread, we attempt to extract and profit from the spread created between two futures contracts of the same underlying but with different expiries. Let us continue with the Wipro example and understand this better –
Wipro Spot is trading at = 653
Current month futures fair value (30 days to expiry) = 658
Actual market value of current month futures = 700
Mid month futures fair value (65 days to expiry) = 663
Actual market value of mid month futures = 665
From the above example, clearly the current month futures contract is trading way above its expected theoretical fair value. However the mid month contract is trading close to its actual fair value estimate. With these observations, I will make an assumption that the current month contract’s basis will eventually narrow down and the mid month contract will continue to trade close to its fair value.
Now with respect to the mid month contract, the current month contract appears to be expensive. Hence we sell the expensive contract and buy the relatively cheaper one. Therefore the trade set up would require me to buy the mid month futures contract @ 665 and sell the current month contract @ 700.
What do you think is the spread here? Well, the spread is the difference between the two future contracts i.e 700 – 665 = 35 points.
The trade set up to capture the spread goes like this –
Sell the current month futures @ 700
Buy the mid month futures @ 665
Do note – because you are buying and selling the same underlying futures of different expiries, the margins are greatly reduced as this is a hedged position.
Now after initiating the trade, one has to wait for the current month’s futures to expire. Upon expiry, we know the current month futures and the spot will converge to a single price. Of course on a more practical note, it makes sense to unwind the trade just before the expiry.
Let us arbitrarily take a few scenarios as below and see how the P&L pans out –
| Expiry Value | Current month P&L (Short) | Mid Month P&L (Long) | Net P&L |
|---|---|---|---|
| 660 | 700 – 660 = +40 | 660 – 665 = -5 | +40 – 5 = +35 |
| 690 | 700 – 690 = +10 | 690 – 665 = +25 | +10 + 25 = +35 |
| 725 | 700 – 725 = -25 | 725 – 665 = +60 | -25 + 60 = +35 |
Of course, do recall the critical assumption we have made here is that i.e. the mid month contract will stick close to its fair value. From my trading experience this happens most of the times.
Most importantly please do bear in mind the discussion with respect to spreads in this chapter is just a sneak peek into the world of trading strategies. We will discuss these strategies in a separate module which would give you an in depth analysis on how one can professionally deploy these strategies.
Key takeaways from this chapter
- The futures pricing formula states that the Futures Price = Spot price *(1+Rf (x/365)) – d
- The difference between futures and spot is called the basis or simply the spread
- The futures price as estimated by the pricing formula is called the “Theoretical fair value”
- The price at which the futures trade in the market is called the ‘market value’
- The theoretical fair value of futures and market value by and large should be around the same value. However there could be slight variance mainly due to the associated costs
- If the futures is rich to spot then the futures is said to be at premium else it is said to be at a discount
- In commodity parlance Premium = Contango and Discount = Backwardation
- Cash and carry is a spread where one can buy in the spot and sell in the futures
- Calendar spread is an extension of a cash and carry where one buys a contract and simultaneously sells another contract (with a different expiry) but of the same underlying
Hi karthik,
Pls explain this : As the number of days to expiry increases, the difference between the fair value and market value widens.
The x/365 factor, where x represents number of days increases when x is large. For example when there are 30 days to expiry, x/365 is 0.082, however when when x is 20, x/365 is 0.54. This makes the spread to increase.
At times during the contract cycle commentators say premium in nifty futures has increased,inspite of the fact that time is diminishing with every passing day of the contract.Accordingly they analyse future prospects.Pls help me understand this.
Besides time other factors also contribute. This is mainly due to the demand and supply in the contract.
Hi Karthik,
what impact volatility will have on premium of nifty futures ?
Nice question. As far as I know volatility and futures premium are not directly related (at least in their mathematical equation). I guess this is because futures is a linear instrument where the only factor that affects its movement is “direction”. On the other hand options premium tends to shoot up when volatility increases. More on this topic when we take up options theory.
Hello Karthik, a doubt.
The price of stock future is always more than its underlying asset, the equity price.
And the prices converge when the future is about to expire.
So when a stock future is priced lower than its equity counterpart, what does it imply?
It means the futures are trading at a discount to spot. Discount situation comes about when futures are heavily sold in the market. All else equal, futures are always at a premium to spot.
correction req :: when when x is 20, x/365 should be 0.054.
Thanks for pointing this, let me look into this.
@nitin
In fair value calculation of nifty future is it necessary to consider dividends of underlying stocks!
DCF does not really take dividend into consideration, Madhukar.
sir,is there any stategy r software to find profitable c spreads in futures,&should we close all positions at atime r can we take advantage of one fut according to mkt&should we wait till expiry,will it not be too long what if get profit of 2000/trade daily r swing should we square off r wait.in this way cant we make 25 trades/month clarify
Based on our earlier interaction, I would suggest you stick to simple swing trade for now before you venture into calender spreads.
sir,evrytime when taking positions in calender spreads(2 futures)should we have to calculate fair value r is there any thumb rule to calculatein %terms for near&mid month explain
There is a workaround for this, which I will explain in the “Trading Strategies” module.
Hi Karthik,
One question that comes to my mind is that how to find such trader? Can we automate a strategy on pi that automatically searches for scrips that have the C&C arbitrage or normal spread? Similarly, if we were to calculate the fair price for each and every scrip then the trade opportunity would be lost.
Thoughts?
There is a different quant angle to this Saurabh. I will share it shortly.
ARBITRAGE – Hi ! If futures for near month is available on discount, then can one buy 2 ATM puts and go long futures in order to benefit from the same spread ? Is it worth it knowing that the profitability may be low ! Thanks
Sounds interesting, but honestly you need to back test this before diving in. Chances are that the discount may persist through the expiry week and spot may come down to futures on expiry.
hi karthik, can the last candle be traded as a bullish harami? do the indicators suggest a long trade?
Just by candlestick perspective it does, in fact its perfect. However I would not get carried away with it, I would check for other checklist items and confirm if it matches.Good luck.
sir,when r we reding trading stategies,its late we r eagerly waiting
Trading strategies will be put up after Options. So I guess it may take sometime.
Hi,
Are there any Trading Strategies specific to Futures?
Yes, have explained a few here – https://zerodha.com/varsity/module/trading-systems/
Sir,done even i to like swing trade but couldn’t resist intraday&loosing small amount (5000) i don’t have patience to wait for 1/2 hours idont know how i can be a good trader is it my fault(inexperienced) or over assesability like Online. Pi. Boss of our mistakes or trying for unnecessary fr ex _today i stayed away from intraday(sensing volatility which I can’t sustain)when I opened pi ishoort BHEL at 274 &buying at 276 causing loss of money &confidence after hour BHEL was trading at 258 what is this nonsense & how to avoid give ideas
You have to be really disciplined Narasimha. This is the core of all trading strategies, control you trading instincts and focus purely in swing trades (by applying the checklist) to begin with. This will really help.
Narasimha, I was in same league before some time and lost more than 5L trading stocks and options. I was also amused about the issue on handling the loss. I was even talked to Kartik also and he advised me to be disciplined and not to take random trade. Also, stick to stop loss and target but I was not not able to stick with stop loss while watching MTM loss. I find the reason. It was the size of trade. When I started to take small size of trade I was less gripped in fear of loosing and if I take my trade on the basis of TA, I do not come out from my trade until stop loss do not hit. That’s it.
It is a long journey to be good trader and cover all losses but today when I trade, I just look the current opportunity and without any external pressure of covering my losses, I am making small profits and gaining my confidence back. Thanks to Kartik.
So happy to note that, Neeraj and thanks for sharing your journey with all of us!
Good luck and stay profitable!
sir,and when we apply candle graph there r lot of timeframe differences for ex-a pattern for 5,15,1hour,daily shows differently justify
I’d suggest EOD charts to begin with.
Sir, What is Swing Trading.
Swing trading is when you buy stock/futures with an intention to hold on to it for few days. Check section 6.8 in this chapter for more details – http://zerodha.com/varsity/chapter/the-stock-markets/
sir,reply for bhel case,waiting
sir,cant it be better to tade OPTION STOCK(INBUILT STOP)RATHER STOCK FUTURES TO MY STYLE OF TRADING(ANXIETY OF CLOSING EARLIER&REPENTING)TILL NOW I WAS TADING ONLY INDEX OPTIOS&STO FUT ADVISE
Sure, but please be aware that Options are not as linear as futures. There are many factors to Options trading. You need to be completely aware of these variables before you take a trade.
Karthik, the TA analysis seems more predictable with Nifty futures (than stock futures) as far as the daily and hourly candles go, but totally unpredictable with the 5-mins candles. Is it a bad idea to carry out TA-based trades on 5-min candles? Is TA more suitable for swing trades rather than intraday trades?
Tough to answer this 🙂 I know extremely good traders who use TA on 5 mins candles. But as a general rule of thumb higher the time frame, better is the quality of signal..and therefore the quality of analysis.
I somehow seem to wipe out all the gains made through my swing trades with my intraday trades. I do hope you’ll include a few intraday strategies in your Trading Strategies module.
I will try and do that. However if you are comfortable with swing trades, stick to it. Don’t venture into day trading till you have a good strategy.
Hi karthik, Banknifty as you know can be extremely volatile yet, very profitable for option trades. i normally look for momentum before entering a trade but, is there a way to place targets when the underlying is so volatile?
Yes, infact you can use Volatility information to place stoploss. I will talk about it when I introduce volatility in options module.
Hi sir, i am eagerly waiting for option trading strategies…when it will be available sir…
We will start options really really soon. Futures have been way delayed than what I imagined.
When the market closes for the day, if the bid quantity onscreen for a certain scrip/future is way higher than the ask quantity, is it safe to assume that the price will go up the next day?
What you see is just the last minute supply demand situation. As you may know, the supply demand changes every minute….going by that if market would have been open for another 5 mins, this could have very well changed. So don’t allow this to mislead you.
Karthik, do you see a recognizable candle pattern at the support on which the price trended upward. i can only make out an inverted hammer. can such a pattern be relied upon? my support line seems to hold. the indicators , specially the RSI did concur by a sharp reversal from oversold zone. do let me know your views. thanks.
Honestly, except for a double bottom around the support line (which btw is a good indicator of price reversal) there was no other indication of a reversal, especially from the candlestick perspective. Also, the inverted hammer also called the shooting star makes sense at the top end of the rally and not really at the bottom end.
Sir, Where can I see/look for BLOCK/BULK deals of the trading day. Thanks
Moneycontrol has it, here is the link – http://www.moneycontrol.com/india/stockmarket/statistics/blockdeals/10/54/NSE
Sir, Which is the best site to Identify the sectors of the stock to which it is belongs and to compare.
Both money control and morningstar India has a good sectoral classification of stocks. Check it out.
sir,how should we understand,long either nifty fut,option r, lot of nifty stocks hoe r they corelated ex-if nifty opt sells will it effect nifty fut vice versa xpain
SIR,
Awaiting for next chapters, thanks
Finally We are done with Futures! Will be uploading the same by end of this week. Thanks for your patience.
Hi karthik, placing stop losses on volatile underlying is challenging. the swing takes out the stop loss and reverses to attain highs or it continues to fall brutally. wanted to know from you if there are thumb rules to follow. i have read your views on stop losses and agree that there cannot be one single strategy. but, would appreciate your thoughts on placing stop losses while trading volatile scripts or the banknifty.
One of the best ways to place stoploss is in fact by measuring volatility. I have not spoken about this so far in Varsity, but will do so in Module 5, where I intend to talk about Volatility in great detail. I will share step by step guide to place stoploss as well. Request you to stay tuned till then 🙂
Sir, While calculating Future price the no. days remaining are calender days or trading days. Thank You
Calender days.
sir,when trading openings they say when stock open&low same buy&open high same go&sell what is this &if its ok till what time&how to cash volatility(nowdays its too much)should we buy on dips r sell on rallies,i mean bull s r bears stategy which suits my style of trading (i think by now u might have idea of my trading)
advice&will follow
Stick to simple EOD based swing trades Narsimha!
Dear Sir, While going thro the queries on Z- connect, I come across Call and Put Strikes. Where to look for increase in OI for Call and Put strikes. For example 9000 CE writers added 40 lakh in OI.
Thanks
The best place to look for OI data is in fact the NSE website, suggest you look at the respective options chain. Here is the link for Nifty’s Option chain – http://www.nseindia.com/live_market/dynaContent/live_watch/option_chain/optionKeys.jsp?symbolCode=-10007&symbol=NIFTY&symbol=NIFTY&instrument=-&date=-&segmentLink=17&symbolCount=2&segmentLink=17
Can you pls do a module on taxation on shares trading pls… Its a complicated subject but i m sure u will explain it in similar simple terms like u have done till now. Ohhh ya eagerly waiting for the Options module to start. Cheers
There is quite a few helpful articles on Taxation on Z-connect, suggest you check this – http://zerodha.com/z-connect/?s=taxation
Options is starting from very soon!
Karthik,
Mid month P&L column values are not correct for Calender Spread. Expiry value won’t be the same for both current month and mind-month right? So Net P&L should be less than 35.
Ganesh – As I have mentioned this is just a preview of calender spread. I have used this illustration to keep it simple and drive the point across. Besides, I have also assumed the mid month contract is trading close to its fair value. We will have a module dedicated to “Trading Strategies” where would get into the details of the trade.
Do you have any expected time when we get Trading Stragies module gets ready, I think many have been waiting for this to comes up 🙂
I understand, but we have to finish 2 module before that – Option Theory and Options Strategy….so cant really speculate on the timelines 🙂
Sir,what is eod please explain in depth
EOD = End of Day. This is usually used with reference to data…if we are talking about EOD data, then it simply means we are looking at the day’s open, high, low, and close.
The Calendar Spread looks like it gives decent returns. However, as per your example taken, it is likely to give profits only. Do you see any time it might be giving losses as well. If so, can you explain what kind of scenario.
I’m taking today’s market example:
NIFTY SPOT AT 8712.05
NIFTY15MARFUT CLOSED AT 8767.65
NIFTY15APRFUT CLOSED AT 8832.15
As this strategy is guaranteed profits irrespective of market direction, I took the positions at
NIFTY15MARFUT for 8845.48 and NIFTY15APRFUT for 8912.48
So I went LONG on MARFUT and SHORT on APRFUT.
Can I assume I don’t get losses at either case. Can’t I?
I tried to understand this strategy for the last two days, but I’m always end up with confusion and wondering how it goes at expiry. 🙂
Can you explain this how much returns does it give at expiry with two scenarios what if Market ends above/below 8767.
Ganesh, there is no strategy which is fool proof in markets, including calender spreads. For example instead of the spread (between current & mid month) converging if the spread diverges then clearly there would be a loss. Also, this is something you should note – at any given point there will always be a spread between the 2 contracts (this is called the normal spread)…an opportunity arises only when this normal spread deviates from its normalcy.
Karthik, sorry I’m confused. Could you please explain a bit detailed. For calendr spread, the table shows profits irrespective of price’s direction. can you show one which gets losses in CS please. Please my example above.
Ganesh – the loss can occur as a function of 2 things – spread behavior and solvency. Let me refer to the Wipro example to illustrate.
Assume you have shorted current month @ 700, long mid month @ 665. At expiry the spot goes to 710, this means you lose 10 in current month and make 45 in mid month and net 35 is your profit. This based on the assumption that mid month behaves well wrt to the futures pricing formula. Imagine for some strange reason (maybe a dividend expectation) the mid month contract trades at a discount and remains at 660. In that case upon expiry you will lose 10 in current month and also lose 5 in mid month.
Solvency is another issue…suppose after you short current month at 700, it goes to 800, and meanwhile the mid month goes marginally higher say to 700 then you are looking at a huge M2M loss, even though at expiry the trade may work in your favor during the time you hold the trade can go against you for a while, if you are not solvent during this period you will be forced to take a loss.
The illustrations that I have put forward here could be a bit exaggerated, the ides is just illustrate the scenarios in which CS can result in a loss. Also, do note at any given point there will always be a spread between this month and next month contract…the money that you make by this spread will be equal to the costs you incur by initiating this trade. So you may want to consider this when you decide to take the trade.
Karthik- What if I trade in NIFTY, do I need to bother about divedend. And let’s say I keep track of divendend calendar in a particular stock and initiate CS ONLY if there is reasonable profits are expected.
I want to look into historical Futures data for Nifty. Is it available? I verified at NSE but it shows only one month contract but not two at the same time.
I just want to understand some practical samples for CS.
Can you suggest If I can get it anywhere.
Yes, if you can build your strategy by taking care of such nitty gritties then obviously you will have a winner. Have you checked this link for historical data? – http://www.nseindia.com/products/content/derivatives/equities/historical_fo.htm
sir this is really nice explanation ..one question, when we do selling this month and buying mid month it will be hedged and margin blocked is low compare to 2 lots …so at any situation are there any chances that we lose more than margin blocked?
and can we take arbitrage trade when this month future trading at discount(buying) and mid month trading at premium(selling)? pls answer
Yes, there are chances of losing more money. When you set up a trade like this, you are essentially playing for a convergence of the spread…but if the spread increases then you will lose money.
t u sir,can we trade any option of all f&o or only high beta stocks bcoz of their trading intrest what is iv,how can we know we brought options @fair price so that we can wait,advice
All of this and more will be answered for you in the options module, request you to please wait for a little more time. Thanks 🙂
Hi Karthik,
Today on one of the blogs I read the following commentary on index: Nifty march future OI added 0.88 lakhs with decrease in cost of carry.Today NF premium has come down from 52 to 37 points suggesting short time bottom is in place and we can see a rally.Karthik what might be responsible for fall in premium and how it helps in projecting future market direction.
A fall in premium as we progress in time is natural…I’ve explained this in the chapter as well. However I’m not sure how a fall in premium can be taken as an indication of a market bottom 🙂
Dear sir, currently I am holding SBI apr-15 future contract,is it possible to sell the same in marc-15 future using spread order. Kindly clarify
You can sell the April 2015 contract anytime you wish before the April expiry. You dont need to create a spread for this, unless you specifically want to sell March 2015 and by April 2015 and thereby creating a calender spread.
Give me an example of calender spread of current month and mid month future of any stock futures.
Current month future closes on spot price of the underlying. on expiry date. At what price the mid month future closes. on the same expiry date?
I bought current month nifty future 26MAR2015 for Rs 8570 and sold mid month future 30APR2015 for Rs 8644.
what is the profit expected if I square off on 26MAR2015 ?.
Cant really be certain about the trade churning out a profit. Also the profit really depends on how the spread between the futures converges or diverges.
How to get the following values for symbol for Ex ACC?
Lots , TYPE , SYMBOL , EXPIRY_DT, STRIKE, Call_CLOSE, Call_VOL, Put_CLOSE, Put_VOL, TRADE_DATE, FUT_PRICE .
Here you go – http://www.nseindia.com/live_market/dynaContent/live_watch/get_quote/GetQuoteFO.jsp?underlying=ACC&instrument=FUTSTK&type=-&strike=-&expiry=30APR2015 . Just change the symbol to any contract you desire.
Futures Contracts
Which one to trade current month or mid month contract?
BOSCHLTD Futures
1. Stock Futures sold BOSCHLTD 28MAY2015 – 23,035.00 bought spot at 22,579.00 Mid 456 points diff
2. Stock Futures sold BOSCHLTD 30APR2015 -22,880.00 bought spot at 22,579.00 Current 301 points diff
expiry futures price converges with spot price.Source: Bloomberg
http://www.idfcmf.com/gamechangers/wp-content/uploads/2013/06/arbitrage.pdf
It always does. That is the way futures contracts works.
From the liquidity perspective the current month is always more preferred than mid month.
sir please name any real time strategy builder software
You can try building one on Zerodha Pi – http://www.zerodha.com/pi
What’s the need to square off each side of the trade before expiry? Even if the prices converge, the profit will still remain the same, right? Please do clarify with a simple example.
Yes, in fact its ok not to square off and let the contracts expiry. The exchange will ensure it gets settled for you.
Good article . I have a similar scenario
spot :388
sell current month future : 390
buy next month future : 375
no of day to expiry 1 day
The gap between bid and ask is 5 points so we cannot square off the next month future before the expiry .
what will happen on current month expiry if we don’t square off .
Is there any higher STT cost involved like options if exchange settled the price ?
Exchange will settle only current month future. How the next month future will be settled .Please explain
No STT implication on futures. Yes, the exchange will settle the current month contract for you upon expiry. However, the next month contract will continue to roll.
Hi Karthik
I want to know why nifty future as well as SBI future is even trading lower than it market price. For SBI it is less than 1% of market price.
Well the futures tends to get into premium or discount every now and then. This is based on pure demand, supply, or the dividend situation on the market.
Dear Karthik,
Can you send me the formula in excel to calculate the Fair Value of the Future. I have tried it in excel and showing error. My Cust. Id is DL 0071
Can you share the error message? I dont have a futures pricing excel as such. It is a simple formula application, can do that for you.
Please send me the formula in order to do it on excel
Here is the formula –
Futures Price = Spot price * [1+ rf*(x/365) – d]
This is the what I am getting when I do it in excel for Future Fair Value
Dear Karthik,
I bought BNF june future at 18780 and sold BNF july at 18862. Is it a good strategy due to present situation in the market?. Can I keep it till expiry ?.
Generally this is a good strategy but please do make sure you understand the behavior of the spread between the two contracts.
Futures Price = Spot price * [1+ rf*(x/365) – d]
Can you do this formula in excel for me please.
Regards,
Have mailed you the excel.
Dear Sir,
Please mail fair value excel to me also.
Watch out for the next module, Rahul. Better excel sheets will be available 🙂
Hands down the most concise and precise information about how futures pricing works. After reading through the module a couple of number of times i’ve learned a lot about Futures. Thanks a lot for your effort in putting up all these. One question which I have for quite a long time is that what are the reason for an Equity to get banned from Futures trading. I mean when i open the Equity futures margin calculator there are always some stocks which are banned for a certain period of time. What causes the bans ? Is it only the market wide position limit or maybe some other reason.
Manish – thank you so much for the kind words.
Derivatives contract gets banned mainly if the OI reaches close to 90% of marketwide position. This is the reason for the ban 90% of the time. The rest can be attributed to corporate actions.
Hi Karthik,
In the cash and carry and spreads example you have given, we have considered the market value of current month futures would drastically rise to 700,.
two doubts
1) does this usually happen ? how can we know in which stock this is happening out of so many stocks out there, I mean a way to find out?
2) only if there is wide difference, we go for c&c/ spreads?
thanks in advance:):) also you mentioned about world of trading strategies, could not find it, can you please point me to that. Eager to read more:):)
700 points movement on Nifty may not be that easy…but I wont be surprised to see a movement of 300-400 points on the Index every month. When I say 300-400 this is what I mean – Nifty today is at 8400…during the month it can fall to 8200 and bounce back to 8300 – thus a movement of about 500 pts. More volatile the stocks, more is the movements per month.
Higher the spread, higher is the chance for making a decent profit.
We will take up trading stratergies as a module – but before we get there ppl should be clear with Options and futures…so we will certainly get there…but cant put a time line on it now.
Karthik,, How to calculate the Nifty Futures rollover price ? Could you please throw some light on it.?
Somewhere I read it as ” Nifty August Future Open Interest Volume is at 1.65 core with liquidation of 0.36 Lakh, with decrease in CoC suggesting short positions got closed today.NF Rollover price came at 8503 and NF and close below it”
Anand – there is only 1 futures pricing formula and its the same for across all expires. There is no separate pricing formula for rollovers.
in order to exercise calender spread trades ….. is it a “MUST FOLLOW THUMBRULE” that either 1 of the securities should trade at a “MARKET PRICE” which is highly different from its ACTUAL THEORITICAL “FAIR PRICE” .
is it possible to exercise SPREAD TRADE when :-
1) MARKET PRICE OF BOTH SECURITIES ARE IN THE “FAIR PRICE” ZONE ?
2) MARKET PRICE OF BOTH SECURITIES ARE HIGHER/LOWER TO THEIR “FAIR PRICE” ?
1) If contracts are at fair price, arbitrage opportunities dont show up.
2) Possible in this case.
thank you sir .
1) how to use the spread trading with reference to only currency & commodity futures ?
2) i still did not understand why the need to square off before market closes ? will we not get the spread-benefit when the positions are auto-squared-off ?
3) is there any way to determine convergence point when we can expect both scripts to be at the same LTP ?
4) is this phenomenon common in currency / commodity derivatives ?
1) Spread trading with Currency and commodities is the same. Same technique, different instruments
2) Can you please give a reference to your 2nd query?
3) On expiry both spot and Futures converge
4) Yup, opportunities do exist in commodities and currency segment.
hello sir,
reference to second query :-
PRACTICAL APPLICATION 10.2 :-
wipro spot = 653 , future fair price = 658 , future actual market price = 700 …… future is expensive…… we sell expensive future and buy cheap spot .
my question :-
1) when we want to do it for example december fut & november fut of USDINR ? what should be the strategy ?
2) since prices keep on changing shall we calculate the fair price using open-price / close-price / LTP ?
3) is there any kind of ready fair price calculator , indicator to say which future is going expensive or cheap compared to fair price ?
thank you
1) Depends on the fair value of the instrument
2) No fair value should be calculate based on Futures pricing formula
3) Not that I know of, its better to build a small excel yourself rather than depend on other resources.
Hi Karthik,
Thanks for explaining the concepts in detail.I have a query.”Sell futures and buy spot”. This means whether we need to sell 1 lot in futures (maybe 250 stocks) and buy same 250 stocks in spot (cash) market?. Dont I have to spend much money in spot market as I dont have leverage and I have to pay full cash,whereas in futures I have the luxury of leveraging.It might be a silly question,but I am novice in futures.
Also,could you please make video tutorials,so that concepts may be more clearly understood.
Yes, its best done in the same proportion and yes the spot purchase requires a huge cash outlay, but there is nothing much you can do about it when it come to opportunities like these.
Sorry, we really don’t have the bandwidth for video tutorials.
sir, i know the futures pricing formula .
but value of SPOT price is what exactly ….. SPOT OPEN PRICE , SPOT CLOSE PRICE , SPOT LTP ?
Spot close.
Hi Karthik
What if the futures of a stock is trading at considerably lower price than the Spot price. Shall we buy it as at the expiry both the prices shall converge? The only demotivating factor being what if the spot price goes down to meet the futures price which can go down by the expiry.
The same thing I can notice with NIfty midcap 50 index as well
Exactly! The futures gets into discount or premium based on demand supply.
Sir. Where to find Calender spread easily.. Pls suggest any mobile app or website..
Thanks
Not sure about an app for this.
In calender spreads selling at higher price of the current month future and buying mid month future at the lower price comparitively is always profitable ..Is vise versa true??????
Its profitable provided an arbitrage opportunity exists, and the trade has been executed well.
hello kartik…
nice module easy to understand…u have explained so easily. i m new to share mkt.. i have some doubt regarding future pricing of infosys that how u calculate the no.of days for mid month(34 days) and for far month(80 days)…
Yup, as long as you take the actual number of days its ok.
in calendar spread section buy current month and sell mid month , at the end of the expiry we make profit , here i have a doubt mid month price and current month price will same at the end of the current month expiry, please explain
Not necessary that they have to be the same. The price of current month futures and spot will be the same, whereas the mid month futures will not be the same as current month futures.
Nifty spot is trading at 7615. When I calculated the fair value for March series, it comes around 7736. However, it is currently trading at 7691. There is a diff of more than 40 points. is there a trade?
Possible. However do note that this is a ‘routine’ premium discount value. Not sure if its worth taking the trade.
To calculate Fair Value of Nifty Future using formula = Spot price * [1+ rf*(x/365) – d]. What wud b value of d in this case?
Dividend yield of Nifty, roughly about 1.49 as of y’day.
Check this – http://www.nseindia.com/products/content/equities/indices/historical_pepb.htm
Spot price * [1+ rf*(x/365) – d]. According to this formula, if I try to calculate fair value of Nifty Jan Future 7601 * [1+7.2274%*(80/365)] – 1.52 The result is 7716. As LTP is 7764, the difference is 48 points. What type of trade can be advisable? Should I Buy March Series and Sell Jan Series? Or Should I get into the conventional Calendar Spread Strategy by Buying Jan Series and Selling March Series?
This spread is between fair price and market price. One of the ways to capture this is by being long and short on the same instrument…you could sell futures and buy the Nifty basket (maybe Niftybees).
How to put calender spread order in pi?
You can do it manually or utilize a the spread order window. Suggest you shoot an email to support at zerodha dot com for this. Thanks.
1. How to put calender spread order in pi?
2. In the future price formula ‘x’ is only no. of days or trading days ? Which is correct?
3. What is the value of ‘d’ in the future price formula for usd/inr currency pair?
Please contact support for queries related to Pi.
What is the value of ‘d’ in the future price formula for usd/inr currency pair?
D (Dividends) would be 0.
Hi Karthik, I have a question about Calendar Spreads. Can I apply Calendar Spreads Strategy as follows,
CEAT Spot LTP @989.30
CEAT Future March 16 @994.85
CEAT Future April 16 @982.00
I see that the current month contract is expensive in compared to mid month contract. There is a 12 points difference between both the contracts. Can I get a benefit from it?
You can sell current month and buy future month contract with a hope they will converge at some point before March expiry.
Hi Karthik, thank you for your reply. I tried to apply this strategy on ceat but the future already converged and there was no difference between current and mid month contract. Both contracts price were same so I missed this opportunity. Hope to see this type of opportunity again. God bless you.
Does the nifty premium or discount indicates the direction of the market
Nope.
hey there hlp me in sorting this out
in above eg, of Wipro the futures are trading higher than cmp of spot eg 700 compared to spot cash cmp of 653 so it was possible to short futures using NRML by holding overnight what if its the other way round ie, future price being lower to spot price i can take long position in nifty futures what about shorting nifty till expiry.. is it possible ?? or i would end up with short delivery ?
There is no concept of short delivery in Futures market, so you can trade futures irrespective of where the futures is trading wrt the spot.
i guess i was misinterpreted. i’ll clear it …. in example of wipro given above,there is this statement
“The thumb rule in any sort of ‘spread trade’ is to buy the cheaper asset and sell the expensive one. Hence going by this, we can sell Wipro Futures on one hand and simultaneously buy Wipro in the spot market. ”
it says buying of wipro from the spot market @ 653 and shorting wipro futures @ 700 cuz obviously wipro futures being expensive than fair value of its spot price
but conversely
if futures are let’s say @ 645 and spot @ 653 and there are 7 days left for expiry i can go long in futures till expiry, but i cannot short in Nifty spot for more than a day to get a fixed return
Rohin – unfortunately you cannot short in spot and carry forward the short position overnight. In such cases, you will simply have to let go.
it would be like Reverse Cash-and-Carry-Arbitrage
Yup, it would be. There is one way out via SLBS – http://www.nseindia.com/products/content/equities/slbs/slbs.htm
Spot price * [1+ rf*(x/365) – d], d assumed for wipro and infosys stock is zero because they haven’t announced the dividend. this means these stocks will be trading at premium until latest dividends are announced?
for nse stocks what is the value of d?
For all stocks, d refers to dividends.
All else equal, Futures always trade at premium to spot.
Sir, how is it possible that a next month future trades at discount to near month future.
can it sustain till expiry of near month or will the spread eventually come in positive
thank you
Technically it should trade at a premium, but the short term demand supply can dictate the theoretical pricing formula. Short term can extent to the entire expiry.
what is the relation between (a) OI (b) Change in OI and (c) premium and/or discount of futures. If there a link where this can be observed. How to interpret it at the same time . Thanks
Naresh – you should check the table I’ve put up in the OI chapter. This will help you get the answer I guess.
is it as simple as that – if open interest increases and premium increases, then it could be bullish ? can you assume that if the stock price increases but futures OI decreases, then this is short covering ???
You will have to combine volume data as well 🙂
What is necessity ( more advantageous) of making Arbitrage in Futures trading , when 1 is sure that , both the equity and its futures have surged / declined to such an extent , that is , in coming days ( … maybe tomorrow ) there will be a correction,
like what happened, 2 days before on 2 nd May 2016 , STFCL spot / futures both May (current month) and June ( *** far month)has gained momentum of +12 % to +16 %,
I am the fair opinion ( many may differ)that , if a scrip behave s either +/- 10 % , one should take a position against the market-movement , once it crosses that 10 % by more i.e + /- 11 %.
so instead of using one’s funds for taking arbitrage position , like as STFCL being closed on 29 th April 2016at 980, and has made rise to 1100 at 13.15hrs on 2 nd may 2016, instead of buying equity 9either intraday- or otherwise STFCL @1100 and selling may / *** june futures @1120
.
when one / you are sure , within short period it is going to correct the price,
so my view one should short 2 position of either may /*** June features of – STFCL @1100 and @1125.
any views specific to counter my view are welcome…… [email protected]
The position that you suggest taking sounds more like a directional bet rather than an arbitrage, unless I’m missing something here.
Hi,
I see ITC JUN fut is trading at a discount to its spot price currently and read news that its gonna announce dividend during q4 results. So this is according to what is written above.
My doubt here is that, will the futures price converge to spot here also at JUN expiry. Or will it be spot = futures + dividend?
Thanks,
Shankar MR
Usually the futures price gets adjusted to spot after the dividends are paid. However this also depends on the demand and supply at that particular moment.
How can one roll over future BUY position to the next month future with minimum loss on premium
The only option for now is to let the current month contract go into expiry while at the same time buy the next month’s contract.
How do I actually trade an arbitrage when the Future Price is less than the Spot Price? How is it possible to sell scripts on the Spot market and hold till expiry when I do not possess shares in the first place? Is there any system that allows me to sell in the spot market and hold till expiry of the future? I understand the mechanism when Future price is more than the Spot though but the mechanism of the reverse has me stumped. Please help. thanks
Well, you cannot short in spot market and hold till expiry. Of course you can use the SLBM window to do this – https://www.nseindia.com/products/content/equities/slbs/slbs.htm, but can get quite messy..mainly because you will not be able to match quantities.
Hi sir,
I have a small doubt regarding the futures trading at discount.you said that SHORT TERM SUPPLY AND DEMAND IMBALANCES IN FUTURES CONTRACT, causes the futures trading discount. can you please give me some clarity on this sir.
Thanks&Regards.
If for some reason, the futures are sold (maybe long unwinding) and goes below the spot, then it is said that the futures is trading at a discount.
Thank you very much for clearing the doubt sir.
one more doubt sir. i saw in a news paper that “bets in f&o segment decreased so the spot price is decreasing” not exactly written like this . can you please explain the reason behind this sir.
Ah, very difficult to explain unless I get the exact context!
in calendar spread (what if the mid month contract doesnt stick to the fair value) , for example if the market value of mid month futures is also high ,then how it will turn out .
thanks®ards
There is certainly a possibility of this, in fact there is no guarantee that the spreads should converge by expiries. One needs to diligently evaluate the situation carefully.
Sir after reading this module i started checking the prices of different stocks having different maturities and i encountered that :
For the july month expiry GMR INFRA is trading at 13.55 For the august month expiry GMR INFRA is trading at 13.70 and for the September month expiry GMR infra is trading at 14.So my question is that is it possible for me to sell GMR infra at Rs 14 having a expiry on september and instantly buying a JULY month contract at Rs 13.55 and make profit of 0.45 per share instantly??
Technically yes, and you will profit as long as you establish that either July/Sept contract is not priced right.
Sir after reading this module i started checking the prices of different stocks having different maturities and i encountered that :
For the july month expiry GMR INFRA is trading at 13.55 For the august month expiry GMR INFRA is trading at 13.70 and for the September month expiry GMR infra is trading at 14.So my question is that is it possible for me to sell GMR infra at Rs 14 having a expiry on september and instantly squaring off or unwind my position by buying a JULY month contract immediately at Rs 13.55 and make profit of Rs 0.45 per share instantly??
Sir if this is the case than every body will first sell far month future contract and instanly square off his position by buying a near month future contract and make instant profits.As in most of the cases far month future contract is priced higher than the near month future contract..
The trick is to make sure you know the pricing right. Agreed, Futures always trade a premium (in most cases), but that alone does not justify for a trade. You need to establish if there is a mismatch between the theoretical and market price, if there is a mismatch, only then you have an opportunity to profit.
Sir i didnt get you….
Sir, as you said that if future trade in premium that cant be justify for a trade but why sir??? Can you please explain me this with an example..
I’d suggest you re-read section 10.5.
Sir , i am unable to find 10.5 paragraph in this article.The last paragraph which is showing here is till 10.3…
My bad, I meant 10.2! Sorry for the confusion caused.
Sir,but in most the cases there is always a mismatch in pricing because the far month future price in most of the cases is higher than near month future contract so all you need to do is just sell far month future contract and immediately square off your position buy buying a near month future contract and earn instant profit.Is that right sir???
Mismatch exist, but you as a trader should be able to figure out to what extent the mismatch is fine. Anything beyond the acceptable level is when true opportunities comes about.
Hi, sir. if iam looking at a 5 min. chart of a an equity future, is it really the buyers and sellers of future contracts driving the market, or is it the buyers and sellers of the underlying equity driving the price of the futures in the chart. i found the charts of futures and equities moving in a similar pattern as if they are moving in sync, if it is so the buyers and sellers of future contracts have no role in driving the price of fututres?
Well, technically speaking its the influence of the spot on derivatives, but if you are looking at short timeframes, then it would be hard to explain which segments influences which one.
Thank you sir.
Welcome!
Under 10.3]calendar spread – you wrote in this chapter that “the spread is the difference between the two future contracts i.e 700 – 665 = 35 points”. Suppose lot size is 1 share, i am long on current month contract and it is trading at 100 rs and i am short on mid month contract and it is trading at 105 rs, spot price is 99 rs, this means that profit must be locked at 5rs i.e the difference between two future contract, if spot price drops to 95 current month contract value also decreases to 96 and i make a loss of Rs 4 when i sell the current month contract and similarly since the spot price has decreased mid month contract [on which i am short]price will also decrease to Rs 101, so when i buy the mid month contract the profit will be Rs 4, thus on current month contract i am loosing Rs4 and on mid month contract i am earning Rs 4 thus no profit no loss, then how can you prove the statement “the spread is the difference between the two future contracts”, as per your saying in this case profit must be Rs 5 but there is no profit no loss.
I’d suggest you also have a look at this chapter – http://zerodha.com/varsity/chapter/the-usd-inr-pair-part-2/
Sir,
For spread using nifty or stocks which is more beneficial. Also we have to wait till expiry or can we square off the spread earlier. Also in Pi, if I add nifty spread for August and September, then it shows a number like 45 (it’s changing during market hours). What is it ?.
Which over contract has higher liquidity is the better one! Given this, I’d stick to Nifty futures. Spreads are not available on Pi, I’d suggest you use NEST.
Sir,
1) If I forget to square off my long position on the expiry day, whether the exchange pays me considering the closing price of futures (closing price* lot size) or the spot market price of the underlying?
2) Is it guaranteed that both the futures price and spot market price would come down to same exact value on the expiry day?
3) If I want to apply CC arbitrage then i need to maintain a huge amount of ((spot price of asset*lot size of futures)+ full margin for 1lot of futures). So that I can hold both the positions till expiry. Correct me if am wrong.
4) Lets say I have two lakhs in my account and I applied calender spread on Nifty current and mid month futures. Now because of hedging only Rs 20000 (just for example) is blocked in my account as there is margin benefit. So can I use the remaining amount (ie Rs 180000) in my account for trading until I close the calendar spread positions at expiry?
1) On expiry day both the futures and spot price converges to a single price.
2) Yes, this is how the Futures theory works, they converge to a single price
3) Yes, it requires you to have enough funds
4) Yes, you can.
Today 25/8/2016, is the expiry day for August 2016 series.When I checked spot price of AB Nuvo, its 1280.80 whereas the futures price is 1279.75.There is a difference of Rs.1.05. As per theory, both prices should converge on expiry day.However,what does this minute difference indicate? Is there any oppurtunity available if such difference exists??
You would have probably seen the last traded price, I’d suggest you look at the settlement price which is updated by 3:40 PM.
I feel so happy to know that now I too know the many jargons of Trading which I wud never have learnt in any classes. Thanking hundred/thousand times will be too less I feel. God bless u and all your team for the wonderful work.
I wanted to get clarity on foll points, I wud like to know:-
1. Do we have to work out the fair value.. or just the market price of resp contract as it is.. gives us the CS.
2. During the normal course, nifty fut spread price of near, mid and far ..does not call for taking adv of CS trade. V can as well take long or short trade on nifty fut ..current fut using TA or our directional view. Is it right to say then that we need not scout for such differential CS .. or is it that we can profit more in such trades in futures rather than going for stocks trading under MIS.
3. can CS trade be squared off on the same day as MIS or… is it wise to carry for few days .. or till nearing expiry.. to get the full potential of the trade. If the target of 10/15 points is achieved , can v square off the trade.
Thank you so much for all the kind words. Words like these motivate us to be better and give much more than 100% 🙂
1) If you intend to do a calendar spread, then estimating the fair value is required. This gives you a sense of how the market is pricing the futures
2) Certainly, the end game is to be be profitable either which ways. However, you need to sure there is some consistency and you can repeat the process of identifying a profitable situation again and again
3) You can choose to square of anytime you wish. But from my experience CS pans out well over few days.
in the table given to explain the calendar spread— so it means that the price of the 1st month futures contract at the time of expiry is same as the spot price(approx), also the 2nd month futures is trading at the same price at that time???
Its kind of tricky…you identify the spread when it occurs (between the 2 future contracts) and close it before the 1st month expiry when you deem it suitable. At the end of the expiry, both spot and futures (of near month) will converge to same value.
can’t it happen that instead of futures price moving down, the spot move up and catch the futures price on expiry? though according to formula this does not seem possible as the futures price will go on decreasing due to reducing expiry days? but in one of your comment you have said that when the futures price is discounted sometimes it might happen that the spot price may fall instead of futures catching up the spot.
It can, the point is that they converge upon expiry. All possibilities should be expected.
As you say that at the expiry both spot and future price converge. Let say today (08 Sep’16) spot price is @100 and Current future(29Sep’16) is @150, so is that mean as the time approach to expiry the spot price move up and future move down? (Because this is only possible in case of convergence). Is the below figure valid?
Many possibilities –
Spot stays where it is and futures catches up
Futures stays where it is and spot catches up
Spot declines, Futures increases
Futures declines, spot increases.
In the calander spread example table row 1: why have you subtracted 660-665? It is necessary that mid month future value will also be equal to expiry value of current month value
Not necessary, I have just assumed the prices here. At expiry the spot and current month futures converge, not the other month contracts. When you initiate a CS, it is important to track the spread and close it when you see a satisfactory convergence.
You mentioned that in calender spread the margins are greatly reduced as this is a hedged position. for ex. In case of one lot of Hindalco futures sell in sept and buy in October , what is the margin required?
What are the risks in such calender spread strategy?
Does your trading software identify such opportunities ?
You can use the margin calculator to identify the margins required – https://zerodha.com/margin-calculator/SPAN/
The greatest risk of CS is execution risk, this bit is explained in the chapter itself.
Pl reply the 3rd query: Does your trading software identify such opportunities ?
No there is no in build tool which will identify such opportunities. However, you could try to build one yourself using the ‘Expert Advisor’ feature – http://zerodha.com/z-connect/tradezerodha/pi-tradezerodha/eas-for-auto-buysell-signals-pi
Hi Karthik, very well explained article, however if you do cash vs futures as explained all the profit will be lost in brokerage and transaction cost..The idea has merit If the basis is high
Exactly why you need a broker like Zerodha 🙂
Dear Sir,
Thank you very much for such a nice explanation.
I have only one doubt about calculating future price. In future we do not pay entire price we pay only margin money. So Ideally the future price should be spot : (Price – Margin money)*(1+Rf(x/365))-d. As we can deploy that difference of spot and margin money to for risk free rate and earn interest on it. As per your formula we are considering interest on entire spot price whereas we atleast have to pay margin money.
Price – Margin Money? This will yield a -ve number I guess? Also, I’m not too sure about the logic you are stating.
Current level of NSE Nifty is 4500. A 3-month Nifty futures contract is available at 4600. Risk-free rate is 10% and a yield of 8% per annum is expected on Nifty. Find out the fair value of the Nifty contract. What is the arbitrage opportunity? Find out the gain or loss to an investor if the Nifty value on the settlement date is 4200.
Could any one please provide me its solution.
Danish – this looks straight out of NISM study material 🙂
Suggest you apply the formula and give it a try!
Dear Karthik
How to apply cash and carry arbitrage strategy for indices (e.g. Nifty / Bank nifty etc.) since we don’t have any instrument in SPOT market to buy index…. Do we need to buy Index based ETF in that case ?
Nope, Futures – ETF arbitrage may not be a great idea as the ETF has low liquidity and higher tracking error.
Thanks Karthik, so cash and carry arbitrage strategy is suited for individual stocks only and not for index
Sort of.
Hello Sir,
In calender spread, if the actual market value of current month futures is trading way above the fair value, why should one long the mid month futures along with the short of the current month futures? Anyway by the current month expiry, we tend to get the guaranteed profits. Pls clarify. Thanks in advance.
The thumb rule any arbitrage trade is to short the expensive contract and go long on the cheaper one. Since current month is trading higher than ita fair value, its perceived expensive.
Futures Price = Spot price * [1+ rf*(x/365) – d]
not able to calculate the future price. Could you please send me an excel file.
would be a great help.
Will try and put up the excel sheet online. Thanks.
hie, kartik.. just a thought stuck me, instead of buying eq shares of a company from cash market can’t we buy it in derivatives market (exclude : quantity parity,dividends,rights etc ) and just keep on rolling it over near the expiry date.. at probably much lower cash compared to taking delivery
Yes, you can do that. But remember you need enough money to fulfill the daily mark to market obligation. In case the stock falls 10-15% intraday, then the obligation can be quite devastating. This can be quite painful, especially if one does not have a deep pocket.
Hi sir. I’m not able to understand the calculation done for future price. When we computer the formula. I’m getting different answer. Pls help me to understand this concept sir
Can you please let me know where you are getting confused/stuck? That will help me, help you better. Thanks.
Hi Few questions reg Calendar spreads ( Futures to Futures)
1) How to chart them
2) How to find if there is misprising ( any screening software ? add on?
3) How to calculate margin offset easily and automatically?
4) Do they really work after paying the brokerage and fees?
Will be discussing this in detail very soon. Thanks.
Sir,I wanted to know,if there is suddenly a strong fundamental news about the stock,will the Calendar Spread technique work?
Most of the short term trading strategies misbehave when there are strong fundamental news flowing in.
Sir,
In the future pricing formula,Is X the number of trading days or calendar days?
Calendar days.
I have query which I need to clear, I analyse stock chart of cash market and get entry, exit price & SL, but how should I get the stock futures entry, exit and SL of the same stock to trade, as there is chart only for cash market to analyse. and spot and future price always different which sometime hit my SL and skip entry order. please help me. if is there any formula in excel to calculate the price difference compare to spot price let me know.
I personally use the corresponding price (whatever it could be) on Futures.
Hi Karthik,
Stock future is trading at Rs.9 discount to spot. Volumes are heavy volumes both in spot and future. what should be done.
Regards,
MSP
Hard to establish a trade with just this much info.
Hello
I have 3 doubts
1)fair value=(1+rf*(x/365)-d)
how to calculate dividends if i want to trade nifty50 futures
Do i need to check whether the top 50 companies are going to announce their dividends dates in near and mid month? or is it something else
2) Also in many comments above or i see that may wrote to square off the contracts before expiry. But we cannot square off the the futures contract until the expiry is reached unless in options. right? We have to wait till the expiry
3)Also suppose today i buy march futures and sell april futures the spread is 30. so on march expiry date the first contract will expire and the other will still be going on…so let it be a loss or profit…the actual profit/loss will only be calculated on april expiry date. right? which depnds on the spot price on april expiry day.
1) You can use the dividend yield of Nifty 50
2) YEs, its mainly for option because of the way STT is charged. Check this – http://zerodha.com/z-connect/queries/stock-and-fo-queries/stt-options-nse-bse-mcx-sx
3) You should trade this with respect to convergence of spreads. On march expiry, March fut and spot will converge…April contract can continue to diverge/converge.
Thank You for the explanation but i have 1 doubt
1)Do i need to check the last day yield or 3 year average yield? i.e. what time period should I take.
TIA.
Latest yield.
Dear kartik,
What my understanding is – ‘opening price of an equity is calculated based on pre-market orders in pre-market session’. But for futures, there is no pre-market session. Please help me to understand how opening price of a future is decided?
Futures takes cues from spot, almost on a real time basis.
Hi Karthik,
When does the arbitrage opportunity for a calendar spread arrive for near and next month of the same future if there is a significant difference in the Cost of Carry between the two future prices?
Thanks,
Dhruv
Dhruv, Cant really take a call on when the opportunity arises. It really depends on the market and liquidity situation.
hello sir,here in this article you are talking about the differences between prices ,sir now applying this concept today I found the ceat ltd the mid month contract traded at 1476.20 and the for month contract is traded at 1550.70 but the my problem is that when I look at spot price the diffrence is in negative no. while in above example you are talking about the diffrence is in positive no. i.e, spot price is low and future price is high so in this sitiuation when the condition is just opposite so how can we take the position…..
You should be comparing the two future contracts. Anyway, when you have an opposite situation, you should take the reverse positions.
I have seen that generally Futures price moves in the same direction as the underlying Spot price, even though not by the same amount. I have been observing the price of TCS (Tata Consultancy Services Limited). When the spot price has been going up, Futures price went up too and vice versa.
However, ONLY TODAY, I found that the spot price of TCS is DOWN -7.10 while the Futures price is UP +14.10. What is the reason that Futures price went UP while the spot price went DOWN only today?
Yes generally – Spot price dictates the futures price.
Maybe futures is discounting a dividend?
Can you give an example with formula about how to calculate the Futures price when dividend is declared? The examples given above do not take into account dividend. Thanks.
Yes, will try and do that soon. However, it is quite straight forward – you just need to subtract the dividend (d) from the return (r) in the formula.
Que 1). In calendar spread;
case1- what if there is few points of differnce(assume 6 pt) between fair value and market value in current month contract.
Case2- there is a gap of around 40 points between fair value and market value in mid month contract.
….what in this case
Will i have to buy the 1st month contract and sell the 2nd month contract.
Que 2) what in case of current month contract and end month contract, will this technique helpfull there?
1) No point breaking your head if the spread is low
2) Always treat in % terms, not absolute points wise
3) Its the same
Que3) sir, what do you mean by rf(risk factor rate), why you have taken it from the rbi current rate(8.3528%)?
Mistake in que3., I mean to why from RBI 91 day treasury bill ?
Becasue RBI issues the 91 day treasury bills and its backed by the Govt of India. So its presumed to be risk free.
Rf is risk free rate, which is the rate offered on 91 day bill.
why is there a difference in the prices of infy on 20 Feb 2015 on nse website https://ibb.co/g78AJ5 and the pi software https://ibb.co/ekKvkk ?
Guess you are looking at two different time periods.
Hi Sir,
Why Future price is lesser than Spot price in today’s Nifty ?
https://www.nseindia.com/live_market/dynaContent/live_watch/get_quote/GetQuoteFO.jsp?underlying=NIFTY&instrument=FUTIDX&expiry=29JUN2017&type=-&strike=-
Thanks
It is possible for the futures to trade lesser than spot. Guess, imbalance in demand supply is one of the reasons.
I am a zerodha member (beginner). I like the above lesson 10. How am I get other lessons? Thanks.
Click on the next lesson 🙂
I sir .I m a beginner .today ultra tech chem spot price decress 70 points .all strick of put call get increase except one stick price .its decress arroud 30 pts .sir may I know the ans why its happed .
I’m guessing you are taking about a call option. Call option premiums decline in value when spot price falls.
Regarding fair value calculation, I have a doubt.
Following numbers I am putting in –
Nifty 50 Spot price: 9,683.35
rf : 6.3149
d : 1.18
Todays Date: 05-June-2017
Future price of near month = 9683.35*(1+0.063149*(24/360))-1.18 = 9722.94 (but current month future is trading at 9,690.00)
Future price of mid month = 9683.35*(1+0.063149*(52/360))-1.18 = 9770.50 (but current month future is trading at 9,707.15)
Future price of far month = 9683.35*(1+0.063149*(87/360))-1.18 = 9829.95 (but current month future is trading at 9,730.70)
I am not able to figure out what the wrong I am doing.
Can you please help?
You need subtract the dividend yield from the risk free rate.
Even when I am subtracting dividend from risk free rate, I am not getting the correct fair.
Can you please calculate near month future fair value of nifty?
Nifty 50 Spot price: 9,683.35
rf : 6.3149
d : 1.18
Todays Date: 06-June-2017
Days to expiry: 23
Thanks
Around 6630?
Shouldn’t dividend yield be 0 since nifty is an index and doesn’t give dividends or it is non zero because the included stocks in nifty might have to pay dividends? Also from where can I get this value?
One more question, when you say you are using RBI 91 Tbill rate as a proxy for risk free rate, what is the actual value and where to find it?
You answered it yourself 🙂
Its non-zero because the stocks give out dividends. Check this for Nifty dividend details – https://www.nseindia.com/products/content/equities/indices/historical_pepb.htm
You will find the 91-day rates on RBI website. Cant paste the link as its popup.
Hey,
In the calendar spread section, you are comparing the price of the mid month contract with the expiry value of the current month contract. Won’t the mid month contract be trading at a different price than the expiry value of the current month contract at the time of expiry of current month contract?
Thanks
Yes, hence we cannot expect a perfect convergence between the two contracts. We need to track the spread continuously and close it at a point where the convergence between the two spreads are satisfactory.
But for the calculation of the mid month P&L, shouldn’t we subtract ‘665’ ( buy price of mid month contract ) from the price at which the mid month contract is trading at the time of expiry of current month contract?
Why are we subtracting it from the expiry value of the current month contract?
665 happens to be the buy price, so we take that value.
No, I’m talking about the expiry value. Shouldn’t the calculation for mid month P/L be (price of mid month contract at the time of expiry of current month contract) – (buy price of mid month contract)
True, it is supposed to be that way.Not sure if I’m missing something here…the assumption here is that the futures will converge to its fair value.
Hi Karthik,
Thanks Karthik for such detailed explaination.
I just want know, up to what extent the future price depends on its demand/supply? Is there any limit on the difference between actual future price and the fair price caused due to high change in demand/supply?
No, there is no boundary conditions as such.
How does futures reflect any corporate announcements in its prices. For example, suppose a company undergoes a demerger which results in the underlying stock price being halved overnight? What happens to the futures in this case?
The futures price gets adjusted as per the corporate action. This is usually informed by the exchanges to all the market participants well in advice via circulars.
Karthik,
In this page you have quoted.
“From the above example, clearly the current month futures contract is trading way above its expected theoretical fair value.”
I am new to futures. Could you please explain how this is possible in futures market. How could the current/mid month futures trade above the value calculated by pricing formula. All I can imagine is that future price is derived from spot and the players in the futures market based on their views decide to either buy or sell looking at the latest price per formula. Is there a concept of last traded price in futures? Please explain.
Well, on one side you have the theoretical value. But on the other, markets have their own demand supply dynamics. This leads to price disruptions, which basically further leads to the price difference between futures and spot.
I think I got your point. In a scenario like below,
Wipro Spot is trading at = 653
Current month futures fair value (30 days to expiry) = 658
If I am bearish on Wipro Spot/Wipro futures , I can sell at a target price less than 658, if there are no buyers at 658.I think this is what brings the difference between fair value and actual value of futures. Please correct me if I am wrong.
I must say one thing. Excellent articles. I have never tried futures trading. Didn’t even understand it. Now I have some idea. Thankful to you Karthik.
True Mahesh, your understanding seems to be headed the right way.
Happy you liked the content, good luck and happy learning!
Hi Karthik, I have a question about Calendar Spreads. Can I apply Calendar Spreads Strategy as follows,
TATA STEEL Spot LTP @520.60
TATA STEEL Future June @521.85
TATA STEEL Future July @ 514.70
NIITECH Spot LTP @577.30
NIITECH Future June @578.40
NIITECH Future July @ 576
I see that the current month contract is expensive in compared to mid month contract. There is some points difference between both the contracts. Can I get a benefit from it? ( If i had done this today ! the expiry for the June month is Tomorrow)
You can based on the assumption that the difference between the two will shrink and you’d profit from it. However, I’d be a little hesitant to carry this out, considering tomorrow is the expiry for June futures.
What if the gap between the both futures price is 6 to 7 rs and it is the start of the month ?
You need to figure if the difference is justifiable, if not, then you probably have an arbitrage deal.
Hi Karthik, Is there any tool for identifying such scenarios.
Nothing that I know about.
Hello Karthik,
Earlier we learnt that futures price mimics the spot price but in ‘Cash & Carry Arbitrage’ we see that both of them are moving in different directions, this is making me confused. Pls tell me Am I thinking wrong? and help me to clarify this doubt.
In cash and carry, we are dealing with the spot price of the same stock across two different exchanges. You essentially buy on one exchange and sell the same qty in the other.
Hi Karthik, It’s regarding Cash and Carry Arbitrage Trading …
Cash and Carry trades executes when BUY @ Cash market and SELL @ Futures market till Expiry …
Say, the Stock had a nice Rally , Our Cash entry will be in Profit, Our Futures entry goes to M2M Process …
My questions, We have used entire fund for taking these positions … what if the Margin amount came less than Exposure Margin
and then came down to SPAN margin ( Span : 7 and Exposure : 5 )… On this occasion, do we need to pump money or will it be balanced with Cash market Positions , because in Cash market we are in excellent Profit ?
Thanks
You need to fund your account with additional cash to continue the position.
HELLO KARTHIK SIR,
I HAVE GONE THROUGH RICH-KNOWLEDGE IMPARTING MODULES OF ZERODHA…I AM THANKFUL TO YOU FOR UPLOADING SUCH BEAUTIFULLY NARRATED MATERIALS FOR NOVICE LIKE US…I FURTHER REQUEST TO YOU UPLOAD MODULE ON ‘ROLLOVER’ ITS IMPORTANCE AND ‘ROLLOVER COST’ SO THAT WE GET BENEFITED.
PLEASE SIR…THANK YOU IN ADVANCE AS EXPECTING YOU WOULD LOVE TO DO IT…
Vijay, rollover is not really a big thing. It is just about carrying forward your position to the next series. In my experience, I’ve not really found any valuable information coming out of ‘rollover data’.
Hi Karthik Sir..
Sir in cash and carry arbitrage why is there a need to find whether future price is at premium or dicount. If we are taking opposite positions in both cash and future market then we will always have profit irrespective of whether price at expiry increases or decreases. Please explain this sir..
Thanks
You need the price to build a perspective, Amit. You cannot be profitable as the price may (or may not) be sustainable.
Thank you Sir for your reply. But still I am having the doubt. It’s not fully clear.
Which part is not clear?
I maen to say that in your example above you took three different prices at expiry to show that the profit would always be same. Then I just can’t understand why is there a need to find the fair price. If I take a long position in Cash market and a short position in Future then I will earn the spread between them irrespective of what the price is and if I take opposite positions in both markets then also I will earn the spread. So why fair future price is necessary and why one would need a perspective?
Thanks
Well, the whole thing is valid because we were able to peg the market price with the theoretical price to get a sense of how cheap or expensive the futures really is.
In the main text futures formula is Futures Price = Spot price * [1+ rf*(x/365) – d] whereas in the key takeaway section the formula is Futures Price = Spot price *(1+Rf (x/365)) – d , sir please clarify the same
Main text is correct, looks like I’ve not placed the brackets properly.
Hi,
I have applied the same formula for Apollo tyres dated:8/9/2017–Spot was at 252.4 & Sept 28th Futures was at 252.65at day close .When I calculated I got the futures price as 253.3 …Can you please explain for Sept futures ..
It seems ok to me PRadeep, why do you think its wrong?
Sir,
There was a difference of 0.65 paise in the market close price of Apollo Tyre futures on 8/9/2017 and the price which was calculated manually .Was wondering where this difference is..Close of Futures price on 8/9/2017 was 252.65 and when calculated it was 253.3.How to trade in such an instance.
Such minor deviations from the fair price is normal, Pradeep. It may not be worth trading these considering the charges involved.
What Should be the dividend yield to be applied for Apollo Tyres for calculating futures pricing for trade date–8/9/2017′
If you are expecting a dividend yield, then subtract that from risk-free rate.
If the Nifty Futures is trading at a premium (say 0.1%) against spot , but well below its fair value (say 0.1%) & change in OI is 4.5% what do you conclude.
This is actually a nonevent as all the numbers that you’ve quoted are quite small. However, if the difference between the fair value and spot is large, then maybe we do have an arbitrage situation.
Sir, can we take future trade on the basis of technical analysis??
Of course, you can!
Hi Karthik,
I’m currently following Infy. And from the historical data, i’ve seen that there is always a price arbitrage of about Rs.17-20 at the start of the series between the spot and the futures mid month contract. For eg: Today infy spot is trading around Rs.939 while the infy fut nov is trading at 919. Is this a price arbitrage opportunity?
Thanks.
Sorry, let me correct. Not *always* but many times. How large do you think the spread should be in this case to make the trade worthwhile?
Let me correct myself again (i wish there was an edit button for the comments). I meant Infy fut oct is trading around Rs. 939.
Isn;t there a quick edit button available? Anyway, yes, I’ve seen this Infy Oct and Nov futures.
About 1.5 – 2% spread is decent for short-term trades.
I noticed this too, Subir. Yes, a decent opportunity assuming no corporate action like dividends etc.
Hi,
In the post, it says days of expiry of contract? Does the remaining days mean the remaining trading days for the contract (or) all the days including weekends + holidays?
Thanks,
Rakesh.
It includes all the calendar days.
Dear KARTHIK SIR,
Great to learn from your simple illustration. I have a query…..For trading long in future contracts , is it compulsory to put stop loss, and is it mandatory to increase margin amount during the trading day when the price of a contract decrease (compare to bought price)
It is a good practice to put a stop loss, not mandatory. Yes, in case of increased volatility on the stock intraday margins can increase.
hello
can i purchase a future contract of current series and sell the future contract of next series simultaneously also
can i square them off next day by setting the target differently for both the order?
what will be the margin required for the trade?
or
do i have to hold them till the expiry ?
pls reply
hitesh
Yes, you can. You can square them off anytime. Margin depends on the contract – https://zerodha.com/margin-calculator/Futures/
Hi Karthik,
Thank you for posting insightful article.
I have a question on the concept of basis . These are conceptual questions and seek help from your end .
At the time of maturity , basis as we discussed should always be zero meaning future price = spot price at maturity
My question is around this point . Consider a farmer who is short on 3 months corn future. Now the very reason he entered into this contract is to reduce possible price decline and hence to reduce exposure against price risk. So in this example let say at the time of maturity if the spot price goes down due to low demand (high supply) , and hence the future price to make basis zero , the very purpose of farmer’s hedging gets defeated.
I think I messed up with this concept .
Thanks
Not really, Saurabh. If the futures price goes down (following the spot), then he makes money on short futures which is offset by the long position in the spot, therefore isolating him from market movements.
hello kartik
can i keep one contract and square off another next day? or
do i have to square off both the contract simultaneously?
regards
hitesh
You can Sq off, one by one.
Hi Karthik,
I have a question regarding calendar spread. In you article you have assumed that Wipro Mid month contract is trading at its fair value 665.
You have also assumed that Mid month contract will continue to trade at its fair value.
While calculating P&L at expiry, for your long position you have taken current spot price as current price for Mid month contract. Is this correct?
Regards,
Rahul Khandelwal
Rahul, this is kind of a generic approach. I’ll be talking about this technique in more details in this module – https://zerodha.com/varsity/module/trading-systems/ , please do stay tunned for more!
Hi, I have a few queries.
What is the market price of a future? Is it the LTP ?
If this is so , then it will vary according to the bids and asks. So, is ‘fair value’ only an indicator to what the price of the future should be theoretically ?
Yes, it is the LTP. Yes, fair value is an indicator of how much the LTP should be.
If the price of futures and underlying asset always converges, then if I buy number of shares equal to lot size and short one lot in futures, will it always return in profit?
You can provided the futures is not priced in properly. I’m covering this strategy in detail in the current module on trading systems.
Dear Karthik Sir,
First of all , thank you very much for making us understand the concepts very easily and for giving amateurs like us the opportunity to take part in the market action all on our own without relying on useless paid advisory services.
I have few doubts related to calendar spreads although you have given the best expalination possible but still i am somehow getting confused in the concept, I have the following example as on 26th dec of nifty futures can you please tell me if there is an opportunity for a calendar spread here
Nifty Spot – 10,531.5
Nifty Dec 2017 Future – 10530.15 (expiry in 2 days) Nifty Fair Price – 10530.45 (my calculation, please correct if i am wrong)
Nifty Jan 2018 Future – 10571 (expiry in 30 days) Nifty Fair Price – 10535.45
Is there any trade here ????
Dear Kartik Sir,
Awaiting your reply on my above query .
I dont mean to be rude but your answer shall clarify my doubts thats why the impatience from my side.
Amey, you can trade in calendar spreads to lock in the arbitrage between the Jan 2018 and Dec 2017 contract
Dear Faisal sir,
Thank you for the reply.
Do u mean that in the above case I buy Dec future and sell Jan future ??
If yes then do I have to wait for expiry to utilise the maximum ability of spreads ???
You can either buy Dec and sell Jan or directly trade the Calendar spreads. You can read more on spreads here
Hi,
Why is futures pricing formula based? Isn’t it supposed to be a buyer willing to bet that stock price might be at price X 1 or 2 months from now? Every buyer can bet at different prices.
If its fixed formula, then any stock if its current price is same now, then their corresponding future price are also same. Formula does not take into account real value of underlying asset and its variations based on sector they are in and other factors. Gold example was good, but with formula based and 1 price for a future seems to a mismatch.
thanks,
The formula is based on the assumption that there is a certain cost for the funds. Also, remember the Futures price has the spot value as a key input.
Hi Karthik,
Is there any way by which I can get all the stock prices and their corresponding future prices (for all the three series) in excel in order to find out the C&C opportunity ?
Secondly for finding out the arbitrage opportunity, where can I get the prices of all the stocks futures prices on two stock exchanges in excel in order to compare immediately and execute the strategy ?
P.S- I am a Zerodha member, please let me know if we have any such resource internally.
1) You can try linking your excel sheet with PI and do this. Check this – https://support.zerodha.com/kb/faq.php?id=52
2) Again you can link PI to excel for this.
Hi karthik,
In the calendar spread example above, have you assumed that the both current month and mid month contract will have the same expiry value?
More or less, just to convey the concept. But this is not true. Will be discussing a practical approach to trading calendar spreads in this module – https://zerodha.com/varsity/module/trading-systems/
Please stay tunned.
Dear Karthik sir,
Is there any formula for calculating the fair value of spot price?
Thanks in advance.
For that, you will have you do a DCF, check this – https://zerodha.com/varsity/chapter/dcf-primer/
Thank you sir.
Regards.
Sir as you have mentioned about the module “Trading Strategies”, is it the one which is under progress under the name “Trading Systems” ?
Yes, they are the same.
why do you say that it makes sense to square off the positions in spot and futures market, just before expiry, in case one has executed the trades to take advantage of cash and carry arbitrage? Same question for calendar spread?
what i understand is, if say spot is 700 and futures is 750, then i will buy in spot market and take short position in futures market. On expiry, if futures is at say 690, then i make profit in futures market (+60) and loss (-10) in spot by selling the share bought at 700 for 690…..so how does it matter whether i square off positions in the two markets before expiry or allow auto square off on expiry?
When I say just before, I’m talking about literally 10 minutes before – at 3:20PM. If the option is ITM, then you will save on STT.
Sir,
Hero Motocorp Feb future -3496.55 and mar future-3512.50 so can i use calendar spread .
is it right to buy Feb future and sell Mar future….
pl revert …
Yes, assuming the trade is justified, you can buy Feb and sell Mar.
thanks sir…
Sir if i am getting current month and mid month future on discounted rate the what i should do… same as for both future on higher rate… so can we use calendar spread techniques at this point….
In this case, the is no scope for arbitrage. Arb works when one of the assets is cheaper compared to the other.
Hi Karthik,
You have shown dividend to be reduced from spot(1+r) … But I have seen some books reduce the dividend yield from the r and then compound the spot rate as follows: spot[1+(r-d)] or in case of continuous compounding Spot e^[r-d]
Which textbook is this, Srinivasan?
Hi Karthik, can you pls explain why sometimes future trades at a discount and what are its implications? Why is dividend reduced from the pricing? Could not understand the logic.
Really Appreciate if you can explain this.
Thank
Murali
Futures in fact trade either at a discount or at a premium, this is purely a function of demand and supply. However, there is a formal formula which guides the rate at which futures should trade given the rate of the spot. Adjusting the dividend is to ensure that the effect of dividend (which is captured on spot) is also captured on the futures. Think of it as a fair representation of the futures price.
Hello Sir,
Sometimes I see in some commodity that the next month future contract is trading at discount to this month contract. Will it be a good trade opportunity to go long with the next month contract and short this month contract.
Yes, as long as the prices are justified. Please remember there will always be some difference but this should not really justify a trade.
Thanks sir for the reply
Sir Nowadays different crude mini contracts are trading at
Crudemini July 4614
Crudemini Aug 4584
Crudemini Sep 4545
What I think that crude is falling nowadays so this can be the reason for discount of next month.
If I take a trade in August and September calender spread, does this specifies a good calender spread trading opportunity??
It probably is, Priyank. I’d suggest you read up on this https://zerodha.com/varsity/chapter/calendar-spreads/
Sir
I had taken this trade and the spread normalized after two weeks and I made profit out of it.
I have gone through that calendar module nowadays I’m back testing it.
What I have found that same type of opportunity is available in many stock futures where next month contract is trading around 1% lower than the near month contract.
I want to ask that this type of spread will also get normal by the end of this series or is there any other factors like divident or price movement affects this.
And Thanks once again for this wonderful content.
Priyank, the spread can converge to mean anytime during the series and not necessarily at the expiry of the series.
Sir , Mar and Apr Future are discounted then what should i do , which future should i buy and sell…
eg..
vedanta spot price 327.60
Mar Future 321.85
Apr Future 317.65
pl suggest ….
srry its hind zinc..
I just did, please check the reply to your previous comment. Thanks.
Both could be discounted, but wrt to the theoretical pricing, one could be cheaper than the other. So the same thumb rule applies – but the cheaper one and sell the expensive one. Alternatively, you can follow a statistical approach here. I will discuss this in the 10th module.
Hello sir,
Today’s nifty spot – 10493
Rf – 6.35%
x- 30
Fair price for FUT NIFTY MAR 2018- 10547
Actual FUT NIFTY MAR 2018 – 10520
Fair price for FUT NIFTY APR 2018- 10604
Actual FUT NIFTY APR 2018 – 10555
So, is there a trade here?? Which one we should buy as both are trading at higher prices.
Thanks
Aishwarya
Not an exciting opportunity this one. Btw, I’d suggest you keep track on the progress of this module – https://zerodha.com/varsity/module/trading-systems/ , I will soon discuss a better way to trade calendar spreads.
Hi Karthik,
First of all hats off to you for your understanding of the subject and putting it up into these modules.
Here is a small doubt I have. Please take some time to resolve it.
In this module the Formula reads ‘Futures Price = Spot*[1 + r(x/360) – d]’
But, in the below link (from CME Group website), I found it to be a little different. Also, In the key takeaway section you have mentioned the same, which reads ‘Futures Price = Spot*[1 + r(x/360)] – d’
http://www.cmegroup.com/trading/equity-index/fairvalue.html
Please clarify the right one.
Also will be greatful if you can provide the excel for the same.
Kind Regards,
Looks like I’ve not placed the brackets properly 🙂
Go with Futures Price = Spot*[1 + r(x/360)] – d .
So if the futures price on the index is above the current value of the index, will that have any effect on the value of the index going forward? Do we expect the index to raise in response?
Nothing really – futures do oscillate above and below the spot – called premium and discount respectively. This is largely because of the demand and supply situation.
is calendar spread a no risk strategy just like cash and futures arbitrage?
No, it has risk elements….it contains the risk of execution and liquidity.
Hi Karthik in your example of Calendar spread shouldn’t the fair value of mid month future on the day of expiry be calculated using the future pricing formula which,obviously is function of spot price. So, for the spot of 660 with T-bill rate 6% and 28 days remaining in expiry future fair value should be 663.04. Similarly, for 690 / 725 spot price it should be 693.18 & 728.34 respectively and if, other demand supply factor are constant future price should be close to it’s fair value thus, using 665 at mid month price seems confusing to me.
Not sure if, above question makes sense but, would appreciate your inputs and sorry, to keep you bugging but, as I keep reading your amazing lessons and doubts keep popping!!!
Vivek, dont worry about bugging me, its not a problem at all 🙂
Also, I’d suggest you keep a track on the progress of this module – https://zerodha.com/varsity/module/trading-systems/ , will post a simpler version to calender spread.
Sir, as you said all short contracts are strictly on intraday basis,so when we initiate a spread position as shown in this chapter where we go long in spot and short in futured ,which includes shorting too,does that mean that we will have to close the spread position in a day..in other words,is this spread just a day lasting?
For this you will have to employ futures. You cannot short in EQ and carry forward the position.
okay thankyou sir.
Welcome, Udit 🙂
One more question sir..What is difference between Cash and carry arbitrage and hedging a single stock ?
As written..both involve position in spot market and counter position in futures market..but we make LOCKED profits in former however no profit /no loss in latter ie hedging.
Well, the intent is different – apart from that, the mechanics of carrying out the trade is somewhat similar.
Please correct me if i am wrong sir
We use c & c arbitrage in case future is not fairly priced ie its expensive or cheap as compared to spot and use hedging when the security is fairly priced however we want to be indifferent to future movements?
Absolutely, Udit. Like I said, the mechanics is the same, the intent or the objective of the trade is different.
You are making invaluable contribution for investor education sir, thankyou 🙂
Happy learning, Udit 🙂
Hi Karthik – While looking for C&C Arbitrage opportunity noticed today that that spread for Fortis is 1.23% (Future is expensive) at closing with expiry being tomorrow. Basis whatever I have learnt from your beautiful lesson the price of both Spot & Future should be the same on day of expiry and this is logical too. My question is that will this spread come to Zero from market opening or sometime during the day.
I think the spread had already narrowed. Did you take the trade?
No I did not take position. I am just doing virtual trading to understand the dynamics before taking plunge in however, have started shorting far off call OTM closer to expiry and made some money in last two months. Thanks to you.
Happy to note that, Vivek 🙂
Markets are full of opportunity, it’s upto you to spot them 🙂
Prepare well and enter when you are convinced! Good luck.
Thanks Karthik. Another question – When doing C&C arbitrage in my understanding M2M should come into play for the future position so, in case the future position is moving against me till I square off the position then every day I will have to deposit some money and thus, affecting my cash flow. Is my understanding correct?
Yes, that is correct. As long as you hold a futures position there is mark to market applicable to it. Good luck with it!
Thanks a lot. In your experience what are the chances of future position reaching Margin call in a month period. I know it is very broad but, just needed to know your expert viewpoint.
Is there a way to predict Margin requirement for worst case scenario for a period?
In case there is no way to do so (predict) will Zerodha give me a Margin call before squaring off my position?
In case Zerodha doesn’t give a call what is the best way forward – may be work your way around by keeping twice or thrice of exposure margin idle?
Finally, (just for now ?) when are you coming with simplified version of Calendar spread?
Vivek, I’ll include that in the current module, hopefully very soon 🙂
Margin call depends on how much money is there in your trading account and how much of it is parked as margins.
Suppose sbin future was trading at a premium of 0.5 points at a particular time. So if i would have sold one lot of futures contract and buy 3000 shares in spot market and hold the position till expiry date. Will it result in rs1500 profit.?
Yes, this is assuming you execute the trade in a way where the difference is 0.5.
no of trading session left to be considered is actual numbers excluding holidays or total number of days?
This is called the day count convention….you can either take the actual number or the number of trading days. It really depends on you. I prefer the actual number of trading days.
If DISH TV spot = 72.70
dish tv April fut = 73
dish tv May fut = 72
According to this chapter, randomly if I make calendar spread-
April fut sell & may fut buy, then my profit will be 73-72 = 1 point per lot correct?
If not please suggest me because i’m new in Future Trading
Thanks Karthik SIR
Yes, that is correct. However, you need to adjust this for transaction charges. By the way, I will discuss a more reasonable approach to calender spread in this module – https://zerodha.com/varsity/module/trading-systems/
(1) But, anytime we have to sell future current month contract & buy mid month future contract, Is it correct? Plz correct me. As newbie trader.
(2) On expiry day current month future price = spot price, correct?
(3) If today is expiry, then mid month future price = spot price or greater than spot price? Which is correct exactly?
(4) Is there future strategies written by you? or share any online link.
Thanks for teaching! 🙂
1) Yes, you certainly can. Nothing wrong with it
2) Yes
3) Mid-month contract will coincide with the spot on the day of the mid month’s expiry day
4) All the strategies are being discussed here – https://zerodha.com/varsity/module/trading-systems/
How to calculate or know the dividend for nifty
Check the dividend yield of Nifty here – https://www.nseindia.com/products/content/equities/indices/historical_pepb.htm
(1) How to make calendar spread- first sell & buy….both orders 1 by 1 ?
(2) For calendar spread, if I sold current future contract first then I require full margin. But, when next when if I buy mid month future contract then I will get margin benefits, correct?????
1) Calendar spreads involve you to buy and sell two contracts of the same assets, across two expiries, in similar quantities. The order as in which contract to buy and sell does not matter
2) Yes, but at the time of execution, you will need full margins.
Dear Sir,
Kindly go through following table of my trade: First 2 orders I booked profit =6000/- (1500 + 4500)
But, for 3rd & 4th order, blank places i want to need to book my profit…..!
So…
What can I do for that? If I will keep this till expiry so is it profitable?
What should I have to do? please tell me as you are most experienced person as well as my teacher…. 🙂
Order Mode Lot Buy Sell Profit / Loss
HCC18APRFUT FUTURES 15000.00 25.00 25.100 1500
HCC18MAYFUT FUTURES 15000.00 25.50 25.800 4500
HCC18APRFUT FUTURES 15000.00 ______ 25.000 9000
HCC18MAYFUT FUTURES 15000.00 25.65 _______ -20250
Thanks 🙂
Prakul, I’m unabe to understand your query. Are you suggesting that you have two buy positions @ 25 (April) and @ 25.65(May). Well, the only way to profit from it is to hold it (assuming you continue to remain bullish). Btw, the markets are up today and you may just get an opportunity to book profits.
Good luck!
Hi Karthik – Before taking plunge in the market of C&C Arbitrage can you let me know how do one ensures that the spread is maintained when acquiring the position on real time basis. The reason of asking this is because if, one places market order for both positions the spread can reduce to an extent that one does not make any money and if, one places limit order there could be a scenario that the one of the position gets picked up and the other one never reaches the limit thus, forcing one to book loss on the position that gets picked up (i.e. if, this position goes against).
Hoping you understand my query.
I understand, Vivek. In fact, this is the biggest risk in taking up these trades. Execution risk can eat away the estimated profits – and you could be left with very little on no real money on the table. Unfortunately, there is no way to deal with it.
Thanks a lot Karthik. All clear. In your experience how are the percentages skewed against us for such trade?
This really depends on how efficient your execution is. I’m of the opinion that if you have a system based order placement, the percentage is highly skewed in your favor. Sorry, I dont really have a number for you 🙂
Thanks a ton. When you say system based order placement do you mean things controlled by software? If, yes do you have some suggestion?
The closest I can think of is https://www.streak.tech/ . You can also checkout API based solution https://kite.trade/.
In first example of practical application (spread between spot and future) I think we can still take trade if future is trading at 658 taking profit of 5 points if not more than that.Correct me if I am wrong.
Hmmm, but you need to account for transaction charges as well.
I hv a question
Futures Price = 2280.5 * [1+8.3528 %( 7/365)] – 0
=2283
how sir plz expln
How as in? That is the futures pricing formula 🙂
Let suppose I am holding Vedanata shares @ price 300 and it is going ex-dividend @ 20 tomorrow. What will happen to my position in future? Will it show a loss or buying price will adjust according to dividend? And what will happen in case of spin-off?
No, it wont show a loss. The futures contract will be adjusted to the extent of dividend paid and hence there will be no P&L influence on the contract.
Karthik,
If the market thinks that price of a stock will fall, then futures will be trading lower than spot. Is this also the case of ‘trading at discount’ or backwardation (for commodities)?
Thanks!
Yup, if at all the futures trade below spot (for whatever reasons), then its considered to be at discount.
Understood. Many thanks for clarification.
Keep learning, Kishan 🙂
Does the price of a future changes, if the interest rate changes after the RBI announcement? If the interest rate goes down, does the people holding future prior to the RBI announcement date have to take a loss?
Yes, the interest rate has an impact on derivatives but there is nothing like they take a loss etc. Really depends on the position they hold.
Hi,
Sir I am little confused in the calender spread strategy for squaring the position of mid month contract. I need to sell the mid month contract to square off the position as we have already bought mid month contract. But the prices will be different in this case, spot price and mid month futures(at the expiry of current month contract).
The spot and future price for mid month will not converge at the expiry of the current contract. Why we are calculating P/L for mid month the same way as we are doing for the current month given the spot will be different?
Yes, you do have a point here, Aman. The example was to give you a basic idea of how calendar spreads can be done. I will discuss a slightly different way of trading calendar spreads in this module – https://zerodha.com/varsity/module/trading-systems/
Hello sir,
Today nifty spot down by -0.75% and nifty may future down by only -0.49%. It is very big difference. If nifty future is mimicking nifty spot, then why this difference happens?
Yes, you are right. In such a case how can we buy the index at the spot price?
This can happen due to the regular demand-supply situation in the market. Its common for the futures to go into premium or discount.
Dear Sir,
Thank you very much for your support. I still have a doubt in cash and carry arbitrage. Today bank nifty expired at 26016.8 and the futures price is 25969.95. In this situation can we sell 1 lot in options at 26016.8 and buy 1 lot in futures at 25969.95.
Kindly clarify.
If you are doing this, then you will have to ensure that the delta matches. So for one lot of futures, you will need 2 lots of ATM options. Have discussed more on Delta in the Options module.
Thank you very much for your speedy response. I have already gone through the options module as well and i had considered deltas but had no idea regarding which one to sell (ITM, ATM or OTM) and the number of lots.
Your guidence has made people like me to think up to this level.
Your efforts to learn is what is helping you, Karthik. Good luck and keep learning 🙂
Dear Sir,
I have a doubt in cash and carry arbitrage. You have mentioned that if there is a difference between the spot and futures price, in the example M/s Wipro, you have mentioned to buy in the spot market and sell in the futures. My doubt is if we sell the futures we have to do it according to lot size but how we have to go along with buying in spot market, that is, quantity?
Yes, for this you will have to adjust based on the Rupee value. I will kind of discuss more on this in the ongoing module i.e Trading Systems.
Amara Raja batteries june future price is 50 rupees discount to its spot price. This is start of the series. Why is there such a huge discount?
Strange, I’m guessing the premium will shrink in a day/2.
Karthik,
Script : Bajaj-auto.
Date : 08.06.18
Futures price for the June month expiry is above than the fair value and futures price for July month expiry is well below than the fair value based on the futures pricing formula i have calculated. Is there a trade here. Can I sell this month expiry and buy next month expiry.
You can, but make sure you close the trade before the expiry. Make sure there is no corporate action during this time.
Sir, there is “Cost of Carry” link below Order Book table in NSE Derivative Quote page. Kindly explain what this is and how does it relate to Futures Trading?
Can I just ignore it?
For all practical purposes, you can ignore it, Anurag. Cost of carry represents the futures premium to spot.
Thanks.
sir wrt cost of carry(ie diffrence between spot and future),will it be logical to get the 200days of cost of carry,get the mean of the data find SD and try to spot opportunity for intraday or swing trading whenever the coc reaches certain level of SD?
Interesting thought, Vinay. Have never explored this angle, maybe there could be some opportunity here 🙂
If futures price is less than spot what does it imply actually? WHat are the reasons behind this?
Does it mean that this stock is in bearish zone?
It just means the futures are trading at a discount owing to the demand-supply situation.
Hi,
There is a small error in the futures pricing formula.
Futures Price = Spot price *(1+ rf – d)
If d is inside the square brackets then it should be dividend yield and not the absolute value of dividend.
Btw, Thanks for explaining futures in such simple terminology.
Cheers!
Ah, let me look into this, Yash. Thanks for pointing this.
In Cash and Carry Arbitrage, we are basically capturing/exploiting the difference of spot price and future contract price. If this difference is large, profit is large and vice versa. I really don’t understand the significance of calculating the fair value of future contract because as long as arbitrage exist between spot and future contact we can capture it.
It will be great if you can provide some more information on significance calculation of fair value. Is there something I am missing ?
This is because that on a regular basis, there is bound to be a difference between cash and futures, this is attributable to the ‘cost of carry’. Fair value gives you this estimate of Futures price. Afterall, you should not mistake the regular difference between cash and futures for an arb opportunity.
Hi,
I have a simple query.
How future price follows spot?
isnt it depend on bids and sells? they may be different in spot and futures market no?
how supply and demand affect futures price?
how spot and future price moves identically?
The pricing is such that the futures price follow the spot price if any difference then the arbitrageurs step in to correct the difference.
Hello sir, In calender spread, lets say jan future price is 500 and feb future price is 550.Assuming to go long on jan and short on feb, lets say convergence price in january end is 525, this means my profit will be 25(Jan long) and 25(feb Short)=50
But talking in terms of price moves,thats a +25 movement in january,which although would give us 25 points profit in jan,But as price moves in tandem,a 25 point increase would also mean a 25 point increase in feb contract,which will do us a loss of 25 points in feb short contract.So effective p&l=0 (as also explained by you in some previous chapter).
Am i missing something or these statements are self contradicting as in 1 context we make profits and in other context that is price moves we make nothing?
Udit, I’d suggest you look at this technique to trade calendar spreads – https://zerodha.com/varsity/chapter/calendar-spreads/
how would corporate action would affect my open futures position for example payments of dividend or stock split etc.
The future contracts will be adjusted accordingly. NSE publishes a circular with the details. Here is an example – https://www.nseindia.com/content/circulars/CMPT38466.pdf
Hi kartik
For the last 1-2 days I have noticed the banknifty futures is trading at high premiums compared to Spot. Bank nifty spot is trading at 27183 at 2 pm and Sept futures are trading at 27354 and Oct futures at 27450 and Oct futures at 27453. Diff of more than 180 points
I wanted to know why is it trading at such diff? Though charts are indicating bearishness does this mean we can expect the price to go up ?
Can we initiate calendar spreads to capture this diff as you said Spot and futures converge.
You can, Shyam. Check this – https://zerodha.com/varsity/chapter/calendar-spreads/
Hi Kartik,
I have a query on Calendar Spreads. If current month future price is cheaper than fair price and far month price is higher than fair price, can be take advantage to pocket the arbitrage. E.g. for a NIFTY stock, spot, current FUT and mid-month FUT are at 317, 315 and 327 respectively. In case I sell mid month and buy current month, I can pocket 12/lot (at 2200 lot size easily making 26400 by blocking 21000 margin). However, if mid month doesn’t restore to its fair value by current month expiry I won’t be hedged. Margin requirement goes up. Is this a good trade to opt for?
Ashish, here is another technique to do this, check this – https://zerodha.com/varsity/chapter/calendar-spreads/
Hi Karthik,
I don’t seem to have the option to trade futures on kite mobile app. Can you please advise if this feature is available on mobile app? if yes – do I have to make any request to enable this to my account?
Kind regards,
Guru
It is very much possible, Guru. Add it to your watchlist like the way you do on Kite web, once you see it the market watch, you can easily trade.
Thanks Karthik, didn’t realise that I can search futures on the same space where I search for equiry stocks.
Also, it is a wonderful feeling to know that somebody is there to listen to your queries (no matter how stupid it is, until you know the answer it bothers a lot) and answers promptly. Thanks for being our mentor. It is a good learning ride for me (including its application on the stock market). Thanks for being there for us 😊👍
Kind regards,
Guru
Always a pleasure, Guru 🙂
Happy trading!
sir,
in the last table you have shown that at the expiry spot will be in 660. so current month future price and far month future price will converge because of that i make a profit of 40 rupee. But i think that far month future price will not converge with the spot at the same day. But you have shown that for the far month future expiry we make a loss of 5 rupee (660-665). How can it be possible because it show that far month future price also converge with the spot in the current month expiry date.
Any help from anyone will be appreciated.
Actually, I’d suggest you read the alternate version here – https://zerodha.com/varsity/chapter/calendar-spreads/ 🙂
Hi Karthik,
Can we look at the delta of
1. ( Market Future – Spot ) for “Cash & Carry Arbitrage”
2. ( Deviation of different expiry Futures contracts (1m/2m/3m) prices from the current spot price ) for “Calendar Spread”
Instead of calculating the fair value with the math formula to validate presence of a “Spread Trade”?
My intuition is that fair value is mostly close to market future price and calculation is based on the dynamics of interest rates and dividend yields .
Hence, can we logically deduce the presence of the “Spread” from extent to which a various future contracts (1m/2m/3m) market price is deviating from spot price and check the outliers (the one which drastically deviates from spot) to either go ahead with calendar or arbitrage.
Thanks in advance!
Of course, you can, Bharath. However, you have to validate these opportunities to check if the spreads eventually make profitable sense. I’d suggest you read this chapter – https://zerodha.com/varsity/chapter/calendar-spreads/
Hi Karthik,
In your example of Wipro,
Wipro Spot is trading at = 653
Actual market value of current month futures = 700 (30 days to expire)
Actual market value of mid month futures = 665 (60 days to expire)
Strategy is “short on current” and “long on mid”.
Assume our spot for current contract expire = 725.
Hence “current month futures” converge with spot price = 725 on expiry date
However, the “mid month” contract price on expiry of “current month” can have a value different from 725 ,is this right?
Assume “mid month contract on expiry of current month contract” = 640. (this means mid month has just turned current)
With this set up,
For short position, i made loss of = 700-725 = -25
For long position , i made a loss of = 640-665 = -25
Total loss = -50.
Hence this calendar spread failed for the above setup.
Do you think this assumption of our mid month contract on expiry of current month ,VALID? if so, then calendar spread also have some risk (no matter how low) , is this correct?
Bharath, there is a slightly better approach to this, I’d suggest you check this – https://zerodha.com/varsity/chapter/calendar-spreads/
Is there any margin benefit in cash and carry arbitrage? Generally to buy a stock and to short the future we need minimum 5 lacs plus maintenance margin. But as both are hedged so are not we given any margin benefit just as we get in calendar spread?
Currently no, Praveen, but we will have this soon going forward.
[…] The Futures Pricing […]
How to you get No. of days remaining for expiry as 34 for mid month and 80 for far month..I am getting 35 and 70 days remaining if i use 19thFeb 2015 as the base date for calculation ?
26thFeb 2015 – 19thFeb 2015 = 7 days
26thMar 2015 – 19thFeb 2015 = 35 days
30thApr 2015- 19thFeb 2015 = 70 days
Are you excluding weekends/holidays during that period?
Dear Karthik,
I have a query regarding Nifty futures and kind of an anamalous behavior of the same:
Nifty Spot on 09-11-2018 closed down -0.12%
Nifty Dec-18 Futures 09-11-2018 closed up 0.09%
Today, i.e. 03-12-2018, I observed that at around 11:00 am, Nifty spot was trading at 10890 while Nifty Futures were at 10912.
Nifty Spot closed lower at 10883.75 while Nifty Dec-18 Futures closed higher at 10931. The difference in closing returns for the single day for Spot and Futures is 0.22% and that too when prices should’ve converged (comparatively).
How can this be? Logically, since spot closed below the observed price at 11:00 am, futures also should have closed below the observed price, but instead, there is a significant difference and divergence. Also, another factor is that since the days to expiry decreased on near closing, the difference between Spot and Futures should have decreased in fact. How did it increase?
Further, even if direction of Nifty Spot and Futures has been the same on most instances, the returns are far from similar. Why is this so? Do the returns of Nifty Spot and futures even out during the whole term of the contract or are there significant differences always?
Lastly, where can we get prices for historical contracts that aren’t traded anymore?
Looking forward to your reply.
Amey, the difference is understandable. This is due to the demand and supply situations leading the premium and discount. All else equal, the contract should trade at a nominal premium attributable to carry.
The minor difference in direction too because of this. However, 0.22% difference on a closing basis is tricky. Need to check. Here is where you can get historical data – https://www.nseindia.com/products/content/equities/indices/historical_index_data.htm
M. Karthik,
I am little confused about “cash & carry arbitrage. In the example Wipro Spot is less than future price. So we buy Wipro Spot. Being Spot is it not necessary to square of the same day. Can we wait till expiry. Please clarify my doubt.
No, you can carry forward the position in the spot for however long you want.
Is the formula given for determining the fair value of futures really correct? Or is it an oversimplification?
The formula seems to assume that the required rate of return from the investment in the futures contract is the risk free rate, adjusting for dividends. But being a risky investment, the required returns should be higher (e.g. calculated using CAPM), right?
The expected spot price in the future can be calculated using CAPM. Then the current fair value of the futures contract can be derived by discounting this “fair future spot price” using the risk free rate as the discounting factor?
Mithun, the formula is to price the futures based on the cost of carry or the risk-free investment opportunity. The expected return is on how you expect the futures contract itself performs across your holding period.
Hi Karthik
I have a Query Regarding Impact of Corporate Actions like Bonus Issue,Stock Split.
Now Let us take a Live Example Say Container Corp Ltd.Recently they have come up with Stock Split of 1:5,Split of FV 10 into 5 shares of FV 2 each. So,Ideally in Cash Market .On Ex Date Share price will be quoted at price reduced to the extent of 1/5 in cash Market.
So very well we know that price gonna fell down by 80% and to that propotion,shares increase.So Can i benefit out of that fall in Price by Shorting the Futures of that particular share???
Will there be any change in Lot size immediately after the announcement of this Stock split in Derivatives Market
Regards
Harish
Harish, in case of corporate action in a security trading in the derivatives segments, the exchange does an adjustment in the futures and options trading in that security on the ex-date itself. Existing Futures and Options contracts are expired on pre-ex date (1 day before the ex-date) and new contracts with revised lot size and strikes are launched on the ex-date. For your specific example, you can check this circular from the exchange and understand how the adjustments were made.
Hi Karthik,
Like the delta of options…is there any parameter for how much the futures prices move for a movement in underlying?
Thanks,
Alok
The delta of the futures is 1, so for every one point movement in the underlying, the futures also moves 1 point.
Thanks…also mathatically the futures are always at a premium…but they can be at discount also…so what are the factors that can cause that…do the option Greek’s also apply to futures? And if yes..how do we apply them in trading.. Thanks..Alok
Yes, mathematically, the futures are always at a premium. They can be under discount, but this is based on the demand-supply situation in the market. Option Greeks dont impact the futures.
Thanks a lot!
Can you tell about cost of carrt in futures?
As i have read this in one of the workbook of NISM equity derivatives
I’m not sure about Carrt, I think I’m hearing this for the first time, Faizan.
Cost of Carry
Dear Karthik,
Just like the current month future and spot converge to single point on expiry, does current month fut and mid month fut too converge to single value on expiry of current month fut?
No, they dont, Arun.
Sir,
I have one question.
In the cash and carry arbitrage situation you mentioned the futures pricing formula to calculate a fair value. If future price is more than its fair price than as you mentioned there is a trading opportunity.But what if future price and fair price do not have much difference.
Will it still generate profit?
For example:
In the example mentioned above
Wipro Spot = 653
Rf – 8.35%
x = 30
d = 0
Given this, the futures should be trading at –
Futures Price = 653*(1+8.35 %( 30/365)) – 0
= 658
if futures are actually trading at 658 or less than 658 but above spot price,Is there still a cash and carry arbitrage situation.Will this trade still make a profit?
No, there is no opportunity if both the fair price and futures price is around the same.
Thanks for the reply sir.
But i don’t understand why there will be no profit?
Can you please explain with the above wipro example:
if Wipro Spot = 653
Futures Price = 653*(1+8.35 %( 30/365)) – 0
= 658
If I buy wipro shares and sell futures @653 & @658 respectively and on expiry if they are on same price then why would it not have 5rs/share profit? Can you please explain this in some more details?
Srikaran, theoretically yes, you make 5 as profits, but you will have to accommodate for transaction charges as well.
Thanks for the detailed description, Karthik. I had a major query: At multiple places, you have mentioned that the future deviates from its formula-derived price due to supply, demand, and “dividend expectation”. Supply and demand is understood. But how does the market estimate the dividend? Is it based on historical data? There is usually no fixed pattern to dividend amount payouts, until the actual announcement. However, in most futures, there doesn’t seem to be a significant jump on the announcement date – which means the market is estimating the dividend pretty accurately. Is there some clue in results? Are there publicly available analyst estimates? Or is something akin to insider trading (info before it is actually “announced” happening?
The dividends have an impact on the future price, Biswanath. Check this thread for more clarity – https://tradingqna.com/t/oil-india-has-declared-a-dividend-of-rs-8-5-and-the-record-date-is-feb-22-can-i-the-buy-the-stock-in-cash-and-sell-futures-and-pocket-the-dividend/54937
Dear Karthik,
I was wondering of another type of calendar spread. Suppose diff between Current and Near month futures is more than 1.5-2%. On expiry of Current month future, the price of current and near future will gradually converge (not equal), resulting in a risk free profit.
am i thinking right, Karthik? is this kind of spread trading possible? plz clarify.thnx
Yes, this works if the spread converges, Arun.
In futures Trading,
Can one end up losing so much that he has to add extra funds to his account?
Or would the loss only be till his funds are zero!?
What about same case in options?
Usually the system ensures your losses are to the extent of the margins available. However, in case of extreme price movements, the losses can go beyond.
Dear Karthik – A question
I got this from moneycontrol
Company Future Spot Basis Basis % Previous Basis Change Lot Size
MRF 57,047.35 56,950.00 97.35 0.17 275.75 -178.40 10
PAGEIND 23,557.75 23,469.85 87.90 0.37 95.85 -7.95 25
So for MRF the basis is 97.35.. so if I sell the future and buy equal quantity ( 1 lot ) in spot can I trap the full basis spread of 97.35 and make profit or will there be any adjustment against fair value and so on ?
Ramki, by default the basis exists. The question is – what is the fair value of the basis. Once you estimate the basis (using the futures pricing), you will figure out if there is a trade or not.
Hi Karthik,
Is risk free rate always taken as 90 day T bills ?
That is a good benchmark for the risk-free rate in the economy.
Hi Karthik,
Thank you for these amazing lessons. You guys are doing a great job.
I have one doubt though regarding the last table where you have arbitrarily taken a few scenarios for Expiry Values 660, 690, 725.
On the day of expiry of the near month contract, I can understand the Future Price (Which you have used to calculate the P&L of the Near Month Short Position) converging with the Spot Price as it is the expiry day.
However, to calculate the Mid Month P&L (Long), you have again considered Spot Values to calculate the P&L of the Long Position, however, in reality the Future Price of the Mid Month contract will not be exactly equal to the spot, as there is almost a month before the Mid Month Future reaches expiry.
Is my understanding correct?
Thats right. After writing this, I realized it could mislead the readers. Here is a better way to set up a calendar spread – https://zerodha.com/varsity/chapter/calendar-spreads/
Hi,
With regards to Shorting Options, the guy who sells, has the advantage of Theta working in his favor.
Is it the same case with Short Futures? Ofcourse, futures don’t have Theta, but the cost of carry?
For example assume Nifty Spot is 11,700, and Near Month Future with 25 DTE is trading at 11,780 (These are just random numbers).
I short a Future at 11,780, and lets assume the market does not move even 1 point either up or down till expiry, and is exactly at 11,700 (Initial Spot) on expiry day.
The Future Price will converge to the Spot 11,700. So basically I can stand to make a profit of 80 points.
Is my understanding right?
Hi,
Any help on this Question?
Hey sorry, dont know how I missed that question.
No, there is no concept of theta in futures. Remember, the futures are a linear instrument as compared to the options, which is non-liner instrument. This means, only the direction of markets influences the futures price whereas multiple factors such as the direction, volatility, speed etc affect the options premium.
Hi,
Thanks for the reply. 🙂 I do not think I put forth my question properly. Let me rephrase it
Assume on 1st June 2019 the Nifty Spot is 11,900 and the future is trading at premium or Rs. 80, which makes the Nifty June FUT CMP 11,980.
Lets assume, for the whole month till expiry day, the Spot does not move at all, so naturally the Future price will converge to the Spot of 11,900 which is a drop of 80 points (Reduction of cost of carry).
So even if this term is not Theta Decay, it is still an advantage to the guy who shorts Future isn’t it??
Thats right 🙂
I was getting confused by the theta decay term 🙂
Hello,
The ‘d’ in the formula is dividend rate or dividend, Because in the formula you put it in the bracket but afterwards you used it outside in every calculation?
THANKS
Dividend rate.
Hi Nithin,
Will this plain Arbitrage thingy work for a small investor like me if I already hold or in time hold a ‘lot of a F&O stock’ and then short the future at the start of series if its at premium.?
Lets say over time I accumulate TCS 250 shares or any other F&O stock, and then keep shorting future for that stock and hope to make some risk free money..at end of series..?
does this make any sense..?
Technically yes, it will work. But I’d suggest you avoid if you have limited capital.
Thanks Karthik,
The margin calculator says I can short a TCS future in about 1L. if I pledge the nifty bees I hold for this margin, and accumulate a lot of TCS shares I should take this trade if there is an opportunity..? or did you mean something else by ‘limited capital’??
I am ok to earn small profits against big losses..And off-course the stock like a TCS or LT or a HDFC appreciates 10% yoy?? if I am able to get additional 4-5% in a year almost risk free why avoid..??
Cheers
Om
My limited capital I meant a lesser amount to trade. There are years where even the best of companies have yielded flat returns. Reliance, for example, was stuck between 800-1000 during 2012-2-14. So it is hard to conclude anything about returns.
The order book of futures of Amaron batteries shows that at the end of the day total buy quantity is 121800 and total sell quantity is 827400
How could this difference be possible? Who buys the difference?
The difference does not get traded. It stays unfilled for the day.
Hi sir,
I am a new one to feature. I saw you chapters , it’s very useful and I learn from it. I have one doubt.
After initial trade done calender spread
Buy current month feature and sell next month feature in same underlying.
How to (exit) close the trade both features close manually in current month or next month, or simply only
leave it intiated trade.
Kindly clarify my doubts sir. Thanks.
I’m glad you find Varsity useful 🙂
Yes, it is best if you can track this and close the position manually.
Thanks sir, if don’t close the position current month expiry, then what happens the next day,
Both position square off automatically
Or current month only square off automatically and still next month position open
Or will come any penalty or any charges will come.
Sorry to distrub you sir. Thanks sir.
Only the current month contract will be squared off, the next month will continue to stay open. No penalty charges as such.
Hey Karthik, had a couple of queries regarding cash future arbitrage-
a) I’m taking an example here to understand the whole process, please let me know if my thought process is correct here.
Suppose Reliance spot price is Rs 1250 & current month future price is Rs 1270. I buy 500 shares of Reliance & sell one lot of futures (since one lot = 500 in Reliance). At the end of month, both price will converge, say that is Rs 1280. Now my profit will be Rs 20 * 500 = Rs 10000. And the monthly return will be 10000/737042 (112042 for selling future + 625000 for buying 500 shares) = 1.3 %.
(have ignored the taxes, brokerage etc. here).
b) Is it realistically possible for retail traders to get an arbitrage opportunity given the algo-based trading these days?
Thanks!
1) Yes, that’s right. Essentially you earn the spread between the spot and futures.
2) Yes, it is possible. Alogos chase high-frequency arbitrage opportunities. However, not all arbitrage opportunities are latency-critical.
Okay thanks!
So, can you suggest how to go about finding an arbitrage opportunity? I mean, if one comes across it, that’s great but one’s basically leaving it upto fate then..
Check this module, Sachin – https://zerodha.com/varsity/module/trading-systems/
Cash & carry Arbitrage and Calendar Spread can be used only in case of major difference between Fair value and Market price or it can be used without major difference?
Larger the difference, the better it is Hemant.
Sir can you please explain what is ‘risk free Rate’ and why we consider its value as RBI’s 91 days treasury bill rate.
Hey Karthik,
Hope you are doing well. Could you help me with the following?
1. Is there any way to determine max loss & max profit for a bull calendar spread or bear calendar spread with futures (Not options)?
2. Also, in both bull and bear calendar (futures) spreads, we want the spread to converge, right? And not diverge?
3. Any scenario where we could benefit from a spread diverge?
Regards,
~Abudhar al Hassan.
1) Its straight forward for Futures. The difference in the buy-sell price of futures should give you the P&L.
2) For a long position, you want the spread to converge, and diverge for short
3) As above
Thank you for your quick responses Karthik.
Could you help me with this: I am trying to setup a zero-cost collar with NIFTY future as the underlying, wherein the premium received by selling the higher strike OTM Call would cover the premium required to buy the lower strike PUT as protection. But its not possible to go zero-cost with same expiry options as the OTM calls would be lower priced than the OTM PUTS. So the only solution is to sell an OTM Call of a farther month expiry. If I implement this, and the price goes south, then I don’t lose anything I suppose, and I can just exit all three positions. But what should I do if the price goes up, beyond the CALL strike? The PUT would be worthless, the future would gain value, and the CALL would become ITM and gain intrinsic value (in negative for me) which should be offset by the gain in futures. Now..
1. Should I wait till the expiry of the farther month CALL? Because only then shall I get the entire premium right?
2. If I wait till the expiry of the farther month call, the protective PUT and the FUTURE would expire in the current month which would leave me with a naked call position, which is quite risky.
3. if I don’t wait till expiry of the farther expiry OTM call and exit the positions when the future and the PUT expires, and if the price is north of the CALL, I won’t get the premium that I had initially used to buy the protective PUT right?
Kindly suggest an ideal solution, if any. Thanks.
~ Abudhar al Hassan.
Technically, you should implement the collar when you see a significant divergence between the futures price wrt to its fair price.
1) This does not matter if the option continues to remain ITM, you will have to anyway bear the loss. Plus the M2M requirement of the futures can be quite high
2) This is a risk, for this reason, its advisable to execute this in the current month
3) Yes
You can try tweaking this a bit and sell slightly OTM Call and buying a deep OTM Put, all of the same month. But either way, it is hard to make this a zero cost, considering you will have to do an M2M on futures.
Just giving some numbers to make the above scenario clearer…
1. Bought BANKNIFTY SEP future @ 27500.
2. Sold BANKNIFTY OCT 28000 CE to receive 570/- premium.
3. Bought BANKNIFY SEP 27500 PUT @ 453/-.
End of sept, lets say expiry happens @ 28500. Now what should I do with the OCT 28000 CE? If I exit, then I shall lose the premium for the sep PUT. If I don’t exit, then it becomes a naked call. Please advise.
Replied to your previous comment.
Hi Karthik, please clarify the price mismatch for INFY Sep and INFY Oct. The current price of spot INFY = 793, INFY Sep = 794 and INFY Oct = 788. Why is the October price lower than the September and Spot price? There is no corporate action on record as well.
Besides being guided by the fair value of futures, these contracts also have their own demand-supply situation, which drives the prices.
Dear Sir,
I currently have the current month futures of India Hulls Housing Finance (closed at 432.10). Since this one of the futures that I have to compulsory delivery can I sell it at an appropriate time in the next few days and buy the October contract that currently closed at 401.25. Does this mean I get to sell high (the current month) and buy low (the next month) and at the same time not compelled to take delivery? Look forward to hearing from you.
Yes, you can sell it and buy into the next month. You need not have to wait for expiry.
You guys are doing a tremendous job 👍👍👍 . You have said that the fno for a script will be banned if they reach 95% of the total volume. so let us take an example that as of now contracts have reached 94% of total contracts and i am about to place one more order so how can i check that as of now contracts limit have reached 94%. In that case how a normal retail trader will get to know that a specific limit has already reached .One more question you said that when a security ia banned no new contracts can be placed,so all the people who are now holding the contract will settle among themselves, am i right or wrong. And also suppose a contract reaches a limitbof 95% just 2 days before expiry than what happens.
Thanks Punit.
The OI has to hit 95% at the end of the day. During the day, it does not really matter, even at 100%.
If the security is banned, then no new fresh positions are allowed, you can only unwind your position.
Thanks a lot sir
Dear can u please clear my query
I want to short natural gas and carry overnight position ( Suppose i have 50k capital in my account ) and the price i want to short is 195 (assume) so as per margin calculator i require a initial margin of 30,938 and span margin of 2961 lets assume approx values of initial as 31k and span of 3k total is 34k.
i have decided to go short and my capital is 50k.
What will happen to my capital of 50K? will it be debited with 34k and remaining will show as 14K
And how much margin do i require after initiating my trade to ensure it does not square off.
Thats right, from your capital 34K will be blocked for margins. You are free to us 14K for other trades. You need to ensure a margin of 34K is constantly available to hold the position overnight.
Hey Karthik,
Could you suggest a way to mitigate losses in a futures calendar spread? I don’t think placing stop losses would be possible since there are two legs involved in the strategy.
Also, is it possible to place spread orders in kite? If we do it one by one we would need a lot of margin to execute the first leg itself.
Thanks n Regards,
~Abudhar al Hassan.
IOC is the best way for spreads. No spread orders on Kite yet.
Thanks Karthik, any advice regarding the first part of my question?
In a well defined arbitrage, what leads to loss is poor execution of the trade. So the focus on arb trades is to ensure you have priced in the arbitrage well and execute it efficiently.
It’s just that I am unable to figure out the max. loss that can occur in future calendar spreads. How do we know when to get out should the spread go against us? Couldn’t find any material on the internet either that explains the losing side of this strategy. Any advice would be highly appreciated.
Thanks.
~ Abudhar al Hassan.
Have you read this – https://zerodha.com/varsity/chapter/calendar-spreads/ ?
mr karthik
while calculating the fair value of TCS Future in the example given in the module, it comes out to be 2284.15 and not 2283. also not able to find the value of rf on the RBI site. can u tell please.
thanks
Let me check the futures rate again. The ref rate is available here – https://www.rbi.org.in/
This question is regarding Cash and carry arbitrage. Let’s say there is an opportunity in Wipro, now shorting one lot of Wipro requires margin of 50K. Now can I first buy stocks of Wipro worth 50k and then pledge those shares on console and then use than money to short futures. Is that possible?
*I have to buy in full amount in spot after that can I pledge it and use that money in shorting futures?
Yes, you can.
Hi Kartik,
Really Informative. I have a query regarding the mid month future vs near month future for a commodity.
If the expectation is that the price of the commodity is going to increase over say 8-9 months, does it make sense to do monthly rollovers or bi-monthly or 3-monthly rollover.
Additionally, the mid month future is much higher priced than near month future. How does that play into equation.
I’d prefer monthly because unless and until you are 200% convinced about your position. Monthly gives your enough liquidity to exit in case your call goes wrong and you want to cut your position.
Sir,
What is ARBITRAGE in stock markets ? Please have a module on this concept also.
Thanks.
Have discussed this is several chapters across Varsity, Akash. Do check the module on trading systems.
Hi Karthik.. I have opened a Cash and Carry arbitrage on Infosys. Given that physical settlement is now compulsory can you please advise do I need to physically close the position on expiry day or broker will automatically give the delivery after market close on expiry day (since I will have those many physical shares in my account) and in case broker will not be able to do that for some reason will there be some sort of penalty.
What would happen if there is no counterpart available on expiry date of future contract. Or what will happen if I forget to square off during expiry date.
The exchange will ensure your contract is settled.
rf 4.2972 ( 91 day T bill )
no of days to expiry : 16 ( expiring on 30th of April )
dividend expected in 7 days : nil
PVR in Spot : 1004.9
PVR APR FUT : 960.15
calculated fair value by futures pricing formula : 1006.79
1 ) Is there a Cash & Carry Arbitrage trade here sir ?
if yes then plz guide
2 ) futures 1 lot is 400 quantity so my spot quantity should also be 400 ?
Thanks n Regards,
Abdul
1) Theoretically yes. But hard to execute because you will have to sell spot and buy futures
2) Yup
why its hard to execute sir…
what will be the difficulties?
thank u
Mostly because Algos eat up the opportunity 🙂
Sir,
Thank u so much for valuable knowledge.
I have prepared excel sheet for future fair value calculation but i have a query that, while determining days to expiry, should i consider actual days as per calendar or actual trading sessions..plz guide
Actual trading sessions will help, Sagar.
Sir how to calculate the dividend yield to get the stock future price. Like i understand its an annual percentage we need to put in the formula. But how exactly it is calculated? Can you give an example? Also for index futures what should be the dividend yield value?
It is a straight forward process, Abhishek. Whatever is the dividend yield, use that value in the formula and get its value. The dividend yield is as such the dividend issued divided by the share price.
hii sir,
I have doubt regarding calendar spread, what if I buy mid (June) month future contract and short far (July) month future, would I be in profit?
for eg.,
reliance industries mid month future contract is trading at 1486rs and far month is at 1492rs. spread between them is 6rs. according to calendar spread sell expensive and buy cheap. so I sell far month and buy mid month. so I calculated from Zerodha margin calculator, the SPAN was 8785 ( which is blocked by broker). and spread benefit was 92416.
obviously I have to sell contract in July month.
my question is can I do this strategy? would I be in profit of 92k with just span of 8K?
correct me if I’m wrong!!!
RIL lot size is 500, so your profits are 3k, assuming you get to kee the entire 6/- spread. Besides, you will also have to factor in costs. The problem is the spread may not converge by June expiry, so there is no guarantee of profits.
obviously I have to sell contract in June month. I’m sorry!!
Yup.
then what is spread benefit??
The spread benefit is on the margin side, Rohan.
What if in futures our trigger price wont hit? how will we exit then? Eg-If i bought at 3000 Trigger price is 2900 at market ?? what if trigger will not get hit ? Is it possible or it is in the case of triggers at limit order not at market?
Yes, it is possible. Hence you need to keep track of the order execution as well.
Hi Karthik,
How do I download the closing prices for the current month and near month Nifty contracts for the past 12 months from Zerodha Pi?
If I select the May futures, it gives me data only from 28th Feb when the contract went live. Do I have to select different expiry Futures and then collate all the data or is there a direct way to do so?
Thanks,
Nikhil
Right-click and click on ‘add to excel’. If you find it difficult, please do call the support desk for this, they will help you with it.
I tried that it is still giving me three months data only; from the day the contract went live.
I googled the same and found something about Continuous data for Futures. The feature is apparently available both on Kite and Pi. However, I am unable to find it anywhere on Kite and when I select the feature on Pi, an error pops up saying “interval exceeds limit:2000 days”. When I click on Ok, another error pops up saying “Cannot perform run time binding on a null reference”. Both these errors repeat for 5 times. Finally, a third error pops up saying ” Unable to fetch historical data for NIFTY20MAYFUT, only live data will be there”.
I have created a ticket with Support for the same. However, if you have seen this issue before and are aware of any quick fix for the same, that would be great.
Thanks,
Nikhil
Check this Nikhil – https://support.zerodha.com/category/trading-and-markets/kite-web-and-mobile/articles/continuous-data-kite
Hello Karthik sir!
Futures Price = Spot price *(1+ rf – d) according to the notes on Varsity.
My question is, why is the dividend subtracted inside the bracket? Like so=> (1+ rf – d). I think the dividend paid should be out of the bracket. what are your thoughts on it?
Just to be more clear. Imagine a company is not paying dividends then the future price will simply be Future price= Spot price*(1+rf)
Now suddenly if the company pays dividend the new future future price will be
New future price= Future price – d = [Spot price*(1+rf)] -d
hence, New future price=[Spot price*(1+rf)] -d
The formula for Futures Price = Spot price *(1+ rf – d) is used where d is dividend yield(annualized) and not the dividend in rupees.
Another formula for calculation of future price is Futures Price = (Spot price-present value of dividend)*(1+ rf).
Even if it annualized it should be out of bracket. As shown below
Future price= [Spot price*(1+rf)] -d
You are probably right. Need to cross-reference this, will get back.
Karthik sir!
Did you manage to check the future price formula?
Oh yes, what you said makes perfect sense. I need to make the changes to the formula, thanks for pointing this.
Thank you very much too!
Thanks for pointing this out 🙂
Hello Karthik,
I wanted to ask a few questions regarding options pricing,
1. What would be the dividend in case of NIFTY? In the formula.
2. If I am supposed go long on 750 NIFTY june20, 750 nifty july20, and go short on 1500 NIFTY August 20, what should be my initial capital required? After all positions are made surely I shall get the margin credited back but what about initial margin?
Thanks and regards
1) Take the Index’s dividend yield
2) Use the margin calculator to get the approx benefit details – https://zerodha.com/margin-calculator/SPAN/
How to get the index dividend yield? Is there any other formula, or source from where I can get it?
I tried calculating nifty future fair value using the formula for June 20 .. dividend yield I got is 1.59… so what I got is, 9580(1+6.22*27/365-1.59) equals -1245..
If I don’t consider the dividend, then also calculation is unusual..
9580(1+6.22*27/365)
Comes to be 1385…. which is actually unusual.
Please give an example for NIFTY future calculation
1.59, should be outside the bracket. Please see the comments section.
To Abhijeet Kumar:
9580(1+6.22*27/365-1.59) There are 2 mistakes here=>
Mistake number 1: 6.22 is a percentage , hence it should be divided by 100!
Mistake number 2: 1.59 should be out of the bracket yes, as Karthik sir says! but 1.59 is dividend yield! which is again a percentage of the face value of nifty. so we cannot simply subtract 1.59!
hence the calculation will be as follows:
Future price= [Spot price*(1+rf)] -d
Future price=[9580 *(1+ [(6.22/100)*(27/365)]) ]- [(1.59/100)* face value of nifty]
Thanks for pitching in, Yanni 🙂
Karthik sir!
Do indices have face values? I checked it up on google i couldn’t find face value of indices.
Also Karthik sir! I wanted to talk to you only for 1 minute. I sent you a connect request on Linkedin but you didn’t respond. Even an email would do. Can you please send me an email whenever you are free on [email protected]
Please! It would mean a lot to me…..
Thank you!
Yanni, I’m not active on Linkedin, I check once in a way. Will msg you there. Regarding the FV, it should be the face value, 100. But I will reconfirm this. Thanks.
Hi Zerodha,
In the futures pricing formula mentioned in the article above,
Futures Price = Spot price *(1+ rf – d)
The dividend “d” should be outside the bracket not inside. otherwise the future value will always be negative if d > 1+rf
Regards
That was sorted from Yanni’s comment.
Hi Karthik,
My question is regarding execution of Baskets in Sentinel. If I have a Spread Order configured in the Basket (Buy 1 Nifty Jun Fut, Sell 1 Nifty Jul Fut), and I execute the basket, will the margin required be checked first for the buy leg and then the margin benefit will apply or will the order go through even if I have only the lesser margin required for the spread in my account?
Similarly, what happens while squaring off the spread trade through a basket?
Thanks,
Nikhil
Since you are dealing with futures, you will need the entire margin to execute, post which excess margin will be released.
Hello Karthik,
I hope you’re doing good.
Is trading using the calendar spread strategy always profitable? I tried to work the maths in a hypothetical trade to find the profit or loss at every price point upon expiry of the current month future. But I couldn’t find any such price at which I could make a loss.
Could you please demonstrate a situation where one can incur loss by trading using calendar spread strategy.
The only issue with calendar spread is the expiry day scenario, where one of your contracts expires, but the other one will be exposed to directional risk.
Hi Karthik,
Hope you and your family are healthy and happy. I had some confusions in the averaging concept, thought you could clear them…
1. Suppose I buy 3 lots of Nifty Jun Future contracts at different prices say, 9000, 9100 & 9200 respectively. My average buying price would be 9100 in this case. Now if I sell all the lots at say 9500, the P&L would be calculated from the average buying price of 9100 right? And the commission & taxes etc. as well?
2. Now, for what ever reason, if I decide to sell just one lot out of the three at say 9200 (please note this was also the buying price of the last lot). Now since I have just sold one lot and not the all three, how would be the P&L calculated on that one lot?
3. What would be the re-calculated average of the remaining two lot?
Thanks & Regards,
~ Abudhar al Hassan.
1) Yes
2) Your buy avg would remain the same. Your P&L would be +100 here
3) No
Okay Karthik, I understand…could you tell me what would happen, with reference to point 2 above, that after I sell one lot at 9200 and book 100 point profit, if the market comes down and I for some reason buy again at a lower price say 8800? How would the new average be calculated?
Thanks.
~ Abudhar al Hassan.
You will have a new average based on 9100 and 8800.
Thanks for such a nice content. I have couple of questions:
I noticed that calendar spread strategy can be used with commodity and currencies as well
1-) Should i consider the dividend for ONS , EUR/USD while calculating future price (not logic)
2-) what about “rf” , is it possible to use it in formula for comm. or currencies
Can you please clarify the dividend and rf for commodity and currencies.
1) No dividends for currency and commodities
2) Yes, you can. Rf will be the same across EQ, CDS, and Commodities.
Dear Karthik,
where can i get the risk free rates for Commodities/Currencies
Many thanks
You can use the same risk-free rate, from RBI.
Hello sir,
I have a doubt in the ‘cash and carry arbitrage’ technique which I read in this chapter.We assumed that Wipro is trading at 653 in the spot market.And by future pricing formula we concluded that the fair future price should be around 658.Instead of trading around 658, it is being traded around 700 which is a premium price.Now let us assume a scenario where the spot price becomes 675 on the expiry date.Let us also assume that right from 658,there is no decline in the stock price till it reaches 675 on the expiry date.
If the future price always mimics the underlying,how can we expect the future price and spot market price to converge.Because to converge at 675,the spot market price has to rise and the future price has to decline!
PS:Thank you very much for curating this entire content.It is very helpful for beginners like me.Explained deeply in a very comprehensive way!
That’s right Roshan, the convergence happens at the time of expiry. Either the futures raises or the spot declines, but on expiry, they do converge. Hence the arbitrage will hold.
But if the spot price rises the future should also rise right ?(since future always mimics the underlying right).So in the above mentioned case if arbitrage holds true,the future fails to mimic the underlying since the spot price rises from 658 to 675 and simultaneously the future price plummets from 700 to 675 simultaneously!
Please correct me if I go wrong anywhere
Thats right, Roshan. The movement wont happen in 1 shot, there are 2 possibilities here –
1) Spot moves up, futures moves at a slower pace
2) Futures move faster than spot
Either way, the price will converge on expiry, there is no other way.
Please make below calculation step wise as i am getting another number i.e 2422.77820822 and your is 2299.
Mid month calculation
Number of days to expiry = 34 (as the contract expires on 26th March 2015)
Futures Price = 2280.5 * [1+8.3528 %( 34/365)] – 0
= 2299
Manik, are sure you are working the parenthesis part properly? Seems to be correct for me.
Yes can you please elebrate your calculation and also would help me to provide rbi direct link to check 91 days treasury bills %.
Hey Manik, 34/365 = 0.093151.
=2280.5*(1+(8.352%*0.093151))
=2299
https://www.rbi.org.in/ – Look for the lending rates on the left-hand side panel.
Sorry now i got the correct calculation and numbers…would be helpful if you provide direct link to 91 days treasury bill %.
Are all the future stock price are valued with this formula?
Yes, thats right.
Just to cross check with you i found the Lending / Deposit Rates as follows.
Base Rate 7.40% – 9.00%
MCLR(overnight) 6.70% – 7.45%
Savings Deposit Rate 2.70% – 3.50%
Term Deposit Rate > 1 Year 5.10% – 5.65%
Is above data is correct . If yes then we have to consider base rate? And what values should we need to use in aur formula on the basis of above data.
You need to take the TBill rates, but yeah you can even consider the overnight rates.
Futures Price = Spot price * [1+ rf*(x/365)]– d
with this future price calculation, is it possible for future price goes to 0 and spot pricing is same, this i have noticed in zerodha app.
Ex: for todays case i was trying to buy sep future for tvs motor and i found it price = 0.
please explain when this is possible, and will i loss all my money if it drop to zero like this?
Not possible. However, there could be zero trades due to lack of liquidity.
You can confirm this in kite app also. so what will happen to investment money?
For tvsmotor margin price is: 149916, So what will i see i kite app when price is 0, might be because of zero trades due to lack of liquidity.
can you please let me know will my trade will be sqared off or what will happen to it, how much loss it mill show?
It won’t be squared off, this is a liquidity issue. Also, the price won’t be 0, it will show an LTP.
Hey Karthik,
In the explanation, you used 5 basis points as for example difference between a future and stock that is permissible and 47 meant initiating a short spread. I have a couple of questions regarding this:-
1. if the spot price and futures converge during expiry, then why even 5 basis point difference is permissible. What I mean is, why won’t it be prudent to initiate a trade even when the difference is as small as 5. In the end, they are always going to converge, so why not make profits out of these 5 points?
2. If indeed there exists a difference between futures and spot, how would one know what level of difference is permissible? How would one know 5 is okay but 47 is not? Is this similar to what we do in calender spreads where we track the historical mean and initiate a trade at +/- 2.5 SD?
1) You need to ensure that you accommodate for the transaction and other applicable charges. So basis this you have a certain minimum you need to factor in for, that could be 5 points or more depending on the individual futures contract
2) Yes, tracking the spread in terms of SD is a better approach. I’ve discussed this method here – https://zerodha.com/varsity/chapter/calendar-spreads/
Please ignore the first part of the question. Also, I am talking about difference between future fair price and market price in the second part
Got it.
Sir,
I have a doubt. I want to know if my understanding is correct or not.
Nifty futures price shown in nse website or kite is basically the price of the last executed trade in the exchange.
And the actual fair price is determined by the formula mentioned above.
So when ever the difference between the last executed trade price in exchange and fair price is huge it creates an arbitrage opportunity?
And is it same for options also? The fair price is determined by black and scholes formula using Greeks. But the price shown in nse is last traded price in exchange?
That also creates arbitrage opportunity in options?
That’s absolutely correct, Saravanan. The idea is to get a good sense of market price and fair price. You should also be aware that these prices may not be similar all the time, so you should expect a divergence, but the trick is to find out the amount of divergence.
“Snapshot of Infosys’s mid month contract”
Please change that to Far Month Contract. Seems to be a mistake. (:
Checking.
Besides algo trading eating up the opportunity and considering the costs for the trades, how would you short spot ? Wouldn’t it go into auction selling if u don’t give deliveries of the script ?
You can short the futures right, no risk of auction here.
My apologies for starting this as a new thread, was replying this to on of ur answers to the query raised by Abdul on 14-16 April 2020
Sir, few questions here-
1) Does this cash and carry arbitrage and calendar spreads opportunity comes often?
2) Why is there a heavy difference between the fair value of futures and the market value of the same?
3) Use of technical analysis in futures is a good combination?
1) It does, but you need to be quick to spot it
2) Depends on the market’s demand and supply situation
3) Yes, you can.
Shouldn’t we use continuous Compounding formula here?
We have right?
Why is there a need to have a formula for pricing futures? Why don’t do they have the same price as their spot?
Also, I could not find a module with the name “Trading Strategies” that you refer in this chapter.
If they are similarly priced, then what is the real advantage?
Check this – https://zerodha.com/varsity/module/trading-systems/
Hi Karthik
I the calculation Futures Price = Spot price * [1+ rf*(x/365)]– d
if one takes the 91 day tbill shouldnt the formula read as Futures Price = Spot price * [1+ rf*(x/91)]– d
This is because the 91 day t bill is the rate for 91 days and not 365 intuitively therefore what I am saying is you get this rate only for 91 days not essentially for 365 days unless offcourse there yield curve for 91 and 365 days is completely flat
so shouldnt we then use 365 days t bill or 1 yr Gsec as the Risk free rate in this formula
Futures Price = Spot price * [1+ rf*(x/365)]– d
f one takes the 91 day tbill shouldnt the formula read as Futures Price = Spot price * [1+ rf*(x/91)]– d ———-> 91 day rate is also expressed as an annual rate rate, so does not make any difference right?
Sorry for posting 2 different queries separately instead of clubbing it in one comment, as i posted this as an after thought.
When the future is trading at a discount to spot how does it work or calculate in the current formula
Futures Price = Spot price *(1+ rf )– d
or is it just that this is a theorotical formula and the very fact it throws the above anomaly means that there is a spread to be made because it goes contrary to the formula
Premium and discount is mainly a function of supply and demand. The pricing formula has nothing to do with that.
Hi Karthik, usually T bills are quoted at simple discount rate. Please advise if the risk free rate (8.3528%) which is used for the calculation of future pricing is simple discount rate or simple interest rate.
This is a simple interest rate, expressed as an annual %.
hi
1) In the formula for calculating the future price, which is, Futures Price = Spot price * [1+ rf*(x/365)]– d, shouldn’t there be (+) sign after Spot price instead of (*) sign? so the formula now becomes spot price + interest rate – dividend? Also,
2) Can you explain more briefly why futures and spot prices converge on expiry?
Thanks.
1) Yes, a mathematical simplification leads to the multiplication sign
2) That is the structure of the contract, designed to converge to a single price point at expiry. I mean, if they don’t, then that means that we are creating two different assets to perpetuity.
Hi Karthik. You said that at the expiry the futures price and spot price converge. Can we always short 2-3 days before the futures expiry ? Correct me if am wrong 🙂 And thank you in advance.
Futures and spot converge, but the way it converges is not certain. By shorting you assume futures will go down and spot stays where it is. What is futures go up and spot catches up?
If I buy the nifty mid month futures contract today then I will have to consider rolling over only on 26th November 2020, is that correct Karthik ? The current month expiry on 29th October has no bearing on my transaction right ?
Thanks
Mid-month is Nov expiry, so there is no need to roll over here.
Hi Karthik,
If we need to incorporate dividend in the fair value calculation, what dividend date is assumed
1) is it that the dividend announcement happens by expiry, or ex dividend date , or cum dividend or actual payout happens? please explain
If its Index, then you can consider the dividend yield. If its stock, look for the latest dividend issue. If the dividend announcement does not have an impact, especially if its a regular dividend. Special dividends do tend to have an impact, the price gets adjusted based on the dividend amount. Expiry day or regular trading day does not really matter.
Sir, I used to study any reading material that I find on stock trading, especially so after becoming Zerodha`s tradding member in July `20. While studying your one such material Trading on Futures, recently, I faced with two doubts that do not move past my mind, without clarity from you. They are:-
1)In Cash & Carry arbitrage, you say trader has to close the trade just before expiry by selling on spot and buying on futures. While I agree buying on futures is necessary to off set the open position, is it necessary to sell on spot to close the trade? If necessary, kindly tell me the implication and rationale behind such closure on spot.
2) In Calendar spread, on the other hand, you say, to close the trade, trader has to wait till expiry of the current month contract and after it`s expiry , trader needs to close the open position of mid month futures by selling it to offset, just before expiry.
Why need to wait for expiry of current month contract? What could be the impact on trade if not done so?
1) Not necessary, but without the future cover, the position in spot will be naked and will alter the P&L dynamics. You should be ok with this.
2) Yes, this is a different strategy and expectations are different.
Hi Karthik,
Based on Recent RBI, 91-day T-Bill Rate, it is (91 day T-bills : 2.9292%*),
If I want to calculate Future price for Nifty, let us say Spot is trading at 12980, and for 31stDec,2020 Expiry , How many days are considered , Today being 27 Nov.
Is it including today (from 27 Nov to 31 Dec=35 days ) or (28 Nov to 31 Dec=34 days).
What is exact to consider ? Please advise
Do we have to include the expiry day also ?
Thanks
D.Anand
35 days, which includes 27th Nov.
I tried to calculate fair value of INFY December contract and looks like I have arrived at a wrong value. INFY December contract is expiring on 31st December 2020. So the number of days to expiry is 34 from today (27th November 2020).
91 day T-bills rate on RBI website is 2.9292%
Last price on INFY December contract on NSE website is 1,119.00
So my calculation is giving me fair value of 1115.38
Is this correct?
The last price you see on NSE is the market value which can/will be different from the fair value.
Hi,
Today (27th November 2020) INFY underlying value is 1112.35 and INFY December contract last price is 1119 so is this a cash and carry arbitrage opportunity? To buy in spot and sell the same quantity in futures and square off both on 31st December 2020?
Theoretically yes, but you will have to factor in charges as well.
Hi Karthik,
Discount situation comes about when futures are heavily sold in the market. So does this mean that futures price is higher than its fair value when they are heavily bought in the market?
Please reply.
Yes, the futures price always fluctuates as an outcome of the market’s demand and supply situation.
Today also, there is a 7 point gap in INFY spot and futures. 5-6 point gap in hdfc also, these are looking like easy and guaranteed profits through cash and carry arbitrage, surely there must be some catch? Is it because the profits are too small in 6-7 points gap that nobody takes these trades?
That just offsets for the expenses incurred fo the transaction, anything over the expenses is a profit.
where can i look the risk free rate for calculation , have looked at rbi website couldnt find , one i found is around 3.7% primary yield can i use it for calculation , is it the true value or where can i find one
You can look at the 91 day T bill rates for this. It is available on RBI site, under market rates.
Karthik ,
Can you please tell me how we can calculate risk-freerate for anyother stocks ? or we need to take RBI’s 91 days treasuary bill intrest rate for every other futures to calculate fair value
or we can blindly go for a 5 points difference
Yes, 91 days T bills is a good benchmark for the risk-free rate.
Hi sir, does the pricing will affect in a reverse manner? Ie; lets suppose if i buy large quantity of futures of ITC, then does it will affect the stock price of ITC?
It will have a short term effect on the spot, but its hard to sustain that effect.
Dear Sir,
The 91 days interest bill you have used for your calculations is the is valid for black and scholes option calculator?
Do people use other interest rates or only use this?
So currently the interest rate is 3.03% for 91 day T bills.
Should I use this for my calculations?
Yes, thats right.
Dear Kartika,
You have mentioned about “trading strategies” modules. Can you please tell where do i get this module. Please share the li k if possible.
Here – https://zerodha.com/varsity/module/trading-systems/
Sir why is the expiry value of the current month (660, 690, 725) is the selling price for the mid month?
Its market driven right?
Sir why is the current month’s expiry (660, 690, 725) is the selling price for the mid month’s long contract. Shouldn’t it be different since its a futures contract for current month as the last current month contract is expired?
Sorry, I dint really get your query. Can you please quote specific numbers?
why are we calculating mid months p&l wrt to the expiry value of the current months contract in the calendar spread ?
We are not right? P&L is calculated wrt the underlying.
Dear Sir,
Please see this link https://imgur.com/a/UM3fYG5.
There is a big difference between future close price and the settlement price.
Why is this possible?
If the closing price is higher than the settlement price, this would be I would have a M2M loss of the difference between close price and settlement price?
Can you please explain this?
Settlement price and close price are the same right? 3696.55 in this case. 3720 is the last traded price, which is different from the closing price. The CLosing price is the average of the last 30 minutes.
Dear Sir,
If I purchase at 3715 and the LTP is 3720 and the settlement time becomes 3696.55 I would end up losing money right?
What time is the settlement price determined?
You had mentioned mainly make trades before closing, but this is bound to lose money.
Is there a way to avoid this?
The settlement price is important for trades held to expiry, otherwise, it may not be. The settlement price is nothing but the last 30 minute average of the traded prices.
u said that future price will be low than spot when contracts sell heavily in the market? we knoew that futures are contracts,how supply and demand work in contract as we can make as much as contract if i could find a counterparty.kindly explain this concept easily
Sorry, I didn’t get your query completely. Can you please elaborate on this?
Sir if itc spot on 213 and future on 210 then how can made spread.
The difference is 3, that’s the spread.
Sir, you have promised to have a separate module on Trading Strategies, when would you release it ?
OR Trading System module is the Trading Strategy module
Yes, Trading system, check this – https://zerodha.com/varsity/module/trading-systems/
Hi, I had purchased one share of BHEL in spot market to see how can I sell it in Futures
Contract of BHEL. However I not not able to do so as I am only getting NSE n BSE option for sell . I am not getting futures option.
Futures is a different segment, also you need to buy and sell in the lot size prescribed.
HI Karthik
I know when there is more days to expiry, there will be some difference between cash and future price because of some formula which i read from this article only. But my question is here yesterday for coal india, closing price for cash is 151.8 and today opening price is 155.5. Difference is 3.7. In futures yesterday closing price was 148.85 and today opening price is 151.85. Difference is 3. i want to know why there is difference of 3.7-3=0.7 here in case of profit. i mean if there is 2% profit in cash, why same 2% profit is not there in futures? Suppose if its closer to expiry, then same percentage of profit we will get?
Kiran, generally speaking, Futur trades at a higher price to spot, but under some circumstances, it could be the other way round as well. This can happen due to –
1) Dividends expected or
2) Demand and supply situation.
Hello kartik,
Why we take 90 days treasury bill rate ?
Secondly if we r using 90 days treasury bill rate then we can use x/90 for calculation .
We take that as a proxy for a risk-free rate. You need to consider this on an annualised basis, hence 365 basis works.
If i forgot to square off my position on expiry date then will exchange take share from my demat account without any penalty
And
Where is the option to give authority to take shares of my demat
Yes, depends on the position you will either get delivery of stock or shares will be debited from your DEMAT.
During short covering, how stock price increase.Future price derived from spot price, so buying in cash is required, while short covering is in futures.Does future price influences cash price also
Sometimes, the reverse is true, although for a short period.
Hi Karthik
I have a doubt… Future price is trading in premium what does it mean… Can v long ..
No, it just means that the futures is trading at a premium to spot. This does not necessarily mean it is a signal to go long.
Sir , In cash and carry arbitrage as u said buy wipro at the spot price and sell wipro futures
But wipro futures has a lot size whereas buying wipro at spot means? like quantity or by how?
Yes, you will have to buy to the extent of the lot size of Wipro to ensure the quantity matches.
I’ve found this part to be the most complicated one in the entire module.
Hmm, pricing is something good to know but can be skipped. Having said, if you have found something difficult, please do let me know and I’ll try my best to explain.
Hello Karthik Sir
I have understood the pricing and the opportunities that exist for arbitrage but i am confused at a point. As per your example, Wipro Spot is trading at Rs 653, Fair value of Futures is Rs 658 while actual value of futures (randomly) is Rs 700. Here, we can arbitrage and sell futures and buy the spot. But let’s say a stock is trading at a spot price of Rs 4550, the fair value of futures is Rs 4707 and the actual futures value is 4600. Does arbitrage exist here ? I’m confused between the following two choices –
1. Buy only futures and hold spot
2. Sell spot and buy futures
Kindly give the reasoning for both
Regards
Ashish
Ashish, the problem with this is that you cannot short spot here, hence it will be tough to carry forward this trade.
Yes, even i thought so. So there’s no arbitrage opportunity exists here right?
Secondly, i have seen lot of articles there’s mentioning of a borrowing cost which is added to the risk free interest rate and then calculated the fair value of futures prices. Can you throw some light on it? Also, does borrowing comes under the definition of carrying cost and if that exists, how will the prices differ?
Another thing is that, i have read there should be a maximum gap of Rs 5 between the spot price and futures price and anything beyond that creates room for arbitrage. Does it apply to all trades ? I mean if a stock’s spot price let say is Rs 65. Fair Value of Futures price is Rs 68 and the actual futures price is also Rs 68, does arbitrage exists here ?
Can you explain and give reasoning for the same ?
Regards
Ashish
The borrowing cost or the cost of carry is kind of baked into the price that you see, Ashish. So don’t worry too much about it. The 5 Rupee thing is to mainly accommodate for the costs incurred. BEst to look at it from a % term so that you can use 1 percentage across all trades. For example, the arb should offer at least 1%, of which you can buffer 0.3% for costs and the rest as your P&L.
Thank you Karthik Sir for the quick response. Clear explanation. I understood now.
Another thing which i want to ask is, are all these rules, techniques, process and procedures limited to individual stock futures and will it differ if we talk about the index futures ?
Also, how does all this differ if we bring into context the commodity and the currency futures ?
Regards
Ashish
They work across any asset, Ashish. Both stocks and Index. Equity, Index, commodities, or FX.
Sir, First of all thank you so much for such valuable information. My question is :can we always take risk free rate equal to 91 day T- bills from RBI site , (currently this is 3.35% )to calculate fair value of Futures.
Yup, you can.
Thank you so much Karthik Sir.
Regards
Ashish
Happy learning, Ashish.
Sir is there any application for scanning cash and carry arbitrage opportunity and calendar spread
Should I every stock is there opportunity
I thought of finding today since expiry is next week I thought almost spot and future price will converge now
2) Is it good idea to find for spread at beginning of expiry month or 15 days left to expiry
Chandu, I think Moneycontrol had a utility long back, not sure if it exists still.
Hello Sir in previous modules you said tha the mid-month contract has high price than current month but here it appears reverse please explain
That is generally true, but at times, the supply-demand dynamics and cause the situation to flip.
Yes sir still money control has this utility
To confirm I applied future pricing formula and calculated some math,actually it woked!
Great! Happy trading 🙂
https://drive.google.com/file/d/1Kag7ww2cgdFzouJfwWTzQPm6EeGG5caB/view?usp=drivesdk
Buying in spot requires huge capital
Kindly go through the link
Will do. Yes, spot requires cash.
Above ultratech cash and carry arbitrage trade,paper traded it went well
Only concern is its capital intensive to buy/sell in spot market
Where retail guy or student like me can’t execute the trade
Is there any way we can manage this
Hmm, no other way to reduce the margins Chandu.
Hello sir
Does shorting or create long of future contract affects on the price of future, if no then why so many analysts emphasizes on data of contracts.
e.g- No. of contracts decreased but price increased it means short covering. While short cover doesn’t affect on price of future. Please clarify…
It does not. They just comment on the Open interest (OI). OI on its own is not of much use, you need to match it with both price and volume to draw conclusions.
Hi Kartik, thanks for the amazing explanation. I had a doubt in the last part of your explanation.
When we are selling current month futures and buying mid month futures, are we squaring off both the transaction on the expiry date of our current month futures?
If yes, then will not the mid month future price change based on the spot price at expiry? For example, if the spot price is 715(as given in your third scenario) wont the mid month future price change to 715*(1+8.35 %( 30/365)) – 0, which is 720.72? It’ll be great if you could explain as to how we are squaring off this trade.
Cheers.
Yup, you need to. However, there is a better way to do this. Check this article – https://zerodha.com/varsity/chapter/calendar-spreads/
Hi Karthik,
I have noticed a few inconsistencies while reading this chapter on mobile version on Varsity. Some content is skipped while publishing on the mobile version. Can you ask team to check?
If it’s skipped, then its because its not so important to know and you can actually make your way through the markets with or without that.
Hi kartik you replied to one question from comment section that price can be on discount due to heavy future selling but according to mathematical equation there is no variable in the equation which affect by selling
Pls explain
What the equation does not capture is the demand and supply situation in that market, which can also lead to discount or premium.
1) Can we find faire value of any future, readymade online?
2) how to find risk free rate (rf) for any particular stock?
1) Not sure, perhaps there are sites that offer this feature.
2) Rf is a standard rate and does not vary from one stock to another. This is available on RBI site.
Card 9/9 of chapter 2 – Future pricing on the varsity app is wrongly placed. You have included hedge effectiveness on the card while it should have been abt Systematic risk.
Checking this, thanks Praveen.
Is it 100% guaranteed that spot and futures price will converge on expiry in every case ?
On expiry yes, spot and futures will converge.
Sir in currency,current month was trading at discount so I bought and sold next month which was trading near fair value.Have I executed in correct order
Trading at a discount should not really be a reason for you to trade next month, unless you have a specific reason for it.
Hi, can anybody tell me whether “Trading Strategies” module is available or not.
Please check this – https://zerodha.com/varsity/module/trading-systems/
Thanks.
Hi Karthic,
I have a Lite trading Account with Edelweiss. How to go for ” Cash & Carry Arbitrage” and ” Calendar Spreads” in Futures contract. I can either take a buy position or sell position. But how to take both positions simultaneously, so as to get margin benefit.
For calendar spreads, check this – https://zerodha.com/varsity/chapter/calendar-spreads/
For margin benefit, I guess you will have to speak to your broker 🙂
In Calendar Spread example, why/how can Mid Month future trading at lower than Current Month? Typically it should be trading at higher price , right? In continue, By knowing Calendar Spread strategy, every one would be Buying Current Month Expiry & Selling Mid Month Expiry( Square -off Position), Can liquidity be an issue in this case?
The price discrepancy occurs due to supply-demand situations in the market.
how to download this data for different expiry futures.
Hello Karthik, My question is that if Spot and Future prices always converge, then why the spot price of TCS today (Rs. 3210, on 24/07/21)is different than its Future Price (Rs 3218.10, contract expires on 29/07/21)? Please clear my confusion, I will be obliged.
They converge, but that happens upon expiry, not during the expiry.
Hi Karthik,
Your articles have been helping me up my game. Thanks a ton!!
Just a quick one, I’m having a hard time finding a source from where I can download continuous futures prices for some historical analysis I wanted to do for spread trading. Does zerodha provide this somewhere? Am not a programmer so am stuck at the first step. Would be of great help if you can guide me on this.
Regards
Anchit
It is available but via the APIs. I’d suggest you contact NSE authorized data vendors for this.
The spot price and future price are even different for expiry day… but you stated here, that will become same
Post expiry, the settlement price will be the same.
Hi.
I have a question regarding future pricing formula
I am taking a example of future ASHOKLEY as this company about to credit the dividend to the shareholders with effective date 31 Aug 2021.
SPOT PRICE – 134.15
dividend declared per share – 0.60
Now how we calculate dividend to get the fair value of September future contract
For all practical purposes, this is a small dividend amount, so it won’t really have an impact on your futures price.
Sorry for bothering you again and again
My next question is when we should deduct the dividend amount from spot price . when it is declare by the company or when it is credited to the shareholders account ( record date ) . To calculate the fair value of future .
Suppose : Declare date of dividend on 1 Sep 2021 and record date is 28 Sep 2021 and I buy to September future on 15 September 2021
So should I deduct dividend to calculate the fair value of future ?
Dont hesitate to ask your queries 🙂
You need to factor the dividend on the record data, Shubhika.
Hi Karthik,
I calculated the future pricing of SBILIFE.
where;
Spot price – 1181.45
Risk rate – ( 1+ 3.30 ) ( T – Bill 91 days)
Maturity – 35 /365 ( long on 27 aug )
Expire on – 30 September
I put all values in a formula where I my answer stands 1186.33
When I check on a website at that particular time future was trading at 1185 .
What’s that mean ?
Is that future value is undervalued and at some later point it will jump to 1186 .
These differences could arise out of small discrepancies while factoring in the variables like maturity, risk rate etc. It’s good to assume that the fair price is in a region rather than an exact price. In this case, maybe between 1184.5 to 1186.5 I’m just giving a random example here, but I hope it conveys the thought.
Hello karthik sir, future price formula doesn’t seem to work , or may be I’m counting it all wrong, the current rf rate is 3.33 it seems
What prices are you getting now, Samay?
Hi,
I checked the IRCTC future , it is trading at discount and I also checked the dividend dates .
On websites dividend declare date ( Aug 2021 ) has given but no effective date has mentioned . So , how would I calculate the present value of dividend .
The present value will be the same, considering there isn’t much time gap between the dividend date and date you receive on.
Sorry, Wrong Month has mentioned .
IRCTC dividend announcement date Was 29 june 2021 and no effective date has given . It’s Been two month no effective date has updated and they are paying 5 rs per share .
So, I supposed to Take 5rs as a present Value of dividend to calculate the future value of contract .
Got it, in such cases, you usually minus the dividend value. No need to take the present value.
Futures Price = Spot price *(1+ rf )– d
Where d is the dividend.
Sorry Karthik Sir, the formula is working just fine.
I miscalculated days to expiry. 🙏
Good luck!
Hi, why it is better to unwind just before the expiry as suggested here?
Its just that you don’t have to deal with physical delivery.
Hello Sir,
I am a little confused by this.
When ever the future price is trading below the spot what exactly does this signify? Future is trading at a discount, is this a bullish or bearish sign.
Does the Future lead the spot or the Spot lead the future?
Like during Covid 2020 time future was below the spot constantly and nifty kept falling down.
Yesterday on Friday 23/09/21 Future was below the spot by 10-20 points and eventually it moved up.
Not sure how to understand what can be done if future is below or above the spot.
It just means that the futures are either at a discount or premium to spot. Does not really signify bullish or bearishness. Spot leads the futures, small variations do happen and that is mainly due to the demand and supply situation.
Hello Karthik Sir,
As answer to another question, you’ve explained that ‘Spot and Futures converge upon expiry; not during expiry’.
From this what I understood is that in Cash & Carry arbitrage, we’ve to close our positions in both Spot and Futures just before expiry ( to be precise around 3.20 PM on expiry day) to realise the profit in that particular trade.
Is my understanding correct..?
Or is it in any other way that we should execute C&C arbitrage..?
It is better that way because you can avoid the hassle of physical delivery, Abu.
Hi Karthik,
First of all many thanks for creating such a wonderful and comprehensive educational stuff.
I have following questions regarding “Cash & Carry Arbitrage”
1) Irrespective of whether futures of any stock is priced at premium or is near its fair value, till the time there is difference btw spot & future price, can’t it be traded? This spread (Future – Spot) will anyways be locked as profit.
2) In your Cash & Carry example, you have considered futures price to be higher than spot price. That’s why short position is taken in futures and long in spot. However, if it’s other way around then how to proceed? After all, in spot market short position is not possible beyond intra-day.
3) There must be different ideal spread value (future minus spot price) range for stocks in different price range (like – stocks in 3-fig, 4-fig, 5-fig price etc). Basically, how to determine whether current futures is trading near its fair value or is it drastically different? For eg.:
spot price of stock A is Rs 500,
current month future price = Rs 502 (calculated using formula)
Actual current month future price is Rs 505.
So, should it be considered at premium or around its fair value?
Thanks
Sumit
1) Yes, but for this, you need to ensure that the futures is trading far away from its fair value. Plus you need to ensure to carry out both the transactions happen i.e. sell/buy futures and buy/sell the spot
2) Yes, shorting spot is not possible
3) YOu need to apply fair value formula, get a sense of what is the right futures price, factor for some errors and then figure the price. Overtime, you will develop a sense for this.
1) My point is even if a futures is trading near its fair value, and if we take opposite positions in spot and futures market, then also theoretically speaking price difference btw fut & spot (at the time of taking position) is guaranteed as profit. Isn’t it?
2) How to deal the scenario when future is trading below spot price?
1) No, what you make will get adjusted towards applicable charges
2) The only way is to set up a synthetic i.e. buy futures + buy put + sell call. Gets a little cumbersome.
Got it Karthik. Thanks again for clearing doubts.
Good luck!
Hi Karthik,
It’s always a pleasure to read your articles, thank you for all your efforts.
Query regarding “Cash & Carry Arbitrage”, If you can help me to understand, in a situation where we have to Sell in Spot and Buy in Futures for a particular stock, how to we are going short the shares in Spot and carry it till the end of expiry.
Please let em know if I am missing something.
Amey, that’s not possible to short the spot and carry it forward. You will have to do something like an SLB – https://www1.nseindia.com/live_market/dynaContent/live_analysis/slbs_chain/chainDataBySeries.jsp , get a little complex.
Do you have any videos doing futures live trading? If yes please do share it
Not yet, but noted!
is the calculation correct over here?
Futures Price = 2280.5 * [1+8.3528 % ( 7/365) ] – 0
i am getting 2304 here.
but the article says 2283.
please correct me if i am wrong somewhere.
Try this – 2280.5 * [1+8.3528 % * ( 7/365) ]
Why did Kartik u said it makes sense to square the position in futures just one day before the expiry
Because upon expiry, the futures is physically settled. Just to avoid the physical settlement headache.
Why do professional always track future chart rather than spot chart
Both the charts are tracked, its just that with Futures, you get volumes (number of lots traded).
Hi,
F & O will be shown as business income, how to valuate its closing stock
You can take the closing price on the day you wish to calculate the business income.
Hello Sir. I have a very basic doubt. Market moves based on Demand and Supply. In the spot market, when then there is more demand, the price goes up. Increase in demand for Reliance, the stock price went from 1000 to 1150. But Derivatives is another market where Buyers and Sellers meet to trade on Contracts right. What if the demand is abnormally huge for Reliance Stock Futures in Derivatives Market. Can this make reliance future price go up from 1000 to 1300. Obviously that’s not happening as I observe. Why do Equity Markets and Derivative Markets follow the same direction with minor price difference even when both markets have different set of participants. They Demand and Supply can vary in both the markets right? Sorry if I am wrong in my interpretation. Please do reply. Thanks in Advance.
This is because both these markets are interconnected, Anand. The price of Futures is based on the price of the spot. Traders base their decision in derivatives based on the movement in the spot.
Hi kartik
I want to ask you if i sell on 700 and buy on 660 a so expiry i will get perimum
hy sir
in what conditions, the nifty spot and future price at discount will converge.
the futures will only be at discount when the expiry is crossed.
They will converge upon expiry, Yash and that’s the only known thing. When and how is tough to say.
as in the example of wipro, why we are buying wipro in spot instead from futures.
if we are buying then what is the quantity of the wipro is preferred in spot market
Yash, that depends on so many things right. Leverage, capital availability etc.
Hi Karthik
I have a question on the calendar spread calculation example. Please refer to the table in your notes The third column is “Mid Month P&L(Long)”. You have calculated it at the same as the expiry value as that of the current month future. On this day, the mid month future need not sell at the expiry value of the current month future. It should be higher right? Let me reproduce the second row form the table
Expiry Value = 690
Current month P&L (Short)= 700 – 690 = +10
Mid Month P&L (Long) = 690 – 665 = +25 – Will this be sold at 690? It should be higher since it has one more month to expire right?
Please explain me if I am missing something. Thanks
Kalyan, I understand what you are saying. Yes, it’s an assumption, and may not always be right. I’d suggest you check this method instead – https://zerodha.com/varsity/chapter/calendar-spreads/
Thanks Karthik
Hello Karthik sir,
Sir in previous chapters we discussed that volatility also impacts the pricing of futures. Can you please put some light on that.
Not pricing per say, but the margins will be affected by volatility.
Dear Sir,
Escort share was trading at 1754 rs on28 March 2022 at 1415 hrs..
Stcok suddenly observed 70 Rs up rally in 45 Min….and reached 1830 with final closing at 1798.
When i observed , escort April 2022 future price… i founf that it was trading at 1518 rs….i expected it to move up by atleast 50 rs during strong up rally of 75 rs…
My questions are
1) Why so much difference in future price and spot price.
2) Why future price is negative compared to spot price?
Srikanth, the difference can arise out of the demand-supply mismatch. In this case, the stock is also undergoing a corporate action.
Sir Hdfc amc’s june future is trading way below it’s spot. Almost 40 points. Is this because the company has declared a dividend of Rs. 42/- in its results and a correction to that level is imminent?
Yes, it’s an adjustment to the dividend.
Sir, I have one doubt sir. Kindly reply. If a future price is 2% discount to the spot price before the dividend and results announcement.. What it indicates? In such scenario one should avoid take Long positions on spot
Or Is it sure that spot will fall even on strong result and divnd meet? Or Such discount to spot is nothing to do with actual mkt reaction as per Results?. Pls reply sir.
That won’t really have an impact on future prices as the price will be adjusted and the futures will reflect the adjusted price.
Hi
while calculating Banknifty fair value got confused…Please help
Taken (05/19/2022) close price (spot)= 33315
Rbi 91 days T-Bill was 4.91%
formula of may 26th expiry including saturday and sunday (total 7 days)…..33315*(1+4.91% (7/365))-0= 33346
formula for June 20th expiry (total 35 days)……33315* (1+4.91% (35/365))-0= 33471
if executed calendar spreads in those instruments settled daily M2M (profit & Loss)…..(Above example)
Both may(33290-future price) and june (33399-future price) futures are not trading near fair value which one to buy and sell in above example
Here is a better way to do this – https://zerodha.com/varsity/chapter/calendar-spreads/
Hello Karthik, a big fan of yours!
Is closing price of current month contract = opening price of mid month contract?
I think its not. Because of higher spread between spot and futures price at the beginning of the month.
Then is calender spread strategy always profitable?
Nope, that’s not true as technically they are two different contracts 🙂
hello sir
spot rate =650
current month contract=700
midmonth contract=652
1)if i buy mid month contract at 652 and short current montjh contract at 700 ,if spot rate comedown to 25 pts before expiry so here my loss is zero.
2)Is the decline of 25 pts will reflect in spot rate,current month contract rate and mid month contract rate?
3)and anyway current contract has to converge to spotrate on expiry day my profit is 50 pts.
is my analysis corrrect sir.
1) This is based on the assumption that both contracts expiry on the same date, but that’s not true
2) Not necessary
3) Yes, but that happens only on the expiry date.
it is not hegded. In Basket I tried to Buy a asset at spot which is lower than its spot price but its showing total value rewquired
Sir just one doubt :
Sir in the calendar spread example we will sell the mid term contract also right , though it is not expiring.?
Yes. That is correct.
Hi please explain like the price of the future is lower than the price of the spot. The reason for the same and also who plays catch up in this case. eg today in the case of Dr. Lal path labs future is trading at 2395.25 and the stock is trading at 2636.70. The reason for such price variation and which side does play catch up
This happens mainly due to the supply and demand mismatch.
1- is there a strategy to trade backwardation
2- and what can be derived if the current month, mid month and far month contracts are all below the spot price and also there is no dividend declaration
1) The obvious ones long/short fut and short/long spot will not work, even if you figure a way to short spot. Simply because the opportunities get picked up by algos
2) Demand supply dynamics are play. You can deploy calendar spreads – https://zerodha.com/varsity/chapter/calendar-spreads/
as you said above that even if there is way to short the spot, the opportunity gets picked up by the algos then can they have an opportunity where the algos can short the spot on a CNC basis
You can use the securities lending and borrowing mechanism to short spot.
where can I do that can you please guide me a little bit
Sorry, I lost context. Do what?
you told me in the above comments that if I need to short the spot I can use the securities lending and borrowing mechanism to do it.
so I just wanted to what is this securities lending and borrowing mechanism and if want to get started with it how can I do that, please guide me on this a bit
Ah, we dont have any connect on this. But please do call out support and ask to talk to the person dealing with SLB, you will get all the info you want.
the support team of zerodha or anywhere else
Support team.
“Not always does the futures trade richer than the spot. There could be instances – mainly owing to short term demand and supply imbalances where the futures would trade cheaper than its corresponding spot. This situation is when the futures is said to be trading at a discount to the spot.”
Here when future is trading at discount to the spot, which is attributable to imbalance of supply and demand, what we can conclude? is it due to supply is more than demand?
If it is so then can we have bearish look on spot for short term?
Yes, it just means more activity in spot.
Also, As yo said, future and spot prices converge on expiry, do they become equal necessarily? or pretty close to each other?
The settlement price is the basis that both converge to a single price point.
Hi Kartik,
Can the trading activity in nifty future somehow impact value of nifty?
To make it more generic, can the heavy trading in futures affect underlying somehow?
It can, sometimes.
So if Future and spot converge (settle down at single price by expiry) then when I get opportunity where there is big difference between future and spot, I can short future and buy spot. Ultimately I will be in profit by expiry
Is it true or is there any catch here?
Thats the idea, you can explore in this direction.
Thank you!
Welcome!
Hi Karthik, around 5th sep, i saw that the far month nifty fut, that is the November future was around 140 points premium from the spot. Then for next 10-15 days it changed only about 2-3 points, but within last 3-4 days, it reduced by 40 points instantly. My question is, that just like an option premium decays with the passage of time, do a mid & far month future’s premium also decay with time ?
2) Also, no matter how bearish the market is, i have noticed that the far month future is always in premium, why so ?
1) Yes, time decay affects all options contract
2) Do check this video – https://www.youtube.com/watch?v=FqRB7NGnOtA
Thank you Karthik for replying. Also is it ok to make out a conclusion from this video, that even if the market sentiment is extremely bearish for upcoming months, just like the 2008 scenario, even then the far month future would always be in premium from the spot ?
By the way, the discount and premium will also depend on the market’s demand and supply dynamics.
Sir in calendar spread buying cheaper future and selling higher future. End of expiry day liquidity issue is there. What we will do that time?
Stick to the top 10 stocks and Nifty/Bank Nifty indices Mahesh.
The difference b/w spot future price is not in mind but mid month future is discount as current month future… In this case,
Buy mid month future and
Sell current month future
Is always profitable on expiry day or not?
Not always, based on the execution price 🙂
Execute calendar spread in futures
Buy SHREECEM Dec future and
Sell SHREECEM Nov future.
Both contracts margin locked only 25000.
On expiry day any extra margin required or not.
YOu will need full margins for the Dec contract as the hedge (Dec Contract) will expire.
OK but unwind both contracts on November expiry no need extra margin?
Thats right, Mahesh.
Sorry both Nov & Dec contracts exit on November expiry 3 pm. No need extra margin required?
Yes, as long as you unwind both, its not needed.
Thank you so much karthik sir resolving my queries. Thanks a lot.
Happy learning 🙂
Is it okay to enter a calendar spread in futures and keep exiting the profitable leg daily and entering a similar position the next day, retaining the loss-making leg so that it turns profitable enough to exit at a future date? The process keeps repeating.
If no, what exactly is the problem with this strategy? Thanks in anticipation.
Yes, but this is based on the assumption that the loss will turn to a profit 🙂
Karthikji,
I will clarify using the following example.
1) Nov 22, 2022: Buy 1 lot Silvermic Feb23 Fut @ 100 and Sell Silvermic Apr23 Fut @110
2) Nov 23, 2022: Sell the Feb23 Silvermic @ 105 and retain Apr23 Silvermic as it is trading at 115
3) Nov 24, 2022: Buy Feb23 Silvermic @ 98 and Buy Apr23 Silvermic @ 105
4) Nov 25, 2022: Retain Feb23 Silvermic as it is trading at 97 and Sell Apr23 Silvermic @ 103
And so on.
Is there something fundamentally wrong with this strategy?
Thanks for your valuable insights and help.
At the end of the day, you need to figure if the position is profitable either –
1) Individually or
2) As a strategy as a whole
In your case, there are multiple positions and the success of it depends on the strategy as a whole. One issue I see here is that the costs will start eating into your profits soon.
Thanks a lot for your response. Let me figure out what to do.
Sure, happy learning.
I bought 1 lot of december future of banknifty and sold 1 lot of bankifty of january month having 220 rs spread ,it will converge or there may be a chance it will increase.
They wont converge as they are of two different expiries.
Do they calculate future prices based on the T bill interest rate every time, or do they even take interest in any other bonds,debt funds
?
Usually it’s the 91 day bill.
I had the understanding that interest on the leverage is priced into the futures price. Shouldn’t that be a part of the formula?
Brokers dont charge you for the leverage, Rakshay.
Hi Karthik, I have a question on the relationship between “Risk-free rate” and the “RBI’s 91-day Treasury bill%”. Is “RBI’s 91-day Treasury bill%” the only value to be taken to calculate the fair value of the futures or there are other sources also than “RBI’s 91-day Treasury bill %”? Thanks
Its just the RBI ref rate.
Hi Karthik, one more question about an example of Wipro under section 10.2 – Practical Application. Looking at the P&L table and the last line in second last paragraph which says that “This would require you to sell Wipro in spot market and buy back Wipro in Futures market.” not sure if this will be other way around i.e. “This would require you to sell Wipro in FUTURES market and buy back Wipro in SPOT market.” This is how I interpret it as a beginner :). Thanks
There is another way too, but its just that its not easily doable 🙂
Most importantly please do bear in mind the discussion with respect to spreads in this chapter is just a sneak peek into the world of trading strategies. We will discuss these strategies in a separate module which would give you an in depth analysis on how one can professionally deploy these strategies.
Which module you are referring to?
Check the module on trading stratergies.
What is unwinding at expiry means, pls elaborate
Its referred to the closing of the position on the expiry day.
Hi Karthik, is there a way to buy nifty futures at nifty spot price. Let’s say nifty spot trading at 18000 and nifty futures at premium of 18060. Now I would like to buy nifty futures at spot price 18000 instead of 18060.
Not exactly at the same price, but sometimes, Nifty futures can go below the spot and trade at a discount to spot price.
In the calculation of the Calendar Spread P&L, I do not understand the calculation for the mid month P&L. You have correctly calculated the “Current Month P&L (short)” (second column in the table) as expiry price of the current month future is same as spot price.
But for the Mid or Far month P&L, the price of the future on the expiry day of current month future is not the same as the underlying price as expiry is still one or two months away. Thus, for the third column, “Mid Month P&L (Long)” calculation should use the price of the Mid Month future on the day of expiry current month future. I think, here the fair price formula of the future price computation should be used.
Another point is that the future computation formula assumes simple interest. It should instead use compounding interest formula: Spot price * [(1+ rf/365)^x]– d, where ^x denotes “to the power x”. Only with this exponential relation, the current month future premium will reduce faster near the expiry.
Yeah, the mid month is based on the assumption that its trading at these levels when the current month expires. But I get your point that the mid-month will not expire and converge. Do check out the other method of calender spread here – https://zerodha.com/varsity/chapter/calendar-spreads/
Thanks for your reply. I went through the other method on the link you provided. I think that whole module on Trading Systems is useful.
I am commenting here just to maintain the thread.
1. My initial thought was that calendar spread is longer term, like you take in the beginning of the month and exit at expiry. But in the new method, you exit almost always the next day. I think the P&L is very small.
2. My other observation is that calculation based on theoretical fair value formula does not give correct results.
3. Lastly, I would like to say that I “discovered” this strategy when I was playing with different combinations in Sensibull. Then I came across your this article on future pricing where I found some justification of what I saw in Sensibull: It showed constant profit for the entire range of the underlying (Banknifty/Nifty in my case). The profit changes at different times in the day, but it increases in fixed steps as the expiry nears. So the way I enter is by first looking at Sensibull and then take trade. I keep the positions till expiry and exit just before expiry. Max profit if I sell current month and buy far month (not near month). I have seen profit in the range of 4-11% for the last 2 months. Is what I am observing and doing, the correct way of doing it?
1) Yes, the idea is to run it like an algo and set up high-frequency trades 🙂
2) So, you just take the spread here, with the assumption that the futures price has baked in all the theoretical calculations
3) Thats roughly how this works. Yeah, you are in the right direction.
Is number of contracts in future trading affects respective stock price ?
For example: Infosys (Share price 1427, MAY future 1437 ), If big institutions make short positions in INFY MAY FUT, will it directly affect the share price ? Will INFY share price fall because of large number of short positions in INFY future contracts ?
Sometimes it does have an impact. But generally speaking, the higher the liquidity, the lower the chances of such price interdependence.
Sir,
I have the following queries here:
(i) Do we always make profit for the “Cash and Carry arbitrage” trade?
(ii) Is the amount of profit equals the difference of spot price and future price?
(iii) Suppose initially the future price is greater than spot price. Is there any probability that before expiry the future price drops below spot price?
(iv) To make the sure shot profit in the “Cash and carry arbitrage”, does one need to simultaneously square off both the positions od spot and future?
(iv) Is it make sense/much better to go for the “Cash and carry Arbitrage” when the fair price (calculated through formula) is much lower than the market price?
(v) In case of backwardation, is it possible to buy future and sell the spot (since shot selling should not be allowed in CNC, as we studied)? Please help understand here.
(v) Will it be good choice for trading with futures of two different months even if the mid month’s market price is not close to fair price?
(vi) Won’t it be better choice to trade between two different futures rather than spot & future since the former one requires much lesser margin? Please suggest.
(vii) Is this sure shot profit applicable even if one initiates opposite trades between mid & far month future/ current & far month future?
Request your much valuable help on the above please.
1) Nope, no guarantees in market
2) Yes
3) No
4) Yes
5) Yes, or higher. Either situation works. But futures higher works as you can short futures and buy spot
6) Tough
7) Yes, please see my other chapter on the calendar spread
8) Yes, please see above
9) No guarantee 🙂
Mr. Karthik,
My question is in Far month futures. I found the decay in Nifty futures price is less but where as the decay in Bank nifty futures price is higher. Please guide me what formula defines for Index futures pricing changes.
Decay is also a function of individual script volatility. Not all instruments have the same decay.
Hello Karthik sir,
I have been facing an issue regarding the constantly changing “Premium/discount of stock futures prices compared to spot.”
Say, I short a stock future when it is trading at a discount of Rs. 10 compared to spot. After a while, the discount reduced to Rs. 5 compared to spot.
(I refer spot charts to trade in futures)
If the lot size is 1000, this extra Rs. 5000 loss causes unnecessary dent on the portfolio. (due to reduction in discount to spot)
Simply put,
When short, spot prices fall but futures do not &
When long, the spot rises but futures do not.
Such fluctuations skew the returns.
Have any thoughts on how to tackle this?
Many thanks!!!
Shubham, basing your trades only on premium and discount is not a great idea. There should be other factors that should drive your trade and not just the premium and discount. One good way to start is by reviewing the checklist we discussed in the TA module.
Sir, why do we see high change in profit/loss in futures as compared to equity shares for same amount of fluctuations in the chart.
HEY, I JUST USED YOUR FORMULA TO CALCULATE NIFTY FUTURE PRICE (TODAYS DATE IS 10th july 2023).
I have some confusions in the formula.
Here are the calculation i just undertook (10th july 2023) –
nifty price 19355.90
Risk free rate (as per rbi website) – 6.72
number of days to expiry – 13 (trading days left to expiry) / 17 (total days left to expiry)
Futures Price = 19355.90 * [1+6.72/100( 13/365)]
= 19402.22689
Futures Price = 19355.90 * [1+6.72/100( 17/365)]
= 19416.48132
Now, the problem is that the actual future price for 27th july expiry NIFTY is 19524.00.
Can you explain this???
The price you’ve calculated is the theoretical price. The price that you see is the market price. Both can be different. The market price is determined based on the actual demand and supply. At any given point, there will be price difference between the two 🙂
I got your point that market price can be different than theoretical price.
But is there any chance that market price can go below theoretical price.
if yes, then can you please tell any instance when future jas gone below spot price in nifty.
I am not able to get any such instance from last 3 years.
Yes, this keeps happening. Nifty is either at a discount or premium to spot. I think around Covid time, Nifty was at a discount to spot. Can you check March 2020 once?
Hi Karthik sir, thanks for knowledge you are providing.
I have 2 doubts. Please answer sir. Thanks in advance
1. What is present dividend factor for nifty in fair price calculation.where can I see. Please share link if possible sir.
2.can you please share risk free interest rate link of RBI ( i know it’s not accurate but proxy)
1) This will be unpdated on NSE’s website. I know it used to be somewhere here – https://www.nseindia.com/market-data/live-equity-market?symbol=NIFTY%2050, but unable to get find now. Maybe you can do some digging around 🙂
2) Check on the left-hand side – https://rbi.org.in/ under policy rates.
Also where can I get 3 months futures as automatic Excel . Please share link sir. 🙏
Not sure about this, please check with a NSE authorised data vendor for this.
Thank you so much sir
Happy learning 🙂
Sir, if that’s the case, if buying spot and selling futures then, won’t theta decay affect spot option bought.
Theta decay is only for options, not for futures Sam.
If the prices of the stock or Nifty remain same for the entire month (theoretically) what would be the price of the future lot? For example, let’s say on the 1st day of the month…. Nifty is at 20000 and Nifty future for the current month is at 20100. I buy the future at 20100 today. Now for the entire month, the nifty remains same at 20000, what will be the future price at the expiry? And how will it reflect in the P&L?
So difference between the spot and futures will be noticed by market participants and they would try to arbitrage it away, hence the price would converge 🙂
In terms of commodies i.e. for example am looking to buy a 1 kg lot of gold – FUT 5 Dec 23 – what would be the gold price i will book this lot at ? is it going to be the same as gold spot price currently in MCX or will be gold Spot price + X amount ? and where we could find this in zerodha ? Thank you
This will be gold futures price as on MCX.
Sir, First of all, Hats off to you!!! It’s really wonderful for the novice like us who know nothing about markets in general. You are doing a great job!
My question is I cannot see futures market data live or historical in sensibull. Where and how can I find it? Second query is if futures and options both are derivatives, then which one should I choose and why? At least, which one is easier to learn and get profit?
Thanks, Prakash.
YOu can try downloading from NSE, they used to provide historical data, maybe they still do. Can you check once? I cant tell you which one is easier to make a profit, but I can tell you that futures is easier to understand 🙂
1. If the contract is valid for 90 days then why we are taking 365 in the formula?
2. In the future we can minus dividends from underlying assets (As per the formula), What are we doing with options to remove price variation of dividends?
1) To get the annualized number right
2) The options formula too has a method to factor in the dividends.
Hi kartik,
I have this question, how does SGX nifty predict exactly where Nifty will open the next day? Doesn’t the future’s value be derived from the underlying and not the other way round?
Thanks,
Kunal
Its not exact right? The directional movement is known, values will differ.
Nicely explained.
`Futures Price = Spot price * [1+ rf*(x/365)]– d` Here you used multiplication with rf*(x/365) but in examples it’s show %. Which one is correct?
If you use –
rf*(x/365) = daily interest
Percentage = annual
So based on what you are trying to do, use can use the appropriate formula. But both work.
sir ,
it means , in calendar spread , one should make position at the start of the month and hold on to the expiry . and make good profit, as at the start , the difference between the two spread in colander spread is enough good .
Yeah, generally speaking, the higher the time to expiry, the larger the spread. But there are times when this can also expand basis volatility in the market.
What is the calculation of loss. In what scenario we face loss in it.
Take the difference between the buy and sell price of futures and multiply with the lot size. You will get the P&L.
Sir, owing to demand and supply, future at premium indicates to huge demand to buying side. am I right ?
Yes, thats correct.
Mid month futures’ price will be different(not equal to the spot) when near term contract expires. Why did you subtract the spot price from 665??
I’d suggest you check this – https://zerodha.com/varsity/chapter/calendar-spreads/
Hi Karthick,
Is there in any module for different of arbitrage technique, if not can you brief about in any module
You can check this – https://zerodha.com/varsity/module/trading-systems/
In calculating future price, say am calculating the price for next week expiry, If there are 2 holidays in between expiry Do I have to exclude the holidays? also what about weekends? include or exclude?
Thanks
You can include the days, thats ok.
Futures Price=Spot price×[1+rf×(365x)]−d
Karthik, In the above formula, X denotes calendar days or trading days? Sensibull said its calendar days and all days including weekends and holidays included?, People I’ve known said its trading days. Which one is correct?
YOu can include them, its ok. Another thing that you can do is to calculate with and without the holidays and see which price is closest to the market and use that format 🙂
Okay Thanks karthik,
On Expiry day If future price is trading at discount than spot, what will happen here, Will spot reduce to future price or future rise to spot price?
Either could happen, but they do converge to a single price on the expiry day.
Hi Karthik
On an intraday basis some times Future closes by some 10 to 30 points higher and some other days the opposite, Why does this happen, Is there a way to find on which days the future would trade higher/lower than spot
Its hard to predict, but it happens due to the simple demand and supply situation.
Hi Karthik,
How does price of NIFTY FUTURES get’s affect if say huge number of market participant go long in NIFTY FUTURE, will the NIFTY FUTURE’S price get increased?
at time, I see nifty moves, 30-40 points but nifty future moves more than the underlying (say 45-55pts), what causes this?
Kindly direct me towards resource from where i can learn more about NIFTY SPOT AND FUTURE’S relation.
Thankyou
– Mohit
Yes, if there are many people buying/going long then the prices tend to go up 🙂
hai Karthik,
can i do calendar future spread on every month. if yes.. what is the best time to deploy this strategy.
if not on every month, how can i find chances to delpoy and at what time.
You can, and the best time to deploy is when the spreads are wide enough. Unfortunately you cant fix a particular date for this.
Hi Sir,
Thanks for making such wonderful materials.
My question is in future pricing formula we add Risk free rate in order to determine. Why so? Is the future contract price do not involve any risk? so we add back that
Risk free rate is to account for the opportunity cost, Ankit, and yes, futures involves risk, its not risk free 🙂
Hi sir , I have one doubt pls revert me
You have told that one can take RBI’s tbills as risk free rate
Can we take this at any time or we need to look another best risk free rate as per current situation
You can take this at any point, Kamesh.
Can we say that cash n carry strategy needs more capital to trade than calender spread as we have to buy spot which need huge amount?
Secondly,spread is more in cash n carry so profit is comparatively more than calender spread strategy.
Thank you.
Yes, of course. With calendar spreads, you have reduced risk, hence reduced margins. About reward, yes, you can say that.
rather than 2 atm put buy , go for one ITM put buy (eventually you are shorting the future) along with longing futute at discount . Loss shall be limited may be zero and profit -> linear like future .
1 ATM put = delta of 0.5. 2 = 0.5+0.5 = 1 = futures delta.
Thanks for this lesson. How often do you come across Cash & Carry Arbitrage or Calendar Spread opportunities?
They continue to exist, but it is getting increasingly difficult to grab these opportunities by a retailer, thanks to the algos at play 🙂