Friday, February 22, 2013

Excellent Trading School - 11 - Derivatives Trading


Derivatives Trading on NSE
The F&O segment on NSE provides trading facilities for the following derivative instruments:
Index futures,  Index options,  Individual stock futures, and  Individual stock options.
As an investor one can invest in any of these products. All these products have different contract specifications.

Contract specifications for index futures
Index futures are futures contracts on an index, like the Nifty. The underlying asset in case of index futures is the index itself. For example, Nifty futures traded in NSE track spot Nifty returns. If the Nifty index rises, so does the pay off of the long position in Nifty futures. Apart from Nifty other indices such as CNX IT, Bank Nifty etc. are also traded on the NSE.

On NSE’s platform one can trade in Nifty, CNX IT, BANK Nifty, etc. futures contracts having one-month, two-month and three-month expiry cycles. All contracts expire on the last Thursday of every month. Thus, a January expiration contract would expire on the last Thursday of January and a February expiry contract would cease trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three-month expiry would be introduced for trading.

The Instrument type refers to “Futures contract on index” and Contract symbol - NIFTY denotes a “Futures contract on Nifty index” and the Expiry date represents the last date on which the contract will be available for trading.

Each futures contract has a separate limit order book. All passive orders are stacked in the system in terms of price-time priority and trades take place at the passive order price (similar to the existing capital market trading system). The best buy order for a given futures contract will be the order to buy the index at the highest index level whereas the best sell order will be the order to sell the index at the lowest index level.

Contract Specification for S&P Nifty Index Futures
Underlying Index S&P CNX Nifty
Exchange of trading National Stock Exchange of India Limited
Security Descriptor FUTIDX NIFTY
Contract Size Permitted lot size is 50  (minimum value Rs 2 lakh)
Trading Cycle The future contracts have a maximum of three month trading cycle - the near month (one), the next month (two), and the far month (three). New contracts are
introduced on the next trading day following the expiry of the near month contract.
Expiry Day The last Thursday of the expiry month or the previous trading day if the last
Thursday is a trading holiday
Settlement Basis Mark-to-market and final settlement are cash settled on T+1 basis
Settlement Price Daily Settlement price is the closing price of the futures contracts for the trading day and the final settlement price is the value of the underlying index on the last trading day

Example: If trading is for a minimum lot size of 50 units and the index level is around 5000, then the appropriate value of a single index futures contract would be Rs.250,000. The minimum tick size for an index future contract is 0.05 units. Thus a single move in the index value would imply a resultant gain or loss of Rs.2.50 (i.e. 0.05*50 units) on an open position of 50 units.
  
Contract specification for index options
Index based options are similar to index based futures as far as the underlying is concerned i.e., in both the cases the underlying security is an Index. As the value of the index increases, the value of the call option on index increases, while put option value reduces. All index based options traded on NSE are European type options and expire on the last Thursday of the expiry month. They have expiries of one month or two months, or three months. Longer dated expiry contracts with expiries up to 3.5 years have also been introduced for trading.

On NSE’s index options market, there are one-month, two-month and three-month expiry
contracts with minimum nine different strikes available for trading. Hence, if there are three serial month contracts available and the scheme of strikes is 6-1-6, then there are minimum 3 x 13 x 2 (call and put options) i.e. 78 options contracts available on an index. Option contracts are specified as follows: DATE-EXPIRYMONTH-YEAR-CALL/PUT-AMERICAN/ EUROPEAN- STRIKE.

Contract Specification for S&P CNX Nifty Options
Underlying Index S&P CNX Nifty
Security Descriptor OPTIDX NIFTY
Contract Size Permitted lot size is 50 (minimum value Rs. 2 lakh)
Trading Cycle The Option contracts have a maximum of three month trading cycle---the near month (one), the next month (two), and the far month (three). New contracts are
introduced on the next trading day following the expiry of the near month contract.
Expiry Day The last Thursday of the expiry month or the previous trading day if the last
Thursday is a trading holiday
Settlement Basis Cash Settlement on T+1 basis
Style of Option European (Closing value of the index on the last trading day.)
Daily Settlement Not Applicable
Final Settlement price Closing value of the index on the last trading day.

For example the European style call option contract on the Nifty index with a strike price of 5000 expiring on the 26th November 2012 is specified as ’26NOV2012 5000 CE’.

Just as in the case of futures contracts, each option product (for instance, the 26 NOV 2012 5000 CE) has it’s own order book and it’s own prices. All index options contracts are cash settled and expire on the last Thursday of the month. The minimum tick for an index options contract is 0.05 paise.
  
Contract specifications for stock futures
Stock based futures are futures based on individual stocks. The underlying on these futures are the individual company stocks traded on the Exchange. The expiration cycle of the stock futures is same as that of index futures.

Contract Specification for Stock Futures
Underlying Individual Securities
Exchange of Trading NSE
Security Descriptor FUTSTK
Contract Size As specified by the exchange (minimum value of Rs. 2 lakh)
Trading Cycle The futures contracts have a maximum of three month trading cycle---the near month (one), the next month (two), and the far month (three). New contracts are
introduced on the next trading day following the expiry of the near month contract
Expiry Day The last Thursday of the expiry month or the previous day if Thursday is a trading holiday
Settlement Basis Mark to market and final settlement is cash  settled on T+1 basis
Settlement Price Daily settlement price is the closing price of the futures contracts for the trading day and the final settlement price is the closing price of the underlying security on the last trading day.

Contract specifications for stock options
Trading in stock options commenced on the NSE from July 2001. Stock based options are options for which the underlying is individual stocks. Currently these contracts are European style and are settled in cash. The expiration cycle for stock options is the same as for index futures and index options. A new contract is introduced on the trading day following the expiry of the near month contract.

Contract Specification for Stock Options
Underlying Individual Securities available for trading in cash market
Security Descriptor OPTSTK
Style of Option European
Contract size As specified by the exchange (minimum value of Rs 2 lakh)
Trading Cycle The options contracts have a maximum of three month trading cycle—the near month (one), the next month (two), and the far month (three). New contracts are
introduced on the next trading day following the expiry of near month contract
Expiry Day The last Thursday of the expiry month or the previous trading day if the last
Thursday is a trading holiday
Settlement Basis Daily Settlement on T+1 basis and final option exercise settlement on T+1 basis
Daily Settlement Premium value (net)
Final Settlement price Closing price of underlying on exercise day or on expiry day

NSE provides a minimum of eleven strike prices for every option type (i.e. call and put) during the trading month. There are at least five in-the-money contracts, five out-of-the-money contracts and one at-the-money contract available for trading.


Eligibility Criteria for Stocks and Index Eligibility for Trading
• The stock is chosen from amongst the top 500 stocks in terms of average daily market capitalisation and average daily traded value in the previous six months on a rolling basis.

• The stock’s median quarter-sigma order size over the last six months should be not less than Rs. 5 lakhs. For this purpose, a stock’s quarter-sigma order size should mean the order size (in value terms) required to cause a change in the stock price equal to one-quarter of a standard deviation.

• The market wide position limit in the stock should not be less than Rs.100 crores. The market wide position limit (number of shares) is valued taking the closing prices of stocks in the underlying cash market on the date of expiry of contract in the month.

The market wide position limit of open position (in terms of the number of underlying stock) on futures and option contracts on a particular underlying stock shall be 20% of the number of shares held by non-promoters in the relevant underlying security i.e. free-float holding.

For an existing F&O stock, the continued eligibility criteria is that market wide position limit in the stock shall not be less than Rs. 60 crores and stock’s median quarter-sigma order size over the last six months shall be not less than Rs. 2 lakh. If an existing security fails to meet the eligibility criteria for three months consecutively, then no fresh month contract will be issued on that security. However, the existing unexpired contracts can be permitted to trade till expiry and new strikes can also be introduced in the existing contract months.

Once the stock is excluded from the F&O list, it shall not be considered for reinclusion for a period of one year.

Futures & Options contracts may be introduced on (new) securities, which meet the above mentioned eligibility criteria, subject to approval by SEBI.
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