Tuesday, February 26, 2013

Excellent Trading School - 23 - Frequently Asked Questions about Futures Contracts - part 2

Question: How can I use futures contracts?
Answer: You can do directional trading using futures. In case you are bullish on the underlying stock or index, you can simply buy futures on stock/index. Similarly if you are bearish on the underlying, you can sell futures on stock/index.

Question: Can I square up my position at any time before expiry?
Answer: Yes. It is not necessary to wait for the expiry day once you have entered into the position. You can square up your position at any time during the trading session, booking profit or cutting losses.

Question: What are the advantages and risks of trading in futures over cash?
Answer: The biggest advantage of futures is that you can short sell without having stock and you can carry your position for a long time, which is not possible in the cash segment because of rolling settlement.

Conversely you can buy futures and carry the position for a long time without taking delivery, unlike in the cash segment where you have to take delivery because of rolling settlement.

Further futures positions are leveraged positions, meaning you can take a Rs100 position by paying Rs25 margin and daily mark-to-market loss, if any. This can enhance the return on capital deployed.
For example, you expect a Rs100 stock to go up by Rs10. One way is to buy the stock in the cash segment by paying Rs100.  You make Rs10 on investment of Rs100, giving about 10% returns.
Alternatively you take futures position in the stock by paying about Rs30 toward initial and mark-to-market margin. You make Rs10 on investment of Rs30, ie about 33% returns. Please note that taking leveraged position is very risky, you can even lose your full capital in case the price moves against your position.

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