Nifty Futures – Working, Facts & How to trade it?

A derivative means a financial instrument that gets its value from its underlying asset. Nifty Futures is a form of derivative, the underlying asset of which is the Nifty50 index. With a rise in the index value, there is a corresponding rise in the value of the futures contract and vice versa. The Nifty futures contract allows the buyer or seller the right to buy/sell the derivative on the Nifty50 index on a future date at a predetermined price. 

Nifty50 happens to be one of India’s most traded and therefore most liquid futures contracts. Let’s learn more details about the Nifty Futures.

What does the Nifty Futures contract consist of?

Under the Nifty Futures contract, there are two options: 

1. Call

With a call option, the contract owner has an option to buy a Nifty index within a given time and as per the price mentioned in the contract. The owner is not obligated to execute the option.

2. Put

A put option is just the opposite of a call option, in that, the contract owner has an option to sell a Nifty index, but is not obligated to execute the option.

How does the Nifty Futures contract work?

Here’s an example to easily understand the functioning of a Nifty Futures contract. 

Nisha, an investor, believes that the Nifty index may rise from its current trading price of Rs. 17,700. So, what does she do?

She buys one lot of Nifty Futures with a margin placed at a small percentage of the contract’s cost. She thereby gains access to 75 shares. This makes Nisha eligible to receive these shares from the seller, Rahul, for Rs. 17,700.

Now, Nisha’s estimate turns right, and the share goes up to Rs. 17,800. Since she opted for a Nifty call, Nisha can buy the shares from Rahul at Rs. 17,700 and resell them at Rs. 17,800. Thereby she can fetch Rs. 100 as options premium income per share. Since she owns 75 shares, the sale income adds up to Rs. 7,500. 

In case, however, if Nifty futures fall to Rs.17,600, Rahul has the option to sell the futures to Nisha at Rs. 17,700. Thus, she may incur a loss of Rs. 100 on every share bought.

Did you know?

• Before the year 2000, National Stock Exchange/NSE and Bombay Stock Exchange/BSE were electronically operated equity spot exchanges.
• The exchanges started derivative trading only in June 2000 with a single scrip, NIFTY. The name of this scrip has evolved from “S&P CNX Nifty” to “Nifty 50”.
• Nifty 50 future contract enjoys a daily turnover of more than 10000.

Quick facts on Nifty Futures

Here are some quick facts on Nifty Futures:

• Trading symbol – NIFTY (equity derivative)
• Instrument type: Index futures
• Underlying asset: NIFTY 50 Index
• Value (lot size): Rs. 5,00,000 (approximately)
• Current lot size: 75 shares
• SPAN margin (NIFTY NSE): 5%
• Exposure margin (NIFTY NSE): 3%

How to trade in Nifty Futures

Here are some important points to note while trading in Nifty Futures:

• Be cautious about leveraged positions – Just like all futures positions, Nifty futures positions too are leveraged. For normal trades, you get a 10% margin while a 5% margin is applicable for intraday trades. You should be cautious about leveraged positions since it means that profits and losses will be multiplied. It is important to know the risk involved in leverage to further use profit targets appropriately and stop losses.
• Evaluate the spread over spot – Careful assessment of the spread over spot price is crucial to understand the exact reason behind it. Never purchase Nifty Futures lots in a haste, even if you think there’s a very steep premium in comparison to the spot price. This spread may be due to overpricing and such occurrences are common. Also, be careful of buying Nifty futures when they seem to be trading at a discount, as this could very well be a result of aggressive selling.
• Go through the open interest data: Before buying Nifty futures, it is highly recommended to have a closer look at the open interest data for better assessment of trend accumulation. It can give insights into the direction (long side or short side) that the open interest is going towards to further make an informed investment decision.
• Know the counterparty perspective: You should know that every Nifty futures position will have a counterparty, who could be a hedger or trader. While entering into a contract, try to know your seller’s intentions to further ascertain the reason behind certain price levels. This will offer additional clarity in decision-making.
• Keep a close watch on additional costs: Nifty futures come with certain statutory and brokerage costs. These costs can have a significant impact on your breakeven point. Any profits or losses from Nifty futures are considered as capital gains or capital losses. Therefore, there will be tax implications on the same, resulting in an additional cost. Being cautious about these additional costs can help in saving money in the long run.

Conclusion

Futures contracts offer many advantages to all kinds of investors whether speculative or otherwise. However, highly leveraged positions combined with large contract sizes may also result in huge losses, even with small market movements. Thus, an investor should always strategize and carry out due diligence before trading in Nifty futures to understand both the advantages and the risks involved.

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