Sunday, June 25, 2017

Understanding futures in stock market

Let us know talk about futures. Please complete going through the previous post on derivatives before reading this. What are futures? As you already know, futures are a kind of derivatives, whose value most closely resembles the price of the underlying stock.

For example, consider an RCOM stock. Futures have an expiry date, which is usually the last Thursday of the month. Today's date is 26th June, so we we have a 29th June derivative of RCOM which expires on 29 June and whose value is closely resembles the underlying stock. Below is a snapshot taken from the NSE website of 29th June future.


As you can see the closing price of the derivative on Friday at the market closing hours is Rs. 21.4. Now let's see the underlying stock RCOM closing price on the same day when the market closed which is as below.


As you can see the values are a close resemblance of each other. Also if you see their intraday chart which is a graph in the bottom right corner of both, you can observe both have almost same moment except the price point. This gives you a glimpse of future, and at any particular day if you can predict the movement of the stock you can buy its derivative and make good money even though you have around less than 20000 rupees in your account. Sometimes you can even get an almost equal amount of money as profit, that is the power of futures.

Now take a look at the derivative snap which I posted again by scrolling above. As you can see the derivative opened at 20.5 it reached an intraday high of 21.8 and intraday low of 19.9. This means as you can just see in the intraday chart, at different times of the day the derivative keep moving. Now, just consider you bought the derivative of RCOM when the derivative price is trading at 20.2. You know for sure that RCOM is trying to sell Assets and that is positive for the stock. So since the stock goes up, it means this future also will go up. So, as per  RCOM leverage rules, you can buy 12000 shares of RCOM future for about 16000 rupees. And it is mandatory that whatever you buy it has to be in multiple of 12000. Now you have invested your 16000 rupees in the morning by buying 12000 shares of rcom derivative at price rupees 20.2. Now wait till evening when the price reaches to do 21.2 and sell it off so you can see that you have a 1 Rupee profit per share. This can be automated, where you can put target at 21.2, and keep doing your other work also as all stock broking accounts now offer this feature. At around 2 PM your target is reached. Now, if you multiply 1 rupee profit per share with 12000 shares you got this 12000 rupees. So you can see the power of futures, in giving you the maximum value for your money invested at the same time even if you don't have the high amount of money to buy 12000 stocks. Isn't it great.

But there is a downside also. If the stock after you bought it for 20.2, would have gone to 19.2 you would have made a loss of 12000 rupees. So you must be cautious enough while buying the derivatives that you try to get it when you are buying for as low price as possible and when you are selling don't be greedy that it will reach more highs. Keep a target for your profits too. We will discuss about options in my next post.