The method of buying and selling a futures contract on the same day without maintaining open long or short positions overnight is referred to as day trading. The duration of day transactions varies. They can last a few minutes or the entirety of a trading session. To day trade futures well, you’ll need a lot of information, expertise, and discipline.
Is it possible to buy cash and sell futures on the same day?
The term arbitrage has a variety of meanings. It relates to pricing discrepancies on a conceptual level. When the NSE first opened its doors in 1994, there was a significant pricing gap between the BSE and the NSE for the same stock. Brokers would buy the stock on one exchange at a lower price and sell it on the other for a higher price. This disappeared after a while.
With the introduction of futures, a new type of arbitrage technique known as cash future arbitrage approach emerged. Stock futures, as we all know, have a monthly expiration cycle and expire on the last Thursday of each month. There are three monthly contracts available at any given time: near month, mid-month, and distant month. Stock-futures arbitrage involves buying in the cash market and selling the same stock in the futures market in the same quantity. The difference becomes the risk-free spread for the arbitrageur because the futures price will expire at the same price as the spot price on the F&O expiry day. Arbitrage is possible in futures and options.
There is a cost of carry, commonly known as the interest cost, because futures prices refer to a contract that is one month away. As a result, if the yearly risk-free rate of interest is 12%, the 1-month futures price must be 1% higher than the cash price. Of course, there are other elements that influence the futures price, but this is the most important one. By buying in the cash market and selling in the futures market, you can lock in a monthly return of 1%. Consider the following scenario.
In the above Reliance Industries live price chart, the cash price on January 25th is Rs.960.50, while the Feb 22nd Futures price is Rs.965.15. As a result, the arbitrage spread is, which equals 0.48 percent. That is the return for a 28-day period.
Arbitrageurs often want an annualized return of 12-14 percent because they must cover their funding costs as well as the transaction and statutory costs of conducting the arbitrage, in addition to the tax consequences. So, how does futures arbitrage work?
This is the most crucial aspect of the arbitrage deal. You’ve locked in a riskless arbitrage profit, but how can you actually cash in on it? You can genuinely make money in the cash market by selling your shares. There are two ways to realize the lock-in profit on an arbitrage transaction in the arbitrage market.
You can profit from arbitrage by unwinding your trade, which implies reversing your long equities position and short futures position at the same time.
You can keep your cash market position in your portfolio, but based on the spread, you can roll over your futures position to the next contract.
An arbitrage deal, as we all know, involves buying in the cash market and selling in the futures market. That is, on the same stock and in the same quantity, you are long in the cash market and short in the futures market. It’s worth noting that you don’t have to wait until your position expires to unwind your position. If the spread has narrowed significantly, you can even terminate your arbitrage sooner. Let’s look at an example to better grasp this.
Adaptable (in an arbitrage trade)
Quantity (in an arbitrage trade)
Reliance cash price (bought) on February 01Rs.920Reliance futures price (sold) on February 01Rs.930
Rs.10 spread on cash futures (1.09 percent )
Annualized arbitrage spread: 18.95 percent What method will be used to unwind this arbitrage position? Reliance’s cash price on February 11 was Rs.955 and its February futures price was Rs.958. Spread on cash futuresRs.3 Reliance Cash Position ProfitRs.35 (955-920) Reliance Futures Position LossRs.(-28) (930-958) Arbitrage net profit / lossRs.7
Unwinding the arbitrage results in a net profit of Rs.7, which can be viewed as either the profit on the trade or the difference between the two spreads. It refers to the same item. Remember that the market price of cash and futures is irrelevant to you. Is it only the spread that matters? If the spread falls below Rs.10, you will profit. In this situation, you will earn Rs.7 in ten days.
The disadvantage of this method is that you must construct new positions and unwind them every month. Higher transaction costs, statutory costs, and short-term capital gains on cash market earnings result as a result of this. Rolling over your futures is a better and more popular way of generating arbitrage profits.
By keeping your cash positions and rolling your futures positions to the next month, you may avoid the difficulties of unwinding and constructing arbitrage positions each month. Consider the following scenario.
The dark area depicts the SBI futures price for the January and February contracts. Because you have a long cash market position and a short Jan Futures position, you can purchase SBI Jan futures at Rs.320.80 and sell SBI Feb futures at Rs.322.35. This results in a Rs.1.55 arbitrage spread (0.48 percent ). This is your monthly spread profit, and you earned it without affecting your cash market position. In arbitrage, this is how most institutions operate.
Is it possible to buy and sell futures at the same time?
A futures contract is a legally binding agreement to buy or sell a certain commodity, asset, or security at a defined price at a future date.
Is it possible to hold futures overnight?
To hold a Futures or Options on Futures position overnight in any Futures contract, clients must have the overnight margin requirement pursuant to TD Ameritrade Futures & Forex’s requirements for the specific contract available at the closing of the day’s session.
Can you day trade futures without a deposit of $25,000?
Traders with less than $25,000 in their margin account are only allowed to make three day trades in a rolling five-day period, according to the PDT. So, if you make three day transactions on Monday, you won’t be able to make any more until the following Monday.
Is it possible to sell futures before they expire?
Purchasing and selling futures contracts is similar to purchasing and selling a number of units of a stock on the open market, but without the need to take immediate delivery.
The level of the index moves up and down in index futures as well, reflecting the movement of a stock price. As a result, you can trade index and stock contracts in the same way that you would trade stocks.
How to buy futures contracts
A trading account is one of the requirements for stock market trading, whether in the derivatives area or not.
Another obvious prerequisite is money. The derivatives market, on the other hand, has a slightly different criteria.
Unless you are a day trader using margin trading, you must pay the total value of the shares purchased while buying in the cash section.
You must pay the exchange or clearing house this money in advance.
‘Margin Money’ is the term for this upfront payment. It aids in the reduction of the exchange’s risk and the preservation of the market’s integrity.
You can buy a futures contract once you have these requirements. Simply make an order with your broker, indicating the contract’s characteristics such as theScrip, expiration month, contract size, and so on. After that, give the margin money to the broker, who will contact the exchange on your behalf.
If you’re a buyer, the exchange will find you a seller, and if you’re a selling, the exchange will find you a buyer.
How to settle futures contracts
You do not give or receive immediate delivery of the assets when you exchange futures contracts. This is referred to as contract settlement. This normally occurs on the contract’s expiration date. Many traders, on the other hand, prefer to settle before the contract expires.
In this situation, the futures contract (buy or sale) is settled at the underlying asset’s closing price on the contract’s expiration date.
For instance, suppose you bought a single futures contract of ABC Ltd. with 200 shares that expires in July. The ABC stake was worth Rs 1,000 at the time. If ABC Ltd. closes at Rs 1,050 in the cash market on the last Thursday of July, your futures contract will be settled at that price. You’ll make a profit of Rs 50 per share (the settlement price of Rs 1,050 minus your cost price of Rs 1,000), for a total profit of Rs 10,000. (Rs 50 x 200 shares). This figure is adjusted to reflect the margins you’ve kept in your account. If you make a profit, it will be added to the margins you’ve set aside. The amount of your loss will be removed from your margins if you make a loss.
A futures contract does not have to be held until its expiration date. Most traders, in practice, exit their contracts before they expire. Any profits or losses you’ve made are offset against the margins you’ve placed up until the day you opt to end your contract. You can either sell your contract or buy an opposing contract that will nullify the arrangement. Once you’ve squared off your position, your profits or losses will be refunded to you or collected from you, once they’ve been adjusted for the margins you’ve deposited.
Cash is used to settle index futures contracts. This can be done before or after the contract’s expiration date.
When closing a futures index contract on expiry, the price at which the contract is settled is the closing value of the index on the expiry date. You benefit if the index closes higher on the expiration date than when you acquired your contracts, and vice versa. Your gain or loss is adjusted against the margin money you’ve already put to arrive at a settlement.
For example, suppose you buy two Nifty futures contracts at 6560 on July 7. This contract will end on the 27th of July, which is the last Thursday of the contract series. If you leave India for a vacation and are unable to sell the future until the day of expiry, the exchange will settle your contract at the Nifty’s closing price on the day of expiry. So, if the Nifty is at 6550 on July 27, you will have lost Rs 1,000 (difference in index levels – 10 x2 lots x 50 unit lot size). Your broker will deduct the money from your margin account and submit it to the stock exchange. The exchange will then send it to the seller, who will profit from it. If the Nifty ends at 6570, though, you will have gained a Rs 1,000 profit. Your account will be updated as a result of this.
If you anticipate the market will rise before the end of your contract period and that you will get a higher price for it at a later date, you can choose to exit your index futures contract before it expires. This type of departure is totally dependent on your market judgment and investment horizons. The exchange will also settle this by comparing the index values at the time you acquired and when you exited the contract. Your margin account will be credited or debited depending on the profit or loss.
What are the payoffs and charges on Futures contracts
Individual individuals and the investing community as a whole benefit from a futures market in a variety of ways.
It does not, however, come for free. Margin payments are the primary source of profit for traders and investors in derivatives trading.
There are various types of margins. These are normally set as a percentage of the entire value of the derivative contracts by the exchange. You can’t purchase or sell in the futures market without margins.
Do futures trade around the clock?
- Stock index futures, such as the S&P 500 E-mini Futures (ES), reflect expectations for a stock index’s price at a later date, based on dividends and interest rates.
- Index futures are two-party agreements that are considered a zero-sum game because when one party wins, the other loses, and there is no net wealth transfer.
- While the stock market in the United States is most busy from 9:30 a.m. to 4:00 p.m. ET, stock index futures trade almost continuously.
- Outside of normal market hours, the rise or fall in index futures is frequently utilized as a predictor of whether the stock market will open higher or lower the next day.
- Arbitrageurs use buy and sell programs in the stock market to profit from price differences between index futures and fair value.
Is futures trading the same as day trading?
During a trading day, stock day traders buy and sell equities based on price fluctuations. Futures day traders purchase and sell derivatives and options depending on fluctuations in the price of commodities futures contracts on a daily basis.
Is it possible to trade futures without using leverage?
Trading in futures is, as we all know, quite similar to trading in the cash market. Futures, on the other hand, are leveraged because they merely require a margin payment. If the price change goes against you, however, you will have to pay mark to market (MTM) margins. Trading futures presents a significant difficulty in terms of minimizing leverage risk. What are the dangers of investing in futures rather than cash? What’s more, what are the risks of trading in the futures market? Is it possible to utilize efficient day trading futures strategies? Here are six key techniques to limit the danger of using leverage in futures trading.
Avoid using leverage just for the sake of using it. What exactly do we mean when we say this? Assume you have a savings account with a balance of Rs.2.50 lakhs. You want to invest the funds in SBI stocks. In the cash market, you can buy roughly 1000 shares at the current market price of Rs.250. Your broker, on the other hand, claims that you can purchase more SBI if you buy futures and pay a margin. Should you invest in futures with a notional value of Rs.2.50 lakh or futures with a margin of Rs.2.50 lakh? You can acquire the equivalent of 5000 shares of SBI if you buy it with a margin of Rs.2.5 lakh. That implies your profits could rise fivefold, but your losses could also rise fivefold. What is a middle-of-the-road strategy?
That brings us to the second phase, which is deciding how many SBI futures to buy. Because your available capital is Rs.2.50 lakh, you’ll need to account for mark-to-market margins as well. Let’s say you predict the shares of SBI to have a 30% corpus risk in the worst-case scenario. That means you’ll need Rs.75,000 set aside solely for MTM margins. If you want to roll over the futures for a longer length of time, you must throw in a monthly rollover cost of approximately 1%. So, if you wish to extend your loan for another six months, you’ll have to pay an additional Rs.15,000 to do so. Additional Rs.10,000 can be provided for exceptional volatility margins. Effectively, you should set aside Rs.1 lakh and spend only Rs.1.50 lakhs as an initial margin allowance. That would be a better way to go about calculating your initial margins.
You can hedge your futures position by adding a put or call option, depending on whether you’re holding futures of volatile equities or expecting market volatility to rise dramatically. You may ensure that your MTM risk on futures is largely offset by earnings on the options hedge this manner. Remember that buying options has a sunk cost, which you should consider carefully after considering the strategy’s risks and rewards.
Use rigorous stop losses while trading futures. This is a fundamental rule in any trading activity, but it will ensure that you exit losing positions quickly. Is it feasible that the stock will finally meet my target after I set the stop loss? That is entirely feasible. However, as a futures trader, your primary goal is to keep your money safe. Simply exit your position when the stop loss is triggered. That’s because if you don’t employ a stop loss, you’ll end up losing money.
At regular intervals, book profits on your futures position. Why are we doing this? It ensures that your liquidity is preserved, and it adds to your corpus each time you book gains. This means you’ll be able to get more leverage out of the market. Because you’re in a leveraged position, it’s just as crucial to keep your trading losses to a minimum as it is to maintain your trading winnings to a minimum.
Last but not least, keep your exposure from becoming too concentrated. If all of your futures positions are in rate-sensitive industries, a rate hike by the RBI could have a boomerang impact on your trading positions. To ensure that the impact of unfavorable news flows does not become too prohibitive, it is always advisable to spread out your leveraged positions. It has an average angle as well. When we buy futures and the price of the futures drops, we usually average our positions. Again, this is risky since you risk overexposure to a certain business or theme.
Leverage is an integral aspect of futures trading. How you manage the risk of leverage in futures is entirely up to you.