Because the Nifty is fairly indicative of the market and the economy in general, investing in Nifty futures is a typical proxy for trading the market as a whole. Nifty futures are simply Nifty futures contracts. The Nifty’s minimum lot size is 75 units, putting the lot value at just over Rs.7.50 lakhs. What are the best strategies for trading Nifty futures and how do you trade Nifty futures? Let’s go over some key points to keep in mind as we learn how to trade Nifty futures intraday and in the long run.
Futures typically trade at a discount to spot prices. The monthly spread over the spot price is established by the current cost of funds under normal circumstances. Futures typically quote at a premium to the cost of carry, which is also known as the cost of carry. There are two things to keep in mind here. If Nifty futures are trading at a significant premium over the spot index, it could be a sign of overpricing and overconfidence. Also, don’t buy when the Nifty futures are trading at a discount, as this could indicate strong futures selling. Before trading Nifty futures, you need understand the spread’s logic.
Nifty futures, like all futures contracts, are leveraged. Your margin is roughly 10% for normal trading and 5% for MIS (intraday) deals when you buy one lot of Nifty in the next month. That means a conventional trade is 10 times leveraged, whereas intraday trades are 20 times leveraged. This is true in both directions. Profits can be multiplied by leverage, but losses can be multiplied as well. As a result, any trading in Nifty futures must follow rigorous stop-loss and profit-target guidelines.
Before buying Nifty futures, it’s always a good idea to undertake some scientific data research. A brief examination of the Nifty futures open interest and accumulation trends will reveal if the open interest is rising on the long or short side. You can gain a better understanding of the Nifty’s direction.
Because the Nifty futures is one of the most liquid products, liquidity is never a huge issue, but there are times when the Nifty futures might get you into a liquidity bind. To begin with, after the rollovers are significantly finished on the expiry day, the volumes on the Nifty futures usually vanish. Furthermore, in a market that is rapidly declining, spreads can widen dramatically, increasing your risk when trading Nifty futures.
Buying or selling Nifty futures is a linear position since it can result in endless profits and losses on both sides. When trading the Nifty, stop losses are essential, but one must also be aware of the margins. To begin, you must pay an initial margin, which includes the VAR and ELM margins, at the time of taking the position. Brokers must now collect both of these margins, and ELM is no longer an option. Second, you must pay MTM (mark to market) margins based on price change on a daily basis. These have an impact on your capital allocation.
Even if you place stop losses throughout the day, they will not cover the danger you face overnight. What do you do, for example, if you are long on Nifty Futures and the Nifty drops 200 points on opening owing to a Dow crash? Stop losses don’t operate in Nifty futures, so you’re exposed to overnight risk.
This is an intriguing feature of trading Nifty futures. When you buy Nifty futures, another party is selling, and when you sell Nifty futures, the same rationale applies. The other party could be a trader or a hedger, and open interest data will provide you with the information you require. While your Nifty view is typically what drives you, it is always beneficial to comprehend the opposing view because it can help you clarify your Nifty vision. When dealing in Nifty Futures, there are eight factors to keep in mind.
When trading Nifty futures, keep in mind that you are risking real money, thus three factors are crucial. For starters, futures do not pay dividends, hence dividends cause futures to trade at a discount. Consider this when making a decision. Second, there are brokerage and statutory charges to consider when trading Nifty futures. This has an impact on your breakeven point. Finally, because Nifty futures are classified as securities for tax purposes, any profit or loss will be treated as a capital gain or loss, with the corresponding tax implications.
What is the Nifty futures margin requirement?
The Nifty Index is a basket of 50 equities, as you may know. These stocks were chosen to reflect a broad range of India’s economic sectors. As a result, Nifty is a good indicator of India’s overall economic activity. This indicates that if overall economic activity is increasing or expected to increase, Nifty’s value will increase as well, and vice versa. Trading Nifty Futures is also a better option than trading single stock futures because of this. There are numerous causes for this, including the following:
- It is diversified Taking a directional judgment on a single stock might be difficult at times, primarily due to risk considerations. Let’s imagine I decide to invest in Infosys Limited in the hopes of seeing positive quarterly results. If the findings fail to impress the markets, the stock, as well as my profit and loss, will suffer. Nifty futures, on the other hand, has a 50-stock portfolio that is well-diversified. The Index’s movement is not entirely dependent on a single stock because it represents a portfolio of stocks. Of course, a few stocks (index heavyweights) can have an impact on Nifty from time to time, but not on a daily basis. To put it another way, when you trade Nifty futures, you eliminate all ‘unsystematic risk’ and just deal with’systematic risk.’ I understand that these are new terminology for you; we’ll go over them in further depth when we talk about hedging.
- Hard to manipulate – The Nifty movement is a reaction to the collective movement of India’s top 50 companies (by market capitalization). As a result, manipulating the Nifty index is practically impossible. Individual stocks, on the other hand, are a different story (remember Satyam, DHCL, Bhushan Steel etc)
- Liquidity (easier fills, minimal slippage) We talked about liquidity previously in the chapter. Because the Nifty is so liquid, you can literally trade any amount of it without fear of incurring a loss due to impact costs. Furthermore, there is so much liquidity that you can transact as many contracts as you like.
- Margin requirements are substantially lower for Nifty futures than for individual stock futures. To put things in context, Nifty’s margin requirement is from 12 to 15%, but individual stock margins might be as high as 45-60%.
- Trading the Nifty futures necessitates the use of a broad-based economic call rather than company-specific directional recommendations. Performing the former is considerably easier than the latter, in my opinion.
- Technical Analysis – Technical Analysis is most effective on liquid instruments. Because liquid equities are difficult to manipulate, they often move in accordance with market demand-supply dynamics, which is what a TA is primarily focused on.
- Less volatile When compared to individual stock futures, Nifty futures are less volatile. To put things in perspective, Nifty futures have an annualized volatility of roughly 16-17 percent, whereas individual equities, such as Infosys, have an annualized volatility of up to 30 percent.
For futures, how much margin do you require?
Why are margins required when buying or selling a futures contract? Futures trading is risky since price movements can go against you. If you buy Nifty futures at a price of 10,300 and the Nifty drops to Rs.10,200, you will lose money, and that is the risk you are taking. Markets are inherently volatile, and these margins are essentially gathered to mitigate the risk of market volatility. So, what exactly is futures margining and how does it work? In general, there are two sorts of margins that are gathered. You must pay the Initial Margin on the trade (SPAN + Exposure margin) at the time of taking the position.
The SPAN margin is calculated using the VAR statistical concept (Value at Risk). Essentially, the initial margin should be wide enough to absorb the loss of your position in 99 percent of circumstances. There will be days when the Black Swan appears, but that is a separate matter. The initial margin is calculated using the portfolio’s maximum possible loss in a single day. The higher the stock’s volatility, the higher the risk, and thus the higher the initial margin. The mark-to-market (MTM) margin, which is collected for daily fluctuation in the price of futures, is the second form of margin. The first margin only considers the danger of a single day. If the stock continues to move against you (falling when long, rising when short), the MTM will be collected on each succeeding day. So, how does the futures margin in practice work? Let’s look at a live example of Initial Margins and MTM margins to learn more about margins on futures contracts.
The starting margin is calculated as the total of the SPAN and Exposure margins in the chart above. The stock exchange determines the minimum margins required for each given position. Brokers are allowed to collect more than this margin, but they are not allowed to collect less. The ACC contracts for November, December, and January are considered in the table above. As the contract matures further into the future, the margins will increase due to increased risk. The three types of initial margins levied by the broker on your futures account are what matters here. Let’s look at the specifics of this futures margin example.
This is the standard margin that must be charged if you want to carry your futures trade ahead beyond the day. Depending on the risk and volatility of the stock, the initial margin for a Carry Forward trade typically ranges from 10% to 15% of the contract’s notional value. In the example above, the notional value of the futures contract for the November 2017 contract is Rs.708,580/- (1771.45 X 400). The initial margin is collected at Rs.89,338/- per lot on that notional value, which works out to 12.61 percent of the notional value. As previously stated, the percentage of initial margin for a futures position will be determined by the stock’s volatility and risk.
The standard margin is for a futures position that you intend to continue over to the next day. But what if you want to close the position inside the day? The initial margins (MIS) will be lower because the risk is lower. The initial margin for intraday index futures is set at 40% of the usual initial margin, whereas the initial margin for intraday stock futures is set at 50% of the normal initial margin. In the example above, the margin will be half of the regular margin, or Rs.44,669/-. Margin Intraday Square-off (MIS) margin is the name given to this margin.
The BO/CO margin is the third category, and it is even lower than the MIS margin. The Bracket Orders and Cover Orders are the two types of orders. The intraday trade in a cover order is required to have an in-built stop loss. The Bracket Order takes it a step further by defining a stop loss as well as a profit target, resulting in a closed bracket order. The margin in this situation will be 30-33 percent of the typical margins, which is Rs.28,343/- in the case of ACC.
One thing to keep in mind is that in the case of MIS orders, CO orders, and BO orders, your broker’s risk management system (RMS) will typically close out any open positions 15-30 minutes before the close of stock market trading on the same day.
MTM (Mark to Market) margin is a type of accounting adjustment. If you bought Tata Motors futures at Rs.409, you don’t have anything to worry about as long as the price stays over Rs.409. When Tata Motors’ market price falls below Rs.409, the MTM problem would arise. There are two scenarios here as well. To begin, most brokers will verify if your margin amount is sufficient to cover the SPAN margin if the price drops to Rs.407 or lower. (Remember that SPAN + Exposure Margin equals Initial Margin.) That is still OK. If the stock price falls below Rs.395, on the other hand, your margin balance is likely to go below the SPAN Margin. The broker will then issue a Margin Call, requesting that you settle the margin deficit, and if you are unable to do so, your position will be closed out by the RMS. MTM margins only apply to carry forward contracts; they do not apply to intraday, BO, or CO positions.
So that’s everything there is to know about margins in futures contracts. The example of futures margins above demonstrates how futures margins function in practice. In a nutshell, it’s a risk mitigation strategy!
In futures, how is margin calculated?
Let’s go back to the forwards market scenario we used earlier (chapter 1). In the example given, ABC Jewelers agrees to buy 15 kilograms of gold from XYZ Gold Dealers for Rs.2450/- per gram in three months.
We can see that any change in the gold price will have a negative impact on ABC or XYZ. If the price of gold rises, XYZ will lose money, whereas ABC will profit. Similarly, if the price of gold falls, ABC loses money while XYZ profits. Furthermore, we are aware that a forwards agreement is based on a gentleman’s word. Consider a scenario in which the price of gold has skyrocketed, putting XYZ Gold Dealers in a tight predicament. Clearly, XYZ can claim that they are unable to make the required payment and hence default on the contract. Obviously, what follows will be a long and arduous legal battle, but that is outside our scope. It’s worth noting that the scope and motivation to default in a forwards agreement are both very great.
The default angle is carefully and intelligently dealt with in the futures market because it is an improvisation over the forwards market. Here’s where the margins come into play.
There is no regulation in the forwards market. The agreement is reached between two parties with no third party overseeing their transaction. In the futures market, however, all trades must pass via an exchange. In exchange, the exchange assumes responsibility for ensuring that all trades are settled. When I say ‘onus of guaranteeing,’ I mean that the exchange is responsible for ensuring that you receive your money if you are eligible. This also entails ensuring that the money is collected from the person that is obligated to pay.
So, how does the exchange ensure that everything runs smoothly? They accomplish this by employing
In the last chapter, we briefly discussed the idea of Margin. The concepts of margin and M2M must be understood in tandem in order to completely comprehend futures trading dynamics. However, because it’s impossible to describe both concepts at the same time, I’d want to take a break from margins and move on to M2M. We’ll learn everything there is to know about M2M before returning to margins. After that, we’ll revisit margins while keeping M2M in mind. However, before we go on to M2M, I’d like you to bear the following factors in mind:
- Margin is banned in your trading account at the time you start a futures position.
- The first margin consists of two parts: the SPAN margin and the Exposure Margin.
- The initial margin in your trading account will be frozen for the number of days you choose to hold the futures contract.
- The initial margin fluctuates on a daily basis, as it is determined by the futures price.
- The lot size is set, but the price of futures fluctuates every day. As a result, the margins change on a daily basis.
So, for the time being, remember only these points. We’ll go ahead and learn about M2M before returning to margins to finish this chapter.
What is the size of a futures lot?
A lot size in futures is the smallest number of shares that can be traded in a single transaction. You can only buy and sell futures and options in increments of one lot or multiples of the lot size while trading futures and options. The lot size of the Nifty, for example, is 75 units, thus you can only trade it in multiples of 75.
What is the future profit margin?
When you open a futures contract, you must deposit and keep on hand a certain amount of money with your broker. You do not own the underlying commodity, and it is not a down payment. Margin is a phrase that is used in a variety of financial markets.
In futures trading, who pays the margin?
Margin money is money put up by the buyer or seller of a futures contract to cover a portion of the total value of the commodities future being bought or sold. This deposit is required by commodity exchange laws and must be made with a registered futures commission merchant (RFCM) prior to the purchase or sale of a futures contract. Margin money is simply an assurance that the trader, who is also the RFCM’s customer, will keep his end of the bargain.
What exactly is a day margin?
The minimal need to day trade a contract is day margin, which means initiating and closing the position within the same trading session and not carrying a position through the day’s end.
Is it possible to trade futures without using margin?
Although you must have enough in your account to cover all day trading margins and variations that come from your positions, there is no legal minimum balance you must maintain to day trade futures. The day trading margins differ from broker to broker.