Equity Derivatives
CH3 · Introduction to Forwards & Futures
Forwards = bilateral, OTC, counterparty risk, hard to exit
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Equity Derivatives
Forwards = bilateral, OTC, counterparty risk, hard to exit
Currency Derivatives
IRP, USDINR futures, MTM, FIFO, open positions
Interest Rate Derivatives
T-bill futures, bond futures, MIBOR, ticks, expiries and contract value
Detailed notes
Equity Derivatives
Forwards = bilateral, OTC, counterparty risk, hard to exit
NISM Series VIII — Equity Derivatives | 20% weightage | ~20 exam questions
Along with CH4, this is the most important chapter in the exam. 20% weightage, 60 questions in the bank, 8 numericals. Futures are how most professional traders and institutions manage risk in equity markets. This chapter covers what futures are, how they're priced, how you make or lose money on them, and all the key terminology you need to navigate the market. Expect heavy numerical questions here — P&L calculations, contract value calculations, margin calculations.
Forward Contract — private agreement between two parties to buy/sell an asset at a future date for a price agreed today. Bilateral, customised, settled between the two parties, NOT traded on an exchange. Main problem: counterparty risk and difficulty exiting before maturity (illiquid).
Futures Contract — standardised forward contract traded on an exchange. Key differences from forwards:
| Feature | Forward | Futures | |---------|---------|---------| | Trading | OTC (bilateral) | Exchange | | Standardisation | Customised | Standardised | | Settlement | At maturity | Daily MTM + final | | Counterparty risk | Yes | No (clearing corp) | | Exit before maturity | Very difficult | Easy (square off) | | Transparency | Low | High |
Contract specifications — must know:
Key terminology:
*Open Position* — contracts bought or sold but not yet squared off or expired
*Squaring Off* — closing an existing position by doing the opposite trade (bought → sell same contract; sold → buy same contract)
*Long Position* — you have bought futures. You profit when price rises.
*Short Position* — you have sold futures. You profit when price falls. You do NOT need to own the underlying to sell futures — only margin is required.
*Calendar Spread* — simultaneous long and short in futures of the SAME underlying but DIFFERENT expiry months. Carries only basis risk, very low market risk, hence lower margins. When near month expires, the far month leg becomes a naked/open position.
*Open Interest* — total number of outstanding contracts in the market. Rising price + rising OI = strong trend (new longs entering). Rising price + falling OI = short covering (weak move, shorts exiting).
*Near Month / Far Month* — near month = current expiry month. Far month = third month out.
*Basis* = Futures price − Spot price. Usually positive (futures > spot) = Contango. Occasionally negative (futures < spot) = Backwardation.
Futures pricing — Cost of Carry model:
Futures Price = Spot Price + Cost of CarryCost of carry = interest cost of financing the purchase of the underlying asset.
Example: Nifty spot = 24,000. Annual interest rate = 12% (1% per month). One month futures fair value = 24,000 + (24,000 × 1%) = 24,240.
*Contango* — futures price > spot price (normal market, cost of carry positive) *Backwardation* — futures price < spot price (happens when near-term demand is unusually high, or in commodities with storage costs)
Payoff from futures — this is where numericals come:
*Long futures (bought):*
*Short futures (sold):*
Contract value = Futures price × Lot size
P&L Calculation: You buy 2 lots of Nifty futures at 24,000 (lot size 75). Nifty rises to 24,300 and you square off.
Profit = (24,300 − 24,000) × 75 × 2 = 300 × 150 = ₹45,000
Short futures: You sell Nifty futures at 24,500 expecting it to fall. It falls to 24,200.
Profit = (24,500 − 24,200) × 75 = 300 × 75 = ₹22,500
Calendar Spread: You buy March Nifty futures and sell April Nifty futures simultaneously. You're not betting on direction — you're betting on the spread between the two contracts narrowing or widening. If March expires, your April short becomes a naked short position.
Trap 1: "A long futures position can only be reversed with the SAME counterparty" → FALSE Futures are anonymous — you don't know who's on the other side. The clearing corporation is the counterparty to ALL trades. You square off by selling to ANY buyer on the exchange.
Trap 2: "You must own the underlying to sell futures" → FALSE You only need to deposit margin. No ownership of underlying required. This is what makes short selling easy in futures.
Trap 3: "Futures P&L is only settled at maturity" → FALSE Futures are marked to market DAILY. Profits and losses are credited/debited to your margin account every day. Not just at expiry.
Trap 4: "Calendar spread margin is high because of double the risk" → FALSE Calendar spread carries ONLY BASIS RISK (no market risk), so margins are LOWER than two naked positions. The two legs offset each other's market risk.
Trap 5: "If far month futures price < near month futures price, it's contango" → FALSE That's backwardation. Contango = far month > near month (normal). Backwardation = far month < near month (unusual).
Trap 6: "In futures trading, only the seller pays initial margin" → FALSE BOTH buyer and seller pay initial margin in futures. (In options, only the seller pays initial margin — buyer pays premium instead.)
Contract Value = Futures Price × Lot Size
P&L (Long) = (Exit Price − Entry Price) × Lot Size × No. of Lots
P&L (Short) = (Entry Price − Exit Price) × Lot Size × No. of Lots
Initial Margin = Contract Value × Margin %
Futures Fair Price = Spot Price + (Spot Price × Rate × Time/12)
Calendar Spreads possible = n(n-1)/2 where n = number of series
(3 series → 3×2/2 = 3 spreads: 1&2, 2&3, 1&3)20% of exam = ~20 questions. Expect 6-8 numericals involving P&L calculations, contract values, and margin calculations. The rest are definitional questions on terminology. This chapter combined with CH4 determines whether you pass or fail.
Currency Derivatives
IRP, USDINR futures, MTM, FIFO, open positions
NISM Series I — Currency Derivatives | ~16% weightage | ~101 questions
This is the most tested chapter in the entire exam at 16%. Master this one chapter and you've secured more marks than any other. Currency futures work on the same logic as equity futures but with one crucial difference — pricing is driven by Interest Rate Parity (IRP) instead of cost of carry. The exam hammers IRP calculations, MTM calculations, open position tracking, and FIFO P&L relentlessly. Every exam set has 6-8 numericals from this chapter alone.
| Currency Pair | Lot Size | Tick Size | Tick Value | |--------------|---------|---------|-----------| | USDINR | 1,000 USD | Rs 0.0025 | Rs 2.50 | | EURINR | 1,000 EUR | Rs 0.0025 | Rs 2.50 | | GBPINR | 1,000 GBP | Rs 0.0025 | Rs 2.50 | | JPYINR | 1,00,000 JPY | Rs 0.0025 | Rs 2.50 |
Note: JPYINR lot size is 1,00,000 JPY but P&L is calculated per 100 JPY (quoted as INR per 100 JPY). So for P&L: multiply lots × 1,000 (not 1,00,000).
Expiry: Two working days PRIOR to the last business day of the expiry month, at 12:30 PM. If that day is a holiday, move to the previous trading day.
Maximum maturity: 12 months (12 contract series always available)
Settlement: Always cash-settled in INR at the FBIL/RBI reference rate
Final settlement price: FBIL reference rate published at ~1:30 PM on expiry day
Operating ranges: ±3% of base price for contracts up to 6 months; ±5% for contracts above 6 months
Base price on Day 1: Theoretical futures price (derived from IRP formula)
Base price on subsequent days: Previous day's daily settlement price
Closing price: Weighted average price of last 30 minutes of trading
This is the most important formula in the entire exam. Currency futures price = spot rate adjusted for interest rate differential between the two countries.
Formula:
Futures Price = Spot Price × (1 + r_quotation) / (1 + r_base)For USDINR: Quotation currency = INR, Base currency = USD
USDINR Futures = USDINR Spot × (1 + r_INR) / (1 + r_USD)Why? If India rates are higher than US rates, holding INR is more attractive. To prevent arbitrage, the rupee must trade at a forward DISCOUNT to USD (USDINR futures must be higher than spot). This is Interest Rate Parity in action.
Example — 1 year forward: Spot USDINR = 83, India rate = 7%, US rate = 2%
Futures = 83 × (1.07 / 1.02) = 83 × 1.049 = 87.07Example — 6 month forward: Spot USDINR = 64, India rate = 10%, US rate = 2% One-year cost = 64 × (1.10/1.02) = 69.02 Interest cost for year = 69.02 − 64 = 5.02 Six-month cost = 5.02 / 2 = 2.51 Six-month futures = 64 + 2.51 = 66.51
Reverse IRP — find spot from futures:
Spot = Futures / (1 + r_INR/12) × (1 + r_USD/12)Key rule: Higher interest rate country's currency trades at a DISCOUNT in futures market (its futures price is higher than its spot when measured as INR per USD).
Long futures (bought):
Profit/Loss = (Exit Price − Entry Price) × Lot Size × Number of LotsShort futures (sold):
Profit/Loss = (Entry Price − Exit Price) × Lot Size × Number of LotsWith bid-ask spread:
Example: Sell 10 lots USDINR at 74.50/74.70, square off 5 lots at 73.55/73.75
Sell at BID = 74.50 Buy back at ASK = 73.75 Profit per USD = 74.50 − 73.75 = 0.75 Total profit = 0.75 × 5 lots × 1,000 = Rs 3,750
Daily settlement of P&L. Three scenarios:
1. Squared off positions (same day): P&L = (Buy price − Sell price) × lots × lot size
2. Open positions not squared off: P&L = (Settlement price − Trade price) × lots × lot size
3. Brought forward positions (carry forward): P&L = (Today's settlement − Yesterday's settlement) × lots × lot size
Example — Day 2 MTM on carry forward: TM bought 100 lots, sold 60 lots on Day 1. Net long 40 lots. Day 1 settlement = 66.30, Day 2 settlement = 66.80 MTM = (66.80 − 66.30) × 40 × 1,000 = Rs 20,000 profit
Trading Member open position = Proprietary position + ALL client positions
Not netted across clients. Each client's buy-sell is netted separately, then ADDED together.
Example: TM proprietary: bought 20, sold 5 → net long 15 lots = 15,000 USD Client A: bought 12, sold 2 → net long 10 lots = 10,000 USD Client B: bought 12, sold 2 → net long 10 lots = 10,000 USD
TM total open position = 15,000 + 10,000 + 10,000 = 35,000 USD
Client A and Client B positions are reported separately: 10,000 USD each.
When multiple contracts are outstanding and some are squared off, the FIRST contracts bought are treated as FIRST squared off.
Example: Buy 20 lots at 74.70 at 10:30 AM (Day 1) Buy 10 lots at 74.50 at 2:00 PM (Day 1) Buy 20 lots at 74.30 at 11:30 AM (Day 2) Sell 20 lots at 74.70 on Day 3
FIFO = first 20 lots bought were at 74.70. Sale at 74.70. P&L = (74.70 − 74.70) × 20 × 1,000 = Rs 0 (zero profit/loss)
USDINR tick = Rs 0.0025 per USD 100 ticks = 100 × 0.0025 = Rs 0.25 per USD For 10 lots: 0.25 × 10 × 1,000 = Rs 2,500
For JPYINR (per 100 JPY): 400 ticks × 0.0025 = Rs 1.00 per 100 JPY For 1 lot (1,00,000 JPY = 1,000 units of 100 JPY): 1.00 × 1,000 = Rs 1,000
Simultaneous long in one expiry and short in another expiry of the SAME underlying.
Calendar spread P&L: Current: 3M at 60.20, 6M at 61.10 (spread = 0.90) Expected: 3M at 59.90, 6M at 60.50 (spread = 0.60)
Spread narrows from 0.90 to 0.60 — profit for "sell near, buy far" spread Profit = (0.90 − 0.60) × 1,000 = Rs 300 per lot
RBI keeps repo rate at 6.5%. US Fed funds rate at 2%. Spot USDINR = 83.
One-year USDINR futures should trade at: 83 × (1.065 / 1.02) = 83 × 1.0441 = 86.66
If you see one-month futures at 83.70 (premium of 0.70), that's approximately: Annual rate premium = 0.70 / 83 × 12 = ~10.1% — close to India's rate premium over US.
Trap 1: "Calendar spread is same underlying, same expiry, different strikes" — FALSE That's a vertical spread (options). Calendar spread = same underlying, DIFFERENT expiry months.
Trap 2: "JPYINR lot size P&L multiplier is 1,00,000" — WRONG Use 1,000 for P&L calculations (since price is quoted per 100 JPY, and lot = 1,00,000/100 = 1,000 units).
Trap 3: "Settlement price on expiry = closing price of futures" — FALSE Final settlement = FBIL/RBI reference rate, NOT the futures closing price. Daily MTM uses futures closing price, but final settlement uses the RBI reference rate.
Trap 4: "Operating range = circuit filter for equities" — NOT the same name For currency futures, it's called "operating range" (not price band or circuit filter). Same concept, different name.
Trap 5: "Currency with higher interest rate trades at premium in futures" — WRONG Higher interest rate country's currency trades at DISCOUNT in the forward/futures market. USDINR futures > USDINR spot because INR has higher rates → INR expected to depreciate.
IRP: F = S × (1 + r_INR) / (1 + r_USD)
P&L: (Exit − Entry) × Lot size × Lots [for long]
(Entry − Exit) × Lot size × Lots [for short]
MTM: (Today settlement − Yesterday settlement) × Lots × Lot size
Ticks: N ticks × 0.0025 × Lot size × Lots
Cross: N ticks × 0.0025 × 1000 (for USDINR/EURINR/GBPINR)
N ticks × 0.0025 × 1000 (for JPYINR, not 1,00,000)
Spread: N ticks × Rs 2.50 per lot (for any INR pair)
Contract value: Futures price × Lot size × Number of lots~16% = ~101 questions — the most tested chapter. Expect 6-8 pure numericals per exam. IRP appears in 2-3 questions, MTM in 2-3, FIFO in 1-2, open position in 1-2, tick calculations in 1-2. Every exam also has 4-5 conceptual questions on lot sizes, expiry, settlement, and operating ranges. This chapter alone can make or break your exam result.
Interest Rate Derivatives
T-bill futures, bond futures, MIBOR, ticks, expiries and contract value
NISM Series IV — Interest Rate Derivatives | ~20% weightage | ~80 questions
The most operational chapter. Two products: 91-day T-bill futures and 10-year G-Sec bond futures. Know every contract specification cold: lot size, tick size, expiry day, settlement method, price quotation, operating range, contract months. The exam tests every number in this chapter. The "100 ticks = Rs 500 change" calculation appears repeatedly.
| Feature | 91-Day T-Bill Futures | G-Sec Bond Futures (10Y) | |---------|----------------------|--------------------------| | Underlying | 91-day Treasury Bill | 10-year G-Sec (notional) | | Underlying type | Actual T-bill | Notional bond | | Lot size (face value) | Rs 2 lakhs | Rs 2 lakhs | | Tick size | Rs 0.0025 | Rs 0.0025 | | Price quotation | 100 minus discount yield | Price per Rs 100 face value | | Settlement | Cash | Cash (current) or Physical (single bond) | | Last trading day | Last Wednesday of expiry month | Last Thursday of expiry month | | Settlement day | Next working day after last trading day | Next working day after last trading day | | Operating range | ±5% of base rate (MIBOR) | Specified % |
Contract amount (market lot) = Rs 2,00,000 face value for BOTH T-bills and G-Sec futures
Price quotation: 100 minus discount yield
Last trading day: Last Wednesday of expiry month (T-bills) If that Wednesday is a holiday → previous trading day
Settlement: Cash settled. Final settlement price = weighted average price of T-bill in RBI auction on expiry day.
Contract months: Three nearest serial months + Three nearest quarterly months = 6 contracts available at any time
Underlying: Notional coupon-bearing G-Sec
Price quotation: Price per Rs 100 face value
Last trading day: Last Thursday of expiry month If Thursday is a holiday → previous trading day
Settlement: Currently cash-settled. Can be physical (for single bond futures).
Cash-settled closing price: Weighted average price of last 30 minutes of trading across all exchanges.
G-Sec maturities currently permitted for cash-settled IRF: 6 years, 10 years, 13 years
Contract months for G-Sec futures: Three serial months + Three quarterly (Mar/Jun/Sep/Dec) = 6 contracts
Quarterly months: March, June, September, December
Tick size = Rs 0.0025
For one contract (face value = Rs 2,00,000):
Value of 1 tick = 2,00,000 × 0.0025 / 100 = Rs 5100 ticks change = 100 × Rs 5 = Rs 500 per contract
500 ticks change = 500 × Rs 5 = Rs 2,500 per contract
This Rs 500 per 100 ticks is tested in almost every exam.
G-Sec futures can only be traded in MULTIPLES of Rs 2 lakhs face value:
Exam question: "Which quantity can be bought?" → Rs 6 lakhs, Rs 8 lakhs (multiples of 2L). NOT Rs 1L, Rs 5L, Rs 15L.
T-bill futures price = based on underlying T-bill price + cost of carry (forward rate) Both the underlying price and the forward rate are used.
G-Sec bond futures price = Cash price + Financing cost − Income on cash position
Futures price = Spot price + (Spot × repo rate × days/360) − Accrued coupon incomeIf you expect 3-month rates to RISE in 1 month:
Key rule: Match the EXPIRY DATE to when you expect the rate change. Match the UNDERLYING TENOR to which rate you're targeting.
If expecting rate change in short term: Use T-bill futures (short expiry) If expecting rate change in long term: Use G-Sec bond futures (long expiry)
Rate rises → Bond price FALLS → Short futures makes profit Rate falls → Bond price RISES → Long futures makes profit
If you expect rates to RISE: SELL G-Sec bond futures (short) If you expect rates to FALL: BUY G-Sec bond futures (long)
Notional bond futures: Underlying is a theoretical/hypothetical bond (not a specific actual bond). Current cash-settled IRF in India are notional.
Single bond futures: Underlying is a specific actual government bond. Can be physically settled.
Underlying: FBIL Overnight MIBOR (Mumbai Inter-Bank Offered Rate) Operating range: ±5% of base rate Example: Base = 5.00, range = 5.00 ± 0.25 = 4.75 to 5.25
Trap 1: "T-bill futures and bond futures have same last trading day" — FALSE T-bills = Last Wednesday | G-Sec bonds = Last Thursday
Trap 2: "T-bill futures contract size is different from G-Sec futures" — FALSE Both = Rs 2 lakhs face value
Trap 3: "T-bill futures are physically settled" — FALSE T-bill futures = always CASH SETTLED
Trap 4: "Bond futures are always cash settled" — DEPENDS Cash-settled: current notional bond futures | Can be physical: single bond futures
Trap 5: "Rs 5 lakh can be traded in G-Sec futures" — FALSE Only multiples of Rs 2L: Rs 5L is NOT a multiple. Rs 6L, Rs 8L are valid.
Trap 6: "Operating range for overnight MIBOR futures = 3%" — FALSE It's ±5% of base rate.
Trap 7: "6Y, 10Y, 13Y refers to current maturities of securities" — partially These are the permitted maturities for cash-settled IRF contracts per SEBI.
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