What
is a Futures Contract?
Futures contract means a legally binding agreement to buy or sell the
underlying security on a future date. Future contracts are the organised/standardised
contracts in terms of quantity, quality (in case of commodities), delivery
time and place for settlement on any date in future. The contract expires
on a pre-specified date which is called the expiry date of the contract.
On expiry, futures can be settled by delivery of the underlying asset
or cash. Cash settlement entails paying/receiving the difference between
the price at which the contract was entered and the price of the underlying
asset at the time of expiry of the contract.
What is an Option contract?
Option contract is a type of derivatives contract which gives the buyer/holder
of the contract the right (but not the obligation) to buy/sell the underlying
asset at a predetermined price within or at end of a specified period.
The buyer/holder of the option, purchases the right from the seller/writer
for a consideration which is called the premium. The seller/writer of
an option is obligated to settle the option as per the terms of the
contract when the buyer/holder exercises his right. The underlying asset
could include securities, an index of prices of securities etc.
Under Securities Contracts (Regulations) Act, 1956 options on securities
has been defined as "option in securities" means a contract
for the purchase or sale of a right to buy or sell, or a right to buy
and sell, securities in future, and includes a teji, a mandi, a teji
mandi, a galli, a put, a call or a put and call in securities. An Option
to buy is called Call option and option to sell is called Put option.
Further, if an option that is exercisable on or before the expiry date
is called American option and one that is exercisable only on expiry
date, is called European option. The price at which the option is to
be exercised is called Strike price or Exercise price.
Therefore, in the case of American options the buyer has the right to
exercise the option at anytime on or before the expiry date. This request
for exercise is submitted to the Exchange, which randomly assigns the
exercise request to the sellers of the options, who are obligated to
settle the terms of the contract within a specified time frame.
As in the case of futures contracts, option contracts can be also be
settled by delivery of the underlying asset or cash. However, unlike
futures cash settlement in option contract entails paying/receiving
the difference between the strike price/exercise price and the price
of the underlying asset either at the time of expiry of the contract
or at the time of exercise / assignment of the option contract.
What are Index Futures and Index Option Contracts?
Futures contract based on an index i.e. the underlying asset is the
index, are known as Index Futures Contracts. For example, futures contract
on NIFTY Index and BSE-30 Index. These contracts derive their value
from the value of the underlying index.
Similarly, the options contracts, which are based on some index, are
known as Index options contract. However, unlike Index Futures, the
buyer of Index Option Contracts has only the right but not the obligation
to buy / sell the underlying index on expiry. Index Option Contracts
are generally European Style options i.e. they can be exercised / assigned
only on the expiry date.
An index in turn derives its value from the prices of securities that
constitute the index and is created to represent the sentiments of the
market as a whole or of a particular sector of the economy (Sectoral
Index).
By its very nature, index cannot be delivered on maturity of the Index
futures or Index option contracts therefore, these contracts are essentially
cash settled on expiry.
What is minimum contract size?
The Standing Committee on Finance, a Parliamentary Committee, at the
time of recommending amendment to Securities Contract (Regulation) Act,
1956 had recommended that the minimum contract size of derivative contracts
traded in the Indian Markets should be pegged not below Rs. 2 Lakhs.
Based on this recommendation SEBI has specified that the value of a
derivative contract should not be less than Rs. 2 Lakh at the time of
introducing the contract in the market.
What is the lot size of a contract?
Lot size refers to number of underlying securities in one contract.
Additionally, for stock specific derivative contracts SEBI has specified
that the lot size of the underlying individual security should be in
multiples of 100 and fractions, if any, should be rounded off to the
next higher multiple of 100. This requirement of SEBI coupled with the
requirement of minimum contract size forms the basis of arriving at
the lot size of a contract.
For example, if shares of XYZ Ltd are quoted at Rs.1000 each and the
minimum contract size is Rs.2 lacs, then the lot size for that particular
scrips stands to be 200000/1000 = 200 shares i.e. one contract in XYZ
Ltd. covers 200 shares.
