We learned a variety of futures market-related ideas in the previous chapter. Keep in mind that any trader who enters into a futures agreement is doing so with the intention of earning money. The trader needs to be able to predict the direction of the underlying asset’s price. 

Perhaps it’s time to use a real-world futures deal as an example to show how this is . Let’s look at an example with stocks as we depart from the gold example.

Today (15^th Dec 2014), Tata Consultancy Services (TCS) management, a leading Indian Software Company, had investors meet, wherein the TCS management announced that they are cautious about the revenue growth for the December Quarter.  The markets do not like such cautious statements, especially from the company’s management. 

After the statement, the markets reacted to it, and as we can see from the TCS’s spot market quote, the stock went down by over 3.6%. In the snapshot below, the price per share is  in blue. Ignore the red highlight; we will discuss it shortly.

As a trader, I believe that the TCS stock price reaction to the management’s statement is . 

Here is my rational – If you follow TCS or any Indian IT sector company in general, you will know that December is usually a lacklustre month for the Indian IT companies. December is the financial year-end in the US (the biggest market for the Indian IT companies) and the holiday season; hence the business moves quite slowly for such companies. This furlough has a significant impact on the IT sector revenues. 

This information is already known and factored in by the market. Hence, I believe the stock sinking by 3.6% is unwarranted.  I also feel this could be an opportunity to buy TCS, as I believe the stock price will eventually go up. Hence I would be a buyer in TCS after such an announcement.

Notice, based on my thoughts (which I perceive as rational), I have developed a ‘directional view’ on the asset’s price (TCS). I believe the TCS (underlying asset) stock price will increase in due course of time from my analysis. In other words, I am bullish about TCS at the current market price.

I choose to purchase TCS Futures rather than TCS Shares on the Spot Market (for reasons I will discuss in the next chapter). I only need to look at the price at which the TCS Futures are trading after deciding to purchase futures. On the NSE website, the contract information are easily accessible. In reality, the spot market quotes have a link to access specifics for a TCS futures contract. In the picture above, I’ve  the same thing in red.

Remember that the futures price ought to constantly mirror the spot price, thus if the spot price has decreased, the futures price ought to decrease as well. Here is a screenshot of the TCS Futures price from the NSE website.

Because the futures price has, as anticipated, followed the spot price, the TCS Futures are likewise down 3.77 percent. Now, you might have two inquiries:

1. TCS is down 3.61 percent in the spot market. TCS futures, however, are down 3.77 percent. Why the distinction?
2. TCS spot price is at Rs.2362.35, but Futures price is at Rs.2374.90? Why the difference?

Both of these are legitimate questions at present moment, and the answers to them depend on the “Futures Pricing Formula,” a subject we shall cover later. But the most crucial thing to remember at this time is that the spot price and the futures price have moved in lockstep and are both down for the day.

 Let’s take another look at the futures contract and analyse a few crucial components before moving on. I’ll re-post the futures contract with a few key points .

The box indicated in red at the top contains three crucial details, beginning at the top:

1. Instrument Type: Keep in mind that the underlying asset is a company’s stock, and that we are in the future contract for the asset. As a result, the type of instrument in this case is “stock futures.”
2. Symbol – This draws attention to the stock’s name, in this case TCS.
3. Expiry Date – This is the date on which the contract ceases to exist. As we can see, the TCS futures contract specifies 24^th Dec 2014 as the expiry. You may be to know that all derivative contracts in India expire on the last Thursday of the month. We will discuss more what happens on the expiry date at a later point.

The blue box, which just displays the future price, is something we had briefly examined earlier.

Finally, the black box draws attention to two crucial variables: the market lot and the underlying value.

1. The price at which the underlying is on the spot market is as the underlying value. TCS was reportedly trading at Rs. 2362.35 a share when I took the above picture, but it had since dropped by a few more points. Consequently, the share price we see here is Rs. 2359.90.
2. Remember that a futures contract is a standardised contract with a market lot (lot size). It prefixes the parameters. The minimum number of shares we must buy or sell in order to reach an agreement is as the lot size. The TCS futures’ minimum lot size is 125 shares, hence in order to trade TCS futures, a minimum of 125 shares (or a multiple of 125 shares) must be.

Recall that the “contract value,” which is equal to the “Lot size” times the “futures price,” was  in the previous chapter. Now, we can determine the contract value for TCS futures using the formulas below.

Lot size times futures price equals contract value.

=150x 2500.00

=3,75,000

Let’s quickly look at another “Futures Contract” to cement our understanding before moving on to the TCS futures deal. Here is a screenshot of the “State Bank of India (SBI)” futures contract.

You might be able to provide answers to the following queries using the above snapshot:

1. What kind of instrument is it?
2. What is the futures price for SBI?
3. How does the future price of SBI compare to the current pricing?
4. What is the expiry date of the Futures contract?
5. What are the lot size and the contract value of SBI futures?