1. WHAT ARE DERIVATIVES?
Derivatives, such as futures or options, are financial contracts which derive their value from a spot price, which is called the “underlying”. The term “contracts” is often applied to denote the specific traded instrument, whether it is a derivative contract in commodities, gold or equity shares. The world over, derivatives are a key part of the financial system. The most important contract types are futures and options, and the most important underlying markets are equity, treasury bills, commodities, foreign exchange, real estate etc.
2. WHAT IS A FORWARD CONTRACT?
In a forward contract, two parties agree to do a trade at some future date, at a stated price and quantity. No money changes hands at the time the deal is signed.
3. WHY IS FORWARD CONTRACTING USEFUL?
Forward contracting is very valuable in hedging and speculation. If a speculator has information or analysis which forecasts an upturn in a price, then he can go long on the forward market instead of the cash market. The speculator would go long on the forward, wait for the price to rise, and then take a reversing transaction making a profit.
4. WHAT ARE THE PROBLEMS OF FORWARD MARKETS?
Forward markets worldwide are afflicted by several problems:
(a) Lack of centralisation of trading,
(b) Illiquidity, and
(c) Counterparty risk.
5. WHAT IS A FUTURES CONTRACT?
Futures markets are exactly like forward markets in terms of basic economics. However, contracts are standardized and trading is centralized (on a stock exchange). There is no counterparty In futures markets, unlike in forward markets, increasing the time to expiration does not increase the counter party risk. Futures markets are highly liquid as compared to the forward markets.
6. WHAT ARE VARIOUS TYPES OF DERIVATIVE INSTRUMENTS TRADED AT EXCHANGES?
There are two types of derivatives instruments traded on Exchanges; namely Futures and Options:
Options are of two types - Calls and Puts options:
Further the Options are classified based on type of exercise. At present the Exercise style can be European or American.
7. WHAT ARE VARIOUS PRODUCTS AVAILABLE FOR TRADING IN FUTURES AND OPTIONS?
Futures and options contracts are traded on Indices and on Single stocks.
8. WHY SHOULD I TRADE IN DERIVATIVES?
FUTURES TRADING WILL BE OF INTEREST TO THOSE WHO WISH TO:
1) Invest - take a view on the market and buy or sell accordingly.
2) Price Risk Transfer- Hedging - Hedging is buying and selling futures contracts to offset the risks of changing underlying market prices. Thus it helps in reducing the risk associated with
exposures in underlying market by taking a counter- positions in the futures market
3) Leverage- Since the investor is required to pay a small fraction of the value of the total contract as margins, trading in Futures is a leveraged activity since the investor is able to control the total value of the contract with a relatively small amount of margin.
Thus the Leverage enables the traders to make a larger profit (or loss) with a comparatively small amount of capital.
OPTIONS TRADING WILL BE OF INTEREST TO THOSE WHO WISH TO :
1) Participate in the market without trading or holding a large quantity of stock.
2) Protect their portfolio by paying small premium amount.
BENEFITS OF TRADING IN FUTURES AND OPTIONS :
1) Able to transfer the risk to the person who is willing to accept them
2) Incentive to make profi ts with minimal amount of risk capital
3) Lower transaction costs
4) Provides liquidity, enables price discovery in underlying market
5) Derivatives market are lead economic indicators.
9. WHAT ARE THE BENEFITS OF TRADING IN INDEX FUTURES COMPARED TO ANY OTHER SECURITY?
An investor can trade the ‘entire stock market’ by buying index futures instead of buying individual securities with the efficiency of a mutual fund.
The advantages of trading in Index Futures are:
• The contracts are highly liquid
• Index Futures provide higher leverage than any other stocks
• It requires low initial capital requirement
• It has lower risk than buying and holding stocks
• It is just as easy to trade the short side as the long side
• Only have to study one index instead of 100s of stocks
10. WHAT IS THE EXPIRATION DAY?
It is the last day on which the contracts expire. Futures and Options contracts expire on the last Thursday of the expiry month. If the last Thursday is a trading holiday, the contracts expire on the previous trading day.
11. WHAT IS THE CONCEPT OF IN THE MONEY, AT THE MONEY AND OUT OF THE MONEY IN RESPECT OF OPTIONS?
In- the- money options (ITM) - An in-the-money option is an option that would lead to positive cash fl ow to the holder if it were exercised immediately. A Call option is said to be in-the-money when the current price stands at a level higher than the strike price. If the Spot price is much higher than the strike price, a Call is said to be deep in-the-money option. In the case of a Put, the put is in-the-money if the Spot price is below the strike price.
At-the-money-option (ATM) - An at-the money option is an option that would lead to zero cash fl ow if it were exercised immediately.An option on the index is said to be “at-the-money” when the current price equals the strike price.
Out-of-the-money-option (OTM) - An out-of- the-money Option is an option that would lead to negative cash flow if it were exercised immediately. A Call option is out-of-the-money when the current price stands at a level which is less than the strike price. If the current price is much lower than the strike price the call is said to be deep out-of-the money. In case of a Put, the Put is said to be out-of-money if current price is above the strike price.
12. IS THERE ANY MARGIN PAYABLE?
Yes. Margins are computed and collected on-line, real time on a portfolio basis at the client level. Members are required to collect the margin upfront from the client & report the same to the Exchange.
13. WHAT ARE THE RISKS ASSOCIATED WITH TRADING IN DERIVATIVES?
Investors must understand that investment in derivatives has an element of risk and is generally not an appropriate avenue for someone of limited resources/ limited investment and / or trading experience and low risk tolerance. An investor should therefore carefully consider
whether such trading is suitable for him or her in the light of his or her financial condition. An investor must accept that there can be no guarantee of profits or no exception from losses while executing orders for purchase and / or sale of derivative contracts.
14. Importance of Derivatives: Derivatives are very important financial instruments for risk management as they allow risks to be separated and more precisely controlled. Derivatives are used to shift elements of risk and therefore can act as a form of
OPENING PURCHASE TRANSACTION
An opening purchase transaction is one that creates or increases a long position in a given option series.
OPENING SALE TRANSACTION
An opening sale transaction is one that creates or increases a short position in a given option series. Such a sale is also referred to as "writing" an option contract.
CLOSING PURCHASE TRANSACTION
A closing purchase transaction is one that eliminates or reduces a short position in a given option series. Such a purchase is commonly referred to as "covering" a short option position.
CLOSING SALE TRANSACTION
A closing sale transaction is one that eliminates or decreases a long position in a given option series.
WHAT IS OPEN INTEREST?
Open interest refers to the number of outstanding contracts in the exchange market.
Futures & Options Contracts On Global Indices: Nse Had Introduced Futures & Options Contracts On Global Indices With Effect From August 29,2011 With The Introduction Of s&p 500 Indices & Dow Jones Industrial Average (Djia) Indices. Three Serial Monthly Contracts And Following Three Quarterly Expiry Contracts In Mar-Jun-Sep-Dec Cycle Are Available For Trading In Global Indices. On May 03,2012 Futures & Options Contracts Of Ftse 100 Introduced. Expiry Day Of Global Indices Is Thhird Friday Of The Expiry Month. In Case The Third Friday Of The Expiry Month Is a Holiday, The Contract Shall Expire On The Preceding Business Day Of The Expiry Month. The Final Settlement Price Shall Be Based On The Rates In Respective Markets.
1. What is Online share trading?
Online share trading is the process of buying and selling of shares through the internet on the secondary market with a view to profiting from the difference in the buying price and selling price. The share price of a stock is determined by the demand and supply of a particular share. Online share trading enjoys various advantages such as accessibility, security, convenience in tracking portfolio etc over traditional branch trading.
2. What is an Equity Share?
An equity share represents the form of ownership. The holder of such a share is a member of the company and has voting rights.
3. What returns can I expect from my investments in equity shares? What are the risks?
Equity shares are “High-Risk High-Return Investments.” The major distinction of Equity investment from all other investment avenues is that while the return from many avenues such as Bank Deposits,Small Saving schemes, Debentures, Bonds etc are fixed and certain, the earnings from equity investments are highly uncertain and varied. A good scrip picked up at the right time could fetch fairly good returns else the return may be meager or it may even turn negative, i.e. the invested fund itself may be eroded. In short, if the investment in fixed income category instruments is secured and risk-free to a large extent, investment in equities and related fields could be termed as risky.
4. What is Dividend?
Dividend is the part of profit distributed by the company among its investors. It is usually declared as a percentage of the paid-up value or face value of the share.
5. What is a Bonus Share?
A Share issued by companies to their shareholders free of cost by capitalization of accumulated reserves from the profits earned in the earlier years.
6. What is a Bond?
A Bond is a promissory note issued by a company or government to its lenders. A Bond is evidence of debt on which the issuing company usually promises to pay the bondholder a specified amount of interest at intervals over a specified length of time, and to repay the original loan on the expiration date. A bond investor lends money to the issuer and in exchange, the issuer promises to repay the loan amount on a specified maturity date.
7. What is a Debenture?
It is a Bond issued by a company bearing a fixed rate of interest usually payable half-yearly on specific dates and principal amount repayable on a particular date on redemption of the debentures. Debentures are normally secured/charged against the asset of the company in favor of debenture holder.
8. What is a Stock Exchange ?
A Stock Exchange is a place where the buyer and seller meet to trade in shares in an organized manner. There are at present 25 recognized stock exchanges in the country that are governed by the Securities Contact (Regulation) Act, 1956.
9. What shares can I buy?
You can buy the shares that are listed on any of the recognized Stock Exchanges.
10. Whom should I contact for my Stock Market related transactions?
To be able to buy or sell shares in the stock markets a client would need to be registered with a stock broker like Meli & Co who holds membership in stock exchanges and who is registered with SEBI.
11. Am I required to sign any agreement with the broker or sub-broker?
Yes, you have to sign the “Member-Client agreement” for the purpose of engaging a broker to execute trades on your behalf from time to time and furnish details relating to yourself to enable the member to maintain Client Registration Form.
12. What is a Member–Client Agreement form?
This form is an agreement entered into between client and broker in the presence of witnesses wherein the client agrees (is desirous) to trade/invest in the securities listed on the concerned Exchange through the broker after being satisfied of broker’s capabilities to deal in the same.
13. What is Buying and Selling?
There are several types of orders that you can dictate to a broker. The most common type, which is a regular buy or sell order, is called a market order. Another type of order is a limit order wherein you ask the broker to trade only if the price reaches a specific level. In a stop order, you tell the broker to sell your shares if the price drops to a certain level to prevent significant loss because if it drops to that level it is likely to drop further and your losses are likely to increase.
14. How do I place my orders?
Trading can be done via the phone or by coming in person to the office of Meli & Co or through any other facility provided by Meli & Co like Internet trading. The dealer (employee of Meli & Co who is supposed to input the investors order into the stock exchange order system) after checking the authenticity of the person calling and after checking the margin available in the account would put/enter the order into the stock exchange system.
15. What is meant by bullish and bearish trend?
When the market goes up it is called a bullish trend and when the market goes down it is called a bearish trend.
16. What is taking a position?
When you act upon a stock and buy into it, you are taking a position. A position is an amount of money committed to an investment in anticipation of favorable price movements.
There are two kinds of positions : -
17. What is an index?
An index is a stock-market indicator created as a statistical measure of the performance of an entire market or segment of a market based on a sample of securities from the market. An index is thus a means to evaluate the overall performance of a market or of a segment of the market. An index measures aggregate market movements. Apart from being a general market indicator, indices are used as a benchmark to evaluate individual portfolio performance. Professional money managers will always try to outperform the market, i.e. they will always try to do better than the indices. For example, if the value of a portfolio moves up by 10% while the index moved up by only 5% then the portfolio is doing better than the market.
We have 2 renowned indices viz.
BSE Sensex comprises of 30 large-cap companies. As the name suggests, it is a premier index on Bombay Stock Exchange (BSE).
Nifty comprises of 50 large-cap companies on the National Stock Exchange (NSE).
18. What is Methodology of trades?
The market watch, i.e the screen kept open normally on the trade screen would show the following columns -
The first 2 columns as given above show the available buyers for a particular share in the stock exchange and the next 2 columns show the available sellers, and the fifth column shows the price at which the last trade took place. Hence when a investor wants to buy a share at “market price” ideally the 3rd and the 4th column would depict how many shares one can get at a stipulated price. The client can also put a limit price order which would sit in the order book till it reaches a price time priority when the trade can be executed.
19. What is a Contract Note?
Contract Note is a confirmation of trades done on a particular day on behalf of the client. It establishes a legally enforceable relationship between the client and Meli & Co with respect to the settlement of the trades. The Contract Note would show settlement number, order number, trade number, time of trade, quantity and price of the trades, brokerage charged, etc and it would be signed by an authorised person of Meli & Co.
20. What is pay-in day and pay-out day?
Pay-in day is the day when the broker shall make payment or delivery of securities to the exchange. Pay-out day is the day when the exchange makes payment or delivery of securities to the broker.
21. What is a depository?
A depository can be compared to a bank. A depository holds securities (like shares, debentures, bonds, Government Securities, units etc.) of investors in electronic form. Besides holding securities, a depository also provides services related to transactions in securities. There are two main depositories in India, namely, a) National Securities Depository Ltd. (NSDL) and b) Central Depository Securities Ltd. (CDSL), both of which are regulated by SEBI. Meli & Co is a Depository Participant of NSDL and will hold your securities in electronic form.
22. What should I do when I want to open an account with a DP?
You can approach Meli & Co or any DP of your choice and fill up an account opening form. At the time of opening an account, you have to sign an agreement with DP in a NSDL prescribed standard agreement, which details your and your DP’s rights and duties.
23. What do you mean by ‘Market Trades’ and ‘Off Market Trades’?
Any trade settled through a clearing corporation is termed as a ‘Market Trade’. These trades are done through stock brokers on a stock exchange. ‘Off Market Trade’ is one which is settled directly between two parties without the involvement of a clearing corporation. The same delivery instruction slip can be used either for market trade or off-market trade by ticking one of the two options.
24. How do I deliver or receive shares to or from Meli & Co?
In case of sales, the investor would need to transfer the shares to the pool account of Meli & Co for the specified settlement number. The pool account number for shares sold on BSE is IN603287 and for NSE it is IN506594. The delivery should necessarily come from the demat account of the investor and not from any other person. Similarly Meli & Co would directly transfer shares bought to the account of the investor.
25. How do I make or receive payments to or from Meli & Co?
Payments to Meli & Co has to be made via a Account Payee cheque/Demand Draft in favor of Meli & Co. The payment should necessarily come from the bank account of the investor and not from any other person. Similarly Meli & Co would pay an Account Payee cheque in the name of the investor, which will also contain the Bank name and account number of the client.
26. How long does it take to receive my money for a sale transaction and my shares for a buy transaction?
The pay-out of funds and securities to the clients by Meli & Co will be within 24 hours of the pay-out.
27. What is a Rolling Settlement?
In a Rolling Settlement trades executed during the day are settled based on the net obligations for the day. In NSE and BSE, the trades pertaining to the rolling settlement are settled on a T+2 day basis where T stands for the trade day. Hence trades executed on a Monday are typically settled on the following Wednesday (considering 2 working days from the trade day). The funds and securities pay-in and pay-out are carried out on T+2 day.
28. What is an Auction?
The securities are put up for auction by the Exchange on account of non-delivery of securities by the selling trading member to ensure that the buying trading member receives the securities due to him. The non-delivery by the trading member could arise on account of short delivery. The Exchange purchases the requisite quantity in the Auction Market and gives them to the buying trading member.
29. What happens if I could not make the payment of money or deliver shares on the pay-in day?
In case of purchase on your behalf, the member broker has the liberty to close out transactions by selling securities in case you fail to make full payment to the broker for the execution of contract before pay-in day as fixed by Stock Exchange for the concerned settlement period unless you already have an equivalent credit with the broker. The shortages in case of sales are met through auction process and the difference in price indicated in Contract Note and price received through auction is paid by member to the Exchange which is then liable to be recovered from the client.
In both the cases any loss in transactions will be deductible from the margin money paid by you.
30. What happens if the shares are not bought in the auction?
If the shares could not be bought in the auction i.e. if shares are not offered for sale in the auction, the transactions are closed out as per SEBI guidelines. The guidelines stipulate that “the close out price will be the highest price recorded in that scrip on the exchange in the settlement in which the concerned contract was entered into and upto the date of auction/close out OR 20% above the official closing price on the exchange on the day on which auction offers are called for, whichever is higher.”
Since in the rolling settlement the auction and the close out takes place during trading hours the reference price in the rolling settlement for close out procedures would be taken as the previous day’s closing price.
31. What happens if I do not get my money or share on the due date?
In case a broker fails to deliver to you in time and make the proper payment of money/shares or you have a complaint against the conduct of the broker, you can file a complaint with the respective stock exchange. The exchange is required to resolve all complaints. To resolve the dispute the complainant can also resort to arbitration as provided on the reverse of Contract Note /Purchase or Sale Note. However, if the complaint is not addressed by the Stock Exchanges or is unduly delayed then the complaints along with supporting documents may be forwarded to Secondary Market Department of SEBI. Your complaint would be followed up with the exchanges for expeditious redressal.
In case of a complaint against a sub-broker, for redressal the complaint may be forwarded to the concerned broker with whom the subbroker is affiliated.
32. What are the additional charges other than brokerage that can be levied on the investor?
The trading member can charge:
Note : The brokerage and service tax is indicated separately in the contract note.
33. How are margins paid?
Exchange prescribes margin rules from time to time, which currently are calculated on the Value at Risk model. Margins are to be paid by the investor before placing the order.
34. What are the rights of the investor?
The right to get -
Proof of price/brokerage charged, Money/shares on time, Statement of Accounts and Contract Note from trading member.
35. What are the obligations of the investor?
The obligation to -
Sign a proper Member-Constituent Agreement
Possess a valid contract or purchase/sale note
Deliver securities & make payment on time
Provide Margin before trade
36. What are the various kinds of accounts that I need to trade via Internet with Meli & Co?
Three kinds of accounts are required to be able to trade on-line. They are:
37. What are the tax implications of investing in Indian equities?
Tax rates on investments gains are categorized as long term & short term capital gains.
38. Who is a Portfolio Manager?
Any person who pursuant to a contract or arrangement with a client, advises or directs or undertakes on behalf of the client (whether as a discretionary portfolio manager or otherwise) the management or administration of a portfolio of securities or the funds of the client, as the case may be is a Portfolio Manager.
Meli & Co is a SEBI Registered Portfolio Manager (Reg. No.INP000000316) that offers Discretionary Portfolio Management Services to Residents who can invest a minimum of Rs.10 lakhs and for Non-Residents who can invest a minimum of Rs. 25 lakhs.
39. What is the function of the Capital Market?
Capital Market enhances capital formation in the economy and comprises of -