18.13 First trade basics
Since futures are contracts for future date, you should know the current spot market price of that commodity (spot prices are available in various exchange portals).
If we discuss the theoretical relationship between the spot and futures prices, it is calculated as follows: Futures Price= Spot Price + Cost of Carry.
"Cost of Carry" includes storage costs, transportation costs, insurance costs, interest costs, other opportunity costs as well as benefits. So, the actual difference between the futures price and the spot price traded on a particular day is called as the BASIS for that particular contract month of the commodity. Please note that usually the futures price of commodity is greater than the spot price (With the further months contracts priced slightly higher). However, it is not necessary in all cases.
For most storable commodity the difference between the spot price traded on a particular day is positive and as the contract month keeps coming nearer to the expiry date, it goes on decreasing and finally on the day of the delivery, the Future Price is nearly the same as the spot price.
After knowing this, you will have to find out the following information’s for making the first trade.
- which commodities are traded on which exchanges,
- who are registered members,
- what are the delivery months for those commodities,
- what are the margin requirements,
- what is the volume of activity on those commodities, etc.
Now you are ready for your First Trade?
Let us assume that here also Mahesh is the trader and current date is 29 March 2010. Mahesh finds that spot price of MUSTERED OIL on 9th March 2010 is 350/10kgs and the prices quoted on the exchange are available for March, April, May, June and July.
Note: earlier contract months won’t be available for trade as they would have already expired. Also, later months contracts beyond July are not available as they are not yet started. In the present month, there won’t be much volume as it has entered into delivery period. (let’s assume that delivery period for the contract is from 1st to15th of delivery month – so obviously avoid taking fresh positions in such contracts and go for next month, that is April).
Mahesh is bearish (believe market will go down) about the market. So he would like to sell 10 MT of Mustard oil @ 360 for April delivery. Now, he has to wait for the market to give him a lower level to buy back the contract before the delivery date in April.
Note: The obligation to take delivery by a BUYER can be removed by selling back the contract before the delivery period. And obligation to give delivery by a SELLER can be removed by buying back the contract before the delivery period.
Mahesh’s sample trade is as follows
SELL 10 lots April MUSTERED OIL @ 360/10kgs. After a few days the market goes down and you are able to come and buy back from the market at 354/ 10 kgs. Then you square off the trade or your liquidation would be BUY 10 April MUSTERED OIL @ 354.
Profit and Loss Calculations
Profit/Loss = (Selling Price- Buying Price) X No of Units or lots X Price Factor – Fees. Price Factor = Contract Size/Price Quotes quantity. In this case the Price Factor = 1000kgs (1MT)/ 10 Kgs (price quoted for 10 kgs).So, the Profit/Loss = (360- 354) X 10 X 100 – Fees = Rs 6000 – Fees.
In case you have to keep the initial SELL open for several days before you can get your level of exit or square off or liquidation, then in that case, the clearing corporations of the exchange will calculate your open position value on mark-to-market basis at the lose of each day and depending on the profit or loss made in the position, the amount will be credited or debited to your account. Fees are usually charged only once during entry and exit. There is no carry forward cost involved.