\n| Selling price<\/td>\n | Rs. 2519 per share<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n So with a bullish outlook in TCS shares and with a capital of \u20b9 100000 to invest, we have two options to deal with. Option 1 \u2013 Buy TCS shares in the spot market. Option 2 \u2013 Buy TCS shares in the futures derivatives market. Now let’s evaluate both these options.<\/p>\n Buy TCS shares in the spot market<\/h2>\nTo buy TCS shares in the spot market, we need to know its price. It has to be seen how many shares we can buy with our capital. After buying the shares, we have to wait for 2 days (T+2) so that the shares can be credited to our demat account. After the shares come in the demat account, we have to wait for the right opportunity so that we can sell the shares. Let’s take a look at some of the highlights of the spot market delivery deals-<\/p>\n When we buy stocks with delivery in the spot market, we have to wait for 2 days for it to arrive in our demat account. This means that if there is an opportunity on the next day of buying where we can sell it and earn profit, then we cannot take advantage of that opportunity.<\/p>\n We can only buy as many shares as we have the money. Meaning if we have \u20b9 100000, then we can not buy shares of more than \u20b9 100000.<\/p>\n There is no time pressure, we can keep the stocks for as long as we want and wait for the right opportunity for ourselves.<\/p>\n If we have one lakh rupees on 15th December 2014, then how many shares can we buy?<\/p>\n = 100,000 \/ 2362<\/p>\n = 42<\/p>\n Now, if we square off on 23rd December, when the share price of TCS is 2519\/-, we will get \u2013<\/p>\n = 42\u00d7 2519<\/p>\n = 105,798<\/p>\n This means that the shares of TCS purchased on 14th December 2014 for \u20b9100,000 will reach \u20b9105,798 on 23rd December i.e. we will make a profit of \u20b95798. Let’s see what percentage return we got<\/p>\n = [5798\/100,000]\u00d7100<\/p>\n = 5.79%<\/p>\n Earning a return of 5.79% in 9 days is a good thing. If you want to look at it as an annual return, then it comes out to 235% per annum, which is a very good return. Now let’s compare it with your other option.<\/p>\n Option 2 \u2013 Buy TCS shares in the futures derivatives market<\/h2>\nNow you know that the terms of the deal in the futures market are pre-determined. For example, you can buy at least 125 shares of TCS or buy in lots of 125. Multiplying the lot size by the price, we get the contract value. If the share price is 2362 per share then the contract value will be<\/p>\n 125\u00d72362<\/p>\n = Rs 295,250<\/p>\n Does it mean that \u20b9295250 is required to buy one lot of TCS in the futures market? No!!! If the contract value is Rs 295250 then we have to pay only the margin amount. For TCS this margin is 14%. 14% of 295,250 is Rs 41,335. This is the only amount you have to pay for this deal. Now some questions may come<\/p>\n What will happen to the remaining amount after margin (Rs 253,915)? (295,250- 41,335 = 253,915)<\/p>\n In fact this amount is never paid<\/p>\n What does it mean to never get paid?<\/p>\n We will understand this in the chapter Settlement \u2013 \u200b\u200bMark to Market<\/p>\n Is the margin only 14% per transaction?<\/p>\n No, it is different for each company’s stock.<\/p>\n Now let’s move on to our futures trade. We have \u20b9100,000 whereas we need margin money \u20b941335 that means we can buy not one but two lots of TCS i.e. 250 shares for \u20b982670. Even after paying \u20b9 82670 as margin money for both the lots, we will still have \u20b9 17330 in cash. With this we cannot buy more shares as it is necessary to buy at least one lot. Now let’s see the details of this deal<\/p>\n Lot Size \u2013 125<\/p>\n Total Lots \u2013 2<\/p>\n Purchase Price \u2013 \u20b92362 per share<\/p>\n Contract value = lot size \u00d7 total lot \u00d7 price<\/p>\n = 125 \u00d7 2 \u00d7 \u20b9 2362<\/p>\n = \u20b9590,500<\/p>\n Margin Money \u2013 \u20b9 82670<\/p>\n Selling Price \u2013 \u20b92519<\/p>\n Contract Value = 125 \u00d7 2 \u00d7 2519<\/p>\n = \u20b9629,750<\/p>\n Thus we got profit of \u20b939250 (629750-590500=39250).<\/p>\n Now you must have understood the difference. The share price increased from some \u20b92361 to \u20b92519. Due to which the profit in the spot market was 5798 while in the future market the profit was \u20b9 39250. Remember that we have invested \u20b9 82670 here, so we have to see our return on the same amount.<\/p>\n [39250 \/ 82670 ] \u00d7 100 = 47%<\/p>\n The return of 47% in 9 days is very good. Now compare that with the returns received in the spot market which was 5.79%. If we look at the annual return from the futures market, it makes 1925%. Now you must have understood completely why the futures market is a very profitable deal for the short term trader.<\/p>\n In the futures market<\/strong>, you can trade many times bigger than straight deals in the spot market \u2013 only on margin basis. You get a chance to do bigger deals with the same capital and you can make a lot of money if your opinion on the price turns out to be right.<\/p>\nBecause of margin<\/strong>, we can make big deals with less money, that’s why it is called leverage. Always remember one thing about leverage, it is a double-edged sword. It can make a big profit but it can also cause a big loss.<\/p>\nBefore we proceed further, let us see the comparison of this spot and futures deal.<\/p>\n \n\n\n| Information<\/th>\n | Spot Market<\/th>\n | Future Market<\/th>\n<\/tr>\n | \n| Available Finance<\/td>\n | Rs.100,000\/-<\/td>\n | Rs.100,000\/-<\/td>\n<\/tr>\n | \n| Date of purchase<\/td>\n | 15 Dec. 2014<\/td>\n | 15 Dec. 2014<\/td>\n<\/tr>\n | \n| buy price<\/td>\n | Rs. 2362 per share<\/td>\n | Rs. 2362 per share<\/td>\n<\/tr>\n | \n| total quantity<\/td>\n | 100,000 \/ 2362 = 42 shares<\/td>\n | according to lot size<\/td>\n<\/tr>\n | \n| lot size<\/td>\n | not applicable<\/td>\n | 125<\/td>\n<\/tr>\n | \n| margin<\/td>\n | not applicable<\/td>\n | 14%<\/td>\n<\/tr>\n | \n| contract value of every lot<\/td>\n | not applicable<\/td>\n | 125 * 2362 = 295,250\/-<\/td>\n<\/tr>\n | \n| margin for every lot<\/td>\n | not applicable<\/td>\n | 14% * 295,250 = 41,335\/-<\/td>\n<\/tr>\n | \n| how many lots can be buy<\/td>\n | not applicable<\/td>\n | 100,000\/41,335= 2.4 or 2 lots<\/td>\n<\/tr>\n | \n| deposited margin<\/td>\n | not applicable<\/td>\n | 41,335 * 2 = 82,670\/-<\/td>\n<\/tr>\n | \n| no. of buy shares<\/td>\n | 42 (as above calculated)<\/td>\n | 125 * 2 = 250<\/td>\n<\/tr>\n | \n| buy price<\/td>\n | 42 * 2362 = 100,000\/-<\/td>\n | 2 * 125 * 2362 = 590,500\/-<\/td>\n<\/tr>\n | \n| selling date<\/td>\n | 23 Dec. 2014<\/td>\n | 23 Dec. 2014<\/td>\n<\/tr>\n | \n| how many days did the trade last<\/td>\n | 9 days<\/td>\n | 9 days<\/td>\n<\/tr>\n | \n| sales price<\/td>\n | Rs. 2519 per share<\/td>\n | Rs. 2519 per share<\/td>\n<\/tr>\n | \n| sale price<\/td>\n | 42 * 2519 = 105,798<\/td>\n | 250 * 2519 = 629,750\/-<\/td>\n<\/tr>\n | \n| profit<\/td>\n | 105798 \u2013 100000 = 5798\/-<\/td>\n | 629750 \u2013 590500 = 39,250\/-<\/td>\n<\/tr>\n | \n| 9 days return<\/td>\n | 5798 \/ 100,000 = 5.79 %<\/td>\n | 39250 \/ 82670 = 47%<\/td>\n<\/tr>\n | \n| % annual return<\/td>\n | 235%<\/td>\n | 1925%<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n We have talked about the advantages of futures deals, but what are the risks? What if the price didn’t move in the direction we expected? To understand this we need to know how much money we can lose if our opinion doesn’t turn out to be correct. This is called futures pay off.<\/p>\n Leverage Calculation<\/h2>\nWhen it comes to leverage, the first question that is asked is how leveraged are you? The higher the leverage, the higher the risk and the higher the profit potential.<\/p>\n It is quite easy to calculate the leverage-<\/p>\n Leverage = [Contract Value \/ Margin]<\/p>\n Leverage = [Contract Value\/Margin]<\/p>\n Means leveraged for TCS trade<\/p>\n = [295,250 \/ 41,335]<\/p>\n = 7.14 This is called 7.14 times leverage, in the ratio 1:7.14<\/p>\n This means that for every rupee you can buy TCS shares worth \u20b97.14. This ratio is fine. But if this ratio increases, the risk increases. Lets understand with an example. With 7.14x leverage, TCS shares will have to fall by 14% and then your entire margin money will be gone. It is calculated like this \u2013<\/p>\n 1\/ Leverage<\/p>\n = 1\/ 7.14<\/p>\n = 14%<\/p>\n Now suppose the margin would have been \u20b97000 instead of \u20b941,335. This means that the leverage would have been<\/p>\n = 295,250 \/ 7000<\/p>\n = 42.17 times<\/p>\n This leverage is very high, so if the TCS stock falls even a little, all your capital will be gone. See:<\/p>\n 1 \/ 42.17<\/p>\n = 2.3%<\/p>\n Meaning the 2.3% fall in TCS share is enough to lose your margin money. The higher the leverage, the higher the risk. When the leverage is high, even a small change in the price of the underlying asset can blow away the entire margin deposit.<\/p>\n But this also means that a gain of 2.3 percent with 42x leverage can double your money.<\/p>\n Personally, I don’t like very high leverage. I only trade where the leverage is 1:10 or as high as 1:12, not above.<\/p>\n Futures Pay-off<\/h2>\nWhen I bought the futures of TCS, we expected the share price of TCS to go up and this would benefit me. But if the share price of TCS goes down instead of going up, then I will lose. In a futures trade, your profit or loss keeps on changing as the price changes. The pay-off structure tells you how much money you are making gains or how much money you are losing at each price level. To understand the pay-off better, let’s look at this TCS deal by creating a pay-off structure. Remember that there is a long trade which is done at Rs.2362. After making this deal, the price of TCS can go either way on 23rd December and I will gain or lose according to that price. For each price level, I have to create and analyze my P&L. see in the table below<\/p>\n \n\n\n| Expected price on December 23<\/b><\/th>\n | Buyer’s P&L (Price as on December 23 \u2013 Purchase Price)<\/th>\n<\/tr>\n | \n| 2160<\/td>\n | (202)<\/td>\n<\/tr>\n | \n| 2180<\/td>\n | (182)<\/td>\n<\/tr>\n | \n| 2200<\/td>\n | (162)<\/td>\n<\/tr>\n | \n| 2220<\/td>\n | (142)<\/td>\n<\/tr>\n | \n| 2240<\/td>\n | (122)<\/td>\n<\/tr>\n | \n| 2260<\/td>\n | (102)<\/td>\n<\/tr>\n | \n| 2280<\/td>\n | (82)<\/td>\n<\/tr>\n | \n| 2300<\/td>\n | (62)<\/td>\n<\/tr>\n | \n| 2320<\/td>\n | (42)<\/td>\n<\/tr>\n | \n| 2340<\/td>\n | (22)<\/td>\n<\/tr>\n | \n| 2360<\/td>\n | (2)<\/td>\n<\/tr>\n | \n| 2380<\/td>\n | 18<\/td>\n<\/tr>\n | \n| 2400<\/td>\n | 38<\/td>\n<\/tr>\n | \n| 2420<\/td>\n | 58<\/td>\n<\/tr>\n | \n| 2440<\/td>\n | 78<\/td>\n<\/tr>\n | \n| 2460<\/td>\n | 98<\/td>\n<\/tr>\n | \n| 2480<\/td>\n | 118<\/td>\n<\/tr>\n | \n| 2500<\/td>\n | 138<\/td>\n<\/tr>\n | \n| 2520<\/td>\n | 158<\/td>\n<\/tr>\n | \n| 2540<\/td>\n | 178<\/td>\n<\/tr>\n | \n| 2560<\/td>\n | 198<\/td>\n<\/tr>\n | \n| 2580<\/td>\n | 218<\/td>\n<\/tr>\n | \n| 2600<\/td>\n | 238<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n If you bought a share at \u20b92362 and the price of TCS is \u20b92160 on 23rd December, you can see that you are incurring a loss of \u20b9202 per share as per the table.<\/p>\n Similarly, if the price of TCS reaches \u20b92600, you will make a profit of \u20b9238 per share.<\/p>\n You will remember that we said that if the buyer is making a profit of \u20b9 x, then the seller will lose only \u20b9 x. So if the price of TCS is \u20b9 2600 per share on December 23, the buyer will make a profit of \u20b9 238 per share and the seller will lose \u20b9 238 per share.<\/p>\n Another way of looking at this can be that money comes out of the pocket of the seller and goes into the pocket of the buyer. In a way, only money is being transferred here.<\/p>\n Transfer of money and the creation of capital are two different things. Capital is created when you hold the TCS share for a long time, the business is doing well, the profits of the business and its margin are increasing continuously, due to which the shareholder is benefiting. Because this does not happen in futures transactions, money moves from one pocket to another, that is why many times futures are called “Zero Sum Game – Zero Sum Game”.<\/p>\n Now, look at a graph. This is based on the buyer’s P&L based on the TCS price probabilities as of December 23. This is called \u201cPay Off Structure \u2013 Payoff Structure\u201d.<\/p>\n You can see that any price above the buy price makes a profit and any price below the buy price indicates a loss. Since the deal is done in two lots i.e. 250 shares, therefore, an increase of one point leads to a profit of \u20b9 250, a fall of 1 point causes a loss of \u20b9 250. It moves in very straight proportion and that is why this line is straight and it is called \u201cLinear Pay-off Instrument \u2013 \u200b\u200bLinear Payoff Instrument\u201d. it is said.<\/p>\n | | |