How to settle futures contracts?

Just as you understand futures trading, it is also important to understand the future contract settlement and especially the future contract settlement process. Remember that all futures are contracts and do not build any asset-based relation. Hence all the future contracts will automatically expire on the last day of the F&O expiry at the close of trade. Apart from the futures contract settlement that happens on the last day of F&O expiry, there is also a future contract settlement process that the exchange follows daily. Let us now turn to the nuances of how to settle future contracts.

Settle futures contracts

As we said earlier, there is a future contract settlement that happens daily and also a final settlement that happens on the last day of expiry, which is the last Thursday of the month. Remember that in India when you buy futures or sell futures, it does not tantamount to taking delivery of the underlying shares or giving delivery of the underlying shares. The futures contract has to be settled. That means if you are long on futures, you have to sell it off and if you are short on futures you need to buy it back. The other option is that you just leave the futures contract to expire on the last day and any profit or loss is adjusted to your trading account based on the closing price of the underlying asset.

Let us understand this entire process in practical terms. For example, you bought RIL 1 lot futures at Rs.2100, and the lot size is 250 shares for RIL. If on the last Thursday of the month, RIL closes at a price of Rs.2,200 in the cash market, then your futures position will be settled at that price. What is the outcome now? You will receive a profit of Rs.100 per share (the settlement price of Rs 2,200 less your cost price of Rs 2,100). Of course, there are brokerage charges and statutory charges which we will leave aside, for now, to keep it plain and simple. Now since the lot size is 250 shares, your profit will be Rs.25,000 in absolute terms. In this case, since you made a profit, it will be added to your margin account. Of course, had you made a loss, it would have been deducted from your margin account. 

Let us also understand MTM settlement

Why is MTM settlement or mark-to-market settlement so important? Even though futures expire on the last Thursday of the month, traders normally do not hold on to their positions until the expiry date of the contract. As and when they get a profitable opportunity during the month, they will exit their futures position. Even if you don’t sell or buy back your open futures position, the futures position will still be subject to an MTM settlement daily on the assumption that you have marked your position to the latest market price of the stock to eliminate any risk on the price.

Here is how MTM settlement works in practice.

All open futures contracts are marked-to-market (MTM) based on the daily settlement price of the relevant futures contract at EOD. Then the profits are losses are computed as: 

Once this process of daily settlement computation is completed, all the open positions across all futures are reset to the daily settlement price. Such positions become the open positions for the next day and the next day MTM for carrying forward positions will now use this settlement price as the base.

Finally, what exactly is the daily settlement price and how is it calculated. It is simply the closing price of the specific futures contract on that day. The closing price for a futures contract is calculated as the weighted average price of the contract in the F&O Segment of NSE in the last half hour. Only in the case of final settlement, the closing spot price is considered since all futures are deemed to expire at the underlying spot price.

• The difference between the trade price and the day’s settlement price for contracts executed during the day but not squared up
• The difference between the previous day’s settlement price and the current day’s settlement price in the case of a futures contract that you have been holding longer
• Difference between the buy price and the selling price in the case of contracts executed during the day and squared up. 

What are market indicators?

Market indicators are essentially quantitative and help to interpret stock or financial index data to extrapolate future price moves. Market indicators are normally looked at as a subset of technical indicators but that may not exactly be the correct way to look at it as they have some unique features. 

Some of the examples of market indicators are advance/decline ratio, 52-week high/low ratio, upper circuit/lower circuit ratio, shifts in open interest, shifts in implied volatility, etc. They can be spot market-related or futures and options market-related.

What are futures?

A future is a contract between a buyer and seller to buy or sell a particular underlying asset at a future date at a mutually agreed price. The profits and losses can be unlimited for the buyer and the seller of the futures contract. Futures are subject to initial margins at the time of initiation and also MTM margins daily based on the daily price movements.