# Futures and Options

#### 1W Change in Call OI

1w change in call open interest is calculated as percentage change between current days call OI and the call OI 5 trading days ago. Suppose current day’s call OI is 120 and the call OI 5 trading days ago was 98, 1w change in call OI is 22.44% ((120/98) – 1)*100.

A positive change in call OI indicates that more people have bought call contracts compared to 5 days ago. This suggests that participants are bullish on the stock. On the contrary if the output is negative it indicates that investors have squared off their open positions and are not confident about the future price rise.

Let’s start with a small story that will allow us to better understand the working of futures market. Two women, Sita and Noor are both active in the housing market of Mumbai. Sita is looking to buy a 2 bedroom apartment. Noor is planning to sell her 2 bedroom apartment for about Rs.1 crore and utilize the proceeds to set up a catering business.

Sita does like Noor’s apartment but is not able to pay immediately. Her money is locked in fixed deposit which will mature in 6 months and Sita does not want redeem it before the maturity date. However she wants to seal the deal and agree on the purchase consideration as she is concerned that prices might go up in the future. Noor is also keen to seal the deal. However since she has not yet found another rented accommodation to move into, she wants some grace time before handing over the possession of the apartment to Sita. Hence Sita enters into an agreement with Noor to buy the house after six months for a consideration of Rs 1.1 Crore. This way both were able to achieve their respective objectives.

This is a basic futures contract. Sita has agreed to buy the house and hence holds the **long** position. Noor has agreed to sell the house and hence holds the **short** position. A long position holder buys the “underlying” asset whereas short position holder agrees to sell the asset.

What is an underlying asset though? An underlying asset is an item that has been agreed to be bought or sold. In the above example the underlying asset is the 2 bedroom apartment. Futures are more standardized contracts which are traded on exchanges and have underlying’s like stocks, bonds and commodities

Now let’s look at some technical aspects of the futures contract:

#### Fair Value

The price at which Sita agreed to buy the apartment from Noor was Rs.1.1 crore. This is the price that Sita will pay at the expiry/maturity of the contract after 6 months. But is this the fair price, assuming the same apartment can be bought today for Rs 1 crore?

Let’s assume that the current bank interest rate is 6% pa. Keeping things simple and not counting in compounding, Sita will be able to earn 3% returns in 6 months on her investment. So if Sita invests Rs 1 crore in the bank today, she will have Rs 1.03 crore after 6 months. This is called the Fair Value of the futures contract. If the future contract was priced at Rs 1.03 crore, instead of Rs 1.1 crore, Sita would have been indifferent in buying the house today or after six months.

Simply put, fair value of any future contract is the amount that you will have at maturity of the contract, if you simply invest an amount equivalent to the current underlying price in the bank and earn the risk free rate on it.

**We use 3month MIBOR for all our calculations*

#### Future Close Price

As mentioned above, futures are standardized contracts on stocks and/or bonds, traded on exchanges. In the screener you will find data regarding future contracts for different stocks traded on NSE – National Stock Exchange.

Just as in stock prices, future contract prices are also determined by demand and supply pressures of market. If there are too many people buying the future contract of Reliance, its price will go up. Similarly, if there are too many traders selling the future contract of HDFC, its price will come down. This price will always remain close to the fair value which we determined above, but might vary depending upon the current market demand and supply. In our example of Sita and Noor, at 1.1 crore future contract price is different from the fair value price of Rs 1.03 crore.

The future close price that you see in the screener is the closing price of the current month future contract from the last day it got traded on the exchange. So if you are checking the future close price of the Reliance contract today, it will be the closing price of the contract yesterday (previous traded day).

#### Lot Size

In our example, both parties entered into a futures contract to buy/sell a single apartment, hence the lot size is 1. Suppose they had entered into a futures contract that required buying/selling 2 apartments then the lot size would have been 2 and so on.

In the stock futures market, lot size refers to the number of shares of the company contained in one contract and which an investor is required to buy in a single transaction. For example, suppose the lot of size of Asian Paints is 600, then purchasing a single future contract of Asian Paints would involve 600 shares of the company. This lot size is not divisible. The stock exchange specifies the lot size and it is different for different stocks/commodities.

#### Future Open Interest

Let’s move beyond the example of Sita and Noor and consider the entire housing market of Mumbai. Just like the before mentioned characters, suppose 12 other people have agreed to buy houses from 12 other sellers after 6 months. So the total number of futures contract that are open is 12+1 = 13. Suppose 2 days later another futures contract is signed, then the open interest increases by 1 to 14. Now let’s assume Sita sells her futures contract to her friend Rita, who is also interested in buying Noor’s apartment. The contract is now between Noor and Rita. However the number of open interest’s still remains at 14 as Rita merely took Sita’s position as the buyer and did not enter into a new contract.

If out of the 14 open contracts one of the set of buyers and sellers execute the transaction i.e buy/sell the house, the number of open interest drops by 1 to 13.

Hence when an investor who has bought / sold a futures contract does not complete the transaction by subsequently selling / buying the contract or actual delivery or receipt of the stock / commodity, the contract is said to be “open”. Open interest (OI) is the number of futures contract that are yet to be settled and exist on the books of the clearinghouse / stock exchange

A single purchase and sale, involving two transacting parties – constitutes an OI of 1. OI is a measure of the flow of money into futures market. Increasing OI represents new or additional money flowing into the market. Decreasing OI indicates money flowing out of the market.

#### 1D Change in Future OI

This is percentage change in open interest between 2 subsequent trading days. Suppose the open interest (OI) position on Monday is 100 and on Tuesday is 120, 1 day change in OI is calculated as (120/100) – 1*100 = 20%. A positive output indicates rising number of OI’s whereas a negative output indicates drop in OI’s.

As a rule of thumb, if the spot price of the stock and OI of futures both move up, it indicates a bullish signal and prices might continue to rise. A decrease in price with an increase in OI or conversely an increase in price with a fall in OI both indicates a bearish signal.

#### 1W Change in Future OI

The data item is calculated as percentage change in OI between 5 trading days. Suppose the open interest (OI) position on Friday is 100 and on last Friday it was 170, 1W change in OI is calculated as (170/100) – 1*100 = 70%. A positive output indicates rising number of OI’s whereas a negative output indicates drop in OI’s.

As a rule of thumb, if the spot price of the stock and OI of futures both move up, it indicates a bullish signal and prices might continue to rise. A decrease in price with an increase in OI or conversely an increase in price with a fall in OI both indicates bearish signal.

#### Future Volume

Volume refers to the total number of future contracts that have been executed on the stock exchange on any given trading day

Let’s look at the same example which we discussed in the Future Open Interest section. Initially open interest was 1, as the only contract was between Sita and Noor. The next day 12 new contracts were opened between 12 different sellers and buyers, and the total open interest increased to 13. On this day the volume was 12, as 12 contracts got executed, however open interest was 13 as these are the number of open contracts.

Next day one more contract got opened between a new buyer and seller. Thus the open interest became 14, but the volume for that day was just 1 as only one contract got executed. The purchase by the buyer and sale by the seller of one futures contract equals a volume of 1.

For example if you see that the Volume for the near month Reliance future contract on the screener as 120,000, it means these many contracts were executed on the previous trading day.

#### 1D Change in Volume

This is percentage change in total traded volume between 2 subsequent trading days. Suppose the total volume on Monday is 100 and on Friday it was 120, 1 day change in volume is calculated as (120/100) – 1*100 = 20%. A positive output indicates rising number of volumes whereas a negative change indicates drop in volumes.

Change in volume needs to be viewed in conjunction with price change and open interest change. Rise in price accompanied by increase in open interest and volume traded is a bullish signal. Rising price accompanied by falling open interest and volume as well as falling price accompanied by rising open interest and volume are both signals of bearish trend.

#### 1W Change in Volume

The data item is calculated as percentage change in total traded volume between 5 trading days. Suppose the traded volume on Friday is 100 and on last Friday it was 170, 1W change in volume is calculated as (170/100) – 1*100 = 70%. A positive output indicates rising number of volume whereas a negative output indicates drop in volume.

Change in volume needs to be viewed in conjunction with price change and open interest change. Rise in price accompanied by increase in open interest and volume traded is a bullish signal. Rising price accompanied by falling open interest and volume as well as falling price accompanied by rising open interest and volume are both signals of bearish trend.

#### Basis

Basis is the difference between the current price of the future contract and the current price of the underlying. In our example of Sita and Noor, we established that the fair value of the futures contract is Rs 1.03 crore and the price at which the future contract got executed between Sita and Noor was Rs 1.1 crore. Let’s assume that 1.1 crore is the current market price. This means that if Sita wants to sell her position in the contract there are buyers who will be willing to pay her Rs 1.1 crore to enter into the futures contract with Noor.

Let’s say Sita sells her future contract to Karishma for Rs 1.1 crore. Thus in this case, now the contract is between Karishma and Noor with Karishma holding the long position. Open Interest remains the same, as no new contract was created. Let’s say the price to buy the house today is Rs 1 crore. Thus, basis would be Rs 10 lakh (1.1 – 1), as it represents the difference between the current market price of the future contract and the current price of the underlying.

#### Fair Value Spread

Fair value spread is the difference between fair value and the current market price of the future contract. We have already understood the meaning of fair value and current future price. In our example of Sita and Noor, fair value of the house was Rs 1.03 crore and the current market price was Rs 1.1 crore, so the fair value spread would be – 70,000 (1.03 – 1.1).

Fair Value spread can be used to detect arbitrage opportunities in the market. A positive fair value spread highlights cash and carry arbitrage opportunity and a negative value indicates reverse cash and carry arbitrage opportunities. Read more about cash and carry arbitrage here.

#### Rollover cost

In the example of Mumbai housing market the contract was valid for a period of 6 months. However in case of futures contracts traded on national stock exchange, the contracts are available in 1 month, 2 month and 3 month time frame. The time frame up to which the contract lasts is called ‘The expiry’ of the contract.

Suppose Sita wants to enter into a 6 month contract with Noor on the stock exchange she will have to buy a futures contract with 3 months validity and then at expiry again buy a 3 month contract. This is called rolling over the position. It refers to carrying forward a particular periods future contract position to the next month. This can be done by selling the contract which is about to expire and buying the new longer contract

Suppose investor X is bullish about Nifty futures, when his current month contract is due for expiry he will exit the position and buy the subsequent month’s contract rolling over his position.

Rollover cost is calculated as the percentage change between futures contract price for the next month and the futures contract price for the current month contract. For example let’s assume X holds 10 futures contract of Ashok Leyland that is expected to expire at the end of this month. Price of each contract is Rs.94.35. He decides to roll over his position. Price of each contract for next month expiry is Rs.95.45 and he needs to buy 10 contracts to carry forward his position.

Rollover cost = ((95.45 / 94.35) -1 )*100 = 1.2%

It means he will get 10 * 94.35 = 943.5 by selling the current month contract, but when he buys the 10 lots of next month contract he will pay 10* 95.45 = 954.5. Thus he will pay an additional cost of 954.5 – 943.5 = 11 which is 1.2% of his current investment ie. 943.5.

#### Percentage Rollover

As discussed earlier, rollover refers to carrying forward a particular month’s derivative position to the next month. Rollover data allows to understand how much of current month’s open interest positions in futures, are being carried forward to the next month series.

Rollover percentage is calculated as open interest for the next month divided by the open interest of the futures contract across all periods. For example suppose open interest position of Ashok Leyland futures are as below:

Near month | Mid month | Far month |
---|---|---|

5,50,83,000 | 34,30,000 | 28,000 |

A high rollover percentage indicates that a lots of positions are being carried forward to the next month and traders are still holding onto their belief about the direction of stock’s movement. On the contrary, a low rollover percentage indicates lack of confidence about the future direction of the underlying stock or commodity.

Rollover percentage = 34,30,000 / (5,50,83,000 + 34,30,000 + 28,000) = 5.9%

#### Calendar spread

Let’s assume that the futures contract for houses in Mumbai is trading on the stock exchange. Currently contracts are open for July expiry (near month), August expiry (mid month) and September expiry (far month). The difference between the August future contract price and July future contract price is called the calendar spread

If prices of distant delivery futures contract are higher than near delivery futures contract, it results in positive calendar spread and such a situation is called contango market. For example in the above example if the price of August futures is higher than the price of July futures, it is called contango. Conversely if in the above example if the price of July futures contract were higher than price of August futures contract, it would result in negative spread and is called backwardation.

#### Options

Let’s continue with the same example which we discussed in the Futures section. In the example, Sita had agreed to buy Noor’s 2BHK flat after 6 months at a price of Rs 1.1 crore. Let us modify the example slightly to understand options. Recall that though Sita likes Noor’s apartment and is keen on buying it, as her money is locked in fixed deposit maturing in 6 months she is not able to pay for the apartment immediately. Sita is also concerned that house prices will rise in the future and is keen to lock in the price as of today. Noor is selling the house so that the proceeds can be utilized to set up a catering business. She is also keen to seal the deal with Sita, but needs some time to find a suitable rented accommodation. Thus it made sense for both of them to enter into a futures contract executable after 6 months.

Let’s suppose Noor is keen to sell the apartment right away and move out. If she has to wait for 6 months to receive the purchase consideration and vacate the apartment, then Noor expects to be adequately compensated for the same. The compensation is because Noor will have to maintain the apartment for 6 months and is liable to pay property taxes, maintenance expenses etc. Let’s assume Sita agrees to pay Rs.5 lakh immediately to Noor. By doing so, Sita is buying the right to buy Noor’s apartment after 6 months at a predetermined price of Rs 1.1 crore and Noor is charging her some premium to grant this right. This is an example of call option. Sita is entering into a call option with Noor, this gives her the right to buy Noor’s apartment after 6 months; this is called the **long** position. Noor is giving Sita the right to buy her apartment and holds the **short** position. Predetermined price of the underlying apartment is called **strike price. **In this example strike price of the call option is Rs 1.1 crore and maturity period is 6 months. ** **

#### Call Open Interest

Let’s take our example further. Just like Sita and Noor, suppose 12 other people have agreed to buy houses from 12 other sellers after 6 months. They have also paid a premium to enter into these call option contracts. So the total number of call option contract that are now open is 12+1 = 13. Suppose 2 days later another call option contract is signed, then the open interest increases by 1 to 14. Now let’s assume Sita sells her call option contract to her friend Rita, who is also interested in buying Noor’s apartment. The contract is now between Noor and Rita, however the number of open interest still remains at 14 as Rita merely took Sita’s position as the buyer and did not enter into a new contract.

Hence when an investor who has bought/sold a call option contract does not complete the transaction by subsequently selling / buying the contract, the contract is said to be “open”. Open interest (OI) is the number of contract that are yet to be settled and exist on the books of the clearinghouse / stock exchange.

A single purchase and sale, involving two transacting parties – constitutes an OI of 1. OI is a measure of the flow of money into option market. Increasing OI represents new or additional money flowing into the market. Decreasing OI indicates money flowing out of the market.

Call OI that you see on the screener is the sum of all open call contracts across all the strike prices for all expiry periods. Suppose 15 call options are open across all strike prices that are set to expire this month. Similarly 27 call options are open that will expire next month and 8 open call options will expire the month after that. The total call option open interest is 50 (15+27+8).

#### Put Open Interest

We have already understood the concept of open interest. Now let’s understand a put option. We have already explained that access to the right to buy is a call option. In our example Sita got the right to buy Noor’s house and we established that she holds a long position in a call option contract. Opposite of right to buy is the right to sell and this is called a put option. In this case, the buyer of the option will pay a premium to seller of the option to get a right to sell.

Always remember that the option lies with the buyer of the call/put contract. Call option buyer has the right to buy and thus an option to buy or not, as per her wish. But if she wants to buy, seller of the option is obligated to sell the underlying. This is the reason buyer of the option is paying a premium to get this right. Similarly, in the case of put option, buyer has the right to sell the underlying and thus the option to decide if she wants to sell the same or note. But if she wants to sell the underlying, seller of the put contract is obligated to buy the underlying.

Put open interest is the sum of open put contracts across all strike prices for all expiry periods. Suppose 8 put options are open across all strike prices that are set to expire this month. Similarly 12 put options are open that will expire next month and 3 open put options will expire the month after that. The total put option open interest is 23 (8+12+3).

#### 1D Change in Call OI

1D change in call open interest is calculated as percentage change between current days call OI and the previous days call OI. Suppose current days call OI is 113 and the previous days call OI is 100, 1D change in call OI is 13% ((113/100) – 1)*100.

A positive change in call OI indicates that more people have bought call contracts compared to previous day. This suggests that participants are bullish on the stock. On the contrary if the output is negative it indicates that investors have squared off their open positions and are not confident about the future price rise.

#### 1D Change in Put OI

1d change in put open interest is calculated as percentage change between current day’s put OI and the previous day’s put OI. Suppose current day’s put OI is 89 and the previous day’s put OI is 75, 1d change in put OI is 18.67% ((89/75) – 1)*100.

A positive change in put OI indicates that more people have bought put contracts compared to previous day. This indicates that market participants expect the price of the stock to fall and are buying put options to protect the downside to the stock. On the contrary if the output is negative it indicates that investors have squared off their open put positions and are not fearful about the price fall.

#### 1W Change in Put OI

1w change in put open interest is calculated as percentage change between current day’s put OI and the put OI 5 trading days ago. Suppose current day’s put OI is 91 and the put OI 5 trading days ago was 82, 1w change in put OI is 10.97% ((91/82) – 1)*100.

A positive change in put OI indicates that more people have bought put contracts compared to previous week. This indicates that market participants expect the price of the stock to fall and are buying put options to protect the downside to the stock. On the contrary if the output is negative it indicates that investors have squared off their open put positions and are not fearful about the price fall.

#### Highest Call OI Strike

Strike price is the price at which that specific derivative contract can be executed. In case of call option, strike price is the price at which the call buyer can buy the stock. Whereas in case of put option, strike price is the price at which the put buyer can sell the stock. In our example of the call option contract between Sita and Noor, strike price was Rs 1.1 crore.

Generally retail clients take long position in the option contracts and institutions take the short position. Strike with highest call OI indicates the price level at which institutions have sold a lot of call options, thus it means institutions don’t feel that price will go above this particular level. This level indicates the maximum upside. For example if in case of Maruti, Rs.7800 represents the strike with highest call OI, then it means that institutions expect the price to remain below 7800.

#### Highest Put OI Strike

We have already explained the concept of OI and strike price above. As mentioned earlier, retail investors generally take the long position and institutions short the option contracts. Strike with highest Put OI indicates the price level at which institutions have sold/written a lot of put option contracts. Thus, it means that they expect price to not fall below this level. For example, if Rs.7200 represents the strike with highest put OI for Maruti, then it means that institutions expect the price to not fall below Rs.7200.

#### Highest 1D/1W OI Change CE Strike

The OI percentage difference for a particular strike price between 2 subsequent trading days is first calculated. Suppose Union Bank of India has 3 different strike prices: Rs.162, Rs.165 and Rs.168.

Strike price | Call option OI on Monday | Call option OI on Tuesday | 1 day percentage change in OI |
---|---|---|---|

Rs.162 | 1820 | 1953 | 7.30% |

Rs.165 | 2789 | 3586 | 28.57% |

Rs.168 | 1758 | 1548 | -11.94% |

In the above example Rs.165 strike price has the highest call option OI as well as recorded the highest percentage increase in OI over the previous day.

The same exercise done for 2 days separated by 5 trading days results in the highest 1W OI change call option strike. The maximum increase in percentage change is sought out and this is the strike with the highest call OI change.

#### Highest 1D/1W OI Change PE Strike

The OI percentage difference for a particular strike price between 2 subsequent trading days is first calculated. Suppose Union Bank of India has 3 different strike prices: Rs.162, Rs.165 and Rs.168.

Strike price | Put option OI on Monday | Put option OI on Tuesday | 1 day percentage change in OI |
---|---|---|---|

Rs.162 | 1200 | 1322 | 10.16% |

Rs.165 | 1892 | 2010 | 6.23% |

Rs.168 | 798 | 763 | - 4.39% |

In the above example though Rs.165 strike price has the highest put option OI, over the previous day Rs.162 strike price has recorded the highest percentage increase in OI.

The same exercise done for 2 days separated by 5 trading days results in the highest 1W OI change put option strike. The maximum increase in percentage change is sought out and this is the strike with the highest put OI change.

#### Put Call Ratio

The put call ratio is calculated by dividing the total open interest in put options of an underlying by the total open interest in call options of the underlying. Suppose the OI of put options on stock ABC is 120 and the OI of call option on the same stock is 100, put call ratio will be 1.2 (120/100).

Put call ratio is used to understand the mood of the options market. A high put call ratio indicates that open interest in put options are more than the open interest in the call option and sentiment is bearish in the market. Similarly a low put call ratio indicates that open interest in call options is more and the market sentiment is bullish. Thus, it is important to determine what is considered as high and low for the put call ratio. One can track the historical ratio and then compare the same with the current number to determine or gauge the sentiment around a stock or index.