What? F&O?

If you have ever joined a telegram group, chances are you have seen a message like this:

Both calls ended in loss that day. The messages with the fire emojis stopped the minute it went into loss.

Curious why they only selectively post their winning trades?

Stock market seems simple. You buy low and sell high. That is like saying batting in a world cup final easy, just hit the ball with the bat. Both statements oversimplify the complexities massively. If you are trading in cash delivery markets, 9 out of 10 times you will not need to know about technical complexities besides the T+2 settlement cycle and the new rule of margin requirement for selling your shares. If you are trading intraday you have to learn how leverage works, and what happens when your MTM loss at the end of the day is more than the money you had in your account in the morning.

But these are still trivially simple compared to what you need to know to tread into derivatives market of equity, currency and commodities (pun intended!). If you jump in directly, you will realize that you did not know what you did not know.

I thought I will give you a small checklist of things you will need to know by heart to be safe in the market.

  1. Expiry time – Know the expiry time and date for the contract you are trading. Equities expire on Thursdays at the end of the day. Currencies expire on Fridays at noon. Recheck the details yourselves. I may be wrong, or rules might have changed since publishing this article.
  2. Type of settlement – Nifty and Banknifty contracts are cash settled, meaning you receive the gains or pay the losses and the contract is considered settled. Stock futures and in the money stock options are physically settled. Meaning, depending upon the side of the contract you hold, you must either take delivery or give delivery equal to the number of lots you hold. An ITM Reliance contract would be settled with 505 shares of Reliance. That requires full value of contract i.e. 505 x CMP of Reliance and not just 2.5L margin that the broker takes.
  3. Margin Maintenance – Unlike cash trades where once you buy the shares and pay for them, you do not need to maintain any money in the account, derivatives need cash or margin. (Cash can be given as margin but margin cannot be paid as cash!). If you go long in a futures contract and market goes down a little, resulting in an MTM loss of 5000 Rs. Then you must pay 5000 Rs cash at the end of the day. If you are holding an option position however, just some margin will be blocked. So, you can get a margin call if you run out of cash to pay for the futures MTM settlement EOD even if you have plenty of non-cash margin left. Some brokers require additional margin two days prior to the expiry of physically settled contracts. If you are carrying the position throughout the month for about 1.5L margin, you will need about 3L margin to keep the position open on the last two days of expiry. Your trade could very well have ended in profit had you been able to keep it open till expiry. But if you get a margin call on Wednesday, you might be forced to close the position at a loss.
  4. Liquidity – F&O market is much more illiquid than stock. It might be quite easy for a seasoned trader to enter and exit from a 10,000-share position of GODREJCP. But it will be difficult for her to square off 10 call options at slightly OTM strike of the same stock since the liquidity is much less. So, your position might show 2000 rupees profit, but by the time you exit fully, you might have paid 400-500 rupees to slippages. That is 20-25% less than the profit you were expecting. This is especially true for multi leg option strategies.

There are many more factors you need to look out for while trading in F&O market, but hope this post gets you started on at least some of them…

Also read my article on starting to trade in FnO market: What is the ideal size?

Black Swan Events

two black ducks on grass lawn

This is the catch phrase every single news channel likes to throw around. It is an event that is beyond what is normally expected. The word ‘normally’ is a bit subjective. When you start trading, for the first few months upper or lower circuits would seem like abnormal events. Soon you would get used to extreme volatility where 8% up and 9% down happens one day after another. You will see a stock tanking 10% after a historically bumper result. And through all this if you manage to keep your account afloat, you will see the shortest bear market in the history lasting about a month from peak to trough.

But let us see some events that would have surely caught many ‘professional’ traders off guard too.

There is one event I would like to talk about. One where the value of crude oil contracts went negative.

No, it did not mean that you could go to petrol pump and get paid to fill the tank of your car. It was a time where world was locked down due to COVID-19. There was little demand for crude. People holding long futures of crude would have to take delivery of oil on expiry of their contract. It is worth mentioning here that crude contracts are physically settled in US unlike on MCX where they are cash settled. So long traders would have been stuck with barrels upon barrels of crude which had no demand in the market or any economically viable place to store. So, traders started selling the contracts. Selling did not stop. Eventually the ask side of the orders started working in negative. Traders were ready to pay money to close their long positions because taking a delivery would have meant an astronomical loss.

At least in the US the exchanges could process negative orders and the market kept running. In India last traded price of April month future contact was 965 rupees but the final settlement price was assigned as negative 2884 rupees.

A lot of traders and brokers have moved to various courts of appeal. Traders and brokers claim that MCX had no system to submit negative price in spreads and hence it cannot assign a negative price for settlement.

The cases are still in the court. The difference between LTP and settlement price was over 3500 Rs. Multiply that by 100 barrels per contract and a long trader could have potentially lost 3.5 lakhs per contract that day. That is more than the margin requirement for the same contract at that time.

Results from the court are still awaited. The traders who lost big that day might get some of their money back. But that will take time. And they would have lost precious opportunities that presented themselves from April till today.

Nobody, not even our exchanges had anticipated negative prices before this event. Since then the margin requirement on crude oil has increased a lot. Currently it is more than even the notional value of the contract.

Black swan events are unexpected. So naturally there are little safeguards in place against them. But there is always a way to prevent large losses. Here I mean losses large enough to mess with your psychology, make you lose confidence. It might reduce your capital so much that it is no longer viable for you to trade.

Remember, in trading, not losing money is more important than making a lot of money. It is prudent to hope for the best but prepare for the worst.