Stock Market Trading

ADVANTAGES AND BENEFITS OF COVERED CALL STRATEGY

‘The biggest advantage of covered call strategy is it increases and improves the odds of successful trading. Another biggest share tips benefit is that it can be implemented in two of the three possible stock movement scenarios. If the stock goes up, it’s profitable. Ifthe stock goes sideways, it’s profitable. The only case when it is not profitable is when the stock goes down. Any strategy that works 66% of the time automatically has higher oddsof success.

On the other hand, when buying either options or stocks, traders and investors make money only in one out of three possible eventualities. Which is if the stock goes in the desired direction. Also, the covered call puts a premium on time, as time passes you gain the time value of the option.

COVERED CALLS GIVES YOU BEST RETURNS OVER THE LONG TERM

Covered call writing has taken the stress out of stock market trading. The odds of making money in naked futures, options, and stocks are stacked against both the buyer and the seller. This is because their probability of making money is one out of three. Covered call is the only strategy in market stock tips which the trader makes money most of the time and even when he is wrong, the losses are lower than in the case of the other strategies. In the long bear phases, markets as well as individual stocks take years to form bases and move up. Covered call is a good way to make money during such periods. In India, the call and put buyers would actually need a miracle to make money in the fifteen trading sessions that there effectively are in a month. This is because there are eight to ten holidays in a money mantra month and in the last five days before expiry, the decay in time value is often higher or.equal to any favourable movement. In India, therefore, currently the covered call is as good as it can get.

In India a majority of traders dont write calls. One of the reasons is the myth that futures and options are inherently risky. On the contrary, as we have seen futures and options are option trading courses excellent tools for managing risk and returns. Like anything else they can certainly cause great harm if not used properly.

Another reason is that most people like to follow the common practice and are suspicious of looking at anything new, selling covered calls is share trading courses something that the earlier generations of traders ever had the opportunity to do.

There is another myth that the option buyer is the smartest and the most risk averse person around, and that options are sold by people who are either gamblers or very rich since selling options is, theoretically, very risky. Neither of the above is true, particularly in the case of writing covered calls. In general the option buyer always gets a raw deal, and this is particularly true in India.

The logical reasoning behind writing covered calls is simple. It makes money and generally it does so better than most naked stock, futures or free share market tips options buying. Actually, the concept is so simple that people get confused and think they are missing something. The best part about the covered call is that it outperforms the other methods 70 to 75% of the time when market goes sideways.

 

Traders And Investors

SOME STRATEGIES FOR WRITING COVERED CALLS

STRATEGY 1      

This is the strategy that works best in India since options of fundamentally strong stocks continue to have some time premium left till the last day. You should write at-the-money calls since these give the maximum premium inflow. It is critical, however, that once covered call writing is accepted as a strategy, nse india,  traders should write calls on an ongoing basis. On the last Thursday of every month, it should be a ritual to write fresh calls for the next month. Traders and Investors should look to invest their funds every month in order to get consistent benefits of call writing.

Generally speaking, options written in big stocks do not get exercised and it is possible to either square up the transaction on the last day, or let the option expire and sell the stock as well towards the close in order to initiate new positions. In case the same stock still looks good, traders can sell fresh calls while letting the old ones expire. This might entail some cash outflow if the stock market tips stock had moved up very sharply in the previous month, the call sold deep in-the-money, and the fresh call is written for a lower premium inflow. The additional premium paid on the expensive call is captured as the intrinsic value in the stock, which remains notional if the stock is held. Again the approach is different for traders who are using covered call as a strategy and for those who have the stock position and just want some extra income online trading tips.

STRATEGY 2

In some cases the calls you write might be exercised by the buyer. Typically, this happens when the price of the stock rises very sharply certificate in technical. And this can happen since individual stocks have American Options which can be exercised at any time during the month.

Should this happen, the trader needs to review the entire situation and decide whether the stock could be expected to rise much further or if the rise was a one-off-move. This is never easy to determine. Nevertheless, some points such as volumes, breakout after a narrow range, or from a bullish pattern, would be the likely signals to look at.

In such cases traders should go on writing at-the-money calls as soon as a previous call is exercised against them. They can also write one or two strikes further from the at-the-money call if the stock looks bullish and technical analysis training is expected to rise further. You should not be worried about the exercise against you because you have captured the entire gain in the intrinsic value of the stock in any case. Fresh call writing needs to be looked at asa fresh situation. Sometimes writing a call on another stock which is range bound might be more useful.

STRATEGY 3

If the stock breaks down all its supports you should close your entire covered call positions.. As mentioned earlier a covered call needs to have an ultimate stop loss should the stock starts tanking. Despite the best technical analysis, sometimes a stock starts failing its supports and goes into a down trend. At that point it is critical that the entire covered call position in the stock V be closed at a stop loss determined by a strong support. You might use the idea of closing out a part of the position driven by the fact that your outlook on a given stock might have changed. You now have a more bullish view on the stock. This might tempt you to buy back a share tips portion of your sold calls, maybe at a higher rate, and aim for some capital appreciation too. You should not think like this because once you have decided to write a call, you should be clear that you are giving up the upsides. Changing one’s objective midway only leads to higher transaction costs and sometimes the gain envisaged does not mater ialise.

WRITING INDEX COVERED CALL OPTIONS

For a large mutual fund or very high net worth investors, it makes sense to write index options to enhance returns as w’ell as hedge in times of uncertainty or consolidation. For smaller traders and investors, selling index options is a good way of playing in the index futures market. Trading naked index futures is generally pretty tough even for seasoned traders. For a retail trader, on the other hand it is often easier to judge if the index will hold a particular level.

So by going long in the index futures and selling an at-the-money index call option, the retail trader gets a larger stop loss in terms of breakdown. By doing so, he gets into the advantageous situation of the option seller, rather than being the option buyer and getting wrong end of the stick. Indian Markets, and for that matter al markets, go sideways for long periods of time, so buying futures and selling at-the-money call options technical analysis can be a profitable option, still, as discussed earlier, it is critical to apply a stop loss in all futures and stock positions. Generally in bullish markets, at-the-money Nifty index call options sometimes sell for ever. RS.50, so the trader immediately gets Rs.50 in his account as profit and as stop loss, in the case of sensex this would be 150 points. Unless the trader get the trend wrong, a 50 point stop loss is generally enough.

PARTIAL WRITING

This involves writing calls on a part of your stock holding thereby fine tuning your portfolio to achieve fixed as well as variable returns. Writing covered calls on all of your stock holding is a good idea in the Indian Scenario. In twenty trading sessions, it is difficult for most stocks to consistently beat the covered call premium.

 

MIXED WRITING

Mixed writing is done by writing calls, at different strike prices. Again therd could be lot size problems here. There is another way of fine tuning returns but in the Indian scenario not very viable nor profitable, mainly because

1.    You end up having a large position in single stock

2.    Stock movement might not be according to expectation unless the stock is trending.

RATIO WRITING

Ratio writing means writing higher calls in the ration of 1:2, or more, to the stock held. But it is not advisable to write more than 1:3 because un­expected things happen in the market. This strategy is also used where you have a shortened month and the call premiums are high. It is critical to understand the breakeven in this transaction on both sides.

 

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Stock Trading

WRITING COVERED CALLS 

Writing (Selling) Call Options when you already own the underlying is called writing covered call options. It is against writing Naked options which can have unlimited risk.

HOW WRITING COVERED CALL OPTION WORKS

As discussed earlier a Call is the right to buy an underlying asset above a certain price, and before a certain date. Now only the liquid calls in India are the near month expiry which means that there are, at most, 30 days for the calls to expire. If you eliminate holidays roughly it comes to an average of 20 trading sessions per month. Now lets understand the number of ways the covered call seller benefits.

]. If the options volatility reduces, he makes the difference of the volatility premium.

2.     As the time to expiry reduces, he makes money on the time value.

3.     If at expiry the price is below the strike price,, he took the entire premium as profit, no questions asked.

The above advantages of the option call writer/seller turns into disadvantage for the call buyer. The call Buyer thinks that he is minimising his risk because he has paid a fixed amount and that is all he is risking. Actually though, he makes money only if the price of the stock rises very strongly. Previous experiences shows that markets and stocks trend only 25 % of the time. So Generally the call writer/seller makes most of the money frequently. WORLD WIDE DATA SUGGESTS THAT ONLY 15% OF THE OPTIONS ARE AC TALLY EXERCISED. The reason behind this is very simple, markets don’t trend most of the time. It is only during these relatively rare trending periods that option buyer make money, the rest of the time when markets consolidate or turn sideways, it is the option writer who makes consistent profits. A month is simply too short a time for an option buyer to make money except in a raging bull market.

If the stock starts trending upwards, how is option writer protected? Well, he is protected because he OWNS THE UNDERLYING. In a delivery settled system he w’ould deliver the stock but in India’s cash settled system he needs to pay only the difference between the strike price and the stock price prevailing at the end of the month* which he can do by selling the stock he owns. So the upside risk is covered because of his ownership of the underlying. If the covered call writer writes a call all twelve months of the year in a good market and makes 4% per month, it is a return of 48% per annum. Generally the call is not exercised till it is deep in-the-money. However when it is exercised, the trader can simply write a new, higher call option.

But, always remember, the covered call writer may lose if the stock starts declining sharply. This is the situation in which the cover call writer can lose. This risk can also be reduced by a technical analyst wrho chooses his covered call stocks properly. The call writer can thus greatly reduce the risk of writing calls. In reality, therefore the call buyer is not the one reducing his risk. Actually, he is the one that is taking all the risk and is giving the cal I seller a consistent, high return on his stock holding.You should write covered calls only in a sideways, mildly bullish, or an extremely bullish market. If the market environment is very bearish where every stock is getting slaughtered to half its value, writing covered calls may not do you any good. In such situations, it would be advisable to wait till the market completes its sharp falls and goes into a sideways mode in forming a basing formation. These bases often take six month to form, sometimes it could take as long as two years. Investors and traders can then again start writing covered calls once the market bottoms out.

THE IMPORTANCE OF STOP LOSS IN WRITING COVERED CALLS

As the covered call only protects the covered call writer to the extent of the premium, it is extremely important that traders keep some kind of a stop loss in case the stock starts declining in a major way, such as breaking of crucial supports, breaking down from a range, some unexpected fundamental news, etc., Generally speaking, in most cases You should not keep the stock if it starts to give back the entire premium and/or starts breaking down supports. If you do not want to get rid of the stock then buying puts based on the chart patterns may not be a bad idea. But the key idea is never to get stuck on a sinking ship in the hope that a covered call will bail you out in the end.

 

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Options Premium Value

TAXATION OF DERIVATIVES TRANSACTIONS IN SECURITIES 

SECURITIES TRANSACTIONS TAX ON DERIVATIVES TRANSACTIONS

Finance Act (N0.2) of 2004 has introduced Securities Transactions Tax on all derivatives transactions entered into a recognized stock exchange. This tax is payable by the seller of the derivative instrument. The rate of tax free trading tips applicable on the same has been revised to 0.0133% of the value of taxable securities transaction by Finance Act, 2005. (It is subject to change from time to time).

The value of taxable securities transactions relating to “Option in securities” is the aggregate of the strike price and the option premium of such technical analysis “option in securities”. The value of taxable securities transaction relating to “futures” is the price at which such “futures” are traded.

Securities Transaction Tax Rules, 2004 provide for rounding off of the value taxable securities transaction, online trading tips amount of securities transaction tax, interest and penalty payable and the amount of refund due to the nearest rupee.

EXAMPLE – A: Mr.X sells a futures contract of M/s XYZ ltd., (Lot size: 1000) expiring on 29th sep, 2005 for Rs.300. The spot price of the share is Rs.290. The securities transaction tax thereon would be calculated as under:

1.   Total futures contract value = 1000×300 = Rs.3,00,000

2.  Securities transaction tax payable thereon is 0.0133% = 300000 x 0.0133% = Rs.40.

Note: No tax on such a transaction is payable by the buyer of the futures contract.

EXAMPLE – B: Mr. X Sells an options contract of M/s XYZ Ltd., (Lot size: 1000) expiring on 29th sep, 2005 for Rs.10. The strike price of the certificate in technical contract is Rs.300. The spot price of the share is Rs.290, The securities transaction tax there on would be calculated as follows:

1.    Total options contract value = 1000 x 300 = Rs.3,00,000

2.    Total options premium value = 1000 x 10 =Rs. 10,000

3.     Total value of securities transaction = Rs.3,10,000

4.     Securities transaction tax payable there on 0.0133% i.e., 3,10,000×0.0133 = Rs.41

NOTE: No Tax on such a transaction is payable by the buyer of the options contract.

TAXATION OF PR0FIT/I0SS ON DERIVATIVES TRANSACTIONS

Prior to Financial Year 2005-06, transaction in derivatives were onsidered as speculative transactions for the purpose of determination of tax liability under the Income Tax Act. This is in view of Section 43(5) of the Income Tax Act which defined speculative transaction as a transaction in which a contract for purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the option trading courses commodity or scrips. However, such transactions entered into by hedgers and stock exchange members in course of jobbing or arbitrage activity were specifically excluded from the purview of definition of speculative transaction.

In view of the above provisions, most of the transactions entered into in derivatives by investors and speculators were considered as speculative transactions. The tax provisions provided for differential treatment with respect to set off and carry forward of loss on such transactions. Loss on derivative transactions could be set off only against other speculative income and the same could not be set off against any other income. This resulted in payment of higher taxes by an assesse. Again, loss on derivative transactions which could not be set off against any other speculative gains could be carried forward for a period of four years. If such loss could not be set off against speculat.’ve income over the said period. The assesse could not claim any tax relief with respect to the loss suffered.

Finance Act, 2005 has amended section 43(5) so as to exclude transactions in derivatives carried out in a “Recognized Stock Exchange” for this purpose. This implies that income or loss on derivative transactions which are carried out in a “Recognized Stock Exchange” is not taxed as speculative income or loss. Thus, loss on derivative transactions can be set off against any other income during the year. In case the same cannot be set off it can be carried forward to subsequent assessment option trading courses year and set off against any other income of the subsequent year. Such losses can be carried forward for a period of 8 assessment years. It may also be noted that securities transaction tax paid on such transactions is eligible for rebate under section 88E of the Income Tax Act in the manner provided in the said Section.

Equity Index Options Premium Account

ACCOUNTING AT THETIMi OF PAYMENT/RECEIPT OF MARGIN

Payments made or received by the seller/writer for the margin should be credited/debited to the bank account and the corresponding debit/credit for the same should also be made to “Equity Index option Margin Account” or to “Equity Stock Option Margin Account, free trading tips as the case may be. Sometimes, the client deposit a lump sum amount with the trading/clearing member in respect of the margin instead of paying/receiving margin on daily basis. In such case, the amount of margin paid/received from/into such accounts should be debited/credited to the “Deposit for Margin Account”. At the end of the year the balance in this account would be shown as deposit under “Current Assets”.

ACCOUNTING FOR OPEN POSITIONS AS ON BALANCE SHEET DATES

The Equity Index Option premium Account and the Equity Stock Option Premium Account should be shown under the head Current Assets or Current-Liabilities, as the case may be.

In the books of the buyer/holder, a provision should be made for the amount by which the premium paid for the option exceeds the premium prevailing on the balance sheet date. The provision so created should be credited to “Provision for Loss on Equity stock market Index Option Account” to the Provision for Loss on Equity Stock Option Account, as the case may be. The provision made as above should be shown as deduction from “Equity Index Option Premium” or “Equity Stock Option Premium”, which is shown under “Current Assets”.

In the books of the seller/writer, the provision should be made for the amount by which premium prevailing on the balance sheet date exceeds the premium received for that option. The stock futures provision should be credited to “Provision for Loss on Equity Index Option Account” or to the “Provisions for Loss on Equity Stock Option Account”, as the case may be, with a corresponding debit to profit and loss account. “Equity Index Options Premium Account” or “Equity Stock Options Premium Account” and Provisions for Loss on Equity Index Options Account or Provision for Loss on Equity Stock Options Account should be shown under Current Liabilities and Provisions.

In case of any opening balance in the Provision for Loss on Equity Stock Options Account or the Provision for loss on Equity Index Options Account, the same should be adjusted against the provision nifty future required in the current year and the profit and loss account be debited/credited with the balance provision required to be made/excess provision written back.

ACCOUNTING AT THE TIME OF FINAL SETTLEMENT

On exercise of the option; the buyer/holder will recognize premium as an expense and debit the profit and loss account by crediting Equity Index Option Premium Account or Equity Stock Option Premium Account. Apart from the above, the buyer/holder will receive favorable difference, if any, between final settlement price as on the technical analysis exercise/expiry date and the strike price, which will be recognized as income. On exercise of the option, the seller/writer will recognize premium as an income and credit the profit and loss account by debiting “Equity Index Option Premium Account” or “Equity Stock Option Premium Account”. Apart from the above, the seller/writer, will pay the adverse difference if any, between the final settlement price as on the bse india exercise/ expiry date and the strike price. Such payment will be recognized as a loss. As soon as an option gets exercised, margin paid towards such option would be released by the exchange, which should be credited to “Equity Index Option Margin Account” or to “Equity Stock Option Margin Account”, as the case maybe, and the bank account will be debited.

 

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Equity Stock Option

ACCOUNTING IN CASE OF DEFAULT

When a client defaults in making payment in respect of a daily settlement, the contract is closed out. The amount not paid by the client is adjusted against the initial margin. In the books of the client, the amount so adjusted should be debited to Mark to Market Equity Index Futures account with a corresponding credit to ‘Initial Margin – Equity index futures account’. The amount of initial margin on the contract, in excess of the amount adjusted against the mark to market margin not paid, will be released. The accounting treatment in this regard will be the same as explained above. In case, the amount to be paid on the daily settlement exceeds the initial margin the excess is a liability and should be shown as such under the head “current liabilities and provisions”, if it continues to exist on the balance sheet date. The amount of profit or loss on the contract so closed out should be calculated and recognized in the profit and loss account in the manner dealt above.

DISCLOSURE REQUIREMENTS

The amount of bank guarantee and book value as also the market value of securities lodged should be disclosed in respect of contracts having open positions at the year end, where initial margin money has been paid by way of bank guarantee and/or lodging of securities.

Total number of contracts entered and gross number of units of equity index futures traded (separately for buy or sell) should be disclosed in respect of each series of equity index futures.

The number of equity index futures contracts having open position, number of units of equity index futures pertaining to those contracts and the daily settlement price as of the balance sheet date should be disclosed separately for long and short positions, in respect of each series of equity index futures.

ACCOUNTING FOR EQUITY INDEX OPTIONS AND EQUITY STOCK OPTIONS

The institute of chartered accountants of India issued guidance note on accounting for index options and stock options from the view point of the parties who enter into such contracts as buyers/holders or sellers/writers. Following are the guidelines for accounting treatment in case of cash settled index options and stock options.

ACCOUNTINGAT THE INCEPTION OF A CONTRACT

The seller/writer of the options is required to pay initial margin for entering into the option contract. Such initial margin paid would be debited to “Equity Index Option MaiginAccount” orto ” Equity Stock Option Margin Account” as the case may be. In the balance sheet, such account should be shown separately under the head “current assets”. The buyer/holder of the option is not required to pay any margin. He is required to pay the premium. In his books, such premium would be debited to “Equity Index Option Premium Account” or Equity Stock Option Premium Account” as the case may be. In the books of the seller/writer, ■ such premium received should be credited to “Equity Index Option Premium Account” or Equity

ACCOUNTING IN CASE OF DEFAULT

When a client defaults in making payment in respect of a daily settlement, the contract is closed out. The amount not paid by the client is adjusted against the initial margin. In the books of the client, the amount so adjusted should be debited to Mark to Market Equity Index Futures account with a corresponding credit to ‘Initial Margin – Equity index futures account’. The amount of initial margin on the contract, in excess of the amount adjusted against the mark to market margin not paid, will be released. The accounting treatment in this regard will be the same as explained above. In case, the amount to be paid on the daily settlement exceeds the initial margin the excess is a liability and should be shown as such under the head “current liabilities and provisions”, if it continues to exist on the balance sheet date. The amount of profit or loss on the contract so closed out should be calculated and recognized in the profit and loss account in the manner dealt above.

DISCLOSURE REQUIREMENTS

The amount of bank guarantee and book value as also the market value of securities lodged should be disclosed in respect of contracts having open positions at the year end, where initial margin money has been paid by way of bank guarantee and/or lodging of securities.

Total number of contracts entered and gross number of units of equity index futures traded (separately for buy or sell) should be disclosed in respect of each series of equity index futures.

The number of equity index futures contracts having open position, number of units of equity index futures pertaining to those contracts and the daily settlement price as of the balance sheet date should be disclosed separately for long and short positions, in respect of each series of equity index futures.

ACCOUNTING FOR EQUITY INDEX OPTIONS AND EQUITY STOCK OPTIONS

The institute of chartered accountants of India issued guidance note on accounting for index options and stock options from the view point of the parties who enter into such contracts as buyers/holders or sellers/writers. Following are the guidelines for accounting treatment in case of cash settled index options and stock options.

ACCOUNTINGAT THE INCEPTION OF A CONTRACT

The seller/writer of the options is required to pay initial margin for entering into the option contract. Such initial margin paid would be debited to “Equity Index Option MaiginAccount” orto ” Equity Stock Option Margin Account” as the case may be. In the balance sheet, such account should be shown separately under the head “current assets”. The buyer/holder of the option is not required to pay any margin. He is required to pay the premium. In his books, such premium would be debited to “Equity Index Option Premium Account” or Equity Stock Option Premium Account” as the case may be. In the books of the seller/writer, ■ such premium received should be credited to “Equity Index Option Premium Account” or Equity Stock Option Premium Account” as the case may be.

 

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Account” as the case may be.

 

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Equity Index

ACCOUNTING AT THE INCEPTION 0f THE CONTRACT

Every client is required to pay to the trading member/ clearing member, the initial margin determined by the clearing corporation as per the bye-laws/regulations of the exchange for entering into an equity index futures contracts. Such initial margin paid/payable should be debited to “Initial Margin – Equity Index futures account”. Additional margins, if any, should also be accounted for in the same manner. It may be mentioned that at the time when the contract is entered into for purchase/sale of equity index futures, no entry is passed . for recording the contract because no payment is made at that time except for the initial margin. At the balance sheet date, the balance in the “Initial Margin – Equity Index futures account” should be shown separately under the head ‘ current assets ‘. In those cases where any amount has been paid in excess of the initial/additional margin, the excess should be disclosed separately as a deposit under the head ‘current assets’. In cases where instead of paying initial margin in cash, the client provides bank guarantees or lodges securities with the member, a disclosure should be made in the notes to the financial statements of the client.

ACCOUNTING AT THE TIME OF DAILY SETTLEMENT

This involves the accounting of payment/receipt of mark- to-market margin money. Payments made or received on account of daily settlement by the client would be credited/debitedtothe bank account and the corresponding

debit or credit for the same shouldbe made to an account titled as “Mark-to-Market margin-Equity Index futures account”

Some times the client may deposit a lump sum amount with the broker/trading member in respect of mark to market margin money instead of receiving/paying mark to market margin money on daily basis. The amount so paid is in the nature of a deposit and should be debited to an appropriate account, say, “Deposit for mark to market margin account”. The amount of mark to market margin received/paid from such account should be credited/debited to “Mark-to-Market Margin – Equity Index futures account” with a corresponding debit/credit to “deposit for mark-to-market margin account”. At the year end, any balance in the “Deposit for mark to market margin account” should be shown as a deposit under the head “Current Assets”.

ACCOUNTING FOR OPEN POSITIONS

Position left open on the balance sheet must be accounted for. Debit/credit balance in the “mark-to-market margin – Equity Index futures account”, maintained on global basis, represents the net amount paid/received on the basis of movement in the prices of index futures till the balance sheet date. Keeping in view of ‘prudence’as a consideration for preparation of financial statements, provision for anticipated loss, which may be equivalent to the net payment made to the broker (represented by the debit balance in the mark to market equity index futures account) should be created by debiting the profit and loss account. Net amount received being anticipated profit should be ignored and no credit for the same should be taken in the profit and loss account. The debit balance in the said ‘mark to market margin equity index futures account’ i.e., net payment made to the broker, may be shown under the head ‘current account, loans and advances’ in the balance sheet and the provision created there against should be shown as a deduction there from. On the other hand, the credit balance in the said account, i.e., the net amount received from the broker, should be shown as a current liability under the head ‘current liabilities and provisions in the balance sheet.’

ACCOUNTING AT THE TIME OF FINAL SETTLEMENT

This involves accounting at the time of final settlement or squaring up of the contract. At the expiry of a series of equity index futures, the profit/loss, on final settlement of the contracts in the series, should be calculated as the difference between final settlement price and contract prices of all the contracts in the series. The profit or loss so computed, should be recognized in the profit and loss account by corresponding debit/credit to ‘mark to margin – equity index futures account’. However, where a balance exists in the provision account created for anticipated loss, any loss arising on such settlement should be first charged to such provision account to the extent of the balance available in the provision account, and the balance of loss, if any should be charged to the profit and loss account. Same accounting treatment should be made when a contract is squared up by entering into a reverse contract. If more than one contract in respect of the series of equity index futures contracts to which the squared up contract pertains is outstanding at the time of the squaring of the contract, the contract price of the contract so squared up should be determined using the weighted average method for calculating profit or loss on squaring up. On the settlement of an equity index futures contract, the initial margin paid in respect of the contract is released which should be credited to ‘Initial Margin – Equity Index futures account’ and a corresponding debit should be given to the bank account or the deposit account (where the amount is not received).

 

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Future Trading

REPORTING OF CLIENT MARGIN

Clearing Members and Trading Members are required to collect upfront initial margins from all their Trading Members L constituents.

Clearing members are required to compulsorily report, on a daily basis, details in respect of such margin amount due and collected, from the Trading Members/Constituients clearing and settling through them, with respect to the trades executed and open positions of the Trading Members, which of the clearing members have paid to NSCCL, for the purpose of meeting margin requirements.

Similarly, Trading Members are required to report on a daily basis details in respect of such Margin amount due and collected from the constituents clearing and settling through them, with respect to the trades executed/open positions of the constituents, which the trading members have paid to the Clearing Members and on which the Clearing Members have allowed initial margin limit to the Trading Members.

ACCOUNTING FOR FUTURES

The Institute of Chartered Accountants of India has issued guidance notes on accounting of equity index and equity stock futures and options contracts from the view point of parties who enter into such futures contracts as buyers or sellers. For other parties involved in the trading process, like brokers, trading members, clearing members and clearing corporations, a trade in equity index futures is similar to a trade in say shares and does not pose any peculiar accounting problems. Hence in this section we shall largely focus on accounting treatment of equity index futures in the books of the client. But before we do so, a quick re-look at some of the terms used:

  1. CLEARING CORPORATION/HOUSE:

Clearing corporation or house means the clearing corporation or house approved by SEBI for clearing and settlement of trades on the derivatives exchange/ segment. All the clearing and settlementfor trades that happen on the NSE’s market is done through NSCCL.

  1. CLEARING MEMBER:

Clearing member means a member of the clearing corporation and includes all categories of clearing members as may be admitted as such by the clearing corporation to the derivatives segment.

  1. CLIENT:

A Client means a person, on whose instructions and, on whose account, the trading member enters into any contract for the purchase or sale of any contract or does any act in relation thereto.

  1. CONTRACT MONTH:

Contract Month means the month in which the exchange or clearing corporation rules require a contract to be finally settled.

  1. DAILY SETTLEMENT PRICE:

Daily settlement price is the closing price of the equity index futures contract for the day or such other price as may be decided by the clearing house from time to time.

  1. DERIVATIVE EXCHANGE/SEGMENT:

Derivative exchange means a an exchange approved by SEBI as a derivative exchange. Derivative segment means segment of an existing exchange approved by SEBI as derivatives segment.

  1. FINAL SETTLEMENT PRICE:

The final settlement price is the closing price of the equity index futures contract on the last trading day of the contract or such other price as may be specified by the clearing corporation, from time to time.

  1. LONG POSITION:

Long position in an equity index futures contract means outstanding purchase obligations in respect of the equity index futures contract at any point of time.

  1. OPEN POSITION:

Open Position means the total number of equity index futures contracts that have not yet been offset and closed by opposite position.

  1. SETTLEMENT DATE:

Settlement date means the date on which the settlement of outstanding obligations in an equity index futures contract are required to be settled as provided in the Bye­Laws of the Derivatives exchange/segment.

  1. SHORT POSITION:

Short position in an equity index futures contract means outstanding sell obligations in respect of an equity index futures contract at any point of time.

  1. TRADING MEMBER:

Trading Member means a Member of the Derivatives exchange/segment and registered with SEBI.

 

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Market Wide Position

CLIENT LEVEL POSITION LIMITS

The gross open position for each client, across all the derivative contracts on an underlying, should not exceed 1 % of the free float market capitalization (in terms of number of shares) or 5% of the open interest in all derivative contracts in the same underlying stock (in terms of number of shares) whichever is higher.

MARKET WIDE POSITION LIMITS

The market wide limit of open position (in terms of the number of underlying plus stock) on futures and option contracts on a particular underlying stock should be lower of 30 times the average number of shares traded daily during the previous calendar month, in the relevant underlying security in the underlying segment or 20% of the number of shares held by non promoters in the relevant underlying security i.e., free-float holding. This limit is applicable on all open positions in all futures and option contracts on a particular underlying stock. The enforcement of the market wide position limits is done in the following manner:

a.     At the end of the day the exchange tests whether the market wide open interest for any scrip exceeds 95% of the market wide position limit for that scrip. In case it does so, the exchange takes note of open position of all cl ient/TMs as at the end of that day for that scrip and from next day onwards they can trade only to decrease their positions through offsetting positions.

b.     At the end of each day during which the ban on fresh positions is in force for any scrip, the exchange tests whether any member or client has increased his existing positions or has created a new position in that scrip. If so, that client is subject to a penalty equal to a specified percentage (or basis points) of the increase in the position (in terms of notional value). The penalty is recovered before trading begins next day. The exchange specifies the percentage or basis points, which is set high enough to deter violations of the ban on increasing positions.

c. The normal trading in the scrip is resumed after the open outstanding positions comes down to 80% or below of the market wide position limit. Further, the exchange also checks on a monthly basis, whether a stock has remained subject to the ban on new position for a significant part of the month consistently for three months. If so, then the exchange phases out derivative contracts on that underlying.

Fll AND SUB-ACCOUNT POSITION LIMITS

FII and sub-account position limits are specified as given below:

i.    The FII position limit in all index options contracts on a particular underlying index is Rs.250 crore or 15% of the total open interest of the market in index options, whichever is higher, per exchange. The limit is applicable on open positions in all option contracts on a particular underlying index.

ii.    FII position limit in all index futures contracts on a particular underlying index is the same as mentioned above for FII position limits in index option contracts. This limit is applicable on open positions in all futures contracts on a particular underlying index.

 

In addition to the above, Fils can take exposure in equity index derivatives subject to the following limits:

i.      Short positions in index derivatives (short futures, short calls, long puts) not exceeding (in notional value) the Fils holding of stocks.

ii.    Long positions in index derivatives (long futures, Long calls and short puts) not exceeding (in notional value) the Fils holding of cash, government securities, and T-Bills and similar instruments.

The FIis should report to the clearing member (custodian) the extent of the Fils holding of stocks, cash, government securities, T-Bills and similar instruments before the end of the day. The clearing Member (custodian) in turn should report the same to the exchange. The exchange monitors the FII position limits. The position limit for sub-account is same as that of client level position limits.

 

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Trading Member Position

FORMS OF COLLATERALS ACCEPTARLE AT NSCCL

Members and dealers, authorised dealer have to fulfill certain requirements and provide colleteral deposits to become members of the Future and Options segment. All colleteral deposits are segregated into cash component and non-cash component. Cash component means cash, bank guarantee, fixed deposit receipts. T-Bills and dated government securities. Non cash component means all other forms of colleteral deposits like deposit of approved demat securities.

REQUIREMENTS TO RECOME AUTHORISED/APPROVED USER

Trading members and participants are entitled to appoint, with the approval of the Futures and Options segment of the exchange authorised persons and approved users to operate the trading workstation(s). These authorised users can be individuals, registered partnership firms or corporate bodies.

Authorised persons cannot collect any commission or any amount directly from the clients he introduces to the trading member who appointed him. However he can receive a commission or any such amount from the trading member who appointed him as provided under regulation.

Approved users on the Futures and Options segment have to pass a certification program which has been approved b y SEBI. Each approved user is given a unique identification number through which he will have access to the NEAT system. The approved user can access the NEAT system through a pass word and can change such password from time to time.

POSITION LIMITS

Position limits have been specified by SEBI at trading member, client, market and FI I levels respectively.

TRADING MEMBER POSITION LIMITS

The trading member position limits are specified as given below:

a. Trading member position limits in equity index option contracts: The Trading Member position limits in equity index option contracts is higher of Rs.250 Crore or 15 % of the total open interest in the market in equity index option contracts. The limit is applicable on open positions in all option contracts on a particular underlying index.

b. Trading Member position limits in equity index futures contracts: The trading member position limits in equity index futures contracts is higher of Rs.250 Crore or 15 % of the total open interest in the market in equity index futures contracts. This limit is applicable on open positions in all futures contracts on a particular underlying index.

 

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