TYBMS SEM 5 : Finance: Commodity & Derivatives Market (Q.P. November 2023 with Solution)

 Paper/Subject Code: 46006/Finance: Commodity & Derivatives Market

TYBMS SEM 5 : 

Finance:

Commodity & Derivatives Market 

(Q.P. November 2023 with Solution)

Note: 1) All Questions are compulsory subject to internal choice.

2) All question carry 15 marks.

3) Use simple calculator

Q1. A. Fill in the blank. Answer any 8 out of 10                (8 Marks)

1............... risk is a loss may occur from the failure of another party to perform according to the terms of a contract?

a) Credit

b) Currency 

c) Market 

d) Liquidity

2. Financial derivatives includes?

a) Stock 

b) Bonds 

c) Future

d) None of these

3. By hedging a portfolio; a bank manager

a) Reduces interest rate risk 

b) Increases re investment risk 

c) Increases exchange rate risk 

d) None of these

4. A long contract requires that the investor

a) out his position in the future Sell securities in the future 

b) Buy securities in the future 

c) Hedge in the future 

d) Close

5. Hedging by buying an option

a) Limits gain 

b) Limits losses 

c) Limits gain & losses 

d) Has no limit on losses

6.An option allowing the owner to sell an asset at a future date is a ________

a) Put option

b) Call option

c) Forward option

d) Future contract

7. Composite value of traded stocks group of secondary market is classified as

a) Stock index 

b) Primary index 

c) Stock market index

d) Limited liability index

8. ________ is the minimum amount which must be remained in a margin account?

a) Maintenance margin 

b) Variation margin

c) Initial margin

d) None of these

9. The amount paid for an option is the

a) Strike price

b) Discount 

c) Premium

d) Yield

10. Futures contracts are more successful than interest rate forward contracts because they: 

a) are less liquid 

b) have greater default risk

c) are more liquid

d) have an interest rate tied to the discount rate

Q1. B. True or false. (Any 7)            (7 Marks)

1. Derivative is a contract written on given underlying

Ans: True

2. Equity options are options on individual stocks.

Ans: True

3. Commodity future market in India is regulated by Forward Market Commission.

Ans: False

4. The difference between future and spot price is initial margin.

Ans: False

5. Insurance companies manage risk by risk pooling.

Ans: True

6. Binomial model breaks down the time to expiration into number of time intervals.

Ans: True

7. Option seller has no obligation but only right. 

Ans: False

8. If a speculator is bearish, she will buy security.

Ans: True

9. Lot size is contract size.

Ans: True

10. Expiry date is the first date on which contract is traded.

Ans: False

Q2. Attempt a, b or c, d.

a. What is imperfect hedge? What are the reasons for imperfect hedge?

An imperfect hedge occurs when a hedging strategy does not completely eliminate the risk of price fluctuations in the underlying asset. In such cases, there remains some residual risk, known as basis risk.

Example:

• A farmer hedges wheat prices using wheat futures, but due to differences in contract size or expiration dates, the hedge does not fully protect against price changes.

Reasons for Imperfect Hedge

1️⃣ Basis Risk

• The difference between the spot price and the hedging instrument's price (e.g., futures price) leads to incomplete risk coverage.

• Example: If a company hedges crude oil prices using futures, but oil prices fluctuate differently in the spot and futures markets, the hedge remains imperfect.

2️⃣ Mismatched Contract Sizes

• The lot size of a derivative contract may not match the exact exposure of the underlying asset.

• Example: A company needs to hedge 12,000 barrels of crude oil, but futures contracts are available in lots of 10,000 barrels, leaving 2,000 barrels unhedged.

3️⃣ Different Expiry Dates (Maturity Mismatch)

• The hedging contract's expiration date may not align with the actual risk exposure period.

• Example: A company hedges using a three-month futures contract, but its exposure lasts for four months, leading to a gap in protection.

4️⃣ Liquidity Constraints

• Some derivatives markets may have low trading volumes, making it difficult to execute a perfect hedge.

• Example: If an investor wants to hedge a mid-cap stock, but no liquid futures contracts exist for it, the hedge may not be effective.

5️⃣ Correlation Risk

• A hedge may be placed using a related asset (proxy hedge), but if the correlation weakens, the hedge becomes imperfect.

• Example: A gold jewelry manufacturer hedges gold price risk using silver futures due to a strong historical correlation, but if gold and silver prices diverge, the hedge fails.

6️⃣ Regulatory & Market Restrictions

• Trading restrictions, margin requirements, or market disruptions (such as price limits on futures contracts) can prevent a hedge from being fully executed.

• Example: A government-imposed ban on wheat futures trading can make it impossible for a farmer to hedge wheat price fluctuations.

b. Differentiate between forwards and future.

	Forward Contract	Future Contract
Definition	A private agreement between two parties to buy or sell an asset at a future date for a predetermined price.	A standardized contract traded on an exchange to buy or sell an asset at a future date for a predetermined price.
Trading Venue	Over-the-Counter (OTC)	Exchange-traded
Standardization	Customized contract terms (quantity, price, expiration date, etc.)	Highly standardized with fixed contract sizes, expiration dates, and specifications.
Counterparty Risk	High, as the contract is private and not regulated by an exchange.	Low, as clearing houses act as intermediaries and guarantee the trade.
Liquidity	Low, as contracts are tailor-made and not easily tradable.	High, as contracts are standardized and actively traded on exchanges.
Margin Requirement	No margin requirement; settlement occurs at maturity.	Requires margin deposits and daily mark-to-market settlements.
Settlement	Settled at the contract’s expiration (physical or cash settlement).	Marked-to-market daily, meaning profits/losses are settled daily.
Flexibility	More flexible in terms of contract terms and conditions.	Less flexible due to standardization.
Example	A farmer agrees with a mill to sell 1000 bushels of wheat at $5 per bushel in 3 months.	A trader buys an oil futures contract on the Chicago Mercantile Exchange (CME) with set expiry and contract size.

OR

c. Calculate arbitrage free pricing of a 2-month contract of SBI if it is currently traded at 210.15/- and funds can be borrowed at 8%. Is the future price contango or backwardation? 

d. What will be the price of a 2-month forward contract of Fox Itd, if spot price is Rs 465/- per share and rate of interest is 11%, assuming no dividend is paid?

Q3. Attempt a, b or c, d.

a. Ms R is bullish on Timber Ltd. She purchased call option with strike price 820/- paying premium of Rs 30/-. Calculate her profit /loss in following situations and also draw pay off diagram if price on expiry is - 750, 700, 900, 820,850                     7.5.

b. Explain the following terms with the help of an example.

1) Premium

Definition:
A premium is the price paid for a product, service, or financial instrument, often in the context of insurance, bonds, or options trading. It represents an additional cost for a particular benefit or coverage.

Example in Insurance:

Imagine you buy car insurance. The insurance company agrees to cover any damage to your car, but in return, you must pay a premium of Rs.500 per year. This is the cost of keeping the insurance policy active.

Example in Options Trading:

Suppose you buy a call option on a stock, giving you the right to purchase the stock at Rs. 100 within a month. If the market price of the stock is currently Rs. 95, you might pay a premium of Rs. 3 per share for this option. This is the price you pay for the right to buy the stock in the future.

2) M2M

Definition:
Mark-to-Market (M2M) is the process of adjusting the value of an asset, liability, or financial position to reflect its current market price instead of its original cost. This ensures that financial statements reflect the real-time value of holdings.

Example in Futures Trading:

Imagine you buy a futures contract for gold at Rs. 2,000 per ounce. If, by the end of the trading day, the market price of gold rises to Rs. 2,050 per ounce, the exchange will credit your account with the profit of Rs. 50 per ounce.

However, if the price drops to Rs. 1,980 per ounce, your account will be debited by Rs. 20 per ounce. This daily adjustment based on market price movements is called M2M settlement.

Example in Banking & Investments:

A bank holds bonds that it bought for Rs. 1 million. If market interest rates rise, the value of those bonds might drop to Rs. 900,000 in the market. The bank must report the bonds at Rs. 900,000 on its balance sheet under M2M accounting, reflecting their real-time market value.

3) Strike price

Definition:
The strike price is the predetermined price at which an options contract can be exercised. It is the fixed price at which the buyer of a call option can buy the underlying asset or the buyer of a put option can sell the underlying asset.

Example in Options Trading:

Suppose you buy a call option for Apple stock with a strike price of Rs. 150 and an expiration date of one month.

• If Apple's stock price rises to Rs.170, you can exercise the option and buy the stock at Rs. 150, making a Rs 20 per share profit (excluding premiums and fees).

• If Apple's stock price stays below Rs. 150, the option expires worthless, and you lose only the premium paid.

Similarly, for a put option with a strike price of Rs.150:

• If Apple's stock falls to Rs. 130, you can sell the stock at Rs. 150, making a Rs.20 per share profit.

• If the stock stays above Rs. 150, the put option expires worthless.

OR 

c. What are the factors affecting option premium?

The premium of an option (price paid by the buyer to the seller) is influenced by several factors, mainly derived from the Black-Scholes model and market dynamics. These factors include:

1. Stock Price (Underlying Asset Price)

• Call Option: Premium increases when the stock price rises.

• Put Option: Premium increases when the stock price falls.
  Example: If Apple’s stock rises from Rs.150 to Rs.160, the call option premium will increase.

2. Strike Price

• Call Option: Lower strike prices have higher premiums.

• Put Option: Higher strike prices have higher premiums.
  Example: A call option with a strike price of Rs. 140 will have a higher premium than one with a strike price of Rs. 160, assuming Apple is trading at Rs. 150.

3. Time to Expiration (Time Value)

• More time to expiration = higher premium (more chance for price movement).

• As expiration nears, the time value decays (Theta decay).
  Example: A call option expiring in 3 months will have a higher premium than the same strike price option expiring in 1 week.

4. Volatility (Implied Volatility - IV)

• Higher volatility = higher premium (more uncertainty, bigger potential gains).
  Example: If Tesla’s stock is highly volatile, option premiums will be expensive, even if the stock price stays the same.

5. Interest Rates (Risk-Free Rate)

• Call Option: Higher interest rates increase call option premiums.

• Put Option: Higher interest rates decrease put option premiums.
  Example: If interest rates rise, call options become slightly more expensive, while put options become slightly cheaper.

6. Dividends

• High expected dividends = Lower call premiums & Higher put premiums.
  Example: If a company announces a large dividend, its call options may become cheaper, as stock prices often drop on ex-dividend dates.

7. Market Demand & Liquidity

• Higher demand = higher premium (more buyers).

• Low liquidity = wider bid-ask spread, making options expensive to trade.
  Example: Popular stocks like Apple and Tesla have liquid options with tight spreads, while lesser-known stocks may have wider spreads.

d. Why should one invest in Commodity Market? Explain the reasons.

Investing in the commodity market can be a strategic move for portfolio diversification, inflation protection, and high return potential. Below are the key reasons why investors consider commodities:

1. Portfolio Diversification 🏦

• Commodities often have a low correlation with stocks and bonds.

• When equities decline, commodities like gold and oil may rise, balancing the portfolio.
  Example: During a stock market crash, gold prices typically increase as investors seek safe-haven assets.

2. Inflation Hedge 📈

• Commodities increase in value when inflation rises, as raw material costs go up.

• Gold, silver, and oil serve as inflation hedges.
  Example: If inflation rises, the price of crude oil also rises, benefiting oil investors.

3. High Return Potential 🚀

• Commodities experience strong price movements due to supply-demand dynamics.

• Investors can benefit from bullish trends in energy, metals, and agricultural products.
  Example: In 2022, oil prices surged due to geopolitical tensions, offering huge gains for investors.

4. Hedge Against Currency Fluctuations 💱

• Commodities are priced in US dollars, so investing in them can hedge against local currency depreciation.
  Example: If the Indian Rupee weakens against the USD, gold and crude oil prices in INR rise, benefiting commodity investors.

5. Safe-Haven Investment 🛡️

• Precious metals like gold and silver act as safe-haven assets during economic uncertainty.

• Investors shift to gold during financial crises, making it a stable investment.
  Example: During the 2008 financial crisis, gold prices surged as stock markets collapsed.

6. Demand Growth & Global Trends 🌍

• Rising demand for industrial metals (copper, aluminum, lithium) due to EVs and renewable energy.

• Increased demand for agricultural commodities due to population growth.
  Example: The shift to electric vehicles has increased demand for lithium and nickel, making them attractive investments.

7. Leverage & Hedging Opportunities ⚖️

• Commodity futures allow investors to trade with margin, amplifying returns.

• Hedging strategies protect against price fluctuations.
  Example: A farmer can hedge by selling wheat futures to lock in a fixed price before harvest.

8. Accessibility & Liquidity 💰

• Commodities can be traded through futures, ETFs, and mutual funds.

• Highly liquid markets provide easy entry and exit.
  Example: Investors can trade gold ETFs instead of buying physical gold.

Q4. Attempt a, b or c, d.

a. What are the different types of settlement?          

Settlement refers to the process of completing a trade by transferring assets (stocks, commodities, derivatives, or currency) and payments between buyers and sellers. There are three main types of settlement:

1. Cash Settlement 💰

• In cash settlement, the trade is settled in cash rather than by delivering the actual asset.

• Common in derivatives (futures & options) and index trading, where delivering physical assets is impractical.

Example: You hold an index futures contract on the Nifty 50. On the expiration date, instead of receiving stocks, you receive the difference between the buy price and the final settlement price in cash.

2. Physical Settlement 📦

• In physical settlement, the actual asset (stocks, commodities, or bonds) is delivered upon contract expiration.

• Used in commodities (like gold, silver, wheat) and stock derivatives.

Example: If you hold a crude oil futures contract until expiry, you must take physical delivery of crude oil at the specified price.

3. Net Settlement 

• Used in banking and payment systems, where multiple transactions are netted to reduce settlement risk and capital requirements.

• Includes Net Asset Settlement (NAS) in forex and interbank settlements.

Example: Suppose two banks have multiple transactions with each other:

• Bank A owes Rs. 10M to Bank B

• Bank B owes Rs. 8M to Bank A

• Instead of transferring Rs. 18M, only the net difference of Rs. 2M is settled.

Other Variations of Settlement

🔹 T+1, T+2, T+3 Settlement – Trades are settled 1, 2, or 3 business days after execution.
🔹 Rolling Settlement – Settlement happens on a continuous basis, usually T+1 or T+2.

🔹 Instant/Real-Time Settlement – Used in blockchain & crypto (e.g., Bitcoin transactions are settled immediately).  

b. What are the functions of NSCCL?

The National Securities Clearing Corporation Limited (NSCCL) is a subsidiary of the National Stock Exchange (NSE) of India and plays a critical role in the clearing and settlement of trades. It ensures smooth functioning, risk management, and financial stability in the stock market.

1. Clearing & Settlement of Trades 

• Acts as a clearing house for all trades executed on NSE.

• Ensures T+1 settlement for equity trades.

• Handles futures & options (F&O), currency, and debt market settlements.

Example: If you buy 100 shares of Reliance, NSCCL ensures shares are credited to your Demat account and the seller receives funds.

2. Risk Management & Trade Guarantee 

• NSCCL guarantees trade settlement, even if a counterparty defaults.

• Uses margins, collateral, and risk monitoring to prevent defaults.

Example: If a trader buys shares on margin but fails to pay, NSCCL covers the risk using margin money or penalties.

3. Netting & Multilateral Settlement 

• Reduces the number of transactions by netting buy and sell positions.

• Ensures only the net difference is settled, reducing liquidity pressure.

Example: If a trader buys 500 shares and sells 300 shares, only net 200 shares need to be settled.

4. Collateral & Margin Management 

• Collects Initial Margin, Exposure Margin, and Mark-to-Market (M2M) Margin.

• Manages collateral deposits from traders and brokers.

Example: A trader in Nifty Futures must maintain a margin deposit, which NSCCL monitors daily.

5. Surveillance & Compliance 

• Monitors market volatility and ensures brokers follow SEBI regulations.

• Implements circuit breakers to prevent extreme price movements.

Example: If the Sensex drops by 10%, NSCCL may halt trading temporarily to avoid panic selling.

6. Settlement of Corporate Actions 

• Manages dividends, bonuses, stock splits, and rights issues for investors.

• Ensures corporate benefits reach shareholders accurately.

Example: If Infosys declares a 1:1 bonus, NSCCL ensures new shares are credited to investors.

7. Default Handling & Investor Protection 

• If a broker defaults, NSCCL ensures investors don’t suffer losses.

• Maintains an Investor Protection Fund (IPF).

Example: If a brokerage firm collapses, NSCCL steps in to protect clients' funds and stocks.

c. What is VAR? Explain one method to measure VAR.

Definition:
Value at Risk (VaR) is a statistical measure used to estimate the maximum potential loss of an investment or portfolio over a given time period at a certain confidence level. It helps investors and financial institutions assess risk exposure.

🔹 VaR is expressed as:
"There is a 95% probability that the portfolio will not lose more than $1 million in one day."

Components of VaR:

1️⃣ Time Horizon: (e.g., 1-day, 1-week, or 1-month VaR)
2️⃣ Confidence Level: (e.g., 95% or 99% probability)
3️⃣ Potential Loss: (Maximum expected loss)

Methods to Measure VaR

There are three main methods to calculate VaR:

1️⃣ Historical Method (Past Data Analysis)
2️⃣ Variance-Covariance Method (Statistical Approach)
3️⃣ Monte Carlo Simulation (Randomized Scenarios)

Example: Variance-Covariance Method (Parametric VaR) 📊

This method assumes returns follow a normal distribution and calculates VaR using mean and standard deviation of returns.

🔹 Formula:

$$VaR=\text{Mean Return }-(Z\times \text{Standard Deviation})$$

where Z is the Z-score based on confidence level:

• 95% confidence → Z = 1.65

• 99% confidence → Z = 2.33

Example Calculation:

• Portfolio Value = Rs.10 million

• Mean daily return = 0.2%

• Standard deviation (σ) = 1.5%

• Confidence Level = 95% (Z = 1.65)

• VaR=(0.002−(1.65×0.015))×10,000,000

• VaR = (-2.275%) x 10,000,000 = -Rs.227,500

Interpretation:
At a 95% confidence level, the portfolio is expected to lose no more than Rs. 227,500 in one day under normal market conditions.

d. Explain the participants in commodity market.

The commodity market consists of different participants who trade commodities like gold, crude oil, wheat, and metals for various reasons such as hedging, speculation, and investment. The key participants are:

1. Hedgers (Risk Managers)

Hedgers are businesses or individuals who use the commodity market to protect themselves from price fluctuations by taking an opposite position in the futures market.

Example:

• A wheat farmer fears prices will fall at harvest time, so he sells wheat futures to lock in a price.

• An airline company buys crude oil futures to avoid rising fuel costs.

2. Speculators (Risk Takers)

Speculators trade commodities for profit rather than physical delivery. They take positions based on price movements and market trends.

Example:

• A trader expects gold prices to rise, so he buys gold futures today and sells at a higher price later.

• A hedge fund predicts crude oil prices will fall, so they short-sell oil futures.

3. Arbitrageurs (Price Difference Exploiters)

Arbitrageurs take advantage of price differences between different markets or exchanges by buying in one and selling in another.

Example:

• If gold is priced at $1,800 on MCX (India) and $1,805 on COMEX (USA), an arbitrageur buys on MCX and sells on COMEX for a risk-free profit.

4. Investors (Long-Term Holders)

Investors buy commodities as an asset class for diversification and hedging against inflation. They invest through commodity ETFs, mutual funds, or physical assets.

Example:

• A portfolio manager invests in gold ETFs to hedge against inflation.

• A retail investor buys silver bars as a store of value.

5. Commodity Exchanges 🏛️ (Market Platforms)

Exchanges facilitate commodity trading, ensuring liquidity, transparency, and price discovery.

🔹 Major commodity exchanges:

• MCX (Multi Commodity Exchange, India)

• NCDEX (National Commodity & Derivatives Exchange, India)

• CME Group (Chicago Mercantile Exchange, USA)

• LME (London Metal Exchange, UK)

6. Brokers & Market Makers 🤝 (Intermediaries)

Brokers and market makers connect buyers and sellers, ensuring smooth transactions. They earn commissions or spreads.

Example: Zerodha, Angel One, and ICICI Direct provide platforms for commodity trading in India.

Q5. a. Differentiate between hard and soft commodities traded in commodity market?

	Hard Commodities	Soft Commodities
Definition	Natural resources that are mined, extracted, or drilled	Agricultural products that are grown or cultivated
Examples	Gold, Silver, Crude Oil, Natural Gas, Copper, Aluminum	Wheat, Corn, Coffee, Cotton, Sugar, Cocoa, Livestock
Source	Found underground or extracted from nature	Comes from farming or livestock
Market Influences	Geopolitical events, economic conditions, supply chain disruptions	Climate conditions, pests, seasonal cycles, demand-supply
Storage & Transportation	Requires refineries, pipelines, or industrial storage	Perishable, requires warehouses, cold storage, or silos
Volatility Factors	Impacted by industrial demand, energy prices, and global economic trends	Affected by weather, crop yields, and consumer demand
Examples of Trading Exchanges	MCX (Multi Commodity Exchange), NYMEX (New York Mercantile Exchange), LME (London Metal Exchange)	CBOT (Chicago Board of Trade), ICE (Intercontinental Exchange), NCDEX (National Commodity & Derivatives Exchange)

b. Explain clearing mechanism in derivative market.

The clearing mechanism in the derivatives market ensures smooth trade settlement by managing counterparty risk and ensuring financial security. The clearing corporation, like NSCCL (National Securities Clearing Corporation Ltd.) in India, acts as an intermediary between buyers and sellers.

Steps in the Clearing Process

1. Trade Execution

• A buyer and a seller execute a derivative contract (futures or options) on an exchange (e.g., NSE, BSE).

• The details are sent to the clearing corporation for verification.

Example: A trader buys Nifty 50 Futures at ₹20,000, expecting the price to rise.

2. Trade Novation (Counterparty Risk Transfer)

• The clearing house steps in as the counterparty for both buyers and sellers.

• This removes the risk of default by either party.

Example: Instead of Buyer A dealing directly with Seller B, the clearing house becomes the new counterparty for both.

3. Margin Collection (Risk Management)

• The clearing house collects margins from traders to cover potential losses.

• Types of margins:
  ✅ Initial Margin – Upfront margin to open a position.
  ✅ Mark-to-Market (M2M) Margin – Adjusted daily based on market movement.
  ✅ Exposure Margin – Additional margin for volatile contracts.

Example: If a trader buys a Nifty Futures contract, an Initial Margin of ₹1.5 lakh might be required.

4. Mark-to-Market (M2M) Settlement 

• Open positions are revalued daily based on market prices.

• Profits are credited, and losses must be paid immediately.

Example: If Nifty moves from ₹20,000 to ₹20,500, the buyer makes ₹500 per lot, which is credited. The seller loses ₹500, which must be paid.

5. Final Settlement 

• On expiry, futures contracts are cash-settled or physically settled.

• Options contracts are settled based on intrinsic value (profit/loss).

Example: If a Bank Nifty Futures contract expires at ₹48,000, final settlement is based on this price.

6. Default Handling 

• If a trader fails to pay M2M losses, the clearing house liquidates their positions.

• A settlement guarantee fund ensures smooth operations.

Example: If a broker defaults on payments, NSCCL covers the loss and takes legal action.

Q5. Short notes. (Any 3)

1. M2M Margin.

Mark-to-Market (M2M) Margin is the daily settlement of profits and losses in futures and options (F&O) trading. It ensures that traders maintain enough funds in their accounts to cover potential losses.

🔹 Applicable to: Futures contracts (mandatory) & sometimes options.
🔹 Purpose: To reduce counterparty risk and maintain financial stability.

How M2M Works?

1️⃣ At the end of each trading day, the futures contract is revalued at the closing market price.
2️⃣ Profits are credited to gaining traders.
3️⃣ Losses are debited from losing traders, who must deposit additional margin if required.
4️⃣ This process repeats until expiry or position closure.

Example of M2M Settlement 

Suppose you buy 1 lot of Nifty Futures at ₹20,000. The lot size is 50.

Day Closing Price Daily Gain/Loss M2M Settlement Day 1 (Buy at ₹20,000) ₹20,200 +₹200 × 50 = ₹10,000 Profit credited Day 2 ₹20,100 -₹100 × 50 = ₹5,000 Loss debited Day 3 ₹20,300 +₹200 × 50 = ₹10,000 Profit credited

If your margin balance is low after a loss, you must add funds to continue holding your position.

2. Limit order.

A Limit Order is an order to buy or sell a security at a specific price or better. It ensures that the trade is executed only at the desired price or a more favorable price, preventing unfavorable market fluctuations.

🔹 Buy Limit Order – Placed below the current market price (to buy at a lower price).
🔹 Sell Limit Order – Placed above the current market price (to sell at a higher price).

Advantage: You control the price at which you buy or sell.
Disadvantage: The order may not execute if the price does not reach the limit level.

Example of a Limit Order

Suppose TCS is trading at ₹3,500. You want to buy at ₹3,450, so you place a Buy Limit Order at ₹3,450.

Case 1: Price Falls to ₹3,450 –  Order is executed.
Case 2: Price Stays Above ₹3,450 –  Order remains pending.

Similarly, if you own Reliance shares at ₹2,700 and want to sell at ₹2,750, you place a Sell Limit Order at ₹2,750. The order will execute only if the price reaches ₹2,750 or higher.

3. Call option 

A Call Option is a derivative contract that gives the buyer the right (but not the obligation) to buy an asset at a fixed price (strike price) before or on the expiry date. The seller (writer) of the call option is obligated to sell the asset if the buyer exercises the option.

Buyer’s View: Expects the price to rise (bullish).
Seller’s View: Expects the price to fall or stay the same (bearish/neutral).

Features of a Call Option

🔹 Strike Price (K): The price at which the buyer can purchase the asset.
🔹 Premium: The cost paid by the buyer to the seller for the option contract.
🔹 Expiry Date: The last date on which the option can be exercised.
🔹 Lot Size: The minimum quantity of the asset in one contract.

Call Option Example 

Suppose Reliance Ltd. is trading at ₹2,500. You buy a call option with a strike price of ₹2,600 for a premium of ₹50 per share.

Scenario 1: Profit (Stock Price Rises Above ₹2,600 )

If Reliance rises to ₹2,700 before expiry:

• You exercise the call option and buy at ₹2,600.

• Your total cost = ₹2,600 + ₹50 (premium) = ₹2,650.

• Your profit = ₹2,700 - ₹2,650 = ₹50 per share.

Scenario 2: Loss (Stock Price Stays Below ₹2,600 )

If Reliance stays at ₹2,500 or below:

• The option expires worthless because buying at ₹2,600 is not profitable.

• Your loss = ₹50 premium paid.

4. Backwardation.

Backwardation is a market condition where the futures price of a commodity or asset is lower than its current spot price. It typically occurs when investors expect the price of the underlying asset to decrease over time. In such scenarios, buyers are willing to pay a premium for the immediate delivery of the commodity rather than waiting for a future date, often due to supply shortages or high immediate demand.

Backwardation contrasts with contango, where futures prices are higher than the spot price, reflecting expectations of rising prices over time. Backwardation can benefit traders who hold short positions in futures contracts, as the futures price converges upward toward the spot price as the contract nears expiration.

5. Contango.

Contango is a market condition where futures prices are higher than the current spot price of an asset. This happens when traders expect prices to rise in the future due to factors like storage costs, interest rates, and inflation.

Characteristic:  Futures Price > Spot Price

Why Does Contango Occur?

Contango happens when:
Storage Costs Exist – Storing commodities (oil, gold, wheat) adds costs, making future prices higher.
Higher Demand for Future Delivery – Traders prefer buying later due to economic expectations.
Inflation Expectations – Prices are expected to increase over time.
Interest Rate Impact – Higher rates increase the cost of holding the asset today.

Common in Commodities Markets – Seen in oil, gold, and agricultural products.

Example of Contango

Let’s assume:

• Spot Price of Crude Oil = ₹6,000 per barrel

• 3-Month Futures Price = ₹6,300 per barrel

• 6-Month Futures Price = ₹6,600 per barrel

Since the futures prices are higher than the spot price, this is a contango market.

🔹 A trader may buy oil today at ₹6,000, expecting to sell it later at a higher futures price.

Impact of Contango on Traders & Investors

Profitable for Arbitrageurs – Traders use cash & carry arbitrage to profit from price differences.
Good for Long-Term Investors – Investors expect prices to rise in the future.
Bad for Short-Term Traders – Futures contracts may depreciate as they approach expiry.
Higher Costs for Hedgers – Hedging in a contango market can be expensive.