The Hindu Business Line : Futures: The discount effect

What do you do with the balance of Rs 1,800, assuming that that you do not have to provide market-to-market margins? You may invest in a fixed deposit, earning Rs 7 per month as interest.

If everybody is as smart, there will be no demand for shares in the spot market. To remove this easy income opportunity, the futures contract has to price in the interest income. Financial economists call this the no-arbitrage condition.

So, you may have to pay Rs 2,007 to buy Infosys futures. That is why futures contract has to typically trade at a premium to the spot price. Except where the stock carries corporate actions such as dividends, rights or bonus offers.

Suppose Infosys declares a dividend of Rs 10 per share. If you hold Infosys futures, you will not be eligible for the dividend. The futures price should, hence, be lower than the spot price.

But corporate actions do not seem to be the reason for the large discount on the Nifty. Some experts, hence, claim that the discount could be because of short selling restrictions.

You can short-sell futures but not the underlying stock. So, the selling pressure is greater in the futures market than in the spot market. This argument is not always convincing, as the discount persists even if the market moves up. That is why traders are confused.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Enfield Bullet has its unique aura

Large-cap Indian pharma — Effective drugs, but dosages may need tweaking

Benchmarking boosts turnover — Churn for the cream

Stanchart plans equity fund

A volatile quarter (Jan-March 2005)
Stellar show by funds from SBI MF stable

Deutsche Alpha Equity: Invest in small lots

SBI Magnum Emerging Businesses Fund: Hold

Will my portfolio deliver?

ACC: Buy

Indian Oil: Pare exposures

Urea producers: Pare exposures