Stock Futures Basics

Advantages of Stock Futures

1. Leverage
2. Lower Transaction Costs
3. Hedging/Shorting

Market Participants

1. Cash volumes are mainly generated by Long Only funds, DII and Retail participants. The volume in retail is fairly stable over time, compared with futures volume.

2. In Stock Futures, major participants are retail speculators and hedge funds – looking for high leverage.

3. Index Futures are mainly used for hedging purposes by institutional players – long only funds.

OI Information
Stock Futures OI largely are a function of speculative activities in the market. In periods of heavy bullishness (2007-end), there was huge OI build-up in the stock futures (and not much in Index Futures). However, that corrected after the crash, and came back to normal levels. Index Futures OI do not fluctuate too much as hedging requirements do not wildly fluctuate.
 
Important Indicators

1. Basis: Sign of pressure from longs or shorts
2. Open Interest: Amount of interest in the underlying
3. Price Change: Direction of the momentum in the underlying

Have to see these indicators together to make sense of the activities of the market participants – for example, when basis is strong, and OI is rising, a price rise indicates long side speculative activities.
 
Index Arbitrage
Nifty futures usually trade at a discount to the fair value (as it is used as a hedging instrument by the long only guys), and as a result, arbitrageurs put up positions in Long Nifty Futures and Short Stock (or SSF).
A large chunk of this position is sticky, in line with the fact that a large chunk of short Nifty (hedge) is also sticky. However, not all arbitrage players have access to the full 50 stocks at all times, and hence they usually have to short a few SSF also in the stock basket. Hence, some of the stock futures also trade at a discount due to this factor (mostly those whose inventory is not readily available). Most of the under-owned stocks trade at discounts (only Nifty stocks).
 
Futures Rolls
At expiry, investors have the following options:

1. Unwind
2. Expire
3. Rollover
4. Convert to Spot (buy/sell spot in VWAP)

Considerations during the expiry

1. Basis: If the futures have been trading in premium over the month, then there would pressure from the long side – rolls also might happen at a premium (the premium in near month would move to next month close to expiry)
2. Market Trend: A rising market would imply futures in premium – and hence rolls also might happen at a premium
3. OI with Price Action: A rising OI with price increase would also mean more and more pressure on the long side, and higher roll premiums.
4. Historical Rollover Ratio: The proportion of futures positions getting rolled every expiry also gives a good indication of the remaining interest in the counter.