INTRADAY NIFTY

Level Type	R5	R4	R3	R2	R1	Pivot Point	S1	S2	S3	S4	S5
PIVOT POINTS	8121.95	8063.30	8004.65	7946.00	7910.65	7887.35	7852.00	7828.70	7770.05	7711.40	7652.75
FIBONACCI PIVOTS	7982.25	7961.95	7946.00	7923.60	7909.75	7887.35	7864.95	7851.10	7828.70	7812.75	7792.45
CAMARILLA PIVOTS	7939.82	7907.56	7891.43	7886.05	7880.68	7887.35	7869.92	7864.55	7859.17	7843.04	7810.79

A Beginners Guide to The Capital Market

What is Commodities Futures Trading in India ? How Do I Do it ? Where do I do it?

Indian markets have recently thrown open a new avenue for retail investors and traders to participate: commodity derivatives. For those who want to diversify their portfolios beyond shares, bonds and real estate, commodities are the best option.

Till some months ago, this wouldn't have made sense. However, with the setting up of three multi-commodity exchanges in the country, retail investors can now trade in commodity futures without having physical stocks!

Commodities actually offer immense potential to become a separate asset class for market-savvy investors, arbitragers and speculators. Retail investors, who claim to understand the equity markets, may find commodities an unfathomable market. But commodities are easy to understand as far as fundamentals of demand and supply are concerned. Retail investors should understand the risks and advantages of trading in commodities futures before taking a leap. Historically, pricing in commodities futures has been less volatile compared with equity and bonds, thus providing an efficient portfolio diversification option.

With the introduction of futures trading, the size of the commodities market grow many folds here on.

Like any other market, the one for commodity futures plays a valuable role in information pooling and risk sharing. The market mediates between buyers and sellers of commodities, and facilitates decisions related to storage and consumption of commodities. In the process, they make the underlying market more liquid.

Here's how a retail investor can get started:

Where do I need to go to trade in commodity futures?

You have three options - the National Commodity and Derivative Exchange, the Multi Commodity Exchange of India Ltd and the National Multi Commodity Exchange of India Ltd. All three have electronic trading and settlement systems and a national presence.

How do I choose my broker?

Several already-established equity brokers have sought membership with NCDEX and MCX. The likes of Motilal Oswal, SSKI (Sharekhan) and ICICIcommtrade (ICICIdirect), and IIFL ( India Infoline ) are already offering commodity futures services. Some of them also offer trading through Internet just like the way they offer equities. You can also get a list of more members from the respective exchanges and decide upon the broker you want to choose from.

What is the minimum investment needed?

You can have an amount as low as Rs 5,000. All you need is money for margins payable upfront to exchanges through brokers. The margins range from 5-10 per cent of the value of the commodity contract.

Do I have to give delivery or settle in cash?

You can do both. All the exchanges have both systems - cash and delivery mechanisms. The choice is yours. If you want your contract to be cash settled, you have to indicate at the time of placing the order that you don't intend to deliver the item.

If you plan to take or make delivery, you need to have the required warehouse receipts. The option to settle in cash or through delivery can be changed as many times as one wants till the last day of the expiry of the contract.

What do I need to start trading in commodity futures?

As of now you will need only one bank account. You will need a separate commodity demat account from the National Securities Depository Ltd to trade on the NCDEX just like in stocks.

What are the other requirements at broker level?

You will have to enter into a normal account agreements with the broker. These include the procedure of the Know Your Client format that exist in equity trading and terms of conditions of the exchanges and broker. Besides you will need to give you details such as PAN no., bank account no, etc.

What are the brokerage and transaction charges?

The brokerage charges range from 0.10-0.25 per cent of the contract value. Transaction charges range between Rs 6 and Rs 10 per lakh/per contract. The brokerage will be different for different commodities. It will also differ based on trading transactions and delivery transactions. In case of a contract resulting in delivery, the brokerage can be 0.25 - 1 per cent of the contract value. The brokerage cannot exceed the maximum limit specified by the exchanges.

Where do I look for information on commodities?

Daily financial newspapers carry spot prices and relevant news and articles on most commodities. Besides, there are specialised magazines on agricultural commodities and metals available for subscription. Brokers also provide research and analysis support.

But the information easiest to access is from websites. Though many websites are subscription-based, a few also offer information for free. You can surf the web and narrow down you search.

Who is the regulator?

The exchanges are regulated by the Forward Markets Commission. Unlike the equity markets, brokers don't need to register themselves with the regulator.

The FMC deals with exchange administration and will seek to inspect the books of brokers only if foul practices are suspected or if the exchanges themselves fail to take action. In a sense, therefore, the commodity exchanges are more self-regulating than stock exchanges. But this could change if retail participation in commodities grows substantially.

Who are the players in commodity derivatives?

The commodities market will have three broad categories of market participants apart from brokers and the exchange administration - hedgers, speculators and arbitragers. Brokers will intermediate, facilitating hedgers and speculators.

Hedgers are essentially players with an underlying risk in a commodity - they may be either producers or consumers who want to transfer the price-risk onto the market.

Producer-hedgers are those who want to mitigate the risk of prices declining by the time they actually produce their commodity for sale in the market; consumer hedgers would want to do the opposite.

For example, if you are a bullion company with export orders at fixed prices, you might want to buy gold futures to lock into current prices. Investors and traders wanting to benefit or profit from price variations are essentially speculators. They serve as counterparties to hedgers and accept the risk offered by the hedgers in a bid to gain from favourable price changes.

In which commodities can I trade?

Though the government has essentially made almost all commodities eligible for futures trading, the nationwide exchanges have earmarked only a select few for starters. While the NMCE has most major agricultural commodities and metals under its fold, the NCDEX, has a large number of agriculture, metal and energy commodities. MCX also offers many commodities for futures trading.

Do I have to pay sales tax on all trades? Is registration mandatory?

No. If the trade is squared off no sales tax is applicable. The sales tax is applicable only in case of trade resulting into delivery. Normally it is the seller's responsibility to collect and pay sales tax.

The sales tax is applicable at the place of delivery. Those who are willing to opt for physical delivery need to have sales tax registration number.

What happens if there is any default?

Both the exchanges, NCDEX and MCX, maintain settlement guarantee funds. The exchanges have a penalty clause in case of any default by any member. There is also a separate arbitration panel of exchanges.

Are any additional margin/brokerage/charges imposed in case I want to take delivery of goods?

Yes. In case of delivery, the margin during the delivery period increases to 20-25 per cent of the contract value. The member/ broker will levy extra charges in case of trades resulting in delivery.

Is stamp duty levied in commodity contracts? What are the stamp duty rates?

As of now, there is no stamp duty applicable for commodity futures that have contract notes generated in electronic form. However, in case of delivery, the stamp duty will be applicable according to the prescribed laws of the state the investor trades in. This is applicable in similar fashion as in stock market.

How much margin is applicable in the commodities market?

As in stocks, in commodities also the margin is calculated by (value at risk) VaR system. Normally it is between 5 per cent and 10 per cent of the contract value.

The margin is different for each commodity. Just like in equities, in commodities also there is a system of initial margin and mark-to-market margin. The margin keeps changing depending on the change in price and volatility.

Are there circuit filters?

Yes the exchanges have circuit filters in place. The filters vary from commodity to commodity but the maximum individual commodity circuit filter is 6 per cent. The price of any commodity that fluctuates either way beyond its limit will immediately call for circuit breaker.

TYPES OF DERIVATIVES IN INDIA

TYPES OF DERIVATIVES IN INDIA

At present the Indian market trades in both exchange-traded and over the counter derivatives on various assets including securities, both equity and debt commodities, currencies, etc. the various types of derivatives being traded in India are discussed below:

•           GENERIC DERIVATIVE PRODUCTS

Today, Indian and International financial markets trade innumerable derivative products on all kinds of underlying assets, both tangible and intangible. Before proceeding with the regulatory issues of derivatives trading, it is important to have a detailed understanding of the four generic derivative products in detail.

1. FORWARD CONTRACTS

A forward contract is defined as an agreement, which ‘obligates one counterparty to buy, and the other counterparty to sell, a specific underlying at a specific price, amount and date in the future.

It is more clearly a one-to-one, bipartite/tripartite contract, which is to be performed mutually by the contracting parties, in future, at the term decided upon, on the contract date. In other words, a forward contract is an agreement to buy or sell an asset on a specified future date for a specified price. One of the parties to the contract assumes a long position, i.e. agrees to buy the underlying asset while the other assumes a short position, i.e. agrees to sell the asset. As this contract is traded off the exchange and settled mutually by the contracting parties, it is called an Over-the-counter product. It can be better understood with the help of an illustration.

Assume that there are two parties, Mr. A (buyer) and Mr. B (seller), who enter into a contract to buy and sell 500 units of asset X at Rs 100 per unit, at a predetermined time of two months from the date of contract. In this case, the product(asset X), the quantity (500 unites), the product price (Rs 100 per unit) and the time of delivery (2 months from the date of contract) have been determined and well understood, in advance, by both the contracting parties. Delivery and payment (settlement of transaction) will take place as per the terms of the contract on the designated date and place.

It is pertinent to note that forward contracts are negotiated by the contracting parties on a one-to-one basis and hence offer tremendous flexibility in terms of determining contract terms such as price, quantity, quality(in place of commodities), delivery time and place.

Like other OTC products, forward contracts offer tremendous flexibility to the contracting parties. However, as they are customized, they suffer from poor liquidity. Furthermore, as thee contracts are mutually settled and generally not guaranteed by any third party, the counter party risk/default risk/credit risk is considerable in such contracts.

2. FUTURES CONTRACTS

A futures contract is similar to a forward contract, in that it is an agreement to buy or sell a specified commodity or instrument, at a specified price, at a date in the future. Illiquidity and counter party risk were the two issues concerning forward contracts that offered the exchanges a tremendous business opportunity and they started trading these forward contracts, but with a difference. In order to differentiate between the exchange-traded forwards and the OTC forward, the market renamed the exchange-traded forwards as Futures Contract. Hence, future contracts are essentially standardized forward contracts, which are traded on the exchanges and settled through the clearing agency of the exchanges. The clearing agency also guarantees the settlement of these trades.

Reasons for using futures contracts can be diversified and complicated. First, they attract lower transaction costs. They are normally only a fraction of the costs of trading in the underlying commodity or instrument. Second, counterparty risk is minimal as it is unlikely that the clearinghouse would collapse, as it is usually well-backed financially. In addition, if a participant defaults, the rules of a typical clearinghouse will provide for the allocation of the losses to the surviving participants according to a predetermined formula. Third, futures contracts permit anonymity of participants as most brokers act for undisclosed principals. Fourth, there is no requirement for large capital outlays as initial deposits range between five to fifteen percent only. Fifth, futures markets are more liquid, and therefore, it is easier for the participants to ‘close-out’ or settle their contracts. However, a major disadvantage of using futures contracts is their inflexibility. Any investor using futures contracts for hedging would be exposed to basis risk. ‘Basis risk’ refers to the risk where the futures contract and the instrument that is being hedged may not be perfectly matched.

3. SWAPS

Swaps like forward contracts, are customized over-the-counter transactions. A swap has been described as ‘an agreement between two parties to pay each other a series of cash flows, based on fixed or floating interest rates in the same or different currencies.’

Swap transactions are broadly classified into interest rate, currency, commodity or equity swaps. It is possible to use swaps for a variety of purposes including the reduction of borrowing costs; asset and liability management; and yield enhancement.  The principle of comparative advantage, a concept central to international trade, plays an important role in swap transactions. Each counterparty borrows in the market where it enjoys a comparative advantage, and through the use of swap obtains financing at a more favorable rate than it would otherwise be able to do so. Swap cash flows can be decomposed into equivalent cash flows from a bundle of simple forward contracts. This has implications for the hedging of swap risks. Swaps are now hedged with a variety of derivative products, and no longer only by matching two identical but opposing swaps.

A swap derivative is nothing but barter or an exchange but it plays a critical role in international finance. Currency Swaps help eliminate barriers caused by international capital markets. Interest rate Swaps help eliminate barriers caused by regulatory structure. While Currency rate swaps result in exchange of one currency with another, interst rate swaps help exchange a fixed rate of interest with a variable rate. Swaps are private agreements between two parties and are not traded on exchanges but they do have an informal market and are traded among dealers. Swaptions is an option on swap that gives the party the right, but not the obligation to enter into a swap at a later date.

4. OPTIONS

An option is the ‘right to buy or sell a specific price on or before a specific date in the future’. It is a right that the option seller gives to the option buyer to buy or sell an underlying asset at a predetermined price, within or at the end of a specified period. The party taking a long position, i.e. buying the option is called the buyer/holder of the option and the party taking a short position, i.e. selling the option is called the seller/writer of the option.

The option buyer who is also called long option, or long premium or holder of option, has the right and no obligation with regard to buying or selling the underlying asset while the option seller/ writer who is also called short on option or short on premium, has the obligation but no right, in the contract. In other words, the option buyer may or may not exercise his option but if he decides to exercise it the option seller/writer is legally bound to honor the contract.

The right to buy an asset is a ‘call option’, while the right to sell an asset is a ‘put option’. An option which gives the buyer a right to buy the underlying asset, is called a call option and the option, which gives the buyer a right to sell the underlying asset is called put option.

An American option is one which can be exercise any time until maturity, while a European option is one which can be exercised on maturity date. The buyer of an option is usually called the ‘option holder’, and the seller of the option, the ‘option writer’. The option holder must pay the option writer a price known as the ‘premium’ in order to acquire the rights under the option. Options are available on a wide range of assets including commodities, foreign currencies, shares, bonds and even other derivatives.

•           EQUITY DERIVATIVES

India joined the league of exchange-traded equity derivatives in June 2000, when futures contracts were introduced at its two major exchanges, viz. the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). The BSE sensitive index, popularly known as the SENSEX (compromising 30 scrips), and S&P CNX Nifty Index (compromising 50 scrips), commenced trade in futures on June 9, 2000 and June 12, 2000 respectively. Index options and individual stock options on 31 selected stocks were subsequently added to the derivatives basket, in 2001. November 2001 witnessed the introduction of single stock futures in the Indian market. This list of stocks was selected, based on a predefined eligibility criteria linked to the market capitalization of stocks, floating stock, liquidity, etc.

•           COMMODITY DERIVATIVE

The Forward Contract Regulation Act (FCRA) governs commodity derivatives in India. The FCRA specifically prohibits OTC commodity derivatives. Accordingly, at this point in time, we have only exchange-traded commodity derivatives. Furthermore, FCRA does not even allow options on commodities. Therefore, at present, India trades only exchange-traded commodity futures.

Though commodity derivatives in the country have existed for a long time, trading has been regionally concentrated due to the regional nature of the commodity exchanges. Recently however, India began trading in commodity derivatives through two nation-wide, online commodity Exchanges- the National Commodities and Derivatives Exchange (NCDEX) and the Multi Commodity Exchange (MCX). They started functioning in the last quarter of 2003 with the introduction of futures contracts on various assets such as gold, silver, rubber, steel, mustard seed, etc.

It is important to note that both these exchanges have been recording a very high rate of growth. But it is interesting to note that the growth in volume of commodity derivatives has been achieved without institutional participation in the market. At present, banks, financial institutions, mutual funds, pension funds, insurance companies and Foreign Institutional investors are not allowed to participate in the commodities market.

•           CURRENCY DERIVATIVES

India has been trading forward contracts in currency, for the last several years. Recently, the RBI has allowed options in the OTC market. The OTC currency market in the country is considerably large and well-developed. However, the business is concentrated with a limited number of market participants.

•           INTEREST RATE DERIVATIVES

An Interest Rate Derivative is a derivative where the underlying asset is the right to pay or receive a (usually notional) amount of money at a given interest rate. There has also been significant progress in interest rate derivatives in the Indian OTC market. The NSE introduced trading in cash settled interest rate futures in the year 2003.

Derivative transaction

 Derivative transactions carried out through stock exchanges from 1 April 2005 to 25 January 2006, which are recognised by the notification issued by the CBDT on 25 January 2006, would be eligible for being treated as non-speculative transactions within the meaning of clause (d) of proviso to s 43(5) and, accordingly, are available for set-off against regular business income, as held by AhdTrib in ACIT v Hiren Jaswantrai Shah — In favour of: The assessee; ITA No 3361 (Ahd) of 2009: (AY 2006–2007).

ACIT v Hiren Jaswantrai Shah

ITAT, Ahmedabad

ITA No. 3361 (Ahd.) of 2009

Assessment Year: 2006-07

Bhavnesh Saini, JM and D.C. Agrawal, AM

Decided on: 17 June 2011

Counsel appeared:

Samir Tekriwala for the appellant

Mehul K. Patel for the respondent

Order

D.C. Agrawal, AM

1. This is an appeal filed by the revenue raising following grounds:-

"1. The ld. CIT(A) Ahmedabad has erred in law and on facts in holding that the derivative

transactions are business transactions which cannot be treated as speculative transaction and

thereby directing the Assessing Officer to allow the set off of loss. In derivative transactions

of Rs.23,62,200 against the regular business Income without properly appreciating the facts of

the case and the material brought on record by the Assessing Officer.

1.2 In doing so, the ld. CIT(A) has erred in law and on facts in not appreciating that the

assessee could not establish as to how the conditions laid down in section 43(5) were fulfilled

in assessee's case and whether the transactions had been made through the recognized Stock

Exchange and whether the same were eligible transactions within the meaning of the

provisions of the said section.

2. The only issue involved in the appeal is whether profit arising from derivative transactions at

Rs.23,62,290 should be treated as non-speculative and accordingly available to be set off against

regular business income.

3. The facts relating to the issue are that assessee is engaged in the whole-sale business of iron and steel. He is also carrying out daily transactions in shares. He has made investment in shares, and also trading in shares and securities and money lending. The assessee has shown income from long term capital gains/short term capital gains from shares. During the assessment year in question assessee has shown loss from derivative transactions at Rs.23,62,290 which is sought to be adjusted against normal business income. The Assessing Officer disallowed the claim on the ground that Government notification for treating income/loss from derivative transactions in shares as regular business income/loss is issued on 25-1-2006 under Explanation to section 43(5). Therefore, such loss cannot be treated as from non-speculative transaction. The Assessing Officer accordingly disallowed the claim of set off.

4. The ld. CIT(A) allowed the claim as under:-

"3.2 During the course of appellate proceedings, the ld. Counsel for the appellant has

submitted that no valid cogent, tenable grounds for such treatment/disallowance are shown at

all by the Assessing Officer for treating the loss of Rs.23,62,290 as speculative loss instead of

regular business loss claimed by the assessee. The assessee ought to have been allowed the set

off of such loss against his business income in view of decision of the Hon'ble ITAT in the

appellant's own case for assessment year 2005-06 where the similar issue was involved and

the Hon'ble ITAT has allowed the set off of the derivative transactions against the regular

business income. The ld. Counsel has also relied on the decision of Hon'ble ITAT, Jaipur 'A'

Bench in the case of P.S. Kapur v. ACIT in ITA No. 214/Jp./2008, dated 31-7-2008 - (2009)

120 TTJ 422 wherein the similar issue was involved and the appeal of the assessee is allowed.

Therefore, the ld. Counsel for the appellant urged to allow the set off of loss in derivative

transaction of Rs.23,62,290 against the regular business income.

3.3 I have carefully considered the contentions of the ld. Counsel for the appellant and have

also carefully gone through the assessment order. The case law relied upon by the ld. Counsel

for the appellant has also been carefully considered. It is seen in this case that the Assessing

Officer has not come with any adverse findings as regards the loss claimed by the appellant

on derivative transactions. It is now very clear that derivative transactions are business

transactions and cannot be treated as speculative transactions. In view of the facts and

circumstances of the case and in the light of judicial pronouncements cited supra of the

Hon'ble Ahmedabad and Jaipur Tribunals, the Assessing Officer is directed to allow the set

off of loss in derivative transactions of Rs.23,62,290 against regular business income as the

same is to be treated as business loss only."

5. Before us, the ld. DR submitted that as per clause (ii) of Explanation below section 43(5)

notification for declaring as to what are the recognized stock exchanges through which assessee can

carry out derivative transactions was published on 25-1-2006 and, therefore, the assessee could not

carry out derivative transactions through recognized stock exchanges prior to this date as required

under that clause (ii) of Explanation to section 43(5) and, therefore, transactions carried out prior to

this date would be speculative transactions and accordingly the loss in them cannot be set off against

normal business income.

6. On the other hand, the ld. AR submitted that this notification is clarificatory in nature. Recognized

stock exchanges are already in existence even prior to 25-1-2006. He relied on the decision of Special Bench of the Tribunal, Kolkata, in the case of Shree Capital Services Ltd. v. Asstt. CIT [2009] 121 ITD 498 wherein it is held that clause (d) of section 43(5), defining special transactions in derivatives, would be prospective in nature and would be effective from 1-4-2006.

7. We have heard the rival arguments and perused the material on record. The only issue involved in

this appeal is whether by virtue of notification from CBDT dated 25-1-2006 in S.O.(89E) recognizing

National Stock Exchange and Bombay Stock Exchange for the purpose of derivative transactions

would make the application of clause (d) of section 43(5) effective only from 25-1-2006 or this

provision will remain in effect from 1-4-2006 when the clause (d) of sub-section (5) was brought into

statute. For the sake of convenience we reproduce section 43(5), (which includes clause (d) also

which was introduced by the Finance Act, 2005 with effect from 1-4-2006) as under:-

"(5) "speculative transaction" means a transaction in which a contract for the 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 commodity or scrips:

Provided that for the purposes of this clause-

(a) a contract in respect of raw materials or merchandise entered into by a person in the course

of his manufacturing or merchanting business to guard against loss through future price

fluctuations in respect of his contracts for actual delivery of goods manufactured by him or

merchandise sold by him ; or

(b) a contract in respect of stocks and shares entered into by a dealer or investor therein to

guard against loss in his holdings of stocks and shares through price fluctuations ; or

(c) a contract entered into by a member of a forward market or a stock exchange in the course

of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise

in the ordinary course of his business as such member ; or

(d) an eligible transaction in respect of trading in derivatives referred to in clause (aa) of

section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956), carried out in a

recognised stock exchange;

shall not be deemed to be a speculative transaction ;

Explanation.-For the purposes of this clause, the expressions-

(i) "eligible transaction" means any transaction,-

(A) carried out electronically on screen-based systems through a stock broker or sub-broker or

such other intermediary registered under section 12 of the Securities and Exchange Board of

India Act, 1992 (15 of 1992), in accordance with the provisions of the Securities Contracts

(Regulation) Act, 1956 (42 of 1956), or the Securities and Exchange Board of India Act,

1992, or the Depositories Act, 1996 (22 of 1996) and the rules, regulations or bye-laws made

or directions issued under those Acts or by banks or mutual funds on a recognised stock

exchange ; and

(B) which is supported by a time stamped contract note issued by such stock broker or subbroker

or such other intermediary to every client indicating in the contract note the unique

client identity number allotted under any Act referred to in sub-clause (A) and permanent

account number allotted under this Act ;

(ii) "recognised stock exchange" means a recognised stock exchange as referred to in clause

(f) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956), and which

fulfils such conditions as may be prescribed and notified by the Central Government for this

purpose."

In derivative transactions there is no purchase or sale directly. These instruments, however, depend

upon original assets and derive their value from them. Such derivatives are in the form of future and

options. Before the amendment brought in by the IT Act with effect from 1-4-2006 in section 43(5),

all the transactions in derivatives were treated as speculative in nature and, therefore, losses arising

therein could not be allowed to be set off against other business income. However, with effect from 1-

4-2006 amendments were made in section 43(5) and the transactions involved in derivatives were

taken out of definition of speculative transactions. For this purpose clause (d) was inserted in section

43(5). This amendment was held prospective in nature and applicable from assessment year 2006-07 as held by the Special Bench in Shree Capital Services Ltd.'s case (supra) as under:-

"The Finance Act, 2005 has provided that certain transactions in respect of trading in

derivatives shall not be deemed to be speculative transactions-within the meaning of section

43(5). If the transaction in derivatives did not fall within the definition of "speculation

transaction" under section 43(5), there was no question of exempting certain types of

transaction in derivatives from the scope of speculative transaction under section 43(5) and

clause (d) and Explanation thereto below section 43(5) introduced by the Finance Act, 2005

would be redundant. The term "derivatives" in which the underlying asset is shares, will fall

within the meaning of "commodity" used in section 43(5) of the Act. Clause (d) of section

43(5) cannot be said to be clarificatory in nature. Clause (d) of section 43(5) is prospective in

nature and will be effective from the date on which the Legislature made it effective, i.e.,

April 1, 2006 and will be applicable to the assessment year 2006-07 onwards."

8. This view was upheld by Hon'ble Bombay High Court in the case of CIT v. Shri Bharat R. Ruia

(HUF) [2011] 199 Taxman 87/10 Taxmann.com 265 pronounced on 18-4-2011 while interpreting

clause (d) to the proviso to section 43(5) (that it is effective from 1-4-2006) as under:-

"Plain reading of clause (d) to the proviso to section 43(5) makes it clear that with effect from

1-4-2006, only those eligible transaction in derivatives referred to under section 2(ac) of the

1956 Act, which are carried out in a recognized stock exchange, shall not be deemed to be a

speculative transaction. It is only because the transactions in derivatives referred to under

section 2(ac) of the 1956 Act carried out in a recognized stock exchange were covered under

section 43(5), the Legislature could exclude those transactions from the purview of section

43(5) with effect from 1-4-2006. In other words, unless the transactions referred in clause (d)

were not covered under section 43(5), there would be no question of excluding those

transactions from the purview of section 43(5)." [Para 23]

9. Explanation to section 43(5) was also inserted by Finance Act, 2005 with effect from 1-4-2006. The conditions that a stock exchange is required to fulfil for being notified as recognized stock exchange for the purposes of clause (d) to section 43(5) were inserted by Income-tax 20th amendment Rules, 2005 with effect from 1-7-2005. These conditions as per rule 6DDA of Income-tax Rules, 1962 at the relevant time were as under:-

"6DDA. Conditions that a stock exchange is required to fulfil to be notified as a recognised

stock exchange for the purposes of clause (d) of proviso to sub-section (5) of section 43.-For

the purposes of clause (d) of proviso to sub-section (5) of section 43, a stock exchange shall

fulfil the following conditions in respect of trading in derivatives, namely:-

(i) the stock exchange shall have the approval of the Securities and Exchange Board

of India established under the Securities and Exchange Board of India Act, 1992 (15

of 1992) in respect of trading in derivatives and shall function in accordance with the

guidelines or conditions laid down by the Securities and Exchange Board of India ;

(ii) the stock exchange shall ensure that the particulars of the client (including unique

client identity number and PAN) are duly recorded and stored in its databases ;

(iii) the stock exchange shall maintain a complete audit trial of all transactions (in

respect of cash and derivative market) for a period of seven years on its system;

(iv) the stock exchange shall ensure that transactions once registered in the system

cannot be erased or modified.

Income-tax (20th Amend.) Rules, 2005, with effect from 1-7-2005."

Rule 6DDB provides the procedure for notification as required under Explanation (ii) to section 43(5).

This procedure is laid down as under:-

"6DDB. Notification of a recognised stock exchange for the purposes of clause (d) of proviso

to sub-section (5) of section 43:-

(1) An application for notification of a stock exchange as a recognised stock exchange for the

purposes of clause (d) of proviso to sub-section (5) of section 43 may be made to the Member

(L), Central Board of Direct Taxes, North Block, New Delhi-110 001.

(2) The application referred to in sub-rule (1) shall be accompanied with the following

documents, namely:-

(i) approval granted by Securities and Exchange Board of India for trading in

derivatives ;

(ii) up-to-date rules, bye-laws and trading regulations of the stock exchange ;

(iii) confirmation regarding fulfilling the conditions referred to in clause (ii) to clause

(iv) of rule 6DDA ;

(iv) such other information as the stock exchange may like to place before the Central

Government.

(3) The Central Government may call for such other information from the applicant as it

deems necessary for taking a decision on the application.

(4) The Central Government, after examining the information furnished by the stock

exchange under sub-rule (2) or sub-rule (3), shall notify the stock exchange as a recognised

stock exchange for the purposes of clause (d) of proviso to sub-section (5) of section 43 or

issue an order rejecting the application before the expiry of four months from the end of the

month in which the application is received.

(5) The notification referred to in sub-rule (4) shall be effective until the approval granted by

the Securities and Exchange Board of India is withdrawn or expired, or the notification is

rescinded by the Central Government."

*I.T. (20th Amend.) Rules, 2005, with effect from 1-7-2005."

A combined reading of the provision of clause (d) to proviso to section 43(5) and the Explanation (ii)

to section 43(5) and above rules 6DDA and 6DDB indicate that a stock exchange whether newly

created or already existing should satisfy above conditions as per rule 6DDA and such stock exchange

should be approved by the Stock Exchange Board of India (SEBI) under the SEBI Act, 1992 for

recognition of a stock exchange should keep record of particulars of the clients, complete audit trial of

all transactions are maintained for seven years and that such transactions are not erased or modified.

On an application filed with CBDT along with particulars as given in rule 6DDB, the stock exchange

will be notified as recognized stock exchange for the purpose of clause (d) to proviso to sub-section

(5) of section 43. In our considered view rule 6DDA has come into effect from 1-7-2005 and will

accordingly be effective from date only. In other words, a stock exchange can file an application with

CBDT for recognition within the meaning of clause (d) of proviso to section 43(5) after this date. The

main provision i.e., clause (d) of proviso to section 43(5) has come into effect from 1-4-2006. It

means that the Government has prescribed the conditions and made effective in advance so that stock

exchanges can take steps to file application for recognition for derivative transactions much in

advance. However, rule 6DDB is only a procedural law as it prescribes the method how to apply for

necessary recognition and consequent notification. The issue is whether notification issued on 25-1-

2006 can curtail the applicability of clause (d) of proviso to section 43(5) so as to make transactions in

derivatives done prior to 25-1-2006 as speculative and transactions after 25-1-2006 as non-speculative

as argued by the revenue.

10. We do not, however, agree with the view advanced by the revenue that notification dated 25-1-

2006 is prospective in effect. It is undisputed that rule 6DDB is only procedural in nature. When a

rule or provision does not affect or empower any right or create an obligation or only relates to

procedures, then it is deemed to be retrospective unless such inference is likely to lead absurdity. Thus if an amendment is made in procedure it will apply to all proceedings pending or to be initiated. In the context of rule 1BB Hon'ble Rajasthan High Court in CWT v. Man Bahadur Singh [1994] 208 ITR 658/74 Taxman 344 held that such procedural amendment in rule would be retrospective. Therefore, in our considered view if transactions are carried out through stock exchanges from 1-4-2005 to 25-1- 2006 which are recognized by notification issued by CBDT on 25-1-2006 would be eligible for being treated as non-speculative within the meaning of clause (d) of proviso to section 43(5). The notification issued under rule 6DDB does not empower any right or create obligation but only recognizes what is already in existence. It is not a case that NSE or BSE were created after 25-1-2006 and, therefore, transactions could not have been carried out through them and, therefore, transactions carried out prior to this date would not be covered for being treated as non-speculative. In other words if transactions are derivatives and are carried out through stock exchange which are already in existence during assessment year 2006-07 i.e., financial year 1-4-2005 and 31-3-2006 onwards and which are subsequently recognized under rule 6DDB and there is no allegation that such transactions or the stock exchanges have violated any condition prescribed under rule 6DDB then such recognition to stock exchanges by CBDT for the purpose of clause (d) of proviso to section 43(5) would be retrospective effect from 1-4-2006.

11. Our view that notification dated 25-1-2006 would be effective from 1-4-2005 i.e., it would be

applicable to entire assessment year 2006-07 is also supported by a recent decision of ITAT, Mumbai in Asstt. CIT v. Parimal D. Nathwani [2011] 9 Taxmann.com 284 (Mum. - ITAT) pronounced on 21- 1-2011 wherein following decision of the ITAT Delhi Bench in the case of G.K. Anand Bros.

Buildwell (P.) Ltd. v. ITO [2009] 34 SOT 439 held that notification dated 24-1-2006 is only a

subordinate legislation and cannot over ride the principal legislation enacted by the Parliament. ITAT

Mumbai Bench in that case held as under:-

"11. It is the contention of the revenue that the notification was issued on 24-1-2006 and

accordingly the transactions effected prior to 24-1-2006 are to be considered as speculative

transactions and the transactions after that date can be considered as non-speculative, in view

of the notification issued by the Board. The Coordinate Bench in the case of G.K. Anand

Bros. Buildwell (P.) Ltd. v. ITO 234 SOT 439 (Delhi) has considered the issue and held that

notification dated 24-1-2006 is by way of a subordinated legislation but cannot override the

principal legislation enacted by the Parliament. Therefore the loss in question was to be

treated as business loss and not as speculative loss in the above said case. The facts and

reasons for holding as such are as under:-

"The assessee is carrying on business as builder, developer and contractor. During the

year it has also done trading in shares by way of future and option transactions. This

resulted into a loss of Rs.20,36,328, The Assessing Officer was of the opinion that

loss in future and option segment is to be considered as speculation loss in terms of

section 43(5) r/w Explanation to section 73. The assessee submitted that the

transactions are carried on through a broker M/s. March Securities (P.) Ltd. who is a

registered member of National Stock Exchange. The speculative transaction is

defined in section 43(5). Clause (d) of the proviso to section 43(5) provides, "an

eligible transaction in respect of trading in derivatives referred to in Securities

Contracts (Regulation) Act, 1956 carried out in a recognized stock exchange, shall

not be deemed to be a speculative transaction". The phrases "eligible transaction" as

also "recognized stock exchange" is defined in Explanation below the proviso to

section 43(5). It was also noted that clause (d) is inserted in the proviso by Finance

Act, 2005 with effect from 1st April, 2006. Accordingly, for assessment year 2006-07

the transaction in the derivatives in the form of future and option cannot be

considered as speculative transaction and hence loss in such transaction cannot be

classified as loss in speculation business."

The Assessing Officer held, that the transactions are carried on at National Stock Exchange

and Bombay Stock Exchange. Bombay Stock Exchange Ltd. and National Stock Exchange of

India Ltd. are recognized stock exchanges as per notification dated 25th January, 2006.

Therefore the transactions in F and O segment prior to 25th January, 2006 are regarded as

speculative loss.

Section 43(5) defined 'speculative transaction' means a transaction in which a contract for the

purchase or sale of any commodity including stocks and shares is periodical or ultimately

settled otherwise than by the actual delivery or the transfer of commodity or scrips. Proviso

below section 43(5) carves out exceptions to section 43(5). As per clause (d) of the said

proviso "an eligible transaction in respect of trading in derivatives referred in Securities

Contracts (Regulation) Act, 1956 carried out in a recognized stock exchange shall not be

deemed to be a speculative transaction". Clause (d) in the proviso was inserted by Finance

Act, 2005 with effect from 1st April, 2006. Therefore, if a transaction falls within clause (d)

of the proviso will not be deemed to be a speculative transaction in respect of transaction

pertaining to assessment year 2006-07. Under clause (d) of the proviso, a transaction is not a

speculative transaction provided it is an eligible transaction within the meaning of clause (i)

of Explanation and it is carried on at recognized stock exchange as explained in clause (ii) of

the said Explanation below proviso to section 43(5)(d). The recognized stock exchange means

a recognized stock exchange as notified by the Central Government for this purpose.

Therefore, even if the notification is from a particular date, as per clause (d) inserted, the

same will apply to all the transactions in relation to assessment year 2006-07 and onwards.

Clause (d) does not mention that unless the recognized stock exchange is notified, the

transaction will not be deemed to be a speculative transaction. The power to notify the stock

exchange is granted under the statute and hence once the recognized stock exchange is

notified, the same will apply in respect of all eligible transactions carried out in relation to

financial year relevant to assessment year 2006-07 and onwards. The Special Bench of

Tribunal in the case of Shree Capital Services Ltd. (supra) in para 7 held that "clause (d) of

section 43(5) is prospective in nature and will be effective from the date from which the

Legislature made it effective, i.e., 1st April, 2006 and will be applicable to assessment year

2006-07 onwards". The notification is by way of a subordinated legislation but cannot

override the principal legislation enacted by the Parliament. It only clarifies but will not

override unless statutorily so prescribed. Since there is no dispute to the fact that the

transactions in the present case in FandO segment are the eligible transactions carried out in a

recognized stock exchange, loss in such transactions cannot be deemed to be transaction in

speculation business. The same being considered as regular business transaction, loss incurred

in the same is to be treated as business loss and not loss in speculation business."

12. In view of this, respectfully following the same we are of the opinion that there is no merit

in ground No. 2 raised by the Revenue. Accordingly ground No. 2 is rejected and Assessing

Officer is directed to treat the profit/loss on derivatives as non-speculative business profits as

per the provisions of the Act effective from 1-4-2006."

12. In view of above, we do not find any reasons to take a different view than what is taken by ld.

CIT(A). As a result, appeal filed by the revenue is dismissed.

13. In the result, the appeal filed by the revenue is dismissed.

What do you mean by Futures & Options ? And how are they traded !

 

What is Futures Trading?

The goal of this post is to explain the basic idea underlying a futures trading or futures contract by means of an example. Market derivatives like Stock Market futures and Options have the reputation of being 'hard to understand' although the underlying idea of futures trading is not that hard as it seem and is best understood by studying an example.

1.    Stock Futures Contract.

2.    Index Futures Contract (like Dow Futures, Nifty Futures, Sensex Futures, etc.)

3.    Commodity Futures (like Gold Futures, Crude Oil Futures, etc.)

Although it looks like '3 types' the underlying principles and ideas behind trading any of the above futures contract is the same. Let me try to explain futures trading with the help of an example.

Futures Trading: Example of a Futures Contract:

Suppose the current price of Tata Steel is Rs. 200 per stock. You are interested in buying 500 shares of Tata Steel. You find someone, say John, who has 500 shares you tell John that you will buy 500 shares at Rs. 200, but not now, at a later point of time, say on the last thursday of this month. This agreed date will be called the expiry date of your agreement or contract. John more or less agrees but the following points come up in your agreement.

1.    John will have to go through the hassle of keeping the shares with him until the end of this month. Moreover, the economy is doing well, so it is likely that the price of the stock at the end of the month will be not Rs. 200, but something more. So he says lets strike a deal not at the current price of Rs 200 but Rs. 202/-. The agreed price of the deal will be called the Strike price of the futures contract. He says you can think of the Rs. 2 per share as his charge for keeping the shares for you until the expiry date. This difference between the strike price and the current price is also called as Cost of Carry.

2.    The total contract size is now Rs. 202 for 500 shares, which means Rs 101000. However both you and John realise that each of you is taking a risk. For e.g. if tomorrow the price of the stock falls from Rs. 200 to Rs. 190, in that case it is much more profitable for you buy shares from the market than from John. What if you decide not to honour the contract or agreement? it will be a loss for John. Similarly if the price rises you are at a risk if John doesn't honour the futures contract. So both of you decide that you will find a common friend and keep Rs. 25000 each with this friend in order to take care of price fluctuations. This money paid by both of you is called Margin paid for the futures contract.

Finally you decide that the futures contract will cash settled. Which means at the expirty date of the contract, instead of actually handing over 500 shares - John will pay you the money if the price rises, or if the price falls you will pay John the balance amount. For example at the end of the expiry date if you find out that the price of the share is Rs. 230, then the difference

Rs. 230 - Rs. 202 = Rs. 28

will be paid to you by John. You can then purchase the shares fromt he Stock Market at Rs. 230. Since you will get Rs. 28 per share from John, you will effectively be able to buy the shares at Rs. 202 , the agreed strike price of the futures contract. Similarly John can directly sell his 500 shares in the market at Rs. 230 and give you Rs 28 (per share) which means he effectively sold each share at Rs. 202, the agreed price.

Stock Futures trading - Commodity Futures trading - Index Futures trading

Just like the above example of Stock Futures you can have commodity futures where instead of dealing with stock you deal with commodities - for e.g. gold futures , crude oil futures, etc. You can also have futures on Index. For e.g. Nifty is a stock market index in India. If you buy 1 futures contract of Nifty then at the expiry date you will be gain or loose money accordingly as the index moves up or down. Index futures contracts are always cash settled as there is nothing to 'actually buy or sell' in case of an index. You simply pretend that you are buying the 'index' and cash settle it at the expiry date. Anyone can buy or sell a futures contract.

Futures Trading: some minor differences between Actual Futures contract and
the above example of futures contract

In concept the above example illustrates all the basic notions of a futures trading. However in real life, while trading stock futures on stock market exchange or commodities futures on commodity exchange you have to keep in mind the following points.

1.    You directly deal with the stock exchange or the commodity exchange when buying or selling a futures contract. The Margin money is kept with the stock exchange. The margin is calculated in real time and constantly updated. For e.g. if you buy a futures contract and the price of the stock / commodity goes down - you will be required to provide additional margin, etc.

2.    The expiry date of the futures contract is decided by the Exchange. It is usually the last Thursday of every month except when there is a public holiday in which case it is the earliest

3.    All futures contract are sold in multiple of a lot size which is decided by the Stock Market exchange or the commodity exchange. For e.g. if the lot size of Tata Steel is 500, then one futures contract is necessarily for 500 shares. You can however buy or sell multiple futures contracts and hence you will be able to deal with only multiples of the given lot size of the contract.

4.    The exchange decides whether the futures contract is cash settled or settlement is delivery based. For e.g. all index futures are always cash settled because there is no concept of actual 'delivery' of the index. In india even all stock futures are currently cash settled.

5.    You dont have to actually have the stock or commodity (or index) in order to sell a futures contract. For e.g. even if I have no gold with me, and I believe that the price of gold is going to go down, I can simply sell a futures contract and hope to benefit from my speculation. In case the futures contract is delivery settled, you can simply buy it again (called squaring your position) just before the expiry.

Advantages of Futures Trading: Why trade Futures?

There are several advantages of trading in futures. Here are some.

1.    Futures trading allows you to trade in 'large amounts' with low cash. For e.g. if you want to buy a futures contract of 500 shares of Tata steel - Actually buying them would cost much more than the margin you have to pay for trading futures. Note however, leveraged position of futures can also be dangerous.

2.    Trading in stock market Futures is usually less expensive than actually buying stocks. For e.g. if you realise that you have 500 stocks and want to sell them and again buy them when the price is low, it is much cheaper (brokerage charges etc.) to sell futures than actually selling stocks.

3.    You can sell futures contract even if you dont have shares or the commodity. Thus if you have reasons to believe that the stock market is going down you can sell a particular stock future or index future and benefit from the price fall. This is possible only if you trade futures and not with physical stocks or commodity.

4.       Trading futures can be used in several hedging strategies which will be discussed in a later post.

put option

Definition

An option contract that gives the holder the right to sell a certain quantity of an underlying security to the writer of the option, at a specified price (strike price) up to a specified date (expiration date); here also called put.

An options trader can be long a Put, in which case they have bought a Put contract, and have the right of exercise described above. Or a trader can be short a Put, in which case they have sold a Put contract, and may be required to buy the underlying commodity if they are chosen by the exchange (or options clearing system) to complete their contract obligations.

call option

Definition

An option contract that gives the holder the right to buy a certain quantity (usually 100 shares) of an underlying security from the writer of the option, at a specified price (the strike price) up to a specified date (the expiration date). also called call.

An options trader can be long a Call, in which case they have bought a Call contract, and have the right of exercise described above. Or a trader can be short a Call, in which case they have sold a Call contract, and may be required to sell the underlying commodity if they are chosen by the exchange (or options clearing system) to complete their contract obligations.

Trading in Futures Derivatives
Idea about futures derivatives
Future trading can be done on stocks as well as on Indices like IT index, Auto index, Pharma index etc

Stock future trading -
Let’s first understand what the meaning of futures trading is. In simple language one future contract is group of stocks (one lot) which has to be bought with certain expiry period and has to be sold (squared off) within that expiry period.
Suppose if you buy futures of Wipro of one month expiry then you have to sell it within that one month period.
Important - Future contract get expires at every last Thursday of every month.

If you buy October month expiry future contract then you have to sell it within last Thursday of October month. Likewise you can buy two months and three months expiry period future contract.
You can buy maximum of three month expiry period.
For example - suppose this is month of October then you have to buy till maximum month of December expiry and you have to sell it within last Thursday of December month. You can sell anytime between these periods.
Lot size (group of stocks in one future contract) varies from future to future contract.
For example Reliance Industries future lot size has 150 quantities of shares while a Tata Consultancy service has 250 shares.
In the same manner all futures have different lot sizes decided by SEBI (Securities Exchange Board of India).
The margin (in other words price of one lot size) varies on daily basis based on its stocks closing price.
Future trading can be done on selected stocks listed under Nifty and Jr. Nifty and not on all stocks.
The price of future contract is determined by its underlying stock.
Important - You can’t buy future contract of expiry period of not more than 3 months.

Indices future trading
As you can do future trading on stocks likewise you can do trading on different indices like Nifty index, IT index, Auto index, Pharma index etc.Successful trading in futures
Future or derivative trading is the process of buying or selling stock future or index future for a certain period of time and squaring off before the expiry date.
Expiry period can be of one month, two month and three month and not more then of three month.
Its not compulsion that you have to square off your positions on the expiry date or wait till the expiry period but in fact  you can square off at any time even, at the same day, or you can hold as long as you want but remember to square off before expiry date.
Most of the times on 3rd month expiry future you may see very less trading volumes.
Generally most of the traders/investors trade or invest on current month future or second month future contract and you may see very low volumes on last month means third month expiry .
But on Nifty index contract or on other index contract you may see good trading volumes even on 3rd month expiry future also.
You can also buy and sell or sell and buy future contract on the same day of any expiry month. This is called as day trading or intraday in futures.
Selling future contract before buying is called short selling. Short selling is allowed in futures trading.

Major Advantages of Futures Trading over Stock Trading
1) Margin is available -
    In future trading you get margin to buy (but can hold only up to maximum of 3 months), while in stock trading you
    must have that much of amount in your account to buy.
    For example - If you plan to buy stock XYZ at Rs. 100 and quantity 1000 shares then you have to pay 1 lakh
    rupees (RS 100 x1000 qty). But if you plan to buy XYZ future contract and that contract lot size has 1000 quantity
    of shares then instead of paying 1 lakh rupees you have to pay just 20% to 30% of whole amount which comes to
    20 thousand to 30 thousand rupees.
    In short in future trading you have to pay just 20% to 30% of the whole amount what you pay if you buy stock of
    that price. But limitation for this is your expiry period. Means if you bought future of one month expiry then you
    have to square off within that one month likewise you can buy maximum of three months expiry.

2) Possible to do short selling -
    You can short sell futures- You can sell futures without buying them which is called short selling and later buy within
    your expiry period, to cover up your positions.
    This is not possible in stocks. You can’t sell stocks before buying them in delivery (you can do in intraday). You can
    short sell futures and can cover off within your expiry period.
    For example - If expiry period of your future contract is of 1 month then you have time frame of one month to cover off
    your order like wise if your future expiry period is of two months then you have time frame of two months and this
    continues till three months and not more then three months.
    In short selling of futures also you get margin as you get in buying of futures.

3) Brokerages are low -
    Brokerages offered for future trading are less as compared to stock delivery trading.

Disadvantages of Future Trading over Stock Trading
1) Limitation on holding -     If you buy or sell a future contract then you have limitation of time frame to square off your position before expiry
    date.
    For example - If you buy or sell future contract of one month expiry period then you have to square off your position
    before your expiry date of that month, so in this example you got one month period. So likewise if you go for two
    month expiry period then you get 2 months and if you go for three month expiry then you will get 3 month expiry
    period to square off your position.

2) Level of Risk -      Due to margin facility in future trading you may earn huge profit by investing fewer amounts but at the contrary side
    if your trade goes wrong then you may have to suffer huge loss.

3) Limitation on stocks -     You can’t do future trading on all stocks. You can only do on listed stocks on Nifty and Jr. Nifty.

Important points to Remember while doing future trading
1) First up all you have to decide whether you want to buy stock derivatives or index derivative. After this you have to 
    select the expiry period. Once you buy certain expiry period then you have to sell (cover off) your order before that
    period.
    Its no need to wait till the expiry period, you can even square off on the same day (if you are getting profit) or
    anytime whenever you feel to book profit, no compulsion to cover off your order on the last day of expiry.
2) Check out for Futures current market price.
3) Futures Lot Size (number of shares in that particular Lot).
4) Futures Lot price (this is the amount you must have in your account to buy one lot of future) also called as margin
    amount.
5) Selection of expiry period - you want to trade on expiry of one month, two month or last 3rd month.
6) No need to wait till expiry period can book profit wherever applicable.Method of Short Selling
Short selling (selling before buying in future trading)
In future trading you can do short selling and buy (cover) later when price comes down from your selling price you can short sell stock future as well as index future. But again same restriction will apply and that is of expiry period.