Pass Certification Examination for Mutual Fund - Specialized Investment Fund Distributors Difficulty: Beginner 2 Questions   5 min read
📌 Chapter 15.2 — Futures contracts

Consider a client who has historically invested only in large-cap equity mutual fund schemes and is now intrigued by the hedging potential of index futures. When you explain that futures are exchange-traded, they might assume this removes all risk; your role is to clarify that while the exchange mitigates counterparty risk, the mechanics of daily survival are driven by margins and Mark-to-Market (MTM) settlements.

You must explain that the clearing corporation acts as the buyer to every seller and the seller to every buyer, but it maintains this stability by requiring both parties to put up collateral, known as the margin.

In the Indian context, this margin is not a one-time fee but a dynamic requirement. Every single day after the market closes, the exchange calculates the settlement price. If your client’s position shows a loss, their account is debited, and if it shows a gain, it is credited. This daily MTM settlement ensures that losses do not accumulate to a point where a counterparty could default on their entire obligation.

It is the reason why an investor can trade with confidence on the NSE or BSE without ever knowing who sits on the other side of the trade.

For a distributor, explaining this is a crucial part of the suitability and risk-disclosure process. If a client is accustomed to the buy-and-hold nature of a mutual fund scheme where the NAV is updated daily but the investor is not required to inject capital during interim volatility, the cash-flow implications of futures trading can be jarring.

You should illustrate this with an example: if a client holds a long position and the index drops sharply, they will receive a margin call demanding additional funds immediately. Failing to meet this requirement leads to the automatic squaring off of their position, potentially locking in a loss at an inopportune time.

When recommending strategies involving derivatives, ensure your client understands that their liquid assets must be sufficient to support these daily adjustments. This is fundamentally different from a SIF investment strategy, where the ₹10 lakh minimum threshold is a static entry barrier. Futures demand constant liquidity vigilance, which makes them unsuitable for clients who are fully invested in long-term locked-in assets. By framing the MTM process as a safety mechanism rather than a cost, you help the investor view the volatility of their collateral as a professional price for market participation.

Nuance

⚠️ Nuance
Candidates often confuse the ‘Initial Margin’ with the ‘Mark-to-Market’ settlement, assuming the initial margin is a total cost of the trade. In reality, the initial margin is merely a security deposit that is returned when the position is closed, whereas MTM is the real-time profit or loss transfer that occurs daily. A prudent advisor must emphasize that while the initial margin grants entry, the MTM settlement determines the ongoing financial impact on the client’s liquid cash reserves.

Check Your Understanding

Practice Question 1

A client has a long position in Nifty futures. At the end of the day, the settlement price is lower than the price at which the client bought the contract. How does the clearing corporation manage this?

Practice Question 2

Why does the exchange insist on both an Initial Margin and a daily MTM process for futures contracts?

This is a companion read for Section 15.2 — Futures contracts from Pass Certification Examination for Mutual Fund - Specialized Investment Fund Distributors by Akhilesh Gururani, available on Amazon Kindle.

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