Pricing of a future/forward contract should be based on the dividend that is expected to come and due to the expected dividend, the price of futures is lesser than the spot.
Take the case of Coal India, the underlying quote is available at
The current market price is 299.9
The company is giving dividend of Rs 29 and the Ex-date is 17th Jan (tomorrow), so the price should fall by 29 tomorrow.
We should expect the futures to trade at discount, but see the futures price here
Futures is trading at 299.75, so there is no impact of dividend at all??
Why - what could be the reason?
The reason is that there is concept of adjustment of the futures price and the strike price of the option in case of large dividend.
Here is what the NSE website state
Link source- http://www.nseindia.com/products/content/derivatives/equities/adjust_in_case_corp.htm
Dividends
- Dividends which are below 10% of the market value of the underlying stock, would be deemed to be ordinary dividends and no adjustment in the Strike Price would be made for ordinary dividends. For extra-ordinary dividends, above 10% of the market value of the underlying security, the Strike Price would be adjusted.
- To decide whether the dividend is "extra-ordinary" (i.e. over 10% of the market price of the underlying stock.), the market price would mean the closing price of the scrip on the day previous to the date on which the announcement of the dividend is made by the Company after the meeting of the Board of Directors. However, in cases where the announcement of dividend is made after the close of market hours, the same day's closing price would be taken as the market price. Further, if the shareholders of the company in the AGM change the rate of dividend declared by the Board of Directors, then to decide whether the dividend is extra-ordinary or not would be based on the rate of dividend communicated to the exchange after AGM and the closing price of the scrip on the day previous to the date of the AGM.
- In case of declaration of "extra-ordinary" dividend by any company, the total dividend amount (special and / or ordinary) would be reduced from all the strike prices of the option contracts on that stock.
- The revised strike prices would be applicable from the ex-dividend date specified by the exchange.
Also, In case of futures contract, the price of the futures contract would be adjusted downward (without loss to the long party)
The closing price of Coal India on 14th Jan was Rs 288.9 => 10% of 288.9 = Rs 28.89, if you round off it would be Rs 29. So, this is considered as a special dividend.
If the dividend had been even Rs 1 lower, then it would not be special dividend.
Spot Prices
Price of futures contract
On 14th Jan EoD futures price is - 276.05
Which is around Rs 14 lower than the spot, It means that market was expecting that the dividend would be around this range. But due to higher dividend, the futures price increased on 15th Jan.
Futures opened at Rs 300 and closed at Rs 295.90
Stock opened at Rs 301 and closed at Rs 295.20
So, futures went into contango from backwardation. Those who were long in Futures would have made a kill.
These are the uncertainty in the market.
Also, what if they had chosen Rs 28 as the dividend - then the futures price would have depressed more!!
Interesting point to note is that the Futures price did increase towards the end of 14th Jan and the dividend announcement was done after the market hours.
Was somebody leaking the information to few folks?
Insider information and trading can't be ruled out in this case.
Thanks
Ratan
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