Futures and options F&O trading requires investors and traders to calculate the average buying price of contracts or securities purchased, called the buy average. So this helps to assess profitability, performance and risk associated with F&O trades.
Calculating a buy average involves considering multiple buy transactions with their respective quantities and prices to calculate one consolidated average purchase price for one F&O contract or security. Knowing the calculation process gives investors greater power to manage their portfolios effectively while optimising trading activities.
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Every investor hopes to pay less and gain more; unfortunately, in the share market, you cannot predict accurate share prices and returns accurately enough to do this. Like everyone else, you might buy your stocks when they reach a peak, only to wait until it's time to exit. So judicious price averaging may help; using a simple average will result in losses being reduced by investors. Hence, it is important to understand the right way to calculate the buy average.
Uncertainty and volatility in share prices are regular features of the stock market. Price fluctuations of securities are, therefore, normal occurrences. Also, as an investor, you will probably want to purchase stocks at reasonable prices with long-term objectives in mind.
An appropriate average in the stock market could be the answer to achieving reasonable stock prices that provide adequate returns. Thus, average pricing is ideal for long-term buying and selling decisions.
Let us understand how to calculate the buy average for the F&O positions.
The position's average price can vary when the same contract is traded multiple times. F&O buy averages are calculated using FIFO (First In, First Out), regardless of the product typically used to close positions (MIS or NRML).
Since all trades must utilise the FIFO method, applying this same calculation when filing income tax returns makes sense.
Let’s consider the following trades to understand FIFO:
|Date||Symbol||Trade Type||Quantity||Rate (₹)|
In the above case, the buy trade executed on 06th August would become the open quantity by day end, and hence its average price would be Rs 12100 on 07th August irrespective of product type (NRML/MIS).
P&L will show a booked profit of Rs 3750 [i.e. (12050-12000)*75], while position details show an open position gain/loss equalling Rs 12100 as gain/loss for open trades.
FIFO logic applies equally well for carried forward (NRML) and intra-day (MIS) trades. Yet an MIS position can only be closed using its related product type, and also, for NRMLs, an NRML position can never be closed using MIS product types and vice versa.
Some reasons behind the use of the FIFO method are:
The FIFO method assumes that trades executed first will be closed or settled first - in other words, earlier transactions should be sold off before later ones. This ties in well with accounting's basic principle, which emphasizes recording and valuing items according to when they were acquired.
F&O trades involve opening and closing multiple positions at various times and prices; to accurately represent an average buy price, it is vitally important to determine their respective acquisition costs using FIFO principles to account for all positions equally over time. Hence, this ensures an accurate reflection of an accurate average buy price representation.
The FIFO accounting method has long been accepted by regulatory authorities like tax and financial regulators as a reliable means of keeping transactions compliant and transparent. So this is applicable when it comes to gains, losses, and tax obligations. By employing this accounting practice, traders can remain compliant with regulatory requirements.
So the FIFO method helps to calculate the Buy Average. It is easy for traders of various levels of expertise to implement. No complex calculations or subjective judgment are needed; rather, it works off the chronological order of transactions. We hope that traders have an idea of how the FIFO method works.