Introduction To Derivatives
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INTRODUCTION TO OPTIONS AND FUTURES
CLASSIFICATION OF FINANACIAL MARKETS
NATURE OF CLAIM MATURITY OF CLAIM SEASONING OF CLAIM TIMING OF DELIVERY ORGANISATIONAL STRUCTURE
DERIVATIVE ACCORDING TO SC(R) ACT 1956; -
A SECURITY DERIVED FROM DEBT INSTRUMENT,SHARE,LOAN,CONTRACT FOR DIFFERENCES,COMMODITY,INDEX OR ANY OTHER FORM OF SECURITY
-
A CONTRACT WHICH DERIVES ITS VALUE FROM THE PRICES OF UNDERLYING SECURITIES/ASSETS.
FINANCIAL DERIVATIVES
FORWARD CONTRACTS
FUTURES
OPTIONS
FORWARD CONTRACTS
AN AGREEMENT BETWEEN TWO PARTIES TO BUY OR SELL AN ASSET AT A SPECIFIED FUTURE DATE AND PRICE
-
OTC CONTRACT BILATERAL CUSTOMISED PRICE IS NOT AVAILABLE PUBLICLY SETTLEMENT BY DELIVERY ON MATURITY
LIMITATIONS OF FORWARD CONTRACTS
LACK OF CENTRALISED TRADING
ILLIQUIDITY
COUNTERPARTY RISK
FUTURES
-
-
AN AGREEMENT TO BUY OR SELL AN ASSET/SECURITY IN FUTURE AT A CERTAIN PRICE EXCHANGE TRADED ANONYMOUS TRADING STANDARDISED MARGINS MARK TO MARKET SETTLEMENT IS GUARANTEED
FUTURES V/S FORWARDS
EXCHANGE TRADED STANDARDISE D LIQUID REQUIRES MARGIN DAILY SETTLEMENT
OTC IN NATURE
CUSTOMISED ILLIQUID NO MARGIN ON MATURITY
OPTIONS
A CONTRACT WHICH GIVES RIGHT BUT WITH NO OBLIGATION
-
CALL OPTION:OPTION THAT GIVES RIGHT TO BUY A SECURITY
-
PUT OPTION:OPTION THAT GIVES RIGHT TO SELL A SECURITY
-
AMERICAN OPTION:CAN BE EXERCISED ANY TIME
-
EUROPEAN OPTION:CAN BE EXERCISED ONLY ON MATURITY
-
Asian Options: Asian options are options whose payoffs depend on the average price of the underlying asset during some portion of the life of the option.
FUTURES V/S OPTIONS
EXCHANGE TRADED STANDARDISED PRICE IS ZERO BOTH PARTIES ARE REQUIRED TO PERFORM LINEAR PAY OFF BOTH LONG AND SHORT ARE AT RISK
EXCHANGE TRADED STANDARDISED OPTION PREMIUM ONLY OPTION WRITER WILL HAVE OBLIGATION NON LINEAR PAY OFF ONLY SHORT IS AT RISK
Options BUYER/HOLDER
SELLER/WRITER
RIGHTS/ OBLIGATIONS RIGHTS
BUYERS HAVE RIGHTSNO OBLIGATIONS
SELLERS HAVE ONLY OBLIGATIONS-NO
CALL
RIGHT TO BUY/TO GO LONG
OBLIGATION TO SELL/GO SHORT ON EXERCISE
PUT BUY/GO
RIGHT TO SELL/ TO
PREMIUM
PAID
EXERCISE
BUYER’S DECISION
SELLER CANNOT INFLUENCE
MAX. LOSS POSSIBLE MAX. GAIN POSSIBLE CLOSING OPTION POSITION OF EXCHANGE TRADED
COST OF PREMUIM
UNLIMITED LOSSES
GO SHORT
UNLIMITED PROFITS • EXERCISE • OFFSET BY SELLING OPTION IN MARKET • LET OPTION LAPSE
OBLIGATION TO LONG ON EXERCISE RECEIVED
PRICE OF PREMIUM • ASSIGNMENT ON • OFFSET BY BUYING BACK OPTION IN MARKET • OPTION EXPIRES AND KEEP
FUNCTIONS OF DERIVATIVES MARKETS
RISK TRANSFER HIGH LIQUIDITY,PRICE DISCOVERY LOW TRANSACTION COSTS PROFITS WITH MINIMUM CAPITAL INDICATES MARKET PERCEPTION ELIMINATE SECURITY SPECIFIC RISK ARBITRAGE OPPORTUNITY
ORIGIN OF DERIVATIVES MARKET IN INDIA
1995 SECURITIES LAWS AMENDMENT ORDINANCE 1996 L.C.GUPTA COMMITTEE 1998 SUBMITTED ITS REPORT 1998 J.R.VARMA COMMITTEE 1999 SCR ACT AMENDED 2000 WITHDRAWAL OF BAN ON FORWARD TRADING
INTRODUCTION OF DERIVATIVES TRADING
12 JUNE 2000 INDEX FUTURES 4 JUNE 2001 INDEX OPTIONS 2 JULY 2001 STOCK OPTIONS 9 NOV 2001 STOCK FUTURES 24 JUNE 2003 INTEREST RATE FUTURES 29 AUG 2008 CURRENCY FUTURES
REQUIREMENTS FOR SUCESSFUL DERIVATIVES MARKETS
REGULATORY MECHANISM RISK MANAGEMENT TOOLS CLEARING CORPORATION MONITORING AND SURVEILANCE INVESTOR EDUCATION AND TRANING TECHNOLOGY
FACTORS LED FOR THE GROWTH OF DERIVATIVES
INSTABILITY IN MACROECONOMIC VARIABLES INCREASED VOLATILITY IN CASH MARKET INCREASED FOREIGN TRADE TECHNOLOGY REFINED PRICING TOOLS
PARTICIPANTS
SPECULATORS
HEDGERS
ARBITRAGEURS
USERS OF DERIVATIVES
COMPANIES MUTUAL FUNDS BANKS BROKERS PORTFOLIO MANAGERS/ADVISERS INDIVIDUALS
Terminology -
OPTION HOLDER AND OPTION WRITER
– EXERCISE PRICE OR STRIKING PRICE – EXPIRATION DATE OR MATURITY DATE – EUROPEAN OPTION AND AMERICAN OPTION – EXCHANGE-TRADED OPTIONS AND OTC OPTIONS – AT THE MONEY, IN THE MONEY, AND OUT OF THE MONEY OPTIONS
Futures Terminology SPOT PRICE FUTURES PRICE CONTRACT CYCLE EXPIRY DATE CONTRACT SIZE THE AMOUNT OF ASSET THAT HAS TO BE DELIVERED UNDER ONE CONTRACT. FOR INSTANCE, THE CONTRACT SIZE ON NSE’S FUTURES IS 50 NIFTIES BASIS FUTURES PRICE - SPOT PRICE INITIAL MARGIN MARKING TO MARKET MAINTENANCE MARGIN
OPTION PAYOFF
OPTION BUYER-CALL OPTION STRIKE PRICE
SPOT PRICE OPTION PRICE
PAY OFF
500
400
20
-20
500
450
20
-20
500
500
20
-20
500
550
20
+30
500
600
20
+80
500
650
20
+130
140
120
100
80
60 PAY OFF 40
20
0
-20
-40
OPTION BUYER-PUT OPTION STRIKE PRICE
SPOT PRICE
OPTION PRICE
PAY OFF
2000
1700
50
+250
2000
1800
50
+150
2000
1900
50
+50
2000
2050
50
0
2000 2000 2000
2100 2150 2200
50 50 50
-50 -50 -50
300
250
200
150
100
50
0
-50
-100
PAY OFF
OPTION SELLER-CALL OPTION STRIKE PRICE
SPOT PRICE
OPTION PRICE
PAY OFF
500
400
20
+20
500
450
20
+20
500
500
20
+20
500
550
20
-30
500
600
20
-80
500
650
20
-130
40 20 0 -20 -40 PAY OFF -60 -80 -100 -120 -140
OPTION SELLER-PUT OPTION STRIKE PRICE
SPOT PRICE
OPTION PRICE
PAY OFF
2000 2000 2000 2000 2000 2000 2000
1700 1800 1900 2050 2100 2200 2300
50 50 50 50 50 50 50
-250 -150 -50 +50 +50 +50 +50
100
50
0
-50
-100
-150 -200
-250
-300
PAY OFF
FUTURES PAYOFF
PAY OFF FOR FUTURES BUYER FUTURES PRICE
SPOT PRICE
PAY OFF
2000
1800
-200
2000
1900
-100
2000
2000
0
2000
2100
100
2000
2200
200
250 200 150 100 50 0 -50 -100 -150 -200 -250
PAY OFF
PAY OFF FOR FUTURES SELLER FUTURES PRICE
SPOT PRICE
PAY OFF
2000
1800
200
2000
1900
100
2000
2000
0
2000
2100
-100
2000
2200
-200
250
200
150
100
50
0
-50
-100
-150
-200
-250
PAY OFF
CLASSIFICATION OF FINANACIAL MARKETS
NATURE OF CLAIM MATURITY OF CLAIM SEASONING OF CLAIM TIMING OF DELIVERY ORGANISATIONAL STRUCTURE
DERIVATIVE ACCORDING TO SC(R) ACT 1956; -
A SECURITY DERIVED FROM DEBT INSTRUMENT,SHARE,LOAN,CONTRACT FOR DIFFERENCES,COMMODITY,INDEX OR ANY OTHER FORM OF SECURITY
-
A CONTRACT WHICH DERIVES ITS VALUE FROM THE PRICES OF UNDERLYING SECURITIES/ASSETS.
FINANCIAL DERIVATIVES
FORWARD CONTRACTS
FUTURES
OPTIONS
FORWARD CONTRACTS
AN AGREEMENT BETWEEN TWO PARTIES TO BUY OR SELL AN ASSET AT A SPECIFIED FUTURE DATE AND PRICE
-
OTC CONTRACT BILATERAL CUSTOMISED PRICE IS NOT AVAILABLE PUBLICLY SETTLEMENT BY DELIVERY ON MATURITY
LIMITATIONS OF FORWARD CONTRACTS
LACK OF CENTRALISED TRADING
ILLIQUIDITY
COUNTERPARTY RISK
FUTURES
-
-
AN AGREEMENT TO BUY OR SELL AN ASSET/SECURITY IN FUTURE AT A CERTAIN PRICE EXCHANGE TRADED ANONYMOUS TRADING STANDARDISED MARGINS MARK TO MARKET SETTLEMENT IS GUARANTEED
FUTURES V/S FORWARDS
EXCHANGE TRADED STANDARDISE D LIQUID REQUIRES MARGIN DAILY SETTLEMENT
OTC IN NATURE
CUSTOMISED ILLIQUID NO MARGIN ON MATURITY
OPTIONS
A CONTRACT WHICH GIVES RIGHT BUT WITH NO OBLIGATION
-
CALL OPTION:OPTION THAT GIVES RIGHT TO BUY A SECURITY
-
PUT OPTION:OPTION THAT GIVES RIGHT TO SELL A SECURITY
-
AMERICAN OPTION:CAN BE EXERCISED ANY TIME
-
EUROPEAN OPTION:CAN BE EXERCISED ONLY ON MATURITY
-
Asian Options: Asian options are options whose payoffs depend on the average price of the underlying asset during some portion of the life of the option.
FUTURES V/S OPTIONS
EXCHANGE TRADED STANDARDISED PRICE IS ZERO BOTH PARTIES ARE REQUIRED TO PERFORM LINEAR PAY OFF BOTH LONG AND SHORT ARE AT RISK
EXCHANGE TRADED STANDARDISED OPTION PREMIUM ONLY OPTION WRITER WILL HAVE OBLIGATION NON LINEAR PAY OFF ONLY SHORT IS AT RISK
Options BUYER/HOLDER
SELLER/WRITER
RIGHTS/ OBLIGATIONS RIGHTS
BUYERS HAVE RIGHTSNO OBLIGATIONS
SELLERS HAVE ONLY OBLIGATIONS-NO
CALL
RIGHT TO BUY/TO GO LONG
OBLIGATION TO SELL/GO SHORT ON EXERCISE
PUT BUY/GO
RIGHT TO SELL/ TO
PREMIUM
PAID
EXERCISE
BUYER’S DECISION
SELLER CANNOT INFLUENCE
MAX. LOSS POSSIBLE MAX. GAIN POSSIBLE CLOSING OPTION POSITION OF EXCHANGE TRADED
COST OF PREMUIM
UNLIMITED LOSSES
GO SHORT
UNLIMITED PROFITS • EXERCISE • OFFSET BY SELLING OPTION IN MARKET • LET OPTION LAPSE
OBLIGATION TO LONG ON EXERCISE RECEIVED
PRICE OF PREMIUM • ASSIGNMENT ON • OFFSET BY BUYING BACK OPTION IN MARKET • OPTION EXPIRES AND KEEP
FUNCTIONS OF DERIVATIVES MARKETS
RISK TRANSFER HIGH LIQUIDITY,PRICE DISCOVERY LOW TRANSACTION COSTS PROFITS WITH MINIMUM CAPITAL INDICATES MARKET PERCEPTION ELIMINATE SECURITY SPECIFIC RISK ARBITRAGE OPPORTUNITY
ORIGIN OF DERIVATIVES MARKET IN INDIA
1995 SECURITIES LAWS AMENDMENT ORDINANCE 1996 L.C.GUPTA COMMITTEE 1998 SUBMITTED ITS REPORT 1998 J.R.VARMA COMMITTEE 1999 SCR ACT AMENDED 2000 WITHDRAWAL OF BAN ON FORWARD TRADING
INTRODUCTION OF DERIVATIVES TRADING
12 JUNE 2000 INDEX FUTURES 4 JUNE 2001 INDEX OPTIONS 2 JULY 2001 STOCK OPTIONS 9 NOV 2001 STOCK FUTURES 24 JUNE 2003 INTEREST RATE FUTURES 29 AUG 2008 CURRENCY FUTURES
REQUIREMENTS FOR SUCESSFUL DERIVATIVES MARKETS
REGULATORY MECHANISM RISK MANAGEMENT TOOLS CLEARING CORPORATION MONITORING AND SURVEILANCE INVESTOR EDUCATION AND TRANING TECHNOLOGY
FACTORS LED FOR THE GROWTH OF DERIVATIVES
INSTABILITY IN MACROECONOMIC VARIABLES INCREASED VOLATILITY IN CASH MARKET INCREASED FOREIGN TRADE TECHNOLOGY REFINED PRICING TOOLS
PARTICIPANTS
SPECULATORS
HEDGERS
ARBITRAGEURS
USERS OF DERIVATIVES
COMPANIES MUTUAL FUNDS BANKS BROKERS PORTFOLIO MANAGERS/ADVISERS INDIVIDUALS
Terminology -
OPTION HOLDER AND OPTION WRITER
– EXERCISE PRICE OR STRIKING PRICE – EXPIRATION DATE OR MATURITY DATE – EUROPEAN OPTION AND AMERICAN OPTION – EXCHANGE-TRADED OPTIONS AND OTC OPTIONS – AT THE MONEY, IN THE MONEY, AND OUT OF THE MONEY OPTIONS
Futures Terminology SPOT PRICE FUTURES PRICE CONTRACT CYCLE EXPIRY DATE CONTRACT SIZE THE AMOUNT OF ASSET THAT HAS TO BE DELIVERED UNDER ONE CONTRACT. FOR INSTANCE, THE CONTRACT SIZE ON NSE’S FUTURES IS 50 NIFTIES BASIS FUTURES PRICE - SPOT PRICE INITIAL MARGIN MARKING TO MARKET MAINTENANCE MARGIN
OPTION PAYOFF
OPTION BUYER-CALL OPTION STRIKE PRICE
SPOT PRICE OPTION PRICE
PAY OFF
500
400
20
-20
500
450
20
-20
500
500
20
-20
500
550
20
+30
500
600
20
+80
500
650
20
+130
140
120
100
80
60 PAY OFF 40
20
0
-20
-40
OPTION BUYER-PUT OPTION STRIKE PRICE
SPOT PRICE
OPTION PRICE
PAY OFF
2000
1700
50
+250
2000
1800
50
+150
2000
1900
50
+50
2000
2050
50
0
2000 2000 2000
2100 2150 2200
50 50 50
-50 -50 -50
300
250
200
150
100
50
0
-50
-100
PAY OFF
OPTION SELLER-CALL OPTION STRIKE PRICE
SPOT PRICE
OPTION PRICE
PAY OFF
500
400
20
+20
500
450
20
+20
500
500
20
+20
500
550
20
-30
500
600
20
-80
500
650
20
-130
40 20 0 -20 -40 PAY OFF -60 -80 -100 -120 -140
OPTION SELLER-PUT OPTION STRIKE PRICE
SPOT PRICE
OPTION PRICE
PAY OFF
2000 2000 2000 2000 2000 2000 2000
1700 1800 1900 2050 2100 2200 2300
50 50 50 50 50 50 50
-250 -150 -50 +50 +50 +50 +50
100
50
0
-50
-100
-150 -200
-250
-300
PAY OFF
FUTURES PAYOFF
PAY OFF FOR FUTURES BUYER FUTURES PRICE
SPOT PRICE
PAY OFF
2000
1800
-200
2000
1900
-100
2000
2000
0
2000
2100
100
2000
2200
200
250 200 150 100 50 0 -50 -100 -150 -200 -250
PAY OFF
PAY OFF FOR FUTURES SELLER FUTURES PRICE
SPOT PRICE
PAY OFF
2000
1800
200
2000
1900
100
2000
2000
0
2000
2100
-100
2000
2200
-200
250
200
150
100
50
0
-50
-100
-150
-200
-250
PAY OFF
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