HDFC Securities LTD.: Basics On Futures & Options

HDFC Securities Ltd.
Basics on Futures & Options
Structured by:
1
Derivatives
Derivative is a product whose value is derived from the value of the underlying asset. Underlying asset can be equity, forex, commodity, or any other asset.
Features
Centralization of Trading No counter party risk Standardization of contracts Liquidity Mark to Market (MTM) margining system
3
Features
contd
No. of contracts existing at any given point of time is called Open Interest. Squared off in cash on expiration. Three series trade at any point in time. The market lot is 200 for Nifty and 50 for Sensex Contract expires on last Thursday of the month
4
Options
Hyundai is launching SONATA Price is Rs 15 Lakh You can book the car by paying Rs 50,000
contd
By booking the car, what have you bought? When booking matures, can Hyundai force you to buy SONATA? Can you force Hyundai to sell SONATA?
6
Options
gives the buyer the right not the obligation to buy or sell a specified underlying at a set price on or before a specified date
Features
Option Premium
Price paid by the buyer to acquire the right Intrinsic and Time
Strike Price or Exercise Price

Price at which the underlying may be purchased or sold
Strike Prices
In-the-money (ITM)
Option with positive cash flow
At-the-money (ATM)
Exercise Price = Market Price
Out-of-the-money (OTM)
Option with negative cash flow
9
contd
At-The-Money-Strike In-The-Money Calls Out-The-Money-Calls 950 1050 1150 1250 1350 1450 1550
Spot
950 1050 1150 1250 1350 1450 1550 Out-The-Money-Puts In-The-Money-Puts At-The-Money-Strike
10
contd
Expiration Date
Last date for exercising the option or the date on which option expires.
Exercise Date
Date on which the option is actually exercised
11
contd
Assignment
When the holder of an option exercises his right to buy/ sell, a randomly selected option seller (at the client level) is assigned the obligation to honor the underlying contract
Open Interest
The total number of options contracts outstanding in the market at any given point of time.
12
Types of Option
European Option
can be exercised only on the expiration date
American Option
can be exercised any time on or before the expiration date
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Call Option
A call option gives the buyer, the right to buy specified quantity of the underlying asset at the set strike price on or before expiration date. The seller (writer) however, has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy.
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Buying of a Call Option

View: Bullish Buy a one month Nifty Call With the Strike of 1250 Premium of Rs 100
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Payoffs
Nifty Spot 1000 1100 1200 1250 1350 1400 1500
Below strike Value of 1250 call Premium paid Net Profit / (Loss) 0
Below strike 0
Below strike 0
At strike
Break even 100
Above strike 150
Above strike 250
-100
-100
-100
-100
-100
-100
-100
-100
-100
-100
-100
50
150
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200
Payoff chart
150
100
50
0 1,000
1,100
1,200
1,250
1,350
1,450
1,550
-50
-100
HDFC Securities Ltd. -150
17
Selling of a Call Option

View: Bearish Sell / Write a one month Nifty Call With the Strike of 1250 Premium of Rs 100
18
Payoffs
Nifty Spot 1000 1100 1200 1250 1350 1450 1550
Below strike Value of 1250 call Premium recd Net Profit / (Loss) 0
Below strike 0
Below strike 0
At strike
Break even -100
Above strike -200
Above strike -300
100
100
100
100
100
100
100
100
100
100
100
-100
-200
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Payoff Chart
200 150 100
50
0 1,000
1,100
1,200
1,250
1,350
1,450
1,550
-50
-100
-150
-200
-250 HDFC Securities Ltd.
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Put Option
A Put option gives the buyer the right to sell specified quantity of the underlying asset at the set strike price on or before expiration date. The seller (writer) however, has the obligation to buy the underlying asset if the buyer of the put option decides to exercise his option to sell.
21
Buying of a Put Option

View: Bearish Buy a one month Nifty Put With the Strike of 1250 Premium of Rs 100
22
Payoffs
Nifty Spot 1000 1100 1150 1250 1350 1450 1550
Below strike Value of 1250 put Premium paid Net Profit / (Loss) 250
Below strike 150
Break even 100
At strike
Above strike 0
Above strike 0
Above strike 0
-100
-100
-100
-100
-100
-100
-100
150
50
-100
-100
-100
-100
23
Payoff Chart
200 150
100
50
0 950
1050
1150
1250
1350
1450
1550
-50
-100
24
Selling of a Put Option

View: Bullish Sell / write a one month Nifty Put With the Strike of 1250 Premium of Rs 100
25
Payoff
Nifty Spot 1000 1100 1150 1250 1350 1450 1550
Below strike Value of 1250 put Premium recd Net Profit / (Loss) -250
Below strike -150
Break even -100
At strike
Above strike 0
Above strike 0
Above strike 0
100
100
100
100
100
100
100
-150
-50
100
100
100
100
26
Payoff Chart
200 150 100
50
0 950
1050
1150
1250
1350
1450
1550
-50
-100
-150
-200
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Futures Contract
Agreement between two parties to exchange an asset at a certain date in future at a certain price. It is a standardized forward contract that is traded on an exchange.
32
Futures Buyer
Mr. X buys a Nifty futures at 1250.
Nifty 1,000 1,100 1,200 1,300 1,400
Payoff -250 -150 -50 50 150

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Payoff for Futures buyer

250 150
50
1,000 -50
1,100
1,200
1,300
1,400
1,500
1250
-150
-250
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Futures Seller
Mr. X sells a Nifty futures at 1250.
Nifty 1,000 1,100 1,200 1,300 1,400
Payoff 250 150 50 -50 -150

35
Payoff for Futures seller

250 150
50
1,000 -50
1,100
1,200
1,300
1,400
1,500
1250
-150
-250
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MTM margining system

Mr. X buys Nifty futures at 1050
Date 23rd July 24th July 25th July TOTAL
Closing 1100 1000 1200
MTM a/c +50 -100 +200 +150

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Points to remember
Derivatives can be a very effective tool to take advantage of a rising, falling and range bound underlying. The following points may be kept in mind while trading in derivative products: Choose a month that allows enough time for the anticipated move in the underlying. In-the-money calls are initially more responsive to underlying price changes than out-of-the-money calls. Choose a strike price level that offers a good risk/reward ratio given the expected price movement.
41
contd
Watch for Bid/Ask price offered for Spot, Future, & Options simultaneously Liquidity of products involved Transaction Costs
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To sum up
Derivatives is a financial instrument with Infinite Opportunities

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Thank You
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HDFC Securities Ltd.

Basics on Futures & Options