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DERIVATIVES FUTURES AND OPTIONS

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INTRODUCTION TO DERIVATIVES
Derivative is a product whose value is derived from the value of one or more basic variables, called bases which can be:
index value, value of an underlying assets

The underlying asset can be equity, forex, commodity or any other asset.

DEFINITION
The term Derivative has been defined in securities

Contracts (Regulations) Act, as:A Derivative includes: a security derived from a debt instrument, share, loan,

whether secured or unsecured, risk instrument or contract for differences or any other form of security; a contract which derives its value from the prices, or index of prices, of underlying securities

Forwards

Futures
Options Warrants

Leaps
Baskets Swaps

Swaptions

The essential features of a forward contract are: Contract between two parties Price decided today Quantity decided today Quality decided today Settlement will take place sometime in future No margins are generally payable by any of the parties to the other

IMPORTANCE OF FORWARD CONTRACTS: Hedging Speculation


NEGATIVE ASPECTS OF FORWARD CONTRACTS Too much of flexibility and generality Counter party Risk

A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price.
Exchange traded Standardized

F= SerT R= cost of financing T= time till expiration in years E= 2.71828 S= Spot Price If, Nifty is at 4500, thus using this formula, futures price is 4545.

OPTIONS:
Option is the derivative product traded on NSE An option gives the holder of the options the right to do something. Whereas it costs except margin requirements to enter into a futures contract, the purchase of an option requires an upfront payment.

Call Option: A call option gives the holder the right

but not the obligation to buy an asset by a certain date for a certain price.
Put Option: A put option gives the holder the right but

not the obligation to sell an asset by a certain date for a certain price.

The contract months available for options: one, two and three-month contracts available Strike price or exercise price: The price at which you have the right to buy or sell is called the strike price.

Index based futures


One, two, three month expiry cycles. All contracts expire on the last Thursday. On the Friday, new contract with 3 month expiry would be

introduced. Minimum lot size is 50 units.


Individual stock futures

Settlement is on the basis of mark-to-market Final settlement will be Cash-settled on T+1 basis. Expiration cycle same as for index futures.

Index based options


One, two, three month expiry cycles. Seven different strikes available for trading.

Individual stock options


These contracts are cash settled on T+1 basis. These options are American style options.

As there are mainly three types of investors :hedgers, speculators and arbitrageurs

Hedging means minimizing ones losses. The futures market was created as a parallel market

where one can create a reverse position to the one in

the cash market,


so that the loss (profit) in cash market gets offset by

profits (loss) in the futures market.

Suppose you have a view that the markets will bounce

back after two months. You buy two or three month Sensex futures. Here you are betting that the markets will increase and want to profit from it. Somebody buying or selling futures without any exposure in the underlying is doing it with a speculative intent and hopes to profit from any unforeseen movements. Speculative trades no doubt require higher margins since they are riskier. This can result in windfall profits or losses based on market movements.

Stock index arbitrage is buying and selling between

cash and futures market to profit from any under or overpricing in either of the markets.
It involves buying and selling two different futures

either in different indices or with different maturities.

With the help of various strategies a person can earn

irrespective of the fact whether market is going up or down. With the help of derivative market we can convert our unlimited losses into the limited ones. Derivatives-Futures and Options can be used as effective risk managing tool, and one can earn risk less profits.

THANK YOU

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