Description
Derivatives Concept
Forwards Futures Options Swaps
What are Derivatives ?
Derivatives are financial instruments whose value depends upon the value of an
• Equities (most common in Indian markets)
• Commodities (the oldest form of derivatives) • Currencies (forex rates) • Interest rates • Debt instruments (bonds, T – Bills)
• Traded on stock/derivative exchange • Derivative Exchange/Segment - SelfRegulatory Organization (SRO) • SEBI - oversight regulator. • Clearing & settlement is done through a Clearing House • Entities to trading system ? ? ? ? Trading member Clearing member Trading member – Clearing member Self clearing member
Participants
Hedgers
Speculators
Arbitrageurs
FORWARDS
FUTURES
TYPES OPTIONS SWAPS
Forwards
A Forward contract is an agreement to buy or sell an asset on a specified date for a specific price.
At start Omkar Buy Rs 10,40,000 Sell At end of 1 year Omkar Ashika (Initial price10,00,000)
Buy Rs 10,40,000 Sell Ashika (Market valuation11,00,000)
How prices are agreed upon
Buy Omkar Rs 10,40,000
Sell
Ashika
Rs.10,00,000
Bank deposit @ 4%
Futures
•A future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price.
•They are standard and highly liquid.
Example Rahul purchases following two lots of Nifty Futures Contracts on 4th Sept. 2000: October 2000 Series November 2000 Series 1 Contract @ 1 Contract @ Rs. 2,500 Rs. 2,850
Initial Margin is 6%, Amount of Margin -Rs 16,050 (50 Units per Contract on the NSE).
Futures payoff
Futures Terminology
• Spot Price (S) • Cost of carry
• Futures price (F) • Contract Size • Contract cycle • Basis • Futures Payoff • Open Interest • Normal Backwardation • Contango
• Initial margin • Mark to Market (MTM) margin
Example Romit buys Nifty futures at 1300 Day One Two Three Total Closing 1310 1305 1315 MTM a/c +10 -05 +10 +15
• Maintenance Margin
Convergence of Future price to spot price
Delivery period – Future price = Spot price i. Futures price delivery Period: spot price during the
•Sell a futures contract •Buy the asset •Make delivery
ii. Futures price delivery period : spot price during the
Companies will acquire the asset.
Future price and Expected Future spot Price
Commodity-Corn
Now
June 300 (spot price)
September 350 (future price)
Later
September Spot price < 350
OR September Spot price > 350
September Future price
September Future price
Options
An option is a contract giving the buyer the right, but not the obligation, to buy or sell an underlying (a stock or index) at a specific price on or before certain date.
American option
Exercise before maturity
European option
Exercise only on maturity
Options Terminology
• Index options
• Stock Options • Option buyer
• Option premium
• Strike Price • Expiration Date
• Option seller
• Open Interest
Call Options
• A call option is a contract giving the buyer the right, but not the obligation, to buy an underlying (a stock or index) at a specific price on or before a certain date.
CALL OPTION
Eg:
Spot price: Rs 1000 Strike price = Rs 975 Option premium= Rs 50 Maturity: 3 months
Case I : Spot price < Strike price (Rs 950) (Rs 975)
Case II : Spot price > Strike price (Rs 1025) (Rs 975)
CALL OPTION
Spot price
950
975
990
1050
Exercised
Buyer Writer
No
-50 50
No
-50 50
Yes
-35 35
Yes
25 -25
Call option pay-off
50 0 -50
BEP
975
1025
BEP= Strike price + Premium
Put Options
• A put option is a contract giving the buyer the right, but not the obligation, to sell an underlying (a stock or index) at a specific price on or before a certain date.
PUT OPTION
Eg:
Spot price: Rs 1000 Strike price = Rs 975 Option premium= Rs 50 Maturity: 3 months
Case I : Spot price < Strike price (Rs 950) (Rs 975)
Case II : Spot price > Strike price (Rs 1025) (Rs 975)
PUT OPTION
Spot price
950
900
1000
1050
Exercised
Buyer Writer
Yes
-25 +25
Yes
+25 -25
No
-50 +50
No
-50 +50
Put option pay-off
50 0 -50
BEP
925
975
BEP= Strike price - Premium
Moneyness of an option
Call Option S>X S=X SX S=X S
Derivatives Concept
Forwards Futures Options Swaps
What are Derivatives ?
Derivatives are financial instruments whose value depends upon the value of an
• Equities (most common in Indian markets)
• Commodities (the oldest form of derivatives) • Currencies (forex rates) • Interest rates • Debt instruments (bonds, T – Bills)
• Traded on stock/derivative exchange • Derivative Exchange/Segment - SelfRegulatory Organization (SRO) • SEBI - oversight regulator. • Clearing & settlement is done through a Clearing House • Entities to trading system ? ? ? ? Trading member Clearing member Trading member – Clearing member Self clearing member
Participants
Hedgers
Speculators
Arbitrageurs
FORWARDS
FUTURES
TYPES OPTIONS SWAPS
Forwards
A Forward contract is an agreement to buy or sell an asset on a specified date for a specific price.
At start Omkar Buy Rs 10,40,000 Sell At end of 1 year Omkar Ashika (Initial price10,00,000)
Buy Rs 10,40,000 Sell Ashika (Market valuation11,00,000)
How prices are agreed upon
Buy Omkar Rs 10,40,000
Sell
Ashika
Rs.10,00,000
Bank deposit @ 4%
Futures
•A future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price.
•They are standard and highly liquid.
Example Rahul purchases following two lots of Nifty Futures Contracts on 4th Sept. 2000: October 2000 Series November 2000 Series 1 Contract @ 1 Contract @ Rs. 2,500 Rs. 2,850
Initial Margin is 6%, Amount of Margin -Rs 16,050 (50 Units per Contract on the NSE).
Futures payoff
Futures Terminology
• Spot Price (S) • Cost of carry
• Futures price (F) • Contract Size • Contract cycle • Basis • Futures Payoff • Open Interest • Normal Backwardation • Contango
• Initial margin • Mark to Market (MTM) margin
Example Romit buys Nifty futures at 1300 Day One Two Three Total Closing 1310 1305 1315 MTM a/c +10 -05 +10 +15
• Maintenance Margin
Convergence of Future price to spot price
Delivery period – Future price = Spot price i. Futures price delivery Period: spot price during the
•Sell a futures contract •Buy the asset •Make delivery
ii. Futures price delivery period : spot price during the
Companies will acquire the asset.
Future price and Expected Future spot Price
Commodity-Corn
Now
June 300 (spot price)
September 350 (future price)
Later
September Spot price < 350
OR September Spot price > 350
September Future price
September Future price
Options
An option is a contract giving the buyer the right, but not the obligation, to buy or sell an underlying (a stock or index) at a specific price on or before certain date.
American option
Exercise before maturity
European option
Exercise only on maturity
Options Terminology
• Index options
• Stock Options • Option buyer
• Option premium
• Strike Price • Expiration Date
• Option seller
• Open Interest
Call Options
• A call option is a contract giving the buyer the right, but not the obligation, to buy an underlying (a stock or index) at a specific price on or before a certain date.
CALL OPTION
Eg:
Spot price: Rs 1000 Strike price = Rs 975 Option premium= Rs 50 Maturity: 3 months
Case I : Spot price < Strike price (Rs 950) (Rs 975)
Case II : Spot price > Strike price (Rs 1025) (Rs 975)
CALL OPTION
Spot price
950
975
990
1050
Exercised
Buyer Writer
No
-50 50
No
-50 50
Yes
-35 35
Yes
25 -25
Call option pay-off
50 0 -50
BEP
975
1025
BEP= Strike price + Premium
Put Options
• A put option is a contract giving the buyer the right, but not the obligation, to sell an underlying (a stock or index) at a specific price on or before a certain date.
PUT OPTION
Eg:
Spot price: Rs 1000 Strike price = Rs 975 Option premium= Rs 50 Maturity: 3 months
Case I : Spot price < Strike price (Rs 950) (Rs 975)
Case II : Spot price > Strike price (Rs 1025) (Rs 975)
PUT OPTION
Spot price
950
900
1000
1050
Exercised
Buyer Writer
Yes
-25 +25
Yes
+25 -25
No
-50 +50
No
-50 +50
Put option pay-off
50 0 -50
BEP
925
975
BEP= Strike price - Premium
Moneyness of an option
Call Option S>X S=X SX S=X S