Description
This is a PPT highlighting on Derivatives.Covers Futures,Options,warrants,swaps,rates in detail.Useful for person wanting to understand the basics of derivatives.
Derivatives
Introduction to derivatives
Emergence of Derivatives
• The emergence of the market for
derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices.
Derivatives defined
• In the Indian Context the Securities Contract (Regulation) Act, 1956 SC(R)A defines “derivative” to include• 1) 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. • 2) A contract which derives its value, from the prices or index of prices, of underlying securities.
• Derivatives are securities under the SC(R)A and hence the trading of derivatives is governed by the regulatory framework under the SC(R)A.
Products , participants and functions.
• Forwards, Futures, Options and Swaps. • Hedgers, Speculators and Arbitragers. • Reduce or eliminate risk, leverage potential gains or losses, taking advantage of a discrepancy between two different markets .
Derivatives market performs a number of economic functions
• Reflect the perception of market participants about the future and lead the prices of underlying to the perceived future level. • The prices of derivatives converge with that of the underlying at the time of expiration of the derivative contract. Thus derivatives help in discovery of the future as well as the current prices.
Economic funtions…contd
• Derivatives market helps to transfer risks from those who have them but may not like them to those who have an appetite for them. • The underlying markets witnesses higher trading volumes because of participation by more players who would otherwise not participate for lack of an arrangement to transfer risk.
Economic functions …contd
• Speculative trades shift to a more controlled environment of derivatives market. • Incidental benefit- it acts as a catalyst for new entrepreneurial activity. It attracts many bright, creative and well-educated people to create new businesses, new products and new employment opportunities.
Economic functions… contd
• Finally, it helps increase savings and investments in the long run. • Transfer of risk enables market participants to expand their volume of activity.
Types of derivatives
• Forwards: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today’s pre-agreed price.
Types of derivatives-2
• Futures: 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. This are special types of forward contracts in the sense that they are standardized exchange-traded contracts.
Types of derivatives-3
• Options: Options are of two types – calls and puts. Calls give the buyer the right not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right not the obligation to sell a given quantity of the underlying asset, at a given price on or before a given future date.
Types of derivatives-4
• Warrants: Longer dated options usually more than a year are called warrants are generally traded over-the-counter. • Basket options: Options on portfolios of underlying assets. e.g. Equity index options.
Types of derivatives-5
• Swaps – Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as a portfolio of forward contracts. The two commonly used swaps are : • Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency.
• Currency swaps: These entails swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.
Futures Terminology
• Spot price : The price at which the asset trades in the spot market .
• Futures price : The price at which the futures contract trade in the futures market. • Contract cycle: The period over which the contract trades. • Expiry Date: Last day on which the contract will be traded, then it ceases to exist. • Contract size: The quantity that has to be delivered under one contract. • Basis: Futures price minus the spot price. In a normal market, basis will be positive.
Futures terminology…contd
• Cost of carry : This is the relationship between the spot price and the futures price. This measures the storage cost plus the interest that is to be paid to finance the asset less the income earned on the asset.
• Initial margin : The amount that must be deposited in the margin account at the time the futures contract is first entered into.
Futures terminolgy…contd
• Marking-to-market : At the end of each trading day, the margin account is adjusted to reflect the investors gain or loss depending upon the closing price. • Maintenance Margin : This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and he is expected to bring it to the levels of initial margin before trading commences the next day.
Options terminolgy
• Index options: Index is the underlying. There can be European or American index options. • Stock options: Options on individual stocks. • Buyer of an option : One who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer.
Options terminology…2
• Writer of an option : Writer of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.
• Call option : A call option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price.
Options terminology…3
• Put option : A put option gives the holder the right to sell but not the obligation to sell an asset by a certain date for a certain price.
• Option price: The price the option buyer pays to the option seller. Also called option premium.
Options terminology…4
• Expiration date : The date specified in the options contract. Also called exercise date, the strike date or the maturity.
• Strike price : The price specified in the options contract. Also called Exercise price.
Options terminology …5
• American Options: Options that can be exercised at any time up to the expiration date. Most exchange traded options are American. • European Options : Options that can be exercised only on the expiration date itself.
Options terminology…6
• In-the-money option: An option that would lead to a positive cashflow if it were exercised immediately. i.e. Spot price > Exercise price for call option and Exercise price > spot price for put option. If the difference is very high, then it is deep in the money.
Options terminology…7
• At-the-money option: An option that would lead to a zero cashflow if it were exercised immediately. i.e. Spot price = Exercise price for both call and put option .
Options terminology…8
• Out-of-the-money option: An option that would lead to a negative cashflow if it were exercised immediately. i.e. Spot price < Exercise price for call option and Exercise price < spot price for put option. If the difference is very high, then it is deep out of the money.
Options terminology…9
• Intrinsic value of an option : The option premium can be broken down into two components – intrinsic value and time value. • Call option intrinsic value = Max[0, S-K]
• Put option intrinsic value = Max[0, K-S]
• K=Strike price , S=Spot price at time t .
Options terminology…10
• Time value of an option : Difference between premium and intrinsic value. An option that is OTM or ATM has only time value. Longer the time to expiration, greater is an options time value. At expiration the option should have no time value.
• THANK YOU.
doc_952702977.ppt
This is a PPT highlighting on Derivatives.Covers Futures,Options,warrants,swaps,rates in detail.Useful for person wanting to understand the basics of derivatives.
Derivatives
Introduction to derivatives
Emergence of Derivatives
• The emergence of the market for
derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices.
Derivatives defined
• In the Indian Context the Securities Contract (Regulation) Act, 1956 SC(R)A defines “derivative” to include• 1) 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. • 2) A contract which derives its value, from the prices or index of prices, of underlying securities.
• Derivatives are securities under the SC(R)A and hence the trading of derivatives is governed by the regulatory framework under the SC(R)A.
Products , participants and functions.
• Forwards, Futures, Options and Swaps. • Hedgers, Speculators and Arbitragers. • Reduce or eliminate risk, leverage potential gains or losses, taking advantage of a discrepancy between two different markets .
Derivatives market performs a number of economic functions
• Reflect the perception of market participants about the future and lead the prices of underlying to the perceived future level. • The prices of derivatives converge with that of the underlying at the time of expiration of the derivative contract. Thus derivatives help in discovery of the future as well as the current prices.
Economic funtions…contd
• Derivatives market helps to transfer risks from those who have them but may not like them to those who have an appetite for them. • The underlying markets witnesses higher trading volumes because of participation by more players who would otherwise not participate for lack of an arrangement to transfer risk.
Economic functions …contd
• Speculative trades shift to a more controlled environment of derivatives market. • Incidental benefit- it acts as a catalyst for new entrepreneurial activity. It attracts many bright, creative and well-educated people to create new businesses, new products and new employment opportunities.
Economic functions… contd
• Finally, it helps increase savings and investments in the long run. • Transfer of risk enables market participants to expand their volume of activity.
Types of derivatives
• Forwards: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today’s pre-agreed price.
Types of derivatives-2
• Futures: 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. This are special types of forward contracts in the sense that they are standardized exchange-traded contracts.
Types of derivatives-3
• Options: Options are of two types – calls and puts. Calls give the buyer the right not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right not the obligation to sell a given quantity of the underlying asset, at a given price on or before a given future date.
Types of derivatives-4
• Warrants: Longer dated options usually more than a year are called warrants are generally traded over-the-counter. • Basket options: Options on portfolios of underlying assets. e.g. Equity index options.
Types of derivatives-5
• Swaps – Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as a portfolio of forward contracts. The two commonly used swaps are : • Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency.
• Currency swaps: These entails swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.
Futures Terminology
• Spot price : The price at which the asset trades in the spot market .
• Futures price : The price at which the futures contract trade in the futures market. • Contract cycle: The period over which the contract trades. • Expiry Date: Last day on which the contract will be traded, then it ceases to exist. • Contract size: The quantity that has to be delivered under one contract. • Basis: Futures price minus the spot price. In a normal market, basis will be positive.
Futures terminology…contd
• Cost of carry : This is the relationship between the spot price and the futures price. This measures the storage cost plus the interest that is to be paid to finance the asset less the income earned on the asset.
• Initial margin : The amount that must be deposited in the margin account at the time the futures contract is first entered into.
Futures terminolgy…contd
• Marking-to-market : At the end of each trading day, the margin account is adjusted to reflect the investors gain or loss depending upon the closing price. • Maintenance Margin : This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and he is expected to bring it to the levels of initial margin before trading commences the next day.
Options terminolgy
• Index options: Index is the underlying. There can be European or American index options. • Stock options: Options on individual stocks. • Buyer of an option : One who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer.
Options terminology…2
• Writer of an option : Writer of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.
• Call option : A call option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price.
Options terminology…3
• Put option : A put option gives the holder the right to sell but not the obligation to sell an asset by a certain date for a certain price.
• Option price: The price the option buyer pays to the option seller. Also called option premium.
Options terminology…4
• Expiration date : The date specified in the options contract. Also called exercise date, the strike date or the maturity.
• Strike price : The price specified in the options contract. Also called Exercise price.
Options terminology …5
• American Options: Options that can be exercised at any time up to the expiration date. Most exchange traded options are American. • European Options : Options that can be exercised only on the expiration date itself.
Options terminology…6
• In-the-money option: An option that would lead to a positive cashflow if it were exercised immediately. i.e. Spot price > Exercise price for call option and Exercise price > spot price for put option. If the difference is very high, then it is deep in the money.
Options terminology…7
• At-the-money option: An option that would lead to a zero cashflow if it were exercised immediately. i.e. Spot price = Exercise price for both call and put option .
Options terminology…8
• Out-of-the-money option: An option that would lead to a negative cashflow if it were exercised immediately. i.e. Spot price < Exercise price for call option and Exercise price < spot price for put option. If the difference is very high, then it is deep out of the money.
Options terminology…9
• Intrinsic value of an option : The option premium can be broken down into two components – intrinsic value and time value. • Call option intrinsic value = Max[0, S-K]
• Put option intrinsic value = Max[0, K-S]
• K=Strike price , S=Spot price at time t .
Options terminology…10
• Time value of an option : Difference between premium and intrinsic value. An option that is OTM or ATM has only time value. Longer the time to expiration, greater is an options time value. At expiration the option should have no time value.
• THANK YOU.
doc_952702977.ppt