GMCS Derivatives

8/4/2019 GMCS Derivatives

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Derivatives Jignesh Shah

Dhiren Prajapati

Kaustubh Parkar

Akash Jadhav

Deepali Jain

Rahul Gavali


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What will we look at?

Basic concepts of Derivatives

Futures

Options


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Derivatives

What is Derivatives?

Classification of Derivatives

Risk Associated with Derivatives

Participants of Derivatives


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A Derivative is a financial instrument which derives its valuefrom its underlying assets.

It does not have any value of its own

The underlying assets can be Futures, Equities, Index andCurrency

What is Derivatives?


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Futures

Options

Forward Contracts

Classification of Derivatives


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Definition

Futures :

Its a standardized agreement between buyer and seller, where theseller is obligated to deliver a specific assets to a buyer on thespecified date and buyer is obligated to pay the future priceprevailing in the exchange on the delivery of the asset.

Options :

An option is the right, but not the obligation to buy or sell theunderlying assets and other financial instrument at an agreed price,on or before a given expiry date.

Forward Contracts :

Its an agreement between two persons for purchase and sale ofcommodity or financial asset at specified price to be delivered atspecified future date.


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Risk Associated With Derivatives

Market Risk : It is price sensitive to fluctuation in interest rateand foreign exchange rate.

Liquidity Risk : Most derivatives are customized instrumenthence they have substantial liquidity risk.

Credit Risk : Derivatives are traded in over the counter marketwhich are subject to counter party default.

Hedging Risk : Hedge are used to reduce specific risk, it theanticipated risk do not develop it may limit the total return.

Regulatory Risk : The regulatory controls are some time toooppressive for market participants.


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Participants of Derivatives

Hedgers

Those who are interested in the underlying and want to hedge out theirrisk of price changes. For eg. farmers who sell future contracts for thecrops that guarantee a certain price. Also, hedging against an existingequity position with a view to earn on short term fluctuation while

keeping the original position as intact.

Speculators

Those who seek to make profit by predicting market movements andhave no interest in the underlying equity / commodity.

Strategist / Traders

With the help of cash and derivative products, large number ofstrategies are being formulated and traded.


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Futures

What is Futures?

Futures Vs Forwards

Characteristics of Futures

Types of Futures

Example

Margin Components Advantages


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What is futures ?

Definition:

A future contract is astandardisedcontract traded on anexchange, to buy or sell a certain underlying instrumentat a

certain date in thefuture,

at apre-setprice.


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Futures vs. Forwards

Standardized

Standard Lot size

Exchange Traded

Not Standardized

Odd lot size

Over the Counter(OTC)


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Some of the Exchanges

Chicago Mercantile Exchange (CME)

Chicago Board of Trade (CBOT)

New York Board of Trade (NYBOT)

New York Mercantile Exchange (NYMEX) National Stock Exchange (NSE)


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Characteristics

Standardisation

Pricing

Margin

Always traded on an Exchange

Settlement


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Standardisation

The contract usually specifies the following:

i. The underlying instrument

ii. Whether the settlement would be in cash or physical

iii. The amount and number of units of the underlying assets.

iv. Currency in which the future contract is quoted.

v. Date of delivery & month.

vi. Last date of delivery This varies from exchange toexchange.


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Types of Futures

Equity

Commodity

Index

Foreign Currency


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Example:

Spot price of Gold is $ 400.

Futures Price of Gold is $ 415 at the beginning of the day.

The movements over 3 days as shown below explains theconcept of Mark to Market:

Time period Gold Future Buyer's Cash Flow

1 $420.00 $5.002 $430.00 $10.003 $425.00 - $5.00

Net Cash Flow $10.00

Mark to Market


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Margin Components

Initial margin VAR technique

Maintenance margin minimum requirement

Margin Call -Variation margin

Additional margin market trends / volatility

Any credit balance in a margin account can be withdrawn.


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Reliance Future having lot size of 600 @ Rs. 1000/-= Rs. 600,000/-

Margin fixed by Exchange = 15% = Initial Margin

Amount deposited with Broker = Rs. 600,000/- *15% = Rs. 90,000/-

Maintenance margin = 50% of initial margin =

90,000/- * 50% = 45,000/-

Simple Illustration


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2nd day :

Next day, the rate of Reliance future is Rs. 950/-Mark to market: 600 lots @ Rs. 950/- = Rs. 570,000/-

Current Margin 90,000.00 15%Less : Notional loss 30,000.00 (600,000 570,000)

60,000.00 > 45,000

3rd day:

Next day, the rate of Reliance future is Rs. 900/-Mark to market: 600 lots @ Rs. 900/- = Rs. 540,000/-

Calculation :Current Margin 60,000.00Less : Notional loss 30,000.00 (570,000 540,000)

30,000.00 < 45,000

Required margin 90,000.00Variation Margin required (60,000.00) margin call


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Calculation:

Future Contract:

Date B / S Lot Multiplier Price Mark-to-market Comm. Fees

16th June Sell 10 * 10 * 3,514.60 = 351,460.00/- 25.00

30th June Buy 2 * 10 * 3,639.505 = 72,790.10/- 109.19

Cash Flow:

On 16th June: Commission fees: 25.00 is the cash flow generated on this day.

On 30th June: 72,790.10 - 70,292.00/- (2 lots * 10 * 3,514.60) = 2,498.10+ Commission Fees 109.10 = 2,607.2


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Options

What is Options?

Kinds of Options.

Types of Options.

Characteristics of Options.

Call Options

Put Options In / At / Out the Money Options

Benefits of Options Trading


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What is an options ?

Definition:

An option contract is a standardised contract traded

on an exchange, offering the right, but not theobligation, to buy or sell a certain underlyinginstrument at a pre-set price called the strike price.


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Kinds of Options

European Options:

These are exercised only on the maturity date. On theexpiry date, the option buyer's right to exercise the option(and the seller's obligation to perform) ends.

American Options:

These can be exercised at any time prior to or up to thematurity date.

This presentation presumes European options for ease ofcalculation.


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Types of Options

Equity

Commodity

Index

Foreign Currency

Future Contracts


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Characteristics

Standardisation

Premium

Call / Put option

Always traded on an Exchange

Settlement


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Standardisation

The contract usually specifies the following:

i. The underlying instrument

ii. Whether the settlement would be in cash or physical

iii. The amount and number of units of the underlying assets.

iv. Currency in which the option contract is quoted.

v. Date of delivery & month.

vi. Last date of delivery This varies from exchange toexchange.

C ll / P t O ti


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CALL OPTIONS

Buyer gets a RIGHT,

To BUY underlying shares at a price.

On or before a determined date.

PUT OPTIONS

Buyer gets a RIGHT,

To SELL underlying shares at a price.

On or before a determined date.

Call / Put Options


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BUY CALL:

Buyer gets right to BUY underlying at the strike price

BUY PUT:

Buyer gets right to SELL underlying at the strike price

SELL CALL:

Seller has an obligation to SELL the underlying at strike price

SELL PUT:

Seller has an obligation to BUY the underlying at strike price

Options-Positions


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In The Money

Concepts from the buyers perspective.

Option is said to be in the money when the option hasintrinsic value.

Call option is in the money when the Strike price is < Spot

price Put option is in the money when the strike price is > spot

price

Eg. Strike Price 250 Call option of Satyam Computers when

the Spot price is 300. The difference of Rs. 50 is said to be the intrinsic value of the

option.

Options- Spot & Strike price Relationship

Options S t & St ik i


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Out of The Money

Option is said to be out of money when it does not have anyintrinsic value

Call option is out of the money when the Strike price is > CMP

Put option is out of the money when the strike price is < CMP

Eg. Strike Price 350 Call option of Satyam Computers when the Spotprice is 300.

At The Money

Strike price = Spot Price

Options- Spot & Strike priceRelationship


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Call Option Buyer - Example

Mr. X holds a bullish view on Microsoft. Microsoft is trading on NASDAQ in the cash market at $ 100. Call option on Microsoft with 3 months maturity is available at various

strikes. Lets takes strike of $ 100. Mr. X Buys one call Options contract with 3 months maturity (Say one

contract has 100 underline shares). He Pays a premium, say @ $ 5 per share i.e. $ 500. He waits for 3 months. During this time Microsoft may go up, it may go down or it may

remain stable. If Microsoft remains same or goes down i.e. below $ 100, Mr.X will not

exercise his option and would loose the premium amount i.e. $ 500. Inother words, Mr. X lose is Capped at this value.

If the Microsoft rises above $ 105 (Strike Price of $ 100 + Premium of $5) Option would generate money for Mr. X

The Higher the Microsoft rises, the higher the profit to Mr. X. Hence the maximum profit potential of Mr. X is unlimited, While the

maximum lose is limited to premium paid ($ 500).


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Consider the Option on Microsoft, Which Mr. X had bought, Say

for Mr. Y. The Position of Call Option Seller i.e Mr. Y is exactly the

opposite of the Option Buyer i.e Mr. X.

Mr. Y collects the Premium amount of $ 500 from Mr. X.

If Microsoft falls below $ 100, Mr. Y pockets the premium

amount, which is the Maximum Profit he can make. However if the Stocks moves up Mr. Ys loss is unlimited which

is proportional to Mr. Xs gain.

Call Option Seller - Example


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Benefits of Option Trading

Leverage

Limited risk

No margin, only premium


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Futures - Advantages over Delivery Trading

You can take 4 5 times more than limits

Close positions anytime before expiry. On expiry day, exchangeautomatically closes out positions.

Keep your positions open up to 3 months

Profits / losses are paid / recovered on a daily basis

If you feel the market will be bearish, take short positions infutures, which is not possible in delivery based trading without

actual shares in demat.


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Intrinsic Value Difference between the Strike Price and Spot Price

Time Value - Theta

Time to expiry of the contract

As the expiry date comes nearer, the options premium decays

Volatility of underlying- Beta

Higher volatility of stock would attract higher premium

Premium in HINLEV (low beta) would be lesser than SATCOM(high beta) - other factors remaining same

Options- Pricing

Options Ri k


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BUYER of CALL / PUT options

Maximum loss : PREMIUM

Maximum Gain : UNLIMITED

SELLER of CALL / PUT options

Maximum loss : UNLIMITED

Maximum Gain : PREMIUM

Options-Risk


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Options-Exercise

Only In the Money (ITM) options are allowed to be exercised

Buyer/Holder receives the difference

Call Option: Spot price-Strike price

Put Option: Strike price-Spot price

Writer/Seller pays the difference

Call Option : Spot price-Strike price

Put option: Strike price-Spot price

All At the Money (ATM) and Out of the Money (OTM) contractsexpires worthless

Assigned to seller/writer who is Out of the Money (OTM)


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Options - Exercise v/s Square-off

EXERCISE SQUARE-OFF

Difference between Difference betweenSTRIKE PRICE and PREMIUM Amounts atCLOSING PRICE of the time of Square-off.

underlying on exercise day

EXERCISE can be done only by the BUYER.

SQUARE-OFF can be made by both BUYER & SELLER


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To sum up

Some of the key uses of options are

- Leverage

- Protecting the value of equity positions

- Limiting risk

- Alternative to direct investment in equitymarkets.


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How can you get the most out of

these instruments?

- Adopt the appropriate strategy that suits

- Your personal circumstances and

- Your market view


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Life is all about Choices,

Good or Bad; Right or Wrong;Your Destiny will unfold according to

the Choices you make


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Thank You

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GMCS Derivatives