New Derivatives Session

8/13/2019 New Derivatives Session

1/66

DERIVATIVES

(Futures & Options)


2/66

What will we look at?

Basic concepts of Derivatives (Futures & Options)

How to protect equity investments using some basic

strategies in derivatives.

Market direction / trend indicators


3/66

Specified Guide lines - Derivatives

Contract Size: SEBI has specified minimum contractvalue of Rs. 200,000.00

Lot Size: Different lot size applicable for differentunderlying

Contract for three different monthsin existence knownas Near month, Middle month & Far month.

Expiry Date: Date on which F/O contract will ceases toexist. It is always Last Thursday of the month or the dayprior in case last Thursday of the month is a Tradingholiday

Settlement : Futures & Options are CASH SETTLED.


4/66

Futures

Index Futures

Stock Futures

Options

Index Options

Stock Options

Derivatives Products

Derivatives is a product which does not have its own value but is derived fromsome underlying.

Incase of Futures & Options value is derived from the CASH or SPOTMarket


5/66

Benefits Of Derivatives

Reduces market risk

Willingness to Trade

Lower cost of trading

Increase trading volume in stock market liquidity.


6/66

Futures - Definitions

Future Contract: Legally binding agreement to buy or sell a financialinstrument sometime in future.

QuantityLot size fixed.

Delivery time - Expiry date is fixed

Futures Position

BUY Futures : Right as well as obligation to buy the underlying shares atthe future date

SELL Futures: Right as well as obligation to sell underlying shares at thefuture date

RightTo claim profit, if any

ObligationTo pay loss, if any


7/66

Futures - Pricing

FUTURES= S (Spot price) + C (Cost to carry)

COST OF CARRY= Interest Cost / Opportunity Cost

COST OF CARRY (factors affecting it)

Prevailing interest rate

Volatility of the stock

Demand and Supply of stock

(Determination of cost of carry is not fixed. Its entirely market

driven)


8/66

FuturesPricing.(contd)

Expiry Date

SPOT PRICE = FUTURES PRICE (Cost to Carry is zero)

WHEN IS SPOT PRICE HIGHER THAN FUTURES PRICE

Dividend declared by company (during the contract period)

Mis-pricing (Lack of Price discovery)

3 monthsContract

Price

2 month

Contract

Price

1 month

Contract PriceSPOT Price


9/66

FuturesRisk & Settlement

Both BUY & SELL position carries unlimited risk

Both positions are margined

Mark to Market on daily basis at closing price of a particularcontract

Difference is paid/recovered on T+1 basis

Settlement Price: Closing price on underlying in Cash /Spot

market on contract expiry date


10/66

How To Use Index Futures

Speculation

Hedging


11/66

SpeculationBearish outlook

What to do:

Believe market would go down

Sell liquid stocks like Infosys

Sell entire index portfolio

What can go wrong

Costly to sell the entire set of stocks

Vulnerable to company specific risk

What you could do

Short Sell S&P CNX Nifty futures


12/66

Speculation (contd.)

04th April 2011

You feel the market will fall Sells 100Nifties expiring on Apr 28

Nifty April contract is trading at 5600

Your position is worth Rs. 560000

28th April 2011

Nifty April futures has fallen to 5500

Square off your position at 5500

Make a profit of Rs. 10,000 (100*100)


13/66

Payoff for Nifty Futures Short at 5600

NIFTY PAYOFF

5600 0

5550 50

5500 100

5450 150

5400 200


14/66

SpeculationBullish outlookWhat to do:

Believe market would go up

Buy liquid stocks like Infosys

Buy entire index portfolio

What can go wrong

Costly to buy the entire set of stocks

Vulnerable to company specific risk

What you could do

Long Buy S&P CNX Nifty futures


15/66

Speculation (contd.)04th April 2011

You feel the market will rise

Buy 100 Nifties expiring on April 28

Nifty April contract is trading at 5600

Your position is worth Rs. 5,60,000

28th April 2011

Nifty April futures has risen to 5650

Square off your position at 5650

Make a profit of Rs. 5,000 (100*50)


16/66

Payoff for Nifty Futures Long at 5600

NIFTY PAYOFF

5400 -200

5500 -100

5600 05700 100

5800 200


17/66

Hedging

Stocks carry two types of risk :-

Company specific Market risk

Company specific risk can be reduced by

divercification.

Market risk cannot be diversified but has to behedged.

Market risk is known from Beta


18/66

How to hedge your stock position

using futures

This first thing one needs to know is the beta of the stock.

That is the impact a 1 per cent movement in the Nifty will

have on the stock

This is known as hedging


19/66

How to hedge your stock position

using futures

Lets assume you expect Reliance to go up and want to takea long position on Reliance worth Rs 2,50,000.

The scrip has a beta of 1.07.

To remove the hidden Nifty exposure in the above position

the size of the sell position that will have to be taken in the

Nifty futures is 1.07 * 2,50,000 = 2,67,500.


20/66

Hedging

So if the Nifty is at 5600 and each market lot is

100(one contract)

Then the contract size would be Rs 5,60,00.

As such, to sell Rs 5,60,000 worth of Nifty we

need to sell one market lot (rounded off to the

nearest market lot).


21/66

Hedging

This would give us the following position.

Long (Buy)2 lots(250) Reliance Rs 5,00,000

Short (Sell) Nifty Rs 5,600,000

By building such a position what you are essentially doingis removing the hidden Nifty exposure and a positionwhich will reflect the price changes inherent only toReliance.

Assuming the Index falls and Reliance also moved in lineyou will lose on Reliance but the losses and risk could beoffset or reduced by the short Nifty.


22/66

Futures - Advantages over Cash

You can take 45 times more than limits

Close positions anytime before expiry. On expiry day,exchange automatically closes out positions.

Keep your positions open up to 3 months

Lower brokerage / transaction costs

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 CASH segment without actualshares in demat.


23/66


24/66

Confers right to the holder/buyer of option to buy/sell a specified

assets at a specific price on or before a specific date. Seller/Write

has an obligation to fulfil the contract if buyer/holder exercises hi

option

BUYER SELLER

Gets a RIGHT Has an OBLIGATION

Pays PREMIUM Receives PREMIUM

OPTIONS - DEFINITION


25/66

CALL OPTIONS: BUYER

Buyer gets a RIGHT,

To BUY underlying shares at a price.

On or before a determined date.

SELLER

Seller has an obligation

To SELL underlying shares at a price

On or before a determined date

Option-Definitions


26/66

. PUT OPTIONS:

BUYER

Buyer gets a RIGHT,

To SELL underlying shares at a price.

On or before a determined date.

SELLER

Has an obligation

To BUY underlying shares at a price.

On or before the determined date.


27/66

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


28/66

American Options: It is exercisable anytime on or

before the expiry date. OPT-RELIANCE-APR-28--2011-1000-CA

European Options: It is exercisable only on the expiry

date on contract note. OPT-NIFTY-28-APR-2011-2050-CE

Indian Scenario:

Index Options- European cash settled

Stock Options- American cash settled

Settlement Price: Difference between Strike Price and

Underlying Price

Options - Exercisability & Settlement


29/66

In The Money Concepts from the buyers perspective.

Option is said to be in the money when the option has

intrinsic 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 950 Call option of Reliance industries when the

Spot price is 1000.

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

option.

Options- Spot & Strike price Relationship


30/66

Out of The Money Option is said to be out of money when it does not have

any intrinsic 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

Documents

New Derivatives Session