Fundamentals of Derivatives-
F&O
Presented by:-Hemal Muchhala 65Abhishek Pathak 75Yogesh Periwal 78Amit Shah 88
Points to remember……….
Long – Buy …………..(going long)
Short – Sell …………...(going short)
Squaring off – opposite transaction to the
previous one
Close out – opposite transaction to the previous
one (usually done by the exchange)
Buy low, sell high - gives a profit
Sell high, buy low - also gives a profit
What are Derivatives?
Derivatives are financial contracts whose value/price is dependent
on the behavior of the price of one or more basic underlying assets
(often simply known as the underlying).
Commodities
Equity shares
Equity share index
Bonds
Currencies
Eg:- CURD
Derivatives were introduced gradually in our country in thefollowing order:
NSE Index Future 12.06.2001
NSE Index Option 04.06.2001
Stock Options 02.07.2001
Stock Futures 09.11.2001
No. of securities have been increased gradually for inclusionin F&O.
Important Dates and Facts
Market Players
Speculators/ Investors
Hedgers
Arbitrageurs
Banks
Mutual Funds / Hedge Funds /
Pension Funds
Corporates
NBFCs
Brokers / Primary Dealers
Individual Investors (HNI / Retail)
Types of Derivatives
DERIVATIVES
Forwards Futures Options Swaps
Commodity
Equity
Put
Call
Currency
Interest rate
Commodity
Interest Rate
Currency
What are forward contracts?
A forward contract is a customised
contract between the buyer and the seller
where settlement takes place on a specific
date in future at a price agreed today.
What are futures?
Futures are exchange-traded contracts to
buy or sell an asset in future at a price
agreed upon today. The asset can be share,
index, interest rate, bond, rupee-dollar
exchange rate, sugar, crude oil, soybean,
cotton, coffee etc.
Future Contracts
Three different contracts run simultaneously in Indian Market.
Current month or near month contract
Next month or mid month contract
Third month or far month contract
Forward Vs Future
Forward
OTC in nature
Customised contract terms
hence
Less Liquid
No Secondary market
No margin Payment
Settlement happens at end of
period
Future
Trade on an organised
exchange
Standardised contract terms
hence
More liquid
Secondary market
Requires margin requirement
Follows daily settlement
Theoretical way of pricing futures
The Cost of Carry model:
Forward(or Futures) = (Spot Price+Carry Cost-Carry Return)
F=S0+CC-CR
Spot Price = Current Price
Carry Cost = Holding Cost, Interest Charges on Borrowing.-
Insurance,Storage Costs etc.
Carry Return= Dividends
Hedging in Futures
Hedging stock position using stock futures
Hedge the position using Index futures
Options
It is a contract
It gives one party (the holder of the option) the right to choose, during a
specified period of time, to buy (or sell, respectively) a specified
quantity of a specified asset (for instance a stock) at a given price
The other contract party (the writer of the option) has the obligation to
fulfill the holder's right
Some terms unique to options trading
OPTION PREMIUM
Price paid by the buyer to acquire the right
STRIKE PRICE OR EXERCISE PRICE
Price at which the underlying may be purchased or sold
EXPIRATION DATE
Last date for exercising option or the date on which option
expires
EXERCISE DATE
Date on which the option is actually exercised
Life of an option
The life of an option is limited: it has an expiration date.
After the expiration date all the rights and obligations conferred
by the option are null and void.
Participants in the Options Market
Buyers of Calls
Sellers of Calls
Buyers of Puts
Sellers of Puts
Styles of Options
American options
Buyer can exercise the option at any time between the purchase date and the expiry date of the futures contract
European options
Buyer of the option can choose to exercise his option only on the date of expiration of the futures contract
Options
Options are of two types – CALLS and PUTS
CALL OPTIONS : give the buyer the right but not the obligation to buy a
given quantity of the underlying asset, at a given price on or before a given
future date.
PUT OPTIONS: give the buyer the right , but not the obligation to sell a
given quantity of the underlying asset at a given price on or before a given
date.
Market Price
Strike Prices Strike Prices
166 168 170 172164162160
In the Money Call Options
Out of the Money Call Options
Out the Money Put Options
In the Money Put Options
Calls
Puts
Intrinsic Value
For a CALL OPTION:
Intrinsic value = Spot Price – Strike price
For a PUT OPTION:
Intrinsic value = Strike price – Spot Price
Intrinsic value can never be negative
Problems with derivatives
1. “We know where our markets are going”
2. “We don’t understand risk management
markets”
3. “Risk management is a zero-sum game”
4. “Futures markets are speculative”