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TERMINOLOGIES OF DERIVATIVES
HEINZ FINANCE CLUB – WORKSHOP
FEBRUARY 14, 2015
Corey Sattler and Mahesh Nair
SPOT PRICE, FORWARD/FUTURE PRICE
• Spot Price: • Referred to as Cash Prize
• Price that is quoted for immediate delivery of asset
• Forward/Futures price:• Price agreed upon at the date of contract for delivery of an asset
• At a specific future date
• Dependent on:
• Spot price
• Prevalent Interest Rate
• Expiry date of Contract
STRIKE PRICE
• Price at which the buyer of the option can:
• Buy the stock Call Option
• Sell the stock Put Option
• Conditions Apply: On/before the expiry date of options contract
• Price at which stock will be brought/sold when the option is exercised
• USED IN CASE OF OPTIONS ONLY. NOT FOR FUTURE/FORWARDS
EXPIRATION DATE
• In case of Futures, Forwards and Index Options:
• It is the only date on which settlement takes place
• In case of Stock Options
• Last date on which option can be exercised
• Also called FINAL SETTLEMENT DATE
TYPES OF OPTIONS
• DEPENDING UPON PRIMARY EXERCISE STYLE
• AMERICAN Can be exercised on any day – on/before expiry date.
• Example: Stock Options.
• EUROPEAN Can be exercised only on Expiration Date.
• Example: Index based option
CONTRACT SIZE AND VALUE
• CONTRACT SIZE: Represents certain number of shares of underlying asset
• CONTRACT VALUE: Notional Value of transaction in case one transaction is brought/sold• Contract Value = (Contract Size) x (Price of Futures)
• Example: 1 futures contract of ABC consists of 300 shares trading at $2000
• Contract Size? Future Price? Contract Value?
TRADING FUTURES & PAY OFFS
• PAY OFF Profit/ Loss in a Trade
• + ve Payoff – Investors make profit - ve Payoff – Investors make
loss
Stock Price
Pro
fit/
Loss
TRADING FUTURES & PAY OFFS
• Future Pay off on maturity depends on:
• Spot price of the underlying asset at the time of maturity (ST)
• Price at which the contract was initially traded (F)
POSITIONS TAKEN IN FUTURE CONTRACT
• LONG: One who buys the asset at the Futures price (F)
• SHORT: One who sells the asset at Futures price (F)
LONG PAY OFF
• Long Pay Off: ST - F
• ST = Spot price of the asset at the expiry of the contract
• F = Traded Futures Price
• Note: Holder of contract obligated to buy asset worth ST for F
• Profit Condition? Larger the ST larger the profits – when (ST>F)
Spot price (ST)
Pro
fit/
Loss
F
SHORT PAY OFF
• Short Pay Off: F - ST
• ST = Spot price of the asset at the expiry of the contract
• F = Traded Futures Price
• Note: Holder of contract obligated to Sell asset worth ST for F
• Loss Condition? Larger the ST larger the Loss – when (ST>F)
Spot price (ST)
Pro
fit/
Loss
F
TRADING OPTIONS
Two sides of every Option contract
• Option Buyer: Pays Premium
• Option Seller: Receives Premium
Taken into account for computing profit-loss
STRIKE PRICE (Revisited)
• Price at which the buyer of the option can:
• Buy the stock Call Option
• Sell the stock Put Option
• Conditions Apply: On/before the expiry date of options contract
• Price at which stock will be brought/sold when the option is exercised
• USED IN CASE OF OPTIONS ONLY. NOT FOR FUTURE/FORWARDS
LONG CALL
• An investor having Bullish (market will rise up) opinion on the underlying asset can expect to have +ve return buying call options on that asset.
• When purchased: Holder exposed to stock performance in the spot market without actually possessing the stock
• Cost incurred by call option = Option Premium
LONG PUT
• An investor having Bearish(market will fall) opinion on the underlying asset can expect to have + ve return buying put options on that asset.
• When purchased: Holder/Buyer of option has the right to sell the stock @ Strike price on or before expiry depending on underlying price
SHORT CALL & SHORT PUT
• Short Call: An investor having Bearish(market will fall) can take advantage of falling stock prices by selling a call option on the asset.
• Short Put: An investor having Bullish (market will rise) can take advantage of rising stock prices by selling a put option on the asset.
Reference
Materials taken from Indian National Stock Exchange NCFMcertification modules:
Equity Derivatives: Beginner’s Module
http://www.nseindia.com/education/content/module_ncfm.htm