INTRODUCTION TO

OPTIONS AND
FUTURES
CLASSIFICATION OF
FINANACIAL MARKETS

 NATURE OF CLAIM
 MATURITY OF CLAIM
 SEASONING OF CLAIM
 TIMING OF DELIVERY
 ORGANISATIONAL STRUCTURE
DERIVATIVE

ACCORDING TO SC(R) ACT 1956;

- A SECURITY DERIVED FROM DEBT
INSTRUMENT,SHARE,LOAN,CONTRACT
FOR DIFFERENCES,COMMODITY,INDEX
OR ANY OTHER FORM OF SECURITY

- A CONTRACT WHICH DERIVES ITS

VALUE FROM THE PRICES OF
UNDERLYING SECURITIES/ASSETS.
FINANCIAL
DERIVATIVES
 FORWARD CONTRACTS

 FUTURES

 OPTIONS
FORWARD CONTRACTS

 AN AGREEMENT BETWEEN TWO

PARTIES TO BUY OR SELL AN ASSET AT
A SPECIFIED FUTURE DATE AND PRICE
- OTC CONTRACT
- BILATERAL
- CUSTOMISED
- PRICE IS NOT AVAILABLE PUBLICLY
- SETTLEMENT BY DELIVERY ON MATURITY
LIMITATIONS OF
FORWARD CONTRACTS
 LACK OF CENTRALISED TRADING

 ILLIQUIDITY

 COUNTERPARTY RISK
FUTURES
 AN AGREEMENT TO BUY OR SELL AN
ASSET/SECURITY IN FUTURE AT A
CERTAIN PRICE
- EXCHANGE TRADED
- ANONYMOUS TRADING
- STANDARDISED
- MARGINS
- MARK TO MARKET
- SETTLEMENT IS GUARANTEED
FUTURES V/S
FORWARDS
 EXCHANGE  OTC IN
TRADED NATURE
 STANDARDISE
D  CUSTOMISED
 LIQUID  ILLIQUID
 REQUIRES  NO MARGIN
MARGIN  ON MATURITY
 DAILY
SETTLEMENT
OPTIONS
 A CONTRACT WHICH GIVES RIGHT BUT
WITH NO OBLIGATION
- CALL OPTION:OPTION THAT GIVES RIGHT TO BUY A
SECURITY

- PUT OPTION:OPTION THAT GIVES RIGHT TO SELL A

SECURITY

- AMERICAN OPTION:CAN BE EXERCISED ANY TIME

- EUROPEAN OPTION:CAN BE EXERCISED ONLY ON MATURITY

- Asian Options: Asian options are options whose

payoffs depend on the average price of the
underlying asset during some portion of the life of
the option.
FUTURES V/S OPTIONS
 EXCHANGE TRADED  EXCHANGE TRADED
 STANDARDISED  STANDARDISED
 PRICE IS ZERO  OPTION PREMIUM
 BOTH PARTIES ARE  ONLY OPTION
REQUIRED TO WRITER WILL HAVE
PERFORM OBLIGATION
 LINEAR PAY OFF  NON LINEAR PAY
 BOTH LONG AND OFF
SHORT ARE AT RISK  ONLY SHORT IS AT
RISK
 Options
BUYER/HOLDER SELLER/WRITER
RIGHTS/ BUYERS HAVE RIGHTS- SELLERS HAVE ONLY
OBLIGATIONS NO OBLIGATIONS OBLIGATIONS-NO
RIGHTS

 CALL RIGHT TO BUY/TO GO OBLIGATION TO SELL/GO

LONG SHORT ON EXERCISE

 PUT RIGHT TO SELL/ TO OBLIGATION TO

BUY/GO
GO SHORT LONG ON EXERCISE

 PREMIUM PAID RECEIVED

 EXERCISE BUYER’S DECISION SELLER CANNOT

INFLUENCE

 MAX. LOSS COST OF PREMUIM UNLIMITED LOSSES

POSSIBLE
 MAX. GAIN UNLIMITED PROFITS PRICE OF PREMIUM
POSSIBLE
 CLOSING • EXERCISE • ASSIGNMENT ON
OPTION
POSITION OF • OFFSET BY SELLING • OFFSET BY BUYING BACK
EXCHANGE OPTION IN MARKET OPTION IN MARKET
TRADED • LET OPTION LAPSE • OPTION EXPIRES AND KEEP
FUNCTIONS OF
DERIVATIVES
MARKETS
 RISK TRANSFER
 HIGH LIQUIDITY,PRICE DISCOVERY
 LOW TRANSACTION COSTS
 PROFITS WITH MINIMUM CAPITAL
 INDICATES MARKET PERCEPTION
 ELIMINATE SECURITY SPECIFIC
RISK
 ARBITRAGE OPPORTUNITY
ORIGIN OF
DERIVATIVES MARKET
IN INDIA
 1995 SECURITIES LAWS
AMENDMENT ORDINANCE
 1996 L.C.GUPTA COMMITTEE
 1998 SUBMITTED ITS REPORT
 1998 J.R.VARMA COMMITTEE
 1999 SCR ACT AMENDED
 2000 WITHDRAWAL OF BAN ON
FORWARD TRADING
INTRODUCTION OF
DERIVATIVES TRADING
 12 JUNE 2000 INDEX FUTURES
 4 JUNE 2001 INDEX OPTIONS
 2 JULY 2001 STOCK OPTIONS
 9 NOV 2001 STOCK FUTURES
 24 JUNE 2003 INTEREST RATE
FUTURES
 29 AUG 2008 CURRENCY
FUTURES
REQUIREMENTS FOR
SUCESSFUL DERIVATIVES
MARKETS
 REGULATORY MECHANISM
 RISK MANAGEMENT TOOLS
 CLEARING CORPORATION
 MONITORING AND SURVEILANCE
 INVESTOR EDUCATION AND
TRANING
 TECHNOLOGY
FACTORS LED FOR THE
GROWTH OF
DERIVATIVES
 INSTABILITY IN MACROECONOMIC
VARIABLES
 INCREASED VOLATILITY IN CASH
MARKET
 INCREASED FOREIGN TRADE
 TECHNOLOGY
 REFINED PRICING TOOLS
PARTICIPANTS
 SPECULATORS

 HEDGERS

 ARBITRAGEURS
USERS OF
DERIVATIVES
 COMPANIES
 MUTUAL FUNDS
 BANKS
 BROKERS
 PORTFOLIO MANAGERS/ADVISERS
 INDIVIDUALS
Terminology

- OPTION HOLDER AND OPTION WRITER

– EXERCISE PRICE OR STRIKING PRICE

– EXPIRATION DATE OR MATURITY DATE

– EUROPEAN OPTION AND AMERICAN OPTION

– EXCHANGE-TRADED OPTIONS AND OTC

OPTIONS
– AT THE MONEY, IN THE MONEY, AND OUT OF
THE MONEY OPTIONS
 Futures Terminology
 SPOT PRICE
 FUTURES PRICE
 CONTRACT CYCLE
 EXPIRY DATE
 CONTRACT SIZE
THE AMOUNT OF ASSET THAT HAS TO
BE DELIVERED UNDER ONE
CONTRACT. FOR INSTANCE, THE
CONTRACT SIZE ON NSE’S FUTURES IS 50
NIFTIES
 BASIS
FUTURES PRICE - SPOT PRICE
 INITIAL MARGIN
 MARKING TO MARKET
 MAINTENANCE MARGIN
OPTION PAYOFF
OPTION BUYER-CALL
OPTION
STRIKE SPOT PRICE OPTION PAY OFF
PRICE PRICE
500 400 20 -20
500 450 20 -20
500 500 20 -20
500 550 20 +30
500 600 20 +80
500 650 20 +130
140

120

100

80

60

PAY OFF

40

20

-20

-40
OPTION BUYER-PUT OPTION
STRIKE SPOT OPTION PAY OFF
PRICE PRICE PRICE
2000 1700 50 +250
2000 1800 50 +150
2000 1900 50 +50
2000 2050 50 0
2000 2100 50 -50
2000 2150 50 -50
2000 2200 50 -50
300

250

200

150

100 PAY OFF

50

-50

-100
OPTION SELLER-CALL
OPTION
STRIKE SPOT OPTION PAY OFF
PRICE PRICE PRICE
500 400 20 +20
500 450 20 +20
500 500 20 +20
500 550 20 -30
500 600 20 -80
500 650 20 -130
 40

20

-20

-40
PAY OFF
-60

-80

-100

-120

-140
OPTION SELLER-PUT
OPTION
STRIKE SPOT OPTION PAY OFF
PRICE PRICE PRICE
2000 1700 50 -250
2000 1800 50 -150
2000 1900 50 -50
2000 2050 50 +50
2000 2100 50 +50
2000 2200 50 +50
2000 2300 50 +50
100

50

-50

-100 PAY OFF

-150

-200

-250

-300
FUTURES PAYOFF
PAY OFF FOR FUTURES
BUYER
FUTURES SPOT PRICE PAY OFF
PRICE
2000 1800 -200
2000 1900 -100
2000 2000 0
2000 2100 100
2000 2200 200
250

200

150

100

50

0 PAY OFF

-50

-100

-150

-200

-250
PAY OFF FOR FUTURES
SELLER
FUTURES SPOT PRICE PAY OFF
PRICE
2000 1800 200
2000 1900 100
2000 2000 0
2000 2100 -100
2000 2200 -200
250

200

150

100

50

0 PAY OFF

-50

-100

-150

-200

-250