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Chapter 1....................................................................................................................................................5 Introduction to Derivatives ..................................................................................................5 1.1 Derivatives Defined.......................................................................................................... 5

Chapter 1....................................................................................................................................................5 Introduction to Derivatives ..................................................................................................5 1.1 Derivatives Defined.......................................................................................................... 5

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Published by emailme7
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1
CONTENTS
CHAPTER 1....................................................................................................................................................5
 
INTRODUCTION TO DERIVATIVES..................................................................................................5
 
1.1
 
DERIVATIVES
 
DEFINED..........................................................................................................5
 
1.2
 
FACTORS
 
DRIVING
 
THE
 
GROWTH
 
OF
 
DERIVATIVES.................................................6
 
1.3
 
DERIVATIVE
 
PRODUCTS........................................................................................................7
 
1.4
 
PARTICIPANTS
 
IN
 
THE
 
DERIVATIVES
 
MARKETS........................................................8
 
1.5
 
ECONOMIC
 
FUNCTION
 
OF
 
THE
 
DERIVATIVE
 
MARKET............................................8
 
1.6
 
EXCHANGE-TRADED
VS
.
 
OTC
 
DERIVATIVES
 
MARKETS........................................10
 
1.7
 
NSE'
S
DERIVATIVES
 
MARKET............................................................................................11
 
1.7.1
 
Participants and functions.................................................................................................11
 
1.7.2
 
Trading mechanism.............................................................................................................12
 
1.7.3
 
Turnover...............................................................................................................................13
 
CHAPTER 2..................................................................................................................................................15
 
MARKET INDEX.......................................................................................................................................15
 
2.1
 
UNDERSTANDING
 
THE
 
INDEX
 
NUMBER.......................................................................15
 
2.2
 
ECONOMIC
 
SIGNIFICANCE
 
OF
 
INDEX
 
MOVEMENTS...............................................16
 
2.3
 
INDEX
 
CONSTRUCTION
 
ISSUES........................................................................................16
 
2.4
 
T
YPES OF INDEXES
........................................................................................................................17
 
2.5
 
DESIRABLE
 
ATTRIBUTES
 
OF
 
AN
 
INDEX........................................................................18
 
2.5.1
 
Capturing behavior of portfolios......................................................................................18
 
2.5.2
 
 Including liquid stocks.......................................................................................................19
 
2.5.3
 
 Maintaining professionally................................................................................................19
 
2.6
 
THE
 
S&P
 
CNX
 
NIFTY...............................................................................................................19
 
2.6.1
 
 Impact cost...........................................................................................................................20
 
2.6.2
 
 Hedging effectiveness............................................................................................................20
 
2.7
 
A
PPLICATIONS OF INDEX
..............................................................................................................21
 
2.7.1
 
 Index derivatives..................................................................................................................21
 
2.7.2
 
 Index funds..............................................................................................................................21
 
2.7.3
 
 Exchange Traded Funds....................................................................................................21
 
CHAPTER 3..................................................................................................................................................25
 
INTRODUCTION TO FUTURES AND OPTIONS..........................................................................25
 
3.1
 
FORWARD
 
CONTRACTS........................................................................................................25
 
3.2
 
L
IMITATIONS OF FORWARD MARKETS
........................................................................................26
 
3.3
 
INTRODUCTION
 
TO
 
FUTURES............................................................................................26
 
3.4
 
DISTINCTION
 
BETWEEN
 
FUTURES
 
AND
 
FORWARDS
 
CONTRACTS...................28
 
3.5
 
F
UTURES TERMINOLOGY
..............................................................................................................28
 
3.6
 
INTRODUCTION
 
TO
 
OPTIONS.............................................................................................29
 
3.7
 
OPTION
 
TERMINOLOGY.......................................................................................................29
 
3.8
 
F
UTURES AND OPTIONS
................................................................................................................32
 
3.9
 
I
NDEX DERIVATIVES
.....................................................................................................................33
 
 
2
CHAPTER 4..................................................................................................................................................36
 
APPLICATIONS OF FUTURES AND OPTIONS............................................................................36
 
4.1
 
T
RADING UNDERLYING VERSUS TRADING SINGLE STOCK FUTURES
......................................36
 
4.2
 
F
UTURES PAYOFFS
........................................................................................................................37
 
4.2.1
 
Payoff for buyer of futures: Long futures........................................................................37 
 
4.2.2
 
Payoff for seller of futures: Short futures.......................................................................38
 
4.3
 
P
RICING FUTURES
..........................................................................................................................39
 
4.3.1
 
Pricing equity index futures..............................................................................................40
 
4.3.2
 
Pricing index futures given expected dividend amount................................................40
 
4.3.3
 
Pricing index futures given expected dividend yield.....................................................41
 
4.4
 
P
RICING STOCK FUTURES
.............................................................................................................43
 
4.4.1
 
Pricing stock futures when no dividend expected..........................................................43
 
4.4.2
 
Pricing stock futures when dividends are expected.......................................................44
 
4.5
 
A
PPLICATION OF FUTURES
...........................................................................................................44
 
4.5.1
 
 Hedging: Long security, sell futures................................................................................45
 
4.5.2
 
Speculation: Bullish security, buy futures.......................................................................46 
 
4.5.3
 
Speculation: Bearish security, sell futures......................................................................46 
 
4.5.4
 
 Arbitrage: Overpriced futures: buy spot, sell futures..........................................................47 
 
4.5.5
 
 Arbitrage: Underpriced futures: buy futures, sell spot.................................................48
 
4.6
 
O
PTIONS PAYOFFS
.........................................................................................................................48
 
4.6.1
 
Payoff profile of buyer of asset: Long asset...................................................................49
 
4.6.2
 
Payoff profile for seller of asset: Short asset.......................................................................49
 
4.6.3
 
Payoff profile for buyer of call options: Long call...............................................................49
 
4.6.4
 
Payoff profile for writer of call options: Short call.......................................................51
 
4.6.5
 
Payoff profile for buyer of put options: Long put..........................................................52
 
4.6.6 
 
Payoff profile for writer of put options: Short put.........................................................52
 
4.7
 
P
RICING OPTIONS
..........................................................................................................................53
 
4.8
 
A
PPLICATION OF OPTIONS
............................................................................................................54
 
4.8.1
 
 Hedging: Have underlying buy puts................................................................................54
 
4.8.2 Speculation: Bullish security, buy calls or sell puts.....................................................55
 
4.8.3
 
Speculation: Bearish security, sell calls or buy puts....................................................57 
 
4.8.4
 
 Bull spreads - Buy a call and sell another......................................................................61
 
4.8.5
 
 Bear spreads - sell a call and buy another.....................................................................63
 
4.9
 
T
HE
G
REEKS
..................................................................................................................................66
 
4.9.1 Delta ( ).............................................................................................................................66 
 
4.9.2
 
Gamma ( )..........................................................................................................................66 
 
4.9.3 Theta ( )...........................................................................................................................67 
 
4.9.4
 
Vega .................................................................................................................................67 
 
4.9.5
 
 Rho( ).................................................................................................................................67 
 
CHAPTER 5..................................................................................................................................................71
 
TRADING......................................................................................................................................................71
 
5.1
 
F
UTURES AND OPTIONS TRADING SYSTEM
.................................................................................71
 
5.1.1
 
 Entities in the trading system............................................................................................71
 
5.1.2
 
 Basis of trading....................................................................................................................72
 
 
3
5.1.3
 
Corporate hierarchy...........................................................................................................73
 
5.1.4
 
Client Broker Relationship in Derivative Segment.......................................................74
 
5.1.5
 
Order types and conditions...............................................................................................75
 
5.2
 
T
HE TRADER WORKSTATION
.......................................................................................................77
 
5.2.1
 
The market watch window.................................................................................................77 
 
5.2.2
 
 Inquiry window....................................................................................................................78
 
5.2.3
 
Placing orders on the trading system....................................................................................79
 
5.2.4
 
 Market spread/combination order entry..............................................................................79
 
5.2.5 Basket trading......................................................................................................................79
 
5.3
 
F
UTURES AND OPTIONS MARKET INSTRUMENTS
......................................................................80
 
5.3.1
 
Contract specifications for index futures........................................................................81
 
5.3.2
 
Contract specification for index options.........................................................................82
 
5.3.3
 
Contract specifications for stock futures.........................................................................85
 
5.3.4
 
Contract specifications for stock options........................................................................86 
 
5.4
 
C
RITERIA FOR STOCKS AND INDEX ELIGIBILITY FOR TRADING
...............................................88
 
5.4.1
 
 Eligibility criteria of stocks...............................................................................................88
 
5.4.2
 
 Eligibility criteria of indices.............................................................................................88
 
5.4.3
 
 Eligibility criteria of stocks for derivatives trading......................................................89
 
especially on account of corporate restructuring..........................................................89
 
5.5
 
C
HARGES
........................................................................................................................................90
 
CHAPTER 6..................................................................................................................................................93
 
CLEARING AND SETTLEMENT........................................................................................................93
 
6.1
 
C
LEARING ENTITIES
......................................................................................................................93
 
6.1.1
 
Clearing members.................................................................................................................93
 
6.1.2
 
Clearing banks.....................................................................................................................93
 
6.2
 
C
LEARING MECHANISM
................................................................................................................94
 
6.3
 
S
ETTLEMENT MECHANISM
............................................................................................................96
 
6.3.1
 
Settlement of futures contracts..........................................................................................97 
 
6.3.2
 
Settlement of options contracts.........................................................................................99
 
6.4
 
A
DJUSTMENTS FOR CORPORATE ACTIONS
...............................................................................102
 
6.5
 
R
ISK MANAGEMENT
....................................................................................................................103
 
6.5.1
 
 NSCCL-SPAN......................................................................................................................104
 
6.5.2
 
Types of margins.....................................................................................................................104
 
6.6
 
MARGINING
 
SYSTEM...........................................................................................................105
 
6.6.1
 
SPAN approach of computing initial margins............................................................10
 
6.6.2
 
 Mechanics of SPAN.........................................................................................................10
 
6.6.3
 
Overall portfolio margin requirement..........................................................................111
 
CHAPTER 7...............................................................................................................................................116
 
REGULATORY FRAMEWORK........................................................................................................116
 
7.1
 
S
ECURITIES
C
ONTRACTS
(R
EGULATION
)
 
A
CT
,
 
1956.............................................................116
 
7.2
 
S
ECURITIES AND
E
XCHANGE
B
OARD OF
I
NDIA
A
CT
,
 
1992...................................................117
 
7.3
 
R
EGULATION FOR DERIVATIVES TRADING
..............................................................................118
 
7.3.1
 
Forms of collateral’s acceptable at NSCCL................................................................119
 
7.3.2
 
 Requirements to become F&O segment member........................................................119
 
7.3.3
 
 Requirements to become authorized / approved user................................................121
 

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