1
CONTENTS
CHAPTER 1: INTRODUCTION……………………………..................................................................4
1.1
D
EFINITION OF
D
ERIVATIVES
.....................................................................................................4
1.2
O
RIGIN OF DERIVATIVES
............................................................................................................4
1.3
D
ERIVATIVES IN
I
NDIA
..............................................................................................................5
1.4
T
WO IMPORTANT TERMS
.............................................................................................................6
1.4.1
Spot Market
........................................................................................................................................................6
1.4.2
Index
......................................................................................................................................................................7
CHAPTER 2: DEFINITIONS OF BASIC DERIVATIVES...............................................................8
2.1
F
ORWARDS
...............................................................................................................................8
2.1.1
Settlement of forward contracts
............................................................................................................9
2.1.2
Default risk in forward contracts
.........................................................................................................10
2.2
F
UTURES
................................................................................................................................11
2.3
O
PTIONS
................................................................................................................................12
2.3.1
Call option
.........................................................................................................................................................13
2.3.2
Put option
..........................................................................................................................................................13
2.4
T
ERMINOLOGY OF
D
ERIVATIVES
................................................................................................14
2.4.1
Spot price (ST)
...............................................................................................................................................14
2.4.2
Forward price or futures price (F)
......................................................................................................14
2.4.3
Strike price (K)
...............................................................................................................................................15
2.4.4
Expiration date (T)
.......................................................................................................................................15
2.4.5
Types of options
............................................................................................................................................15
2.4.6
Contract size
....................................................................................................................................................15
2.4.7
Contract Value
................................................................................................................................................16
2.4.8
Margins
................................................................................................................................................................16
2.5
M
ONEYNESS OF AN
O
PTION
......................................................................................................16
2.5.1
In-the-money option
...................................................................................................................................17
2.5.2
Out-of-the-money option
.........................................................................................................................17
2.5.3
At-the-money option
..................................................................................................................................17
CHAPTER 3: APPLICATIONS OF DERIVATIVES………….........................................................19
3.1
P
ARTICIPANTS IN THE
D
ERIVATIVES
M
ARKET
.............................................................................19
3.1.1
Hedgers
...............................................................................................................................................................19
3.1.2
Speculators
.......................................................................................................................................................21
3.1.3
Arbitrageurs
.....................................................................................................................................................22
3.2
U
SES OF
D
ERIVATIVES
............................................................................................................24
3.2.1
Risk management
.........................................................................................................................................24
3.2.2
Market efficiency
...........................................................................................................................................24
2
3.2.3
Price discovery
................................................................................................................................................25
CHAPTER 4: TRADING FUTURES…………………………..............................................................26
4.1
P
AY
-
OFF OF
F
UTURES
..............................................................................................................26
4.1.1
Pay-off diagram for a long futures position
..................................................................................26
4.1.2
Pay-off diagram for a short position
.................................................................................................27
4.2
A
THEORETICAL MODEL FOR
F
UTURE PRICING
.............................................................................28
CHAPTER 5: TRADING OPTIONS…………………………..............................................................29
5.1
O
PTION
P
AYOUT
....................................................................................................................29
5.1.1
A long position in a call option
..............................................................................................................29
5.1.2
A long position in a put option
..............................................................................................................29
5.1.3 A short position in a call option
..........................................................................................................29
5.1.4
A short position in a put option
............................................................................................................30
5.2
O
PTION
S
TRATEGIES
...............................................................................................................33
5.2.1
Long option strategy
...................................................................................................................................33
5.2.2
Short options strategy
...............................................................................................................................35
5.3
D
ETERMINATION OF OPTION PRICES
..........................................................................................36
5.3.1
Intrinsic value and time value
..............................................................................................................37
5.3.2
Factors impacting option prices
..........................................................................................................38
CHAPTER 6: DERIVATIVES TRADING ON EXCHANGE............................................................40
6.1
D
ERIVATIVES
T
RADING ON
NSE...............................................................................................40
6.1.1
Contract specifications for index based futures
.........................................................................40
6.1.2
Contract specifications for index based options
.........................................................................41
6.1.3
Contract specifications for stock based futures
..........................................................................42
6.1.4
Contract specifications for stock based options
.........................................................................43
6.2
U
SING
D
AILY
N
EWSPAPERS TO
T
RACK
F
UTURES AND
O
PTIONS
....................................................44
6.3
S
ETTLEMENT OF
D
ERIVATIVES
..................................................................................................46
6.3.1
Clearing members
........................................................................................................................................46
6.3.2
Clearing banks
................................................................................................................................................47
6.4
S
ETTLEMENT OF
F
UTURES
........................................................................................................47
6.4.1
Mark to market settlement
.....................................................................................................................47
6.4.2
Final settlement for futures
....................................................................................................................48
6.5
S
ETTLEMENT OF
O
PTIONS
........................................................................................................49
6.5.1
Daily premium settlement
.......................................................................................................................49
6.5.2
Exercise settlement
.....................................................................................................................................49
6.6
A
CCOUNTING AND
T
AXATION OF
D
ERIVATIVES
...........................................................................50
6.6.1
Taxation of derivative instruments
....................................................................................................50
MODEL TEST……………………..……………………………...............................................................52
3
Distribution of weights in theEquity Derivatives: A Beginner’s Module CurriculumChapterNo.Title Weights (%)
1 Introduction 152 Definitions of Basic Derivatives 153 Applications of Derivatives 104 Trading Futures 205 Trading Options 206 Derivatives Trading on Exchange 20Note: Candidates are advised to refer to NSE’s website: www.nseindia.com, click on ‘NCFM’ link and then go to ‘Announcements’ link, regarding revisions/updations in NCFM modules orlaunch of new modules, if any.Copyright © 2009 by National Stock Exchange of India Ltd. (NSE)Exchange Plaza, Bandra Kurla Complex,Bandra (East), Mumbai 400 051 INDIAAll content included in this book, such as text, graphics, logos, images, data compilation etc.are the property of NSE. This book or any part thereof should not be copied, reproduced,duplicated, sold, resold or exploited for any commercial purposes. Furthermore, the book in itsentirety or any part cannot be stored in a retrieval system or transmitted in any form or by anymeans, electronic, mechanical, photocopying, recording or otherwise.
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