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DMDM_jun08

DMDM_jun08

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Published by Amit Achha
Notes of derivates
Notes of derivates

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Published by: Amit Achha on Jul 17, 2011
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 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 compilationetc. 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 its entirety or any part cannot be stored in a retrieval system ortransmitted in any form or by any means, electronic, mechanical, photocopying, recordingor otherwise.
 
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
 

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