INTRODUCTION TO OPTIONS AND FUTURES

CLASSIFICATION OF FINANACIAL MARKETS
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NATURE OF CLAIM MATURITY OF CLAIM SEASONING OF CLAIM TIMING OF DELIVERY ORGANISATIONAL STRUCTURE

DERIVATIVE
ACCORDING TO SC(R) ACT 1956;
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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.

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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

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LIMITATIONS OF FORWARD CONTRACTS

LACK OF CENTRALISED TRADING ILLIQUIDITY COUNTERPARTY RISK

FUTURES

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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

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EXCHANGE TRADED STANDARDISE D LIQUID REQUIRES MARGIN DAILY SETTLEMENT

OTC IN NATURE CUSTOMISED ILLIQUID NO MARGIN ON MATURITY

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OPTIONS

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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.

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FUTURES V/S OPTIONS
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EXCHANGE TRADED STANDARDISED PRICE IS ZERO BOTH PARTIES ARE REQUIRED TO PERFORM LINEAR PAY OFF BOTH LONG AND SHORT ARE AT RISK

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EXCHANGE TRADED STANDARDISED OPTION PREMIUM ONLY OPTION WRITER WILL HAVE OBLIGATION NON LINEAR PAY OFF ONLY SHORT IS AT RISK

Options
BUYER/HOLDER RIGHTS/ OBLIGATIONS RIGHTS

SELLER/WRITER SELLERS HAVE ONLY OBLIGATIONS-NO OBLIGATION TO SELL/GO SHORT ON EXERCISE OBLIGATION TO LONG ON EXERCISE RECEIVED SELLER CANNOT INFLUENCE UNLIMITED LOSSES PRICE OF PREMIUM • ASSIGNMENT ON • OFFSET BY BUYING BACK OPTION IN MARKET • OPTION EXPIRES AND KEEP

BUYERS HAVE RIGHTSNO OBLIGATIONS RIGHT TO BUY/TO GO LONG RIGHT TO SELL/ TO GO SHORT PAID BUYER’S DECISION COST OF PREMUIM UNLIMITED PROFITS • EXERCISE • OFFSET BY SELLING OPTION IN MARKET • LET OPTION LAPSE

CALL PUT BUY/GO PREMIUM EXERCISE MAX. LOSS POSSIBLE MAX. GAIN POSSIBLE CLOSING OPTION POSITION OF EXCHANGE TRADED

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FUNCTIONS OF DERIVATIVES MARKETS
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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
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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
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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
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REGULATORY MECHANISM RISK MANAGEMENT TOOLS CLEARING CORPORATION MONITORING AND SURVEILANCE INVESTOR EDUCATION AND TRANING TECHNOLOGY

FACTORS LED FOR THE GROWTH OF DERIVATIVES
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INSTABILITY IN MACROECONOMIC VARIABLES INCREASED VOLATILITY IN CASH MARKET INCREASED FOREIGN TRADE TECHNOLOGY REFINED PRICING TOOLS

PARTICIPANTS

SPECULATORS HEDGERS ARBITRAGEURS

USERS OF DERIVATIVES
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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

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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 PRICE SPOT PRICE OPTION PRICE PAY OFF

500 500 500 500 500 500

400 450 500 550 600 650

20 20 20 20 20 20

-20 -20 -20 +30 +80 +130

140

120

100

80

60 PAY OFF 40

20

0

-20

-40

OPTION BUYER-PUT OPTION
STRIKE PRICE SPOT PRICE OPTION PRICE PAY OFF

2000 2000 2000 2000 2000 2000 2000

1700 1800 1900 2050 2100 2150 2200

50 50 50 50 50 50 50

+250 +150 +50 0 -50 -50 -50

300

250

200

150

100

PAY OFF

50

0

-50

-100

OPTION SELLER-CALL OPTION
STRIKE PRICE SPOT PRICE OPTION PRICE PAY OFF

500 500 500 500 500 500

400 450 500 550 600 650

20 20 20 20 20 20

+20 +20 +20 -30 -80 -130

40 20 0 -20 -40 PAY OFF -60 -80 -100 -120 -140

OPTION SELLER-PUT OPTION
STRIKE PRICE SPOT PRICE OPTION PRICE PAY OFF

2000 2000 2000 2000 2000 2000 2000

1700 1800 1900 2050 2100 2200 2300

50 50 50 50 50 50 50

-250 -150 -50 +50 +50 +50 +50

100

50

0

-50

-100

PAY OFF

-150 -200

-250

-300

FUTURES PAYOFF

PAY OFF FOR FUTURES BUYER
FUTURES PRICE SPOT PRICE PAY OFF

2000 2000 2000 2000 2000

1800 1900 2000 2100 2200

-200 -100 0 100 200

250 200 150 100 50 0 -50 -100 -150 -200 -250 PAY OFF

PAY OFF FOR FUTURES SELLER
FUTURES PRICE SPOT PRICE PAY OFF

2000 2000 2000 2000 2000

1800 1900 2000 2100 2200

200 100 0 -100 -200

250

200

150

100

50

0

PAY OFF

-50

-100

-150

-200

-250

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