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Basics of Derivative Trading Basics of Derivative Trading: Financial Markets
Basics of Derivative Trading Basics of Derivative Trading: Financial Markets
FINANCIAL MARKETS
DERIVATIVES
FUTURES
OPTIONS
Derivatives Defined
It is a product whose value is derived from the value of
one or more variables bases \underlying asset which
could be equity,commodity,forex,other
equity commodity forex other asset
asset.
Derivative Products
The most commonlyy used derivative p
products are
Forwards, Futures and Options.
F
Forwards
d Is a customized contract between two parties to buy or sell
an asset on a specified date in the future for a specified
price.
They are traded outside the exchanges
p
to counter p
party
y risk.
Are exposed
Derivative Products
Futures
These are agreements between two parties to buy or sell an asset at a
certain time in the future at a certain price.
Futures contracts are standardized and exchange traded. This makes them
highly liquid unlike the forward contracts
contracts.
Supply and demand on the secondary market determines the futures
price.
Index futures are all futures contracts where the underlying
y g is the stock
index (Nifty or Sensex) and helps a trader to take a view on the market as a
whole.
In India we have index futures contracts based on S&P CNX Nifty and the
BSE Sensex and near 3 months duration contracts are available at all
times.
Each contract expires on the last Thursday of the expiry month and
simultaneously a new contract is introduced for trading after expiry of a
contract
contract.
4
In terms of expiry
Near Month
Next Month
Far Month
Futures Terminology
Rise
Fall
Price
Open interest
Market
Strong
Warning signal
Weak
Warning signal
Daily margining
Daily margining is of two types:
1.
2.
Initial margins : The initial margin amount is large enough to cover a one-day loss that can be
encountered on 99% of the days.
Mark-to-market p
profit/loss : The daily
y settlement process
p
called "mark-to-market" p
provides for
collection of losses that have already occurred (historic losses) whereas initial margin seeks to
safeguard against potential losses on outstanding positions. The mark-to-market settlement is done
in cash.
A client purchases 4 contract of FUTIDX NIFTY 29JUN2001 at Rs 1500. (Lot size 50)
Loss
Margin released
1400*50*4
=2,80,000
Payment to be
made
20,000 (3,00,000-2,80,000)
3,000 (45,000-42,000)
17,000
(20,000-3000)
(17 000)
(17,000)
Margin = 42,000
Close Price
Gain
Addn Margin
1510*50*4
=3,02,000
22,000 (3,02,0002,80,000)
3,300 (45,300-42,000)
18,700 (22,000-3300)
Payment to be
recd
18,700
Gain
1600*50*4 =3,20,000
18,000 (3,20,000-3,02,000)
Payment to be recd
Margin Account
Margin account*
Initial margin
=
Rs 45
45,000
000
Margin released (Day 1) = (-) Rs 3,000
Position on Day 2
Rs 42,000
Addn margin
= ((+)) Rs 3,300
Total margin in a/c
Rs 45,300*
Net gain/loss
Day 1 (loss)
Day 2 Gain
Day 3 Gain
Total Gain
=
=
=
=
(Rs 17,000)
Rs 18,700
Rs 18,000
Rs 19,700
The client has made a profit of Rs 19,700 at the end of Day 3 and the total
cash inflow at the close of trade is Rs 65000
Types of Options
Index Options Have the index as the underlying.
underlying
Stock Options Options which have stocks as the
underlying asset.
Call Option Gives the holder the right but not the
obligation to buy an asset by a certain date for a
certain price.
price
Put Option Gives the holder the right but not the
obligation to sell an asset by a certain date for a
certain price.
Options Terminology
Options Terminology
Options Terminology
Option Pricing
Factors affecting option price
Stock Price Call options become more valuable as stock
price go up.
Strike Price - Call options become more valuable as strike
price goes down
down.
Time to expiration More the time more the value of the
option
Volatility More the volatility more the value of the option
Risk free interest rate Prices of call options increase as
risk free interest rate increases.
Dividends Has a negative effect on call options and
positive effect on put options as dividends have the effect of
reducing the stock price on ex-dividend date.
P
Payoff
ff for
f Futures
F t
Profit
2500
Nifty
Loss
Profit
0
Nifty
Premium
Loss
Profit
Nifty
0
Premium
Loss
Profit
Premium
Nifty
Loss
Speculation
Bullish Buy Nifty Calls or Sell Nifty Puts
Bearish Sell Nifty Calls or Buy Nifty Puts
Anticipate Volatility Buy a call and put at same strike
Bull Spreads Buy a call and sell another
Bear Spreads Sell a call and buy another
Using
g Index Options
p
When index falls your portfolio will lose value and the put
options
p
bought
g by
y yyou will g
gain.
If Nifty spot is 2500 and you buy puts with a strike of 2400, it will
i
insure
your portfolio
tf li against
i t an index
i d fall
f ll lower
l
th
than 2400.
2400
Speculation
p
Bullish outlook
Buy Nifty Call Options or Sell Put Option
Buying Call Options Limited risk, Unlimited gain
Selling Put Options Limited Upside and Unlimited downside
Strike Price is chosen depending on the view of the market.
Speculation
S
l ti Anticipate
A ti i t volatility
l tilit
If you think that market is going to witness volatile swings but
have no opinion on the direction of the swing, you can
i l
implement
tad
derivative
i ti strategy
t t
called
ll d a straddle.
t ddl
Can be used around budget time or during times of political
uncertainty.
Involves buying a call and a put with the same strike price and
maturity.
Maximum loss is the premium paid for the two options.
Gains are made only if the underlying asset moves significantly.
Receives premium
Obligation to sell shares if exercised
Profits from falling prices or remaining neutral
Potentially unlimited losses, limited gain
PUT OPTION WRITER (Seller)
Receives premium
Obligation to buy shares if exercised
Profits from rising prices or remaining neutral
Potentially unlimited losses, limited gain
Option
Call
Put
Time to expiry
Premium cost
O p tio n
C a ll
Put
V o l a t il it y
P r e m iu m c o s t
Thank you