NCDEX- focus on Agricultural Derivative products/ MCX- focus on Metals, Energy, Bullion

DERIVATIVES IS A ZERO-SUM GAME / DERIVATIVES IS A CONTRACT

FORWARD CONTRACTS:
FUTURES
Index Futures: Nifty Mid month: 31st march contract expiry/ Spot price Nifty 17101.95, risk free rate
7% p.a

On excel =17101.95*EXP(0.07*61/365): 17,303.19 ( Cost of the Futures contract- Cost of Carry)

Equity Futures: Infosys: So=1685.80 , Near Month- 24 Feb, time to expiry Risk Free rate of 6% p.a
Time to expiry: 18 days : 1685.80*e^(0.06*18/365)= INR 1690.79
COMMODITIES:

CONTANGO: when futures price is trading at a premium to the current spot price. the far month
contracts at a premium to near month contracts

BACKWARDATION: When Spot price is trading at a higher price compared to Futures which trading
at a discount. The far month contracts are at a discount to the near month

1.Rolling Yield: yield earned while rolling over futures contract. During contango rolling yield
generated while rolling over short position/ backwardation favours rolling over long position

2. Convenience yield (commodities) / 3. Collateralized yield: stocks, bonds, MF, FD etc as margin,
their increase in value increases my yields

SPAN/ PRISM/ ELM-Extreme loss margin

Types of Traders:

Types of Traders

1. Speculator- These traders take well researched directional positions in the F&O markets
which are leveraged (Smaller margin/ Larger investment exposure) in order to maximize
their profits. The leverage multiplies their gains, however it also enhances their losses in the
case of markets moving against them. (For example in nifty futures : at 16557, lot size of 50,
investment exposure- INR 8,27, 875 and margin for intraday Futures plus is INR 79,926 :
Leverage of 1:10)
If Nifty rises by 5%, your gain is 50% on the margin/ Nifty falls by 3% you lose 30% of margin.
(HIGH RISK-HIGH RETURNS) principle emotion-Greed

Types of Speculators- Scalpers- extremely short term positions (mins etc) | Day Traders-
intraday trading- squaring off positions with the close of the day | Swing Traders- position
for 2 to 3 days | Position traders- week, months –longer time frame

Speculators Positions:
Bullish market- Buying position i.e Long Position (1st position is to buy and 2nd step is to sell
at a higher price squaring off making a profit)
Bearish Market- Selling position i.e Short Position (1st position is to Sell (Sell an asset you
donot own at current price) and 2nd step is to Buy back the underlying asset at a Lower price
squaring off making a profit)

2. Hedger: These traders participate in the derivatives market with the sole intention of
minimizing risks and protecting themselves from future uncertainties, market volatilities and
adverse price fluctuations. They take opposite positions wrt to their existing or future
exposures and also willing to pay upfront costs and premiums in order to protect
 themselves. These increase costs and opposite positions reduce their profitability too. LOW
RISK-LOW RETURNS-Principle emotion Fear

Short Hedge: When you use short futures to protect yourself

Currencies: Exporter- Future receivable in USD. Fear- USD value may depreciate. Takes Short
futures on USD to hedge herself. If USD falls, profit from the short position hedge partly or
fully protects against the loss of receiving a lower price in spot markets

Commodities: Producer, Mining Company, Refiner who fears prices may fall in future. Short
futures as a hedge

Bonds: Bank’s, NBFC, Mutual Funds, PPF, Gratuity funds having big bond portfolios. Fear that
Interest rates may increase, RBI may be heavily selling bonds etc which causes the existing
bonds to lose value. Thus take Short position in Interest rate futures (IRF) market to hedge
themselves.

Equities: Investors/ Traders who have existing Long position in equities/ portfolio, fear that
prices may fall in future. They take short futures on say the Nifty or the respective stocks to
hedge themselves

Basis: Difference between the Spot and futures Price

Basis Risk: A perfect hedge may not be possible due to inherent differences between Spot and
futures settlement, prices, movement between both, for say agricultural commodities qualitative
differences, difference in expiry date of futures contract while spot delivery may be another period
etc.

Strengthening & Weakening of Basis:

 LONG HEDGE

Long Hedge: when you use Long Futures to protect yourself

Currencies: Importer- Futures payable in say USD, Fears that price of usd may go Up. Thus
takes Long futures in USD which benefits if USD goes up, profit from which partly or fully
protects against the loss on buying at a higher price in spot markets

Commodities: Buyers/ manufacturers who buy commodities as an input/ Oil importers who
fear prices may go up in future, take a long futures position to hedge themselves and benefit
from the rising prices on the long position which partly or fully protects against the
increased cost of buying at a higher price in spot markets

Bonds: Bank, Mutual Funds, Pension funds who need to buy bonds at a future date fear
that prices may go up. They Take a long Futures position today on IRF which benefits if prices
go up which partly or fully protects against the cost buying at a higher price in spot markets

Equities: Trader having an existing Short position fears that prices may increase. Take Long
futures position on the respective stocks, Index etc to hedge themselves.

Mutual Funds who need to buy Equities at a future date fear that prices may go up. They
take a long Futures position today on equity futures which benefits if prices go up which
partly or fully protects against the cost buying at a higher price in spot markets
3. ARBITRAGEURS- These traders simultaneously enter 2 or more different markets in order to
capitalize upon price discrepancies and market inefficiencies in order to lock into a Risk free
profit

Commodities- Cash and carry arbitrage

 OPTIONS

Intrinsic value of an option- How much is the option In-The- Money (generating positive cash flows)

When you exercise option you get the difference i.e intrinsic value/ Square off or offset you get the
premium which includes time value)
Intrinsic value can only be zero or positive (NOT Negative)

Time Value: Option premium minus the Intrinsic Value (The highest Time value is on At-The –Money
Options)

Eg. Call option : Strike price is INR 100, Spot price=120, Premium is INR 25: ITM (Intrinsic Value=St-
K=INR 20/ Time value: 25-20= INR 5) On expiry there is no time value: only intrinsic value for all ITM
options

Call Option: K=17,300 (Constant) / Spot Price St=17,367 / Intrinsic Value: INR 67

Premium 9th sept : 136 (Time Value=69) Pr: 30thsept: 268 (TV=201) Pr: 8th
oct :398 (TV=331) Pr: 25th nov : INR 518 (TV=INR 451)

All Out of the money and At the money options only have Time Value

ITM-ATM-OTM: is from the perspective of Option Buyer