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HDFC Securities Ltd.

Basics on Futures & Options

Structured by:
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Derivatives
Derivative is a product whose value is derived from the value of the underlying asset. Underlying asset can be equity, forex, commodity, or any other asset.

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Features
Centralization of Trading No counter party risk Standardization of contracts Liquidity Mark to Market (MTM) margining system
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Features

contd

No. of contracts existing at any given point of time is called Open Interest. Squared off in cash on expiration. Three series trade at any point in time. The market lot is 200 for Nifty and 50 for Sensex Contract expires on last Thursday of the month
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Options
Hyundai is launching SONATA Price is Rs 15 Lakh You can book the car by paying Rs 50,000

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contd
By booking the car, what have you bought? When booking matures, can Hyundai force you to buy SONATA? Can you force Hyundai to sell SONATA?
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Options
gives the buyer the right not the obligation to buy or sell a specified underlying at a set price on or before a specified date
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Features
Option Premium
Price paid by the buyer to acquire the right Intrinsic and Time

Strike Price or Exercise Price


Price at which the underlying may be purchased or sold

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Strike Prices
In-the-money (ITM)
Option with positive cash flow

At-the-money (ATM)
Exercise Price = Market Price

Out-of-the-money (OTM)
Option with negative cash flow
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contd
At-The-Money-Strike In-The-Money Calls Out-The-Money-Calls 950 1050 1150 1250 1350 1450 1550
Spot

950 1050 1150 1250 1350 1450 1550 Out-The-Money-Puts In-The-Money-Puts At-The-Money-Strike
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contd
Expiration Date
Last date for exercising the option or the date on which option expires.

Exercise Date
Date on which the option is actually exercised

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contd
Assignment
When the holder of an option exercises his right to buy/ sell, a randomly selected option seller (at the client level) is assigned the obligation to honor the underlying contract

Open Interest
The total number of options contracts outstanding in the market at any given point of time.
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Types of Option
European Option
can be exercised only on the expiration date

American Option
can be exercised any time on or before the expiration date

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Call Option
A call option gives the buyer, the right to buy specified quantity of the underlying asset at the set strike price on or before expiration date. The seller (writer) however, has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy.
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Buying of a Call Option


View: Bullish Buy a one month Nifty Call With the Strike of 1250 Premium of Rs 100
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Payoffs
Nifty Spot 1000 1100 1200 1250 1350 1400 1500

Below strike Value of 1250 call Premium paid Net Profit / (Loss) 0

Below strike 0

Below strike 0

At strike

Break even 100

Above strike 150

Above strike 250

-100

-100

-100

-100

-100

-100

-100

-100

-100

-100

-100

50

150

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200

Payoff chart

150

100

50

0 1,000

1,100

1,200

1,250

1,350

1,450

1,550

-50

-100

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Selling of a Call Option


View: Bearish Sell / Write a one month Nifty Call With the Strike of 1250 Premium of Rs 100
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Payoffs
Nifty Spot 1000 1100 1200 1250 1350 1450 1550

Below strike Value of 1250 call Premium recd Net Profit / (Loss) 0

Below strike 0

Below strike 0

At strike

Break even -100

Above strike -200

Above strike -300

100

100

100

100

100

100

100

100

100

100

100

-100

-200
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HDFC Securities Ltd.

Payoff Chart
200 150 100

50

0 1,000

1,100

1,200

1,250

1,350

1,450

1,550

-50

-100

-150

-200

-250 HDFC Securities Ltd.

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Put Option
A Put option gives the buyer the right to sell specified quantity of the underlying asset at the set strike price on or before expiration date. The seller (writer) however, has the obligation to buy the underlying asset if the buyer of the put option decides to exercise his option to sell.
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Buying of a Put Option


View: Bearish Buy a one month Nifty Put With the Strike of 1250 Premium of Rs 100
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Payoffs
Nifty Spot 1000 1100 1150 1250 1350 1450 1550

Below strike Value of 1250 put Premium paid Net Profit / (Loss) 250

Below strike 150

Break even 100

At strike

Above strike 0

Above strike 0

Above strike 0

-100

-100

-100

-100

-100

-100

-100

150

50

-100

-100

-100

-100

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Payoff Chart
200 150

100

50

0 950

1050

1150

1250

1350

1450

1550

-50

-100

-150 HDFC Securities Ltd.

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Selling of a Put Option


View: Bullish Sell / write a one month Nifty Put With the Strike of 1250 Premium of Rs 100
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Payoff
Nifty Spot 1000 1100 1150 1250 1350 1450 1550

Below strike Value of 1250 put Premium recd Net Profit / (Loss) -250

Below strike -150

Break even -100

At strike

Above strike 0

Above strike 0

Above strike 0

100

100

100

100

100

100

100

-150

-50

100

100

100

100

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Payoff Chart
200 150 100

50

0 950

1050

1150

1250

1350

1450

1550

-50

-100

-150

-200

-250 HDFC Securities Ltd.

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Futures Contract
Agreement between two parties to exchange an asset at a certain date in future at a certain price. It is a standardized forward contract that is traded on an exchange.

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Futures Buyer
Mr. X buys a Nifty futures at 1250.
Nifty 1,000 1,100 1,200 1,300 1,400
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Payoff -250 -150 -50 50 150


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Payoff for Futures buyer


250 150

50

1,000 -50

1,100

1,200

1,300

1,400

1,500

1250

-150

-250

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Futures Seller
Mr. X sells a Nifty futures at 1250.
Nifty 1,000 1,100 1,200 1,300 1,400
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Payoff 250 150 50 -50 -150


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Payoff for Futures seller


250 150

50

1,000 -50

1,100

1,200

1,300

1,400

1,500

1250

-150

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-250

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MTM margining system


Mr. X buys Nifty futures at 1050
Date 23rd July 24th July 25th July TOTAL
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Closing 1100 1000 1200

MTM a/c +50 -100 +200 +150


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Points to remember
Derivatives can be a very effective tool to take advantage of a rising, falling and range bound underlying. The following points may be kept in mind while trading in derivative products: Choose a month that allows enough time for the anticipated move in the underlying. In-the-money calls are initially more responsive to underlying price changes than out-of-the-money calls. Choose a strike price level that offers a good risk/reward ratio given the expected price movement.
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contd
Watch for Bid/Ask price offered for Spot, Future, & Options simultaneously Liquidity of products involved Transaction Costs
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To sum up

Derivatives is a financial instrument with Infinite Opportunities


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Thank You

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