the derivatives market

7/31/2019 The Derivatives Market

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THE DERIVATIVESMARKET

Presented By

Amol Gaye.Shrikant Bhadre.

Roshan Parate.


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INTRODUCTION

A derivative is a contract whose value is derive

from the value of another asset, known as

underlying, which could be a share, a stock

market index, an interest rate, a commodity , or

a currency.

Derivatives involves payment/receipt of income

generated by the underlying asset.

When the price of this underlying changes , the

value of the derivatives also changes.


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For example, the value of a gold futures contract

derives from the value of the underlying

asset,i.e., gold.

Derivatives are very similar to insurance.

Insurance protects against specific risks , such a

fire ,floods ,and theft.

Derivatives on the other hand ,take care of

market risk- volatility in interest rate , currencyrate , commodity prices and share prices.


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Benefits Of Derivatives

Reduce risk

Enhance liquidity of the underlying asset.

Lower transaction cost.

Enhance price discovery process.

Portfolio management.


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Kind Of Financial Derivatives

The important financial derivatives are the

following,

1) Forward.

2) Futures.

3) Options.

4) Swaps.


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Derivatives Market In India

Derivatives trading formally commenced in

June 2000 on the two major stock exchange , theBSE and NSE.

Future trading based on the sensex commencedat the BSE on 9 June 2000,while future trading

based on the S&P CNX Nifty commenced at the

NSE on 12 June 2000.

The trading in index option commenced in June

2001 and trading in option on individual

securities commenced in July 2001.


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Trading in stock future commenced in January

2002.

New product such as interest rate futures

contract and future and potion contract were

introduced in June 2003 and August 2003respectively.


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Forward

A forward contract is a customised contract

between two parties obligating each to exchange

a particular good or instrument at a set price on

a future date.

Forward contract are private agreement betweentwo financial institution or between a financial

institution and its corporate client.

In forward contract , one party takes a long

position by agreeing to buy asset at certain

specified date for specified price and other party

take short position by agreeing to sell the asset

on same date for same price.


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Features Of Forward Contract

Over the counter trading(OTC).

No down payment.

Settlement at maturity.

Linearity.

No secondary market.

Necessity of a third party.

Delivery.


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Future A future contract is very similar to a forward

contract in all respect expecting the fact that it iscompletely a standardised one.

A future contract is one where there is an

agreement between two parties to exchange anyasset or currency or commodity for cash at a

certain future date , at an agreed price.

As in forward contract, the trader who promises

to buy is said to be inlong position and the one

who promises to sell is said to be in short

position in future also.


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Features Of Futures

1) Highly standardised.

2) Down payment.

3) settlements.

4) Hedging of price risks.5) Linearity.

6) Secondary market.

7) Non delivery of the asset.


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Futures Terminology Futures : a forward contract traded on

exchange.

Long : a party is said to be long on an

instrument when he or she owns the instrument.

Short : a party said to be short if he or she hassold the instrument.

Spot price: the price at which an asset traded in

the spot market.

Future price: the price at which the future

contract trades in the future market.

Expiry date : the last day on which the contract

will be traded.


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Contract size : the amount of asset that has to

be delivered under one contract.

Contract cycle : the period over which a contrcttraded.

Margin : an amount of money deposited by

both buyers and seller of future contract to

ensure performance of the terms of the contract.

Basis: the difference between spot price of an

asset and its future price.

Contango: under normal market conditions,futures contract are priced above the expected

future spot price. This is called contango.


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Pricing Future

Factor that affect future prices are

1)Spot price : the price of good for immediate

delivery . It is also referred to as the cash price

or the current price. 2)Basis : the different between cash price and

future price of a particular good.

basis = current cash pricefutures price.

3) Spreads : a spreads is the difference between

two future price.

Spread may be classified as intra commodity

spread and inter-commodity spread.


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Conti..

If two futures prices that form a spread arefutures prices for futures contracts on the same

underlying good but with different expiration

dates , the spread is an intra commodity

spread.

If two prices that form a spread are futures

prices for two underlying goods , such as silver

and gold futures ,then the spread is an intercommodity spread.

4) Expected Future Spot Rate : the

expectation of market participants also help in

determine futures price.


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If the market participants believe that silver will

sell for Rs.7000 per kg. in three months, then theprice of the futures contract for delivery of silver

in three months cannot be Rs.9000per kg.

Cost Of Storage : the cost of storing is the cost

of storing the underlying good from the presentto the delivery date. It is the cost of carry related

arbitrage that drives the behavior of the futures

price.


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Futures Trading StrategiesStrategies are game plans created by an investor

These game plans are based on an investorsexpectation of how the market will move.

There are four views that an investor can take on

market.

1) Bullish: the investor anticipates a price rise.

2) Bearish: the investor anticipates a price

decline.

3) volatile: the investor anticipates a significantand rapid movement either in the market or scrip

but he is not clear of the direction of the

movement.

4) Neutral: the investor believes that market or


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Type Of Futures StrategiesThese strategies can be classified into three

groups.1) Hedging strategies : Hedge reduces the price

risk of an existing or anticipating position in

cash market . A can help lock in existing

profits.

Hedging does not mean maximization of

return its purpose is to reduce the volatility of

portfolio by reducing the risk.Hedger sell futures when they are long the

cash asset and buy futures when they are short

the cash asset.


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Types Of Hedging Strategies

Long stock , short index future.

Short stock , long index future.

Hedging a portfolio with short index future.

Hedging with long index future.


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There are two strategies for speculation.

If the speculator is bullish about the index , then

he can buy the index future.

If the speculator is bearish about the index, thenhe can sell index futures.

There are two type of speculation strategies.

Long index futures.

Short index futures.

2) Speculative Trading

Strategies


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3) Arbitrage Strategies :

The index arbitrage is the arbitrage between the

index value and the prices of the underlying

stocks.


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Option

As the very name implies , an option gives thebuyer an option to buy or sell an underlying

asset at predetermine price on or before a

specified date in future.

Types of option

1) Call option : The seller of call option is under

the obligation to sell the asset at specified

price in case the buyer exercises his option tobuy.

Thus ,the obligation to sell arises only when

the option is exercised.


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2) Put Option : The seller of a put option is under

the obligation to buy the asset at the exercise

price provided the option holder exercises his

option to sell.

3) Double Option : A double option is one which

gives the option holder both the rights either tobuy or sell an underlying asset at a

predetermined price on or before a specified

date in futures.


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Features Of Option

Highly Flexible.

Down Payment.

Settlement.

Non-Linearity.

No obligation to buy or sell.


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Margins Applicable On Option

Option buyer have to merely pay the premiumand no margin applicable to them . The

exchange levy margins on option writers as they

face unlimited losses.


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Option Terminalogy

Underlying: The specific asset on which anoption contract is based.

Option premium: The price paid by the buyer

to the seller to acquire the right to buy. Strike price: The prepaid price at which the

option may be exercised. It is also called as

exercise price

Open interest: the total number of optioncontract outstanding in the market at any given

point of time.


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Conti Option holder: one who buy an option which

can either be call or put option.

Option class: all listed option of a particular

type on particular underlying instrument.

Moneyness : An option concept that refers tothe potential profit or loss from the exercise of

an option.


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Option Pricing Option values or prices are derived from

theoretial model the black-scholes option

pricing modle.

Factors that affect the determination of

option pricing.1) underlying stock price

2) strike/exercise price

3) time until expiration

4) interest rate

5) volatility


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Derivative Trading In India

At present derivative trading has been permittedby the SEBI on the derivative segment of the

BSE and F&O segment on NSE.

The nature of derivatives contract permitted are:(i) Index future contract introduced in June,2000.

(ii) Index option introduced in June 2001

(iii) Stock option introduced in July 2001.

the derivatives market

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