derivatives

2nd topic

DERIVATIVE MKT

Instrument which derives its value from some

underlying assets. These underlying assets

could be equities, debt,, currencies and even

indices

Spot market

is a securities market in which security are

sold for cash and delivered immediately

INDEX

Barometer to check the movement of

stock

Is a basket of identified stock and its

value is computed by taking the

weighted average of the price of the

constituent stock of index

FORWARDS

It is contract between 2 parties to buy or sell an asset

at a certain future date Expiry for certain price that is

pre decided on the date of contract

Important conditions in fwd contract:

Time of delivery

Qty/volume of underlying assets

Fwd price

SETTLEMENT OF CONTRACT

Physical settlement

Spot price > than fwd price

Spot price < fwd price

Spot price = fwd price

Cash settlement

No delivery of goods only margin involved

FUTURES

Similar to fwd contracts

Agreement between 2 parties

Buyer agrees to buy an asset from seller on

future date @ a predetermined price. However,

futures contract is not a private contract since it

gets traded on a recognized Exchange

All terms except price are decided by exchange

ROLE OF CLEARING CORPORATION

Futures contract are through recognized stock

exchange both buyer and seller are protected

against counterparty risk by an entity called CC

If any of the party defaults cc comes in to

picture to fulfill the obligation thereby

protecting them from counterparty risk

MARGIN MONEY

to be able to guarantee the fulfillment of the

obligations under the contract, the cc holds an

amount as a security from both the parties

Initial margin

Money deposited by both the buyer and seller

to assure the trade

MONEYNESS OF THE OPTION

Call (buy) mkt movement upwards

Put (sell) mkt movement downwards

In the money Mkt price> strike price

Mkt price< strike price

At the money Mkt price= strike price

Mkt price= strike price

Out of the money Mkt price<strike price Mkt price>strike price

INTRINSIC VALUE Price difference between underlying

security and the strike price

Time value

• Price of the option exceeds its intrincic value. Time value premium of an option declines as the expiration date approaches.

Option pricing

• IV+TV= OP

FACTOR INFLUENCING PRICE OF AN OPTION UNDERLYING STOCK

STRIKE PRICE OF THE OPTION ITSELF

TIME REMAINING UNTIL THE OPTION EXPIRES

VOLATILITY OF UNDERLYING STOCKS

BLACK SHOLES OPTION PRICING MODEL

FIRST OPTION PRICING MODEL SIMILAR TO EUROPEAN STYLE MODIFIED TO AMERICAN STYLE MODEL FOR PRICING OPTIONS BEFORE OPTION WERE TRADED

PREMIUM SPECULATIVE AND RISKY OPTION SELLER IS OPTION WRITER (GAIN IS LTD AND LOSS IS

UNLTD) OPTION BUYER LOSS IS LTD TO PREMIUM & GAIN IS UNLTD

CHARACTERISTICS OF OPTION

MOTIVES OF DERIVATIVES

HEDGING

SPECULATORS

ARBITRAGE – RISK FREE SPECULATION

FEATURES OF DERIVATIVES

UNDERLYING ASSETS DELIVERY SPECULATIVE SETTLEMENT (COMPULSORILY SETTLED)

TRADING PROCESS

BUYER

PURCHASE ORDER

BROKER

SELLER

EXCHANGE

SETTLEMENT AND PAYMENT SETTLEMENT AND PAYMENT

TRANSACTION THROUGH TRADING SOFTWAREBROKE

R

SALES ORDER

EXCHANGE

UNDERLYING ASSETS OF DERIVATIVES

COMMODITY STOCK CURRENCY INTEREST RATES

BARTER COMMODITY SWAPS ARE RARE CURRENCY SWAPS (xchange currencies at future

date) INTEREST RATE SWAPS

SWAP

FEATURES OF SWAP

NEGOTIATED CONTRACTS

INTERMEDIARY

COMBINATION OF FORWARD CONTRACTS

SETTLEMENT

ADVANTAGES OF DERIVATIVES

RISK MITIGATION REARRANGEMENT OF RISK EASE IN TRADING INVESTMENT MONEY FLOWS EQULIBRIUM

DISADVANTAGE OF DERIVATIVES

RISK SPECULATION MARKET MOVEMENTS HOT MONEY TIMED SETTLEMENT ACCOUNTING AMBIGUITIES

DERIVATIVE MARKET WORLD WIDE

EUREX- F&O XCHANGE CHOICE FOR TRADING AND CLEARING OF

DERIVATIVES OFFERS OPEN,SIMPLE DEMOCRATIC AND

COST EFFECTIVE ACCES FROM ANY PT OF THE GLOBE

700 LOCATIONS

NASDAQLargest US electronic change3200 companies listed

Derivatives in India1875 mumbai-1st commodity xchangeCC -1918Oilseeds future mkt 1900 then wheat then

rawjutes so on…India original home for options-1898

NCDEX -2003 55 COMMODITIES MCX-7000 CR NABARD,NSE,BANKS,INSURANCE

COMPANIES ETC.. BSE AND NSE Stock market futures and index futures