new derivatives session
TRANSCRIPT
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DERIVATIVES
(Futures & Options)
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What will we look at?
Basic concepts of Derivatives (Futures & Options)
How to protect equity investments using some basic
strategies in derivatives.
Market direction / trend indicators
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Specified Guide lines - Derivatives
Contract Size: SEBI has specified minimum contractvalue of Rs. 200,000.00
Lot Size: Different lot size applicable for differentunderlying
Contract for three different monthsin existence knownas Near month, Middle month & Far month.
Expiry Date: Date on which F/O contract will ceases toexist. It is always Last Thursday of the month or the dayprior in case last Thursday of the month is a Tradingholiday
Settlement : Futures & Options are CASH SETTLED.
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Futures
Index Futures
Stock Futures
Options
Index Options
Stock Options
Derivatives Products
Derivatives is a product which does not have its own value but is derived fromsome underlying.
Incase of Futures & Options value is derived from the CASH or SPOTMarket
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Benefits Of Derivatives
Reduces market risk
Willingness to Trade
Lower cost of trading
Increase trading volume in stock market liquidity.
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Futures - Definitions
Future Contract: Legally binding agreement to buy or sell a financialinstrument sometime in future.
QuantityLot size fixed.
Delivery time - Expiry date is fixed
Futures Position
BUY Futures : Right as well as obligation to buy the underlying shares atthe future date
SELL Futures: Right as well as obligation to sell underlying shares at thefuture date
RightTo claim profit, if any
ObligationTo pay loss, if any
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Futures - Pricing
FUTURES= S (Spot price) + C (Cost to carry)
COST OF CARRY= Interest Cost / Opportunity Cost
COST OF CARRY (factors affecting it)
Prevailing interest rate
Volatility of the stock
Demand and Supply of stock
(Determination of cost of carry is not fixed. Its entirely market
driven)
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FuturesPricing.(contd)
Expiry Date
SPOT PRICE = FUTURES PRICE (Cost to Carry is zero)
WHEN IS SPOT PRICE HIGHER THAN FUTURES PRICE
Dividend declared by company (during the contract period)
Mis-pricing (Lack of Price discovery)
3 monthsContract
Price
2 month
Contract
Price
1 month
Contract PriceSPOT Price
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FuturesRisk & Settlement
Both BUY & SELL position carries unlimited risk
Both positions are margined
Mark to Market on daily basis at closing price of a particularcontract
Difference is paid/recovered on T+1 basis
Settlement Price: Closing price on underlying in Cash /Spot
market on contract expiry date
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How To Use Index Futures
Speculation
Hedging
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SpeculationBearish outlook
What to do:
Believe market would go down
Sell liquid stocks like Infosys
Sell entire index portfolio
What can go wrong
Costly to sell the entire set of stocks
Vulnerable to company specific risk
What you could do
Short Sell S&P CNX Nifty futures
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Speculation (contd.)
04th April 2011
You feel the market will fall Sells 100Nifties expiring on Apr 28
Nifty April contract is trading at 5600
Your position is worth Rs. 560000
28th April 2011
Nifty April futures has fallen to 5500
Square off your position at 5500
Make a profit of Rs. 10,000 (100*100)
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Payoff for Nifty Futures Short at 5600
NIFTY PAYOFF
5600 0
5550 50
5500 100
5450 150
5400 200
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SpeculationBullish outlookWhat to do:
Believe market would go up
Buy liquid stocks like Infosys
Buy entire index portfolio
What can go wrong
Costly to buy the entire set of stocks
Vulnerable to company specific risk
What you could do
Long Buy S&P CNX Nifty futures
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Speculation (contd.)04th April 2011
You feel the market will rise
Buy 100 Nifties expiring on April 28
Nifty April contract is trading at 5600
Your position is worth Rs. 5,60,000
28th April 2011
Nifty April futures has risen to 5650
Square off your position at 5650
Make a profit of Rs. 5,000 (100*50)
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Payoff for Nifty Futures Long at 5600
NIFTY PAYOFF
5400 -200
5500 -100
5600 05700 100
5800 200
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Hedging
Stocks carry two types of risk :-
Company specific Market risk
Company specific risk can be reduced by
divercification.
Market risk cannot be diversified but has to behedged.
Market risk is known from Beta
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How to hedge your stock position
using futures
This first thing one needs to know is the beta of the stock.
That is the impact a 1 per cent movement in the Nifty will
have on the stock
This is known as hedging
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How to hedge your stock position
using futures
Lets assume you expect Reliance to go up and want to takea long position on Reliance worth Rs 2,50,000.
The scrip has a beta of 1.07.
To remove the hidden Nifty exposure in the above position
the size of the sell position that will have to be taken in the
Nifty futures is 1.07 * 2,50,000 = 2,67,500.
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Hedging
So if the Nifty is at 5600 and each market lot is
100(one contract)
Then the contract size would be Rs 5,60,00.
As such, to sell Rs 5,60,000 worth of Nifty we
need to sell one market lot (rounded off to the
nearest market lot).
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Hedging
This would give us the following position.
Long (Buy)2 lots(250) Reliance Rs 5,00,000
Short (Sell) Nifty Rs 5,600,000
By building such a position what you are essentially doingis removing the hidden Nifty exposure and a positionwhich will reflect the price changes inherent only toReliance.
Assuming the Index falls and Reliance also moved in lineyou will lose on Reliance but the losses and risk could beoffset or reduced by the short Nifty.
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Futures - Advantages over Cash
You can take 45 times more than limits
Close positions anytime before expiry. On expiry day,exchange automatically closes out positions.
Keep your positions open up to 3 months
Lower brokerage / transaction costs
Profits / losses are paid / recovered on a daily basis
If you feel the market will be bearish, take short positions infutures, which is not possible in CASH segment without actualshares in demat.
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Confers right to the holder/buyer of option to buy/sell a specified
assets at a specific price on or before a specific date. Seller/Write
has an obligation to fulfil the contract if buyer/holder exercises hi
option
BUYER SELLER
Gets a RIGHT Has an OBLIGATION
Pays PREMIUM Receives PREMIUM
OPTIONS - DEFINITION
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CALL OPTIONS: BUYER
Buyer gets a RIGHT,
To BUY underlying shares at a price.
On or before a determined date.
SELLER
Seller has an obligation
To SELL underlying shares at a price
On or before a determined date
Option-Definitions
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. PUT OPTIONS:
BUYER
Buyer gets a RIGHT,
To SELL underlying shares at a price.
On or before a determined date.
SELLER
Has an obligation
To BUY underlying shares at a price.
On or before the determined date.
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BUY CALL:
Buyer gets right to BUY underlying at the strike price
BUY PUT:
Buyer gets right to SELL underlying at the strike price
SELL CALL:
Seller has an obligation to SELL the underlying at strike
price
SELL PUT:
Seller has an obligation to BUY the underlying at strike
price
Options-Positions
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American Options: It is exercisable anytime on or
before the expiry date. OPT-RELIANCE-APR-28--2011-1000-CA
European Options: It is exercisable only on the expiry
date on contract note. OPT-NIFTY-28-APR-2011-2050-CE
Indian Scenario:
Index Options- European cash settled
Stock Options- American cash settled
Settlement Price: Difference between Strike Price and
Underlying Price
Options - Exercisability & Settlement
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In The Money Concepts from the buyers perspective.
Option is said to be in the money when the option has
intrinsic value.
Call option is in the money when the Strike price is < Spot
price
Put option is in the money when the strike price is > spot
price
Eg. Strike Price 950 Call option of Reliance industries when the
Spot price is 1000.
The difference of Rs. 50 is said to be the intrinsic value of the
option.
Options- Spot & Strike price Relationship
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Out of The Money Option is said to be out of money when it does not have
any intrinsic value
Call option is out of the money when the Strike price is >
CMP
Put option is out of the money when the strike price is