TERMINOLOGIES OF DERIVATIVES

HEINZ FINANCE CLUB – WORKSHOP

FEBRUARY 14, 2015

Corey Sattler and Mahesh Nair

SPOT PRICE, FORWARD/FUTURE PRICE

• Spot Price: • Referred to as Cash Prize

• Price that is quoted for immediate delivery of asset

• Forward/Futures price:• Price agreed upon at the date of contract for delivery of an asset

• At a specific future date

• Dependent on:

• Spot price

• Prevalent Interest Rate

• Expiry date of Contract

STRIKE PRICE

• Price at which the buyer of the option can:

• Buy the stock Call Option

• Sell the stock Put Option

• Conditions Apply: On/before the expiry date of options contract

• Price at which stock will be brought/sold when the option is exercised

• USED IN CASE OF OPTIONS ONLY. NOT FOR FUTURE/FORWARDS

EXPIRATION DATE

• In case of Futures, Forwards and Index Options:

• It is the only date on which settlement takes place

• In case of Stock Options

• Last date on which option can be exercised

• Also called FINAL SETTLEMENT DATE

TYPES OF OPTIONS

• DEPENDING UPON PRIMARY EXERCISE STYLE

• AMERICAN Can be exercised on any day – on/before expiry date.

• Example: Stock Options.

• EUROPEAN Can be exercised only on Expiration Date.

• Example: Index based option

CONTRACT SIZE AND VALUE

• CONTRACT SIZE: Represents certain number of shares of underlying asset

• CONTRACT VALUE: Notional Value of transaction in case one transaction is brought/sold• Contract Value = (Contract Size) x (Price of Futures)

• Example: 1 futures contract of ABC consists of 300 shares trading at $2000

• Contract Size? Future Price? Contract Value?

TRADING FUTURES & PAY OFFS

• PAY OFF Profit/ Loss in a Trade

• + ve Payoff – Investors make profit - ve Payoff – Investors make

loss

Stock Price

Pro

fit/

Loss

TRADING FUTURES & PAY OFFS

• Future Pay off on maturity depends on:

• Spot price of the underlying asset at the time of maturity (ST)

• Price at which the contract was initially traded (F)

POSITIONS TAKEN IN FUTURE CONTRACT

• LONG: One who buys the asset at the Futures price (F)

• SHORT: One who sells the asset at Futures price (F)

LONG PAY OFF

• Long Pay Off: ST - F

• ST = Spot price of the asset at the expiry of the contract

• F = Traded Futures Price

• Note: Holder of contract obligated to buy asset worth ST for F

• Profit Condition? Larger the ST larger the profits – when (ST>F)

Spot price (ST)

Pro

fit/

Loss

F

SHORT PAY OFF

• Short Pay Off: F - ST

• ST = Spot price of the asset at the expiry of the contract

• F = Traded Futures Price

• Note: Holder of contract obligated to Sell asset worth ST for F

• Loss Condition? Larger the ST larger the Loss – when (ST>F)

Spot price (ST)

Pro

fit/

Loss

F

TRADING OPTIONS

Two sides of every Option contract

• Option Buyer: Pays Premium

• Option Seller: Receives Premium

Taken into account for computing profit-loss

TYPES OF OPTIONS (BASIC)

• LONG CALL

• LONG PUT

• SHORT CALL

• SHORT PUT

STRIKE PRICE (Revisited)

• Price at which the buyer of the option can:

• Buy the stock Call Option

• Sell the stock Put Option

• Conditions Apply: On/before the expiry date of options contract

• Price at which stock will be brought/sold when the option is exercised

• USED IN CASE OF OPTIONS ONLY. NOT FOR FUTURE/FORWARDS

LONG CALL

• An investor having Bullish (market will rise up) opinion on the underlying asset can expect to have +ve return buying call options on that asset.

• When purchased: Holder exposed to stock performance in the spot market without actually possessing the stock

• Cost incurred by call option = Option Premium

LONG PUT

• An investor having Bearish(market will fall) opinion on the underlying asset can expect to have + ve return buying put options on that asset.

• When purchased: Holder/Buyer of option has the right to sell the stock @ Strike price on or before expiry depending on underlying price

SHORT CALL & SHORT PUT

• Short Call: An investor having Bearish(market will fall) can take advantage of falling stock prices by selling a call option on the asset.

• Short Put: An investor having Bullish (market will rise) can take advantage of rising stock prices by selling a put option on the asset.

Reference

Materials taken from Indian National Stock Exchange NCFMcertification modules:

Equity Derivatives: Beginner’s Module

http://www.nseindia.com/education/content/module_ncfm.htm

THANK YOU