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Introduction To Derivatives

The document provides an introduction to options and futures markets. It defines key terms like derivatives, forwards contracts, futures contracts, and options. It explains the differences between forwards, futures, and options. It also illustrates the payoffs for buyers and sellers of options and futures contracts depending on the underlying asset price at expiration.

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salil1285
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466 views

Introduction To Derivatives

The document provides an introduction to options and futures markets. It defines key terms like derivatives, forwards contracts, futures contracts, and options. It explains the differences between forwards, futures, and options. It also illustrates the payoffs for buyers and sellers of options and futures contracts depending on the underlying asset price at expiration.

Uploaded by

salil1285
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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INTRODUCTION TO

OPTIONS AND
FUTURES
CLASSIFICATION OF
FINANACIAL MARKETS

 NATURE OF CLAIM
 MATURITY OF CLAIM
 SEASONING OF CLAIM
 TIMING OF DELIVERY
 ORGANISATIONAL STRUCTURE
DERIVATIVE

ACCORDING TO SC(R) ACT 1956;


- A SECURITY DERIVED FROM DEBT
INSTRUMENT,SHARE,LOAN,CONTRACT
FOR DIFFERENCES,COMMODITY,INDEX
OR ANY OTHER FORM OF SECURITY

- A CONTRACT WHICH DERIVES ITS


VALUE FROM THE PRICES OF
UNDERLYING SECURITIES/ASSETS.
FINANCIAL
DERIVATIVES
 FORWARD CONTRACTS

 FUTURES

 OPTIONS
FORWARD CONTRACTS

 AN AGREEMENT BETWEEN TWO


PARTIES TO BUY OR SELL AN ASSET AT
A SPECIFIED FUTURE DATE AND PRICE
- OTC CONTRACT
- BILATERAL
- CUSTOMISED
- PRICE IS NOT AVAILABLE PUBLICLY
- SETTLEMENT BY DELIVERY ON MATURITY
LIMITATIONS OF
FORWARD CONTRACTS
 LACK OF CENTRALISED TRADING

 ILLIQUIDITY

 COUNTERPARTY RISK
FUTURES
 AN AGREEMENT TO BUY OR SELL AN
ASSET/SECURITY IN FUTURE AT A
CERTAIN PRICE
- EXCHANGE TRADED
- ANONYMOUS TRADING
- STANDARDISED
- MARGINS
- MARK TO MARKET
- SETTLEMENT IS GUARANTEED
FUTURES V/S
FORWARDS
 EXCHANGE  OTC IN
TRADED NATURE
 STANDARDISE
D  CUSTOMISED
 LIQUID  ILLIQUID
 REQUIRES  NO MARGIN
MARGIN  ON MATURITY
 DAILY
SETTLEMENT
OPTIONS
 A CONTRACT WHICH GIVES RIGHT BUT
WITH NO OBLIGATION
- CALL OPTION:OPTION THAT GIVES RIGHT TO BUY A
SECURITY

- PUT OPTION:OPTION THAT GIVES RIGHT TO SELL A


SECURITY

- AMERICAN OPTION:CAN BE EXERCISED ANY TIME

- EUROPEAN OPTION:CAN BE EXERCISED ONLY ON MATURITY

- Asian Options: Asian options are options whose


payoffs depend on the average price of the
underlying asset during some portion of the life of
the option.
FUTURES V/S OPTIONS
 EXCHANGE TRADED  EXCHANGE TRADED
 STANDARDISED  STANDARDISED
 PRICE IS ZERO  OPTION PREMIUM
 BOTH PARTIES ARE  ONLY OPTION
REQUIRED TO WRITER WILL HAVE
PERFORM OBLIGATION
 LINEAR PAY OFF  NON LINEAR PAY
 BOTH LONG AND OFF
SHORT ARE AT RISK  ONLY SHORT IS AT
RISK
Options
BUYER/HOLDER SELLER/WRITER
RIGHTS/ BUYERS HAVE RIGHTS- SELLERS HAVE ONLY
OBLIGATIONS NO OBLIGATIONS OBLIGATIONS-NO
RIGHTS

 CALL RIGHT TO BUY/TO GO OBLIGATION TO SELL/GO


LONG SHORT ON EXERCISE

 PUT RIGHT TO SELL/ TO OBLIGATION TO


BUY/GO
GO SHORT LONG ON EXERCISE

 PREMIUM PAID RECEIVED

 EXERCISE BUYER’S DECISION SELLER CANNOT


INFLUENCE

 MAX. LOSS COST OF PREMUIM UNLIMITED LOSSES


POSSIBLE
 MAX. GAIN UNLIMITED PROFITS PRICE OF PREMIUM
POSSIBLE
 CLOSING • EXERCISE • ASSIGNMENT ON
OPTION
POSITION OF • OFFSET BY SELLING • OFFSET BY BUYING BACK
EXCHANGE OPTION IN MARKET OPTION IN MARKET
TRADED • LET OPTION LAPSE • OPTION EXPIRES AND KEEP
FUNCTIONS OF
DERIVATIVES
MARKETS
 RISK TRANSFER
 HIGH LIQUIDITY,PRICE DISCOVERY
 LOW TRANSACTION COSTS
 PROFITS WITH MINIMUM CAPITAL
 INDICATES MARKET PERCEPTION
 ELIMINATE SECURITY SPECIFIC
RISK
 ARBITRAGE OPPORTUNITY
ORIGIN OF
DERIVATIVES MARKET
IN INDIA
 1995 SECURITIES LAWS
AMENDMENT ORDINANCE
 1996 L.C.GUPTA COMMITTEE
 1998 SUBMITTED ITS REPORT
 1998 J.R.VARMA COMMITTEE
 1999 SCR ACT AMENDED
 2000 WITHDRAWAL OF BAN ON
FORWARD TRADING
INTRODUCTION OF
DERIVATIVES TRADING
 12 JUNE 2000 INDEX FUTURES
 4 JUNE 2001 INDEX OPTIONS
 2 JULY 2001 STOCK OPTIONS
 9 NOV 2001 STOCK FUTURES
 24 JUNE 2003 INTEREST RATE
FUTURES
 29 AUG 2008 CURRENCY
FUTURES
REQUIREMENTS FOR
SUCESSFUL DERIVATIVES
MARKETS
 REGULATORY MECHANISM
 RISK MANAGEMENT TOOLS
 CLEARING CORPORATION
 MONITORING AND SURVEILANCE
 INVESTOR EDUCATION AND
TRANING
 TECHNOLOGY
FACTORS LED FOR THE
GROWTH OF
DERIVATIVES
 INSTABILITY IN MACROECONOMIC
VARIABLES
 INCREASED VOLATILITY IN CASH
MARKET
 INCREASED FOREIGN TRADE
 TECHNOLOGY
 REFINED PRICING TOOLS
PARTICIPANTS
 SPECULATORS

 HEDGERS

 ARBITRAGEURS
USERS OF
DERIVATIVES
 COMPANIES
 MUTUAL FUNDS
 BANKS
 BROKERS
 PORTFOLIO MANAGERS/ADVISERS
 INDIVIDUALS
Terminology

- OPTION HOLDER AND OPTION WRITER

– EXERCISE PRICE OR STRIKING PRICE

– EXPIRATION DATE OR MATURITY DATE

– EUROPEAN OPTION AND AMERICAN OPTION

– EXCHANGE-TRADED OPTIONS AND OTC


OPTIONS
– AT THE MONEY, IN THE MONEY, AND OUT OF
THE MONEY OPTIONS
 Futures Terminology
 SPOT PRICE
 FUTURES PRICE
 CONTRACT CYCLE
 EXPIRY DATE
 CONTRACT SIZE
THE AMOUNT OF ASSET THAT HAS TO
BE DELIVERED UNDER ONE
CONTRACT. FOR INSTANCE, THE
CONTRACT SIZE ON NSE’S FUTURES IS 50
NIFTIES
 BASIS
FUTURES PRICE - SPOT PRICE
 INITIAL MARGIN
 MARKING TO MARKET
 MAINTENANCE MARGIN
OPTION PAYOFF
OPTION BUYER-CALL
OPTION
STRIKE SPOT PRICE OPTION PAY OFF
PRICE PRICE
500 400 20 -20
500 450 20 -20
500 500 20 -20
500 550 20 +30
500 600 20 +80
500 650 20 +130
140

120

100

80

60

PAY OFF

40

20

-20

-40
OPTION BUYER-PUT OPTION
STRIKE SPOT OPTION PAY OFF
PRICE PRICE PRICE
2000 1700 50 +250
2000 1800 50 +150
2000 1900 50 +50
2000 2050 50 0
2000 2100 50 -50
2000 2150 50 -50
2000 2200 50 -50
300

250

200

150

100 PAY OFF

50

-50

-100
OPTION SELLER-CALL
OPTION
STRIKE SPOT OPTION PAY OFF
PRICE PRICE PRICE
500 400 20 +20
500 450 20 +20
500 500 20 +20
500 550 20 -30
500 600 20 -80
500 650 20 -130
40

20

-20

-40
PAY OFF
-60

-80

-100

-120

-140
OPTION SELLER-PUT
OPTION
STRIKE SPOT OPTION PAY OFF
PRICE PRICE PRICE
2000 1700 50 -250
2000 1800 50 -150
2000 1900 50 -50
2000 2050 50 +50
2000 2100 50 +50
2000 2200 50 +50
2000 2300 50 +50
100

50

-50

-100 PAY OFF

-150

-200

-250

-300
FUTURES PAYOFF
PAY OFF FOR FUTURES
BUYER
FUTURES SPOT PRICE PAY OFF
PRICE
2000 1800 -200
2000 1900 -100
2000 2000 0
2000 2100 100
2000 2200 200
250

200

150

100

50

0 PAY OFF

-50

-100

-150

-200

-250
PAY OFF FOR FUTURES
SELLER
FUTURES SPOT PRICE PAY OFF
PRICE
2000 1800 200
2000 1900 100
2000 2000 0
2000 2100 -100
2000 2200 -200
250

200

150

100

50

0 PAY OFF

-50

-100

-150

-200

-250

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