Derivatives

Derivatives
A derivative is a financial instrument whose characteristics and value are
derived from the underlying price or value of some other, more basic financial
instrument. The underlying asset (also known as an underlying or underlier)
could be a bond, an equity investment, a commodity, or currency

Conceptually, there are two basic types of derivatives: options and forward
contracts. Other derivative instruments, such as futures and swaps, are some
combination or variation of options and forwards.
 Jan 1 2022
Gold rate = 4000/gram

Gold rate is going to

increase !???!
Gold rate is going to
increase !???! Hmm!
I have no idea what I think I can help you
to do
 On June 30,2022
80 gram gold
4100/gram

This is my offer
There is a condition !
You have to buy
from me anyway
Whether it is profit
or loss for you
 JUNE 30 2022
Gold rate = 4300/ gram
What if , strike price 4100/gram

JUNE 30 2022
Gold rate = 3800/ gram
 Forward Contracts
A forward contract is an over-the-counter agreement between two
parties to buy or sell an asset at a certain time in the future for a
certain price.
Current price for TATA stock = 150/share. KIM expected a possible price hike in TATA
stock with in six months. forward contract is available at 170/share expiring on June 30

Strike price

Strike price (or exercise price) refers to the fixed price of the contract.

Exercise date

Exercise date (also known as maturity date or expiration date) is the last day on which the
buyer can exercise (buy or sell) the underlying asset

long position

The party who agrees to buy the underlying asset on a specified future date assumes a long
position (or is said to be long a forward contract)

Short position

The party who agrees to sell that underlying asset on the specified date assumes a short
position (or is said to be short a forward contract).
 I will give you 10
MRF stocks for 100
on June 30
I will buy 10 MRF
stocks by paying
100/share on June 30

Scenario1
On June 30 MRF stock price = 120
Profit/loss by forward on a stock
Total profit or loss

Scenario 2
On June 30 MRF stock price =90
Profit or loss on a stock ? 10 loss for
long
Total Profit or loss ?10*10=100 loss
 I will give you 20
SBI stocks for 500
on Jan 31

I will buy 20 SBI

stocks by paying
500/share on Jan 31

Scenario1
On Jan 31 SBI stock price = 600
Profit/loss by forward on a stock = 100
Total profit or loss= 100*20=2000

Scenario 2
On JAN 31 SBI stock price =450
Profit or loss on a stock ? 50 loss
Total Profit or loss ? 50*20=1000 loss
Aleena is planning to buy 8 gram Gold march 31, after 3 months. Today’s rate is
3000/ gram there is a forward contract “ 3200/ gram with expiration date Mar 31 st
2022.

• On march 31st gold rate was 3500/ gram

• What is the total savings by Aleena if she had agreed with forward contract

• Market rate = 3500 frd = 3200

• 1 gram = 300 benft , 300*8= 2400

What is the total benefit forgone by Aleena if she had ignored the Forward contract
and bought directly at market rate ?

300*8=2400 benefit forgone

March 31 gold rate = 2500

An Indian company has a bill to be paid after two months to an American
company $100

Today’s conversion rate is 1$= 60inr

A forward contract is available at 1$= 62inr

Company agreed in forward contract . After two months dollar rate was 1$=65
inr . What is the total savings by entering to this forward contract

M rate = 65

Fwd = 62

Savings in i$ = 3 *100= 300 save

Suppose you have a bill receivable from an American company of $50 .after 3
month Current market rate for usd is 1$= 50 INR

But you are worried about exchange rate fluctuation. What you will do ?

Sell forward contract

Dec 31st 1$=53 INR I will sell

If market rate on Dec 31 market rate = 1$=58

Loss /profit = 5 loss

Total loss= 5*50=250 rs

I want to buy 10
gram gold after 3 I will give you the
months. But gold right to buy 10 gram
rate is going to gold at a rate of
increase! 3000/gram on march
31st . But there is no
obligation
 No way!
You have to give me
100/gram as
For no cost !? premium for taking
risk !
If he want to have the right to buy gold at a rate of 3000/gram he have to give
the premium of 100/gram

Total investment of 100*10=1000 for 10 right to sell

• If the market price for gold on Mar 31 st is 2800/ gram what he will do?

• If the market price for gold on 31 st march is 3500/gram what he will do ?

 Options
An option is a contract between two parties wherein the purchaser of the contract has the right,
but not the obligation, to buy or sell a given amount of an underlying asset

• A call option is a type of option contract giving the owner the right to buy the underlying asset
from the writer at a fixed price during the specified time period.

• A put option is a type of option contract giving the owner the right to sell to the writer the
underlying asset at a fixed price during the specified time period. • Strike price (or exercise
price) refers to the fixed price of the contract

• Strike price (or exercise price) refers to the fixed price of the contract

• Exercise date (also known as maturity date or expiration date) is the last day on which the
buyer can exercise (buy or sell) the underlying asset

• The premium is the Initial purchase price of the option; it is usually stated on a per-unit basis
• A 30-day option contract is made between a buyer and a seller for JK stock, the strike
price is $50 per unit. The premium is $2 per unit for call option

a) What is the investment needed for a call option of 10 stocks? 2*10=20

b) We have 10 call option, market price for JK stock on day 30t day is 60, how much
profit we have earned?

30th day jk

60-50= 10

10-2=8*10= 80
The Investor(long position)
The investor who engages in an opening purchase is known as the buyer,
owner, or holder and establishes a long position in the option
An investor can Invest in
1. Call option (option to buy )
2. Put option (option to sell)
Option for sell is doesn't means that he is the seller/writer of option he just
have the right to sell!
Simply he is purchasing the right to sell particular amount of asset at a
particular rate on a particular date
• Profit for an Investor is unlimited
• Loss is limited to the premium amount invested in initial time
 The Writer(short position)
The investor who engages in an opening sale is called the writer. The writer has a
short position in the option contract. An opening sale can be offset with a closing
purchase.

• Maximum profit for a writer is limited to premium

• Loss for writer is unlimited

• Tunerecord Unit Co. stock was trading last year at $24. There were two
types of options available on the stock. Call options with a strike price of
$24, which expire at the end of the year, were trading at $9.60. Put options
with a strike price of $24, which expire at the end of the year, were trading
for $2.40. Berniss invested $144 in common stock. Jewel invested $144 in the
call options. Reynardo invested $144 in the put options. At the end of one
year the price of Tunerecord Unit stock is $20.00. How did their investments
compare at the end of the year?

BERNIS JEWEL REYNARDO

INVESTMENT =144/24=6 =144/9.6=15 call =144/2.4=60 put
AMOUNT OF
INV
PROFITS MADE =4*6=24 loss 144 loss 4*60=240-144=96
1.6*60=96 profit
• Pitchgent Inc. stock was trading last month at $22 per share. There were two types of options
available on the stock. Call options with a strike price of $16, which expire at the end of the month,
were trading at $6.00. Put options with a strike price of $16, which expire at the end of the month,
were trading at $1.10. Larry invested $132 in common stock. Keaty invested $132 in the call
options. Marek invested $132 in the put options. At the end of one month, the price of Pitchgent
Inc. is $25. How much money did Keaty make from the investment?

• Invested 132 in call option no of call optn = 132/6=22 call option

• Premium =6

• Strike price = 16

Mp at expiration date ? 25

25-16=9 benft

Premm= 6

Net bnft = 9-6=3

Total profit made = 3*22= 66 profit

• Pitchgent Inc. stock was trading last month at $22 per share. There were two types
of options available on the stock. Call options with a strike price of $16, which expire
at the end of the month, were trading at $6.00. Put options with a strike price of
$16, which expire at the end of the month, were trading at $1.10. Larry invested
$132 in common stock. Keaty invested $132 in the call options. Marek invested $132
in the put options. At the end of one month, the price of Pitchgent Inc. is $25. How
much money did Marek make from the investment?
Theoretical value of option
• • Current price of the underlying asset

• • Time until expiration of the option

• • Volatility in price of the underlying asset

• • Strike price of the option

• • The interest rate on risk-free income securities (usually Treasury bills)

Futures Contracts
• A futures contract (or futures) is a forward-based contract conceptually
similar to a forward contract but different in its execution

• The basic difference is that unlike forwards, which are often privately
negotiated by an intermediary, futures are standardized contracts traded on
organized exchanges eg: newyork exhanges

• In futures losses for bath parties are limited because both parties can exit
from contract any time. But there is a minimum fund that has to be
maintain called Initial Margin
swap
• A swap is a private agreement between two parties (called “counterparties”)
to exchange (or swap) future cash payments

• The most common type of swap is an interest rate swap—where two parties
exchange future interest payments on a notional amount. The principal
amount is notional because it never changes hands and is used only to
calculate the payment amounts