Derivatives
A presentation by Harita Chanda Sneha Rampalli Nilesh Kotere
Derivatives
Derivative is a product whose value is derived from the value of one or more basic variables, called underlying assets. Those assets can be These underlying assets are of various categories like Stocks(Equity)
Agri Commodities including grains, coffee beans, etc. Precious metals like gold and silver. Foreign exchange rate Bonds Short-term debt securities such as T-bills
PARTICIPANTS
Speculators - willing to take on risk in pursuit of profit. Hedgers - transfer risk by taking a position in the Derivatives Market. Arbitrageurs - aim to make a risk less profit by taking advantage of price differentials and thus bring about an alignment in prices by participating in two markets simultaneously
Types of derivatives
Derivatives
Futures
Index Futures
Forwards
Swaps
Options
Stock Futures
Put
Call
Forward Contract
A Forward Contract is an agreement to buy or sell an asset on a specified date for a specified price.
Salient Features :
1. They are bilateral Contracts and hence exposed to counter party risk. 2. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. 3. 4. 5. The contract price is generally not available in public domain On the expiration date, the contract has to be settled by delivery of the asset. If the party wishes to reverse the contract, it has to compulsorily go to the same counter-party, which often results in high prices being charged.
Limitations of Forward Markets
Lack of centralisation of trading
Illiquidity
Counterparty risk
Futures Contract
Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. Salient Features Obligation to buy or sell Stated quantity At a specific price Stated date (Expiration Date) Marked to Market on a daily basis
Distinction between futures and forwards
Futures
Trade on an organised stock exchange Standardized contract terms hence more liquid. Requires Margin Payments Follows daily settlement.
Forwards
OTC in nature. Customised contract terms hence less liquid No margin payment Settlement happens at the end of period.
OPTIONS
An Options contract confers the right but not the obligation to buy (call option) or sell (put option) a specified underlying instrument or asset at a specified price the Strike or Exercised price up until or an specified future date the Expiry date. The Price is called Premium and is paid by buyer of the option to the seller or writer of the option. Types of option Call Option Put option
Call Option
In-the-Money (ITM) Strike price < Spot price(current price) At-the-Money (ATM) Strike price = Spot price Out-of-the-Money (OTM) Strike price >Spot price
Put Option
In-the-Money (ITM) Strike price > Spot price At-the-Money (ATM) Strike price = Spot price
Out-of-the-Money (OTM) Strike price < Spot price
In simple words swap means exchange. A financial swap represents an exchange of obligations. The most popular swaps include swapping from one cash flow to another or swapping from fixed to floating interest rate or vice versa. Unlike other derivative products which are standardized, swap is a customized form of derivative instrument and most swaps are processed individually.
History of Exchange Traded Derivatives
The National Stock Exchange of India Limited (NSE) commenced trading in derivatives with the launch of index futures on June 12, 2000. The futures contracts are based on the popular benchmark S&P CNX Nifty Index. The Exchange introduced trading in Index Options (also based on Nifty) on June 4, 2001. NSE also became the first exchange to launch trading in options on individual securities from July 2, 2001. Futures on individual securities were introduced on November 9, 2001. Futures and Options on individual securities are available on 224 securities stipulated by SEBI. The Exchange provides trading in other indices i.e. CNXIT, BANK NIFTY, CNX NIFTY JUNIOR, CNX 100 and NIFTY MIDCAP 50 indices. The Exchange is now introducing mini derivative (futures and options) contracts on S&P CNX Nifty index w.e.f. January 1, 2008.
Indias experience with the equity derivatives market has been extremely positive. The turnover of derivatives on the NSE increased from 292,482,211 million in 20102011, and reached ` 157,585,925 million in the first half of 20112012. The average daily turnover in these market segment on the NSE was 1,151,505 million in 20102011 compared to 723,921 in 20092010
