derivatives2

Introduction to Derivatives : 

Introduction to Derivatives Derivative products initially emerged as hedging devices against the fluctuation in commodity prices. The emergence for the derivative products, most notably forwards, futures, and options, can be traced back to the willingness of risk averse economic agents to guard themselves against uncertainties arising out of fluctuation in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. as instrument of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors.

Derivatives : 

Derivatives Derivative is a product whose value is derived from the value of the underlying asset. Underlying asset can be equity, forex, commodity, or any other asset. derivatives are governed by the regulatory frame work under the securities contract regulation act of 1956.

Factors driving the growth of derivatives : 

Factors driving the growth of derivatives Increased volatility in asset prices in financial market. Increased integration of national financial markets with international markets. Marked improvements in communication facilities and sharp decline in their costs. Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies. Innovation in derivatives market, which optimally combine the risk and returns over a large financial assets leading to higher returns and reduced risks.

Economic functions of derivatives market. : 

Economic functions of derivatives market. Helps in discovery of future as well as current prices. Transfers the risk. Leads to higher trading volumes. More secure and systematic for participants. It acts as catalyst for new entrepreneurial activity.

The various products of derivatives are : 

The various products of derivatives are Forwards Futures Options Warrants LEAPS Swaps

Terminologies of derivatives market. : 

Terminologies of derivatives market. Impact cost Spot price Future price Initial margin Mark to market Contract size

Slide 7: 

Futures Options Stock Futures Index Futures Stock Options Index options

Slide 8: 

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. CNX-IT, 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.

Futures Contract : 

Futures Contract Agreement between two parties to exchange an asset at a certain date in future at a certain price. It is a standardized forward contract that is traded on an exchange. Index , interest rate , bond rupee dollar For Eg NIFTY Feb Futures

Futures Buyer : 

Futures Buyer Mr. X buys a Nifty futures at 1250. Nifty Payoff 1,000 -250 1,100 -150 1,200 -50 1,300 +50 1,400 + 150

Payoff for Futures buyer : 

Payoff for Futures buyer Loss Profit

Futures Seller : 

Futures Seller Mr. X sells a Nifty futures at 1250. Nifty Payoff 1,000 250 1,100 150 1,200 50 1,300 -50 1,400 -150

Payoff for Futures seller : 

Payoff for Futures seller Loss Profit

Options : 

Options Option seller (Underwriter) Option Buyer RISK LIMITED TO PREMIUM PAID RETURNS UNLIMTED RETURNS PREMIUM RECIVED RISK LIMITED TO UNLIMTED

Slide 15: 

CALL OPTIONS PUT OPTION BULLISH VIEW BEARISH VEIW TYPES OF OPTIONS

Options : 

Options • gives the buyer the right • not the obligation • to buy or sell • a specified underlying • at a set price • on or before a specified date

Call Option : 

Call Option A call option gives the buyer, the right to buy specified quantity of the underlying asset at the set strike price on or before expiration date. The seller (writer) however, has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy.

Put Option : 

A Put option gives the buyer the right to sell specified quantity of the underlying asset at the set strike price on or before expiration date. The seller (writer) however, has the obligation to buy the underlying asset if the buyer of the put option decides to exercise his option to sell. Put Option

Types of Option : 

Types of Option • European Option – can be exercised only on the expiration date • American Option – can be exercised any time on or before the expiration date

Buying of a Put Option : 

Buying of a Put Option View: Bearish • Buy a one month Nifty Put • With the Strike of 1250 • Premium of Rs 100

Payoffs : 

Payoffs

Payoff Chart : 

Payoff Chart

Selling of a Put Option : 

Selling of a Put Option View: Bullish Sell / write a one month Nifty Put With the Strike of 1250 Premium of Rs 100

Payoff : 

Payoff

Payoff Chart : 

Payoff Chart

participants in derivative market : 

participants in derivative market The participants of derivative market is broadly classified into- Hedgers Speculators Arbitrageurs

Trading mechanism. : 

Trading mechanism. The futures and options trading system of nse, is called NEAT-F&O trading system, provides a fully automated screen based trading for nifty futures & options and stock futures & options on a nationwide basis and online monitoring system. The maximum brokerage chargeable by a trading member in relation to trades effected in the contracts admitted to dealing on the futures & options segment of nse is fixed at 2.5% Entities in the trading system 1. trading member 2. clearing member 3. professional clearing members 4. participants

Turn over : 

Turn over The trading volumes on NSE’s derivative market has seen a steady increase since the launch of first derivatives contract, i.e. index futures in June 2000. the average daily turn over at NSE now exceeds 10000cr.