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Apr 16, 2013

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derivativs

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Meaning:

Forward Contract

A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time.

Futures Contract

A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price.

Customized to customers need. Usually no initial payment erequired. Usually used for Hedging

Transaction method:

Market regulation:

Not regulated

Institutional guarantee:

Clearing House

Risk:

Guarantees:

No guranantee of settlement until the date of maturity only the forward price, based on the spot price of the underlying asset is paid

Both parties must deposit an initial guarantee (margin). The value of the operation is marked to market rates with daily settlement of profits and losses.

Contract Maturity:

Expiry date:

Standardized

Method of pretermination:

Opposite contract with same or different counterparty. Counterparty risk remains while terminating with different counterparty.

Contract size:

Standardized

Definition of 'Delta'

The ratio comparing the change in the price of the underlying asset to the corresponding change in the price of a derivative. Sometimes referred to as the "hedge ratio." For example, with respect to call options, a delta of 0.7 means that for every $1 the underlying stock increases, the call option will increase by $0.70. Put option deltas, on the other hand, will be negative, because as the underlying security increases, the value of the option will decrease. So a put option with a delta of -0.7 will decrease by $0.70 for every $1 the underlying increases in price. As an in-the-money call option nears expiration, it will approach a delta of 1.00, and as an in-the-money put option nears expiration, it will approach a delta of -1.00.

Definition of 'Gamma'

The rate of change for delta with respect to the underlying asset's price. Gamma is an important measure of the convexity of a derivative's value, in relation to the underlying. In a delta-hedge strategy, gamma is sought to be reduced in order to maintain a hedge over a wider price range. A consequence of reducing gamma, however, is that alpha too will be reduced. Mathematically, gamma is the first derivative of delta and is used when trying to gauge the price movement of an option, relative to the amount it is in or out of the money. When the option being measured is deep in or out of the money, gamma is small. When the option is near or at the money, gamma is at its largest. Gamma calculations are most accurate for small changes in the price of the underlying asset.

Definition of 'Theta'

A measure of the rate of decline in the value of an option due to the passage of time. Theta can also be referred to as the time decay on the value of an option. If everything is held constant, then the option will lose value as time moves closer to the maturity of the option. Theta is part of the group of measures known as the "Greeks" (other measures include delta, gamma and vega) which are used in options pricing. For example, if the strike price of an option is $1,150 and theta is 53.80, then in theory the value of the option will drop $53.80 per day. The measure of theta quantifies the risk that time imposes on options as options are only exercisable for a certain period of time. Time has importance for option traders on a conceptual level more than a practical one, so theta is not often used by traders in formulating the value of an option.

Definition of 'Vega'

The measurement of an option's sensitivity to changes in the volatility of the underlying asset. Vega represents the amount that an option contract's price changes in reaction to a 1% change in the volatility of the underlying asset. Volatility measures the amount and speed at which price moves up and down, and is often based on changes in recent, historical prices in a trading instrument. Vega changes when there are large price movements (increased volatility) in the underlying asset, and falls as the option approaches expiration. Vega is one of a group of Greeks used in options analysis, and is the only one not represented by a Greek letter.

Definition of 'Rho'

The rate at which the price of a derivative changes relative to a change in the risk-free rate of interest. Rho measures the sensitivity of an option or options portfolio to a change in interest rate. For example, if an option or options portfolio has a rho of 12.124, then for every percentage-point increase in interest rates, the value of the option increases 12.124%.

Futures Terminologies Spot price: The price at which an asset trades in the spot market. Futures price: The price at which the futures contract trades in the futures market. Basis (also known as Badala): Futures price minus the spot price (Premium/Discount) Cost of carry: This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset. Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin. Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called marking-to-market

Options (Introduction)

An option is a contract written by a seller that conveys to the buyer the right but not the obligation to buy (in the case of a call option) or to sell (in the case of a put option) a particular asset, at a particular price (Strike price / Exercise price) in future. In return for granting the option, the seller collects a payment (the premium) from the buyer. Options can be used for hedging, taking a view on the future direction of the market, for arbitrage or for implementing strategies which can help in generating income for investors under various market conditions

Options Terminologies

Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer. Writer / seller of an option: The writer / seller of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him. Call option (C): A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. Put option(P): A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price. Option price/premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium Expiration date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity. Strike price(K): The price specified in the options contract is known as the strike price or the exercise price. Spot Price(St): The price at which underlying security/index is trading at that point of time is spot price. American options: American options are options that can be exercised at any time up to the expiration date. European options: European options are options that can be exercised only on the expiration date itself.. In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cash flow to the holder if it were exercised immediately. A call option on the index is said to be in-themoney when the current index stands at a level higher than the strike price (i.e. spot price > strike price). If the index is much higher than the strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the index is below the strike price. At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cash flow if it were exercised immediately. An option on the index is at-the-money when the current index equals the strike price (i.e. spot price = strike price). Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative cash flow if it were exercised immediately. A call option on the index is out-of-the-money when the current index stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is much lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the index is above the strike price.

The option premium can be broken down into two components - Intrinsic value and Time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero. Putting it another way, the intrinsic value of a call is Max[0, (St K)] which means the intrinsic value of a call is the greater of 0 or (St K). Similarly, the intrinsic value of a put is Max[0,K St],i.e. the greater of 0 or (K St). K is the strike price and St is the spot price. The time value of an option is the difference between its premium and its intrinsic value. Both calls and puts have time value. An option that is OTM or ATM has only time value. Usually, the maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an option's time value, all else equal. At expiration, an option should have no time value.

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