Derivatives

Concept
• Derivative is a product whose value is
derived from the value of one or more
basic variables.

• Underlying Asset can be Equity, Forex,

commodity or any other asset.
 Types Of Derivatives
• Forwards

• Futures

• Options

• SWAPS
 Forwards
A forward contract is a customized
contract between two entities, where
settlement takes place on a specific
date in the future at today’s pre-agreed
price.
 Futures
• A future is contract to buy or sell an
underlying asset at a specified future
date, at a specified price.
• These contracts are traded and settled
on exchanges.
• Future contracts can be on individual
scrips or indices.
 Futures terminology
• Spot Price
• Futures Price
• Expiry Date
• Contract Cycle -One month
-Two month
-Three month
 Contract Cycle
Jan Feb Mar Apr

Jan 27 Time
Feb 24

Mar 31

April 28
May 26
June 30
 Payoff for futures
Linear payoffs- losses as well as profits
are unlimited.
Payoff for long Nifty at 4000
Profit

+60

3940 4 4060
0 000
Nifty

-60

Loss
Payoff for short Nifty at 4000
Profit

+60

3940 4 4060
0 000
Nifty

-60

Loss
 Pricing of futures
• Theoretically,
Futures price = Spot price + interest for
duration till expiry

• But in market, price depends on demand

supply scenario,which in turn, depends on
market’s view on underlying.
 Options
• Options are derivative instruments
where one party has a right to
buy/sell the underlying while the other
party has an obligation to buy/sell

• The person with the right is called the

buyer of the option. The person with
the obligation is called the writer of
the option
 Types of Options

• Based on the right:

- Call option
- Put option

• Based on the exercise:

- American ( Individual Securities)
- European (S&P CNX Nifty)
 Options Terminology
• Premium
• Strike price
• Expiry date
• Holder of option,Writer of option
• In the Money,At the money,Out of Money.
 Payoff of options
• Non-linear payoffs.

• Losses for the buyer are limited and

profits are unlimited.

• For the writer the payoff is exactly

opposite.
Payoff for buyer of call option
Profit

4
0 000
Nifty

60

Loss
Payoff for seller of call option
Profit

60
4
0 000
Nifty

Loss
Payoff for buyer of put option
Profit

4
0 000
Nifty
6
0

Loss
 Payoff for the writer of put
Profit
option

6
0 4
0 000
Nifty

Loss
 Pricing of Options
• Price of option is called premium.
• Theoretical value of premium can be
calculated by ‘option calculator’ on our
site.
• Market price,however, will be dependent
on demand supply scenario.
 More terminology
• Volatility of underlying • Delta
• Time to expiry • Rho
• Volumes in • Theta
derivatives • Vega
• Open Interest • Hedge Ratio
• Put-Call ratio
• Assignment
• Exercise
 Benefits of trading in F&O
• Transfer of risk
• Incentive to make profit with minimal
amount of risk capital
• Lower transaction costs
• Liquidity, price discovery
• Eliminates security specific risks
• Power to leverage
 Margin
• SPAN Margin
-Initial margin
-Mark to market margin

• Exchange requires customer to

maintain margin with broker.
 Trading strategies
• Speculation
• Hedging
• Arbitrage
• Money / stock lending
• Straddle
• Spreads
• Covered calls
 Participants
• Hedgers
- Reduce risk
• Speculators
- Bet on future movements – leverage
• Arbitrageurs
- Take advantage of discrepancy in prices
Thank You