Beruflich Dokumente
Kultur Dokumente
CONCEPT OF DERIVATIVES-INTRODUCTION
DERIVATIVE
A product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index or reference rate ), in a contractual manner. The underlying asset can be equity , forex commodity or any other asset.
In the Indian context the securities contracts (Regulation)Act, 1956(SC(R)A) defines Derivative to include :
A security derived from a debt instrument ,share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security. A contract which derives its value from the prices, or index of prices, of underlying securities.
TYPES OF DERIVATIVES
Forwards
A forward contract is customized contract between two entities, where settlement takes place on a specific date in the future at todays pre-agreed price. Futures An agreement between two parties to buy or sell an asset at a certain time in the future at a certain price . Futures contacts are special types of forward contracts in the contracts in the sense that the former are standardized exchange-traded contracts. Options Options are of two types calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not obligation to sell a given quantity of the underlying asset at a given price on or before a given date.
OPTION TRADING
OPTION CONTRACTS SETLLEMENT PRICING OF OPTION FUTURES
WHAT IS AN OPTION?
Definition: a type of contract between two investors where one grants the other the right to buy or sell a specific asset in the future the option buyer is buying the right to buy or sell the underlying asset at some future date the option writer is selling the right to buy or sell the underlying asset at some future date
CALL OPTIONS
WHAT IS A CALL OPTION CONTRACT? DEFINITION: a legal contract that specifies four conditions FOUR CONDITIONS the company whose shares can be bought the number of shares that can be bought the purchase price for the shares known as the exercise or strike price the date when the right expires
Role of Exchange
exchanges created the Options Clearing Corporation (CCC) to facilitate trading a standardized contract (100 shares/contract) OCC helps buyers and writers to close out a position
PUT OPTIONS
WHAT IS A PUT OPTION CONTRACT? DEFINITION: a legal contract that specifies four conditions
the company whose shares can be sold the number of shares that can be sold the selling price for those shares known as the exercise or strike price the date the right expires
Call Option
Put Option
Option Buyer
Buys the right to buy the underlying asset at the Strike Price
Buys the right to sell the underlying asset at the Strike Price
Option Seller
Has the obligation to sell the underlying asset to the option holder at the Strike Price
Has the obligation to buy the underlying asset from the option holder at the Strike Price
On the other hand the seller of the call option has a payoff chart completely reverse of the call options buyer. The maximum loss that he can have is unlimited though a profit of Rs.2 per share would be made on the premium payment by the buyer.
Basis: Basis is usually defined as the spot price minus the future price
Terminology - contd.
Spot Price: The price at which an asset trades in the spot market. Future Price:The price at which the futures contract trades in the futures market. Option Price:Option price is the price which the option buyer pays to the option seller. Exercise Price: The price specified in the options contract is known as the strike price or the exercise price.
LONG CALL POSITION ON ACC Strike price 140 Premium 5 5 Spot Price Buy Future Buy Put Synthetic Long Call Buy Call 120 -20 15 -5 -5 125 -15 10 -5 -5 130 -10 5 -5 -5 135 -5 0 -5 -5 140 0 -5 -5 -5 145 5 -5 0 0 150 10 -5 5 5 155 15 -5 10 10 160 20 -5 15 15 165 25 -5 20 20 170 30 -5 25 25 175 35 -5 30 30 180 40 -5 35 35 185 45 -5 40 40 190 50 -5 45 45 195 55 -5 50 50 200 60 -5 55 55 205 65 -5 60 60 210 70 -5 65 65
Buy Call
70 60 50 40 30 20 10 0 -10
15 5
17 5
Sp ot Pr ic
20 5
12 5
14 5
19 5
13 5
16 5
18 5
Short Call Position ON ACC Strike price 140 Premium 5 5 Spot Price Short Future Synthetic Short Call Short Call Sell Put 120 20 5 5 -15 125 15 5 5 -10 130 10 5 5 -5 135 5 5 5 0 140 0 5 5 5 145 -5 0 0 5 150 -10 -5 -5 5 155 -15 -10 -10 5 160 -20 -15 -15 5 165 -25 -20 -20 5 170 -30 -25 -25 5 175 -35 -30 -30 5 180 -40 -35 -35 5 185 -45 -40 -40 5 190 -50 -45 -45 5 195 -55 -50 -50 5 200 -60 -55 -55 5 205 -65 -60 -60 5 210 -70 -65 -65 5
Sell Call
10 0 -10 -20 -30 -40 -50 -60 -70
Sell Call
LONG PUT POSITION ON ACC Strike price 140 Premium 5 5 Synthetic Long Put uy Call B Spot Price Short Future Buy Put 120 20 15 15 -5 125 15 10 10 -5 130 10 5 5 -5 135 5 0 0 -5 140 0 -5 -5 -5 145 -5 -5 -5 0 150 -10 -5 -5 5 155 -15 -5 -5 10 160 -20 -5 -5 15 165 -25 -5 -5 20 170 -30 -5 -5 25 175 -35 -5 -5 30 180 -40 -5 -5 35 185 -45 -5 -5 40 190 -50 -5 -5 45 195 -55 -5 -5 50 200 -60 -5 -5 55 205 -65 -5 -5 60 210 -70 -5 -5 65
Sp o
10 20 15
-10 -5 0 5
tP ric e 5 5 5 5 5 5 18 19 20 5 5 5 12 13 14 15 16 17
Buy Put
Buy Put
SHORT PUT POSITION ON ACC Strike price 140 Premium 5 5 Spot Price Long Future Short Put SyntheticShort Put Short Ca ll 120 -20 -15 -15 5 125 -15 -10 -10 5 130 -10 -5 -5 5 135 -5 0 0 5 140 0 5 5 5 145 5 5 5 0 150 10 5 5 -5 155 15 5 5 -10 160 20 5 5 -15 165 25 5 5 -20 170 30 5 5 -25 175 35 5 5 -30 180 40 5 5 -35 185 45 5 5 -40 190 50 5 5 -45 195 55 5 5 -50 200 60 5 5 -55 205 65 5 5 -60 210 70 5 5 -65
-20 10 -5 0 5
-10
-15
Sp ot Pr ic e 12 5 13 5 14 5 15 5 16 5 17 5 18 5 19 5 20 5
Short Put
Short Put
Life of an option
The life of an option is limited: it has an expiration date. After the expiration date all the rights and obligations conferred by the option are null and void. The option holder can exercise the option, i.e. declare he or she wants to use the right to buy (or to sell) conferred by the option.
OPTION TRADING
FEATURES OF OPTION TRADING
a new set of options is created every 3 months new options expire in roughly 9 months long term options (LEAPS) may expire in up to 2 years some flexible options exist (FLEX) once listed, the option remains until expiration date
OPTION TRADING
Basic option contracts that are available to investors are the call and put options. When an investor expects the share price to increase in the near future, a trading position could be entered into to assure the investor a minimum return from the expected rise. The strategy that the investor would enter into will be to do for a long call or a short put. A long call gives the buyer the right to buy the share at a predetermined price in the future. Since a bullish market expectation is there, the investor can protect against increased price, when prices go beyond the expectation, by buying now at a predetermined price. When the market becomes bullish in the future as anticipated, and share prices rise above the option strike price, the buyer can exercise the option and benefit from the long call trading strategy. However, even if the market prices do not rise beyond expectation, the investor who had entered into the derivative contract benefits since there is no obligation to buy the share. A short put is a position taken by the writer of a option contract to sell the shares in the future. In a bullish market, the market prices are expected to go up and when the expected prices are higher than the strike price, the writer of the put option gains by the amount of premium that has been received in the beginning. Without trading in the market the writer of the put contract makes a profit from the willingness to take the risk.
Futures
1. Concepts 2. Characteristics 3. Types
CONCEPT OF FUTURES
A futures contract is traded on a future exchange as a standardized contract, subject to the rules and regulations of the exchange. The futures contract relates to a given quantity of the underlying asset and only whole contract s can be traded, and the trading of fractional contracts are not allowed in future contracting. A futures contract is a financial security, issued by an organized exchange to buy or sell a commodity, security or currency at a pre-determined future date at a price agreed upon today. The agreed upon price is called the future s price. Future are exchange traded contract t sell or buy financial instruments or physical commodities for future delivery at aggrieved price. There is an agreement to buy or sell a specified quantity of financial instruments/commodity in a designated future month at a price agreed upon by the buyer and seller. The contracts have certain standardized specifications
Contd.
6) The position of the commercials and dealers in interest rate futures are almost evenly divided between long and short positions. 7) The main use of futures by the commercial is to hedge corresponding cash and forward positions. 8) The positions of the non commercial are almost entirely speculative positions. 9) In foreign exchange futures, the positions of the commercials are unbalanced.
Limited downside (to the extent of premium paid) for buyer and unlimited upside. For seller (writer) of the option, profits are limited whereas losses can be unlimited. Prices of options are however, affected by a)prices of the underlying asset, b)time remaining for expiry of the contract and c)volatility of the underlying asset.
Futures contracts prices are affected mainly by the prices of the underlying asset
Instruments
The following instruments are included in these two groups that make up Forwards: Foreign Exchange Forward contracts Forward Rate Agreements Forward Bonds Short-term interest rate futures Bond Futures Stock index futures Commodity futures contracts
FORWARD
OTC in nature Customised contract terms hence
Less Liquid No Secondary market
Vs
FUTURE
Trade on an organised exchange Standardised contract terms hence More liquid Secondary market Requires margin requirement Follows daily settlement
Spot JPY/USD: 6 month JPY rate - % pa A/365 6 month USD rate - % pa A/360
Invest JPY at 2.5% for 6 mths Buy JPY 500m, sell USD 4.85M Spot JPY/USD
Cashflows Day 0 Spot FX : Buy JPY at 103 Day 2 Settle Spot FX Invest JPY at 2.5%pa Borrow USD at 6.5%pa Money market interest Currency Balances Effective Forward FX rate = =
JPY
USD
500,000,000 (500,000,000)
(4,854,369) 4,854,369
Day 182
6,164,384 506,164,384
(157,767) 5,012,136
BADLA CONTRACT
Badla financing is carried out by two ways either by lending money or by lending shares for the short position. The badla money financier enters into contract on the badla financing day. The badla financier cannot use his position for earn higher badla charges in the next settlement period. The shares received from the seller have to be deposited in the clearinghouse fill the arrangement for the borrowed fund is complete. If the original buyer carries forward the position for four settlements the financier gets the principal only at the end of the fourth settlement. Badla provides the facility of borrowing and lending of shares and funds. Badla is a part of a cash market. The borrower of the shares pays a fee or Vyaj badla charges. Badla works without strong margin system results in many payment crises. Badla 1. Expiration date is not clear 2. Mixed up spot market and different expiration dates 3. Counterparty identity not known 4. Counterparty risk is present 5. Default premia charged for badla financing 6. Long and short position may not be equal Futures 1. Expiration date is known 2. Distinct spot market and different expiration dates 3. Clearing corporation is the counterparty 4. Counterparty risk is absent 5. Counterparty guarantee reduces the risk premia 6. Long and short are equal