Professional Documents
Culture Documents
FINANCIAL MARKETS
FUTURES OPTIONS
1
Derivatives Defined
2
Derivative Products
F
Forwards
d -
Is a customized contract between two parties to buy or sell
an asset on a specified date in the future for a specified
price.
They are traded outside the exchanges
p
Are exposed to counter p
party
y risk.
3
Derivative Products
Futures
– These are agreements between two parties to buy or sell an asset at a
certain time in the future at a certain price.
– Futures contracts are standardized and exchange traded. This makes them
highly liquid unlike the forward contracts
contracts.
– Supply and demand on the secondary market determines the futures
price.
– Index futures are all futures contracts where the underlying
y g is the stock
index (Nifty or Sensex) and helps a trader to take a view on the market as a
whole.
– In India we have index futures contracts based on S&P CNX Nifty and the
BSE Sensex and near 3 months duration contracts are available at all
times.
– Each contract expires on the last Thursday of the expiry month and
simultaneously a new contract is introduced for trading after expiry of a
contract
contract.
4
Example of a futures trade
• Buy 1 contract of Nifty Futures @ 5400
• Total contract value is 5400 x 50 lot size
• = Rs.2,70,000.
• Margin is approximately 15%
• Means that trader pays only Rs.40,500 to control Rs.2,70,000.
Example of a futures trade
– If Nift
Nifty moves tto 5700
5700.
– Nifty
Nift moved
d only
l 55.55%.
55% (5400 tto 5700)
Types of future contracts
Existing seller buys from new seller. The Existing No change – there is no increase in short
seller
se e ccloses
oses his
s pos
position
t o by buy
buying
g from
o new
e seseller.
e contracts
co t acts being
be g held
ed
1. Initial margins : The initial margin amount is large enough to cover a one-day loss that can be
encountered on 99% of the days.
Assuming that the contract will close on Day + 3 the mark-to-market position will look as
follows:
Daily margining - continued
Position on Day 1
Close Price Loss Margin released Net cash outflow
Net gain/loss
Day 1 (loss) = (Rs 17,000)
Day 2 Gain = Rs 18,700
Day 3 Gain = Rs 18,000
Total Gain = Rs 19,700
The client has made a profit of Rs 19,700 at the end of Day 3 and the total
cash inflow at the close of trade is Rs 65000
Derivative Products - Options
• Options
Gives the holder the right to do something, but not the
obligation.
obligation
Purchaser of option has to pay something for this right – in the
form of a premium.
One can also sell/write options and receive an option premium
from the buyer.
y A seller is obliged
g to sell/buyy an asset if the
buyer exercises it on him.
5
Types of Options
Profit
2500
Nifty
Loss
Payoff for Buyer of Call Options
Profit
0
Premium Nifty
Loss
Payoff for Buyer of Put Options
Profit
Nifty
0
Premium
Loss
Payoff for Writer of Call Options
Profit
Premium
Nifty
0
Loss
Using Index Futures
• For
F Speculation
S l ti
1. Bullish outlook – Long Nifty Futures
2 Bearish outlook - Short Nifty Futures
2.
Get the advantage of leverage
Using Index Futures
• For
F Hedging
H d i
1. Long Security, Short Nifty Futures
2 Short Security,
2. Security Long Nifty Futures
3. Have portfolio, Short Nifty Futures
4. Have funds, Long Nifty Futures
Using Index Options
• Speculation –
– Bullish – Buy Nifty Calls or Sell Nifty Puts
– Bearish – Sell Nifty Calls or Buy Nifty Puts
– Anticipate Volatility – Buy a call and put at same strike
– Bull Spreads – Buy a call and sell another
– Bear Spreads – Sell a call and buy another
Using
g Index Options
p
• When index falls your portfolio will lose value and the put
options
p bought
g by y yyou will g
gain.
• If Nifty spot is 2500 and you buy puts with a strike of 2400, it will
i
insure your portfolio
tf li against
i t an index
i d fall
f ll lower
l th
than 2400.
2400
• Speculation
p – Bullish outlook
• Buy Nifty Call Options or Sell Put Option
• Buying Call Options – Limited risk, Unlimited gain
• Selling Put Options – Limited Upside and Unlimited downside
• Strike Price is chosen depending on the view of the market.
• Speculation
S l ti – Anticipate
A ti i t volatility
l tilit
• If you think that market is going to witness volatile swings but
have no opinion on the direction of the swing, you can
i l
implement tad derivative
i ti strategy
t t called
ll d a straddle.
t ddl
• Can be used around budget time or during times of political
uncertainty.
• Involves buying a call and a put with the same strike price and
maturity.
• Maximum loss is the premium paid for the two options.
• Gains are made only if the underlying asset moves significantly.
Summary of Call & Put Option
Summary
CALL OPTION BUYER CALL OPTION WRITER (Seller)
•Pays premium
•Right to exercise and buy the shares •Receives premium
•Profits from rising prices •Obligation to sell shares if exercised
•Limited losses, Potentially unlimited •Profits from falling prices or remaining neutral
gain •Potentially unlimited losses, limited gain
•Pays premium
•Right to exercise and sell shares •Receives premium
•Profits from falling prices •Obligation to buy shares if exercised
•Limited losses, Potentially unlimited •Profits from rising prices or remaining neutral
gain •Potentially unlimited losses, limited gain
Concepts / Imp Terms
Strike price
The Strike Price denotes the price at which the buyer of the option has a right to
purchase or sell the underlying.
The strike p
price interval will be of 20. If the index is currently
y at 1,410,
, , the strike prices
p
available will be 1,370, 1,390, 1,410, 1,430, 1,450.
The strike price is also called Exercise Price. This price is fixed by the exchange for
the
entire duration of the option depending on the movement of the underlying stock or
index in the cash market.
Concepts / Imp Terms - continued
In-the-money
A Call Option is said to be "In-the-Money" if the strike price is less than the market
price of the underlying stock.
A Put Option is In-The-Money when the strike price is greater than the market price of
the underlying stock.
eg: Raj purchases 1 SATCOM AUG 190 Call --Premium 10
In the above example, the option is "in-the-money", till the market price of SATCOM is
ruling above the strike price of Rs 190, which is the price at which Raj would like to buy
100 shares anytime before the end of August
August.
Similary, if Raj had purchased a Put at the same strike price, the option would have
been "in-the- money",
y , if the market price
p of SATCOM was lower than Rs 190 p per share.
Concepts / Imp Terms - continued
Out-of-the-Money
A Call Option is said to be "Out-of-the-Money" if the strike price is greater than the
market price of the stock.
A Put option
p is Out-Of-Moneyy if the strike price
p is less than the market p
price.
Similary, if Sam had purchased a Put at the same strike price, the option would have
been "out-of-the-money", if the market price of INFTEC was above Rs 3500 per share.
Concepts / Imp Terms - continued
At-the-Money
The option with strike price equal to that of the market price of the stock is considered as
being "At-the-Money" or Near-the-Money.
In the above case, if the market price of ACC is ruling at Rs 150, which is equal to the
strike price, then the option is said to be "at-the-money".
If the index is currently at 1,410, the strike prices available will be 1,370, 1,390, 1,410,
1 430 1,450.
1,430, 1 450 The strike prices for a call option that are greater than the underlying (Nifty
or Sensex) are said to be out-of-the-money in this case 1430 and 1450 considering that
the underlying is at 1410. Similarly in-the-money strike prices will be 1,370 and 1,390,
which are lower than the underlying
y g of 1,410.
,
Concepts / Imp Terms - continued
The Intrinsic Value of an Option
The intrinsic value of an option is defined as the amount by which an option is in-the-
money, or the immediate exercise value of the option when the underlying position is
marked-to-market.
The intrinsic value of an option must be positive or zero. It cannot be negative. For a
call
option, the strike price must be less than the price of the underlying asset for the call
to
have an intrinsic value greater than 0. For a put option, the strike price must be
greater
than the underlying asset price for it to have intrinsic value.
Concepts / Imp Terms - continued
F Call
For C ll options
i – the
h right
i h to b
buy the
h underlying
d l i at a fifixed
d strike
ik :
Price – as the underlying price rises so does its premium. As the underlying
price falls so does the cost of the option premium
premium.
For Put options – the right to sell the underlying at a fixed strike :
Price – as the underlying price rises, the premium falls; as the underlying
price falls the premium cost rises.
Concepts / Imp Terms - continued
Generally, the longer the time remaining until an option’s expiration, the higher its
premium will be. This is because the longer an option’s lifetime, greater is the
possibility
that the underlying share price might move so as to make the option in-the-money.
Volatility is the tendency of the underlying security’s market price to fluctuate either up or
down. It reflects a price change’s magnitude; it does not imply a bias toward price
movement in one direction or the other.
Thus, it is a major factor in determining an option’s premium. The higher the volatility of
the underlying stock, the higher the premium because there is a greater possibility that
the option will move in-the-money.
Generally, as the volatility of an under-lying stock increases, the premiums of both calls
and puts overlying that stock increase, and vice versa.
O p tio n V o l a t il it y P r e m iu m c o s t
C a ll
Put
Thank you