By: N. P. Singh Associate Prof. JIMS, Rohini Introduction to Derivatives
By: N. P. Singh Associate Prof.
JIMS, Rohini
Introduction to Derivatives
OVERVIEW
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Derivatives are defined as contracts which derive their value from an underlying asset (or bases) like◦ Stock ◦ Index◦ Commodity◦ Currency◦ Interest Rate or ◦ Any other asset
Governed by the regulatory framework of SCRA, 1956
Derivatives Defined
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Risk management – Risk transfer
Boosts the trading volume of underlying asset
Price Discovery – Future price
Provides an organized platform for speculative traders
Economic Functions of Derivatives
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Increased volatility in asset prices in financial markets
Fast and cheap communication
Increased integration of national financial markets with the international markets
Factors Driving the Growth of Derivatives
Higher returns, reduced risk and transaction costs as compared to individual financial assets
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Forwards
Options
Futures
Types of Derivatives
Warrants LEAPS (Long Term Equity Anticipation Securities)
Baskets Swaps Swaption
◦ Payer swaption◦ Receiver swaption
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Hedgers
Speculators
Participants
Arbitrageurs
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Forward contracts are similar to futures except that they trade in the over-the-counter market
The party that has agreed to buy has what is termed a long position
Forward contracts are particularly popular on currencies and interest rates
Forward Contracts
The party that has agreed to sell has what is termed a short position
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Foreign Exchange Quotes for GBP
Bid Offer
Spot 2.0558 2.0562
1-month forward 2.0547 2.0552
3-month forward 2.0526 2.0531
6-month forward 2.0483 2.0489
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PLAYING Profit from a Long Forward Position:
(ST - K)Profit
Price of Underlying at Maturity, ST
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Profit from a Short Forward Position: (K-
ST)Profit
Price of Underlying at Maturity, STK
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Agreement to buy or sell an asset for a certain price at a certain time
Futures Contracts
Similar to forward contract
Whereas a forward contract is traded OTC, a futures contract is traded on an exchange
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Chicago Board of Trade (CBOT)
Exchanges Trading Futures
Chicago Mercantile Exchange (CME) NSE BSE MCX NCDEX
Eurex (Europe)
LIFFE (London)
BM&F (Sao Paulo, Brazil) TIFFE (Tokyo)
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Agreement to:Buy 100 oz. of gold @ US$900/oz. in December (NYMEX) Sell £62,500 @ 2.0500 US$/£ in March (CME)Sell 1,000 bbl. of oil @ US$120/bbl. in April (NYMEX)
Examples of Futures Contracts
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Agreement to:Buy 100 oz. of gold @ US$900/oz. in December (NYMEX) Sell £62,500 @ 2.0500 US$/£ in March (CME)Sell 1,000 bbl. of oil @ US$120/bbl. in April (NYMEX)
Options
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An American option can be exercised at any time during its life e.g. Stock options traded on NSE
American vs European Options
A European option can be exercised only at maturity e.g. Index options on Nifty
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An American option can be exercised at any time during its life e.g. Stock options traded on NSE
American vs European Options
A European option can be exercised only at maturity e.g. Index options on Nifty
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Chicago Board Options Exchange
Exchanges Trading Options
American Stock Exchange Philadelphia Stock Exchange National Stock Exchange (NSE) of India
Bombay Stock Exchange (BSE) of India Pacific Exchange LIFFE (London) Eurex (Europe) etc.
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A futures/forward contract gives the holder the obligation to buy or sell at a certain price An option gives the holder the right to buy or sell at a certain price
Options vs Futures/Forwards
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Global Derivatives Market
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NSE BSE
Market share of NSE in Equity Derivatives Segment (2008-09)
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Equity Derivatives Trading (F&O Segment) at NSE
Year Total Turnover inn F&O Segment(Rs. Crore)
June 2000- March 2001 2,3562001-02 101,9252002-03 439,8552003-04 2,130,6492004-05 2,547,0532005-06 4,824,2502006-07 7,356,2712007-08 13,090,4782008-09 11,010,482
Growth of Turnover in F&O Segment of NSE (Rs. Crore)
0
2000000
4000000
6000000
8000000
10000000
12000000
14000000
2000
-01
2001
-02
2002
-03
2003
-04
2004
-05
2005
-06
2006
-07
2007
-08
2008
-09
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Products available for trading on Derivatives Segment on NSEProducts on Derivative Segment Date of LaunchS&P CNX Nifty Futures June 12, 2000S&P CNX Nifty Options June 4, 2001Single Stock Options July 2, 2001Single Stock Futures November 9, 2001Interest Rate Futures June 24, 2003CNX IT Futures & Options August 29, 2003Bank Nifty Futures & Options June 13, 2005CNX Nifty Junior Futures & Options June 1, 2007CNX 100 Futures & Options June 1, 2007Nifty Midcap 50 Futures & Options October 5, 2007Mini Nifty Futures & Options on S&P CNX Nifty January 1, 2008Long term Options on S&P CNX Nifty March 3, 2008S&P CNX Defty Futures and Options December 10, 2008
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