derivatives
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DERIVATIVE MKT
Instrument which derives its value from some
underlying assets. These underlying assets
could be equities, debt,, currencies and even
indices
Spot market
is a securities market in which security are
sold for cash and delivered immediately
INDEX
Barometer to check the movement of
stock
Is a basket of identified stock and its
value is computed by taking the
weighted average of the price of the
constituent stock of index
FORWARDS
It is contract between 2 parties to buy or sell an asset
at a certain future date Expiry for certain price that is
pre decided on the date of contract
Important conditions in fwd contract:
Time of delivery
Qty/volume of underlying assets
Fwd price
SETTLEMENT OF CONTRACT
Physical settlement
Spot price > than fwd price
Spot price < fwd price
Spot price = fwd price
Cash settlement
No delivery of goods only margin involved
FUTURES
Similar to fwd contracts
Agreement between 2 parties
Buyer agrees to buy an asset from seller on
future date @ a predetermined price. However,
futures contract is not a private contract since it
gets traded on a recognized Exchange
All terms except price are decided by exchange
ROLE OF CLEARING CORPORATION
Futures contract are through recognized stock
exchange both buyer and seller are protected
against counterparty risk by an entity called CC
If any of the party defaults cc comes in to
picture to fulfill the obligation thereby
protecting them from counterparty risk
MARGIN MONEY
to be able to guarantee the fulfillment of the
obligations under the contract, the cc holds an
amount as a security from both the parties
Initial margin
Money deposited by both the buyer and seller
to assure the trade
MONEYNESS OF THE OPTION
Call (buy) mkt movement upwards
Put (sell) mkt movement downwards
In the money Mkt price> strike price
Mkt price< strike price
At the money Mkt price= strike price
Mkt price= strike price
Out of the money Mkt price<strike price Mkt price>strike price
INTRINSIC VALUE Price difference between underlying
security and the strike price
Time value
• Price of the option exceeds its intrincic value. Time value premium of an option declines as the expiration date approaches.
Option pricing
• IV+TV= OP
FACTOR INFLUENCING PRICE OF AN OPTION UNDERLYING STOCK
STRIKE PRICE OF THE OPTION ITSELF
TIME REMAINING UNTIL THE OPTION EXPIRES
VOLATILITY OF UNDERLYING STOCKS
BLACK SHOLES OPTION PRICING MODEL
FIRST OPTION PRICING MODEL SIMILAR TO EUROPEAN STYLE MODIFIED TO AMERICAN STYLE MODEL FOR PRICING OPTIONS BEFORE OPTION WERE TRADED
PREMIUM SPECULATIVE AND RISKY OPTION SELLER IS OPTION WRITER (GAIN IS LTD AND LOSS IS
UNLTD) OPTION BUYER LOSS IS LTD TO PREMIUM & GAIN IS UNLTD
CHARACTERISTICS OF OPTION
MOTIVES OF DERIVATIVES
HEDGING
SPECULATORS
ARBITRAGE – RISK FREE SPECULATION
FEATURES OF DERIVATIVES
UNDERLYING ASSETS DELIVERY SPECULATIVE SETTLEMENT (COMPULSORILY SETTLED)
TRADING PROCESS
BUYER
PURCHASE ORDER
BROKER
SELLER
EXCHANGE
SETTLEMENT AND PAYMENT SETTLEMENT AND PAYMENT
TRANSACTION THROUGH TRADING SOFTWAREBROKE
R
SALES ORDER
EXCHANGE
UNDERLYING ASSETS OF DERIVATIVES
COMMODITY STOCK CURRENCY INTEREST RATES
BARTER COMMODITY SWAPS ARE RARE CURRENCY SWAPS (xchange currencies at future
date) INTEREST RATE SWAPS
SWAP
FEATURES OF SWAP
NEGOTIATED CONTRACTS
INTERMEDIARY
COMBINATION OF FORWARD CONTRACTS
SETTLEMENT
ADVANTAGES OF DERIVATIVES
RISK MITIGATION REARRANGEMENT OF RISK EASE IN TRADING INVESTMENT MONEY FLOWS EQULIBRIUM
DISADVANTAGE OF DERIVATIVES
RISK SPECULATION MARKET MOVEMENTS HOT MONEY TIMED SETTLEMENT ACCOUNTING AMBIGUITIES
DERIVATIVE MARKET WORLD WIDE
EUREX- F&O XCHANGE CHOICE FOR TRADING AND CLEARING OF
DERIVATIVES OFFERS OPEN,SIMPLE DEMOCRATIC AND
COST EFFECTIVE ACCES FROM ANY PT OF THE GLOBE
700 LOCATIONS
NASDAQLargest US electronic change3200 companies listed
Derivatives in India1875 mumbai-1st commodity xchangeCC -1918Oilseeds future mkt 1900 then wheat then
rawjutes so on…India original home for options-1898
NCDEX -2003 55 COMMODITIES MCX-7000 CR NABARD,NSE,BANKS,INSURANCE
COMPANIES ETC.. BSE AND NSE Stock market futures and index futures
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