DERIVATIVES MARKET

Learning Outcomes

After reading this chapter you will be able to :

6.1 INTRODUCTION TO DERIVATIVES

“Derivative” includes—

(A) 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,

(B) a contract which derives its value from the prices, or index of prices, of underlying securities.

6.2 CLASSIFICATION OF DERIVATIVES

6.3

6.5 FUTURES

6.5.1 Futures Contract Terminology

Spot price

Futures price

Contract cycle

Expiry date

Contract Size or Lot size

Price steps

Price bands

6.5.2 Comparison between Forwards and Futures

6.5.3 Types of Financial Futures Contracts

Contract size :

6.6 OPTIONS

An options is a contract that gives its buyer (holder) a right (but not obligation) to buy or sell a specified asset at a specified price (exercise price) on or before a specified future date.

Purpose

6.6.1 Types of Options: a. Call options - An options contract that gives its holder the ‘right to buy’ a specified asset at a specified price on or before a specified future date, is termed as call option. b. Put options - An options contract that gives its holder the ‘right to sell’ a specified asset at a specified price on or before a specified future date, is termed as put option

6.6.2 Styles of Options:

a European options - b American options -

6.6.3 Covered Options and Naked options

a. Covered option - b. Naked option -

6.6.4 Index, stock, currency and interest rate options: a. Index options : b. Stock options : c. Currency options : d. Interest Rate options :

6.6.5 BASIC TERMINOLOGY used in case of options

Exercise price (or strike price) -

Expiration date -

Option premium -

6.6.6 PAYOFFS FROM BASIC OPTION POSITIONS

1. CALL OPTION

1(a) Long Call (Buying a call option)

FIG 6.2 : NET PAYOFF OF A SHORT CALL (OR CALL OPTION WRITER/SELLER)

2. PUT OPTION :

2(a) Long Put (i.e. Buying a Put option or Put option holder)