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    By: Amit Mittal Nitin Mittal

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    Derivatives derive their value from an underlying asset such as equity, fixed income, interest rates, foreign exchange, or commodities. The Chicago Board of Trade began futures trading in 1848 and introduced various derivative products over time, including currency futures in 1972, equity options in 1973, and interest rate swaps in 1982. Derivatives offer advantages like leveraged positions, lower transaction costs, and use for risk management and trading. Exchange-traded derivatives are standardized contracts traded on an exchange, while over-the-counter derivatives are customized contracts without a counterparty guarantee. Common derivative types include futures, forwards, and options.

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    By: Amit Mittal Nitin Mittal

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    67 views34 pages
    Derivatives derive their value from an underlying asset such as equity, fixed income, interest rates, foreign exchange, or commodities. The Chicago Board of Trade began futures trading in 1848 and introduced various derivative products over time, including currency futures in 1972, equity options in 1973, and interest rate swaps in 1982. Derivatives offer advantages like leveraged positions, lower transaction costs, and use for risk management and trading. Exchange-traded derivatives are standardized contracts traded on an exchange, while over-the-counter derivatives are customized contracts without a counterparty guarantee. Common derivative types include futures, forwards, and options.

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    Derivatives derive their value from an underlying asset such as equity, fixed income, interest rates, foreign exchange, or commodities. The Chicago Board of Trade began futures trading in 1848 and introduced various derivative products over time, including currency futures in 1972, equity options in 1973, and interest rate swaps in 1982. Derivatives offer advantages like leveraged positions, lower transaction costs, and use for risk management and trading. Exchange-traded derivatives are standardized contracts traded on an exchange, while over-the-counter derivatives are customized contracts without a counterparty guarantee. Common derivative types include futures, forwards, and options.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    67 views34 pages

    By: Amit Mittal Nitin Mittal

    Uploaded by

    tarun2172
    Derivatives derive their value from an underlying asset such as equity, fixed income, interest rates, foreign exchange, or commodities. The Chicago Board of Trade began futures trading in 1848 and introduced various derivative products over time, including currency futures in 1972, equity options in 1973, and interest rate swaps in 1982. Derivatives offer advantages like leveraged positions, lower transaction costs, and use for risk management and trading. Exchange-traded derivatives are standardized contracts traded on an exchange, while over-the-counter derivatives are customized contracts without a counterparty guarantee. Common derivative types include futures, forwards, and options.

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    of 34

    By:

    Amit Mittal
    Nitin Mittal
    Introduction to Derivatives

    Derivatives are the financial instruments which


    derive their value from the value of the underlying
    asset.
    The underlying asset can be equity, fixed income
    instruments, interest rates, foreign exchange or
    commodities.
    The price movements of derivative products are
    related to that of the underlying securities.
    Various types of Derivatives
    History of Derivatives
    Chicago Board of Trade (CBOT) for derivatives trading,
    became functional in 1848 and by 1865 futures contract in
    commodities started trading.
    In 1972 currency futures were introduced, followed by
    equity options in 1973.
    Year 1975 saw introduction to Interest Rate futures.
    Currency Swaps were introduced in 1981 and in 1982 Index
    futures, Interest Rate swaps and Currency Options were
    started.
    In 1983, Index Options and Options on futures were
    started.
    Advantages of using Derivatives
    Leveraged Positions
    Lesser transaction costs
    Ease of creating positions
    Derivatives as Risk Management Products
    Derivatives as Trading Products
    Structured or Over The Counter
    versus
    Exchange traded Derivatives
    Exchange traded derivatives are standardized contracts
    which can only be traded on a recognized exchange.
    The clearing house of the exchange provides the
    counterparty guarantee
    OTC derivatives on the other hand are customized
    contracts and the terms of the contract are flexible.
    There is no counterparty guarantee.
    The liquidity of an OTC derivative can be limited as it is a
    customized contract.
    Derivatives to be discussed
    Futures
    Forwards
    Options
    In simple terms, a futures contract is a contract that allows
    the counterparties to exchange the underlying assets in
    future at a price agreed upon today. Following are the
    features of a futures contract-
    Contract through an exchange
    To exchange obligations on a future date
    At a price decided today
    For a quantity / quality standardized by the exchange
    Settlement guaranteed by the clearing corporation of the
    exchange
    Difference between forwards and futures
    Forwards Futures Forwards Futures

    Nature of the Customized Standardized


    contract
    Counterparty Any entity Clearing house of
    exchange
    Credit Risk Exists Assumed by the
    exchange
    Liquidity Poor Very High
    Margins Not Required Received / Paid on
    daily
    basis
    Valuation Not Done Done on daily
    basis
    Underlying
    Contract Multiplier
    Tick size
    Contract months
    Expiry date
    Daily settlement price
    Final settlement price
    Pricing of Futures
    Trading of futures
    Margins required for futures contracts
    Settlement of futures
    Forward Contracts
    Forward Contract is an OTC derivative product.
    It is a contract between two parties, which enables
    the buyer to lock a desired value of the underlying
    that will become applicable at some future date, now.
    There is no counterparty guarantee provided by any
    third party.
    Forward contracts unlike futures, are deliverable
    contracts (Though there are non-deliverable forward
    contracts also).
    Different Types of Forward Contracts

    Depending on the underlying asset, the


    most common types of forward contracts
    are:
    Currency Forwards
    Interest Rate Forwards, and
    Commodity Forwards
    Participants in Forward Contracts
    Hedgers – They participate in the forward market with a
    view to protect or cover an existing exposure in the spot
    market.
    Speculators – These dealers based on their opinion about
    the market movements take an exposure in the forward
    market with a view to make profits from the expected
    movement in the underlying element.
    Arbitrageurs – These players neither hedge nor
    speculate. They try to take advantage of the price
    differences in the spot and forward markets.
    Options
    Options or option contracts are instruments
    Right, but not the obligation, is given
    To buy or sell a specific asset
    At a specific price
    On or before a specified date
    Options can be exchange traded derivatives or even
    over the counter derivatives.
    Differences in equity shares and equity options
    Option Terminologies
    Strike Price or Exercise Price
    Expiration Date
    Exercise Date
    Option Buyer
    Option Seller
    American option
    European option
    Option Premium
    Option Classifications
    Call Option : an option which gives a right to buy the
    underlying asset at a strike price.

    Put Option : an option which gives a right to sell the


    underlying asset at strike price.
    Call Option Buying
    A Call option buyer basically is bullish about the underlying stock.
    Put Option buying
    A buyer of put option is bearish on underlying stock.
    Both the Call and Put option buyers are buying the
    rights, that is they are transferring their risks to the
    sellers of the option.
    For this transfer of risk to the sellers, buyers have to
    compensate by paying Option Premium.
    Option premium is also known as Price of the option,
    Cost or Value of the option.
    Option Selling: Motives for selling options
    The seller is ready to assume the risk in option
    exercise. The incentives for the seller to assume that
    risk are two :

     Option Premium – This is the actual amount received by him for


    selling an option to the buyer.
     The possibility of non-exercise of option – In seller’s view the
    possibility of option being exercised by the buyer may be low.
    Factors influencing Option Pricing
    Time to expiration – greater the time to expiration,
    higher the value of the options.

    Volatility –higher the volatility, higher the value of


    the options.

    Risk free Rate of Interest – If interest rate goes up,


    calls gain in value while puts lose value.
    ITM, ATM, OTM Options
    In the money
    At the money
    Out of money
    Intrinsic and Time value of the option

    Intrinsic value is equal to the amount by which


    option is in the money.
    Time value is the difference between market price of
    the option and intrinsic value.
    Settlement of Options
    Physical Delivery

    Cash settlement
    Exercise of calls
    Exercise of Puts
    Pay off from a Long Call
    Payoff from Short Call
    Summary of basic option strategies
    Thank You!

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