jims rohini news - 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

Jagan Institute of Management Studies

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About JIMSJIMS Rohini is one of the leading MBA institutes of Delhi. We impart professional education both at post graduate and undergraduate levels in the fields of management and information technology.

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