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What are Derivatives?What are Derivatives?

A Derivative is a contract whose value is

derived from the value of its underlying.

Underlying product can be a commodity,currency, equity, interest rate, foreign

exchange rate, electricity, etc.

Derivatives are risk management tools.

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Types of underlyingsDerivatives

Gold

Silver

Tangible

Commodities

Time

Weather

Intangible

Commodities

Commodity

Derivatives

Real

Estate

Foreign

Exchange

Index Futures

Index Options

Index products

Stock Options

Stock Futures

Derivatives on

Securities

Equity

Derivatives

Interest rate

Products

GOI Secs,

Bonds,

T-bills

Debt

Derivatives

Financial

Derivatives

Commodity - Wheat, Cotton, Pepper, Turmeric, corn, oats, soybeans,orange juice, crude oil, natural gas, gold, silver, pork-

bellies etc.

Financial - Treasuries, Bonds, Stocks, Stock-index, Foreign

Exchange, Euro-dollar deposits etc.

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Types of Derivatives

Forwards

Futures Options

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Forward Contracts

A Forward Contract is an agreement to buyor sell an asset at a pre-determined future

time for a pre-determined price. The contract is negotiated privately usually

between two parties.

The parties to the contract assumescounter party risk.

The contracts are not standardized.

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Futures Contract

A Futures Contract is an agreementbetween two parties to buy or sell anasset at a certain time in the futurefor a certain price.

Futures are traded on Exchange.

No counter party risk involved. Futures Contracts are standardised.

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Example of

Futures Contract

When the market is bullish

Take a long position When Reliance Futures is at Rs. 480 Market rises and Reliance Futures goes

to Rs. 500

Sell Reliance Futures

Profit is = Rs 20/-

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Reliance Future bought at

Rs.480/-

Day FuturesClosing Price

MTM P/L

Day 1 490 +10

Day2 495 + 5

Day3 490 - 5

Day4 500 (positionclosed)

+10

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Option Contracts

Options are deferred deliverycontracts that give the buyers theright, but not the obligation, to buyor sell a specified underlying at a set

price on or before a specified date.

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A buyer wants to buy a new car worthRs.5 lacs for which he pays a booking

amount of Rs. 25, 000/- to the dealer.If the buyer does not pay the balanceamount and take delivery of the car

within the prescribed time, thebooking amount is forfeited.

Example of an

Option Contract

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Option Terminology

Call Option Option to buy

Put Option Option to sell

Option Buyer

has the right but not the obligation Option Writer/Seller

has the obligation but not the right

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Option Terminology

Option Premium Price paid by the buyer to acquire the right

Strike Price OR Exercise Price Price at which the underlying may be purchased

or sold

Expiration Date

Last date for exercising the option Exercise Date

Date on which the option is actually exercised

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Types ofOptions

American Option can be exercised any time on or before

the expiration date

European Option can be exercised only on the expiration

date

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SettlementType

Derivatives Contracts are settled incash

- final settlement results in flow

of cash from one party to another.

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Ex

ample of a CallOption

Bought a Reliance March 500 Call option bypaying a premium of Rs 10/-.

Spot ric (Rs.) rofit / Loss (Rs.)

-

-

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Ex

ample of a PutOption

Bought a Reliance March 500 Put option bypaying a premium of Rs 10/-

Spot ric (Rs.) rofit/Loss (Rs.)

8

-

-

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Derivatives Products offered at

BSE

SENSEX Futures

SENSEX Options

Stock Futures on 41 individual stocks.

Stock Options on 41 individual stocks.

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SENSEX FUTURES

On the last trading day, the closing value of the Sensex would be the

final settlement price of the expiring futures contract

Final Settlement

Last Thursday of the contract month. If it is a holiday, the

immediately preceding business day.

Note: Business day is a day during which the underlying stock

market is open for trading.

Expiration Day

Last Thursday of the contract month. If it is a holiday, the

immediately preceding business day

Last Trading Day

9:30 a.m. to 3:30 p.m.Trading Hours

Sensex pointPrice Quotation

0.10 pointsTick Size

3 nearest serial monthsContract Months

50Contract Multiplier

SensexUnderlying Asset

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SENSEX OPTIONS

On the last trading day, the closing value of the Sensex would be

the final settlement price of the expiring options contract.

Final Settlement

Last Thursday of the contract month. If it is a holiday, the

preceding business day.

Last Trading Day

/Expiration Day

It would be a specified time (Exercise Session) on the last trading

day of the contract. All in-the money options would deem to be

exercised unless communicated otherwise by the participant

Exercise Notice Time

Closing Value of the Sensex on the expiry day.Settlement Value

CashSettlement Style

0.10 pointsTick Size

European.Exercise Style

Sensex points.Premium Quotation

At any time minimum 3 strikes will be available i.e.1 In-the-

Money, 1 Near-the-Money and 1 Out-the-money).

Strike prices

1, 2 and 3 monthsContract Month

100 (Market lot to be changed to 50 from March 15, 2004)Contract Multiplier

SensexUnderlying Asset

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STOCK FUTURES

The difference is settled in cash on the expiration day on the basis

of the closing value of the respective scrip in the underlying cash

market.

Final Settlement

Last Thursday of the contract month. If it is holiday, the

Immediately preceding business day.

Last rading

/Expiration Day

9:30 a.m. to 3:30 p.m.Trading Hours

Rupees per sharePrice Quotation

Rs. 0.01 i.e 1 paise (except Infosys has a tick size of 10 paise)Tick size

1, 2 and 3 monthsContract Months

Stock specific. For eg. Market Lot of RIL is 600Market Lot

Corresponding stock in the cash marketUnderlying Asset

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STOCK OPTIONS

The difference is settled in cash on the expiration day / exercise day

on the basis of the closing price of the respective underlying scrip in

the cash market on the expiration day / exercise day.

Settlement on

expiry / exercise

Last Thursday of the contract month. If it is a holiday, then the

preceding business day.

Last Trading Day

Closing Price of the respective Stocks in the Cash Segment of BSE.Settlement Price

CashSettlement Style

0.01 i.e 1 paiseTick Size

AmericanExercise Style

Rupees per sharePremium Quotation

Shall have a minimum of 3 strikes i.e. 1 In-the-Money, 1 Near-the-

Money and 1 Out-the-money).

Strike price

1, 2 and 3 monthsContract Month

Stock specificContract Multiplier

Corresponding stock in the Cash MarketUnderlying Asset

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Strike Price Intervals for

Options

Sr. No. Price of the Strike Price

Underlying (Rs.) Interval (Rs.)

1. Less than or equal to Rs. 50 Rs. 2

2. > Rs. 50 to < Rs. 250 Rs. 5

3. > Rs. 250 to < Rs. 500 Rs. 10

4. > Rs. 500 to < Rs. 1000 Rs. 20

5. > Rs. 1000 to < Rs. 2500 Rs. 30

6. > Rs. 2500 Rs. 50

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Market Participants

Hedgers

Speculators

Arbitrageurs

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Risk Management in Derivatives

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L

evels ofR

iskM

anagement

Liquid Networth of a member

Security Deposit (Collateral)

Margining

Position Limits

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Liquid Networth of a Member of

th

e DerivativesS

egment

Clearing Member - Rs. 300 lacs

Trading Member - Rs. 25 lacs

Limited Trading Member Rs. 25 lacs

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M

inimumS

ecurity

Dep

osit By a Clearing Member

- Rs. 50 lacs

- To be deposited with the Exchange.

By a Trading Member/Limited Trading Member

- Rs. 7.5 lacs- To be deposited with the Clearing

Member

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About the

Derivatives Department

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Functions of the Derivatives

Department

Development of new products.

System development and enhancement.

Regulatory compliance.

Marketing.

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Interface with other departments

Information Systems Dept (ISD)

Clearing & Settlement Dept (CSD)

Membership for reporting purpose

Inspection

Dept. of Corporate Services

Debt Segment

Internal Audit dept

Compliance and Secretarial dept.

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New Developments in the

Derivatives Segment

Introduction of Weekly Options in Stocks

and Index.

Introduction of F & O on BSE-TeckIndex

Introduction of additional stocks for F & O

trading.

Marketing of Derivatives to FIIs.

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WeeklyStock & IndexOptions

A Brief Introduction

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Benefits ofWeeklyOption

Contracts

Weekly Options will command lower premiums due to

shorter maturity. Thus the weekly stock options will costless than the monthly options.

On account of low cost, the liquidity will improve as moreparticipants would come in.

It will in turn lead to better price discovery andimprovement in market depth.

The market participants would be able to take a short-

term view in the underlying also. Weekly Stock and Index Options would provide market

participants short term insurance for their short-term

portfolio.

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Thankyou