Derivatives Presentation - Short

8/6/2019 Derivatives Presentation - Short

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DERIVATIVESDERIVATIVESPRESENTATIONPRESENTATION


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Derivatives

What are Derivatives ? A Derivatives is an instrument whose value is derived

from the value of underlying assets. Underlying assets

may be commodities, foreign exchange, bonds, stocks,

stock indices, etc.

Typically derivatives contracts derive their value from

underlying cash market for e.g. derivative of the

Reliance, will derive its value from the cash market

price of Reliance.


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Risk Control : An investor can use derivative in riskcontrol as his risk profile dictates

High Leverage : Derivative contracts enables the investor

to take an exposure to the full value of underlying shares

for a fraction of its value in the form of margin Hedge : Hedge against any unforeseen event & leverage

High Liquidity

Protection

Flexibility

Price Discovery

Why totalkaboutDerivatives


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Futures are derivative contracts to buy or sell a specified quantity

or underlying assets at an agreed price, on or before a specified

time

They are standardized forward contracts, which are traded on the

exchanges. Exchange provides them transparency, liquidity, and

also eliminates the counter party risk due to guarantee provided

by the exchange

Derivative market is a leverage market since Investor/Trader has

to pay only fraction of total value of the contract as a margin to

his broker, who in turn has to pay to the exchange

Currently in India we have 3 types of contracts available for

trading

On last Thursday of each month these contracts expires and then

they are settled at a closing price of underlying cash market

Future Contract


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Hedging : Long Security, Sell Futures

Speculation : Bullish Security, Buy Futures

Speculation : Bearish Security, Sell Futures

Arbitrage : Overpriced Futures : Buy Spot, Sell Futures

Arbitrage : Under priced Futures : Buy Futures, Sell Spot

ApplicationofFutures


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Spot price : Price at which an asset trades in the spot market

Future price : Price at which the future contract trades

Contract cycle : Period over which a contract trades

Expiry date : It is the last day on which the contract will be traded at the

end of which it will cease to exit

Contract Value : The amount of asset that has to be delivered under one

contract

Basis : Basis means future price minus spot price

Cost of carry : The relationship between future price & spot price

Futures Terminology


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Initial margin : The amount that must be deposit in the margin account

at the time a future contract is first entered into is known is initial

margin

Marking to market : At the end of each day, the margin account isadjusted to the investors gain or loss depending upon the futures

closing price

Futures Terminology


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Options


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How much does an option cost?

The premium is the price you pay for the option

For buyer of an option

Risk : limited to the amount of premium paid

Profit potential: unlimited

For a seller of an option

Risk Unlimited

Profit Potential limited to the premium reduced


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Option Terminology

CallOption Option to buy

PutOption Option to sell

OptionBuyer has the right but not the obligation

Option Writer/Seller has the obligation but not the right


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Option Terminology

OptionPremium Price paid by the buyer to acquire the right

StrikePriceorExercisePrice Price at which the underlying may be purchased

ExpirationDate Last date for exercising the option

ExerciseDate Date on which the option is actually exercised


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Options

Option Premium = Intrinsic Value + Time Value

Suppose the derivatives of xyz ltd is trading for Rs 100 /- and 90

call is trading for the premium of Rs15/-, Here 100-90 = 10 is

intrinsic value and 15-10 is time value for options contract.


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Call option

A buyer of Call option has the right but not the

obligation to Buy the underlying at the set price by

paying the premium upfront

He can exercise his option on or before expiry


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Call Buyer v/s Seller

Call Buyer Pays premium

Has right to exercise resulting in a long position in the underlying

Time works against buyer

Risk limited, Reward unlimited

Call Seller Collects premium

Has obligation if assigned resulting in a short position in the

underlying Time works in favor of seller

Risk unlimited, Reward limited


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Put option

A buyer of Put option has the right but not the

obligation to sell the underlying at the set price by

paying the premium upfront

He can exercise his option on or before expiry


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Put Buyer v/s Seller

Put Buyer Pays premium

Has right to exercise resulting in a short position in theunderlying

Time works against buyer

Risk limited, Reward unlimited

Put Seller Collects premium

Has obligation if assigned resulting in a long position in the

underlying Time works in favor of seller

Risk unlimited, Reward limited


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Trading StrategiesTrading Strategies


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Strategiestobeused when Underlyingisin

Bullish Mode

Long Call

Short Put

Bull Call Spread

Bull Short Put Spread

Long Future

Put Hedge

Covered Call


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Bearish Mode

Short Call

Long Put

Bull Put Spread

Bull Short Call Spread

Short Future

Call Hedge

Covered Put


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RangeBound Mode

Short Straddle

Short Strangle

Short Guts

Long Call Butterfly

Long Put Butterfly

Long Condor


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Strategiestobeused whenunderlyingisin

volatilemode

Long Straddle

Long Strangle

Long Guts

Short Call/Put Butterfly

Short Condor

Strip

Strap


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Put HedgeWHEN ?

Put hedge is used when we are bullish on some

stock

And want to hedge our position if the prices move

downwards

HOW ?

In this strategy we firstbuy a future and then hedge

our position by buying aput immediately

Market Expectation : Bullish


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PUT HEDGE

Problems Which strike price?

Whattime?

Premium value?

Reversalofpositions Ifany importantsupport level isbreached

(a) We canreducelossesbysquaringofftheposition

(b) Squaringoffthefuture an persisting with the put


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CALL HEDGE

When?

Call hedge is used when we arebearish on

some stock

And want to hedge our position if the prices

move up

How?In this strategy we first sell a future and then

hedge our position by buying a call

immediately

Market Expectation : Bearish


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Call Hedge

Problems Which strike price ?

What time ?

Premium value ?

Reversal of positions

If any important resistance level is breached

(A) We can reduce losses by squaring off the position

(B) Squaring off the future an persisting with the call


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Risk From Strategies


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Open Interest

Open interest refers to the number of outstandingoption contracts in the exchange market or in aparticular class or series

Open Interest is an important indicator that can helpone in ascertaining the flow of funds

If the open interest rises with rise in price it is a bullishindication

If open interest rises and prices fall it is a bearishindication

If open interest falls and prices rise it is a sign of shortcovering by bears

If open interest falls and prices also fall it is a sign of profit booking by bulls or liquidation of positions


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Put Call Ratio

Put call ratio is an important indicator that canhelp one in gauging the future direction of themarket

If the Put call ratio rises then there is hope of

higher prices in the near future If the Put call ratio falls it is a sign of weakness

in the market

Generally put call ratio is read along with

volatility PCR can be calculated for Open

Interest/positions or no of puts and calls traded


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Impact of rollover is more important at the end of the contract

By analyzing the rollover along with the price movement one can

predict the direction of the stock

Mainly stocks which have a rollover of more than 90% with a price rise

or price consolidation in the previous contract have more chances to

move up immediately in the next contract

Stocks which have good rollover with the fall in price indicates that

market participants are rolling it over in anticipation that the stock may

rise in the next contract

Impact of Rollover


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MythsAboutDerivativesMythsAboutDerivatives

Derivatives are new, complex, high-tech financial products of stockmarket

Derivatives are purely speculative, highly leveraged instrument

Only large MNC, Banks and FIIs have a purpose for using derivatives

Only expert of derivatives can make money


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Derivatives Presentation - Short

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