What is the Intrinsic Value of an option?

The intrinsic value of an option is defined as the amount by which an option is in-the-money, or The immediate exercise value of the option when the underlying position is marked-to-market. For a call option: Intrinsic Value = Spot Price - Strike Price For a put option: Intrinsic Value = Strike Price - Spot Price Index Option? An option whose underlying security is an index. If exercised, settlement is mad e by cash payment, since physical delivery is not possible. Cross currency swap? A financial contract where the buyer and seller agrees to swap floating cash flo ws between two different currencies, during a defined. Interest Rate Swap? An interest rate swap is a contractual agreement between two parties to exchange interest payments Stock Index Future? A futures contract based on a stock index; a bet on the future price of the inde xed group of stocks. Is there a theoretical way of pricing Index Future? The theoretical way of pricing any Future is to factor in the current price and holding costs or cost of carry In general, the Futures Price = Spot Price + Cost of Carry What is Contango? Under normal market conditions Futures contracts are priced above the spot price . This is known as the Contango Market. What is Backwardation? It is possible for the Futures price to prevail below the spot price. Such a sit uation is known as backwardation. This may happen when the cost of carry is nega tive, or when the underlying asset is in short supply in the cash market but the re is an expectation of increased supply in future example agricultural products . What is the concept of Basis? The difference between spot price and Futures price is known as basis. Although the spot price and Futures prices generally move in line with each other, the ba sis is not constant. Generally basis will decrease with time. And on expiry, the basis is zero and Futures price equals spot price. What is the difference between future and option? Futures Options Exchange traded, with notation Exchange defines the product Same as futures Same as futures Strike price is fixed, price moves

Price is zero, strike price moves Price is zero Linear payoff Price is always positive Nonlinear payoff

Both long and short at risk

Only short at risk

What are Option Greeks? Option Greeks are mathematical outputs from an Option Valuation Model which help you to understand the possible future movement in Option Values based on variou s underlying parameters. Greeks help you in possible predictions of Option Value s and help you to fine tune your buy sell hedge decisions much better. While Gre

ek formulae look heavily mathematical and formidable, they are not as difficult as they appear. How many types of derivatives are? Two types of derivatives are exists: Linear Derivatives: Linear derivatives are those financial instruments, which ha s a linear functional relationship with the underlying security such as Forward, Futures and Swaps. Non- linear Derivatives: Non- linear Derivatives are those financial instruments , which has a Non- linear functional relationship with the underlying security s uch as Options and Convertibles. Definition of 'Hedge' Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related securit y, such as a futures contract. Hedging Strategies Using Futures Long & Short Hedges A long futures hedge is appropriate when you know you will purchase an asset in the future and want to lock in the price A short futures hedge is appropriate when you know you will sell an asset in the future & want to lock in the price Convergence of Futures to Spot? Long Hedge Suppose that F1 : Initial Futures Price F2 : Final Futures Price S2 : Final Asset Price You hedge the future purchase of an asset by entering into a long futures contra ct Cost of Asset=S2 (F2 F1) = F1 + Basis Short Hedge Suppose that F1 : Initial Futures Price F2 : Final Futures Price S2 : Final Asset Price You hedge the future sale of an asset by entering into a short futures contract Price Realized=S2+ (F1 F2) = F1 + Basis Role of RBI in Forex Market To administer the foreign Exchange Control; To choose ,the exchange rate system and fix or manages the exchange rate between the rupee and other currencies; To manage exchange reserves; To interact or negotiate with the monetary authorities of the Sterling Area, Asi an Clearing Union, and other countries, and with International financial institu tions such as the IMF, World Bank, and Asian Development Bank. Mark-To-Market Recording the price or value of a security, portfolio, or account on a daily bas is, to calculate profits and losses or to confirm that margin requirements are b eing met. Contract Specifications for Index Futures (Nifty Futures) NSE trades Nifty future, CNX IT and BANK Nifty futures contracts having one-mont h, two-month and three-month expiry cycles. All contracts expire on the last Thursday of every month. Thus a January expirat ion contract would expire on the last Thursday of January and a February expiry contract would cease trading on the last Thursday of February. On the Friday fol lowing the last Thursday, a new contract having a three-month expiry would be in troduced for trading. Depending on the time period for which you want to take an exposure in index fut ures contracts, you can place buy and sell orders in the respective contracts. T

he instrument type refers to Futures contract on Index and contract symbol-NIFTYFU T denotes a Futures contract on Nifty index and the Expiry date represents the las t date on which the contract will be available for trading.

Contract specification S&P CNX Nifty futures Underlying index S&P CNX Nifty Exchange of trading National Stock Exchange of India Limited Security Descriptor 1.N FUTIDX NIFTY 2.N FUTIDX MNIFTY Contract size 1.NIFTYFUT-Permitted lot size shall be 50 (minimum value Rs.2lak h) 2.MNIFTYFUT-Permitted lot size shall be 20(minimum value Rs.80thousand) Expiry day The last Thursday of the expiry month or the previous trading da y if the last Thursday is a trading holiday. Settlement basis Mark to Market and final settlement will be cash settled on T+1 basis. Settlement price Daily settlement price will be the closing price of the futures contracts for the trading day and the final settlement price shall be th e closing value of the underlying index on the last trading day. INDEX CNX IT FUTURES Contract specification S&P CNX Nifty futures Underlying index CNX IT Exchange of trading National Stock Exchange of India Limited Security Descriptor N FUTIDX CNXIT Contract size Permitted lot size shall be 100(minimum value Rs2lakh) Expiry day The last Thursday of the expiry month or the previous trading da y if the last Thursday is a trading holiday. Settlement basis Mark to Market and final settlement will be cash settled on T+1 basis. Settlement price Daily settlement price will be the closing price of the futures contracts for the trading day and the final settlement price shall be th e closing value of the underlying index on the last trading day. BANK NIFTY FUTURES Contract specification S&P CNX Nifty futures Underlying index CNX BANK Exchange of trading National Stock Exchange of India Limited Security Descriptor N FUTIDX BANKNIFTY Contract size Permitted lot size shall be 100(minimum value Rs2lakh) Expiry day The last Thursday of the expiry month or the previous trading da y if the last Thursday is a trading holiday. Settlement basis Mark to Market and final settlement will be cash settled on T+1 basis. Settlement price Daily settlement price will be the closing price of the futures contracts for the trading day and the final settlement price shall be th e closing value of the underlying index on the last trading day.

Forward Contract Future contract Meaning: A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. Structure & Purpose: Customized to customers need. Usually no initial payment erequired. Usually used for Hedging Standardized. Initial margin payment req

uired. Usually used for Speculation. Transaction method: Negotiated directly by the buyer and seller Quoted a nd traded on the Exchange Market regulation: Not regulated Government regulated market Institutional guarantee: The contracting parties Clearing House Risk: High counterparty risk Low counterparty risk Guarantees: No guarantee of settlement until the date of maturity only the f orward price, based on the spot price of the underlying asset is paid Both par ties must deposit an initial guarantee (margin). The value of the operation is m arked to market rates with daily settlement of profits and losses. Contract Maturity: Forward contract mostly mature by delivering the commodi ty Future contracts may not necessarily mature by delivery of commodity Expiry date: Depending on the transaction Standardized Method of pre-termination: Opposite contract with same or different counter party. Counterparty risk remains while terminating with different counterparty. Opposite contract on the exchange. Contract size: Depending on the transaction and the requirements of the contrac ting parties. Standardized Introduction to Currency Derivatives Trading in currency derivatives in India comes under the regulatory control of S EBI & RBI The exchanges for trading are MCX-SX, NSE & USE Participants: Arbitragers Hedgers Importers/exporters, manufacturing companies, services sector companies, SMEs. Investors and traders. Benefits of Currency Derivatives Transparent Screen based rates No Counter party risk Settlement guaranteed by the clearing house Real Time tracking of Mark-to-Market profits/losses High liquidity Standard contract size & well defined contract specifications Benefits of cancellation paid on the day of cancellation and not on maturity dat e Cancelled Contracts can be rebooked again Can Sell currency options. Forwards contracts with banks Disadvantages Subject to default risk (credit risk as the party at disadvantage may default) Rates are not transparent Cancelled contracts cannot be rebooked again In case of cancellation, settlement made on last day of contract expiry Limitation on option strategies