Vous êtes sur la page 1sur 62

DERIVATIVES

&
RISK
MANAGEMENT
What are Derivatives?
A derivative is a financial instrument whose value is derived
from the value of another asset, which is known as the
underlying.

When the price of the underlying changes, the value of the


derivative also changes.

A Derivative is not a product. It is a contract that derives its


value from changes in the price of the underlying.

Example :
The value of a gold futures contract is derived from the
value of the underlying asset i.e. Gold.
The underlying assets for
derivatives are :
Common shares/stock.
Commodities ( Grains, Coffee beans, Pulses,
Vegetables etc.,)
Precious metals ( Gold , Silver )
Debt securities
Interest rates
stock index value( BSE Sensex, NSE Nifty )

Derivatives helps in reducing the risk which


may arise from change in the prices of above
mentioned type of assets.
The basic purpose of derivative is to transfer
Definition of Financial Derivatives
The Securities Contracts (Regulation) Act,
1956 defines derivatives as under :

Derivatives includes
1. Security derived from a debt instrument,
share, loan whether secured or unsecured,
risk instrument or contract for differences
or any other form of security.
2. A contract which derives its value from the
prices, or index of prices of underlying
securities.
Traders in Derivatives Market
There are 3 types of traders in the Derivatives Market :
HEDGER
A hedger is someone who faces risk associated with price movement of
an asset and who uses derivatives as means of reducing risk.
They provide economic balance to the market.

SPECULATOR
A trader who enters the futures market for pursuit of profits, accepting
risk in the endeavor.
They provide liquidity and depth to the market.
ARBITRAGEUR
A person who simultaneously enters into transactions in two or more
markets to take advantage of the discrepancies between prices in
these markets.

Arbitrage involves making profits from relative mispricing.

Arbitrageurs also help to make markets liquid, ensure accurate and


uniform pricing, and enhance price stability

They help in bringing about price uniformity and discovery.


TYPES OF DERIVATIVE MARKETS
OTC Over the counter traded derivatives
Over-the-counter (OTC) or off-exchange trading is to trade
financial instruments such as stocks, bonds, commodities or
derivatives directly between two parties without going through
an exchange or other intermediary.
The contract between the two parties are privately negotiated.

The contract can be tailor-made to the two parties liking.

Over-the-counter markets are uncontrolled, unregulated and have


very few laws. Its more like a freefall.
Exchange Traded Derivatives

Exchange traded derivatives contract (ETD) are those


derivatives instruments that are traded via specialized
Derivatives exchange or other exchanges. A derivatives
exchange is a market where individuals trade
standardized contracts that have been defined by the
exchange.

There is a very visible and transparent market price for


the derivatives.
Use/ Advantages/Applications of
Derivatives ( Factors contributing to
growth of derivatives)
Reduces Risk :

One of the most important services provided by the derivatives


is to control, avoid, shift and manage efficiently different types
of risks through various strategies like hedging, arbitraging,
and speculation etc.

Derivatives helps the holders to shift or modify the risk


characteristics on their portfolios. Derivatives are highly useful
in volatile financial market conditions like highly flexible
interest rates, volatile exchange rates and monetary chaos.
Use/ Advantages of Derivatives
Enhance liquidity of the underlying asset

In derivatives trading no immediate full amount of the


transaction is required since most of them are based
on margin trading. As a result, large number of
traders, speculators , arbitrageurs operate in such
markets.
So, derivatives trading enhances liquidity and
reduce transactions costs in the market for underlying
assets.
Use/ Advantages of Derivatives
Enables the price discovery process.
Derivatives serve as barometers of the future
trends in prices which result in the discovery of
new prices both on spot and futures market.
Further, they help in providing the information
regarding the future markets trading of various
commodities and securities to the society
which enable to form correct equilibrium in the
markets.
Use/ Advantages of Derivatives
Portfolio Management

Derivatives assist the investors, traders and


managers of large pools of funds to devise
such strategies so that they may make proper
asset allocation to increase their yields and
achieve their investment goals. so derivatives
helps the investors to achieve their
investment goals. Thats why, derivatives also
encourages investment activities among the
people.
Use/ Advantages of Derivatives

Increases trading volume in the country

The derivatives trading encourage the competitive


trading in the markets , different risk taking
preference of the market operators like speculators,
hedgers, traders, arbitrageurs, etc. resulting in
trading volume in the country.

Derivatives also attract young investors,


professionals and other experts who act as
catalysts to the growth of financial markets.
Use/ Advantages of Derivatives
Develop the market towards
Complete Markets

Derivative trading develop the


market towards complete markets.
Complete market concept refers to
that situation where no particular
investor be better of than of others.
What is a Forward?
A forward is a contract in which one party
commits to buy and the other party commits
to sell a specified quantity of an agreed
upon asset for a pre-determined price at a
specific date in the future.

It is a customised contract, in the sense that


the terms of the contract are agreed upon
by the individual parties.

Hence, it is traded OTC.


Forward Contract Example
I agree to sell
Farmer 500kgs wheat Bread
at Rs.40/kg Maker
after 3
months.

3 months
Later
500kgs Bread
Farmer wheat
Maker
Rs.20,00
0
Long forward position and short
forward position
LONG FORWARD POSITION the party who has
entered into a contract for buying
shares/commodities that party is said to have
taken the long position.

SHORT FORWARD POSITION- the party who has


entered into a contract for selling
shares/commodities that party is said to have
taken the long position.
Risks in Forward Contracts
Credit Risk Does the other party have the means to
pay?

Operational Risk Will the other party make delivery?


Will the other party accept delivery?

Liquidity Risk In case either party wants to opt out of


the contract, how to find another counter party?
Terminology
Long position - Buyer

Short position - seller

Spot price Price of the asset in the spot market.(market price)

Delivery/forward price Price of the asset at the delivery date.


What are Futures?
A future is a standardized forward contract.

It is traded on an organized exchange.

Standardizations-
- quantity of underlying
- quality of underlying(not required in financial
futures)
- delivery dates and procedure
- price quotes
Terminology
Contract size The amount of the asset that has to be delivered under
one contract. All futures are sold in multiples of lots which is decided
by the exchange board.
Eg. If the lot size of Tata steel is 500 shares, then one futures contract is
necessarily 500 shares.

Contract cycle The period for which a contract trades.


The futures on the NSE have one (near) month, two (next) months,
three (far) months expiry cycles.

Expiry date usually last Thursday of every month or previous day


if Thursday is public holiday.
Terminology
Strike price The agreed price of the deal is called the strike price.

Cost of carry Difference between strike price and current price.


COMPARISON
FORWARD FUTURES

Trade on organized exchanges


No Yes

Use standardized contract terms


No Yes

Use associate clearinghouses to


guarantee contract fulfillment
No Yes

Require margin payments and daily


settlements
No Yes

Markets are transparent


No Yes
What are Options?
Contracts that give the holder the option to
buy/sell specified quantity of the underlying
assets at a particular price on or before a
specified time period.

The word option means that the holder has


the right but not the obligation to buy/sell
underlying assets.
Types of Options
Options are of two types call and put.
Call option give the buyer the right but not the obligation to buy a
given quantity of the underlying asset, at a given price on or before a
particular date by paying a premium.
Puts give the buyer the right, but not obligation to sell a given
quantity of the underlying asset at a given price on or before a
particular date by paying a premium.
Types of Options (cont.)
The other two types are European style options
and American style options.
EUROPEAN STYLE OPTIONS can be exercised
only on the maturity date of the option, also
known as the expiry date.

AMERICAN STYLE OPTIONS can be exercised at


any time before and on the expiry date.
Call Option Example
CALL Current Price =
Premium = Right to buy
OPTION Rs.250
Rs.25/share 100 Reliance
shares at a Strike
Amt to buy price of Rs.300 Price
Call option =
Rs.2500
per share after Expir
3 months. y
Suppose after a date
month, Market price Suppose after a month,
is Rs.400, then the market price is Rs.200,
option is exercised then the option is not
i.e. the shares are exercised.
bought. Net Loss = Premium amt
Net gain = 40,000- = Rs.2500
Put Option Example
PUT OPTION Current Price =
Premium = Right to sell Rs.250
Rs.25/share 100 Reliance
shares at a Strike
Amt to buy price of Rs.300 Price
Call option =
Rs.2500
per share after Expir
3 months. y
Suppose after a date
month, Market price Suppose after a month,
is Rs.200, then the market price is Rs.300,
option is exercised then the option is not
i.e. the shares are exercised.
sold. Net Loss = Premium amt
Net gain = 30,000- = Rs.2500
LONG CALL & LONG PUT
LONG CALL means when call option contract is
purchased. As there is two parties option
writer and option holder so long call position is
taken by the option holder.

LONG PUT means when put option contract is


purchased. As there is two parties option
writer and option holder so long put position is
taken by the option holder.
SHORT CALL & SHORT
PUT
SHORT CALL means when call option contract is
sold. As there is two parties option writer and
option holder so short position is taken by the
option holder.

SHORT PUT means when put option contract is


sold. As there is two parties option writer and
option holder so short put position is taken by
the option holder.
Features of Options
A fixed maturity date on which they expire. (Expiry date)
The price at which the option is exercised is called the exercise price
or strike price.
The person who writes the option and is the seller is referred as the
option writer, and who holds the option and is the buyer is called
option holder.
The premium is the price paid for the option by the buyer to the
seller.
A clearing house is interposed between the writer and the buyer
which guarantees performance of the contract.
Options Terminology
Underlying: Specific security or asset.
Option premium: Price paid.
Strike price: Pre-decided price.
Expiration date: Date on which option expires.
Exercise date: Option is exercised.
Open interest: Total numbers of option contracts that have not yet
been expired.
Option holder: One who buys option.
Option writer: One who sells option.
Intrinsic value : 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.
Options Terminology (cont.)
Option class: All listed options of a type on a particular instrument.
Option series: A series that consists of all the options of a given class
with the same expiry date and strike price.
Put-call ratio: The ratio of puts to the calls traded in the market.
Options Terminology (cont.)
Moneyness: Concept that refers to the potential profit or loss from
the exercise of the option. An option maybe in the money, out of the
money, or at the money.

Call Option Put Option


In the money Spot price > strike Spot price < strike
price price

At the money Spot price = strike Spot price = strike


price price

Out of the Spot price < strike Spot price > strike
money price price
What are SWAPS?
Swaps are private arrangements between two parties to exchange
cash flows in future according to pre-determined formula.(Swaps are
generally arranged by the intermediaries like banks).

Swaps are traded Over The Counter

Swaps areover-the-countercontracts between


businesses or financial institutions..
Types of Swaps
There are 2 main types of swaps:

Plain vanilla fixed for floating swaps


or simply interest rate swaps.

Fixed for fixed currency swaps


or simply currency swaps.
What is an Interest Rate Swap?
In interest swap, two parties agree to pay each others interest
obligation for their mutual benefits.

For e.g., A company agrees to pay a pre-determined fixed interest


rate on a notional principal for a fixed number of years. In return,
it receives interest at a floating rate on the same notional principal
for the same period of time or vice- versa.

The principal is not exchanged. Hence, it is called a notional


amount.
Floating Interest Rate
LIBOR London Interbank Offered Rate
It is the average interest rate estimated by leading banks in London.
It is the primary benchmark for short term interest rates around the
world.
Similarly, we have MIBOR i.e. Mumbai Interbank Offered Rate.
It is calculated by the NSE as a weighted average of lending rates of
a group of banks.
Using a Swap to Transform a
Liability
Firm A has transformed a fixed rate liability into a floater.
A is borrowing at MIBOR + 1%

Firm B has transformed a floating rate liability into a fixed rate


liability.
B is borrowing at 8.5%

Swaps Bank Profits = 8.5%-8% = 0.5%


Interest Rate Swap Example
MIBOR MIBOR
SWAPS
Co.A
+1 %
BANK
+1 %
Co.B
Aim - 8 8.5% Aim -
VARIABLE % FIXED

5 lakh 7 5 lakh MIBOR


+ 1%
% Notional
Amount = 5
Bank lakh Bank
Fixed
A Fixed
B
7% 10%
Variable Variable MIBOR +
MIBOR 1%
What is a Currency
Swap?
It is a swap that includes exchange of principal and interest rates in
one currency for the same in another currency.

It is considered to be a foreign exchange transaction.

The principal may be exchanged either at the beginning or at the end


of the tenure.
Contd.
However, if it is exchanged at the end of the life of the swap, the
principal value may be very different.

It is generally used to hedge against exchange rate fluctuations.


Direct Currency Swap
Example
Firm A is an American company and wants to borrow 40,000 for 3
years.

Firm B is a French company and wants to borrow $60,000 for 3


years.

Suppose the current exchange rate is 1 = $1.50.


Direct Currency Swap Example
7 Firm
Firm %
A B
Aim -
Aim - EURO 5% DOLLAR

$60t
h
7% 40 5%
th

Bank A Bank B

6% 5%
$ $
7% 8%
CHANDIGARH UNIVERSITY
Comparative Advantage
Firm A has a comparative advantage in borrowing Dollars.

Firm B has a comparative advantage in borrowing Euros.

This comparative advantage helps in reducing borrowing cost and


hedging against exchange rate fluctuations.
Derivative Markets in India
FINANCIAL DERIVATIVE COMMODITY FUTURE
MARKET MARKET
REGULATED REGULATED
BY BY

FORWARD
SE RB MARKET
BI I
STOCK EXCHANGES OVER-THE- COMMISSIO
(BSE,NSE) COUNTER N ( Now
(OTC) merged
with SEBI
STOC INDEX STOC INDEX
OPTIO FORWAR w.e.f
K FUTU K OPTIO
FUTU RE OPTIO N
N D September,
COMMODITY FUTURE MARKET
NATIONAL COMMODITY REGIONAL
EXCHANGES EXCHANGES

16 REGIONAL
EXCHANGES

NCD MC NMC ICE AC


EX X E X E
DERIVATIVE MARKETS IN INDIA :

Derivatives trading commenced in Indian


market in 2000 with the introduction of Index
futures at BSE, and subsequently, on National
Stock Exchange (NSE).

Since then, derivatives market in India has


witnessed tremendous growth in terms of
trading value and number of traded contracts.
FINANCIAL DERIVATIVE MARKET
Financial derivative market in India is market
where only financial derivatives are traded
i.e., equity derivatives, currency derivatives,
Bonds etc.

In India financial derivatives are traded


through established stock exchanges and over
the counter which is not a established
exchange.

Stock exchanges under the financial derivative


market are BSE,NSE & Over-the-counter.
BSE (Bombay Stock Exchange) :
The BSE created history on June 9, 2000 when
it launched trading in Sensex based futures
contract for the first time.

It was followed by trading in index options on


June 1, 2001; in stock options and single stock
futures (31 stocks) on July 9, 2001 and
November 9, 2002, respectively. Currently, the
number of stocks under single futures and
options is 109.

BSE achieved another milestone on


September 13,2004 when it launched Weekly
Options, a unique product unparalleled
Index Futures- Sensex June 9,2000
Index Options- Sensex June 1,2001
Stock Option on 109 Stocks July 9, 2001
Stock futures on 109 Stocks November
9,2002
Weekly Option on 4 Stocks September
13,2004
Chhota (mini) SENSEX January 1, 2008
Futures & Options on Sectoral indices namely
BSE FMCG, BSE Metal, BSE Bankex and BSE Oil
& Gas.
NSE (National Stock Exchange)

NSE started trading in index futures, based on popular S&P CNX Index, on
June 12, 2000 as its first derivatives product.

Trading on index options was introduced on June 4, 2001.

Futures on individual securities started on November 9, 2001. The futures


contracts are available on 233 securities stipulated by the Securities &
Exchange Board of India (SEBI).

Trading in options on individual securities commenced from July 2, 2001.


The options contracts are American style and cash settled and are
available on 233 securities. Trading in interest rate futures was introduced
on 24 June 2003 but it was closed subsequently due to pricing problem.

The NSE achieved another landmark in product introduction by launching


Mini Index Futures & Options with a minimum contract size of Rs 1 lac.
NSE crated history by launching currency futures contract on US Dollar-
Rupee on August 29, 2008 in Indian Derivatives market.
Derivatives contracts traded at NSE with underlying assets are-

Index Futures- S&P CNX Nifty June 12,2000


Index Options- S&P CNX Nifty June 4,2001
Stock Option on 233 Stocks July 2, 2001
Stock futures on 233 Stocks November 9,2001
Interest Rate Futures- T Bills and 10 Years Bond June
23,2003
CNX IT Futures & Options August 29,2003
Bank Nifty Futures & Options June 13,2005
CNX Nifty Junior Futures & Options June 1,2007
CNX 100 Futures & Options June 1,2007
Nifty Midcap 50 Futures & Options October 5,2007
Mini index Futures & Options - S&P CNX Nifty index January
1, 2008
long Term Option contracts on S&P CNX Nifty Index March
3,2008
Over-the-counter
Over-the-counter (OTC) or off-exchange trading is to trade
financial instruments such as stocks, bonds, commodities or
derivatives directly between two parties without going through
an exchange or other intermediary.
The contract between the two parties are privately
negotiated.
The contract can be tailor-made to the two parties liking.
Over-the-counter markets are uncontrolled, unregulated and
have very few laws.
The derivative contracts traded are forward, option & swaps
which are taken between private parties ( Banks or
Financial Institutions etc. ).
Commodity Future
Market
Commodity Exchanges is recognised exchange or a
place where trading of commodities takes place.
Commodity Exchange was working under the provisions
of Forward Market Commission but from Sep, 2015 it is
taken over by SEBI( Securities & Exchange Board of
India). So now SEBI is the regulatory body to control the
activities of commodity exchanges
At present there are 6 National commodity exchanges
and 16 regional commodity specific exchanges operating
in Indian commodity futures market. These exchanges
are recognised to regulate trading in a variety of
commodities approved by Forward Market Commission
under the Forward Contracts (Regulation) Act, 1952.
Multi Commodity Exchange of India Ltd.:-
Based in Mumbai, MCX is an independent
commodity exchange of India. It was
incorporated in 2003. MCX offers futures
trading in more than 40 commodities across
various segments such as energy, bullion,
metal and various agricultural commodities.

National Commodity and Derivative


Exchange Ltd.:
NCDEX was incorporated as public limited
company under the Company Act 1956 on
April 23, 2003. Headquartered in Mumbai, the
exchange facilitates futures trading in
precious metals, energy, metals and
National Multi Commodity Exchange of India Ltd.:

Founded in 2002, NMCE is Indias third largest commodity


exchange. It was the first commodity exchange of India to
be granted permanent recognition by government in the
2003.

Indian Commodity Exchange Ltd.:

Incorporated in 2009, ICEX is 4th National on line


derivative exchange of India which has established a
transparent, time-tested and reliable trading platform. It
has its headquarter in Mumbai and many regional offices
across the country which cover agricultural region with a
objective to encourage farmers, traders and actual users
participation to hedge their position against the extensive
price fluctuations.
ACE Derivatives and Commodities Exchange Ltd.:

ACE Derivative Exchange was set up in 2010 as fifth


National Commodity Exchange of India. It has its
registered office at Ahmadabad and corporate office at
Mumbai. It facilitates futures trading in oils & Oilseeds,
pulses, Guar Gum, Sugar and in Fiber .
The following commodities are being traded in
these exchanges.
Bullion: Gold, Siler, Platinum
Base Metals: Copper, Nickel, Lead, Zinc, Tin etc.
Energy Products: Crude Oil, Heating Oil, Gasoline,
Natural Gas etc.
Agricultural Products: Fibre, Pulses, Vegetables &Grains,
Edible Oils, Oilseeds and Oil Cake etc

FAQs
Meaning and purpose of derivatives
Names of underlying assets of derivatives.
Factors contributing to growth of derivatives
Advantages of derivatives
Who is the regulatory authority of derivative
markets.(SEBI)
Applications/uses of derivatives (long question)
Various advantages of derivatives (long question)
in detail the various type of derivatives. (long
question
FAQs
Operators/traders involved in futures Market.
need of speculators in derivatives market
What is hedging?
What is forward contract ? Explain long forward
position and short forward position.
What is futures contract? Explain difference
between forward and futures.
What is options contract? Fe
Features of options. Parties in options contract.
What is call option and put options ? What is long
call and short call?
What is long put and short put
FAQs
What is European style options and american style
options?
Explain with an example when the option is in the
money, out of money and at the money?
When the spot price and strike money are equal
then what it is called?
When it is advantageous to exercise the contract?
Prove it by giving an example.
When it is disadvantageous to exercise the options
contract? Prove it by giving an example.
the difference between futures and options.
the difference between options and swaps.
FAQs
What are swaps? Explain its types (plain vanilla
and currency swap with examples
What is exchange traded and over the counter
markets?
Difference between financial derivative market and
commodity futures market.
Types of derivative markets in India
Types of derivative exchanges in India