Professional Documents
Culture Documents
1
DEFINITION
The Securities Contracts Regulation Act 1956 defines
Derivative as under:
Derivative includes
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MEANING
In a broad sense, many commonly used instruments can be called
For Eg: Equity Share itself is a derivative, since it derives its value
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WHAT IS A DERIVATIVE
In short, a derivative is a contractual relationship established by
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Types of Financial Derivative
Can be plain vanilla or exotic
Forward
Futures
Options
Swaps
TYPES OF FINANCIAL DERIVATIVES
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TYPES OF FINANCIAL DERIVATIVES
FORWARDS
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TYPES OF FINANCIAL DERIVATIVES
FORWARDS
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TYPES OF FINANCIAL DERIVATIVES
Futures: The future contract has been designed to remove
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TYPES OF FINANCIAL DERIVATIVES
A future contract is standardized contract, traded on a future
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TYPES OF FINANCIAL DERIVATIVES
Future contract can be broadly grouped into two types:
Commodity Futures
Financial Futures
A future contact in which the underlying asset is a commodity is referred to a
commodity future contact. Similarly if the underlying asset is financial future it is
referred to a s financial future contract.
Commodity Futures E.g.: Food grains, metals, wheat, wool, gold, copper etc.
Financial Futures E.g.: Equity shares, debentures, bonds, currencies etc.,
In Future contract the buyer is called a long position and the sellter is said to have a
short position.
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TYPES OF FINANCIAL DERIVATIVES
OPTIONS:
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TYPES OF FINANCIAL DERIVATIVES
In an options contract, the seller is usually referred to as a
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TYPES OF FINANCIAL DERIVATIVES
AMERICAN OPTION VS EUROPEAN OPTION
as an American option.
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TYPES OF FINANCIAL DERIVATIVES
SWAPS
SWAP is yet another exciting trading instrument. Swaps are private agreements
between two parties, which are not traded on exchanges but are normally traded
among dealers. The two swaps used commonly are currency swaps and interest
rate swaps.
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BID - PRICES ARE PROVIDED BY BUYERS
VOLATALITY
TERMINOLOGIES
1. Spot price: The price at which an asset trades in the spot market.
2. Futures price: The price at which the futures contract trades in the futures market.
3. Contract cycle: The period over which a contract trades. The commodity futures contracts on
the NCDEX have one month, two months, three months etc (not more than a year) expiry
cycles. Most of the agri commodities futures contracts of NCDEX expire on the 20th day of the
delivery month. Thus, a January expiration contract expires on the 20th of January and a
February expiration contract ceases to exist for trading after the 20th of February. If 20th
happens to be a holiday, the expiry date shall be the immediately preceding trading day of the
Exchange, other than a Saturday. New contracts for agri commodities are introduced on the
Delivery unit: The amount of asset that has to be delivered under one contract. For
instance, the delivery unit for futures on Soybean on the NCDEX is 10 MT. The
delivery unit for the Gold futures contract is 1 kg.
Basis: Basis is the difference between the futures price and the spot price. There
will be a different basis for each delivery month for each contract. In a normal
market, futures prices exceed spot prices. Generally, for commodities basis is
defined as spot price -futures price. However, for financial assets the formula,
future price -spot price, is commonly used.
TERMINOLOGIES
Cost of carry: The relationship between futures prices and spot prices can be summarized in
terms of what is known as the cost of carry. This measures the storage cost plus the interest
that is paid to finance the asset.
Initial margin: The amount that must be deposited in the margin account at the time a futures
contract is first entered into is known as initial margin.
Marking-to-market (MTM): In the futures market, at the end of each trading day, the margin
account is adjusted to reflect the investor's gain or loss depending upon the futures closing
price. This is called marking to market.
Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that
the balance in the margin account never becomes negative. If the balance in the margin
account falls below the maintenance margin, the investor receives a margin call and is
expected to top up the margin account to the initial margin level before trading commences
on the next day.
DIFFERENCE BETWEEN CASH & FUTURE
MARKET
A cash market transaction occurs in the present, but a futures market transaction is an
agreement for an exchange of the underlying asset in the future.
Cash Price (Spot Price): The price of the commodity or financial instrument for current
delivery.
Cash Market (Spot Market): The market in which commodities or financial instruments
the cash market and the futures market. The cash market refers to the buying and
selling of physical commodities. In a cash market transaction, the price and exchange of
product occurs in the present. In contrast, the futures market deals with the buying or
selling of future obligations to make or take delivery rather than the actual commodity.
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CASH FUTURE ARBITRAGE
Earning risk-free profits from an unusual difference
profit margins.
usually less than the futures price, i.e. basis < 0. This is
referred to as a carrying-charge market.
Provide leverage or gearing, such that a small movement in the underlying value can cause a
Speculate and to make a profit if the value of the underlying asset moves the way they expect
(e.g., moves in a given direction, stays in or out of a specified range, reaches a certain level)
Hedge or mitigate risk in the underlying, by entering into a derivative contract whose value
moves in the opposite direction to their underlying position and cancels part or all of it out
Obtain exposure to underlying where it is not possible to trade in the underlying (e.g., weather
derivatives)
Create option ability where the value of the derivative is linked to a specific condition or event
such as:
Hedging
2/3/17 26
A Dal miller and a farmer visit their respective exchange
broker to find the futures prices of chana
Buyer Seller
Dal Miller Farmer
Ji I am
Want to hedge my
showing
chana crop wiil be
it to you
ready in Feb what
price in Feb &
quality parameter
Buyer Exchange
Broker B
Dal Miller
Seller Exchange
Farmer Broker A
Preview of contract specification - Chana
Tick size
(minimum price
movement) Re. 1
Daily price limits 3% + 1% maximum daily price limit will be 4%.
Price Quote Desi Chana ex-warehouse Delhi inclusive of all taxes and
Levies.
Initial margin 5%
Special Margin In case of additional volatility, a special margin is imposed
Delivery unit 10 MT (with tolerance limit of +/- 500 kg), though he will get
the value only for actual quantity delivered by him.
Delivery center Delhi (up to the radius of 50 kms from the municipal limits)
Additional Bikaner (Rajasthan) and Ganj Basoda (Madhya Pradesh) (up
Delivery Centers to the radius of 50 Kms from municipal limit)
Delivery period 25% margin will be imposed on the date of expiry on buyer
margin and seller on marked quantity.
Preview of contract specification - Chana
contd
Quality specification Desi Chana The material should be free of Mathara
and Khesari and live infestation
Moisture Basis 10% up to 12% on 1:1 rebate which shall be applied
Acceptable to such content above 10% rounded off to the higher
0.5%
Varietal admixture 3% Maximum
Delivery Logic Compulsory
Tender Period Last 5 working days of the contract expiry and
1stworking day after expiry of the contract
Delivery period Three working days after expiry of the contract
Tender notice / Delivery The seller may submit Warehouse Receipt and Valid
Pay-in Quality Certificate issued by Quality Certifying
agency by tender period.
Any outstanding positions will be marked for delivery
at the expiry of the contract.
Early Delivery Pay in Seller Clearing Member can make the delivery pay
in on any of the tender period days.
See this is the screen how it looks
like
See i have encircled the prices of chana for you
now I will explain you one by one what does it mean
1st column indicates commodity name here chana 2nd
column the date of expiry of the contract 3rd price
quotation here Rs/qntl 4th shows the days spot prices at
its benchmark center i.e. Delhi mandi
Here 1st column in the box indicates quantity a buyer willing
to buy 2nd column the price at which the buyer is willing to
buy 3rd price at which seller is willing to sell and 4th qnty.
available for sale
The 1st column in the box indicates net price change in Rs
and the 2nd Indicates % change in prices
Here the columns shows the days opening price the days
high price, days low price and yesterdays closing price
Here the 1st column shows the days volume and the 2nd
column shows total open interest Open Interest is the total
outstanding positions of a futures contract
On pressing F6 key best buy and sell quotes is
displayed
DPR
Seller
Exchange Farmer
Broker A
Exchange Buyer
Broker B Dal Miller
I need to buy 10
tons i.e. 1 lot at Rs
2640/qntl with I have
5% initial margin margins in
Rs 13200 will be my account
utilised from my
account
Buyer Seller
Dal Miller Farmer
Seller Exchange
Farmer Broker A
Buy Order
Exchange
Buyer Broker B
Dal Miller
Dont worry Once the system
order already gets the buyer at
placed current your price your
buyer is at lower order will be
price matched and
trade will be
executed
Ok am ready
Ok to pay more
Exchange
Seller
Broker A Farmer Buyer Exchange
Broker B
Dal Miller
Increase my Modified your
price to Rs order and its
2650/qntl bought at your
price
Congrats your
order matched
chana contract
is sold for Rs
2650/qntl Thanks
Buyer Exchange
Broker B
Dal Miller
Exchange Seller
Broker A Farmer
Thanks for informing I
Am sure you must be will decide on the
aware that you can same depending on
either deliver chana crop market prices in Feb
against your sell position if prices fall I will
or else you can buy the deliver it on exchange
same contract before
expiry and cash settle it
Seller
Exchange Farmer
Broker A
Buyer Exchange
Broker B
Dal Miller
Also you may need to
service your account Yes I am fully
with mark-to-market aware I have Margins also applies
margins incase prices arranged the to the buyer
moves against you. finance
Exchange
Broker A Seller Buyer Exchange
Farmer Dal Miller Broker B
Ok store them
and collect the
receipt from the
Want to store my crop in manager and
your exchange accredited come tomorrow for
warehouse send a QC certificate
sample for QC want to
deliver on Exchange
A-1
Exch
a
Accre nge
d
ware ited
hous
e
QC
ware
ho
Accre use
d
Exch ited
ange
A-1
Farmer short hedges his chana crop at Rs 2650/qntl at the time of
sowing
By the time of harvest the prices have decreased to Rs 2550/qntl
selling price
Un-hedged position would have forced the farmer to sell his
Seller Exchange
Broker A
Farmer
TRADER GOING TO TAKE PHYSICAL DELIVERY
Buyer Exchange
Dal Miller Broker B
The Exchange buy & sell
may also intentions are
receive marked against each
delivery other Hmm
intention from
the sellers
Exchange
Broker B Buyer
Dal Miller
You need to deposit the total value
of the contract in your bank
account within 2 days post expiry
Exchange will pay to the seller on Ok its so
third day simple
You will be issued a
delivery receipt
take the delivery
from Exchange
warehouse
Exchange
Broker B Buyer
Dal Miller
POST HARVEST FARMER DECIDES
TO CASH SETTLE HIS FUTURES
CONTRACT
Post harvest farmer has the option to either cash settle
or deliver on exchange.
If the quality of produce doesn't matches with contract
What is the
current price of
chana Feb contract
Ji its Rs
2550/qntl
Seller
Farmer Exchange
Broker A
Its sold sir you
earned Rs 100 a
quintal on your sell
I want to square
position total profit
off my position
of Rs 10,000 for 10
sell at Rs 2550
tonnes
True prices in spot
has fallen too I will
use profit from futures
to offset my loss in
spot market benefit
of hedging Ha ha ha
Exchange
Broker A
Seller
Farmer
Thank
You!