Derivatives:-

a contract or security that derives its value from that of an underlying asset (as another
security) or from the value of a rate (as of interest or currency exchange) or index of asset
value (as a stock index).

Introduction to Derivatives

Derivative is a product/contract which does not have any value on its own i.e. it derives its value
from some underlying.

Forward contracts

• A forward contract is one to one bi-partite contract, to be performed in the future, at the
terms decided today.
(E.g. forward currency market in India).
• Forward contracts offer tremendous flexibility to the parties to design the contract in
terms of the price, quantity, quality (in case of commodities), delivery time and place.
• Forward contracts suffer from poor liquidity and default risk.

Future contracts

• Future contracts are organised/ standardised contracts, which are traded on the
exchanges.
• These contracts, being standardised and traded on the exchanges are very liquid in
nature.
• In futures market, clearing corporation/ house provides the settlement guarantee.

Every futures contract is a forward contract. They :

• are entered into through exchange, traded on exchange and clearing corporation/house
provides the settlement guarantee for trades.
• are of standard quantity; standard quality (in case of commodities).
• have standard delivery time and place.

• European Option - An option which can be exercised only on expiry date.

• Strike Price/ Exercise Price - Price at which the option is to be exercised.
• Expiration Date - Date on which the option expires.
• Exercise Date - Date on which the option gets exercised by the option holder/buyer.

What are Index Futures?

• Index futures are the future contracts for which underlying is the cash market index.
• For example: BSE may launch a future contract on "BSE Sensitive Index" and NSE may
launch a future contract on "S&P CNX NIFTY".

Frequently used terms in Index Futures market

 • Contract Size - The value of the contract at a specific level of Index
• Tick Size - It is the minimum price difference between two quotes of similar nature.
• Contract Month - The month in which the contract will expire.
• Expiry Day - The last day on which the contract is available for trading.
• Open interest - Total outstanding long or short positions in the market at any specific point
in time. As total long positions for market would be equal to total short positions, for
calculation of open Interest, only one side of the contracts is counted.
• Volume - No. of contracts traded during a specific period of time. During a day, during a
week or during a month.
• Long position- Outstanding/unsettled purchase position at any point of time.
• Short position - Outstanding/ unsettled sales position at any point of time.
• Open position - Outstanding/unsettled long or short position at any point of time.

Margining in Futures market

• Whole system dwells on margins:

o Daily Margins
o Initial Margins
o Special Margins

• Compulsory collection of margins from clients including institutions.

Option

Options

Options are instruments whereby the right is given by the option seller to the option buyer to buy
or sell a specific asset at a specific price on or before a specific date.

• Option Seller - One who gives/writes the option. He has an obligation to perform, in case
option buyer desires to exercise his option.
• Option Buyer - One who buys the option. He has the right to exercise the option but no
obligation.
• Call Option - Option to buy.
• Put Option - Option to sell.
• American Option - An option which can be exercised anytime on or before the expiry
date.
• Option Premium - The price paid by the option buyer to the option seller for granting the
option
• In the Money(ITM)
• At the Money(ATM)
• Out the Money(OTM)