Derivative strategies

Group members:
AMOL GAWANDE AMOL KHANVILKAR SHEETAL RAUT BHUMIKA SHAH UJALA YADAV 115 137 141 158

Derivatives
Derivatives are wasting assets, which derive their values from an underlying asset. These underlying assets are of various categories like Stocks(Equity) Agri Commodities including grains, coffee beans, etc. Precious metals like gold and silver. Foreign exchange rate Bonds Short-term debt securities such as T-bills

Features
Centralization of Trading No counter party risk Standardization of contracts Liquidity Mark to Market (MTM) margining system

Trade is judged on basis of OPEN Interest

Squared off in cash on expiration. Three series trade at any point in time.

Contract expires on last Thursday of the month.

PARTICIPANTS
Speculators - willing to take on risk in pursuit of profit. Hedgers - transfer risk by taking a position in the Derivatives Market. Arbitrageurs - aim to make a risk less profit by taking advantage of price differentials and thus bring about an alignment in prices by participating in two markets simultaneously

Types of derivatives

Derivatives

Futures

Options

Forwards

Swaps

Call

Put

Forward Contract
A Forward Contract is a transaction in which the buyer and the seller agree upon a delivery of a specific quality and quantity of asset usually a commodity at a specified future date. The price may be agreed on in advance or in future.

Futures Contract
It involves an obligation on both the parties i.e the buyer and the seller to fulfill the terms of the contract(i.e. these are pre-determined contracts entered today for a date in the future)

Obligation to buy or sell Stated quantity At a specific price Stated date (Expiration Date) Marked to Market on a daily basis

OPTIONS
An Options contract confers the right but not the obligation to buy (call option) or sell (put option) a specified underlying instrument or asset at a specified price the Strike or Exercised price up until or an specified future date the Expiry date. The Price is called Premium and is paid by buyer of the option to the seller or writer of the option. Types of option Call Option Put option

Two Types of Options Put and Call Options

Put Option:
The right to sell a futures contract Provides protection against falling prices Sets a minimum price target

Call Option:
The right to buy a futures contract Protects against rising prices (e.g. feed costs) Allows participation in seasonal price rises

Components of Premium
Intrinsic Value + Time Value = Premium

INTRINSIC VALUE
Positive difference between the strike price and the underlying commodity futures price. FOR A CALL OPTION strike price below futures price FOR A PUT OPTION strike price exceeds futures price
Note: Futures price means current price of underlying futures contract.

Call Option
In-the-Money (ITM) Strike price < Spot price(current price) At-the-Money (ATM) Strike price = Spot price Out-of-the-Money (OTM) Strike price >Spot price For Commodity Markets Spot price is prevailing Futures price

Put Option
In-the-Money (ITM) Strike price > Spot price

At-the-Money (ATM) Strike price = Spot price

Out-of-the-Money (OTM) Strike price < Spot price

SPREADS
1.
2. 3. 4. 5. 6.

Vertical Bull Call Spreads

Vertical Bull Put Spreads Vertical Bear Call Spreads Vertical Bear Put Spreads Straddles Strangles

7. Long Butterfly Spread 8. Short Butterfly Spread 9. Calendar Spreads Involving Call Options 10. Calendar Spreads Involving Put Options

Vertical Bull Call Spreads Vertical Bull Put Spreads

For April 2007 (same expiry)

Rs.790 Sell (Call / Put)

Rs.720 Buy (Call / Put)

Useful in moderately bullish market Limited Profit / Loss

Vertical Bull Call Spreads

Strike Price 4600 4800 Premium (180) 25
Nifty Lot Size = 50 Shares On settlement if Nifty touches

Buy Nifty Call Sell Nifty Call

4580
4400 4950

Particulars (A) Payoff of Nifty Premium Received/Paid Net Payoff Total Net Payoff Nil

4580 (B) Nil 25 25 (A) Nil

4400 (B) Nil 25 25

4950 (A) 350 (180) 170 (B) (150) 25 (125) 45

(180) (180) (155)

(180) (180) (155)

Lot Sise
Profit/Loss(Net Payoff*Lot Size)

50
(7750)

50
(7750)

50
2250

A= Purchase of Call

B= Sale of Call

Vertical Bull Put Spreads

Strike Price
Buy Nifty Put Sell Nifty Put 2000 2500

Premium
(135) 430
Nifty Lot Size = 50 Shares

On settlement if Nifty touches

1900
2100 3200

Particulars

1900

2100

3200

(A)
Payoff of Nifty Premium Received/Paid Net Payoff Total Net Payoff Lot Size Profit/Loss (Net Payoff*Lot Size) A= Purchase of Put 100 (135) 35

(B)
(600) 430 (170) (135) 50

(A)
Nil (135) (135) (105) 50

(B)
(400) 430 30

(A)
Nil (135) (135) 295 50

(B)
Nil 430 430

(6750) B= Sale of Put

(5250)

14750

Vertical Bear Call Spreads Vertical Bear Put Spreads

For April 2007 (Same expiry)

Rs.850 Buy (Call / Put) Rs.750 Sell (Call / Put)

Useful in moderately bearish market Limited Profit / Loss

Vertical Bear Call Spreads

Strike Price Premium (54.95) 146.90 4800 4600

Buy Nifty Call Sell Nifty Call

Nifty Lot Size = 50 Shares On settlement if Nifty touches 4200 4700 5100

Particulars (A)
Payoff of Nifty Premium Received/Paid Net Payoff Total Net Payoff Nil

4200 (B)
Nil 146.90

4700 (A)
(100) (54.95)

5100 (B)
Nil

(A)
(500) (54.95)

(B)
300 146.9 0

(54.95) (54.95)

146.90

146.90 (154.95 146.90 (554.95 446.9 ) ) 0 (8.05) (108.05)

91.95

Lot Size
Profit/Loss (Net Payoff*Lot Size)

50
4597.50

50
(402.50)

50
(5402.5)

A= Purchase of Put

B= Sale of Put

Vertical Bear Put Spreads

Strike Price 4600 4400 Premium (145.70) 66.70
Nifty Lot Size = 50 Shares On settlement if Nifty touches 4150 5300 4500

Buy Nifty Put Sell Nifty Put

Particulars
(A)

4150
(B) (A)

5300
(B) (A)

4500
(B)

Payoff of Nifty
Premium Received/Paid Net Payoff

450
(145.70 )

(250)
66.70

Nil
(145.70 )

Nil
66.70

100
(145.70 ) (45.70)

Nil
66.70 66.70

Total Net Payoff

Lot Size

304.30 (183.30 (145.70 66.70 ) ) 121 (79) 50 50

21
50

Profit/Loss (Net payoff*Lot Size)

A= Purchase of Put

6050

(3950)

1050

B= Sale of Put

Straddles
For April 2007

Rs. 910 Buy Call & Put

When market is volatile

Pay-off of Straddle Strategy

Strike Price 4300
4300

Buy Nifty Call Buy Nifty Put

Premium Paid 98
22
Nifty Lot Size = 50 Shares

On settlement if Nifty touches

4500
4000 4250

Particulars

4500

4000

4250

Payoff of Nifty Call/Put

Total Premium Net Payoff

200
(120) 80

300
(120) 180

50
(120) (70)

Lot Size
Profit/Loss (Net Payoff*Lot Size)

50
4000

50
9000

50
(3500)

Stranglers
For April 2007

Rs. 1000 Buy Call

Rs. 910 Buy Put

When market is volatile

Pay-off of Strangler Strategy

Strike Price
Buy Nifty Call Buy Nifty Put 4400 4200

Premium Paid 120

50

Nifty Lot Size = 50 Shares On settlement if Nifty touches 4600 4000 4300

Particulars
Payoff Nifty Call/Put Total Premium Net Payoff Lot Size

4400
200 (170) 30 50

4200
200 (170) 30 50

4300
Nil (170) (170) 50

Profit/Loss (Net Payoff*Lot Size)

1500

1500 (8500)