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FUTURES AND OPTIONS

TEAM
MEMBERS:
1.APEKSHA
JAIN
2.SNEHA
AGARKAR
3.SAUMITA
PITRE 1
Meaning/Definition of
Derivative
Derivative is a product/ financial instrument
whose value is derived from an underlying
asset.
International Monitory Fund (IMF), defines
derivatives as, “Derivatives are financial
instrument,
that are linked to a specific financial
instrument or indicator or commodity and
through which specific
financial risk can be traded in financial
markets in their own right.’’ 2
Reasons for Development

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Participants in the market

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Advantages of derivative
market

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Advantages of derivative
market

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Types of Derivatives

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Types of Derivatives

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Types of Derivatives

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Emergence/History of
Derivative Market
Liberalisation in the economy.
Demutualisation and corporatisation.
Integration of financial market
Improvement Information technology
Advancement in communication system
Reduced cost of transaction

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Regulatory framework

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L.C. Gupta Committee
Recommendations
 

SEBI set up a 24- member committee under the


Chairmanship of L.C.Gupta. The recommendations
of the committee are as follows:

• Phased introduction of derivative instruments.


• Amendments in SC(R)A
• Annual inspection by Stock Exchanges
• Setting up of Clearing Corporation
• Role of clearing Corporation
• Eligibility criteria of clearing corporation member
• Demutualization of clearing corporation
• Disclosure of risk clause in all the contract
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Amendments in SC(R)A
• For trading derivatives, exchange needs to fulfill the
eligibility criteria
• amendments are made in Section 4 of the SC(R)A,
1956 to include derivative product in the definition of
securities
• Derivatives exchange/segment should have a separate
governing council .
• Exchanges would have to regulate the sales practices
of its members
• The Exchange should have minimum 50 members.
• The members of derivative segment need to fulfill the
eligibility conditions as laid down by the L. C. Gupta
committee.

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Amendments in SC(R)A
• The clearing and settlement of derivatives trades
would be through a SEBI approved clearing
corporation/house.
• Clearing corporations/houses have to apply to SEBI
for grant of approval.
• Derivative brokers/dealers and clearing members
are required to seek registration from SEBI. This is
in addition to their registration as brokersof
existing stock exchanges.
• Strict enforcement of KYC norms
• Disclosure of risk clause compulsory in documents

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Futures

Futures are specialised form of forward


contract.
Futures are fixed value contract
They are exchange traded
Highly liquid than forwards
No counter party risk exist
Follow daily settlement
Always marked to market

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Distinguish between Forwards &
Futures
Forward contract Futures contract

Tailor made Fixed value contract

Traded in over the counter market Traded on exchange

Less liquid Highly liquid

Does not require margin money Requires margin money

Settlement takes place at the end of the Follow daily settlement


period

Settlement is only by delivery Settlement is either by delivery or by


paying price differentiation.

Counter party risk always exist No counter party risk exist, as the
contract is made with Clearing
Corporation.

Profit or loss is booked on conclusion of Here the contracts are marked to market
the contract. on a daily basis. Therefore, the booking
of profit & loss is made daily

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Types of Futures

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Future Terminology
Spot price
Future Price
Contract cycle
Expiry dates
Contract size
Initial Margin
Marking to Market
Maintenance Margin

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Pricing of Stock Futures

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Comparison Between Cash
Market & F&O Market
Particulars Cash Market F&O Market

Investment 100% investment is 15 % to 20% of total value


needed is needed as investment.

Return on Lesser returns as Higher returns as


Investment compared to investment. investment is less.

Brokerage High Less


Stock index Not available Available
Scope of Higher Lesser
Manipulation

Risk Unlimited Limited upto the amount of


premium

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Accounting For Futures
1. Accounting at the inception:
 Initial Margin paid to be debited:
“ Initial Margin- Futures A/c”
 Additional Margins to be accounted as above.
 When contract is made no enrty to be passed.
 On the Balance Sheet date the above account is
shown under the heads Current Assets.
 Initial Margin in the form of Bank guarantees or by
lodging securities should be disclosed in notes to A/cs.

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Accounting For Futures
2. Accounting at the time of daily
settlement :
 Payments made or received on account of
daily settlement is credited/debited to:
“Mark-to-market margin - Futures A/c”

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Accounting For Futures

3. Accounting for open positions:


Anticipated loss to be provided for and
anticipated profits to be ignored.
Net payment made to the broker - “current
assets, loans and advances (net of provision
for loss)”

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Accounting For Futures

4. Accounting at the time of final


settlement:
 Profit / Loss = Final settlement price –
Contract price
Debited / Credited to “Mark to Market Margin
– Futures A/c”
Loss to be adjusted first against the provision
made for the anticipated losses and balance
from the P&L.
FIFO method is followed.
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Options
Fundamentally different from forward and
futures
Gives the holder of the option the right but
not an obligation
Purchase of an option requires an up-front
payment
Basically there are two types of option. They
are Call Option & Put Option

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Option Terminology

Index options
Stock options
Buyer of an option
Writer of an option
Call option
Put option
Option price/premium
Expiration date

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Option Terminology
Strike price
American options
European options
In-the-money option
At-the-money option
Out-of-the-money option
Intrinsic value of an option

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Pricing Options

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Black & Scholes

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Payoff for Investor Who Went
Long Nifty at 2220

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Payoff for Investor Who Went
Short Nifty at 2220

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Payoff For Buyer Of Call
Option

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Payoff For Writer Of Call
Option

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Payoff For Buyer Of Put
Option

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Payoff For Writer Of Put
Option

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Payoff For A Bull Spread
Created Using Call Options

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Payoff For A Bear Spread
Created Using Call Options

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Accounting for options

1. Accounting at the inception:


 Initial Margin paid to be paid by writer / seller to be
debited:
“ Equity Index / Stock Option Margin A/c”
 Buyer / holder not required to pay margin.
 Premium is to be paid to the writer by the holder of
the option.
which is debited:
“Equity Index / Stock Option Premium A/c”

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Accounting for options

2. Accounting at the time of payment/receipt of


margin:
Payments made or received on account of daily
settlement is credited/debited by the writer to :
“ Equity Index / Stock Option Margin A/c”
In case of deposit made by him instead of Bank A/c
“Deposit for Margin A/c” will be debited or credited.
On Balance sheet date balance In the above A/c is
shown under the head “ Current Assets”.

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Accounting for options

3. Accounting for open positions:


Loss to the holder = Premium paid – Premium
on the B/S date.
The above loss to be provided for and to be
shown as deduction from “Equity Index / Stock
Option Premium A/c” under “current assets,
loans and advances”.

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Accounting for options

4. Accounting at the time of final settlement:


On exercise of the option:
a. For holder premium to be debited to P&L and credited to
“Equity Index / Stock Option Premium A/c”
b. For writer premium to be credited to P&L and debited to
“Equity Index / Stock Option Premium A/c”
Final settlement price - Strike price = if -ve then paid by
the writer.

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Accounting for options

5. Accounting at the time of squaring off


an option contract:
On final settlement the writer has to make
delivery of the equity shares.
the premium paid/received will be transferred
to the profit and loss account

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Taxation

Income from derivative contracts:


- not a speculative income
- treated as business income
- losses can be set off against any other
income during the year & carried forward to 8
subsequent years.
- securities transaction tax paid on such
transactions is eligible as deduction.

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THANK YOU

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