Terminologies of Derivatives
- 1. TERMINOLOGIES OF DERIVATIVES HEINZ FINANCE CLUB – WORKSHOP FEBRUARY 14, 2015 Corey Sattler and Mahesh Nair
- 2. SPOT PRICE, FORWARD/FUTURE PRICE • Spot Price: • Referred to as Cash Prize • Price that is quoted for immediate delivery of asset • Forward/Futures price: • Price agreed upon at the date of contract for delivery of an asset • At a specific future date • Dependent on: • Spot price • Prevalent Interest Rate • Expiry date of Contract
- 3. STRIKE PRICE • Price at which the buyer of the option can: • Buy the stock Call Option • Sell the stock Put Option • Conditions Apply: On/before the expiry date of options contract • Price at which stock will be brought/sold when the option is exercised • USED IN CASE OF OPTIONS ONLY. NOT FOR FUTURE/FORWARDS
- 4. EXPIRATION DATE • In case of Futures, Forwards and Index Options: • It is the only date on which settlement takes place • In case of Stock Options • Last date on which option can be exercised • Also called FINAL SETTLEMENT DATE
- 5. TYPES OF OPTIONS • DEPENDING UPON PRIMARY EXERCISE STYLE • AMERICAN Can be exercised on any day – on/before expiry date. • Example: Stock Options. • EUROPEAN Can be exercised only on Expiration Date. • Example: Index based option
- 6. CONTRACT SIZE AND VALUE • CONTRACT SIZE: Represents certain number of shares of underlying asset • CONTRACT VALUE: Notional Value of transaction in case one transaction is brought/sold • Contract Value = (Contract Size) x (Price of Futures) • Example: 1 futures contract of ABC consists of 300 shares trading at $2000 • Contract Size? Future Price? Contract Value?
- 7. TRADING FUTURES & PAY OFFS • PAY OFF Profit/ Loss in a Trade • + ve Payoff – Investors make profit - ve Payoff – Investors make loss Stock Price Profit/Loss
- 8. TRADING FUTURES & PAY OFFS • Future Pay off on maturity depends on: • Spot price of the underlying asset at the time of maturity (ST) • Price at which the contract was initially traded (F)
- 9. POSITIONS TAKEN IN FUTURE CONTRACT • LONG: One who buys the asset at the Futures price (F) • SHORT: One who sells the asset at Futures price (F)
- 10. LONG PAY OFF • Long Pay Off: ST - F • ST = Spot price of the asset at the expiry of the contract • F = Traded Futures Price • Note: Holder of contract obligated to buy asset worth ST for F • Profit Condition? Larger the ST larger the profits – when (ST>F) Spot price (ST) Profit/Loss F
- 11. SHORT PAY OFF • Short Pay Off: F - ST • ST = Spot price of the asset at the expiry of the contract • F = Traded Futures Price • Note: Holder of contract obligated to Sell asset worth ST for F • Loss Condition? Larger the ST larger the Loss – when (ST>F) Spot price (ST) Profit/Loss F
- 12. TRADING OPTIONS Two sides of every Option contract • Option Buyer: Pays Premium • Option Seller: Receives Premium Taken into account for computing profit-loss
- 13. TYPES OF OPTIONS (BASIC) • LONG CALL • LONG PUT • SHORT CALL • SHORT PUT
- 14. STRIKE PRICE (Revisited) • Price at which the buyer of the option can: • Buy the stock Call Option • Sell the stock Put Option • Conditions Apply: On/before the expiry date of options contract • Price at which stock will be brought/sold when the option is exercised • USED IN CASE OF OPTIONS ONLY. NOT FOR FUTURE/FORWARDS
- 15. LONG CALL • An investor having Bullish (market will rise up) opinion on the underlying asset can expect to have +ve return buying call options on that asset. • When purchased: Holder exposed to stock performance in the spot market without actually possessing the stock • Cost incurred by call option = Option Premium
- 16. LONG PUT • An investor having Bearish(market will fall) opinion on the underlying asset can expect to have + ve return buying put options on that asset. • When purchased: Holder/Buyer of option has the right to sell the stock @ Strike price on or before expiry depending on underlying price
- 17. SHORT CALL & SHORT PUT • Short Call: An investor having Bearish(market will fall) can take advantage of falling stock prices by selling a call option on the asset. • Short Put: An investor having Bullish (market will rise) can take advantage of rising stock prices by selling a put option on the asset.
- 18. Reference Materials taken from Indian National Stock Exchange NCFMcertification modules: Equity Derivatives: Beginner’s Module http://www.nseindia.com/education/content/module_ncfm.htm
- 19. THANK YOU