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Introduction to Derivatives - Santosh

Derivatives are known to be among the most powerful financial instruments and it dominates the Indian equity markets in terms of turnover. Our training on 'Derivatives for beginners' talks about different types of equity derivatives, concepts, terminology, trading, clearing and settlement.<br>For more information visit : <br>https://simplehai.axisdirect.in/learn/eclasses<br>https://simplehai.axisdirect.in/offerings/products/derivatives

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Introduction to Derivatives - Santosh

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  1. DERIVATIVES BASICS (Futures & Options)

  2. Welcome Participants Speaker Introduction!

  3. What will the session cover? • Basic concepts of Derivatives (Futures & Options) • Practical approach of Futures & Options Trading • Margin & Risk Management • Basic Strategies of Derivatives • Market Movements & Trends using key Indicators

  4. Introduction to Derivatives • A derivative is a financial instrument return of which is based on the return of some other underlying asset • Exchange-traded vs. over-the-counter (OTC)

  5. Cash Vs Derivatives

  6. Type of Derivative Products available

  7. Basic Terms – Derivatives (F & O)

  8. Key uses of Derivatives are… Protecting the value of equity positions Limiting risk Alternative to direct investment in equity markets Higher trading power (leverage) compared to Delivery transactions

  9. FUTURES

  10. Futures - Definitions FUTURES CONTRACT Legally binding agreement to buy or sell a financial instrument sometime in future POSITIONS YOU CAN CREATE IN FUTURES Right – To claim profit Obligation – To pay loss

  11. Futures – Terminology Contract specification: S&P CNX Nifty Futures Underlying Index : S&P CNX Nifty Exchange of trading : National Stock Exchange of India Limited Contract Size : Permitted lot size shall be 75 Price steps : 0.05 Expiry Day : Last Thursday of the expiry month or the previous trading day if the last Thursday is a trading holiday. Settlement Basis : Market to Market and final settlement will be cash settle on T+1 Basis

  12. Pricing of Futures

  13. Pricing of Futures…….continued On the Expiry Date… SPOT PRICE = FUTURES PRICE (This happens as the Cost to Carry is zero) EXCEPTIONS --- When the SPOT PRICE is HIGHER than FUTURES PRICE Very low price movements / very illiquid contract / Mis-pricing in the contracts Dividend declared by companies during the contract period 3rd month contract 2nd month contract 1st month contract SPOT Price

  14. Futures – Risk & Settlement Margins will be charged to both BUY & SELL positions as they carry unlimited risk Mark to Market on daily basis at closing price of a contract Settlement Cycle : Difference is paid and recovered on T+2 and T basis from trader Settlement Price: Closing price on underlying in cash market on contract expiry date

  15. Uses of Index Futures… Speculation Hedging Arbitrage

  16. Speculation – Bearish outlook(You feel the markets will go down)

  17. Speculation – Bullish outlook(You feel the markets will go up)

  18. Hedging

  19. Hedging example

  20. Hedging example…..continued

  21. Arbitrage opportunities in Derivatives

  22. Advantages of FUTURES You can keep your positions open for up to 3 months and also transact in index When you feel the markets will be bearish, you can create SELL positions in Futures. This will not possible in DELIVERY segment unless you hold shares in your demat account You can close your open positions anytime before expiry. Also on the expiry day, exchange automatically closes out all open positions Lower brokerage / transaction costs in comparison to Delivery transaction Profits / losses are paid / recovered on a daily basis through Mark to Market (MTM). This helps you in keeping track of daily fluctuations in your open positions

  23. OPTIONS

  24. Option - Definition An option is the right, but not the obligation, to buy or sell something at a pre-determined date at a determined price

  25. Option - Types For easier understanding of the concepts, you can look at Options through the BUYERs outlook only

  26. Positions in Options

  27. Options– Terminology Contract specification: S&P CNX Nifty Options Underlying Index : S&P CNX Nifty Exchange of Trading: National Stock Exchange of India Limited Contract Size : Permitted lot size shall be 75 Price Steps : Rs.0.05 Expiry Day : The last Thursday of the expiry month or previous trading day if the last Thursday is a trading holiday Settlement basis : Cash settlement on T+1 basis Daily settlement price: Premium value Final Settlement price: Closing value of the index on the last trading day

  28. Options - Settlement types

  29. Options Pricing – Strike & Spot price

  30. Options Pricing – Strike & Spot price

  31. Options pricing – Some important terms

  32. Options – Risks for a trader

  33. Options – Margins applicable No risk to Options BUYERS as the risk is limited only to the extent of the premium, which is paid when order is placed, Hence no margins are charged for BUY positions in options All SELL positions in options have Unlimited risk, Hence SELL options will be charged margins. The margins charged will be different for different underlying assets (Index, stocks) depending upon the volatility

  34. Options – Rules related to EXERCISE Only BUYER of an option allowed to exercise Buyer can only exercise In the Money (ITM) options Buyer will always receive the difference Call Option: Spot price-Strike price Put Option: Strike price-Spot price Seller will always have to pay the difference Call Option : Spot price-Strike price Put option: Strike price-Spot price All contracts which are At the Money (ATM) and Out of the Money (OTM) on the expiry date will expire worthless Seller who is selected by the exchange and who is Out of the Money (OTM) will pay the difference. This is “Assignment of Option Contract”

  35. Options – Advantages Very high leverage product. The funds (premium) required for creating a position is just a fraction of the total contract value Losses of option buyers are limited to the extent of premium with unlimited profit potential Options positions can be kept open up to 3 months and also transact in Index No delivery involved Transaction charges are far lesser than if a similar position is taken on delivery basis

  36. Options Pricing - Strike & Spot price

  37. Using Derivatives Market Indicators

  38. What is Open Interest ? • The total number of options and/or futures contracts that are not closed on a particular day. • Open Interest acts as a strong indicator used to confirm trends and trend reversals for futures and options contract.

  39. Indicators - Open Interest

  40. Indicators – Put Call Ratio Put Call Ratio = PUT OI / CALL OI It is used to gauge investor sentiment PCR – OI of any strike price above 1.80 indicates strong support PCR – OI of any strike price below 0.60 indicates strong resistance Overall Market PCR in the range of 1.8 – 2.0 is Overbought and 0.8 – 1.0 is Oversold Market.

  41. Understand whether you are a Speculator or investor? Logic of Buying an OTM options - very bullish / bearish - very cheap Same expiry OTM cheaper than ITM Less investment Speculator may look for more leverage with OTM Your perceptions of the market movement Your perceptions of the volatility and interest rates in the market. Options – Selecting the Strike price

  42. Adopt the appropriate strategy that suits your profile Always consider your financial circumstances Be sure of your market view Always opt for liquid stocks Learn to interpret Open Interest, Put Call Ratio and Cost to carry Points to note…

  43. Thank You

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