derivatives presentation - short
TRANSCRIPT
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DERIVATIVESDERIVATIVESPRESENTATIONPRESENTATION
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Derivatives
What are Derivatives ? A Derivatives is an instrument whose value is derived
from the value of underlying assets. Underlying assets
may be commodities, foreign exchange, bonds, stocks,
stock indices, etc.
Typically derivatives contracts derive their value from
underlying cash market for e.g. derivative of the
Reliance, will derive its value from the cash market
price of Reliance.
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Risk Control : An investor can use derivative in riskcontrol as his risk profile dictates
High Leverage : Derivative contracts enables the investor
to take an exposure to the full value of underlying shares
for a fraction of its value in the form of margin Hedge : Hedge against any unforeseen event & leverage
High Liquidity
Protection
Flexibility
Price Discovery
Why totalkaboutDerivatives
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Futures are derivative contracts to buy or sell a specified quantity
or underlying assets at an agreed price, on or before a specified
time
They are standardized forward contracts, which are traded on the
exchanges. Exchange provides them transparency, liquidity, and
also eliminates the counter party risk due to guarantee provided
by the exchange
Derivative market is a leverage market since Investor/Trader has
to pay only fraction of total value of the contract as a margin to
his broker, who in turn has to pay to the exchange
Currently in India we have 3 types of contracts available for
trading
On last Thursday of each month these contracts expires and then
they are settled at a closing price of underlying cash market
Future Contract
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Hedging : Long Security, Sell Futures
Speculation : Bullish Security, Buy Futures
Speculation : Bearish Security, Sell Futures
Arbitrage : Overpriced Futures : Buy Spot, Sell Futures
Arbitrage : Under priced Futures : Buy Futures, Sell Spot
ApplicationofFutures
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Spot price : Price at which an asset trades in the spot market
Future price : Price at which the future contract trades
Contract cycle : Period over which a contract trades
Expiry date : It is the last day on which the contract will be traded at the
end of which it will cease to exit
Contract Value : The amount of asset that has to be delivered under one
contract
Basis : Basis means future price minus spot price
Cost of carry : The relationship between future price & spot price
Futures Terminology
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Initial margin : The amount that must be deposit in the margin account
at the time a future contract is first entered into is known is initial
margin
Marking to market : At the end of each day, the margin account isadjusted to the investors gain or loss depending upon the futures
closing price
Futures Terminology
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Options
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How much does an option cost?
The premium is the price you pay for the option
For buyer of an option
Risk : limited to the amount of premium paid
Profit potential: unlimited
For a seller of an option
Risk Unlimited
Profit Potential limited to the premium reduced
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Option Terminology
CallOption Option to buy
PutOption Option to sell
OptionBuyer has the right but not the obligation
Option Writer/Seller has the obligation but not the right
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Option Terminology
OptionPremium Price paid by the buyer to acquire the right
StrikePriceorExercisePrice Price at which the underlying may be purchased
ExpirationDate Last date for exercising the option
ExerciseDate Date on which the option is actually exercised
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Options
Option Premium = Intrinsic Value + Time Value
Suppose the derivatives of xyz ltd is trading for Rs 100 /- and 90
call is trading for the premium of Rs15/-, Here 100-90 = 10 is
intrinsic value and 15-10 is time value for options contract.
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Call option
A buyer of Call option has the right but not the
obligation to Buy the underlying at the set price by
paying the premium upfront
He can exercise his option on or before expiry
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Call Buyer v/s Seller
Call Buyer Pays premium
Has right to exercise resulting in a long position in the underlying
Time works against buyer
Risk limited, Reward unlimited
Call Seller Collects premium
Has obligation if assigned resulting in a short position in the
underlying Time works in favor of seller
Risk unlimited, Reward limited
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Put option
A buyer of Put option has the right but not the
obligation to sell the underlying at the set price by
paying the premium upfront
He can exercise his option on or before expiry
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Put Buyer v/s Seller
Put Buyer Pays premium
Has right to exercise resulting in a short position in theunderlying
Time works against buyer
Risk limited, Reward unlimited
Put Seller Collects premium
Has obligation if assigned resulting in a long position in the
underlying Time works in favor of seller
Risk unlimited, Reward limited
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Trading StrategiesTrading Strategies
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Strategiestobeused when Underlyingisin
Bullish Mode
Long Call
Short Put
Bull Call Spread
Bull Short Put Spread
Long Future
Put Hedge
Covered Call
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Strategiestobeused when Underlyingisin
Bearish Mode
Short Call
Long Put
Bull Put Spread
Bull Short Call Spread
Short Future
Call Hedge
Covered Put
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Strategiestobeused when Underlyingisin
RangeBound Mode
Short Straddle
Short Strangle
Short Guts
Long Call Butterfly
Long Put Butterfly
Long Condor
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Strategiestobeused whenunderlyingisin
volatilemode
Long Straddle
Long Strangle
Long Guts
Short Call/Put Butterfly
Short Condor
Strip
Strap
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Put HedgeWHEN ?
Put hedge is used when we are bullish on some
stock
And want to hedge our position if the prices move
downwards
HOW ?
In this strategy we firstbuy a future and then hedge
our position by buying aput immediately
Market Expectation : Bullish
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PUT HEDGE
Problems Which strike price?
Whattime?
Premium value?
Reversalofpositions Ifany importantsupport level isbreached
(a) We canreducelossesbysquaringofftheposition
(b) Squaringoffthefuture an persisting with the put
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CALL HEDGE
When?
Call hedge is used when we arebearish on
some stock
And want to hedge our position if the prices
move up
How?In this strategy we first sell a future and then
hedge our position by buying a call
immediately
Market Expectation : Bearish
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Call Hedge
Problems Which strike price ?
What time ?
Premium value ?
Reversal of positions
If any important resistance level is breached
(A) We can reduce losses by squaring off the position
(B) Squaring off the future an persisting with the call
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Risk From Strategies
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Open Interest
Open interest refers to the number of outstandingoption contracts in the exchange market or in aparticular class or series
Open Interest is an important indicator that can helpone in ascertaining the flow of funds
If the open interest rises with rise in price it is a bullishindication
If open interest rises and prices fall it is a bearishindication
If open interest falls and prices rise it is a sign of shortcovering by bears
If open interest falls and prices also fall it is a sign of profit booking by bulls or liquidation of positions
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Put Call Ratio
Put call ratio is an important indicator that canhelp one in gauging the future direction of themarket
If the Put call ratio rises then there is hope of
higher prices in the near future If the Put call ratio falls it is a sign of weakness
in the market
Generally put call ratio is read along with
volatility PCR can be calculated for Open
Interest/positions or no of puts and calls traded
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Impact of rollover is more important at the end of the contract
By analyzing the rollover along with the price movement one can
predict the direction of the stock
Mainly stocks which have a rollover of more than 90% with a price rise
or price consolidation in the previous contract have more chances to
move up immediately in the next contract
Stocks which have good rollover with the fall in price indicates that
market participants are rolling it over in anticipation that the stock may
rise in the next contract
Impact of Rollover
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MythsAboutDerivativesMythsAboutDerivatives
Derivatives are new, complex, high-tech financial products of stockmarket
Derivatives are purely speculative, highly leveraged instrument
Only large MNC, Banks and FIIs have a purpose for using derivatives
Only expert of derivatives can make money
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