Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

Understanding Derivatives


Published on

We hear or read about them every day. But however much we do read about them, they still seem daunting as ever, don’t they? Welcome to the world of Derivatives – a class of instruments that have held the interest of investors over the years. View the presentation to know more about the various types of derivatives.

  • well enough
    Are you sure you want to  Yes  No
    Your message goes here
  • Your explanation of the concept was very lucid. In all its going to help me. Thank You and keep sharing such things.
    Are you sure you want to  Yes  No
    Your message goes here

Understanding Derivatives

  1. 1. Demystifying StocksUnderstanding Derivatives
  2. 2. We hear or read about them every day. But however much we do read aboutthem, they still seem daunting as ever, don’t they?Welcome to the world of Derivatives – a class of instruments that have held theinterest of investors over the years. Derivatives are popular given theirflexibility, returns and their potential to provide market watchers with indicators ofmarket sentiments.
  3. 3. As Indian markets are experiencing one of their cyclical volatilephases, derivatives, may to some of us, seem a lucrative option. But like everyother investment decision, we need to understand them clearly and discoverhow best to use them to our advantage. Thus, we will discover and decipher theworld of derivatives, the jargon used to communicate and the indicators thatdefine possible successes or profits.
  4. 4. To begin with, let us understand derivatives and what they mean:Imagine a market where people like you and me have conflicting views regarding thefuture of stock prices – some of us expect it to rise in the future, while the rest are stillsceptical and expect the prices to fall. We trade in a market that allows us completeflow of information and freedom to trade according to our instincts. Given sharedknowledge, we would all know how the markets are expected to behave in the comingdays and we take our positions – bullish or bearish regards the future price of stocks.This is what forms a typical Derivative Market.
  5. 5. Derivatives are financial instruments that derive their value from other existing assetclasses. The term "Derivative" indicates the instrument derives its values entirely from theasset it represents be it equity, bullion, currency, commodity, realty, rate of interest or evenlivestock. A feature that is common to all underlying assets is that they carry the risk ofchange in value.As the value of a stock may rise or fall, an exchange rate may swing in favour of onecurrency or the other, the price of a commodity may increase or decrease, and so on; itmeans speculating on forward, future prices, placing an option on possible fluctuations orany other such contract made for the possible realisation of those pre determined valuesof financial assets or any index of securities.Derivative contracts seek to transfer these risks from an individual who is not comfortablewith the risk to the one who is.
  6. 6. Simply put, when you invest in derivatives, you actually place a bet on whether the valueof the asset represented will increase or decrease by a certain percentage and within aset period of time. Therefore, derivatives are merely contracts or bets that get their valuefrom existing or future prices of underlying securities. When you deal in derivatives, youare essentially buying a promise from the original owner of the asset to transferownership of the asset rather than the asset itself. This promise gives you tremendousflexibility and is by far the most important trait that appeals to investors.
  7. 7. The most common types of derivatives that you are likely to come across are futures, options, warrants and convertible bonds.An options contract gives you the right to buy or sell an asset at a set price on orbefore a given date. On the other hand, in a futures contract, you are obligated to buyor sell the asset at the end of the contract date.A futures contract means a legally binding agreement to buy or sell the underlyingsecurity at a future date and is an organized contract in terms ofquantity, quality, delivery time and place for settlement at a future date. The contractexpires on a pre-specified date or on an expiry date and on expiry, futures can besettled by delivery of the underlying asset or cash.
  8. 8. The options contract allows you the right but not the obligation to buy or sell theconcerned asset at a predetermined price within or at end of a specified period. Thebuyer / holder of the option would then purchase the right from the seller / writer for aconsideration known as a premium. The seller is then obligated to settle the option asper the terms of the contract or when the buyer exercises his right to buy.Call Option : An option to buyPut Option : An option to sellAmerican Option : An option that is exercisable on or before the expiry dateEuropean option: One that is exercisable only on expiry date - introduced to increaseliquidity volumes in certain segment of options. Currently all the options traded on NSEExchange are European in nature.Strike Price / Exercise Price : The price at which the option is to be exercised is calledStrike price or Exercise price. 8
  9. 9. As in the case of futures contracts, option contracts can also be settled by delivery ofthe underlying asset or cash. However, unlike futures, cash settlement in optioncontract includes the difference between the strike price and the price of theunderlying asset either at the time of contract expiry or at the time of exercising theoption. Futures OptionsRights / Obligation Obligations Rights for buyers, obligations for sellers • Limited to premium paid for buysRisks (potential loss) Unlimited • Unlimited for sellers • Unlimited for buyersOpportunity (potential gain) Unlimited • Limited for premium received for sellersExercise style - American or EuropeanMark to market Daily Daily
  10. 10. As the derivative markets deal in speculation, there is a large amount of risk involved.The Exchanges, however, have a stringent framework for risk control and minimizingloss. But a word of caution to retail investors, invest in derivatives only after takingcare of your financial needs and as an avenue of diversifying your portfolio.Derivatives are merely profits that you should earn and not returns that you shouldbank on.Derivatives are used to hedge risks and for speculative trades; and active marketsneed the equal participation of both such investors. By rule of thumb, if you are acautious investor with limited funds, learn to hedge your bets while if you are ready totake some risk and have ample funds to play the markets, not to mention also possessacumen and understanding of the Indian market trends, play the markets to youradvantage.
  11. 11. Thank You! • READ MORETwitter Website Facebook