The document discusses various derivatives instruments like forwards, futures, and options. Forwards are bilateral contracts where the underlying asset is delivered on maturity. Futures are exchange-traded standardized contracts that are cash settled daily. Options give the holder the right but not obligation to buy/sell the underlying at a strike price. Derivatives allow for hedging against price risks and speculating on market movements. They provide flexibility and leverage compared to trading the actual underlying assets.

1. DERIVATIVES
DR. P. SUGANTHI,
ASSISTANT PROFESSOR,
DEPARTMENT OF MANAGEMENT
STUDIES,
V.V.VANNIAPERUMAL COLLEGE FOR
WOMEN,
VIRUDHUNAGAR

2. INTRODUCTION
 Derivative is a product whose value is derived
from the value of one or more basic variables,
called bases (underlying asset, index, or
reference rate), in a contractual manner.
 The underlying asset can be equity, forex,
commodity or any other asset.
 In the Indian context the Securities Contracts
(Regulation) Act, 1956, (SC(R)A) defines "derivative"
to include-
A security derived from a debt instrument, share, loan
whether secured or unsecured, risk instrument or
contract for differences or any other form of security. 2.

3. FACTORS DRIVING THE
GROWTH OF DERIVATIVES
 Increased volatility in asset prices
 Increased integration of national and
international financial markets
 Marked improvement in communication facilities
and sharp decline in their costs
 Development of more sophisticated risk
management tools and hence, a wider choice of
risk management strategies, and
 Innovations in the derivatives markets, leading
to higher returns, reduced risk as well as
transactions costs as compared to individual

4. FORWARD CONTRACTS
 A forward contract is an agreement to buy or sell
an asset on a specified date for a specified -
One party agrees to buy (long position) and the
other agrees to sell (short position)
 FEATURES:
 bilateral contracts and involves counter-party risk
 custom designed, and hence is unique in terms of
contract size, expiration date and the asset type and
quality.
 contract price is generally not available in public
domain
 the contract has to be settled by delivery of the asset.

5. LIMITATIONS - FORWARDS
 Lack of centralization of trading,
 Illiquidity, and
 Counterparty risk

6. FUTURES
 A futures contract is an agreement between two
parties to buy or sell an asset at a certain time in the
future at a certain price. But unlike forward
contracts, the futures contracts are standardized
and exchange traded.
 The standardized items in a futures contract are:
 Quantity of the underlying
 Quality of the underlying
 The date and the month of delivery
 The units of price quotation and minimum price change
 Location of settlement

7. FUTURES TERMINOLOGY
 Spot price
 Futures price
 Contract cycle
 Expiry date
 Contract size or lot size
 Basis
 Cost of carry
 Initial margin
 Marking-to-market
 Maintenance margin

8. FORWARDS VS. FUTURES
BASIS FOR
COMPARISON
FORWARDS FUTURES
Meaning
Forward Contract is an agreement
between parties to buy and sell the
underlying asset at a specified date
and agreed rate in future.
A contract in which the parties agree
to exchange the asset for cash at a
fixed price and at a future specified
date, is known as future contract.
What is it? Tailor made contract. Standardized contract.
Traded on
Over the counter, i.e. there is no
secondary market. Organized stock exchange.
Settlement On maturity date. On a daily basis.
Risk High Low
Default
As they are private agreement, the
chances of default are relatively high. No such probability.
Size of contract Depends on the contract terms. Fixed
Collateral Not required Initial margin required.
Maturity As per the terms of contract. Predetermined date
Regulation Self regulated By stock exchange
Liquidity Low High

9. OPTIONS
 An option gives the holder of the option the right
to do something. The holder does not have to
exercise this right. the purchase of an option
requires an up-front payment.

10. OPTIONS TERMINOLOGY:
 Index and Stock options
 Buyer and Writer
 Call and Put
 Option Price / Premium
 Expiration date
 Strike Price
 American and European
 At-the-money, In-the-money, Out-of-the-money
 Intrinsic Value, Time Value

11. TRADING IN SECURITY Vs.
FUTURES
 Trading account and
demat account
 Upfront money
 Ownership
 Dividends,
participation in
AGM, power to vote
 Buying and then
selling
 Futures trading
account
 Margin money
 No ownership,
 A promise to buy /
sell underlying in the
future
 Buying before / after
selling
Underlying: Futures:

12. FUTURE PAYOFFS
 Long futures:
 potentially unlimited
upside as well as a
potentially unlimited
downside
 When the index
moves up, the long
futures position
starts making profits,
and when the index
moves down it starts
making losses.

13. FUTURE PAYOFFS
 Short Futures
 potentially unlimited
upside as well as a
potentially unlimited
downside.
 When the index
moves down, the
short futures
position starts
making profits, and
when the index
moves up, it starts
making losses.

14. APPLICATION OF FUTURES
 Hedging: Long security, sell futures
 value of his security falling from Rs.450 to Rs.390.
enter into an offsetting stock futures position, in this
case, take on a short futures position
 Assume – Spot price – Rs.390, Two-month futures -
Rs.402. Now, the price of his security falls to Rs.350,
will result in a fall in the price of futures
 his short futures position will start making profits. The
loss of Rs.40 incurred on the security he holds, will be
made up by the profits made on his short futures
position
 Hedging is for removal of unwanted exposure, i.e.
unnecessary risk and will make lesser profits. Hope

15. APPLICATION OF FUTURES
 Speculation: Bullish security, buy futures
 Speculation: Bearish security, sell futures
 Arbitrage: Overpriced futures: buy spot, sell
futures
 Arbitrage: Underpriced futures: buy futures,
sell spot

16. OPTION PAYOFFS
 Buyer Vs. seller of asset
 Payoff profile for buyer of call options: Long
call

17.  Payoff profile for writer of put options: Short
put

18.  Payoff profile for buyer of put options: Long
put

19.  Payoff profile for writer of call options: Short
call

20. FUTURES VS. OPTIONS
BASIS FOR
COMPARISON
FUTURES OPTIONS
Meaning
Agreement binding the counterparties
to buy and sell a financial instrument
at a predetermined price and a specific
date in the future.
A contract allowing the investors the
right to buy or sell an instrument at a
pre-decided price. It is to be executed
on or before the date of expiry.
Level of Risk High
Restricted to the amount of premium
paid.
Buyer’s
Obligation Full obligation to execute the contract There is no obligation
Seller’s
Obligation Complete obligation
If the buyer chooses then the seller
will have to abide by it.
Payment in
Advance
No advance payment to be made
except commission
Paid in the form of premium which is
a small percentage of the entire
amount.
Extent of
Gain/Loss No Restriction Unlimited Profits but limited loss
Date of Execution
On the pre-decided date as per
contract
Any point of time before the date of
expiry.
Time Value of
Money Not Considered Relied heavily upon

21. In 2008:

22. Futures – NSE- Snapshot

23. Options – NSE- Snapshot

24. Stock Option – Axis Bank