This document provides an overview of derivatives markets, including forwards, futures, and options contracts. It defines each contract type and explains how they work. Forwards involve a private agreement between two parties to buy or sell an asset at a future date at an agreed upon price. Futures are standardized forward contracts that are traded on an exchange. Options provide the right, but not obligation, to buy or sell the underlying asset. The document discusses participants in these markets including hedgers who aim to reduce risk, speculators who take bets on price movements, and arbitrageurs who exploit temporary price differences. It also provides illustrations of how these contracts can be used for hedging or trading purposes.

1. By CA (Dr.) Alok B. Shah
BBA- 13th November, 2013

2. DERIVATIVES ARE FINANACIAL
WEAPONS OF MASS DESTRUCTION
Warren Buffett

3. Derivative Market consist of Three segments
Forward
Futures
Option

4. Execution of Forward contract
Contract
Two Parties
Physical or
Cash
Settlement
Transaction
@ Expiry
date
Forward
Price

5. Participants in Forward Contract
Money
Delivery of Asset
Seller
Takes Short
position
Buyer
Takes Long
Position

6. Execution of Futures contract
1
2
• Standardize Forward contract.
• Contract Between two parties.
• Traded on recognized stock exchange.
3
• Traded on future date.
• Price Agreed on present date.
4
• Futures Contract requires Clearing House, Margins,
Marking to Market, Price Limits.

7. Participants in Futures Contract
Payment
Receipt
Buy cont.
Sell cont.
Clearing House
Futures
Buyer
Futures
Seller

8. Presently Index futures on S&P
CNX NIFTY and CNX IT, Stock
futures on certain specified
Securities and Interest Rate
Futures are available for trading at
NSE. All the futures contracts are
settled in cash.

9. Difference
Points
Structure
Transaction
Method
Market
Regulation
Institutional
Guarantee
Risk
Contract
Maturity
Forward Contract
Customized to
customer needs
Negotiated directly by
the buyer and seller
Not regulated
Futures Contract
Standardized
Quoted and traded on
the Exchange
Government
regulated market
Clearing House
The contracting
parties
High counterparty risk Low counterparty risk
Delivering the
Delivery of
commodity
commodity is not
necessary

10. Option Contract
An Option is a contract which gives the right,
but not an obligation, to buy or sell the
underlying at a stated date and at a stated
price. While a buyer of an option pays the
premium and buys the right to exercise his
option, the writer of an option is the one who
receives the option premium and therefore
obliged to sell/buy the asset if the buyer
exercises it on him.

11. Types Option Contract
Call
Option
Put
Option

13. Seller
Buyer

14. The futures & options trading system of NSE,
called NEAT-F&O trading system, provides a
fully automated screen-based trading for
Index futures & options and Stock futures &
options on a nationwide basis as well as an
online monitoring and surveillance
mechanism.

15. Entities in the trading system
Trading members
• They can trade either on their own account
or on behalf of their clients including
participants.
Clearing members
• They carry out risk management activities
and confirmation/inquiry of trades through
the trading system.

16. Entities in the trading system
Professional clearing members
• A professional clearing member is a clearing
member who is not a trading member.
Participants
• A participant is a client of trading members
like financial institutions.

17. Basis of trading
Order Driven Market
Security, its Price, Time and Quantity.
Notification of regular lot size and tick size
Entered order in trading system is active order
Passive orders sits into the outstanding order book

18. Corporate hierarchy
Corporate manager
Branch manager
Dealer
Admin

19. Order types and conditions
Time
conditions
Price
conditions
Other
conditions

20. Time
conditions
Day order
•
•
A day order, as the name suggests is
an order which is valid for the day on
which it is entered.
If the order is not executed during the
day, the system cancels the order
automatically at the end of the day.

21. Day order
•
•
An IOC order allows the user to buy or
sell a contract as soon as the order is
released into the system, failing which
the order is cancelled from the
system.
Partial match is possible for the order,
and the unmatched portion of the
order is cancelled immediately.

22. Price
conditions
Stop-loss
•
This facility allows the user to release
an order into the system, after the
market price of the security reaches
or crosses a threshold price.

23. Other
conditions
Market price
•
Market orders are orders for which no
price is specified at the time the order
is entered (i.e. price is market price).
For such orders, the system
determines the price.

24. Trigger price
•
Price at which an order gets triggered
from the stop-loss book.
Limit price
•
Price of the orders after triggering
from stop-loss book.

25. For the hedging or
trading purpose:
Illustrations of the
Futures/Options and
Forward Contract.

26. Of Call Option
Suppose you know that a Farm Land having a current
value of Rs. 100,000/- but there is a chance of it
increasing drastically within one year because you
know that a hotel chain is thinking of buying the
property for Rs. 200,000/So you approaches to the Farm owner and tell him
that you want the option to buy the land from him
within one year for Rs. 120,000/- and you pay him
Rs. 5,000/- for this right or option.

27. Rs. 5,000/- or premium, you paid to the owner is his
compensation for giving up the right to sell the
property over the next one year to someone else and
obligating him to sell it to you for Rs. 120,000/- if you
so choose.
After few months the hotel chain approaches the
farmer and tell him they will buy the property for
Rs. 200,000/Unfortunately, for the farmer he must inform them
that he cannot sell it to them because he had already
sold the option to you.

28. The hotel chain then approaches you and states that
they want to buy the land for Rs. 200,000/- since you
have the rights to sale the land.
Now you have two
Choices (Options)

29. Option
one
You can exercise your option and buy
the property for Rs.120,000/- from
the farmer and turn around and sell
it to the hotel chain for Rs.200,000/for a profit of Rs.75,000/-

30. Option
two
Sell the option directly to the
hotel chain for a handsome profit
and there after they can exercise
the option and buy the land from
the farmer.
In both the situations you can
get Rs. 75000/- profit.

31. Put Option
Suppose you bought 100 shares of Reliance Industries
at Rs.500 but wanted to make sure you don't lose more
than 10% on this investment.
You could buy Reliance Industries Ltd. put option with
a strike of Rs.450. That way if the price drops below
Rs.450 a share you will be able to exercise your put
option and sell your stock for Rs.450.
Here you don’t have to compulsorily sell these shares
at Rs.450. That is why it is called “Put Option”
- it is a choice to sell and not an obligation.

32. Forward Contract
Suppose On November 1, 2013 Mr. Birla agrees to buy
from Mr. Tata 100 Tones of polyester on April 1, 2014 at
a price of Rs. 10,000 per Tone.
Now, on April 1, 2014 the spot price (also known as the
market price) of polyester is greater than
Rs. 10,000, say Rs. 12,000 a tone, the buyer has gained.
Rather than paying Rs.12,000 a tone for polyester, it
only needs to pay Rs.2,000.

33. However, the buyer's gain is the seller's loss. The
seller must now sell 100 tones of polyester at only
Rs. 10,000 per tone when it could sell it in the open
market for Rs.12,000 per tone.
Rather than the buyer giving the seller Rs.10,000 per
tone of polyester as he would for physical delivery,
the seller simply pays the buyer Rs. 2,000 per tone.
Rs.2,000 per ton is the cash difference between the
agreed upon price and the current spot price.

34. Futures Contract
On November 1, 2013 the jeweler is setting the price of
jewelry to be sold in December through the catalog he is
printing. His major input expense is the cost of gold, which
changes from day to day in the market. Today, the jeweler
sees the following prices:
Spot Price
Gold Futures
for December
Rs. 30,000 per 10 Gms
Rs. 40,000 per 10 Gms

35. At the expiration of a futures contract, the spot
and futures price normally converge, i.e., become
the same. On December 1, the futures price
(which in this example equals the spot price) can
be above, below or the same as the futures
price was on November 1.
Now let us take two
alternative situations

36. one
The price in December is Rs. 45,000/- per 10
gms, i.e., higher than it was in November
(Rs.40,000/-),
In such a case, the jeweler has gained Rs.5,000/per 10 gms on the futures contract that
he can use to decrease the effective cost of the
spot gold he is purchasing:
from Rs. 45,000/- to Rs.40,000/-.

37. Two
If the futures price of gold on December 1
were Rs. 25,000, the jeweler could buy spot
gold for Rs. 25,000, but he would have had a
loss of Rs. 15,000/- per 10 gms. in the futures
market, resulting again effective cost of
Rs.40,000 per 10 gms of spot gold in
December.

38. In
either
case,
the
jeweler's
effective cost of gold is Rs.40,000 per 10 gms; i.e.,
the futures price (December) he "locked in"
during November.

39. Broadly There are Three types of
participants
Hedgers
Insuring an Investment
Against Risk
Speculators
Bets on Derivative
markets
Arbitrageurs
Attempts to get profit
from price inefficiencies

40. How one can start trading in the
derivatives market
1. Futures/ Options contracts in both index as
well as stocks can be bought and sold
through the trading members of NSE/BSE.
2. Some of the trading members also provide
the internet facility to trade in the futures
and options market.
3. One is required to open an account with one
of the trading members.

41. 4. Further complete the related formalities
which include KYC, Signing of memberconstituent
agreement,
constituent
registration form and risk disclosure
document.
5. The trading member will allot a unique client
identification number.
6. To begin trading, one must deposit cash
and/or other collaterals with their trading
member as may be stipulated by him.

42. Hedgers
•
•
•
•
Hedgers are those who protect themselves from
the risk associated with the price of an asset by
using derivatives.
A person keeps a close watch upon the prices
discovered in trading and when the comfortable
price is reflected according to his wants, he sells
futures contracts.
In this way he gets an assured fixed price of his
produce.
In general, hedgers use futures for protection
against adverse future price movements in the
underlying cash commodity.

43. Speculators
•
•
•
•
•
Speculators are some what like a middle man.
They are never interested in actual owing the
commodity.
They will just buy from one end and sell it to the
other in anticipation of future price movements.
They actually bet on the future movement in
the price of an asset.
They are the second major group of futures
players. These participants include independent
floor traders and investors.
They handle trades for their personal clients or
brokerage firms.

44. Arbitrageurs
•
•
•
•
As per Dictionary meaning - A person who has
been officially chosen to make a decision
between two people or groups who do not
agree is known as Arbitrageurs.
In commodity market Arbitrageurs are the
person who take the advantage of a discrepancy
between prices in two different markets.
If he finds future prices of a commodity edging
out with the cash price, he will take offsetting
positions in both the markets to lock in a profit.
Moreover the commodity futures investor is not
charged interest on the difference between
margin and the full contract value.

45. Overall Benefits to Trade in Derivatives
1. Able to transfer the risk to the person who is
willing to accept them,
2. Incentive to make profits with minimal amount of
risk capital,
3. Lower transaction costs,
4. Provides liquidity, enables price discovery in
underlying market,
5. Derivatives market are lead economic indicators,
6. Arbitrage between underlying and derivative
market,
7. Eliminate security specific risk.

46. • Even after this lecture
• The best way to get a feel of the trading
system, however, is to actually watch the
screen and observe trading.