Descriptions and explanation of all types of derivative instruments to trade with on the capital market.
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3. Forwards
• A forward contract is a customized contract
between two entities, where settlement takes
place on a specific date in the future at today’s
pre-agreed price.
4. Futures
• A future contract is an agreement between
two parties to buy or sell an asset at a certain
time in the future at a certain price.
• Futures are special types of forward contracts
in the sense that futures are standardized
exchange-traded contracts.
• A futures contract may be offset prior to
maturity by entering into an equal and
opposite transaction.
5. Futures (Contd.)
• The standardized items in a futures contract
are:
– Quality & Quantity of the underlying
– The date and month of delivery
– Location of settlement
6. Options
• An option is a contract giving the buyer the
right, but not the obligation, to buy or sell an
underlying asset (a stock or index) at a specific
price on or before a certain date.
• An option is a security, just like a stock or
bond, and constitutes a binding contract with
strictly defined terms and properties.
7. Options (Contd.)
• Types of options:
– Call option
• give the buyer the right but not the obligation to buy a
given quantity of the underlying asset, at a given price
on or before a given future date.
– Put option
• give the buyer the right but not the obligation to sell a
given quantity of the underlying asset, at a given price
on or before a given future date.
8. Warrants
• Longer -dated options are called warrants and are generally
traded over-the-counter (OTC).
• A warrant gives the holder the right but not the obligation
to buy an underlying security at a certain price, quantity
and future time. A warrant is issued by a company. The
security represented in the warrant (usually share equity) is
delivered by the issuing company instead of an investor
holding the shares.
• Companies will often include warrants as part of a new-
issue offering to entice investors into buying the new
security. A warrant can also increase a shareholder's
confidence in a stock, if the underlying value of the security
actually does increase overtime.
9. Warrants (Contd.)
• There are two different types of warrants:
– Call warrant:
• A call warrant represents a specific number of shares
that can be purchased from the issuer at a specific
price, on or before a certain date.
– Put warrant:
• A put warrant represents a certain amount of equity
that can be sold back to the issuer at a specified price,
on or before a stated date.
10. Warrants (Contd.)
• Characteristics of a Warrant:
– All warrants have a specified expiry date, the last day
the rights of a warrant can be executed.
– Warrants are classified by their exercise style:
• “American warrant” can be exercised anytime before or on
the stated expiry date.
• “European warrant”, can be carried out only on the day of
expiration.
– The underlying instrument the warrant represents is
also stated on warrant certificates.
– A warrant typically corresponds to a specific number
of shares, but it can also represent a commodity,
index or a currency.
11. LEAPS
• Long-Term Equity Anticipation Securities.
These are options having a maturity of up to
three years.
• LEAPS are long-term option contracts that
allow investors to establish positions that can
be maintained for a period of up to three
years. CBOE lists LEAPS on Equity and Index
products.
12. LEAPS (Contd.)
• Equity LEAPS :
– Provide long-term stock market investors an opportunity to
benefit from the growth of large capitalization companies
without having to make outright stock purchases.
– Puts can provide a hedge for stock investors against
substantial declines in underlying equities.
– Current equity options users may also find LEAPS appealing if
they desire to take a longer term position of up to three
years in some of the same options they currently trade.
• Index LEAPS:
– Let you trade, hedge or invest in the "entire" stock market or
select industry sectors for a time that can be measured in
years.
– Index options let you take a bullish or bearish position on the
entire market.
– Index options let you hedge your investments against
adverse market moves.
– Let you do all this over a longer time period.
13. Baskets
• Basket options are options on portfolios of
underlying assets. The underlying asset is
usually a moving average of a basket of assets.
Equity index options are a form of basket
options.
14. Swaps
• Are private agreements between two parties to
exchange cash flows in the future.
• A swap is a derivative, where two counterparties
exchange one stream of cash flows against another
stream. These streams are called the legs of the swap.
• Agreement on formula to be used for exchange of cash-
flows is determined in advance
• The cash flows are calculated over a notional principal
amount. Swaps are often used to hedge certain risks, for
instance interest rate risk. Another use is speculation.
15. Swaps (Contd.)
• Swaps are over-the-counter (OTC)
derivatives i.e. they are negotiated outside
exchanges. As each swap is a unique
contract, the only way to get out of it is by
either mutually agreeing to tear it up, or by
reassigning the swap to a third party. This
latter option is only possible with the
consent of the counterparty.
• Types of Swaps:
– Interest Rate Swaps:
– Currency Swaps
16. Common Terms
• Option premium: the price you pay for a Call
option is called the option premium. It secures
your right to buy that certain stock at a specified
price, called the strike price. If you decide not to
use the option to buy the stock, and you are not
obligated to, your only cost is the option
premium.
• Strike (or Exercise) Price: the price at which the
underlying security can be bought or sold as
specified in the option contract.
17. Common Terms (Contd.)
• The Expiration Date is the day on which the
option is no longer valid and ceases to exist.
The expiration date for all listed stock options
in India is the last Thursday of the month.
18. Thanks!
• For more information, explore
– http://www.koffeefinancial.com/Static/Learn.aspx
• Or email us at learn@koffeefinancial.com