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a contract or security that derives its value from that of an underlying asset (as another
security) or from the value of a rate (as of interest or currency exchange) or index of asset
value (as a stock index).
Introduction to Derivatives
Derivative is a product/contract which does not have any value on its own i.e. it derives its value
from some underlying.
Forward contracts
• A forward contract is one to one bi-partite contract, to be performed in the future, at the
terms decided today.
(E.g. forward currency market in India).
• Forward contracts offer tremendous flexibility to the parties to design the contract in
terms of the price, quantity, quality (in case of commodities), delivery time and place.
• Forward contracts suffer from poor liquidity and default risk.
Future contracts
• Future contracts are organised/ standardised contracts, which are traded on the
exchanges.
• These contracts, being standardised and traded on the exchanges are very liquid in
nature.
• In futures market, clearing corporation/ house provides the settlement guarantee.
• are entered into through exchange, traded on exchange and clearing corporation/house
provides the settlement guarantee for trades.
• are of standard quantity; standard quality (in case of commodities).
• have standard delivery time and place.
• Index futures are the future contracts for which underlying is the cash market index.
• For example: BSE may launch a future contract on "BSE Sensitive Index" and NSE may
launch a future contract on "S&P CNX NIFTY".
o Daily Margins
o Initial Margins
o Special Margins
Option
Options
Options are instruments whereby the right is given by the option seller to the option buyer to buy
or sell a specific asset at a specific price on or before a specific date.
• Option Seller - One who gives/writes the option. He has an obligation to perform, in case
option buyer desires to exercise his option.
• Option Buyer - One who buys the option. He has the right to exercise the option but no
obligation.
• Call Option - Option to buy.
• Put Option - Option to sell.
• American Option - An option which can be exercised anytime on or before the expiry
date.
• Option Premium - The price paid by the option buyer to the option seller for granting the
option
• In the Money(ITM)
• At the Money(ATM)
• Out the Money(OTM)