DERIVATIVES

Chapter 7

Types of derivatives
Forwards & futures
Options
Swaps

Forwards and futures

Both buyer and seller are committed to buy and sell
One partys profit is equal to other partys loss; hence pay-

offs are symmetric

Futures are traded on exchanges
Forwards are traded in the OTC market

Options
Option seller/writer has the obligation to perform for which he

receives a price (known as premium)

Option buyer has the right to make the seller perform by
exercising the option but is not obliged to do so
Pay-off from an option is asymmetric gain for option buyer
is unlimited while gain for option seller is limited to the
premium and loss for option buyer is limited while option
sellers loss is unlimited
American and European options
Call option is an option to buy the underlying asset at the
exercise price while put option is an option to sell the
underlying asset at the exercise price
Options are traded on the OTC market as well as exchanges

Swaps
A swap is a contract where two parties agree to exchange
a stream of interest payments (interest rate swap) or
a stream of cash flows in different currencies (currency swap) or
a stream of fixed payments against the variable return on an equity
index (equity swap) or commodity (commodity swap)
A stream of fixed payment in return for protection against default of
the issuer of a bond (credit default swap)
Swaps are traded in the OTC market

Option pricing using Black-Scholes model

Black-Scholes formula for pricing options

Where and

The input to the Black-Scholes model are:

S = spot price of underlying asset
K = exercise price or strike price of option
T = time to maturity of option
r = risk-free interest rate
= volatility of underlying asset

Pay-off to buyer of a call option

A call option will be in-the-money (ITM) if the stock

price is higher than strike price, i.e. if S>K

If call is ITM the pay-off to the buyer of the call is S-K
If stock price < strike price, the call is out-of-themoney
If the call is OTM, the pay-off to the buyer is zero
Hence pay-off to the buyer of a call option is max((SK),0)
The call buyers pay-off can never be negative

Pay-off to buyer of a put option

A put option will be in-the-money (ITM) if the strike

price is higher than stock price, i.e. if K>S

If put is ITM the pay-off to the buyer of the put is K-S
If strike price < stock price, the put is out-of-themoney
If the put is OTM, the pay-off to the buyer of the put is
zero
Hence pay-off to the buyer of a put option is max((KS),0)
The put buyers pay-off can never be negative

Option greeks
Five types of greeks are used by option traders to

manage their option portfolio

These are
Delta
Gamma
Theta
Vega
Rho

Delta
Delta of an option is the rate of change in option price with

respect to a small change in the underlying price

Example: If the call delta is 0.6 it means that the call
option price will change by 60 paise for every Re.1
change in the stock price
Delta of a call is positive and ranges from 0 to +1
Delta of a put is negative and ranges from 0 to -1
Delta is not constant; it keeps changing as the stock price
changes
Delta-hedging involves keeping the delta at the same
level

Gamma
Gamma is the rate of change of delta with respect to

change in the underlying price

It is the second derivative of the option price with respect
to underlying price
Gamma is the same for both call and put

Theta
Theta measures the change in option price with respect

to passage of time, other things remaining constant

Also known as time decay of the option
Theta must be divided by 365 to get the time decay per
calendar day or 250 to get the time decay per trading day
Example A theta of 560 means that the option price will
decline by Rs.1.53 daily (based on calendar days) if there
is no change in the stock price or volatility

Vega
Vega measures the change in option price with respect to

change in volatility of underlying asset

A high vega means that the option is very sensitive to
small changes in volatility and vice versa

Rho
Rho measures rate of change in option price with respect

to change in interest rates

Measures portfolio sensitivity to interest rates

Exchange-traded derivatives in India

Equity stock and index futures and options
Currency futures and options
Interest rate futures
Commodity futures

Equity futures and options on NSE

Equity Derivatives
Parameter

Index Futures

Index Options

Futures on Individual
Securities

Options on Individual
Securities

Long Term Index

Options

Underlying

6 indices

6 indices

158 securities

158 securities

CNX Nifty

FUTIDX

OPTIDX

FUTSTK

OPTSTK

OPTIDX

Expiry Date

Symbol of Underlying Inde

x
DD-MMM-YYYY

Symbol of Underlying Inde

x
DD-MMM-YYYY

Symbol of Underlying Secur Symbol of Underlying Secur NIFTY

ity
ity
DD-MMM-YYYY
DD-MMM-YYYY
DD-MMM-YYYY

Option Type

CE / PE

CE / PE

CE / PE

Strike Price

Strike Price

Strike Price

Strike Price

Security Descriptor:
Instrument
Underlying
Symbol

Three quarterly expiries

(March, June, Sept & Dec
cycle) and next 8half
yearly expiries (Jun, Dec
cycle)

Trading Cycle

3 month trading cycle - the near month (one), the next month (two) and the far month (three)

Expiry Day

Last Thursday of the expiry month. If the last Thursday is a trading holiday, then the expiry day is the previous trading day.

Strike Price
Intervals

Permitted Lot
Size

Depending on underlying p rice

Depending on Underlying vol

atility
Depending on underlying p
*
rice

Underlying specific

Underlying specific

Underlying specific

Underlying specific

Underlying specific

Price Steps

Rs.0.05

Rs.0.05

Rs.0.05

Rs.0.05

Rs.0.05

Operating range of 10% of

the base price

A contract specific price

range based on its delta
value is computed and
updated on a daily basis

Operating range of 10% of

the base price

A contract specific price

range based on its delta
value is computed and
updated on a daily basis

A contract specific price

range based on its delta
value is computed and
updated on a daily basis

Price Bands

Currency options on NSE

Symbol

USDINR

Market type

Instrument type

OPTCUR

Option type

Premium style European Call & Put Options

Premium

Premium quoted in INR.

Unit of trading

1 contract unit denotes USD 1000

Underlying / Order Quotation

The exchange rate in Indian Rupees for US Dollars

Tick size

0.25 paise i.e. INR 0.0025

Trading hours

Monday to Friday
9:00 a.m. to 5:00 p.m.

Contract trading cycle

3 serial monthly contracts followed by 1 quarterly contracts of the cycle

March/June/September/December

Strike price

12 In-the-money, 12 Out-of-the-money and 1 Near-the-money. (25 CE and 25

PE)

Strike price intervals

INR 0.25

Price operating range

A contract specific price range based on its delta value is computed and
updated on a daily basis

Quantity freeze

10,001 or greater

Base price

Theoretical price on the 1st day of the contract.

On all other days, DSP of the contract.

Expiry/Last trading day

Two working days prior to the last business day of the expiry month at 12
noon.

Exercise at expiry

All in-the-money open long contracts shall be automatically exercised at the

final settlement price and assigned on a random basis to the open short
positions of the same strike and series.

Final settlement day

Last working day (excluding Saturdays) of the expiry month.

The last working day will be the same as that for Interbank Settlements in
Mumbai.

Position limits

Position Limits for CDS Segment

Initial margin

SPAN Based Margin

Extreme loss margin

1.5% of Notional Value of open short position

Settlement of premium

Premium to be paid by the buyer in cash on T+1 day

Settlement

Daily settlement : T + 1
Final settlement : T + 2

Mode of settlement

Cash settled in Indian Rupees

Final settlement price (FSP)

RBI reference rate on the date of the expiry of the contact

Currency futures .
Symbol

Price operating
range

USDINR

EURINR

Tenure upto 6
months

+/-3 % of base price.

Tenure greater
than 6 months

+/- 5% of base price.

GBPINR

JPYINR

Initial margin

SPAN Based Margin

Extreme loss margin

1% of MTM value 0.3% of MTM value 0.5% of MTM value 0.7% of MTM value
of gross open of gross open of gross open of
gross
open
position
position
position
position

Calendar spreads

Rs.400 for spread

of
1
month
Rs.500 for spread
of
2
months
Rs.800 for spread
of
3
months
Rs.1000
for
spread
of
4
months and more

Settlement

Daily
settlement:
Final settlement: T + 2

Mode of settlement

Cash settled in Indian Rupees

Daily settlement price

(DSP)

Calculated on the basis of the last half an hour weighted average price.

Final settlement price

(FSP)

RBI
rate

Rs.700 for spread

of
1
month
Rs.1000
for
spread
of
2
months
Rs.1500
for
spread
of
3
months and more

reference RBI
rate

Rs.1500
for
spread of 1 month
Rs.1800
for
spread
of
2
months
Rs.2000
for
spread
of
3
months and more
T

Exchange
rate
published by RBI
in
its
Press
Release captioned
RBI
reference
reference Rate for US$ and
Euro

Rs.600 for spread

of
1
month
Rs.1000 for spread
of
2
months
Rs.1500 for spread
of 3 months and
more
+

Exchange
rate
published by RBI in
its Press Release
captioned
RBI
reference Rate for
US$ and Euro

Currency futures on NSE

Symbol

USDINR

EURINR

GBPINR

JPYINR

Market Type

Instrument Type

FUTCUR

FUTCUR

FUTCUR

FUTCUR

Unit of trading

1 - 1
denotes
USD.

Underlying / Order Quotation

The
exchange
rate in Indian The
exchange
Rupees for US rate in Indian
Dollars
Rupees for Euro.

Tick size

0.25 paise or INR 0.0025

Trading hours

Monday
9:00 a.m. to 5:00 p.m.

Contract trading cycle

12 month trading cycle.

Last trading day

Two working days prior to the last business day of the expiry month at
12:30 pm.

Final settlement day

Last working day (excluding Saturdays) of the expiry month.

The last working day will be the same as that for Interbank
Settlements in Mumbai.

Quantity Freeze

10,001 or greater

Base price

Theoretical
price on the 1st
day
of
the
contract.
On all other
days, DSP of the
contract.

unit 1 - 1
1000 denotes
EURO.

1 - 1 unit
unit denotes
1000 1 - 1 unit
1000 POUND
denotes 100000
STERLING.
JAPANESE YEN.
The
exchange
rate in Indian
Rupees
for
Pound Sterling.

to

Theoretical
price on the 1st
day
of
the
contract.
On all other
days, DSP of the
contract.

Theoretical
price on the 1st
day
of
the
contract.
On all other
days, DSP of the
contract.

The
exchange
rate in Indian
Rupees for 100
Japanese Yen.
Friday

Theoretical
price on the 1st
day
of
the
contract.
On all other
days, DSP of the
contract.

Interest rate futures on NSE

Instrument Type

FUTIRC
840GS2024

772GS2025

827GS2020

788GS2030

Symbol

The symbol shall

denote coupon,
type of bond and
Maturity Year. For
example 8.40%
Central
Government
Security having
maturity on July
28, 2024 shall be
denoted as
840GS2024

The symbol shall

denote coupon,
type of bond and
Maturity Year. For
example 7.72%
Central
Government
Security having
maturity on May
25, 2025 shall be
denoted as
772GS2025

The symbol shall

denote coupon,
type of bond and
Maturity Year. For
example 8.27%
Central
Government
Security having
maturity on June
09, 2020 shall be
denoted as
827GS2020

The symbol shall

denote coupon,
type of bond and
Maturity Year. For
example 7.88%
Central
Government
Security having
maturity on Mar
19, 2030 shall be
denoted as
788GS2030

Underlying

Futures contracts
based on 8.40%
Central
Government
Security having
maturity on July
28, 2024

Futures contracts
based on 7.72%
Central
Government
Security having
maturity on May
25, 2025

Futures contracts
based on 8.27%
Central
Government
Security having
maturity on June
09, 2020

Futures contracts
based on 7.88%
Central
Government
Security having
maturity on Mar
19, 2030

Market Type

Unit of trading

Rs. 2 lakhs face value of GOI securities equivalent to 2000 units. Members shall
place orders in terms of number of lots.

Quotation

Similar to the quoted price of GOI security

Contract Value

Quoted price * 2000

Tick size

Rs.0.0025

Trading hours

Monday to Friday
9:00 a.m. to 5:00 p.m.

Interest rate futures on NSE

Contract trading cycle

Three Serial monthly contracts followed by three

quarterly contracts of the cycle
March/June/September/December

Spread Contract

Near-Mid, Near-Far & Mid-Far

All spread orders shall be placed in terms of price
difference only.

Last trading day

Last Thursday of the month. In case the last Thursday is a

trading holiday, the previous trading day shall be the
expiry/last trading day

Quantity Freeze

1251 lots or greater i.e. orders having quantity up to 1250

lots shall be allowed.

Base price

Theoretical future price of the 1st day of the contract.

On all other days, daily settlement price of the contract

Price operating range

+/-3 % of the base price

(Whenever a trade in any contract is executed at the
highest/lowest price of the band, Exchange may expand
the price band for that contract by 0.5% in that direction
after 30 minutes after taking into account market trend.
Price band may be relaxed only 2 times during the day)

Daily Settlement

Daily MTM settlement on T+1 in cash based on daily

settlement price

Final Settlement

Final settlement on T+1 day in cash based on final

settlement price

Daily Settlement Price

Volume Weighted Average Futures Price of last half an

hour or Theoretical price

Final Settlement Price

Weighted average price of the underlying bond based on

the prices during the last two hours of the trading on
NDS-OM. If less than 5 trades are executed in the
underlying bond during the last two hours of trading, then
FIMMDA price shall be used for final settlement

91-day Treasury Bill futures

Symbol
Market Type
Instrument Type

91DTB
N
FUTIRT

Unit of trading

One contract denotes 2000 units (Face

Value Rs.2 lacs)

Underlying

91-day Government of India (GOI)

Treasury Bill

Tick size

0.25 paise i.e. INR 0.0025

Trading hours

Contract trading cycle

Monday to Friday
9:00 a.m. to 5:00 p.m.
Three Serial monthly contracts
followed by one quarterly contract of
the cycle
March/June/September/December

Last trading day

Last Wednesday of the expiry month at

1.00 pm
In case last Wednesday of the month
is a designated holiday, the expiry day
would be the previous working day

Price Quotation

100 minus futures discount yield

e.g. for a futures discount yield of 5%
p.a. the quote shall be 100 - 5 = Rs 95

Contract Value

Rs 2000 * (100 - 0.25 * y), where y is

the futures discount yield
e.g. for a futures discount yield of 5%
p.a. contract value shall be
2000 * (100 - 0.25 * 5)= Rs 197500

Quantity Freeze

7,001 lots or greater

Base price

Theoretical price of the first day of the

contract
On all other days, quote price
corresponding to the daily settlement
price of the contracts

91-day Treasury Bill futures

Price operating range

+/-1 % of the base price

Position limits
Clients
6% of total open interest or Rs.300
crores whichever is higher

Initial margin

Extreme loss margin

Settlement
Daily settlement

Trading Members
15% of the total open interest or
Rs.1000 crores whichever is higher
SPAN (Standard Portfolio Analysis
of Risk) based subject to minimum of
0.1 % of the notional value of the
contract on the first day and 0.05 % of
the notional value of the contract
thereafter
0.03 % of the notional value of the
contract for all gross open positions
Daily settlement MTM: T + 1 in cash
Delivery settlement : Last business
day of the expiry month.
Mark to Mark (MTM) : T + 1 in cash

Daily settlement price & Value

Rs (100 - 0.25 * yw) where yw is

weighted average futures yield of
trades during the time limit as
prescribed by NSCCL. In the absence
of trading in prescribed time limit,
theoretical futures yield shall be
considered

Daily Contract Settlement Value

Rs 2000 * daily settlement price

Final Contract Settlement Value

Rs 2000 * (100 - 0.25 * yf) where yf is

weighted average discount yield
obtained from weekly auction of 91day T-Bill conducted by RBI on the
day of expiry

Mode of settlement

Settled in cash in Indian Rupees

Volatility futures
India VIX (NVIX) is the volatility index designed by NSE
Futures contracts are offered on India VIX (NVIX)
These contracts enable the trader to trade based on

expected view of volatility or to hedge his

stock/derivatives portfolio

Credit Default Swaps

Investment in non-government bonds involves credit risk
CDS is a contract between two parties where the buyer

buys protection against credit risk of a bond which is the

underlying of the CDS contract
Buyer pays a premium to the seller
Seller agrees to compensate the buyer if the issuer of the bond

defaults

RBI regulations for CDS - Users

Market participants are classified into Users and Market makers
Users are permitted to buy protection only to hedge their credit risk

on corporate bonds
Not permitted to buy protection without having the underlying bond
Not permitted to sell protection or hold short position in CDS
contracts
Cannot buy CDS protection for amounts higher than face value of
bonds or for period longer than maturity of bonds
Cannot exit the CDS position by selling it; either unwind it with
original counterparty or if bond is sold, assign it to the purchaser
Users can be banks, primary dealers, NBFCs, Mutual funds,
housing finance companies, insurance companies, pension funds,
listed corporates, FIIs and any other institution specifically permitted
by the RBI

RBI regulations Market makers

Market makers are entities who can give two-way quotes,

i.e. buy and sell quotes

They are permitted to sell CDS protection and also buy
protection without having underlying bond
Only banks, primary dealers & NBFCs specifically
permitted by RBI can function as market-makers
Insurance companies and mutual funds specifically
permitted by IRDA and SEBI can function as marketmakers
All CDS trades must have an RBI-regulated entity at least
on one side of the transaction