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Q. What are Derivatives? |
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The term "Derivative" indicates that it has no independent value, i.e. its value
is entirely "derived" from the value of the underlying asset. The underlying asset
can be securities, commodities, bullion, currency, live stock or anything else.
In other words, Derivative means a forward, future, option or any other hybrid contract
of pre determined fixed duration, linked for the purpose of contract fulfillment
to the value of a specified real or financial asset or to an index of securities.
With Securities Laws (Second Amendment) Act,1999, Derivatives has been included
in the definition of Securities. The term Derivative has been defined in Securities
Contracts (Regulations) Act, as:- A Derivative includes: - a. a security derived
from a debt instrument, shafre, loan, whether secured or unsecured, risk instrument
or contract for differences or any other form of security b. a contract which derives
its value from the prices, or index of prices, of underlying securities |
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Q.What are derivative instruments? |
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A derivative is an instrument whose value is derived from the value of one or more
underlying, which can be commodities, precious metals, currency, bonds, stocks,
stocks indices, etc. Four most common examples of derivative instruments are Forwards,
Futures, Options and Swaps. |
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Q.What are Forward contracts? |
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A forward contract is a customized contract between two parties, where settlement
takes place on a specific date in future at a price agreed today. The main features
of forward contracts are: a. They are bilateral contracts and hence exposed to counter-party
risk. b. Each contract is custom designed, and hence is unique in terms of contract
size, expiration date and the asset type and quality. f c. The contract price is
generally not available in public domain. d. The contract has to be settled by delivery
of the asset on expiration date. e. In case, the party wishes to reverse the contract,
it has to compulsorily go to the same counter party, which being in a monopoly situation
can command the price it wants. |
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Q.What are Futures? |
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Futures are exchange-traded contracts to sell or buy financial instruments or physical
commodities for Future delivery at an agreed price. There is an agreement to buy
or sell a specified quantity of financial instrument/commodity in a designated Future
month at a price agreed upon by the buyer and seller. To make trading possible,
the exchange specifies certain standardized features of the contract. |
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Q.What is the difference between Forward contracts and Futures contracts? |
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Futures is a type of forward contract a. Standardized Vs Customized Contract - Forward
contract is customized while the future is standardized. To be more specific, the
terms of a Forward Contracts are individually agreed between two counter-parties,
while Futures being traded on exchanges have terms standardized by the exchange.
Counter party risk - In case of Futures, after a trade is confirmed by two members
of exchange, the exchange / clearing house itself becomes the counter-party (or
guarantees) to every trade. The credit risk, which in case of forward contracts
was on the counter party, gets transferred to exchange/clearing house, reducing
the risk to almost nil. b. Liquidity - Futures contracts are much more liquid and
their price is much more transparent due to standardization and market reporting
of volumes and price. c. Squaring off - A Forward contract can be reversed only
with the same counter-party with whom it was entered into. A Futures contract can
be reversed with any member of the exchange. d. Mark to Market - Futures contract
are market to market everyday to reflect the gains or losses the party makes by
crediting or debiting the accounts of the parties respectively. |
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Q.What are Index Futures and Index Option? |
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Futures contract based on an index i.e. the underlying asset is the index, are known
as Index Futures Contracts. For example, futures contract on NIFTY Index and BSE-30
Index. These contracts derive their value from the value of the underlying index.
Similarly, the options contracts, which are based on some index, are known as Index
options contract. However, unlike Index Futures, the buyer of Index Option Contracts
has only the right but not the obligation to buy / sell the underlying index on
expiry. Index Option Contracts are generally European Style options i.e. they can
be exercised / assigned only on the expiry date. An index in turn derives its value
from the prices of securities that constitute the index and is created to represent
the sentiments of the market as a whole or of a particular sector of the economy.
Indices that represent the whole market are broad based indices and those that represent
a particular sector are sectoral indices. By its very nature, index cannot be delivered
on maturity of the Index futures or Index option contracts therefore, these contracts
are essentially cash settled on Expiry. |
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Q.What is the lot size of a contract? |
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Lot size refers to number of underlying securities in one contract. The lot size
is determined keeping in mind the minimum contract size requirement at the time
of introduction of derivative contracts on a particular underlying. For example,
if shares of XYZ Ltd are quoted at Rs.1000 each and the minimum contract size is
Rs.2 lacs, then the lot size for that particular scrips stands to be 200000/1000
= 200 shares i.e. one contract in XYZ Ltd. covers 200 shares. |
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Q.What are the profits and losses in case of a futures position? |
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The profits and losses would depend upon the difference between the price at which
the position is opened and the price at which it is closed. Let us take some examples.
Example 1 Position : Long - Buy June Sensex Futures @ 5500 Payoff : Profit - if
the futures price goes up Loss : if the futures price goes down Calculation : The
profit or loss would be equal to fifty times the difference in the two rates. If
June Sensex Futures is sold @ 5600 there would be a profit of 100 points which is
equal to Rs. 5,000 (100 X 50). However if the June Sensex is sold @ 3250 there would
be a loss of 50 points which is equal to Rs. 2,500 (50 X50). Example 2 Position
: Short Sell June Sensex Futures @ 5500 Payoff : Profit - if the futures price goes
down Loss : if the futures price goes up Calculation : The profit or loss would
be equal to fifty times the difference in the two rates. If June Sensex Futures
is bought @ 5700 there would be a loss of 200 points which is equal to Rs. 10,000
(200 X 50). However if the June Sensex Futures is bought @ 5400, there would be
a profit of 100 points which is equal to Rs. 5,000 (100 X50). |
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Q.What is a spread position? |
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A calendar spread is created by taking simultaneously two positions : a. A long
position in a futures series expiring in any calendar month b.A short position in
the same futures as 1 above but for a series expiring in any month other than the
1 above. Examples of Calendar Spreads 1. Long June Sensex Futures Short July Sensex
Futures 2. Short July Sensex Futures Long August Sensex Futures A spread position
must be closed by reversing both the legs simultaneously. The reversal of 1 above
would be a sale of June Sensex Futures while simultaneously buying the July Sensex
Futures. |
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Q.What are Stock Futures? |
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Stock Futures are financial contracts where the underlying asset is an individual
stock. Stock Future contract is an agreement to buy or sell a specified quantity
of underlying equity share for a future date at a price agreed upon between the
buyer and seller. The contracts have standardized specifications like market lot,
expiry day, unit of price quotation, tick size and method of settlement. |
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Q.How are Stock Futures different from Stock Options? |
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In stock options, the option buyer has the right and not the obligation, to buy
or sell the underlying share. In case of stock futures, both the buyer and seller
are obliged to buy/sell the underlying share. Risk-return profile is symmetric in
case of single stock futures whereas in case of stock options payoff is asymmetric.
Also, the price of stock futures is affected mainly by the prices of the underlying
stock whereas in case of stock options, volatility of the underlying stock affect
the price along with the prices of the underlying stock. |
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Q.What are the opportunities offered by Stock Futures? |
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Stock futures offer a variety of usage to the investors. Some of the key usages
are mentioned below: Investors can take long term view on the underlying stock using
stock futures. Stock futures offer high leverage. This means that one can take large
position with less capital. For example, paying 20% initial margin one can take
position for 100 i.e. 5 times the cash outflow. Futures may look overpriced or under
priced compared to the spot and can offer opportunities to arbitrage or earn risk-less
profit. Single stock ffutures offer arbitrage opportunity between stock futures
and the underlying cash market. It also provides arbitrage opportunity between synthetic
futures (created through options) and single stock futures. When used efficiently,
single-stock futures can be an effective risk management tool. For instance, an
investor with position in cash segment can minimize either market risk or price
risk of the underlying stock by taking reverse position in an appropriate futures
contract. |
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Q.Can I square up my position? |
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The investor can square up his position at any time till the expiry. The investor
can first buy and then sell stock futures to square up or can first sell and then
buy stock futures to square up his position. E.g. a long (buy) position in December
ACC futures, can be squared up by selling December ACC futures. |
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Q.When I am required to pay initial margin to my broker? |
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The initial margin needs to be paid to the broker on an up-front basis before taking
the position. |
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Q.Do I have to pay mark to market margin? |
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Yes. The outstanding positions in stock futures are marked to market daily. The
closing price of the respective futures contract is considered for marking to market.
The notional loss / profit arising out of mark to market is paid / received on T+1
basis. |
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Q.What are the profits and losses in case of a stock futures position? |
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The profits and losses would depend upon the difference between the price at which
the position is opened and the price at which it is closed. Let an investor have
a long position of one November Stock 'A' Futures @ 430. If the investor square
up his position by selling November Stock 'A' futures @ 450, the profit would be
Rs. 20 per share. In case, the investor squares up his position by selling November
Stock 'A' futures @ 400, the loss would be Rs. 30 per share. |
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Q.What are the different contract months available for trading? |
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1, 2 and 3 months contracts are available for trading |
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Q.How can an investor benefit from a predicted rise or predicted fall in the price
of a stock ? |
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An investor can benefit from a predicted rise in the price of a stock by buying
futures. As the price of the futures rises, the investor will make a positive return.
As the investor will have to pay only the margin (which forms a fraction of the
notional value of contract), his return on investment will be higher than on an
efquivalent purchase of shares. An investor can benefit from a predicted fall in
the price of stock by selling futures. As the price of the future falls in line
with the underlying stock, the investor will make a positive return. |
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Q.Important Terminology in Options? |
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Premium is the price paid by the buyer to the seller to acquire the right to buy
or sell Strike Price or Exercise Price - The strike or exercise price of an option
is the specified/ predetermined price of the underlying asset at which the same
can be bought or sold if the option buyer exercises his right to buy/ sell on or
before the expiration day. Expiration date - The date on which the option expires
is known as Expiration Date. On Expiration date, either the option is exercised
or it expires worthless. Exercise Date - The date on which the option is actually
exercised is called as Exercise Date. In case of European Options the exercise date
is same as the expiration date while in case of American Options, the options contract
may be exercised any day between the purchase of the contract and its expiration
date (see European/ American Option). In India, options on "Sensex" are European
style, whereas options on individual are stocks American style. Open Interest -
The total number of options contracts outstanding in the market at any given point
of time. Option Holder: is the one who buys an option, which can be a call, or a
put option. He enjoys the right to buy or sell the underlying asset at a specified
price on or before specified time. His upside potential is unlimited while losses
are limited to the Premium paid by him to the option writer. Option seller/ writer:
is the one who is obligated to buy (in case of Put option) or to sell (in case of
call option), the underlying asset in case the buyer of the option decides to exercise
his option. His profits are limited to the premium received from the buyer while
his downside is unlimited. Option Series : An option series consists of all the
options of a given class with the same expiration date and strike price. e.g. BSXCMAY5500
is an options series which includes all Sensex Call options that are traded with
Strike Price of 5500 & Expiry in May. (BSX Stands for BSE Sensex (underlying index),
C is for Call Option, May is expiry date & strike Price is 3600). |
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Q.What is Assignment? |
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When holder of an option exercises his right to buy/ sell, a randomly selected (by
computer) option seller is assigned the obligation to honor the underlying contract,
and this process is termed as Assignment. |
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Q.What are Call Options? |
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A call option gives the holder (buyer/ one who is long call), the right to buy specified
quantity of the underlying asset at the strike price on or before expiration date
in case of American option. The seller (one who is short call) however, has the
obligation to sell the underlying asset if the buyer of the call option decides
to exercise his option to buy. Example : Investor buys One European call option
on Stock 'A' at the strike price of Rs. 3500 at a premium of Rs. 100. If the market
price of Stock 'A' on the day of expiry is more than Rs. 3500, the option will be
exercised. The investor will earn profits once the share price crosses Rs. 3600
(Strike Price + Premium i.e. 3500+100). Suppose stock price is Rs. 3800, the option
will be exercised and the investor will buy 1 share of Stock 'A' from the seller
of the option at Rs 3500 and sell it in the market at Rs 3800 making a profit of
Rs. 200 {(Spot price - Strike price) - Premium}. In another scenario, if at the
time of expiry stock price falls below Rs. 3500 say suppose it touches Rs. 3000,
the buyer of the call option will choose not to exercise his option. In this case
the investor loses the premium (Rs 100), paid which shall be the profit earned by
the seller of the call option. |
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Q.What are Put Options? |
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A Put option gives the holder (buyer/ one who is long Put), the right to sell specified
quantity of the underlying asset at the strike price on or before a expiry date
in case of American option. The seller of the put option (one who is short Put)
however, has the obligation to buy the underlying asset at the strike price if the
buyer decides to exercise his option to sell. Example : An investor buys one European
Put option on Stock 'B' at the strike price of Rs. 300, at a premium of Rs. 25.
If the market price of Stock 'B', on the day of expiry is less than Rs. 300, the
option can be exercised as it is 'in the money'. The investor's Break-even point
is Rs. 275 (Strike Price - premium paid) i.e., investor will earn profits if the
market falls below 275. Suppose stock price is Rs. 260, the buyer of the Put option
immediately buys Stock 'B' from the market @ Rs. 260 & exercises his option selling
the Stock 'B' at Rs 300 to the option writer thus making a net profit of Rs. 15
{(Strike price - Spot Price) - Premium paid}. In another scenario, if at the time
of expiry, market price of Stock 'B' is Rs 320, the buyer of the Put option will
choose not to exercise his option to sell as he can sell in the market at a higher
rate. In this case the investor loses the premium paid (i.e Rs 25), which shall
be the profit earned by the seller of the Put option.
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Q.How are options different from futures? |
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The significant differences in Futures and Options are as under: Futures are agreements/contracts
to buy or sell specified quantity of the underlying assets at a price agreed upon
by the buyer & seller, on or before a specified time. Both the buyer and seller
are obligated to buy/sell the underlying asset. options the buyer enjoys the right
& not the obligation, to buy or sell the underlying asset. Futures Contracts have
symmetric risk profile for both the buyer as well as the seller, whereas options
have asymmetric risk profile. In case of Options, for a buyer (or holder of the
option), the downside is limited to the premium (option price) he has paid while
the profits may be unlimited. For a seller or writer of an option, however, the
downside is unlimited while profits are limited to the premium he has received from
the buyer. The Futures contracts prices are affected mainly by the prices of the
underlying asset. The prices of options are however; affected by prices of the underlying
asset, time remaining for expiry of the contract, interest rate & volatility of
the underlying asset. |
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Q.Explain 'In the Money', 'At the Money' & 'Out of the money' Options? |
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An option is said to be 'at-the-money', when the option's strike price is equal
to the underlying asset price. This is true for both puts and calls. A call option
is said to be 'in the money' when the strike price of the option is less than the
underlying asset price. For example, a Stock A' call option with strike of 3900
is 'in-the-money', when the spot price of Stock 'A' is at 4100 as the call option
has a positive exercise value. The call option holder has the right to buy the Stock
'A' at 3900, no matter by what amount the spot price exceeded the strike price.
With the spot price at 4100, selling Stock 'A' at this higher price, one can make
a profit. On the other hand, a call option is out-of-the-money when the strike price
is greater than the underlying asset price. Using the earlier example of Sensex
call option, if the Sensex falls to 3700, the call option no longer has positive
exercise value. The call holder will not exercise the option to buy Sensex at 3900
when the current price is at 3700 and allow his 'option' right to lapse. Put option
is in-the-money when the strike price of the option is greater than the spot price
of the underlying asset. For example, a Stock 'A' put at strike of 4400 is in-the-money
when the spot price of Stock 'A' is at 4100. When this is the case, the put option
has value because the put option holder can sell the Stock 'A' at 4400, an amount
greater than the current Stock 'A' of 4100. Likewise, a put option is out-of-the-money
when the strike price is less than the spot price of underlying asset. In the above
example, the buyer of Stock 'A' put option won't exercise the option when the spot
is at 4800. The put no longer has positive exercise value and therefore in this
scenario, the put option holder will allow his 'option' right to lapse. |
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Q.What are Covered & Naked Calls? |
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A call option position that is covered by an opposite position in the underlying
instrument (for example shares, commodities etc), is called a covered call. Writing
covered calls involves writing call options when the shares that might have to be
delivered (if option holder exercises his right to buy), are already owned. E.g.
A writer writes a call on Reliance and at the same time holds shares of Reliance
so that if the call is exercised by the buyer, he can deliver the stock. Covered
calls are far less risky than naked calls (where there is no opposite position in
the underlying), since the worst that can happen is that the investor is required
to sell shares already owned at below their market value. When a physical delivery
uncovered/ naked call is assigned on exercise, the writer will have to purchase
the underlying asset to meet his call obligation and his loss will be the excess
of the purchase price over the exercise price of the call reduced by the premium
received for writing the call. |
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Q.What is the Intrinsic Value of an option? |
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The intrinsic value of an option is defined as the amount, by which an option is
in-the-money, or the immediate exercise value of the option when the underlying
position is marked-to-market. For a call option: Intrinsic Value = Spot Price -
Strike Price For a put option: Intrinsic Value = Strike Price - Spot Price The intrinsic
value of an option must be a positive number or 0. It can't be negative. For a call
option, the strike price must be less than the price of the underlying asset for
the call to have an intrinsic value greater than 0. For a put option, the strike
price must be greater than the underlying asset price for it to have intrinsic value. |
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Q.Explain Time Value with reference to Options? |
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Time value is the amount option buyers are willing to pay for the possibility that
the option may become profitable prior to expiration due to favorable change in
the price of the underlying. An option loses its time value as its expiration date
nears. At expiration an option is worth only its intrinsic value. Time value cannot
be negative. |
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Q.What are the factors that affect the value of an option (premium)? |
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There are two types of factors that affect the value of the option premium: Quantifiable
Factors: a. underlying stock price b. the strike price of the option c. the volatility
of the underlying stock d. the time to expiration and e. the risk free interest
rate Non Quantifiable Factors: Market participants' varying estimates of the underlying
asset's future volatility Individuals' varying estimates of future performance of
the underlying asset, based on fundamental or technical analysis The effect of supply
& demand- both in the options marketplace and in the market for the underlying asset
The "depth" of the market for that option - the number of transactions and the contract's
trading volume on any given day. |
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Q.What are different pricing models for options? |
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The theoretical option pricing models are used by option traders for calculating
the fair value of an option on the basis of the earlier mentioned influencing factors.
The two most popular option pricing models are: Black Scholes Model which assumes
that percentage change in the price of underlying follows a lognormal distribution.
Binomial Model which assumes that percentage change in price of the underlying follows
a binomial distribution. |
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Q.Who decides on the premium paid on options & how is it calculated? |
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Options Premium is not fixed by the Exchange. The fair value/ theoretical price
of an option can be known with the help of pricing models & then depending on market
conditions the price is determined by competitive bids & offers in the trading environment.
An option's premium / price is the sum of Intrinsic value & time value (explained
above). If the price of the underlying stock is held constant, the intrinsic value
portion of an option premium will remain constant as well. Therefore, any change
in the price of the option will be entirely due to a change in the option's time
value. The time value component of the option premium can change in response to
a change in the volatility of the underlying, the time to expiry, interest rate
fluctuations, dividend payments & to the immediate effect of supply & demand for
both the underlying & its option |
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Q.Explain the Option Greeks? |
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The price of an Option depends on certain factors like price and volatility of the
underlying, time to expiry etc. The option Greeks are the tools that measure the
sensitivity of the option price to the above-mentioned factors. They are often used
by professional traders for trading & managing the risk of large positions in options
& stocks. These Option Greeks are: Delta: is the option Greek that measures the
estimated change in option premium/price for a change in the price of the underlying.
Gamma: measures the estimated change in the Delta of an option for a change in the
price of the underlying Vega: measures the estimated change in the option price
for a change in the volatility of the underlying. Theta: measures the estimated
change in the option price for a change in the time to option expiry. Rho: measures
the estimated change in the option price for a change in the risk free interest
rates. |
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Q.What is an Option Calculator? |
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An option calculator is a tool to calculate the price of an Option on the basis
of various influencing factors like the price of the underlying and its volatility,
time to expiry, risk free interest rate etc. It also helps the user to understand
how a change in any one of the factors or more, will affect the option price. |
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Q.Why should I invest in Options? What do options offer me? |
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Besides offering flexibility to the buyer in the form of right to buy or sell, the
major advantage of options is their versatility. They can be as conservative or
as speculative as one's investment strategy dictates. Some of the benefits of Options
are as under: a. High leverage as by investing small amount of capital (in the form
of premium), one can take exposure in the underlying asset of much greater value.
b. Pre-known maximum Risk for an option buyer c. Large profit potential & limited
risk for Option buyer3 d. One can protect his equity portfolio from a decline in
the market by way of buying a protective put wherein one buys puts against an existing
stock position this option position can supply the insurance needed to overcome
the uncertainty of the marketplace. Hence, by paying a relatively small premium
(compared to the market value of the stock), an investor knows that no matter how
far the stock drops, it can be sold at the strike price of the Put anytime until
the Put expires. E.g. An investor holding 1 share of Stock 'A' at a market price
of Rs 3800 thinks that the stock is over-valued and therefore decides to buy a Put
option' at a strike price of Rs. 3800/- by paying a premium of Rs 200/- If the market
price of Stock 'A' comes down to Rs 3000/, he can still sell it at Rs 3800/- by
exercising his put option. Thus by paying a premium of Rs. 200, he insured his position
in the underlying stock. |
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Q.How can I use options? |
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If you anticipate a certain directional movement in the price of a stock, the right
to buy or sell that stock at a predetermined price, for a specific duration of time
can offer an attractive investment opportunity. The decision as to what type of
option to buy is dependent on whether your outlook for the respective security is
positive (bullish) or negative (bearish). If your outlook is positive, buying a
call option creates the opportunity to share in the upside potential of a stock
without having to risk more than a fraction of its market value (premium paid).
Conversely, if you anticipate downward movement, buying a put option will enable
you to protect against downside risk without limiting profit potential. Purchasing
options offer you the ability to position yourself according to your market expectations
in a manner such that you can both profit and protect hedge) with limited risk. |
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Q.Once I have bought an option & paid the premium for it, how does it get settled? |
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Option is a contract, which has a market value like any other tradable commodity.
Once an option is bought there are following alternatives that an option holder
has: You can sell an option of the same series as the one you had bought & close
out /square off your position in that option at any time on or before its expiration
date. You can exercise the option on the expiration day in case of European Option
or; on or before the expiration day in case of an American option. In case the option
is 'Out of Money' at the time of expiry, one will not exercise his option, not being
profitable and therefore, it will lapse or expire worthless. |
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Q.What are the risks for an Option buyer? |
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The risk/ loss of an option buyer is limited to the premium that he has paid |
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Q.What are the risks for an Option writer? |
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The risk of an Options Writer is unlimited whereas his gains are limited to the
Premiums earned. When an uncovered call is exercised for physical delivery, the
call writer will have to purchase the underlying asset and his loss will be the
excess of the purchase price over the exercise price of the call reduced by the
premium received for writing the call. The writer of a put option bears a risk of
loss if the value of the underlying asset declines below the exercise price. The
writer of a put bears the risk of a decline in the price of the underlying asset
potentially to zero. When put option holder exercises his option in the falling
market, the put writer is bound to purchase the underlying at strike price, even
if the underlying is otherwise available in the spot at lower price. |
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Q.How can an option writer take care of his risk? |
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Option writing is a specialized job, which is suitable only for the knowledgeable
investor who understands the risks, has the financial capacity and has sufficient
liquid assets to meet applicable margin requirements. The risk of being an option
writer may be reduced by the purchase of other options on the same underlying asset
and thereby assuming a spread position or by acquiring other types of hedging positions
in the options/ futures and other correlated markets. |
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Q.Who can write options in Indian Derivatives market? |
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In the Indian Derivatives market, SEBI has not created any particular category of
options writers. Any market participant can write options. However, the margin requirements
are stringent for options writers. |
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Q.What are Stock Index Options? |
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The Stock Index Options are options where the underlying asset is a Stock Index
e.g. Options on 'Sensex'. Index Options were first introduced by Chicago Board of
Options Exchange (CBOE) in 1983 on its Index 'S&P 100'. As opposed to options on
Individual stocks, index options give an investor the right to buy or sell the value
of an index which represents group of stocks. |
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Q.What are the uses of Index Options? |
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Index options enable investors to gain exposure to a broad market, with one trading
decision and frequently with one transaction. To obtain the same level of diversification
using individual stocks or individual equity options, numerous decisions and trades
would be necessary. Since, broad exposure can be gained with one trade, transaction
cost is also reduced by using Index Options. As a percentage of the underlying value,
premiums of Index options are usually lower than those of equity options as equity
options are more volatile than the Index. |
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Q.How will introduction of options in specific stocks benefit an investor ? |
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Options can offer an investor the flexibility one needs for countless investment
situations. An investor can create hedging position or an entirely speculative one,
through various strategies that reflect his tolerance for risk. Investors of equity
stock options will enjoy more leverage than their counterparts who invest in the
underlying stock market itself in form of greater exposure by paying a small amount
as premium. Investors can also use options in specific stocks to hedge their holding
positions in the underlying (i.e. long in the stock itself), by buying a Protective
Put. Thus they will insure their portfolio of equity stocks by paying premium. ESOPs
(Employees' stock options) have become a popular compensation tool with more and
more companies offering the same to their employees. ESOPs are subject to lock in
periods, which could reduce capital gains in falling markets - Derivatives can help
arrest that loss |
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Q.How are Weekly Options different from Monthly Options? |
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Weekly Options differ mainly in terms of maturity period. Currently Monthly Options
have maturity of 1 month, 2 months or 3 months. As 1 month options expire, another
options series get generated. In case of Weekly Options, the maturity will be either
1 week or 2 weeks. Monthly Options Series will expire on last Thursday of every
month. In case of Weekly Options, series will expire on Friday of every week. |
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Q.What will happen if expiry day is a Trading Holiday? |
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If the expiry day of Weekly Options fall on a trading Holiday, then the expiry (as
per SEBI guidelines) will be on the previous trading day. If that previous trading
day is the last Thursday of the month (i.e. on the same day, the Monthly series
is expiring) then the relevant Weekly series expiring on that day will not be generated. |
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Q.What are the Similarities between Monthly and Weekly Options? |
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The parameters viz. Underlying, Contract Multiplier, Tick size, Price Quotation,
Trading Hours, Strike price Intervals of the Weekly Options will remain exactly
the same as that of Monthly Options. |
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Q.What are the profits and losses in case of a futures position? |
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The profits and losses would depend upon the difference between the price at which
the position is opened and the price at which it is closed. Let us take some examples.
Example 1 a. Position - Long - Buy June Sensex Futures @ 4,800 b. Payoff b1. Profit
- if the futures price goes up b2. Loss - if the futures price goes down c. Calculation
- The profit or loss would be equal to fifty times the difference in the two rates.
d. If June Sensex Futures is sold @ 4,900 there would be a profit of 100 points
which is equal to Rs. 5,000 (100 X 50). e. However if the June Sensex However if
the June Sensex Futures is sold @ 4,750, there would be a loss of 50 points which
is equal to Rs. 2,500 (50 X50) Example 2 a. Position - Short Sell June Sensex Futures
@ 4,600 b. Payoff b1. Profit - if the futures price goes down b2. Loss - if the
futures price goes up c. Calculation - The profit or loss would be equal to fifty
times the difference in the two rates. c1. If June Sensex Futures is bought @ 4,800
there would be a loss of 200 points which is equal to Rs. 10,000 (200 X 50). c2.
However if the June Sensex Futures is bought @ 4,500, there would be a profit of
100 points which is equal to Rs. 5,000 (100 X50). |
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Q.What happens to the profit or loss due to daily settlement? |
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In case the position is not closed the same day, the daily settlement would alter
the cash flows depending on the settlement price fixed by the exchange every day.
However the net total of all the flows every day would always be equal to the profit
or loss calculated above. Profit or loss would only depend upon the opening and
closing price of the position, irrespective of how the rates have moved in the intervening
days. Lets take the illustration given in example 1 where a long position is opened
at 4,800 and closed at 4,900 resulting in a profit of 100 points or Rs. 5,000. Lets
assume that the position was closed on the fifth day from the day it was taken.
Lets also assume three different series of closing settlement prices on these days
and look at the resultant cash flows. |
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Q.How does the Initial Margin affect the above profit or loss? |
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The initial margin is only a security provided by the client through the clearing
member to the exchange. It can be withdrawn in full after the position is closed.
Therefore it does not affect the above calculation of profit or loss. However there
would may be a funding cost / transaction cost in providing the security. This cost
must be added to your total transaction costs to arrive at the true picture. Other
items in transaction costs would include brokerage, stamp duty etc. |
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Q.What is a spread position? |
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A calendar spread is created by taking simultaneously two positions : 1. A long
position in a futures series expiring in any calendar month 2. A short position
in the same futures as 1 aboFve but for a series expiring in any month other than
the 1 above. Examples of Calendar Spreads 1. Long June Sensex Futures Short July
Sensex Futures 2. Short July Sensex Futures Long August Sensex Futures A spread
position must be closed by reversing both the legs simultaneously. The reversal
of 1 above would be a sale of June Sensex Futures while simultaneously buying the
July Sensex Futures. |
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Q.How are spread rates calculated ? Please illustrate with an example.? |
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The profit or loss in case of spreads depends only upon the difference between the
rates for the two different calendar months. The real position is only of the differential
- irrespective of the two rates. |