NISHANT KUMAR

NISHANT KUMAR
ASSISTANT PROFESSOR
ASSISTANT PROFESSOR
ARKA JAIN
ARKA JAIN UNIVERSITY
UNIVERSITY
 EQUITY DERIVATIVES
 Equity derivatives are financial products/instruments whose value is derived from the
increase or decrease in the underlying assets, i.e., equity stocks or shares in the secondary
market.

 Equity derivatives are agreements between a buyer and a seller to either buy or sell the
underlying asset in the future at a specific price. They can either hold the right or the
obligation to trade the asset at the expiry of the contract.
 To trade an equity derivative, the investor needs to be very knowledgeable about the
product and the industry, as derivatives allow an investor to speculate and make large
gains or losses.
 Investing in equity derivatives comes with a number of risks, such as interest rate risk,
currency risk, and commodity price risk.

Types of Equity Derivatives

 Options
Options give the holder of the option the right, but not the obligation, to buy (call option)
or sell (put option) a particular stock at a given price. The contract provides information
about the given price, which is called the strike price, the expiration date, and the terms
and conditions of the contract. An options contract is best suited for investors who want
to protect or hedge themselves from increases or decreases in prices in the future.
 Warrants
Just like options, warrants give the holder the right, but not the obligation, to buy (call
warrants) or sell (put warrants) the underlying investment in the future. The company
issues the warrants to the holders of its bonds or preferred stock as an incentive to
buying the issue.
 Futures
Futures contracts are traded on the secondary market. In a futures contract, the buyer
agrees to buy the asset on a future date and at a specific price. Unlike options, in a
futures contract, the buyer has an obligation to buy the asset. In simple terms, the buyer
must buy the asset on the date mentioned on the contract at the specified price.
NISHANT KUMAR
ASSISTANT PROFESSOR
ARKA JAIN UNIVERSITY
  Forwards
Like a futures contract, a forward contract specifies the future date and price that the buyer
should purchase the underlying asset from the seller. The only difference is that a forward
contract takes place in the private market and terms are tailored to the parties to the contract.

Risks Associated With Derivatives

Interest rate risk

An investor expecting the interest rates to rise in the future and enters into a derivative contract
to pay a fixed interest rate in the future can face a risk of interest rates going down. By paying a
fixed rate of interest, they may be locked into paying more money rather than taking a loan in
the future at a lower rate.

Currency risk

Importers and exporters enter into derivative contracts to hedge themselves with fluctuating
currency rates. The risk associated with this is if the currency falls or goes in the opposite
direction compared to what the investor is expecting.

EQUITY FUTURES

In finance, a futures contract (sometimes called a futures) is a standardized legal contract to

buy or sell something at a predetermined price for delivery at a specified time in the future,
between parties not yet known to each other. The asset transacted is usually a
commodity or financial instrument. The predetermined price of the contract is known as the
forward price. The specified time in the future when delivery and payment occur is known as
the delivery date. Because it derives its value from the value of the underlying

NIFTY FUTURES
As you know the Nifty Index is a basket of 50 stocks. These stocks are selected to represent a
wide section of the India economic sectors. This makes Nifty a good representative of the
broader economic activity in India. This naturally means if the general economic activity is
going up or at least expected to go up then Nifty’s value also goes up, and vice versa. This also
makes trading Nifty Futures a much better choice as compared to single stock futures.

NISHANT KUMAR
ASSISTANT PROFESSOR
ARKA JAIN UNIVERSITY
 There are many reasons for this, here are some –

1. It is diversified – At times taking a directional call on a single stock can be a tough task, this is
mainly from the risk perceptive. For example, let us just say I decide to buy Infosys Limited
with a hope that the quarterly results would be good. In case the results don’t impress the
markets, then obviously the stock would take a knock and so would my P&L. Nifty futures, on
the other hand, has a diversified portfolio of 50 stocks. As it is a portfolio of stocks, the
movement of the Index does not really depend on a single stock.

2. Hard to manipulate – The movement in Nifty is a response to the collective movement in the
top 50 companies in India (by market capitalization). Hence there is virtually no scope to
manipulate the Nifty index. However the same cannot be said about individual stocks
(remember Satyam, DHCL, Bhushan Steel etc)

3. Highly Liquid (easy fills, less slippage) – We discussed liquidity earlier in the chapter. Since
the Nifty is so highly liquid you can literally transact any quantity of Nifty without worrying
about losing money on the impact cost. Besides, there is so much liquidity that you can literally
transact any number of contracts that you wish.

4. Lesser margins – Nifty futures require much lesser margins as compared to individual stock
futures. To give you a perspective Nifty’s margin requirement varies between 12-15%, however
individual stock margins can go as high as 45-60%.

5. Broader economic call – Trading the Nifty futures requires one to take a broad-based economic
call rather than company specify directional calls. From my experience, doing the former is
much easier than the latter.

6. Application of Technical Analysis – Technical Analysis works best on liquid instruments.

Liquid stocks are hard to manipulate, hence they usually move based on the demand-supply
dynamics of the market, which obviously is what a TA mainly relies on

7. Less volatile – Nifty futures are less volatile compared to individual stock futures. To give you
perspective the Nifty futures has an annualized volatility of around 16-17%, whereas individual
stocks like say Infosys has annualized volatility of upwards of 30%.

NISHANT KUMAR
ASSISTANT PROFESSOR
ARKA JAIN UNIVERSITY
 FEATURES OF FUTURES CONTRACT

Standardized Contracts –The futures contract have a proper format and it does not vary stock
to stock, which makes them convenient to trade. In the futures contract, the parameters are
standardized. They are not negotiable.

Futures Contracts are tradable – The futures contract is easily tradable. If I get into an
agreement with a counterparty, unlike a forward contract, I need not honour the contract until
the end (also called the expiry day). At any point in time, if my view changes, I can transfer the
contract to someone else and get out of the agreement.

Futures Market is highly regulated – A regulatory authority highly regulates the Futures
markets (or, for that matter, the entire financial derivatives market). In India, the
regulatory authority is “Securities and Exchange Board of India (SEBI)”. This means there is
always someone overlooking the activities in the market and making sure things run smoothly.
This also means default on a futures agreement is hardly a possibility.

Futures Contracts are time-bound – All the futures contracts available to you have different
time frames. In the example from the previous chapter, ABC jewellers had a certain view on
gold, keeping 3 months in perspective. If ABC were to do a similar agreement in the futures
market, contracts would be available to them in the 1 month, 2 months, and 3-month time frame.
The time frame upto which the contract lasts is called ‘The expiry of the contract.

Cash settled – Most of the futures contracts are cash-settled. This means only the cash
differential is paid out. There is no worry of moving the physical asset from one place to
another. The cash settlement is overseen by the regulatory authority ensuring total transparency
in the cash settlement process.

NISHANT KUMAR
ASSISTANT PROFESSOR
ARKA JAIN UNIVERSITY
 OPTIONS:

A financial instrument that is based on the value of underlying securities, such as stocks, is
referred to as an option. Depending on the kind of contract they possess, an options contract
gives the buyer the chance to buy or sell the underlying asset. In contrast to futures, if the
holder decides not to buy or sell the asset, they are not obligated to do so.

There will be a set deadline by which the option holder must exercise their right under each
options contract. The striking price is the amount that is specified on an option. Online or
retail brokers are frequently used to buy and sell options.

Points to remember

1. Financial derivatives known as options provide buyers the option, but not the
responsibility, to buy or sell an underlying asset at a predetermined price and date.

2. A variety of option techniques for hedging, earning an income, or engaging in speculation

are based on call options and put options.

3. Options trading, which uses simple to complex tactics, can be utilised for both hedging and
speculation.

4. Despite the fact that there are numerous ways to earn from options, investors should
carefully consider the dangers.

Types of Options

 Calls

A call option gives the holder the right, but not the obligation, to buy the underlying security
at the strike price on or before expiration. A call option will therefore become more valuable
as the underlying security rises in price.

A long call can be used to speculate on the price of the underlying rising, since it has
unlimited upside potential but the maximum loss is the premium (price) paid for the option.

NISHANT KUMAR
ASSISTANT PROFESSOR
ARKA JAIN UNIVERSITY
  Puts

Opposite to call options, a put gives the holder the right, but not the obligation, to instead
sell the underlying stock at the strike price on or before expiration. A long put, therefore, is a
short position in the underlying security, since the put gains value as the underlying's price
falls.

 At-the-money (ATM) - an option whose strike price is exactly that of where the
underlying is trading.
 In-the-money (ITM) - For a call, the strike price of an ITM option will be below the
current price of the underlying; for a put, above the current price.
 Out-of-the-money (OTM) - For a call, the strike price of an OTM option will be
above the current price of the underlying; for a put, below the current price.
 Premium - the price paid for an option in the market
 Strike price - the price at which you can buy or sell the underlying, also known as the
exercise price.
 Underlying - the security upon which the option is based
 Implied volatility (IV) - the volatility of the underlying (how quickly and severely it
moves), as revealed by market prices
 Exercise - when an options contract owner exercises the right to buy or sell at the
strike price. The seller is then said to be assigned.
 Expiration - the date at which the options contract expires, or ceases to exist. OTM
options will expire worthless.

NISHANT KUMAR
ASSISTANT PROFESSOR
ARKA JAIN UNIVERSITY