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Equity
& Derivatives |
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What
are Derivatives? |
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What
is a Futures Contract? |
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What
is an Option contract? |
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What
are Index Futures and Index Option Contracts?
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Why
mini derivative contract? |
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Why
longer dated index options? |
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What
is Bond Index? |
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What
is Volatility Index? |
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| 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,
share, 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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| What
is a Futures Contract? |
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Futures Contract means a
legally binding agreement to buy or sell the
underlying security on a future date. Future
contracts are the organized/standardized contracts
in terms of quantity, quality (in case of
commodities), delivery time and place for
settlement on any date in future. The contract
expires on a pre-specified date which is called
the expiry date of the contract. On expiry,
futures can be settled by delivery of the
underlying asset or cash. Cash settlement
enables the settlement of obligations arising
out of the future/option contract in cash.
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| What
is an Option contract? |
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Options Contract is a type
of Derivatives Contract which gives the buyer/holder
of the contract the right (but not the obligation)
to buy/sell the underlying asset at a predetermined
price within or at end of a specified period.
The buyer / holder of the option purchases
the right from the seller/writer for a consideration
which is called the premium. The seller/writer
of an option is obligated to settle the option
as per the terms of the contract when the
buyer/holder exercises his right. The underlying
asset could include securities, an index of
prices of securities etc.
Under Securities Contracts (Regulations) Act,1956
options on securities has been defined as
"option in securities" meaning a
contract for the purchase or sale of a right
to buy or sell, or a right to buy and sell,
securities in future, and includes a teji,
a mandi, a teji mandi, a galli, a put, a call
or a put and call in securities.
An Option to buy is called Call option and
option to sell is called Put option. Further,
if an option that is exercisable on or before
the expiry date is called American option
and one that is exercisable only on expiry
date, is called European option. The price
at which the option is to be exercised is
called Strike price or Exercise price.
Therefore, in the case of American options
the buyer has the right to exercise the option
at anytime on or before the expiry date. This
request for exercise is submitted to the Exchange,
which randomly assigns the exercise request
to the sellers of the options, who are obligated
to settle the terms of the contract within
a specified time frame.
As in the case of futures contracts, option
contracts can be also be settled by delivery
of the underlying asset or cash. However,
unlike futures cash settlement in option contract
entails paying/receiving the difference between
the strike price/exercise price and the price
of the underlying asset either at the time
of expiry of the contract or at the time of
exercise / assignment of the option contract.
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| What
are Index Futures and Index Option Contracts? |
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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.
In the beginning futures and options were
permitted only on S&P Nifty and BSE Sensex.
Subsequently, sectoral indices were also permitted
for derivatives trading subject to fulfilling
the eligibility criteria. Derivative contracts
may be permitted on an index if 80% of the
index constituents are individually eligible
for derivatives trading. However, no single
ineligible stock in the index shall have a
weightage of more than 5% in the index. The
index is required to fulfill the eligibility
criteria even after derivatives trading on
the index has begun. If the index does not
fulfill the criteria for 3 consecutive months,
then derivative contracts on such index would
be discontinued.
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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| Why
mini derivative contract? |
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The
minimum contract size for the mini derivative
contract on Index (Sensex and Nifty) is Rs.
1 lakh at the time of its introduction in
the market. The lower minimum contract size
means that smaller investors are able to hedge
their portfolio using these contracts with
a lower capital outlay. This means a better
hedge for portfolio, and also results in more
liquidity in the market. |
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| Why
longer dated index options? |
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Longer dated derivatives
products are useful for those investors who
want to have a long term hedge or long term
exposure in derivative market. The premiums
for longer term derivatives products are higher
than for standard options in the same stock
because the increased expiration date gives
the underlying asset more time to make a substantial
move and for the investor to make a healthy
profit. Presently, longer dated options on
Sensex and Nifty with tenure of upto 3 years
are available for the investors. |
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| What
is Bond Index? |
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A bond index is used to measure
the performance of bond markets. The index
is used as a benchmark against which investment
managers measure their performance. It is
also used as a measure to compare the performance
of different asset classes. The government
bond market is the most liquid segment of
the bond market. |
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| What is Volatility
Index? |
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Volatility Index is a measure
of expected stock market volatility, over
a specified time period, conveyed by the prices
of stock / index options. It depicts the collective
sentiment of the market on the implied future
volatility |
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