Explains futures and options...

1. A
Presentation
On
Futures and Options
Submitted in Partial Fulfillment of Degree
of
M.B.A. INSURANCE
(Asset Management)
Submitted By: SubmittedTo:
Abhishek Bora(448) Prof. Dr. Rituparna Das
Rimzim Kachhawaha(459) National Law University, Jodhpur
Surendra Sharma (461)
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2. FUTURES AND OPTIONS
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3. Derivative
 Derivatives are contracts, agreements
between two parties: a buyer and a seller.
Buyer Seller
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4. Derivative
 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.
 The instrument requires little or no
investment at the inception of the contract.
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5. Derivative Markets
The over-the-counter (OTC) market
The exchanges
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6. OTC advantage
 the terms of a contract do not have to be those
specified by an exchange.
 Market participants are free to negotiate any
mutually attractive deal.
OTC disadvantage
 there is usually some credit risk in an over-the-
counter trade.
 Less controlled.
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7. Futures Contract
 A futures contract is an agreement between
two parties, a buyer and a seller, to exchange
an asset at a later date for a price agreed to in
advance, when the contract is first entered
into.
 We call this price the futures price.
 Trades on a futures exchange.
 To make trading possible, the exchange
specifies certain standardized features of the
contract.
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8. Role of future exchange:
 it acts as intermediary
 it mitigate the risk of default by either party in the
intervening period
 For this, both parties put up an initial amount of
cash called as margin
 The difference between the prior agreed-upon price
and the actual daily futures price is settled on a daily
basis. Also called asVariation or Mark-to-Market
Margin.
 If the margin account goes below a certain value set
by the Exchange, then a margin call is made and the
account owner must replenish the margin account.
This process is known as "marking to market“.
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9. Example:
IBM enters into a future contract with a broker
for delivery of 10,000 shares of Google stock
in three months at its current price of $110
per share. => $1,100,000
IBM has received the right to receive 10,000
shares in three months and incurred an
obligation to pay $110 per share at that time.
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10. Options
 An option gives the buyer the right, but not
the obligation, to buy/sell the underlying at a
later date for a price agreed to in advance,
when the contract is first entered into.
 We call this price the strike/exercise price.
 The option buyer pays the seller a sum of
money called the option price or premium.
 Trades OTC or on an exchange.
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11. Example:
IBM enters into a contract with a broker for an
option (right) to purchase 10,000 shares of
Google shares at its current price of $110 per
share.
The broker charges $3,000 for holding the
contract open for two weeks at a set price.
IBM has received the right, but not the
obligation to purchase this stock at $110
within the next two weeks.
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12. Types of options
 Call option: an option to buy the underlying
at the strike price
 Put option: an option to sell the underlying at
the strike price
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13. Example: (Call Option)
A company enters into a call option contract on
January 2, 2007, with Baird Investment Co., which
gives it the option to purchase 1,000 shares of
Google stock at $100 per share. On January 2nd, the
Google shares are trading at $100 per share.The
option expires on April 30, 2007.The company
purchases the call option for $400.
If the price of Google stock increases above $100, the
company can exercise this option and purchase the
shares for $100 per share.
If Google’s stock never increases above $100 per
share, the call option is worthless.
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14. Example: (Put Option)
 An investor buys one 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.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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15. Uses of derivatives
 Derivatives can be used by individuals,
corporations, financial institutions, and
governments to reduce a risk exposure or to
increase a risk exposure.
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16. Traders of derivatives
 Hedgers
 Speculators
 Arbitrageurs
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17. Hedgers
 Hedgers use derivatives to reduce the risk that they face from
potential future movements in a market variable.
 Example:
Heartland –Large producer of potatoes
McDonald –Large consumer of potatoes (French fries)
 The objective is not to gamble on the outcome or to profit
but to lock in a price at which both of them obtain an
acceptable profit.
 Hedge against changes in the price of fuel, interest rates,
exchange rates etc.
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18. Speculators
Speculators use them to bet on the future direction of a
market variable. Example:
 It is May.
 The price of Nortel Networks stock is $28.30.
 A December call option on Nortel stock with a $29 strike
price is selling for $2.80.
 A speculator thinks the stock price will rise.
 To make a profit, the speculator might:
 Buy, say, 100 shares of Nortel stock for $2,830.
 Buy 1,000 options for $2,800
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19.  Suppose the speculator is right. The stock
price rises to $33 by December.
Strategy Profit
Buy the stock (33-28.30)x100
=$470
Buy options (33-29)x1000-2800
=$1200
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20.  Suppose the speculator is wrong. The stock
price falls to $27 by December.
Strategy Loss
Buy the stock (28.30-27)x100
=$130
Buy options $2800
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21. Conclusion:
Over the years, derivatives have attracted the
investors as an important instrument whether it be
for purpose of hedging or speculation and there
has been a significant increase in investments in
them.
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22. THANKYOU
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