Download NISM Work Book Guides free, Simplified Study material pdf format. Equity Derivatives (27 Pages) · Securities Operations (32 pages) · Depository. NISM Equity Derivatives Study Material. 1. portal7.info offers Online Model Exams for NISM, NCFM & BCFM Exams. Register Now!. NISM-Series-VIII: Equity Derivatives Ce. NISM-Series-VIII: To study the history of derivatives. To explain the II: Equity Derivatives Certification Examination.
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Going from 10 stocks to 20 stocks gives a sharp reduction in risk. Going from 50 stocks to stocks gives very little reduction in risk. Going beyond stocks gives almost zero reduction in risk. Hence, there is little to gain by diversifying beyond a point. Stocks in the index are chosen based on certain pre-determined qualitative and quantitative parameters, laid down by the Index Construction Managers.
Once a stock satisfies the eligibility criterion, it is entitled for inclusion in the index. Generally, final 21 decision of inclusion or removal of a security from the index is taken by a specialized committee known as Index Committee. Index Maintenance and Index Revision Maintenance and Revision of the indices is done with the help of various mathematical formulae. In order to keep the index comparable across time, the index needs to take into account corporate actions such as stock splits, share issuance, dividends and restructuring events.
While index maintenance issue gets triggered by a corporate action, index revision is an unabated phenomenon to ensure that index captures the most vibrant lot of securities in the market and continues to correctly reflect the market.
However, few applications on index have emerged in the investment field. Few of the applications are explained below.
Index Funds These types of funds invest in a specific index with an objective to generate returns equivalent to the return on index. These funds invest in index stocks in the proportions in which these stocks exist in the index. For instance, Sensex index fund would get the similar returns as that of Sensex index.
Since Sensex has 30 shares, the fund will also invest in these 30 companies in the proportion in which they exist in the Sensex. Index Derivatives Index Derivatives are derivative contracts which have the index as the underlying asset. Index Options and Index Futures are the most popular derivative contracts worldwide. Index derivatives are useful as a tool to hedge against the market risk.
They have number of advantages over other mutual funds as they can be bought and sold on the exchange. Since, ETFs are traded on exchanges intraday transaction is possible. Further, ETFs can be used as basket trading in terms of the smaller denomination and low transaction cost. Forwards are widely used in commodities, foreign exchange, equity and interest rate markets. Let us understand with the help of an example.
What is the basic difference between cash market and forwards? Assume on March 9, you wanted to download gold from a goldsmith. The market price for gold on March 9, was Rs. You paid him Rs. This is a cash market transaction at a price in this case Rs. Now suppose you do not want to download gold on March 9, , but only after 1 month. Goldsmith quotes you Rs. You agree to the forward price for 10 grams of gold and go away. Here, in this example, you have bought forward or you are long forward, whereas the goldsmith has sold forwards or short forwards.
There is no exchange of money or gold at this point of time. After 1 month, you come back to the goldsmith pay him Rs. This is a forward, where both the parties are obliged to go through with the contract irrespective of the value of the underlying asset in this case gold at the point of delivery. Essential features of a forward are: It is a contract between two parties Bilateral contract. All terms of the contract like price, quantity and quality of underlying, delivery terms like place, settlement procedure etc.
In other words, Forwards are bilateral over-the-counter OTC transactions where the terms of the contract, such as price, quantity, quality, time and place are negotiated between two parties to the contract.
Any alteration in the terms of the contract is possible if both parties agree to it. Corporations, traders and investing institutions extensively use OTC transactions to meet their specific requirements.
The essential idea of entering into a forward is to fix the price and thereby avoid the price risk. Similarly, if the spot price is 15, then you incur loss of Rs. Major limitations of forwards Liquidity Risk Liquidity is nothing but the ability of the market participants to download or sell the desired quantity of an underlying asset.
As forwards are tailor made contracts i. Forwards are not listed or traded on exchanges, which makes it difficult for other market participants to easily access these contracts or contracting parties. The tailor made contracts and their non- availability on exchanges creates illiquidity in the contracts. Therefore, it is very difficult for parties to exit from the forward contract before the contracts maturity. Counterparty risk Counterparty risk is the risk of an economic loss from the failure of counterparty to fulfil its contractual obligation.
For example, A and B enter into a bilateral agreement, where A will download kg of rice at Rs. Here, A is counterparty to B and vice versa. After 6 months, if price of rice is Rs. Similarly, if price of rice falls to Rs. Thus, a party to the contract may default on his obligation if there is incentive to default. This risk is also called default risk or credit risk. In addition to the illiquidity and counterparty risks, there are several issues like lack of transparency, settlement complications as it is to be done directly between the contracting parties.
Simple solution to all these issues lies in bringing these contracts to the centralized trading platform. This is what futures contracts do. Futures contract Futures markets were innovated to overcome the limitations of forwards. A futures contract is an agreement made through an organized exchange to download or sell a fixed amount of a commodity or a financial asset on a future date at an agreed price. Simply, futures are standardised forward contracts that are traded on an exchange.
The clearinghouse associated with the exchange guarantees settlement of these trades. A trader, who downloads futures contract, takes a long position and the one, who sells futures, takes a short position.
The words download and sell are figurative only because no money or underlying asset changes hand, between downloader and seller, when the deal is signed.
Features of futures contract In futures market, exchange decides all the contract terms of the contract other than price. Accordingly, futures contracts have following features: Contract between two parties through Exchange 24 Centralised trading platform i. Instrument type : Future Index 2. Underlying asset : Nifty 3. Expiry date : September 24, 4. Open price in Rs. High price in Rs. Low price in Rs. Closing price in Rs. No of contracts traded : 4,48, 9. Turnover in lakhs : 8,84, Underlying value in Rs.
This is the underlying value of Nifty on September 16, which is Futures Price: The price of the futures contract in the futures market. In India, Index options are European Strike price or Exercise price X : Strike price is the price per share for which the underlying security may be downloadd or sold by the option holder In the money ITM option: This option would give holder a positive cash flow, if it were exercised immediately.
A call option is said to be ITM, when spot price is higher than strike price. And, a put option is said to be ITM when spot price is lower than strike price. In our examples, call option is in the money. At the money ATM option: At the money option would lead to zero cash flow if it were exercised immediately. Therefore, for both call and put ATM options, strike price is equal to spot price.
Out of the money OTM option: Out of the money option is one with strike price worse than the spot price for the holder of option. In other words, this option would give the holder a negative cash flow if it were exercised immediately.
A call option is said to be OTM, when spot price is lower than strike price. And a put option is said to be OTM when spot price is higher than strike price. In our examples, put option is out of the money. Leverage An option downloader pays a relatively small premium for market exposure in relation to the contract value. This is known as leverage Leverage also has downside implications.
Similarly if the price of the underlying asset falls, the value of the call option decreases while the value of the put option increases. Strike Price If all the other factors remain constant but the strike price of option increases, intrinsic value of the call option will decrease and hence its value will also decrease. On the other hand, with all the other factors remain constant, increase in strike price of option increases the intrinsic value of the put option which in turn increases its option value.
Volatility It is the magnitude of movement in the underlying assets price, either up or down. It affects both call and put options in the same way. Higher the volatility of the underlying stock, higher the premium because there is a greater possibility that the option will move in-the-money during the life of the contract.
Time to expiration The effect of time to expiration on both call and put options is similar to that of volatility on option premiums. Generally, longer the maturity of the option greater is the uncertainty and hence the higher premiums. If all other factors affecting an options price remain same, the time value portion of an options premium will decrease with the passage of time. This is also known as time decay.
Options are known as wasting assets, due to this property where the time value gradually falls to zero. Unlike the binomial model, it does not rely on calculation by iteration.
This measures the sensitivity of the option value to a given small change in the price of the underlying asset.
It may also be seen as the speed with which an option moves with respect to price of the underlying asset. Delta for call option downloader is positive Delta for put option downloader is negative Gamma It measures change in delta with respect to change in price of the underlying asset. This is called a second derivative option with regard to price of the underlying asset. It is calculated as the ratio of change in delta for a unit change in market price of the underlying asset.
Theta is the change in option price given a one-day decrease in time to expiration. It is a measure of time decay. Theta is generally used to gain an idea of how time decay is affecting your option positions.
Rho measures the change in an options price per unit increase in the cost of funding the underlying. These are limited profit and limited loss positions. Further, these can be created either using calls as combination or puts as combination. This is also known as time spread or calendar spread. Diagonal spread Diagonal spread involves combination of options having same underlying but different expiries as well as different strikes.
Again, as the two legs in a spread are in different maturities, it is not possible to draw payoffs here as well. Straddle This strategy involves two options of same strike prices and same maturity. A long straddle position is created by downloading a call and a put option of same strike and same expiry whereas a short straddle is created by shorting a call and a put option of same strike and same expiry. Strangle This strategy is similar to straddle in outlook but different in implementation, aggression and cost.
Long Strangle As in case of straddle, the outlook here for the long strangle position is that the market will move substantially in either direction, but while in straddle, both options have same strike price, in case of a strangle, the strikes are different.
Also, both the options call and put in this case are out-of-the-money and hence the premium paid is low. Short Strangle This is exactly opposite to the long strangle with two out-of-the-money options call and put shorted.
Outlook, like short straddle, is that market will remain stable over the life of options Covered Call This strategy is used to generate extra income from existing holdings in the cash market. If an investor has bought shares and intends to hold them for some time, then he would like to earn some income on that asset, without selling it, thereby reducing his cost of acquisition. Protective Put Any investor, long in the cash market, always runs the risk of a fall in prices and thereby reduction of portfolio value and MTM losses.
A protective put payoff is similar to that of long call. This is called synthetic long call position. Its like downloading insurance to protect your existing portfolio against market falls. Downside in short straddle is unlimited if market moves significantly in either direction. To put a limit to this downside, along with short straddle, trader downloads one out of the money call and one out of the money put.
Resultantly, a position is created with pictorial pay-off, which looks like a butterfly and so this strategy is called Butterfly Spread. Butterfly spread can be created with only calls, only puts or combinations of both calls and puts. Here, we are creating this position with help of only calls. Both these trading systems provide a fully automated screen-based trading for index futures, index options, stock futures and stock options.
Entities in the trading system Broadly there are four entities in the trading system Trading Members Trading cum Clearing Members Professional Clearing Members and Participants Corporate Hierarchy In the Futures and options trading software, trading member will have a provision of defining the hierarchy amongst users of the system. This hierarchy comprises: Corporate Manager Branch Manager and Dealer Time conditions Day order: A Day order is an order which is valid for a single day on which it is entered.
If the order is not executed during the day, the trading system cancels the order automatically at the end of the day. An unmatched order will be immediately cancelled. Partial order match is possible in this order, and the unmatched portion of the order is cancelled immediately. The user has to specify this limit price while placing the order and the order gets executed only at this specified limit price or at a better price than that Market order: A market order is an order to download or sell a contract at the bid or offer price currently available in the market.
Price is not specified at the time of placing this order. The best download order will match with the best sell order. For order matching, the best download order is the one with highest price and the best sell order is the one with lowest price. Matching is essentially on the basis of security, its price, time and quantity.
Price Band There are no price bands applicable in the derivatives segment. Eligibility criteria of stocks a The stock shall be chosen from amongst the top stock in terms of average daily market capitalization and average daily traded value in the previous six months on a rolling basis.
For this purpose, a stocks quarter-sigma order size shall mean the order size in value terms required to cause a change in the stock price equal to one-quarter of a standard deviation. Since market wide position limit for a stock is computed at the end of every month, the Exchange shall ensure that stocks comply with this criterion before introduction of new contracts. Further, the market wide position limit which is in number of shares shall be valued taking the closing prices of stocks in the underlying cash market on the date of expiry of contract in the month.
Exit criteria for stocks in equity derivatives The criteria for retention of stock in equity derivatives segment are as under: a The stocks median quarter-sigma order size over last six months shall not be less than Rs. If a stock fails to meet these retention criteria for three months consecutively, then no fresh month contract shall be issued on that stock. However, the existing unexpired contracts may be permitted to trade till expiry and new strikes may also be introduced in the existing contract months.
Besides safeguarding securities, a custodian also keeps track of corporate actions on behalf of its clients. It also helps in: Maintaining a clients securities account Collecting the benefits or rights accruing to the client in respect of securities Keeping the client informed of the actions taken or to be taken by the issue of securities, having a bearing on the benefits or rights accruing to the client The capital adequacy requirements by a trading member comprises of the following two components viz.
An absolute minimum of Rs. Members with a funds pay-in obligation are required to have clear funds in their primary clearing account on or before Closing price of such underlying security on the day of exercise of the options contract.
Closing price of such underlying security or index on the last trading day of the options contract. Closing price of the futures contracts for the trading day.
The reference rate fixed by RBI. Statement of scrip-wise net deliveries to be made by the member. Statement of scrip-wise net deliveries to be received by the member.
Balance Sheet showing the net receivable or net payable by the Member. The Members has to deliver the Securities otherwise known as Securities pay-in to the Exchange as per the Statement of scrip-wise net deliveries downloaded by them. Margin Payment The initial and exposure margin is payable upfront by Clearing Members. Initial margins can be paid by members in the form of Cash, Bank Guarantee, Fixed Deposit Receipts and approved securities.
Members have to de-liver the shares by The securities pay in takes place through both Depositories simultaneously. The securities pay out takes place on the same date as the securities pay in date i. The securities pay-out is done simultaneously through both depositories and the process is usually completed by 1. A Stock Exchange may introduce physical settlement in a phased manner. Such entities are called Custodial Participants CP. A CP is required to register with clearing corporation through this clearing member, which allots them a unique CP code.
The CP and the CM are required to enter into an agreement.
Clearing corporation collects initial margin for all the open positions of a Clearing Member based on the margins computed. Margins are required to be paid up-front on gross basis at individual client level for client positions and on net basis for proprietary positions. This margin is required to be paid by a downloader of an option till the premium settlement is complete. Assignment Margin for Options on Securities It is required to be paid on assigned positions of Clearing Members towards final exercise settlement obligations for option contracts on individual securities, till such obligations are fulfilled.
The margin is charged on the net exercise settlement value payable by a Clearing Member towards final exercise settlement. Exposure Margins Clearing members are subject to exposure margins in addition to initial margins. Client Margins Clearing corporation intimates all members of the margin liability of each of their client. Additionally members are also required to report details of margins collected from clients to clearing corporation, which holds in trust client margin monies to the extent reported by the member as having been collected from their respective clients.
Risk Management Clearing corporations on-line position monitoring system monitors a CMs open position on a real-time basis. Penalties A penal charge will be levied on the amount in default as per the byelaws relating to failure to meet obligations by any Clearing Member Type of Default Overnight settlement shortage of value more than Rs.
It governs the trading of securities in India. Section 18A provides that notwithstanding anything contained in any other law for the time being in force, contracts in derivative shall be legal and valid if such contracts are: o Traded on a recognized stock exchange o Settled on the clearing house of the recognized stock exchange, in accordance with the rules and byelaws of such stock exchanges.
Regulation in Trading A 24 member committee under the chairmanship of Dr. Government Securities and T-Bills 2. Non Cash Component: Liquid Group I Equity Shares as per Capital Market Segment which are in demat form, as specified by clearing corporation from time to time deposited with approved custodians. Mutual fund units other than those listed under cash component decided by clearing corporation from time to time deposited with approved custodians. Cross Margin Salient features of the cross margining available are as under: 1.
Cross margining is available across Cash and Derivatives segment 2. Cross margining is available to all categories of market participants Main objectives of Trade Guarantee Fund TGF : To guarantee settlement of bonafide transactions of the members of the exchange. Chapter 9: Accounting and Taxation When forward contract is for hedging The premium or discount difference between the value at spot rate and forward rate should be amortized over the life of contract. A gain or loss i.
This is in view of section 43 5 of the Income-tax Act which defined speculative transaction as a transaction in which a contract for download or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. Sale of an option in securities, where option is exercised - 0. Investors should be careful to review their monthly account statements and investigate any abnormally high trading activity.
Customer Due Diligence The customer due diligence CDD measures comprises the following: Obtaining sufficient information in order to identify persons who beneficially own or control securities account Verify the customers identity using reliable, independent source documents, data or information Conduct ongoing due diligence and scrutiny, i.