Derivatives Trading
Apr 18th, 2008 by dipankar
What are various types of derivatives?
Futures : A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Presently Index futures on S&P CNX NIFTY and CNX IT , Stock futures on certain
specified Securities and Interest Rate Futures are available for trading at NSE. All the futures contracts are settled in cash.
Options : An Option is a contract which gives the right, but not an obligation, to buy or sell the underlying at a stated date and at a stated price. While a buyer of an option pays the premium and buys the right to exercise his option, the writer of an option is the one who receives the option premium and therefore obliged to sell/buy the asset if the buyer exercises it on him.
Options are of two types - Calls and Puts options :
“Calls” give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. “Puts” give the buyer the right, but not the obligation to sell a given quantity of underlying asset at a given price on or before a given future date. Presently Index Options on S&P CNX Nifty and CNX IT and options on certain specified securities are available for trading at NSE. All the options contracts are settled in cash.
Further the Options are classified based on type of exercise. At present the Exercise style can be European or American.
American Option - American options are options contracts that can be exercised at any time upto the expiration date. Options on individual securities available at NSE are American type of options.
European Options - European options are options that can be exercised only on the expiration date . S&P CNX Nifty and CNX IT options available at NSE are European type of option.
What are the benefits of trading in Index Futures compared to any other security ?
An investor can trade the ‘entire stock market’ by buying index futures instead of buying individual securities with the efficiency of a mutual fund. The advantages of trading in Index Futures are:
- The contracts are highly liquid
- Index Futures provide higher leverage than any other stocks
- It requires low initial capital requirement
- It has lower risk than buying and holding stocks
- It is just as easy to trade the short side as the long side
- Only have to study one index instead of 100’s of stocks
- Settled in cash and therefore all problems related to bad delivery, forged, fake certificates, etc can be avoided.
What is the Expiration Day ?
It is the last day on which the contracts expire. Futures and Options contracts expire on the last Thursday of the expiry month. If the last Thursday is a trading holiday, the contracts expire on the previous trading day. For E.g The January 2004 contracts mature on January 29, 2004.
**Information collected from NSE.