Page 225 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes Forward Contracts
A forward contract is one to one bi-partite contract, to be performed in the future, at the
terms decided today. (E.g. forward currency market in India).

Forward contracts offer tremendous flexibility to the parties to design the contract in
terms of the price, quantity, quality (in case of commodities), delivery time and place.

Forward contracts suffer from poor liquidity and default risk.
Future Contracts
Future contracts are organised/standardised contracts, which are traded on the exchanges.
These contracts, being standardised and traded on the exchanges are very liquid in nature.

In futures market, clearing corporation/ house provides the settlement guarantee.
Every futures contract is a forward contract. They:
are entered into through exchange, traded on exchange and clearing corporation/house
provides the settlement guarantee for trades

are of standard quantity; standard quality (in case of commodities)
have standard delivery time and place.

Table 11.1: Forward/Future Contracts
Features Forward Contract Future Contract
Operational Not traded on exchange Traded on exchange
Mechanism
Contract Differs from trade to trade. Contracts are standardised
Specifications contracts.
Counterparty Risk Exists Exists, but assumed by Clearing
Corporation/ house.
Liquidation Profile Poor liquidity as contracts Very high Liquidity as contracts are
are tailor-made contracts. standardised contracts.
Price Discovery Poor; as markets are Better; as fragmented markets are
fragmented. brought to the common platform.

Options

Options are instruments whereby the right is given by the option seller to the option buyer to
buy or sell a specific asset at a specific price on or before a specific date.

Option Seller: One who gives/writes the option. He has an obligation to perform, in case
option buyer desires to exercise his option.
Option Buyer: One who buys the option. He has the right to exercise the option but no
obligation.
Call Option: Option to buy.
Put Option: Option to sell.

American Option: An option that can be exercised anytime on or before the expiry date.
European Option: An option that can be exercised only on expiry date.
Strike Price/Exercise Price: Price at which the option is to be exercised.

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