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Unit 11: Introduction to Derivatives

Expiration Date: Date on which the option expires. Notes
Exercise Date: Date on which the option gets exercised by the option holder/buyer.
Option Premium: The price paid by the option buyer to the option seller for granting the
option.
Introduction of futures in India
The first derivative product to be introduced in the Indian securities market is going to be
“INDEX FUTURES”.
In the world, first index futures were traded in the U.S. on Kansas City Board of Trade
(KCBT) on Value Line Arithmetic Index (VLAI) in 1982.

Index Futures
Index futures are the future contracts for which underlying is the cash market index.
For example: BSE may launch a future contract on “BSE Sensitive Index” and NSE may
launch a future contract on “S&P CNX NIFTY”.
Frequently used terms in Index Futures market:
Contract Size: The value of the contract at a specific level of index. It is index level multiplier.

Multiplier: It is a predetermined value, used to arrive at the contract size. It is the price per
index point.
Tick Size: It is the minimum price difference between two quotes of similar nature.

Contract Month: The month in which the contract will expire.
Expiry Day: The last day on which the contract is available for trading.
Open interest: Total outstanding long or short positions in the market at any specific point
in time. As total long positions for market would be equal to total short positions, for
calculation of open interest, only one side of the contracts is counted.
Volume: No. of contracts traded during a specific period of time. During a day, during a
week or during a month.
Long position: Outstanding/unsettled purchase position at any point of time.
Short position: Outstanding/unsettled sales position at any point of time.

Open position: Outstanding/unsettled long or short position at any point of time.
Physical delivery: Open position at the expiry of the contract is settled through delivery of
the underlying. In futures market, delivery is low.

Cash settlement: Open position at the expiry of the contract is settled in cash. These contracts
are designated as cash settled contracts. Index Futures fall in this category.
Alternative Delivery Procedure (ADP): Open position at the expiry of the contract is settled
by two parties, one buyer and one seller, at the terms other than defined by the exchange.
Worldwide, a significant portion of the energy and energy-related contracts (crude oil,
heating and gasoline oil) are settled through Alternative Delivery Procedure.
Concept of Basis in Futures Market
Basis is defined as the difference between cash and futures prices:
Basis = Cash prices – Future prices.

Basis can be either positive or negative (in index futures, basis generally is negative).

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