Page 131 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes While in case of options on equity or stock indices a cash exchange occurs when an option is
exercised, the same does not happen in case of futures option. Instead, in a futures option, the
holder acquires a long position (in case of a call) or short position (in case of a put) at a price
equal to the exercise price of the option. After this, when the acquired futures position is marked-
to-market, the holder of a long position can withdraw an amount equal to the excess, if any, of
the current futures price over the exercise price and the holder of a short futures position can
withdraw a cash equivalent to the excess of the exercise price over the current futures price, in
case it is positive. In effect, the exercise of a futures option leaves the holder with a futures
contract with an unrealised gain equal to the exercisable value of the option.

Example: Suppose that on August 20, 2002, an investor buys a short S&P CNX Nifty
index futures call for October expiration with an exercise price of 1530, for a premium of ` 15.50,
or ` 3100 (the market lot of Nifty being 200, which implies that each point is worth ` 200). Now,
assume that after six weeks, the October 2002 S&P CNX Nifty futures contract is at 1575 and the
investor decides to exercise his call option and acquire a long futures position at 1575. This
would give the investor an unrealised profit of ` 9000 [(1575 - 1530) x 200]. In order to realise this
gain, the investor should take a short position in October 2002 S&P CNX Nifty futures contract
at 1575. Since the futures prices change continuously, the profit of ` 9000 is not guaranteed. In
case the profit realised by taking a short position by the investor, his net gain would be ` 5900,
` 9000 minus ` 3100 paid by him for buying the option on August 20.

8.2.1 Sample Contract

A sample contract involving options on NIKKEI 225 stock index futures is presented in Table 8.1.
The underlying in this contract, traded at SIMEX (Singapore International Monetary Exchange
Limited) is a futures contract on NIKKEI 225 stock index of Japan. As of now, such contracts are
not available for trading in the Indian market.
Table 8.1: Options on NIKKEI 225 Stock Index Futures

Contract Site One SIMEX Nikkei 225 Futures Contract
Ticker Symbol Calls: CNK Puts: PNK
Contract Months 5 serial months and 5 quarterly months in the March,
June, September and December cycle
Trading Hours Singapore 7.55 am 10.15 am
11.15am 2.15 pm
Tokyo 8.55 am 11.15 am
12.15 am 3.15 pm
London 11.55 pm 2.15 am
3.15 am 6.15 am
Chicago 5.55 pm 8.15 pm
9.15 pm 12.15 am
New York 6.55 pm 9.15 pm
10.15 pm 1.15 am
Trading Hours on last Trading Day Same as above
Minimum Price Five index points (¥2,500) except that fluctuation trades
may occur at a price of (¥300) whether or not such trades
result in the liquidation of positions for both parties to the
trade.
Strike Price 500 Nikkei index points interval. Strike prices will be
Contd....
integers divisible by 500 without remainder
Trading Halt There shall be no trading in any options contract when the
Nikkei 225 Stock Index Futures contract is bid or offered:
126 LOVELY PROFESSIONAL UNIVERSITY
(1) at its initial daily price limit, or (2) at its expanded daily
price limit, except that the above provisions shall not
apply on an option’s last day of trading.
Option Exercise An option can be exercised by the buyer on any Nikkei 225
business day.
In the absence of contrary instructions delivered to the
Clearing House, an option in the March quarterly cycle
that is in-the-money* will be exercised automatically on
the day of determination of final settlement price.
Similarly, an in-the-money** option that expires in a
month other than those in the March quarterly cycle will
be exercised automatically on the day of termination of
trading.
Last Trading day The day before the second Friday of the contract month.
Expiration The expiration day for options in the March quarterly
cycle (Mar, Jun, Sep, and Dec) will usually be the second
Friday of the contract month. For contract months other
than those in the March quarterly cycle, the options
contract will expire on its last trading day.