Page 77 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes 5.5.2 Contract Specification for Index Options

On NSE’s index options market; there are one-month, two-month and three-month expiry contracts
with minimum nine different strikes available for trading. Hence, if there are three serial month
contracts available and the scheme of strikes is 6-1-6, then there are minimum 3 × 13 × 2 (call and
put options) i.e. 78 options contracts available on an index. Option contracts are specified as
follows: DATE-EXPIRYMONTH-YEAR-CALL/PUT-AMERICAN/ EUROPEAN- STRIKE. For
example the European style call option contract on the Nifty index with a strike price of 5000
expiring on the 26th November 2009 is specified as ’26NOV2009 5000 CE’. Just as in the case of
futures contracts, each option product (for instance, the 26 NOV 2009 5000 CE) has its own order
book and its own prices. All index options contracts are cash settled and expire on the last
Thursday of the month. The clearing corporation does the novation. The minimum tick for an
index options contract is 0.05 paise.

5.5.3 Contract Specifications for Stock Futures

Trading in stock futures commenced on the NSE from November 2001. These contracts are cash
settled on a T+1 basis. The expiration cycle for stock futures is the same as for index futures,
index options and stock options. A new contract is introduced on the trading day following the
expiry of the near month contract.

Self Assessment

Fill in the blanks:
17. ……………are derivative contracts which derive their value from an underlying index.
18. Index derivatives are ……………settled.
19. The index is a large, well-diversified portfolio, and ………………………….of the index is
much harder, and requires much larger resources.
20. Index derivatives are cash-settled, which means that …………………of securities is made.

Case Study Real Estate Option Strategy

et’s use a land option example where Ramesh know of a farm that has a current
value of ` 100,000, but there is a chance of it increasing drastically within the next
Lyear because he know that a hotel chain is thinking of buying the property for
` 200,000 to build a huge hotel there. So, he approaches the owner of the land, a farmer, and
tells him that Ramesh want the option to buy the land from him within the next year for
` 120,000 and Ramesh pay him ` 5,000 for this right or option. The ` 5,000 or premium, he
give to the owner is his compensation for giving up the right to sell the property over the
next year to someone else and requiring him to sell it to Ramesh for ` 120,000 if he chooses
so. A couple of months later the hotel chain approaches the farmer and tell him they will
buy the property for ` 200,000. Unfortunately, for the farmer he must inform them that he
cannot sell it to them because he has sold the option to Ramesh. The hotel chain then
approaches Ramesh and says that they want him to sell them the land for ` 200,000. Since,
Ramesh now have the rights to the property’s sale, Ramesh now have two choices to make
money. In the first choice he can exercise option and buy the property for ` 120,000 from
the farmer and turn around and sell it to the hotel chain for ` 200,000 for a profit of ` 75,000.
Contd....

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