Finance Basics: Derivatives and ETFs

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Questions and Answers

Is the minimum contract value of a futures contract not less than Rs. 1 Lakh?

False (correct)

True

Rs. 50,000 is acceptable

It can be any amount

What is the period within which an arbitrator normally passes the award after the initial hearing?

Four months

One month

Two months (correct)

Three months

How is the option premium primarily determined?

By Stock Exchanges

By SEBI guidelines

By financial analysts

By buyers and sellers (correct)

Can equities be traded through Professional Clearing Members?

Yes, they clear trades for trading members Signup and view all the answers

What is an option that would give a negative cash flow to its holder if exercised immediately called?

Out of the money option Signup and view all the answers

Is it true that ETFs are collections of securities that trade like individual stocks on an exchange?

Yes, they can be bought and sold intraday Signup and view all the answers

What option is known as 'In the money'?

When the spot price is above the strike price for a call option Signup and view all the answers

What authority decides the rules and regulations for trading options?

SEBI and Stock Exchanges Signup and view all the answers

Which statement is true regarding out of the money options?

Call options with strike prices above Rs 300 are out of the money. Signup and view all the answers

What can be concluded about the Brokers on the Governing Board of the derivatives segment?

No broker members should be allowed to sit on the Governing Board. Signup and view all the answers

If the price of a futures contract increases, what happens to the seller's margin account?

It is debited for the losses incurred by the seller. Signup and view all the answers

What is the purpose of derivatives in the market?

To transfer risk from low risk appetite participants to high risk appetite ones. Signup and view all the answers

What is the required Interest Free Security Deposit (IFSD) for each trading member?

2 Lakhs Signup and view all the answers

What is the minimum net worth requirement for a trading member in F&O segment?

Rs 250 lakhs Signup and view all the answers

How are the terms of a futures contract determined?

They are mutually decided by the trading parties. Signup and view all the answers

What does Rho measure in options trading?

The change in option price with a one percentage point change in the risk-free interest rate. Signup and view all the answers

What minimum net worth is required for Trading / Clearing members of the derivatives clearing corporation/house?

Rs 300 Lakhs Signup and view all the answers

Which condition defines a call option that is 'in the money'?

Strike price is lower than the market price Signup and view all the answers

In which situation can a position for a January future contract be reversed?

By squaring up in the same month Signup and view all the answers

What is the maximum gain for a seller of a put option if sold at a premium of Rs 38?

Rs 38 Signup and view all the answers

What type of view does a person have when selling a put option?

Bullish view Signup and view all the answers

What type of risk is associated solely with calendar spreads?

Basis risk Signup and view all the answers

Which of the following assets is not considered an allowable asset when computing net worth?

Intangible assets Signup and view all the answers

What description fits a put option that is 'out of the money'?

Strike price is higher than market price Signup and view all the answers

What percentage of open interest must be disclosed to the clearing corporation for persons acting in concert?

20% Signup and view all the answers

What is the penalty for the first instance margin violation?

0.07% per day Signup and view all the answers

Which of the following factors does NOT affect the value of an option?

The open interest Signup and view all the answers

What is the maximum theoretical loss when selling a Put option with a strike price of Rs.245 and a premium of Rs.49?

196 Signup and view all the answers

Can an equity-based mutual fund sell index futures to hedge its position?

Yes, it can Signup and view all the answers

Which statement accurately describes the difference between futures and forwards?

Futures are standardized and traded on exchanges Signup and view all the answers

Which of the following PUT options is In the Money?

Spot 300 ; Strike Price 280 Signup and view all the answers

In the Indian context, which of the following statements about derivatives is correct?

Includes securities derived from various instruments Signup and view all the answers

What happens to the value of a call option when the spot price increases?

The value decreases Signup and view all the answers

Counterparty risk primarily arises due to what situation?

Default by one of the parties to a contract Signup and view all the answers

What is the term used for the daily settlement of all open positions in futures contracts?

Mark to Market settlement Signup and view all the answers

Nifty consists of securities having which type of market capitalisation stocks?

Large Signup and view all the answers

What is the period within which a stock exchange must complete the physical settlement in stock derivatives when introduced in a phased manner?

Six months Signup and view all the answers

Which statement is true regarding income or loss on derivative transactions carried out in a recognized stock exchange?

Is not taxed as speculative income or loss Signup and view all the answers

What does a seller of an option do?

Receives premium Signup and view all the answers

A protective put payoff is similar to that of which of the following?

Long Call Signup and view all the answers

Study Notes

Derivative Exams

A Derivative Exam is required to complete certain formalities.

Minimum Contract Value of Futures

The minimum contract value of a futures contract is Rs. 2 Lakhs.

Accounting for Open Options

Accounting for open options is not shown under the "Equity Index/Stock Option Premium Account".

Arbitration Procedure

An arbitrator conducts arbitration proceedings.
Arbitrators usually pass awards within three months from the initial hearing date.

Option Premium

The option premium is determined by buyers and sellers, not SEBI or Stock Exchanges.

Equity Trading

Equities can be traded through Professional Clearing Members, who clear trades for their associate Trading Members and institutional clients.

Exchange Traded Funds (ETFs)

ETFs are baskets of securities that trade like individual stocks on an exchange.
ETFs offer advantages over other mutual funds, including the ability to buy and sell on the exchange and intraday trading.

Out of the Money Option

An option that generates a negative cash flow upon immediate exercise is known as an "Out of the Money" option.
Call options are "Out of the Money" when the spot price is lower than the strike price.
Put options are "Out of the Money" when the spot price is higher than the strike price.

Derivative Segment Reporting to SEBI

The derivative segment of the stock market must report to SEBI on specific occasions.

Brokers and Governing Boards

Brokers are not permitted to sit on the Governing Board of a Clearing Corporation.

Margin Account Debits

If the price of a futures contract increases, the seller's margin account is debited for the loss.

Derivatives Market and Risk Transfer

The derivatives market facilitates the transfer of risks from those with low risk appetites to those with high risk appetites.

Clearing Member Deposits

A clearing member is required to deposit Rs. 5 Lakhs as Interest Free Security Deposit (IFSD) and Rs. 10 Lakhs as Collateral Security Deposit (CSD) per trading member they clear and settle.

Minimum Net Worth Requirement

The minimum net worth requirement for a trading member of the Capital Market Segment and F&O segment is Rs. 100 Lakhs.

Futures Contract Terms

The terms of a futures contract are standardized by the exchange.

Rho

Rho measures the change in option price given a one percentage point change in the risk-free interest rate.

Trading Member Net Worth

Trading members are required to maintain a minimum net worth of Rs. 3 Crores (Rs. 300 Lakhs).

Call Option Definitions

A call option is "In the Money" when the spot price is higher than the strike price.

Reversing Futures Positions

A long position in a futures contract can be reversed by selling the same futures contract in the same month.

Selling a Put Option

Selling a put option signifies a bullish view.

Maximum Gain from Selling a Put Option

The maximum gain from selling a put option is equal to the premium received.

Calendar Spreads

Calendar spreads carry only basis risk.

Option Value and Spot Price Changes

The value of a call option decreases with an increase in spot price.

Counterparty Risk

Counterparty risk is the risk arising due to a default on the part of one party to a transaction or contract.

Daily Settlement of Futures

The daily settlement of all open positions in futures contracts is called Mark to Market settlement (MTM).

Nifty Securities

Nifty consists of securities from companies with large market capitalizations.

Trading Member Open Positions

A Trading Member's open position is calculated by adding up their proprietary positions and all their clients' net outstanding positions.

Physical Settlement in Stock Derivatives

A stock exchange introducing physical settlement in stock derivatives must complete this transition within a period of six months.

Derivative Transactions and Taxation

Income or loss from derivative transactions conducted on a recognized stock exchange is not taxed as speculative income/loss.
Losses can be set off against other income during the year.
Losses can be carried forward to subsequent assessment years.

Option Seller Activities

A seller of an option receives a premium.

Protective Put Payoff

A protective put payoff is similar to that of a long call and is considered a synthetic long call position.

Derivatives Instruments Traded on NSE

Derivative instruments traded on the NSE (National Stock Exchange of India) include:
- Index based futures
- Individual stock options
- Index based options
- NOT Individual warrant options

Bear Spreads

A spread designed to profit if prices go down is called a Bear Spread.

Indian Derivatives Trading Act

The Securities and Exchange Board of India (SEBI) Act, 1992, governs the trading of derivatives in India.

Clearing Member Disclosure

A clearing member is required to disclose to the clearing corporation details of any person(s) acting in concert who together own 15% or more of the open interest of all futures and options contracts on a particular underlying index on the stock exchange.

Penalty for Margin/Limit Violation

For the first instance of a margin/limit violation, a penalty of 0.07% per day is levied.

Factors Affecting Option Value

The following factors affect the value of an option:
- NOT the Open Interest.
- The Spot Price.
- The volatility in underlying instruments.
- The strike price.

Maximum Loss from Selling a Put Option

The maximum loss from selling a put option is the difference between the strike price and the premium received.

Mutual Fund Hedging

An Equity based Mutual Fund can sell Index Futures to hedge its position.

Futures vs. Forwards

The key difference between Futures and Forwards is that futures positions are marked-to-market every day.

In The Money Puts

A put option is "In the Money" when the Spot price is below the Strike price.

Definition of "Derivative" in India

In India, a "derivative" is defined as:
- A security derived from a debt instrument, share, loan (whether secured or unsecured), risk instrument, or contract for differences or any other form of security; AND
- A contract that derives its value from the prices, or index of prices, of underlying securities.

Beta of SBI

The beta of SBI is 0.9.

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Description

Test your knowledge on essential finance concepts including derivatives, futures contracts, option premiums, and exchange-traded funds (ETFs). This quiz covers key terms and procedures, ensuring you understand the framework of equity trading and arbitration. Perfect for students and professionals alike!