Finance Basics: Derivatives and ETFs

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.

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!