NISM Series XVI: Commodity Derivative Certification Last Day 2

Explanation:

Reduction in interest rate increases put option price but reduces call option price.

Lower interest rate leads to lower cost of finance of paying the call option premium, so the value of call option decreases.

For put options, the opposite holds true, that is, the lower the interest rates the higher the put option price.

Explanation:

Types of hedge accounting – The Guidance Note of ICAI recognizes the following types of hedging:

– The fair value hedge accounting model is applied when hedging the risk of a fair value change of assets and liabilities already recognized in the balance sheet, or a firm commitment that is not yet recognized.

– The cash flow hedge accounting model is applied when hedging the risk of changes in highly probable future cash flows or a firm commitment in a foreign currency.

Explanation:

Strike price is the price for which the underlying security may be purchased (in case of call) or sold (in case of put) by the option holder, by exercising the option.

Explanation:

If futures price is lower than spot price of an asset, market participants may expect the spot price to come down in future. This expectedly falling market is called “Backwardation market”.

This backwardation inspite of cost-of-carry arises due to seasonality factors in commodities especially in agricultural products. For e.g. during sowing season, spot supplies are less while it increases during harvesting month which will come after around 3 months. Hence, spot prices are expected to be lower during harvesting months (i.e., 3 months later) than the present spot price (i.e., while sowing).

Explanation:

Most commodities follow a certain schedule of production cycle, which impacts the price trend. For example, in agricultural commodities, during the harvesting season, due to an increased supply, prices tend to come down, whereas during the sowing season the overall supply (availability) remains lower, which leads to an increase in prices.

Explanation:

Intrinsic Value = Market price – Strike price

= 1900 – 2000 = -100

Intrinsic value can never be negative, so it will be considered as Zero.

A Call Option is ‘In the Money’ when Market Price is greater than Strike Price. Its ‘At the Money’ when Market Price is equal to Strike Price and its ‘Out of the Money’ when Market Price is less than Strike Price.

Only an ‘In the Money’ ie. a profitable option will have an intrinsic value. Otherwise it will have only time value.

In the above question, the market price (Rs 1900) is below the Strike price (Rs 2000). So this is an Out of the Money Call Option and will have NIL intrinsic value. The option premium of Rs 200 is only the time value.

Explanation:

Weights of commodities in the index are decided by the Exchanges, based on their scoring on production value and liquidity value.

Production Value is average value of deliverable supply in the past 5 financial years. Liquidity Value is the average trading volume of its futures in the last 12 months. Deliverable supply is Production plus Import.

Explanation:

In the case of a both option, the delivery will be executed only when both buyers and sellers agree to take/give delivery. If they do not give intention for delivery, such open positions are cash settled at the Due Date Rate (DDR).

Due date rate is the rate at which contracts is settled by the exchange. Usually it is the average of spot prices (polled) in last few days of Futures contract which is defined under the contract specification of the exchange. It is also referred as final settlement price of the contract.

Explanation:

Index Futures and Index Options are cash settled and hence, delivery period margins do not apply to it. Option on Commodity Futures devolve into Commodity Futures before those futures go into staggered delivery period. Thus, delivery period margin does not apply to Options on Futures.

Explanation:

A Stop Loss order has two prices ie. Trigger Price and Limit Price.

For eg. A trader has sold a commodity at Rs 96 and wants to restrict his losses to Rs 5. For this, he will use a Stop Loss purchase order, the trigger price will be Rs 100 and the Limit price will be Rs 101. Which means if the price rises and reaches Rs 100, it will trigger the Buy Order and the commodity will be bought till Rs 101.

Thus, stop loss trigger acts as the maximum price level to buy.

Explanation:

The fair value of a futures price with continuous/daily compounding can be expressed as:

F = S*e^ (r*n)

where – F: Futures price S: Spot price r: Cost of financing in percentage n: time till the expiry of the contract (number of years) e = 2.71828 = A Constant number used in continuous compounding in mathematics

Explanation:

Delta measures the sensitivity of the option value to a given small change in the price of the underlying asset.

Delta for put option buyer is negative. The value of the contract increases as the underlying price falls. This is similar to a short or ‘bear’ position in the underlying asset. Delta for put option seller will be same in magnitude but with the opposite sign (positive).

Explanation:

Once obligations for delivery are assigned, seller will raise the bill on buyer at Final Settlement Price. The bill will be inclusive of appropriate GST levied on Final Settlement Price.

Even though the trades might have happened at some other traded rates on trade date, the bills are raised at Final Settlement Price. The difference between these two rates was already adjusted earlier during daily MTM obligations.

Explanation:

Stock, Currency and Bond Futures are all financial futures. Gold Futures is a commodity futures.

Explanation:

In barter system, goods were exchanged between two parties with matching and opposite needs (for example, bags of wheat were exchanged for cattle).

Explanation:

If FSP of option falls exactly mid-way between two strike prices, then there is no ATM option. In that case, three contracts of strike price above FSP and three contracts of strike price below FSP are considered as CTM options (i.e., total of 6 strike prices)

Explanation:

In Commodity Exchanges globally, there are various commodity indices.

A few of these are: S&P World Commodity Index , CME Commodity Index , Bloomberg Commodity Index (BCOM) , S&P GSCI Commodity Index at Chicago Mercantile Exchange , LME Commodity Index etc.

Russell 1000 index is not a commodity index and it represents the top 1000 companies by market capitalisation in the United States.

Explanation:

Index Futures are like any other normal Futures with cash settlement without delivery and payment obligations.

On Expiry day of Index Futures, Final Settlement Price (FSP) of index is determined after 5:00 pm. It is based on index calculation on weighted average traded price of constituents’ future contract during 4:00 pm to 5:00 pm.

Explanation:

Once Index is constructed with certain weights of each commodity futures, those weights can remain fixed for one year. Index weights and constituents must be rebalanced atleast once in a year.

In case of rebalancing is proposed, new proposed rebalanced index should be disclosed atleast 3 months before actual rebalancing date.

Explanation:

On expiry of Options, Final Settlement Price (FSP) is determined which is same as Daily Settlement Price (DSP) of respective Futures. The difference between FSP and Strike price is considered MTM gain / loss of the players which is received / credited on T+1 basis i.e., on the next morning.

Exercise window is opened to determine which options are going to be exercised and devolved on Futures.

Explanation:

Commodity Exchanges prescribe different eligibility criterion for different classes of membership.

While admitting members, the commodity exchanges generally take into account specific factors such as corporate structure, capital adequacy, track record, education, experience, infrastructure set-up, manpower, etc. to ensure that the members are equipped to offer quality broking services so as to build and sustain confidence among investors in the Exchange’s operations.

Explanation:

In Commodity spot markets, the counterparties meet at common places where goods are brought for immediate sale and delivery at the market price decided by the demand and supply forces.

Thus in Commodity spot markets, traders sell goods such as rice, wheat etc. for immediate delivery against cash.

Explanation:

CTT is levied as an percent on the option premium and is borne by the seller of options,

(In case the option is exercised, CTT is levied on the settlement price)

Explanation:

MPOR is Margin Period of Risk. This is a period in terms of number of days, for which settlement risk is required to be covered by collecting margins.

Explanation:

In India there have been various equity market indices (like Nifty, Sensex including market cap related and sector related indices). There have been debt market indices as well (such as I-Bex, Composite Bond Index, etc).

These indices serve as comparison of portfolios and their returns with a benchmark to see how much deviation portfolios are taking to earn additional return above markets.

Explanation:

CTT is determined at the end of each trading day. For each client code, all the sell transactions for a trading day shall be aggregated at contract level. CTT is levied on sellers of Futures and Options.

Explanation:

The exchanges need spot price information on a daily basis to be used as the basis for the commodity futures contracts traded on their platforms.

As per the regulatory guidelines, all the exchanges need to disclose following information regarding spot price polling of the commodities:

Details of the contract ; Mechanism of spot prices polling ; How spot prices are arrived at ; Whether these prices include or exclude taxes and other levies ; Whether the spot price polling has been outsourced to any agency and if so, the details thereof ; Criteria for selection of these participants ; Any other information that exchange may consider useful for improving transparency in arriving at spot prices

Explanation:

The Securities Contracts (Regulation) Act, 1956 (SCRA), provides for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges.

SCRA gives SEBI the jurisdiction over stock exchanges through recognition and supervision. It also gives SEBI the jurisdiction over contracts in securities and listing of securities on stock exchanges.

Explanation:

F = S + C – Y – where F: Futures Price, S: Spot Price, C: Cost of carry and Y: Convenience Yield.

Explanation:

SPAN scenarios take into account possible changes in the underlying asset’s price and changes in the underlying asset’s price volatility, time to expiry etc.

Explanation:

Mutual funds are currently not allowed to invest in physical commodities (except Gold) as this requires custodians to be geared up to take up commodity level activities. As of now, custodians are allowed to offer their services only for Gold for the purpose of Gold ETF. (Gold Exchange Traded Funds)

Explanation:

When the futures price is less than the spot price, it is known as backwardation market.

Explanation:

The order matching is done on a price-time priority basis. This means that all the orders received are sorted on ‘best-price’ basis i.e., orders are first ranked according to their prices and similar priced orders are then sorted on a time-priority basis.

Highest buy orders and lowest sell orders are matched first for trade, after which next highest buy order or next lowest sell order comes up for trade match.

Explanation:

Maximum order size is represented as a quantity. For eg. The maximum order size for Gold futures is 10 kgs.

Explanation:

Minimum Support Price (MSP) declared by the Government for its procurement can be considered as a put option for the farmers. These are the guaranteed procurement prices by the Government for its procurement from the farmers.

For eg – For Maize Kharif crop, if MSP = Rs 1,850 per quintal and Market price = Rs 1,350 per quintal: Thus, farmers get a price protection (put option buy position) at a price of Rs 1,850. If the market price continues to remain far below MSP, farmers will sell the farm output post harvesting to Government at Rs 1,850 instead of selling it in the market at Rs 1,350.

The government, like a put option seller, has to take delivery of purchased crop at Rs 1,850 instead of buying from market at Rs 1,350. By chance, actual market price goes above MSP (say, to Rs 2,000, which is greater than the MSP), then farmer may not exercise this option of selling to government but may sell in the market directly.

Explanation:

Trading Unit: It is the quantity for which trading price is shown. For example, price for 10 grams of Gold.

Lot size: It is the minimum quantity which will go for trading or delivery (eg: Silver 30 Kilos lot, Wheat 10 MT lot, etc.). Lot size is equal to or higher than minimum trading unit.

Explanation:

Tick size: It is the minimum price movement in terms of change in price or change in quotation for order.

Tick size is significant for Algo traders as well as Hedgers / Speculators. In most cases, higher tick size benefits Algo traders while lower tick size benefits hedgers.

Explanation:

Client level limits and member level limits are set by the exchange to avoid concentration risk and market manipulation by a trading member or group acting in concert.

Position Limits are set at the client level and member level to prevent any members and clients from building up large position on the buy side or sell side to manipulate short-term price movements to their advantage.

Explanation:

By buying a put option on goods, the put option buyer has created a hedge to protect any downward fall in the price of the goods. For this he has to pay a premium.

So, when he sells the goods, he has to reduce the premium paid from the sale proceeds to get the correct picture.

Explanation:

Weights of commodities in the index are decided by the Exchanges, based on their scoring on production value and liquidity value.

Production Value is average value of deliverable supply in the past 5 financial years. Liquidity Value is the average trading volume of its futures in the last 12 months. Deliverable supply is production plus import.

Explanation:

Client registration documents are to be executed with any new client before allowing the client to start trading in commodity exchanges. Documents obtained from the clients would include: “Know your client (KYC) form”, execution of Client-Member constituent agreement (MCA) and Risk Disclosure document (RDD).

Explanation:

Convenience yield indicates the benefit of owning a commodity rather than buying a futures contract on that commodity.

Producers may face losses, if they do not have enough inventory at all times for uninterrupted production. Therefore, a commodity’s convenience yield is the benefit in rupee term that a user realizes for carrying sufficient stock of physical goods over and above his immediate needs.

Explanation:

A Broker while onboarding a client should satisfy himself about Know your Customer (KYC) norms and KYC documents of the client.

Warehouse service providers have to comply with Know Your Depositor (KYD) Policy to be able to identify the depositor of the goods deposited in registered warehouses.

Explanation:

A Crush Spread is an option trading strategy used in the Soyabean futures market. The general term for this is Crush Margin or Gross processing margin.

Explanation:

For a put option which is in-the-money, intrinsic value is the excess of strike price (X) over the spot price (S). Thus, intrinsic value of put option can be calculated as X-S.

So a put option with higher strike price would have a higher option premium.

Explanation:

SEBI allowed Portfolio Management Services (PMS) to take exposure in the commodity derivatives. This is subject to condition of agreement with the client and adequate risk disclosures. As Foreign Portfolio Investors (FPIs) are not allowed to have exposure in commodity derivatives, no onboarding of FPIs in these schemes of PMS is allowed.

Explanation:

Selling a PUT option means the view is bullish (price to rise). Mr. Harshad has sold a PUT option but the price has fallen from Rs.45000 to Rs. 44000. This means there is a loss of Rs. 1000. He has however earned a premium of Rs.250.

So his net loss is Rs. 1000 – Rs. 250 = Rs. 750

Rs 750 is the loss for 10 grams.

So for 1 kg or 1000 grams (lot size) the loss is (1000 x 750 / 10) = Rs 75000 Loss

Explanation:

Option on goods may be costlier than Option on Futures in relatively shallow markets and one of the reason is – Futures are part of organized markets at Exchanges and have Daily Price Limits (DPL) i.e., circuit breakers which puts a limit on volatility. On the other hand, spot markets in commodity is not centralized and do not have DPL, which may lead to higher volatility.

Explanation:

Options on Goods have one specific advantage against Option on Futures: as futures contracts themselves being used as tools in lot of speculative trades, they may sometime lead to inconsistent price movements.

Explanation:

Weights of commodities in the index are decided by the Exchanges, based on their scoring on production value and liquidity value. These two scores should be in a ratio which should provide minimum 25% weightage to each parameter i.e., production and liquidity should have a minimum of 25% weightage each