Transcript Guidence Note on Accounting for Equity Index and Equity
Guidance Note on Accounting for Equity Index and Equity Stock Futures and Options
Composed By: PRAKASH SOMANI
Derivatives
Types of derivatives instruments: 1. Futures and forward contracts Equity index futures Equity stock futures 2. Options and Swaps contracts Equity stock options Equity index options These are also called as “Equity Derivative Instrument” (EDI)
Applicability
Applicable to all contracts entered into for EDI irrespective of the motive
Forward contracts
Agreement between two parties i.e. buyer and seller At a future time For an agreed price (Contract price) Settled by actual delivery at maturity
Futures contract
An agreement between two parties to buy and sell an asset At a certain time in future At an agreed price No actual delivery Both parties are under obligation Premium is lower then in the options
Options
Option is a contract which gives the buyer/holder the right, but not obligation, to buy or sell a specified underlying asset at a predetermined price on or before the specified future date.
The person who gets such rights is called “option buyer/holder” The person against whom the buyer can exercise his right is called” option seller/writer” Unlike as buyer the option seller has no right to exercise the option but has an obligation to sell/buy the underlying asset as and when option buyer exercise his option. Every option contract is for a specified period of time.
Classification of options
American style options: the buyer can exercise his right at any time before the contract expires or on the expiry date European style options: buyer can exercise his option only on expiry date
Option premium
In order to acquire the right of option the buyer pays to the seller a price paid for the right Premium is higher then in the futures.
Types of options
Call option: buyer/holder gets the right to purchases the underlying asset on or before the expiry date Put option: buyer/holder gets the right to sell the underlying asset Long call/put: buying a option Short call/put: selling a option
summary
Option type Buyer/ holder
Call Put Right but not an obligation to buy the underlying asset Right but not an obligation to sell the underlying asset
Seller/writer
Obligation but no right to sell the underlying asset Obligation but no right to buy the underlying asset
Strike or Exercise price
The price at which the buyer/ holder has the right to buy or sell and the seller/writer has right to sell or buy or, The price specified in the option contract at which the underlying asset may be purchased or sold by buyer/Holder.
Option contract
At the money: current market value=strike price In the money: call option: current market value>exercise price put option: current market value
Trading Area
There can be futures and options on commodities, currencies, securities, stock index, individual stock, etc.
Future and options are permitted in india in two equity indexes viz. BSE SENSEX and S&P CNX NIFTY(NSE)
Equity Index Future
It is a contract to buy / sell equity index at an agreed amount on a specified future date.
Equity Stock Future
It is a contract to buy / sell security at an agreed amount on a specified future date.
Difference
Type
Underlying asset Mode of settlement
EIF
BSE SENSEX,S&P CNX NIFTY
ESF
Equity shares of a company By cash payment of difference between contract price and index value on maturity date Either delivery settled or cash settled.
Presently only in cash in india
Equity Index Options
Whereby a person gets the right to buy or sell An agreed number of units of equity index On a specified future date
Equity Stock Options
Whereby a person gets the right to buy or sell An agreed number of units of a security On or before a specified future date
Difference between EIO & ESO
Type
Underlying asset Time of settlement Mode of settlement
EIO
BSE SENSEX,S&P CNX NIFTY
ESO
Equity shares of a company European style On expiry day By cash payment of difference between contract price and index value on maturity date American Style Any time before expiry.
Either delivery settled or cash settled.
Presently in India cash settlement only
Daily settlement price
The closing price of the equity index/stock futures contract for the day.
Contract month
In relation to futures contract: the month in which the contract is to be finally settled In relation to options contracts: the month in which the expiry date falls.