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NISM-Series-VIII: Equity Derivatives Question Bank

Published on Friday, April 26, 2024
We’ve prepared a question bank for the NISM-Series-VIII: Equity Derivatives exam. It covers all necessary topics and is designed for effective practice and understanding. We believe it will greatly assist in your exam preparation.


Q.1 Initial margin to be paid in derivatives is set up taking into account the volatility of the underlying market. Generally ___?

  1. Lower the volatility, higher the initial margin
  2. Higher the volatility, lower the initial margin
  3. Higher the volatility, higher the initial margin
  4. None of these

Answer (c)

Explanation: This is because the initial margin is a type of security deposit, set up to cover potential future losses on the position due to adverse price movements. Higher volatility means higher uncertainty or risk, so a higher initial margin is required to mitigate this risk.

Q.2 In a derivatives exchange, the networth requirement for a clearing member is higher than that of a non-clearing member – State whether True or False?

  1. True
  2. False

Answer (a)

Explanation: In a derivatives exchange, the networth requirement for a clearing member is indeed higher than that of a non-clearing member. This is because clearing members are responsible for the financial commitments of their customers. Therefore, they need to maintain a higher networth to ensure they can meet these obligations. Non-clearing members, on the other hand, do not have these responsibilities and thus have lower networth requirements.

Q.3 What will be the Delta for a Far Out-of-the-money option?

  1. Near 0
  2. Near 1
  3. Near -1
  4. Near 2
  5. None of these

Answer (a)

Explanation:

  • Delta is a measure of how much an option’s price is expected to change per $1 change in the price of the underlying security or index.
  • For a far out-of-the-money option, the delta is near 0 because the likelihood of the option ending up in-the-money (and thus having intrinsic value) at expiration is very low.
  • Therefore, changes in the price of the underlying security or index will have little effect on the price of the option.

Q.4 On final settlement, the buyer/holder of the option will recognize the favorable difference received from the seller/writer as ______ in the profit and loss account.

  1. Income
  2. Expense
  3. Loan
  4. Amortization
  5. None of these

Answer (a)

Explanation: On final settlement, the buyer/holder of the option will recognize the favorable difference received from the seller/writer as income in the profit and loss account. This is because the favorable difference represents a gain to the option holder, which is recorded as income.

Q.5 How is the forward contract, which is for hedging purpose, accounted for in books of accounts?

  1. The premium or discount will be shown in the Profit and Loss Account
  2. The premium or discount will be ignored for accounting
  3. The premium or discount will be amortized over the life of contract
  4. No premium or discount will be recognized in the books of accounts
  5. None of these

Answer (c)

Explanation: For a forward contract used for hedging purposes, the premium or discount on the contract is typically amortized over the life of the contract. This means that the premium or discount is gradually written off to the profit and loss account over the period of the contract. This method of accounting helps to match the cost of the hedge with the risk it is intended to mitigate.

Q.6 In case of a member’s default, the Clearing Corporation cannot transfer clients positions to another member or close out all open positions of defaulting member, without prior approval from SEBI – State True or False ?

  1. True
  2. False

Answer (b)

Explanation: The statement is False.

In case of a member’s default, the Clearing Corporation has the authority to transfer client positions to another member or close out all open positions of the defaulting member. This can be done without prior approval from SEBI (Securities and Exchange Board of India). These actions are part of the risk management measures that Clearing Corporations have in place to protect the integrity of the market and the interests of the investors.

Q.7 Is it true that at expiration, the value of an option is its intrinsic value?

  1. Yes, its true for all options
  2. No, its not true for all options
  3. Yes, its true but only for Call options
  4. Yes, its true but only for Put options

Answer (a)

Explanation: At expiration, the time value of an option becomes zero and the option is worth only its intrinsic value. This is true for both call and put options. The intrinsic value is the amount by which the option is in-the-money. For call options, this is the amount by which the underlying asset’s price exceeds the strike price. For put options, it is the amount by which the strike price exceeds the underlying asset’s price. If the option is out-of-the-money or at-the-money, its intrinsic value is zero.

Q.8 At price level of Rs. 6900, what will be the value of one lot of ABC futures contract (contract multiplier 50)?

  1. 289000
  2. 690000
  3. 345000
  4. 460000
  5. None of these

Answer (c)

Explanation: The value of the futures contract is the Price X  Lot size

                                        = Rs 6900 X 50 = Rs 345000

Q.9 The price at which the underlying asset can be bought or sold on exercise of an option is called ________

  1. Spot Price
  2. Risk Premium
  3. Strike Price
  4. Option Premium
  5. None of these

Answer (c)

Explanation: The strike price, also known as the exercise price, is the predetermined price at which the underlying asset can be bought (for call options) or sold (for put options) by the holder of the option. It plays a crucial role in determining an option’s moneyness and is essential for calculating the break-even point and profit or loss for all options positions. The strike price remains fixed throughout the life of the option contract, while the underlying security’s price (spot price) constantly fluctuates. The relative difference between the strike price and the underlying price determines whether an option is in the money (ITM), at the money (ATM), or out of the money (OTM)3.

For example:

If the Nifty50 spot price is trading at 16,200, the 16,200 call option strike is considered “at the money” (ATM), the 16,300 call option strike is “out of the money” (OTM), and the 16,100 call option strike is “in the money” (ITM).

Similarly, for put options, if the Nifty50 spot price is 16,200, the 16,200 put option strike is ATM, the 16,100 put option strike is OTM, and the 16,300 put option strike is ITM.

Q.10 Trader A wants to sell 20 contracts of August series at Rs 4500 and Trader B wants to sell 17 contracts of September series at Rs 4550. Lot size is 50 for both these contracts. The Initial Margin is fixed at 6%. How much Initial Margin is required to be collected from both these investors (sum of initial margins of A and B) by the broker?

  1. 5,02,050
  2. 2,70,000
  3. 4,10,000
  4. 2,32,050
  5. None of these

Answer (a)

Explanation: For Trader A:

Total value of contracts = 20 contracts * Rs 4500 * 50 (lot size) = Rs 45,00,000

Initial Margin = 6% of Rs 45,00,000 = Rs 2,70,000

For Trader B:

Total value of contracts = 17 contracts * Rs 4550 * 50 (lot size) = Rs 38,67,500

Initial Margin = 6% of Rs 38,67,500 = Rs 2,32,050

So, the total Initial Margin to be collected from both these investors by the broker is Rs 2,70,000 (Trader A) + Rs 2,32,050 (Trader B) = Rs 5,02,050.

Q.11 An Index Option is ______

  1. a derivative product
  2. settled in cash
  3. rarely traded on the Indian stock exchanges
  4. Both 1 and 2
  5. None of these

Answer (d)

Explanation: An Index Option is indeed a derivative product and is settled in cash.

  • It’s a type of option contract where the underlying asset is an index.
  • These options give the holder the right, but not the obligation, to buy or sell an index at a specified price by a certain date. Index options are typically cash-settled, meaning the holder receives the difference between the closing settlement index value and the strike price of the option in cash if the option is in-the-money at expiration. They are actively traded on many exchanges, including Indian stock exchanges.

Q.12 Mr. Sunil places a stop loss sell order on ABC stock with a trigger price of Rs. 450. The current market price of ABC stock is Rs 470. The order will be released for execution ______

  1. As soon as the market price of ABC touches Rs. 470
  2. As soon as the market price of ABC touches Rs. 450
  3. As soon as the order is placed in the system
  4. If similar orders are available in the order book at Rs. 450
  5. None of these

Answer (b)

Explanation: A stop loss sell order is designed to limit an investor’s loss on a position in a security. It becomes a market order when the stock trades at or below the trigger price. So, in this case, Mr. Sunil’s stop loss sell order will be released for execution as soon as the market price of ABC stock touches Rs. 450. This is the trigger price he has set for the order.

Q.13 In case of Bonus shares, the new option strike price is arrived at by ______ the old strike price by the adjustment factor.

  1. Adding
  2. Dividing
  3. Subtracting
  4. Multiplying
  5. None of these

Answer (b)

Explanation: In the context of bonus shares, the new option strike price is determined by dividing the old strike price by the adjustment factor. This adjustment factor is typically calculated based on the bonus issue ratio. For instance, in a 1:1 bonus issue, the factor would be 2. Additionally, the revised lot size can be obtained by multiplying the current lot size by this adjustment factor1. So, to summarize:

New Strike Price: Old Strike Price / Adjustment Factor

Q.14 Can Professional Clearing members act only on behalf of institutional clients ?

  1. Yes
  2. No

Answer (b)

Explanation: Professional Clearing Members (PCMs) can act on behalf of both institutional and non-institutional clients. PCMs are members of a clearing corporation and are permitted to clear trades executed by trading members and self-trades. They can clear trades of institutional as well as non-institutional clients. So, it’s not true that PCMs can act only on behalf of institutional clients.

Q.15 Securities Transaction Tax (STT) is levied on ________.

  1. Purchase of Equity Shares
  2. Sale of Derivatives
  3. Purchase of Derivatives
  4. Only 1 and 2
  5. None of these

Answer (d)

Explanation: STT is levied on transactions involving equity, derivatives and equity oriented mutual funds.

It is levied on purchase and sale of equity shares.

STT is applicable only on all SELL transactions for futures and option contracts and not on purchase transactions.

Q.16 A unique principle of futures trading makes trading possible for those who do not want to make or take delivery of underlying assets. Which is that principle ?

  1. Traded on a recognised exchange
  2. Price uncertainty
  3. Standardisation of contracts
  4. Cash settlement
  5. None of these

Answer (d)

Explanation:  The unique principle of futures trading that makes trading possible for those who do not want to make or take delivery of underlying assets is Cash settlement. In a cash-settled futures contract, the buyer or seller does not physically deliver or receive the underlying asset at the end of the contract. Instead, they settle the difference in cash, which allows traders to participate without the need to handle the actual asset. This makes futures trading more accessible and flexible. So, the correct answer is “Cash settlement”.

Q.17 Mr. Hitesh is a trading member. One of his clients has purchased 12 contracts of March series index futures and another client as has sold 10 contracts of March series index futures. The exposure of Mr. Hitesh as trading member is ________.

  1. grossed up at 22 contracts
  2. netted out at 2 contracts
  3. maximum of 10 and 12 which is 12 contracts
  4. The Exchange will decide to either gross up or net out the exposure depending upon his past record
  5. None of these

Answer (a)

Explanation: The open position of all the clients of a trading member are grossed up to arrive at the total exposure of the trading member.

Q.18 Does the difference between exercise price of the option and spot price affects option premium ? State Yes or No.

  1. Yes
  2. No

Answer (a)

Explanation:  Yes, the difference between the exercise price of the option and the spot price does affect the option premium. This difference is known as the intrinsic value of the option. If the exercise price is below the spot price for a call option (or above for a put option), the option has intrinsic value and this will be reflected in the premium. 

Q.19 Contract month means_____

  1. Month in which the transaction is done
  2. Month of expiry of the futures contract
  3. Month of beginning of the futures contract
  4. None of these

Answer (b)

Explanation: The term “Contract Month” in futures trading typically refers to the Month of expiry of the futures contract. It is the month when the futures contract expires and the final settlement (either physical delivery or cash settlement) occurs. Therefore, the correct answer is “Month of expiry of the futures contract”.

Q.20 In an Out-of-the Money (OTM) Put option ____

  1. Strike price would be higher than the market price
  2. Exercise price would be equal to the market
  3. Strike price would be lower than the market price
  4. strike price would be zero
  5. None of these

Answer (c)

Explanation:  A put option is said to be OTM when spot (market) price is higher than strike price.

A call option is said to be OTM, when spot (market) price is lower than strike price.

In the Money (ITM) Options:

  • An option is considered in the money if its intrinsic value is greater than zero.
  • For call options, this means that the market price of the underlying stock (or security) is higher than the strike price of the call option.
  • Conversely, for put options, being ITM implies that the strike price is higher than the current market price of the underlying security. You could buy the stock at the lower market price and then sell it at the higher strike price, capturing the intrinsic value.

Out of the Money (OTM) Options:

  • OTM options have zero intrinsic value (it cannot be negative).
  • For call options, this means the strike price is higher than the current market price of the underlying stock.
  • In the case of put options, the strike price is lower than the current market price.
  • OTM options primarily consist of time value and do not provide any immediate profit from exercising.

At the Money (ATM) Options:

  • ATM options have a strike price that is almost equal to the spot price (current market price) of the underlying security.
  • These options have no intrinsic value but may still have significant time value.

Q.21 Any person who wishes to open a Trading Account must be given the following documents by his trading member -

  1. Complete version of all the laws of SEBI
  2. Risk disclosure document
  3. All the rules & regulations of the exchange
  4. SEBI guidelines on the subject
  5. None of these

Answer (b)

Explanation:  When a person wishes to open a Trading Account, the trading member must provide them with a Risk disclosure document. This document outlines the various risks associated with trading. It’s crucial for the client to understand these risks before they start trading. In addition, the client should also be made aware of the rules & regulations of the exchange. These rules govern how trading is conducted on the exchange and provide a framework for fair and transparent trading.

Q.22 A person sells a put option of Strike Price 265, market lot 1000, at a premium of Rs 40, the maximum profit he can make is _____.

  1. Rs 25,000
  2. Rs 2,65,000
  3. Rs 40,000
  4. Unlimited
  5. None of these

Answer (c)

Explanation: When a person sells a put option, the maximum profit they can make is the premium received from selling the option. This is because the best-case scenario is that the option expires worthless (i.e., the market price of the underlying asset is above the strike price at expiration), and the seller gets to keep the entire premium.

In this case, the premium is Rs 40 per contract, and each contract represents 1000 units (the market lot). Therefore, the maximum profit the seller can make is Rs 40 * 1000 = Rs 40,000.

Q.23 When a person sells a put option, he has an –

  1. Bullish view
  2. Bearish view
  3. Mixed view
  4. Long term view
  5. None of these

Answer (a)

Explanation: When a person sells a put option, they typically have a Bullish view. This is because selling a put option means that they expect the price of the underlying asset to rise or stay the same. If the price of the asset rises above the strike price, the option will not be exercised, and the seller will keep the premium.

Q.24 Rho is ______ .

  1. is the change in option price given a one percentage point change in the risk-free interest rate
  2. the change in option price given a one-day decrease in time to expiration
  3. speed with which an option moves with respect to price of the underlying asset
  4. a measure of the sensitivity of an option price to changes in market volatility
  5. None of these

Answer (a)

Explanation: Rho is the measure for the accumulation of electric charge in a given particular field. It quantifies how much the option price is expected to change for a one-percentage-point change in the risk-free interest rate.

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