Financial Derivatives

Introduction

With the approval of the derivatives bill in union cabinet, the investors are

now in the position to trade through futures and options, which provides the investors

a greater hedging facility. Derivatives product initially emerged as hedging devices

against fluctuations in commodity prices, and commodity linked derivatives offer

organization the opportunity to break financial risks into smaller components and then

to buy and sell those components to best meet specific risk management objectives.

Financial derivatives came into spotlight in the year 1970 period due to

growing instability in the financial markets. However since their emergence, these

accounted for about two-third of totals transactions in derivatives products. In recent

years, the market for financial derivatives has grown tremendously in terms of variety

of instruments available, there complexity & also turn over. In the class of equity

derivatives, futures & options on stock indices gained more popularity than individual

stocks, especially among institutional investors, who are major users of index-linked

derivatives. Even small investors find these useful due to high correlation of popular

indices’ with various portfolios. The ease of use and the lower costs associated with

index derivatives vis-à-vis derivatives products based on individuals securities is

another reason for their growing use. I wanted to have better understanding about

futures and options market and their trading mechanism and therefore I took up this

project.

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NEED AND IMPORTANCE

An individual or a firm may have to face a large amount risk in the

international markets. Hence it becomes necessary to look for other sources whereby

this need can be met. Different types of derivatives have really proved to be given a

sharp focus as of late.

Different types of derivatives have come into existence to cater the needs of

variety of individuals in the global markets. A few prominent one’s being varied

categories, different types of derivatives suitable for various trades and firms. This

study of derivatives is utmost important in recent days.

SCOPE OF THE STUDY

o The scope of the study is limited to “DERIVATIVES” with the special

reference to Indian context and the National stock exchange has been taken as a

representative sample for the study. The study includes futures and options.

o There are many organizations trading in the NSE, but my study is only for

selected organizations such as INFOSYS & DR REDDY for one month period.

o My study for both the companies traded in exchange of NSE (National Stock

Exchange Ltd).

OBJECTIVES

To study the role of derivatives in Indian financial markets (F & O)

To find out profit/loss of option holder/writer.

To study the cause for fluctuations in the futures and options market.

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RESEARCH METHODOLOGY

The methodology adopted for the study is discussions with the personnel in

Share khan ltd. and gathering information through secondary sources.

PRIMARY DATA: The primary data that has been collected through personnel

interview with various heads and individual traders in Share khan ltd.

SECONDARY DATA: The secondary data has been collected from the Share khan

value line magazine, Books and the internet.

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DERIVATIVES

Derivatives are products whose value is derived from one or more variables

called bases. These bases can be underling asset such as foreign currency, stock or

commodity, bases or reference rates such as LIBOR or US treasury rate etc. Example,

an Indian exporter in anticipation of the ric9ipt of dollar denominated export proceeds

may wish to sell dollars at a future date to eliminate the risk of exchange rate

volatility by the data. Such transactions are called derivatives, with the spot price of

dollar being the underlying asset.

Derivatives thus have no value of their own but derive it from the asset that is

being dealt with under the derivative contract. A financial manager can hedge himself

from the risk of a loss in the price of a commodity or stock by buying a derivative

contract. Thus derivative contracts acquire their value from the spot price of the asset

that is covered by the contract.

The primary purposes of a derivative contract is to transfer “risk” from one

party to another i.e. risk in a financial sense is transfer from a party that is willing to

take it on. Here, the risk that is being dealt with is that of price risk. The transfer of

such a risk can therefore be speculative in nature or act as a hedge against price

movement in a current or anticipated physical position.

Derivatives or derivative securities are contracts which are written between

two parties (counterparties) and whose value is derived from the value of underlying

widely-held and easily marketable assets such as agricultural and other physical

(tangible) commodities or currencies or short term and long-term and long term

financial instruments or intangible things like commodities price index (inflation

rate), equity price index or bond piece index. The counterparties to such contracts are

those other than the original issuer (holder) of the underlying asset.

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Derivatives are also known as “deferred delivery or deferred payment instruments”. In

a sense, they are similar to securitized assets, but unlike the latter, they are not the

obligations which are backed by the original issuer of the underlying asset or security.

It is easier to take a short position in derivatives than in other possible to combine

them to match specific requirements, i.e., they are more easily amenable to financial

engineering.

The values of derivatives and those of their underlying assets are closely

related. Usually, in trading derivatives, the taking or making of delivery of underlying

assets is not involved; the transactions are mostly settled by taking offsetting positions

in the derivatives themselves. There is, therefore, no effective limit on the quantity of

claims which can be traded in respect of underlying assets. Derivatives are “off

balance sheet” instruments, a fact that is said to obscure the leverage and financial

might they give to the party. They are mostly secondary market instruments and have

little usefulness in mobilizing fresh capital by the companies (warrants, convertibles

being the exceptions). Although the standardized, general, exchange-traded

derivatives are being contracts which are in vogue and which expose the users to

operational risk, counterparty risk, liquidity risk, and legal risk. There is also an

uncertainty about the regulatory status of such derivatives.

There are bewilderingly complex varieties of derivatives already in existence,

and the markets are innovating newer and newer ones continuously: plain, simple or

straightforward, composite, joint or hybrid, synthetic, leveraged, mildly leveraged,

customized or OTC-traded, standardized or organized-exchange traded. Although we

are not going to discuss all of them, the names of certain derivatives may be noted

here: futures, options, range forward and ratio range forward options, swaps, warrants,

convertible bonds, credit derivatives, captions, stations, futures options, the ratio

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swaps, periodic floors, spread lock one and two, treasury-linked swaps, wedding

bands three and six, inverse floaters, index amortizing swaps, and so on; because of

their complexity, derivatives have become a continuing pain for the accounting person

and a true mind-bender for anyone trying to value them.

Definition

Contracts, whose values are to be derived from the asset covered by them

(such as paddy), are commonly named as “derivatives”. These are basically, financial

instruments whose value depends on the value of the other, more basic underling

variable-such as commodity, stock, currency, etc…

“A contract or an agreement for exchange of payments, whose values derives

from the value of an underling asset or underling reference rates or indices”.

A derivative is a security whose price ultimately depends on that of another

asset called underling.

“Derivatives means forward, futures or options contracts of predetermined

fixed duration, linked for the purpose of contract fulfillment to the value of specified

real or financial asset or to an index security”.

With securities Laws (second Amendment) Act, 1999, derivatives has been

included in the definition of securities. The term derivative has been defined:

In Securities Contract (Regulation) Act; as Derivatives include:

a. 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;

b. A contract which derives its value from the prices, or index of prices, of underling

securities;

The international monetary fund defines derivatives as “financial instruments

that are linked to a specific financial instrument or indicator or commodity and

through which specific financial risks can be traded in financial markets in their own

right. The value of financial derivatives derives from the price of an underling item,

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such as asset or index. Unlike debt securities, no principle is advanced to be repaid

and no investment income accrues”.

History

Derivatives have probably existed ever since people have been trading with

another. Forward contracting dates back at list to the twelfth century and may well

have been around before then. However the development and growth of the

derivatives products has been one of the most extraordinary things to happen in the

financial markets place. In 1972, the Breton Woods agreement, the post-war pact that

instituted a fixed exchange rate regime to the world’s major nations, effectively

collapsed, when the US suspended the dollar convertibility into the gold. This resulted

in exchange rate volatility derivative products have come quite handy. They have

established themselves as irreplaceable tools to hedge against risks in currency, stock

and commodity markets.

The history of the derivatives can be traced to the Middle Ages when formers

and traders in gains and other agriculture products used certain specific types of

futures and forwards to hedge, their risks. Essentially the former wants to ensure that

he receives a reasonable price for the grain that he would harvest (say) three to four

months later. An oversupply will hurt him badly. For the grain merchant, the opposite

is true. A fall in the agricultural production will push up the prices. It made sense

therefore for the both of them to fix a price for the future. This was now the future

market first developed in agricultural commodities such as cotton, coffee, petroleum,

Soya bean, sugar and then to financial products such as interest rates, foreign

exchange and shares. In 1995 the Chicago Board of Trade commenced trading in

derivatives.

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For the derivatives market to develop, three kinds of participants are necessary. They

are the hedgers, the speculators and the arbitrageurs. All the three must co-exist. For a

hedging transaction to be completed three must be another person willing to take

advantage of price movements. That is speculator.

Contrary to the hedger who avoids uncertainties the speculator thrives on

them. The speculator may loss plenty of money if his forecast goes wrong but a stand

to gain enormously if he is proved corrects.

The third category of participant is the arbitrage, which looks at risk less profit

by simultaneously buying and selling the same or similar financial products in

different financial markets.

With the government of India permitting futures trading in several

commodities and with futures trading have arrived in the stock markets, index based

derivative trading has finally arrived in India. For smooth functioning of derivative

trading the government of India has commenced the process of dematerialization of

shares, short sale facility, electronic fund transfer facility and rolling settlements in

stock markets. This will hopefully bring transparency in the process of price

discovery of the derivative and also attract a board spectrum of hedgers and

speculators.

The need for a Derivatives Market

The derivatives market performs a number of economic functions:

1. They help in transferring risks from risk adverse people to risk oriented

people.

2. They help in the discovery of future as well as current prices.

3. They catalyze entrepreneurial activity.

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4. They increase the volume traded in markets because of participation of risk

adverse people in greater numbers.

5. They increase savings and investment in the long run.

Stock options and stock futures were introduced in both the exchange in the

year 2001. Thus started trading in derivatives in India stock exchanges (both

BSE & NSE) covering index options, index futures, stock options and futures at in the

wake of the new millennium. In a short span of three years the volume traded in the

derivative market has outstripped the turnover of the cash market.

NATURE OF THE PROBLEM:

The turnover of the stock exchanges has been tremendously increasing from last 10

years. The number of trades and the number of investors, who are participating, have

increased. The investors are willing to reduce their risk, so they are seeking for the

risk management tools.

Prior to SEBI abolishing the BADLA system, the investors had this system as a

source of reducing the risk, as it has many problems like no strong margining system,

unclear expiration date and generating counter party risk. In view of this problem

SEBI abolished the BADLA system.

After the abolition of the BADLA system, the investors are seeking for a hedging

system, which could reduce their portfolio risk. SEBI thought the introduction of the

derivatives trading, as a first step it has set up a 24 member committee under the

chairmanship of Dr.L.C.Gupta to develop the appropriate regulatory framework for

derivative trading in India, SEBI accepted the recommendations of the committee on

May 11, 1998 and approved the phased introduction of the derivatives trading

beginning with stock index futures.

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There are many investors who are willing to trade in the derivative segment, because

of its advantages like limited loss and unlimited profit by paying the small premiums.

FUNCTIONS OF DERIVATIVES MARKET:

The following are the various functions that are performed by the derivatives markets.

They are:

Prices in an organized derivatives market reflect the perception of market

participants about the future and lead the prices of underlying to the perceived

future level.

Derivatives market helps to transfer risks from those who have them but may not

like them to those who have an appetite for them.

Derivative trading acts as a catalyst for new entrepreneurial activity.

DR. L. C. GUPTA COMMITTEE RECOMMENDATIONS:

The securities and exchange board of India (SEBI) appointed with

Dr.L.C.Gupta as its chairman on 18th November, 1996 to develop regulatory frame

work for derivatives trading in India and to suggest buy-laws for regulation and

control of trading and settlement of derivatives contracts. The committee was also to

focus on the financial derivatives and equity derivatives. The committee submitted its

report in March 1998.

The committee recommended introduction of derivatives market in a phased

manner with the introduction of index futures and SEBI appointed a group with

Prof.J.R.Varma as its chairman to recommended measures for risk containment in the

derivative market in India.

The board of SEBI in its meeting held on may 11, 1998 accepted the

recommendation and approved the introduction of derivatives trading in India

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beginning with stock index futures. The board also approved the “suggestive bye-

laws” recommended by the L.C.Gupta committee for regulation and control of trading

and settlement of derivatives contracts. SEBI circulated the contents of the report in

June 1998.

The L.C.Gupta committee had conducted a wide market survey with contract

of several entities relevant to derivatives trading like brokers, mutual funds,

banks/FIIs, FIIs and merchant banks. The committee observation was that there is

widespread recognition of the needs for derivatives products including equity, interest

rate and currency derivatives products. However stock index future is the most

preferred product followed by stock index options. Options on individual stocks are

the third I the order of preference. The participants took interviews, mostly stated that

their objective in derivative trading would be hedging. But there were also a few

interested in derivatives dealing for speculation or dealing.

The recommendations of L.C.Gupta committee at a glance:

1. Stock index futures to be the starting point of equity derivatives.

2. SEBI to approve rules, buy-laws and regulations of the derivatives exchange level

regulations.

3. SEBI need not be involved in framing exchange level regulations.

4. SEBI should create a special derivatives cell as it involves special knowledge and

a derivatives advisory council may be created a tap outside exports for

independent advice.

5. Legal restrictions on institutions, including mutual funds, on use of derivatives

should be removed.

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6. Existing stock exchanges with cash trading to be allowed to trade derivatives if

they meet prescribed eligibility conditions-importantly a separate governing

council and at least 50 members.

7. Two categories of members – clearing members and non clearing members, with

the later depending on the former for settlement of trades. This is to bring in more

traders.

8. Broker members, dealers and salespersons in the derivatives market must have

passed a certificate program to be registered with SEBI.

9. Co-ordination between SEBI and the RBI of financial derivatives market must

have passed a certificate program registered with the SEBI.

10. Clearing corporation to be the centre piece of the derivative market, both for

implementing the margin systems and providing trade guarantee.

11. Minimum net worth requirement of Rs.3 crore for participants, maximum

exposure limits for each broker/dealer on gross basis and capital adequacy

requirement to be prescribed.

12. Mark to market margins to be collected before next day’s trading starts.

13. As a conservative measure, margins for derivatives purposes not to take into

account positions in cash and futures, market and across all stock exchanges.

14. Margin to be systematically collected and not left to discretion of brokers/dealers.

15. Much stricter regulation for derivatives as compared to cash trading.

16. Strengthen cash market with uniform settlement cycles among all SEs and

regulatory over weight.

17. Proper supervision of sales practices with regulation of every client with the

dealer/broker and risk disclosure as the corner stone.

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The Important Recommendations of L.C.Gupta Committee

Need for coordinated development

To quote from the report of the committee- “the committee’s main concerns is

with equity based derivatives but it has tried to examine the need for financial

derivatives in a broader perspective. Financial transactions and asset-liability

positions are exposed to three broad types of price risks, viz;

Equities, market risk, also called systematic risk (which can not be diversified

away because the stock market as a hole may up or down from time to time).

Interest rate risk (as in the case of fixed income securities, like treasury bond

holding, whose market price could fall heavily it interest rates shot up),and

Exchange rate risk (where the position involves a foreign currency, as in the

case of imports, exports, foreign loans or investments).

The above classification of price risk explains the emergence of

(a) equity futures, (b) interest rate futures, (c) currency futures, respectively. Equity

futures have been the last to emerge.

The recent report of the RBI appointed committee on capital account

convertibility (Tara pore Committee) has expressed the view that time is ripe for

introduction of futures in currencies and interest rates to facilitate various users to

have access to a wide spectrum of cost-efficient hedge mechanism. In the some

context, the Tara pore Committee has also opinioned that a system of trading in

futures….is more transparent and cost efficient than the existing system (of forward

contracts). Having a common trading infrastructure will have important advantages.

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The committee, therefore, feels that the attempt should be to develop an integrate

market structure.

SEBI-RBI co-ordination mechanism

As all the three types of financial derivatives are set to emerge in India in the

near future, it is desirable that such development be coordinated. The committee

recommends that a formal mechanism be established for such coordination between

SEBI and RBI in respect of all financial derivatives markets. This will help to avoid

the problem of overlapping jurisdictions.

Derivatives exchange

The committee strongly favored the introduction financial derivatives to

facilitate hedging in most cost-efficient way against market risk. There is a need for

equity derivatives, interest rate derivative and currency derivatives; there should be

phased introduction of derivatives products. To start with, index future to be

introduced, which should be followed by options on index and later options on stocks.

The derivative trading should take place on separate segment of the existing

stock exchanges with an independent governing council where the number of trading

members should be limited to 40 percent of the total number. Trading to be based on

online screen trading with disaster recovery site. Per half hour capacity should 4-5

times the anticipated peck load. Percentage of broker-member in the council to be

prescribed by the SEBI.

The settlement of derivatives to be through an independent clearing

corporate/clearing house, which should become counter party for all trades or

alternatively guarantee the settlement of all the trades. The clearing corporation to

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have adequate risk containment measures and to collect margins through EFT. The

derivative exchange to have both online trading and surveillance system. It should

disseminate trade and price information on real time basis through two information

vending networks. The committee recommended separate membership for derivatives

segment.

Specification regarding trading

Stock exchanges to stipulate in advance trading days and hours. Each contract

to have pre determined expiration date and time. Contract expiration period may not

exceed 12 months. The last trading day of the trading cycle to be stipulate in advance.

Membership eligibility criteria

The trading and clearing member will have stringent eligibility conditions.

The committee recommended for separate clearing and non-clearing members. There

should be separate registration with SEBI in addition to registration with stock

exchange.

Clearing corporation

The clearing system to be totally re-structured. There should be no trading

interests on board of CC. the maximum exposure limit to be liked to be deposit limit.

To make the clearing system effective the committee stressed stipulation of initial and

mark to market margins. Extent of margin prescribed to co-relate to the level of

volatility of particular .

Marked to Market settlement

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There should the system of daily settlement of futures contracts. Similarly the

closing price of futures to be settled on daily basis. The final settlement price to be as

per the closing price of underlying security.

Sales practices

Risk disclosure document with each client mandatory.

Sales person to pass certification exam.

Specific authorization from client’s board of directors/trustees.

Trading parameters

Each order- buy/sell and open/close

Unique order identification number

Regular market lot size, tick size

Gross exposure limits to be specified

Price bands for, each derivative contract

Maximum permissible open position

Off line order entry permitted

Brokerage

Prices on the system shall be exclusive of brokerage

Maximum brokerage rates shall be prescribed by the exchange

Brokerage to be separately indicated in the contracts note

Margins from Clients

Margins to be collected from all clients/trading members

Daily margins to be further collected

Losses if any to be charged clients/TMs and adjusted against margins

Other recommendations

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Removal of regulatory prohibition on the use of derivative by mutual funds while

making the trustees responsible to restrict the use of derivatives by mutual funds

only to hedging and portfolio balancing and not for speculation.

Creation of derivative cell, a derivative advisory committee, and economic

research wing by SEBI.

Derivatives Market

There are two types of derivative market:

1. Exchanged based market.

2. Over the counter (OTC) markets.

Exchanged based market and clearing houses

These markets are developed, highly organized and regulated by their own

owners who are usually traders. It is the exchange with decides on the

1. Standard units – currency, size maturity to be traded and the times when trading

begin and cease each day.

2. Rules of the clearing house through which all deals are routed.

3. Margin requirements that all members have to deposit with the clearing house to

ensure that the default is unlikely.

Mechanics of the markets

Example: In S&P 500 stock index futures contracts are tied to the standard

and Poor’s composite stock index. The futures have standard maturity and the

exchange prescribes rules for settlement of any outstanding contracts in cash on the

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expiration dates. In contrast, OTC derivatives are customized to meet the specific

needs of the counterparty. A financial swap is a good example of OTC derivative.

An important difference between exchange traded and OTC derivative is the credit

risk. In the OTC markets, one party is exposed to the risk that his counterparty may

default on the co

Market participants in DERIVATIVES

1. Hedgers use for protecting (risk-covering) against adverse movement.

Hedging is a mechanism to reduce price risk inherent in open positions. Derivatives

are widely used for hedging. A hedge can help lock in existing profits. Its purpose is

to reduce the volatility of a portfolio, by reducing the risk.

2. Speculators to make quick fortune by anticipating/forecasting future

market movements. Speculators wish to bet on future movements in the price of an

asset. Futures and options contracts can give them an extra leverage; that is, they can

increase both the potential gains and potential losses in a speculative venture.

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Speculators on the other hand arte those classes of investors who willingly take price

risks to profit from price changes in the underlying.

3. Arbitrageurs to earn risk-free profits by exploiting market imperfections.

Arbitrageurs profit from price differential existing in two markets by simultaneously

operating in the two different markets. Arbitrageurs are in business to take advantage

of a discrepancy between prices in two different markets.

Indian derivatives market

Indian derivatives market, through has a history of more than a century, is still

in its nascent stage vis-à-vis global derivatives market.

The first step towards development of derivatives markets in India is the

appointment of L.C.Gupta committee by SEBI to go into the question of derivatives

trading and to suggest various policy and regulatory measures that need to be

undertaken before such trading is formally allowed. We have today active derivative

markets in the segment of stock and foreign currency while trading in commodities is

in the process of stabilization. Stock market derivative have indeed picked up

momentum and the volumes under futures on individual stock have reached global

proportions. We have also well established OTC currency derivatives market. In a net

shall we may say that derivatives market in India an evolving phase.

Derivatives products

Derivatives are in fact as old as trading but their Dramatic rise in popularly

took place in the last thirty years. The breakdown of Breton woods system of fixed

exchange rates and the resulting volatility in forex markets put the derivative on a

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pedestal. The key reason for their popularly has been that derivatives such as futures

and options have indeed filed a gape in the financial system. Prier to their emergence,

there was no mechanism for that could protect to trades, banks, etc, from price risk.

Secondly, they are highly flexible and thus have a universal applicability.

For instance, stock market index futures provide insurance against stock price risk due

to market fluctuations, while currency futures provide insurance against price risk due

to exchange rate fluctuations.

All derivatives can be classified based on the following features:

1. Nature of contracts

2. Underlying assets

3. Market mechanism

Underlying assets: Most derivatives are based on one of the following four types of

assets:

Foreign exchange

Interest being financial assets

Commodities (grain, coffee, cotton, wool, etc.)

Equities

Precious metals (gold, silver, copper, etc.)

Bonds of all types

Market mechanism:

OTC products

Exchange traded products

Role of clearing house

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A clearing house is a key institution in the derivatives market. It performs two

critical functions. Offering customer’s deals and assuring the financial integrity of the

transactions that take place in the exchange. The clearing house could be a part of the

exchange of a separate body coordinating with the exchange.

Trading in derivatives

Indian securities markets have indeed waited for too long for derivatives

trading to emerge. Mutual funds, FIIs, and other investors who are deprived of

hedging opportunities will now have a derivatives market to bank on. First to change

are the globally popular variety – index futures.

While derivatives markets flourished in the developed world Indian markets

remain deprived of financial derivatives to the beginning of this millennium. While

the rest of the world progressed by the leaps and the bonds on the derivatives front,

Indian market lagged behind. Having emerged in the market of the developed nations

in the 1970s, derivatives market grew from strength to strength. The trading volumes

nearly doubled in every three years making it a trillion-dollar business. They become

so ubiquitous that, now one cannot think of the existence of financial markets without

derivatives.

Two board approaches of SEBI is to integrate the securities market at the

national level, and also to diversify the trading banks, financial institutions, insurance

companies, mutual funds, primary dealers etc, choose to transact through the

exchanges.

In this context the derivatives through Indian stock exchanges permitted by SEBI in

2000 AD is real landmark.

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SEBI first appointed the L.C.Gupta committee in 1998, to recommend the

regulatory frame work for derivatives recommended suggestive buy-laws for

regulation and control of trading and settlements of derivatives contracts. The board

of SEBI in its meeting held on May 11, 1998 accepted the recommendations of the

Dr.L.C.Gupta, committee and approved the phased introduction of derivatives trading

in India beginning with stock index futures. The board also approved the “suggestive

Bye-laws” recommended by the committee for regulation and control of trading and

settlement of derivatives contracts.

SEBI subsequently the J.R.Varma committee to recommended risk

containment measures in the Indian stock index futures market. The report was

submitted in the same year (1998) in the month of November by the said committee.

Derivatives market today:

Foreign currency options in currency pairs other than rupee were the first

options permitted by RBI.

The RBI has permitted options, interest rate swaps, currency swaps, and other

risk reduction OTC derivative products.

Beside the forward market to currencies has been a vibrant market in India for

several decades.

In addition the forward markets commission has allowed the setting up of

commodities futures exchanges. Today we have 18 commodities exchanges most of

which trade futures e.g. the Indian Paper and Spice Trader Association (IPSTA) and

the Coffee Owners Futures Exchange of India (COFEI).

The year 2000 heralded the introduction of exchange traded equity derivative

products.

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DERIVATIVES

OPTIONS FUTURES SWAPS FORWARDS

PUT OPTION

CALL OPTION

COMMODITY

SECURITY

INTEREST RATE

CURRENCY

TYPES OF DERIVATIVES

There are four most commonly traded derivative instruments: Forwards,

Futures, Options, and Swaps. Futures and options are actively traded on many

exchanges. Forward contracts and swaps and certain kind of options are mostly traded

as over the counter (OTC) products.

Derivative products initially emerged as hedging devices against fluctuations in

commodity prices, and commodity-linked derivatives remained the sole form of such

products for almost three hundred years. Financial derivatives came into spotlight in

the post-1970 period due to growing instability in the financial markets. However,

since their emergence, these products have become very popular and by 1990s, they

accounted for about two-thirds of total transactions in derivative products, in recent

years, the market for financial derives has grown tremendously in terms of variety of

instruments depending on their complexity and also turnover. In this class of equity

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derivatives the world over, futures and options on stock indices have gained more

popularity than on individual stocks, especially among institutional investors, who are

major users of index-linked derivatives. Even small investors find these useful due to

high correlation of the popular indices with various portfolios and ease of use. The

lower costs associated with index derivatives vis-à-vis derivative products based on

individual securities is another reason for their growing use.

The most commonly used derivatives contracts are forwards, futures and options.

Here we take a brief look at various derivatives contracts that have come to be used

CLASSIFICATION OF DERIVATIVES:

1. ETF (Exchange Traded Fund)

2. OTF ( Out Side Traded Fund)

ETF (Exchange Traded Fund):

An exchange-traded fund (or ETF) is an investment vehicle traded on stock

exchanges, much like stocks. An ETF holds assets such as stocks or bonds and trades

at approximately the same price as the net asset value of its underlying assets over the

course of the trading day.

Futures

Options

OTF (Out Side Traded Fund):

An Outside traded fund (or OTF) is an investment vehicle traded out side or at

the counter much like stocks. The net asset value of its underlying assets over

the course of the trading day may change.

Forwards

Swaps

Warrants

Leaps

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http://en.wikipedia.org/wiki/Net_asset_value

http://en.wikipedia.org/wiki/Stocks

http://en.wikipedia.org/wiki/Collective_investment_scheme

http://en.wikipedia.org/wiki/Net_asset_value

http://en.wikipedia.org/wiki/Stocks

http://en.wikipedia.org/wiki/Stock_exchange

http://en.wikipedia.org/wiki/Stock_exchange

http://en.wikipedia.org/wiki/Collective_investment_scheme

Baskets

FORWARDS:

A forward contract is a customized contract between two entities, where

settlement takes place on a specific date in the future at today’s pre-agreed price.

FUTURES

A futures contract is an agreement between two parties to buy or sell an asset

at a certain time in the future at a certain price. Futures contracts are special types

forward contracts in the sense that the former are standardized exchanged-traded

contracts.

OPTIONS:

Options are of two types - calls and puts. Calls give the buyer the right but not

the obligation to buy a given quantity of the underlying asset, at a given price on or

before a given future date. Puts give the buyer the right, but not the obligation to sell a

given quantity of the underlying asset at a given price on or before a given date.

WARRANTS:

Options generally have lives of up to one year; the majority of options traded

on options exchanges having a maximum maturity of nine months. Longer-dated

options are called warrants and are generally traded over-the-counter.

LEAPS:

The acronym LEAPS means Long-Term Equity Anticipation Securities. These

are options having a maturity of up to three years.

25

BASKETS:

Basket options are options on portfolios of underlying assets. The underlying

asset is usually a moving average of a basket of assets. Equity index options are a

form of basket options.

SWAPS:

Swaps are private agreements between two parties to exchange cash flows in

the future according to a prearranged formula. They can be regarded as portfolios of

forward contracts.

The two commonly used swaps are:

Interest rate swaps:

These entail swapping only the interest related cash flows between the

Parties in the same currency.

Currency swaps:

These entail swapping both principal and interest between the parties,

with the cash flows in one direction being in a different currency than those in the

opposite Direction.

SWAPTIONS:

Swaptions are options to buy or sell a swap that will become operative at the

expiry of the options. Thus a swaption is an option on a forward swap. Rather than

have

calls and puts, the swaptions market has receiver swaptions and payer swaptions.

26

REGULATORY FRAMEWORK:

The trading of derivatives is governed by the provisions contained in the SCRA,

the SEBI Act, the rules and regulations framed there under and the rules and bye-

laws of stock exchanges.

Securities contracts Regulation Act, 1956:

SCRA aims at preventing undesirable transactions in securities by regulating the

business of dealing therein and by providing for certain other matters connected

therewith. This is the principal Act, which governs the trading of securities in

India. The term “securities” has been defined in the SCRA. As per section 2(h),

the ‘securities’ include:

1. Shares, scrip’s, stocks, bonds, debentures, debenture stock or other marketable

securities of a like nature in or of any incorporated company or other body

corporate.

2. Derivative

3. Units or any other instrument issued by any collective investment scheme to

the investors in such schemes

4. Government securities

5. Such other instruments as may be declared by the Central Government to be

securities

6. Rights or interests in securities.

“Derivative” is defined to include:

27

A security derived from a debt instrument, share and loan whether secured

or unsecured, risk instrument or contract for differences or any other form

of security.

A contract which derives its value from the prices or index of prices, of

underlying securities.

Section 18A provides that notwithstanding anything contained in any other

law for the time being in force, contracts in derivatives shall be legal and

valid if such contracts are:

Traded on a recognized stock exchange settled on the clearinghouse of the

recognized stock exchange, in accordance with the rules and byelaws of such

stock exchanges

Securities and exchange board of India act, 1992:

SEBI act, 1992 provides for establishment of securities and exchange board of

India (SEBI) with statutory powers for (a) protecting the interests of investors in

securities (b) Promoting the development of the securities market and (c)

regulating the securities market. Its regulatory jurisdiction extends over corporate

in the issuance of capital and transfer of securities, in addition to all intermediaries

and persons associated with securities market. SEBI has been obligated to

perform the aforesaid functions by such measures as it thinks fit.

In particular, it has powers for:

Regulating the business in stock exchanges and any other securities markets.

Registering and regulating the working of stockbrokers, sub broker etc.

Promoting and regulating self-regulatory organizations.

Prohibiting and fraudulent and unfair trade practices.

28

Calling information from, undertaking inspection, conducting inquiries and

audits the stock exchanges, mutual funds and other persons associated with the

securities marker and intermediaries and self-regulatory organizations in the

securities market performing such functions and exercising according the

securities contracts (regulation) act, 1956, as may be delegated to it by the central

government.

SEBI (stock brokers and sub-brokers) regulations, 1992:

In this we shall have a look at the regulations that apply to brokers under the SEBI

regulations.

Brokers

A broker is an intermediary who arranges to buy and sell securities on behalf of

clients (the buyer and the seller). According to Section 2(e) of the SEBI

(stockbrokers and sub-brokers) rules 1992, s Stock Broker means a member of a

recognized stock exchange.

No stockbroker is allowed to buy, sell or deal in securities, uses he or she holds a

certificate of registration granted by SEBI through a stock exchange of which he or

she is admitted as a member. SEBI may grant a certificate to a stock-broker (as per

SEBI rules, 1992) subject to the conditions that:

1. He holds the membership of any stock exchange:

2. He shall abide by the rules, regulations and byelaws of the stock exchange or

stock exchanges of which he is a member.

3. In case of any change in the status and condition, he shall contain prior

permission of SEBI to continue to buy, sell or deal in securities in any stock

exchange;

29

4. He shall pay the amount of fees for registration in the prescribed manner; and

5. HE shall take adequate steps for redress of grievances of the investors within

one month of the date of the complaint and keep SEBI informed about the

number, nature and other particulars of the complaints.

As per SEBI (stock brokers and sub-brokers) regulations, 1992, SEBI shall

take into account for considering the grant of a certificate all matters relating to

buying, selling, or dealing in securities and in particular the following, namely

whether the stockbroker-(a) is eligible to be admitted as a member of a stock

exchange; (b)has the necessary infrastructure like adequate office space, equipment

and man power to effectively discharge his activities; (c) has any past experience in

the business of buying selling or dealing in securities; (D) is subjected to disciplinary

proceedings under the rules, regulations and bye-laws of a stock exchange with

respect to his business as a stock-brokers involving either himself or any of his

partners, directors or employees.

Regulations for derivatives trading:

SEBI set up a 24-member committee under the chairmanship of Dr.L.C.Gupta to

develop the appropriate regulatory framework for derivatives trading in India. The

committee submitted its report in March 1998. On May 11, 1998 SEBI accepted the

recommendations of the committee and approved the phased introduction of

derivatives trading in India beginning with tock index futures. SEBI also approved

the “suggestive bye-laws” recommended by the committee for regulation and

“suggestive bye-laws” recommended by the committee for regulation and control of

trading and settlement of derivatives contracts.

30

The provisions in the SC(R) A and regulatory framework developed there

under govern trading in securities.

The amendment of the SC(R)A to include derivatives within the ambit of

‘securities’ in the securities in the SC(R)A made trading in derivatives

possible within the framework of that Act.

Any Exchange fulfilling the eligibility criteria as prescribed in the L.C.

Gupta committee report may apply to SEBI for grant of recognition under

section 4 of the SC(R) A, 1956 to start trading derivatives. The derivatives

exchange/segment should huge a separate governing council and

representation of trading/clearing members shall be limited to maximum of

40% of the total members of the governing council. The exchange shall

regulate the sales practice of its members and will obtain prior approval of

SEBI before start of trading in any derivative contact.

The Exchange shall have minimum 50 members.

The members of an existing segment of the exchange will not

automatically become the members of the derivative segment need to

fulfill the eligibility conditions as laid down by the L.C.Gupta committee.

The clearing and settlement of derivatives trades shall be through a SEBI

approved clearing corporation/house. Clearing corporations/houses

complying with the eligibility conditions laid down by the committee have

to apply SEBI for grant of approval.

Derivative brokers/dealers and clearing members are required to seek

registration from SEBI. This is in addition to their registration a brokers of

existing stock exchanges.

31

The minimum net worth for clearing members of the derivatives clearing

corporation/house shall be Rs.300 lakhs. The net worth of the member

shall be computed as follows:

Capital Free reserves

Less non-allowable assets viz,

(a) Fixed assets

(b) Pledged securities

(c) Member’s card

(d) Non-allowable securities (unlisted securities)

(e) Bad deliveries

(f) Doubtful debts and advances

(g) Prepaid expenses

(h) Intangible assets

(i) 30% marketable securities

The minimum contract value shall not be less than Rs.2lakhs. Exchanges

should also submit details of the futures contract they propose to introduce.

The initial margin requirement exposure limits linked to capital adequacy

and SEBI/Exchange shall prescribe margin demands related to the risk of

loss on the position from time to time.

The L.C.Gupta committee report requires strict enforcement of “Know

you customer” rule and requires that every client shall be registered with

the derivatives broker. The members of the derivatives segment are also

required to make their clients aware of the risks involved in derivatives

trading by issuing to the client the Risk Disclosure Document and obtain a

copy of the same duly signed by the client.

32

The trading members are required to have qualified approved user and

sales person who have passed a certification program me approved by

SEBI.

REGULATION FOR CLEARING AND SETTLEMENT:

1) The L.C.Gupta committee has recommended that the clearing corporation

should interpose itself between both legs of every trade, becoming the legal

counter party to both or alternati9vely should provide an unconditional

guarantee for settlement of all trades.

2) The clearing corporation should ensure that none of the Board members has

trading interests.

3) The definition of net-worth as prescribed by SEBI needs to be incorporated in

the application/regulations of the clearing corporation

4) The regulations relating to arbitration need to be incorporated in the clearing

corporation’s regulations.

5) The clearing corporation in its regulations must incorporate specific

provision/chapter relating to declaration of default.

6) The regulations relating to investor protection fund for the derivatives market

must be included in the clearing corporation application/regulations.

7) The clearing corporation should have the capabilities to segregate upfront

initial margins deposited by clearing members for trades on their own account

and on account of his clients. The clearing corporation shall hold the clients’

margin money in trust for the clients’ purposes only and should not allow its

diversion for any other purpose. This condition must be incorporated in the

clearing corporation regulations

33

8) The clearing member shall collect margins from his constituents

(client/trading members). He shall clear and settle deals in derivative

contracts on behalf of the constituents only on the receipt of such minimum

margin.

9) Exposure limits based on the value at its risk concept will be used and the

exposure limits will be continuously monitored. These shall be within the

limits prescribed by SEBI from time to time.

10) The clearing corporation must lay down a procedure for periodic review of

the new worth of its members.

11) The clearing corporation must inform SEBI how it reposes to monitor the

exposure of its members in the underlying market.

12) Any changes in the byelaws, rules or regulations, which are covered under the

“suggestive bye-laws for regulations and control of trading and settlement of

derivatives contracts”, would require prior approval of SEBI.

Product specifications BSE-30 Sensex Futures:

Contract Size -Rs.50 times the Index

Tick size – 0.1 points or Rs.5

Expiry day – last Thursday of the month

Settlement basis – cash settled

Contract cycle – 3 months

Active contracts – 3 nearest months

Product Specifications S&P CNX Nifty Futures:

Contract Size – Rs.200 times the Index

Tick Size – 0.05 points or Rs.10

Expiry day – last Thursday of the month

34

Settlement basis – cash settled

Contract cycle - 3 month

Active contracts – 3 nearest months

Membership:

Membership for the new segment in both the exchanges is not automatic

and has to be separately applied for:

Membership is currently open on both the exchanges.

All members will also have to be separately registered with SEBI before

they can be accepted.

Membership Criteria – National Stock Exchange (NSE)

Clearing Member (CM)

Net worth Rs.300 lakhs

Interest-Free Security Deposits – Rs.25 lakhs

Collateral Security Deposit – Rs.25 lakhs

In addition for every TM he wishes to clear for the CM has to deposit Rs.10 lakhs.

Trading Member (TM)

Net worth – Rs.100 lakhs

Interest-Free Security Deposit – Rs.8 lakhs

Annual Subscription fees – Rs.1 lakh

Membership Criteria – Mumbai Stock Exchange (BSE)

Clearing Member (CM)

Net worth – 300 lakhs

Interest-Free Security Deposit – Rs.25lakhs

Collateral Security Deposit – Rs.25 lakhs

35

Non-refundable Deposit – Rs.5 lakhs

Annual Subscription Fees – Rs.50, 000.

In addition for every TM he wishes to clear for the CM has to deposit Rs.10 lakhs

with the following break-up.

i. Cash – Rs.25 lakhs

ii. Cash Equivalents – Rs.25 lakhs

iii. Collateral Security Deposit – Rs.5 lakhs

Trading Member (TM)

Net worth – Rs.50 lakhs

Non-refundable deposit – Rs.3 lakhs

Annual Subscription Fees – Rs.25 thousand

The Non-refundable fee paid by the members is exclusive and will be a

total of Rs.8 lakhs if the member has both clearing and trading rights.

TRADING SYSTEMS:

NSE’s trading system for its futures and options segment is called NEAT

F&O. It is based on the NEAT system for the cash segment.

BSE’s trading system for its derivatives segment is called DTs. It is built

on a platform different from the BOLT system though most of the features

are common.

36

RISK MANAGEMENT by using DERIVATIVES:

Derivatives are high-risk instruments and hence the exchanges have put a lot of

measures to control this risk. The most critical aspect of risk management is the daily

monitoring of price and position and the margining of those positions.

NSE used the SPAN (Standard Portfolio Analysis of Risk). SPAN is a system that

has origins at the Chicago mercantile exchange, one of the oldest derivative

exchanges in the world.

The objective of SPAN is to monitor the positions and determine the maximum loss

that a stock can incur in a single day. This loss is covered by the exchange by

imposing mark to market margins.

SPAN evaluates risk scenarios, which are nothing but market conditions. The specific

set of market conditions evaluated, are called the risk scenarios, and these are defined

in terms of

a) How much the price of the underlying instrument is expected to change

over one trading day, and

b) How much the volatility of that underlying price is expected to change

over one trading day?

Based on the SPAN measurement, margins are imposed and risk covered. Apart from

this, the exchange will have a minimum base capital of Rs.50 lakhs and brokers need

to pay additional base capital if they need margins about the permissible limits.

37

LOT SIZES OF CONTRACTS:

Underlying Symbol Market Lot

S&P CNX Nifty Nifty 100

CNX IT CNX IT 100

Bank Nifty BANK NIFTY 100

Derivatives on Individual Securities:

Underlying Symbol Market Lot

ABB Ltd. ABB 100Associated cement Co. Ltd ACC 375Allahabad Bank ALBK 2450Alok Industries Ltd. ALOKTEXT 3350Andhra Bank ANDHRABANK 2300Arvind Mills Ltd. ARVINDMILL 4300Ashok Leyland Ltd. ASHOKLEY 4775Aurobindo pharma Ltd. AUROPHARMA 350Bajaj Auto Ltd. BAJAJAUTO 100Bank Of Baroda BANKBARODA 1400Bank of India BANKINDIA 1900Bharat Electronics Ltd. BEL 275Bharti Tele-Ventures Ltd. BHARTI 1000Bharat Heavy Electricals Ltd. BHEL 150Ballarpur Industries Ltd. BILT 1900Bongaigaon Refinery Ltd. BONGAIREFN 4500Bharat Petroleum Corporation Ltd. BPCL 1100Canara Bank CANBK 1600Century Textiles Ltd. CENTURYTEX 425CESC Ltd. CESC 550Chambal fertilizers Ltd. CHAMBALFERT 6900Chennai Petroleum Corp Ltd. CHENNPETRO 900Cipla Ltd. CIPLA 1250Colgate Palmolive (I) Ltd. COLGATE 525Corporation Bank CORPBANK 1200Cummins India Ltd. CUMMINSIND 950

38

Dabur India Ltd. DABUR 2700Divi’s Laboratories Ltd. DIVISLAB 250Dr. Reddy’s Laboratories Ltd. DRREDDY 400Escorts India ltd. ESCORTS 2400Essar Oil Ltd. ESSAROIL 5650Federal Bank Ltd. FEDERALBNK 1300GAIL (INDIA) Ltd. GAIL 750Great Eastern Shipping Co.Ltd. GESHIPPING 600GlaxoSmithKline Pharma Ltd. GLAXO 300Gujarat Narmada Fertilizer Co. Ltd. GNFC 2950Grasim Industries Ltd. GRASIM 175Gujarat Ambuja Cement Ltd. GUJAMBCEM 2062HCL Technologies Ltd HCLTCH 650Housing Development Finance Corporation Ltd.

HDFC 150

HDFC Bank Ltd. HDFCBANK 200Hero Honda Motors Ltd. HEROHONDA 400Hindalco Industries Ltd. HINDALCO 1595Hindustan Lever Ltd. HINDLEVER 1000Hindustan Petroleum Corporation Ltd. HINDPETRO 1300ICICI Bank Ltd. ICICIBANK 350I-FLEX Solutions Ltd. I-FLEX 150Industrial Development Bank Of India Ltd. IDBI 2400Infrastructure Development Finance Co. Ltd.

IDFC 2950

IFCI Ltd. IFCI 7875Indian Hotels Co.Ltd. INDHOTEL 1750India Cements Ltd. INDIACEM 1450Indusind Bank Ltd. INDUSINDBK 3850Infosys Technologies Ltd. INFOSYSTCH 200Indian Petrochemicals Corp. Ltd IPCL 1100Indian Over Seas Bank IOB 2950Indian Oil Corp Ltd. IOC 600ITC Ltd. ITC 1125IVRCL Infrastructure & Projects Ltd. IVRCLINFRA 500J & K Bank Ltd. J&KBANK 300Jet Airways (INDIA) Ltd. JETAIRWAYS 400Jindal Steel & Power Ltd. JINDALSTEL 125Jaiprakash HyDro-Power Ltd. JPHYDRO 6250Jindal Stainless Ltd. JSTAINLESS 2000The Karnataka Bank Ltd. KTKBANK 1250LIC Housing Finance Ltd. LICHSGFIN 1700MahinDra & MahinDra Ltd. M&M 625Maharashtra Seamless Ltd. MAHSEAMLES 600Marti Udyog Ltd. MARUTI 400Matrix Laboratories Ltd. MATRIXLABS 1250Mphasis BFL Ltd. MPHASISBFL 800Mangalore Refinery and Petrochemicals MRPL 8920

39

Ltd.Mahanagar Telephone Nigam Ltd. MTNL 1600Nagarjuna Fertilizers & Chemicals Ltd. NAGARFERT 14000National Aluminum Co. Ltd. NATIONALUM 1150NDTV Ltd. NDTV 1100Neyveli Lignite Corporation Ltd. NEYVELILIG 5900Nicolas Piramal India Ltd. NICOLASPIR 1045National Thermal Power Corp. Ltd. NTPC 1625Oil & Natural Gas Corp. Ltd. ONGC 225Orchid Chemicals Ltd. ORCHIDCHEM 1050Oriental Bank Of Commerce ORIENTBANK 1200Patni Computer System Ltd. PATNI 650Punjab National Bank PNB 600Punjab Lloyd Ltd. PUNJLLOYD 1500Polaris Software Lab Ltd. POLARIS 1400Ranbaxy Laboratories Ltd. RANBAXY 800Reliance Energy Ltd. REL 550Reliance Capital Ltd. RELCAPITAL 550Reliance Industries Ltd. RELIANCE 150Satyam Computer Services Ltd. SATYAMCOMP 600State Bank Of India SBIN 250Shipping Corporation Of India Ltd. SCI 1600Siemens Ltd. SIEMENS 375SRF Ltd. SRF 1500Strides Arcolab Ltd. STAR 850Sterlite Industries (I) Ltd. STER 875Sun Pharmaceuticals India Ltd. SUNPHARMA 225Suzlon Energy Ltd. SUZLON 200Syndicate Bank SYNDIBANK 3800Tata Chemicals Ltd. TATACHEM 1350Tata Consultancy Services Ltd. TCS 250Tata Motors Ltd. TATAMOTORS 412Tata Power Co. Ltd TATAPOWER 400Tata Steel Ltd. TATASTEEL 675Tata Tea Ltd. TATATEA 275Titan Industries Ltd. TITAN 411TVS Motor Company Ltd. TVSMOTOR 2950Union Bank Of India UNIONBANK 2100UTI Bank Ltd. UTIBANK 450Vijaya Bank VIJAYABANK 6900Videsh Sanchar Nigam Ltd. VSNL 525Wipro Ltd. WIPRO 600Wockhardt Ltd. WOCKPHARMA 600

LOT SIZES OF SELECTED COMPANIES FOR ANALYSIS

CODE LOT SIZE COMPANY NAME

40

DRREDDY400

Dr.Reddy`s Pharmaceuticals Ltd.

INFOSYSTCH 200Infosys Technologies Ltd.

The following tables explain about the trades that took place in futures and options

between 05/05/2008 and 10/06/2008. The table has various columns, which explains

various factors involves in derivatives trading.

Date – the day on which trading took place

Closing premium – premium for the day

Open interest – No. of Options that did not get exercised

Traded quantity – No. of futures and options traded on that day

N.O.C – No. of contacts traded on that day

Closing price – the price of the futures at the end of the trading day.

41

1 REVIEW OF LITERATURE

Futures and options represent two of the most common form of derivatives.

Derivatives are financial instruments that derive their value form an underlying .The

underlying can be a stock issued by a company a currency gold etc., the derivative

instruments can be traded in dependently of the underlying asset.

- -

PRASANNACHANDRA

A “future contract is an agreement between two parties to buy or sell an asset at a

certain time in the future at a certain price”

Options are of two types CALL and PUT.

CALL option gives the buyer the right but not the obligation to buy a given quantity.

PUT option given the buyer the right but not the obligation to sell the given quantity.

-V.A AVADHNI

With options and futures, trades can construct strategies that profit in advancing

declining are even stable markets, while that the same time reducing risk and

increasing leverage, How ever before you incorporate options into your trading and

risk management decisions you should thoroughly investigate the risk, nomenclature

and strategic uses of these instruments.

-J.C VANHORN

Today options and futures contracts offer a wide and diverse range of potentially

attractive investment opportunities. Futures contracts have been traded on us

exchange, since 1865 options and futures contracts were not introduced until

1982.Futures and options provide you with a basic understanding of option on futures

42

contract what they are how they work and opportunities and risks involved in trading

them. -B.BANERJEE

The best policy for futures and options contracts on the values of which are derived

rational restrictions generally involve premature exercise and a model is developed

for valuing options and futures. Contracts in a constant interest rare setting. Another

model is developed for valuing options with stochastic interest rate with it shown that

the pricing errors resulting from ignoring the location if interest rate relative to its

long run.

-SUDHARSAN RAMASWANY KRISHNA

In the futures and options market an open contract means any contact. Future or a Put

or a Call that has not been exercised closed or expired. The daily settlement price of

future contract is calculated as half an hour weighted average options on individual

securities have intermediate settlement and final settlement.

-SUDHARSHAN REDDY

In the simplest form, both options and futures are insurance against events that may or

may not happen in the future. In their most complex forms options and futures are not

only an insurance against future events but also highly speculative and very risky

investments instruments, For their reason they should not be traded by those who have

a basic understanding of how the stock market work.

-CHANDRA BOSE

Futures and options are forms of exchange regulated forward trading in which you

enter in to a transaction today, the settlement of which is scheduled to take place at

the future date expiry of the contract the settlement data is called future contract.

-KHAN & JAIN

43

INDUSTRY PROFILE

BOMBAY STOCK EXCHANGE

This stock exchange, Mumbai, popularly known as “BSE” was established in

1875 as “The Native share and stock brokers association” as a voluntary non-profit

Making association. It has an evolved over the year into its present status as the

premiere Stock exchange in the country .it may be noted that the stock exchange the

oldest one in Asia, even older than the Tokyo stock exchange, which was founded in

1878.

The exchange, while providing an efficient and transparent market for trading in

securities, upholds the interests of the investors and insurers dressed of their

grievances, whether against the companies or its own member brokers. It also strives

to educate and enlighten the investors by making available necessary informative

inputs and conducting investor education programmers.

A governing board comprising of 9 elected directors, 2 SEBI nominees, 7

public representatives and an executive director is the apex body, which decides the

policies and regulates the affairs of the exchange.

The executive’s directors as the chief executive officer are responsible for the

day today administration of the exchange. The average daily turnover of the exchange

during the year 2000-01(April-March) was Rs 3984.19 corers and average number of

Daily trades 5.69 lakes.

However the average daily turnover of the exchange during the year 2001-02

has declined to R s. 1244 .10 cores and number of average daily trades during the

period to 5.17 lakes.

44

The average daily turnover of the exchange during the year 2002-03 has

declined and number of average daily trades during the period is also decreased.

The Ban on all deferral products like BLESS AND ALBM in the Indian

capital markets by SEBI with effect from July 2, nd2001, abolition of account period

settlements, introduction of compulsory rolling settlements in all scripts traded on the

exchange with effect from Dec 31, 2001, etc., have adversely imprecated the liquidity

and consequently there is a considerable decline in the daily turnover of the exchange

present scenario is 110363 (laces) and number of average daily trades 1075 (laces).

BSE INDICES:

In order to enable the market participants, analysts etc., to track the various

ups and downs in the Indian stock market, the exchange has introduced in 1986 an

equity stock index called BSE- SENSEX that subsequently became the barometer of

the movements of the share prices in the Indian stock market. It is a “Market

capitalization weighted” index of 30 component stocks representing a sample of large,

well-established and leading companies. The base year of sensex is 1978-79. The

sensex is widely reported in both domestic and international markets through print as

well as electronic media.

Sensex is calculated using a market capitalization weighted method. As per this

methodology, the level of the index reflects the total market value of all 30-

component stocks from different industries related to particular base period. The total

market value of a company is determined by multiplying the price of its stocks by the

number of shares outstanding. Statisticians call an all index of a set of combined

variables (such as price and number of shares) a composite index. An indexed number

45

is used to represent the results of this calculation in order to market the value easier to

work with and track over a time. It much easier to graph a chart based on indexed

values than one based on actual values world over majority of the well-known indices

are constructed using “Market capitalization weighted method”.

In practice, the daily calculation of SENSEX is done by dividing the

aggregate market value of the 30 companies in the index by a number called the index

Divisor. The Divisor is the only link to the original base period value of the SENSEX.

The Divisor Keeps the Index comparable over a period or time and if the reference

point for the entire index maintenance adjustments. SENSEX is widely used to

describe the mood in the Indian stock markets. Base year average is changed has per

the formula new base year average =old base year average *(new market value/old

market value).

1.1.1.1.1.1 NATIONAL STOCK EXCHANGE

The NSE was incorporated in Now 1992 with an equity capital of R s 25 crs.

The international securities consultancy (ISC) of Hong Kong has helped in setting up

NSE. ISE has prepared the detailed business plans and installation of hardware and

software systems. The promotions for NSE were financial institutions, insurances

companies, banks and SEBI capital market Ltd, infrastructure leasing and financial

services ltd and stock holding corporation ltd.

It has been set up to strengthen the move towards professionalization of the

capital market as well provided nationwide securities trading facilities to investors.

NSE is not an exchange in the traditional sense where brokers own and

manage the exchange. A two tier administrative set up involving a company board

and a governing aboard of the exchange envisaged. NSE is a national market for

46

shares PSU bonds, debentures and government securities since infrastructure and

trading facilities are provided.

NSE-NIFTY:

The NSE on April 22, 1996 launched a new equity index. The NSE-50. The

new index, which replaces the existing NSE-100 index, is expected, to serve as an

appropriate index for the new segment of futures and options.” Nifty” means national

index for fifty stocks.

The NSE-50 comprises 50 companies that represent 20 broad industry groups

with an aggregate market capitalization of around R s .1 70,000 crs. All companies

included in the index have a market capitalization in excess of R s 500 crs each and

should have traded for 85% of trading days at an impact cost of less than 1.5%.

The base period for the index is the close of prices on Nov 3, 1995, which

makes one year of completion of operation of NSE‘s capital market segment. The

base value of the index has been set at 1000.

NSE –MIDCAP INDEX:

The NSE madcap index or the junior nifty comprises 50 stocks that represent

21 a board industry groups and will provide proper representation of the madcap

segment of the Indian capital market. All stocks in the index should have market

capitalization of greater than R s list of 200 cores and should have traded 85% of the

trading days at an impact cost of less 2.5%.

47

The base period for the index is Nov 4, 1996, which signifies two years for

completion of operations of the capital market segment of the operations. The base

value of the Index has been set at 1000.

INDUSTRY PROFILE

HISTORY OF STOCK EXCHANGES:

The only stock exchanges operating in the 19 th century were those of

Mumbai setup in 1875 and Ahmedabad set up in 1894. These were organized as

voluntary non-profit-marking associations of brokers to regulate and protect their

interests. Before the control on securities under the constitution in 1950, it was a

state subject and the Bombay securities contracts (control) act of 1925 used to

regulate trading in securities. Under this act, the Mumbai stock exchange was

recognized in 1927 and Ahmedabad in 1937. During the war boom, a number of

stock exchanges were organized. Soon after it became a central subject, central

legislation was proposed and a committee headed by A.D.Gorwala went into the

bill for securities regulation. On the basis of the committee’s recommendations

and public discussion, the securities contract (regulation) act became law in 1956.

FUNCTIONS OF STOCK EXCHANGES:

Stock exchanges provide liquidity to the listed companies. By giving quotations to

the listed companies, they help trading and raise funds from the market. Over the

hundred and twenty years during which the stock exchanges have existed in this

country and through their medium, the central and state government have raised

48

crores of rupees by floating public loans. Municipal corporations, trust and local

bodies have obtained from the public their financial requirements, and industry,

trade and commerce- the backbone of the country’s economy-have secured capital

of crores of rupees through the issue of stocks, shares and debentures for financing

their day-to-day activities, organizing new ventures and completing projects of

expansion, diversification and modernization. By obtaining the listing and trading

facilities, public investment is increased and companies were able to raise more

funds. The quoted companies with wide public interest have enjoyed some

benefits and assets valuation has become easier for tax and other purposes.

VARIOUS STOCK EXCHANGES IN INDIA:

At present there are 23 stock exchanges recognized under the securities contracts

(regulation), Act, 1956. Out of these major two Stock Exchanges are:

1. NSE (National Stock Exchange)

2. BSE (Bombay Stock Exchange)

NSE (National Stock Exchange):

The National Stock Exchange of India Limited has genesis in the

report of the High Powered Study Group on Establishment of New Stock

Exchanges, which recommended promotion of a National Stock Exchange by

financial institutions (FI’s) to provide access to investors from all across the

country on an equal footing. Based on the recommendations, NSE was promoted

49

by leading Financial Institutions at the behest of the Government of India and was

incorporated in November 1992 as a tax-paying company unlike other stock

exchanges in the country. On its recognition as a stock exchange under the

Securities Contracts (Regulation) Act, 1956 in April 1993, NSE commenced

operations in the Wholesale Debt Market (WDM) segment in June 1994. The

Capital Market (Equities) segment commenced operations in November 1994 and

operations in Derivatives segment commenced in June 2000.

NSE's mission is setting the agenda for change in the securities markets in India.

The NSE was set-up with the main objectives of:

Establishing a nation-wide trading facility for equities and debt instruments.

Ensuring equal access to investors all over the country through an

appropriated communication network.

Providing a fair, efficient and transparent securities market to investors using

electronic trading systems.

Enabling shorter settlement cycles and book entry settlement systems, and

Meeting the current international standards of securities markets.

The standards set by NSE in terms of market practices and technology, have

become industry benchmarks and are being emulated by other market participants.

NSE is more than a mere market facilitator. It's that force which is guiding the

industry towards new horizons and greater opportunities.

BSE (Bombay Stock Exchange):

The Stock Exchange, Mumbai, popularly known as "BSE" was established in

1875 as "The Native Share and Stock Brokers Association". It is the oldest one in

Asia, even older than the Tokyo Stock Exchange, which was established in 1878.

It is a voluntary non-profit making Association of Persons (AOP) and is currently

50

engaged in the process of converting itself into demutualised and corporate entity.

It has evolved over the years into its present status as the premier Stock Exchange

in the country. It is the first Stock Exchange in the Country to have obtained

permanent recognition in 1956 from the Govt. of India under the Securities

Contracts (Regulation) Act 1956.The Exchange, while providing an efficient and

transparent market for trading in securities, debt and derivatives upholds the

interests of the investors and ensures redresses of their grievances whether against

the companies or its own member-brokers. It also strives to educate and enlighten

the investors by conducting investor education programmers and making available

to them necessary informative inputs.

A Governing Board having 20 directors is the apex body, which decides the

policies and regulates the affairs of the Exchange. The Governing Board consists

of 9 elected directors, who are from the broking community (one third of them

retire ever year by rotation), three SEBI nominees, six public representatives and

an Executive Director & Chief Executive Officer and a Chief Operating Officer.

The Executive Director as the Chief Executive Officer is responsible for the day-

to-day administration of the Exchange and the Chief Operating Officer and other

Heads of Department assist him.

The Exchange has inserted new Rule No.126 A in its Rules, Byelaws pertaining to

constitution of the Executive Committee of the Exchange. Accordingly, an

Executive Committee, consisting of three elected directors, three SEBI nominees

or public representatives, Executive Director & CEO and Chief Operating Officer

has been constituted. The Committee considers judicial & quasi matters in which

the Governing Board has powers as an Appellate Authority, matters regarding

annulment of transactions, admission, continuance and suspension of member-

51

brokers, declaration of a member-broker as defaulter, norms, procedures and other

matters relating to arbitration, fees, deposits, margins and other monies payable by

the member-brokers to the Exchange, etc.

REGULATORY FRAME WORK OF STOCK EXCHANGE:

A comprehensive legal framework was provided by the “Securities

Contract Regulation Act, 1956” and “Securities Exchange Board of India 1952”.

Three tier regulatory structure comprising

Ministry of finance

The Securities And Exchange Board of India

Governing body

MEMBERS OF THE STOCK EXCHANGE:

The securities contract regulation act 1956 has provided uniform

regulation for the admission of members in the stock exchanges. The

qualifications for becoming a member of a recognized stock exchange are given

below:

The minimum age prescribed for the members is 21 years.

He should be an Indian citizen.

He should be neither a bankrupt nor compound with the creditors.

He should not be convicted for fraud or dishonesty.

He should not be engaged in any other business connected with a

company.

He should not be a defaulter of any other stock exchange.

The minimum required education is a pass in 12th standard examination

52

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI):

The securities and exchange board of India was constituted in 1988

under a resolution of government of India. It was later made statutory body by the

SEBI act 1992.according to this act, the SEBI shall constitute of a chairman and

four other members appointed by the central government.

With the coming into effect of the securities and exchange board of India act,

1992 some of the powers and functions exercised by the central government, in

respect of the regulation of stock exchange were transferred to the SEBI.

OBJECTIVES AND FUNCTIONS OF SEBI:

To protect the interest of investors in securities.

Regulating the business in stock exchanges and any other securities

market.

Registering and regulating the working of intermediaries associated with

securities market as well as working of mutual funds.

Promoting and regulating self-regulatory organizations.

Prohibiting insider trading in securities.

Regulating substantial acquisition of shares and take over of companies.

Performing such functions and exercising such powers under the

provisions of capital issues (control) act, 1947 and the securities to it by

the central government.

53

SEBI GUIDELINES TO SECONDARY MARKETS:

Board of Directors of Stock Exchange has to be reconstituted so as to include

non-members, public representatives and government representatives to the

extent of 50% of total number of members.

Capital adequacy norms have been laid down for the members of various stock

exchanges depending upon their turnover of trade and other factors.

All recognized stock exchanges will have to inform about transactions within

24 hr

54

COMPANY PROFILE

ABOUT SHAREKHAN LIMITED:

Sharekhan Limited is one of the fastest growing financial services providers with a

focus on equities, derivatives and commodities brokerage execution on the National

Stock Exchange of India Ltd. (NSE), Bombay Stock Exchange Ltd. (BSE), National

Commodity and Derivatives Exchange India (NCDEX) and Multi Commodity

Exchange of India Ltd. (MCX). Sharekhan provides trade execution services through

multiple channels - an Internet platform, telephone and retail outlets and is present in

280 cities through a network of 704 locations. The company was awarded the 2005

Most Preferred Stock Broking Brand by Awwaz Consumer Vote.

ORIGIN:

Sharekhan traces its lineage to SSKI, an organization with more than decades

of trust and credibility in the stock market.

Pioneers of online trading in India- Sharekhan.com was launched in 2000 and

is now the second most visited broking site in India.

Has one of the largest networks of Share shops in the country.

SHAREHOLDING PATTERN:

SHAREHOLDERS HOLDINGS

CITI Venture Capital and other Private Equity Firm 81%

IDFC 9%

Employees 10%

55

MANAGEMENT TEAM CONSISTS OF:

NAME POST

Tarun Shah Chief Executive Officer

Mr. Pathik Gandotra Head Of Research

Mr. Rishi Kohli Vice President Of Equity Derivative

Jaideep Arora Director- Products And Technology

Shankar Vailaya Director- Operation

Share khan Limited offers blend of tradition and technology like Share shops,

dial-n-trade and online trading- where there is choice of three trading interfaces which

are speed trade for active trader, web based classic interface for investor, web based

applet- fast trade for investor. Share khan Limited was formerly known as SSKI

Investor Services Private Limited. The company is based in Mumbai, India and its

address is- A-206 Phoenix House, 2nd Floor

Senapati Bapat Marg, Lower Parel

Mumbai, 400 013. India.

Phone: 91 22 24982000

Fax: 91 22 24982626

www.sharekhan.com

ADVANCED TECHNOLOGY USED BY SHAREKHAN:

Share khan has selected Aspect® EnsemblePro™ from the Aspect Software Unified

IP Contact Center product line, a unified contact centre solution delivering advanced

multichannel contact capabilities, because it provided the best total value over other

solutions evaluated. It enabled Share khan to meet customer service needs for inbound

call handling, voice self service, predictive outbound dialing, call blending, call

56

http://www.sharekhan.com/

monitoring and recording, and creating outbound marketing campaigns, among other

capabilities.

This helps them to

Increased agent efficiency and productivity.

Enabled company to execute proactive customer service calls and expand

services offered to customers.

Enhanced call monitoring for improved service quality

Financial services are a highly competitive and volume-driven industry which

demands high standards of customer service, effective consultation and quick

deliverables. This is something Share khan Limited, a financial services provider

based in India, understands. The company offers several user-friendly services for

customers to manage their stock portfolios, including online capabilities linked to an

information database to help customers confidently invest, and inbound customer

services using voice self-service technology and customer service agents handling

telephone orders from clients.

With a customer base of more than 500000, and a employee of 3100 Share khan

continues to grow at a fast pace. Customer satisfaction is a top priority in Share

khan’s agenda.

Its primary objective

To help and support its customers in managing their portfolio in the best

possible manner through quality advice, innovative product and superior

service.

Scheme which are provided by Share khan cover almost every segment of the

customer.

57

SCHEME INVESTOR

First Step New Comer

Classic Trade Occasionally

Speed Trade Day Trader

Platinum Circle High Net Worth Individuals

COMPANY BACKGROUND:

Share khan is the retail broking arm of SSKI, securities pvt ltd. SSKI owns 56%

in share khan, balance ownership is HSBC, first caryle, and Intel pacific.

Into broking since 80 years.

Focused on providing equity solutions to every segment.

Largest ground network of 210 branded share shops in 90 cities.

STOCK MARKETS IN INDIA:

Stock exchanges are the perfect type of market for securities whether of

government and semi-govt bodies or other public bodies as also for shares and

debentures issued by the joint-stock companies. In the stock market, purchases

and sales of shares are affected in conditions of free competition. Government

securities are traded outside the trading ring in the form of over the counter sales

or purchase. The bargains that are struck in the trading ring by the members of the

stock exchanges are at the fairest prices determined by the basic laws of supply

and demand.

58

Definition of “Stock Exchange”:

“Stock Exchange means any body or individuals whether incorporated or not,

constituted for the purpose of assisting, regulating or controlling the business of

buying, selling or dealing in securities.” The securities include:

Shares of public company.

Government securities.

Bonds

59

TABLE 4.1:Futures of ‘INFOSYS’Date OPEN

Rs.HIGHRs.

LOWRs.

CLOSERs.

N.O.C.

02-SEP-10 1755 1780 1750 1761.7 6577

03-SEP-10 1754.95 1833 1725 1782.5 12076

06-SEP-10 1829.95 1839.9 1795 1816.55 12420

07-SEP-10 1795 1795 1736.4 1762.75 10606

08-SEP-10 1748 1772 1721 1731.05 9547

09-SEP-10 1800 1800 1689.9 1762.8 15560

10-SEP-10 1765 1794 1704.9 1725.8 10675

13-SEP-10 1760 1808.9 1725.2 1800.4 16253

14-SEP-10 1811 1877.6 1811 1861.85 15243

15-SEP-10 1874 1895.1 1842 1852.45 12720

16-SEP-10 1840 1884.5 1833.1 1863.3 10210

17-SEP-10 1860 1885 1807.75 1885 5637

20-SEP-10 1835 1835 1835 1835 12139

21-SEP-10 1800 1800 1800 1800 10634

22-SEP-10 1785.3 1856 1771 1849.5 19275

23-SEP-10 1857 1869.9 1836.3 1847.45 19252

24-SEP-10 1877 1900 1877 1896 14500

27-SEP-10 1880 1900 1880 1900 14738

28-SEP-10 1890 1950 1871 1983.9 16334

29-SEP-10 1946 2021 1943 1951.95 13914

30-SEP-10 1955 1955 1885.7 1928.2 13456

01-OCT-10 1900 1921.5 1855.8 1874.75 10158

04-OCT-10 1890 1990 1890 1983.95 12770

05-OCT-10 1990 2019.5 1980.35 1983.35 8646

06-OCT-10 1946 1970.8 1892.2 1912.9 161

07-OCT-10 1900 1911 1799 1854.25 13052

GRAPH 4.1:

60

0%

20%

40%

60%

80%

100%

6-Sep-

10

9-Sep-

10

14-S

ep-1

0

17-S

ep-1

0

22-S

ep-1

0

27-S

ep-1

0

30-S

ep-1

0

N.O.C.

CLOSE

LOW

HIGH

OPEN

INTERPRETATION:

The closing price of Infosys at the end of the contract price is

1854.25 and this is considered as settlement price and the No of contracts of Infosys is

13052 and there is a fluctuation in the price of the Infosys. At the end of the date the

price is high at 1911 and price is low at 1799.

TABLE 4.2:

Futures of ‘Dr.REDDY’

61

Date OPENRs.

HIGHRs.

LOWRs.

CLOSERs.

N.O.C.

02-SEP-10 625 639 625 637.1 364

03-SEP-10 638.9 653.95 637.05 648.05 553

06-SEP-10 644 651.4 635.45 648 335

07-SEP-10 649 657.7 636.2 655.7 558

08-SEP-10 649 649 628.5 631.5 498

09-SEP-10 628 638.8 620 635.25 3669

10-SEP-10 626 636.4 620.3 624.15 455

13-SEP-10 620 679 620 672.45 1472

14-SEP-10 655.1 655.1 651.1 651.1 1260

15-SEP-10 653 664.8 648.5 652.8 758

16-SEP-10 644 656.4 633.5 641.75 1590

17-SEP-10 630 665 630 657.6 1328

20-SEP-10 643 689.5 642.5 681.95 2742

21-SEP-10 679.4 694 669 677.5 2275

22-SEP-10 675.95 705.8 675.95 682.5 1150

23-SEP-10 685 692.9 677.5 686.9 2264

24-SEP-10 688.2 691 675.5 683.63 1599

27-SEP-10 685.5 703.9 674.85 679.75 1911

28-SEP-10 697 697 697 6967 1956

29-SEP-10 714.4 724.45 697.05 713.6 1763

30-SEP-10 705.5 715.45 683.25 697.3 1395

01-OCT-10 692.2 710 664 669.83 984

04-OCT-10 674.9 707.3 672 699.20 1324

05-OCT-10 701.1 707.8 689.1 693.4 744

06-OCT-10 670 711 670 690.05 1342

07-OCT-10 695 695 695 695 1249

GRAPH 4.2:

62

0%

20%

40%

60%

80%

100%

6-S

ep-1

0

9-S

ep-1

0

14-S

ep-1

0

17-S

ep-1

0

22-S

ep-1

0

27-S

ep-1

0

30-S

ep-1

0

5-O

ct-1

0

N.O.C.

CLOSE

LOW

HIGH

OPEN

INTERPRETATION

The closing price of Dr.Reddy at the end of the contract price is

695 and this is considered as settlement price and the No of contracts of Dr.Reddy is

1249 and there is a fluctuation in the price of the Infosys. At the end of the date the

price is high at 695 and price is low at 695.

63

TABLE 4.3:PUT OPTIONS OF “INFOSYS”

Options PA 1650 PA 1680 PA 1740 PA 1770 PA 1800Date C.P N.C C.P N.C C.P N.C C.P N.C C.P N.C

02-SEP-10 26.35 23 38.2 2 57 15 75 1 99 1

03-SEP-10 24.35 30 31.55 14 46.65 31 79 1 58.65 4

06-SEP-10 18 37 20.55 5 31.5 151 79 0 61.9 70

07-SEP-10 20 32 25.5 4 51 133 30 1 82.1 72

08-SEP-10 26 29 36.9 2 63.3 34 30 0 103 8

09-SEP-10 20.55 40 36.1 10 40.85 45 62 4 115 1

10-SEP-10 29.95 28 32 11 61.65 41 84.7 3 110 127

13-SEP-10 12.25 49 15.8 4 22.45 39 40.05 2 52 93

14-SEP-10 5.95 30 8.5 12 14.45 163 19.95 14 29 329

15-SEP-10 6 1 5.05 2 9.05 21 16 6 25.6 119

16-SEP-10 3.5 4 4 3 6.35 10 10.1 1 18.4 69

17-SEP-10 2.8 3 4 0 6.7 14 10.1 0 14.2 5020-SEP-10 2.5 3 4 0 8.45 28 10.1 0 19.7 6921-SEP-10 2.2 2 2.5 1 8.5 23 29 9 25.35 13822-SEP-10 1.5 12 2 1 4.0 15 6 11 19.9 3623-SEP-10 1.1 4 1.1 6 1.55 19 5.79 3 9.35 4424-SEP-10 1.1 0 1.1 0 0.65 10 5.75 0 1.1 4127-SEP-10 0.25 6 0.3 4 0.2 7 0.25 1 0.2 3528-SEP-10 203.9 0 221.4 0 223.5 0 13 1 26.85 4629-SEP-10 14 1 221.4 0 223.5 0 20 56 20.25 10030-SEP-10 14 0 221.4 0 223.5 0 20.6 8 24.75 4801-OCT-10 14 0 221.4 0 223.5 0 26 7 38.4 4304-OCT-10 14 0 221.4 0 223.5 0 19.35 355 20.45 7705-OCT-10 14 0 221.4 0 223.5 0 18 90 18.25 2606-OCT-10 14 0 221.4 0 223.5 0 21.6 22 25.16 17607-OCT-10 14 0 125.03 0 221.4 0 244.4 0 262 0

GRAPH 4.3:

64

0%

20%

40%

60%

80%

100%

9/2/

2010

9/9/

2010

9/16

/201

0

9/23

/201

0

9/30

/201

0

10/7

/201

0

CA 1770 N.C

CA 1770 C.P

CA 1740 N.C

CA 1710 N.C

CA 1710 C.P

CA 1680 N.C

CA 1680 C.P

CA 1650 N.C

CA 1650 C.P

Put Option:

Buyers pay off

Those who have purchased put option at a strike price of 1650, the premium payable

is 26.55

On the expiry date the spot market price enclosed at 1785.95 and strike price is

1650 .so the buyer will lose only premium .

(Premium is 26.55 and lot size is (828*26.55)21990

I.e. total loss =21990

seller pay off

As seller is entitled only for premium if he is in profit

So his profit is only premium

I.e. 828*26.55=21990

65

TABLE 4.4:CALL OPTIONS OF “INFOSYS”Options CA 1650 CA 1680 CA 1710 CA 1740 CA 1770Date C.P N.C C.P N.C C.P N.C C.P N.C C.P N.C

02-SEP-10 144.5 10 122.3 10 97 19 71.9 9 56.25 12

03-SEP-10 179 1 149 13 122.15 20 104.65 68 83.55 25

06-SEP-10 198.5 10 163.5 14 141.25 1 114 84 95 10

07-SEP-10 1985 0 124 12 100 1 81.85 53 81.85 531

08-SEP-10 198.5 0 87 2 87 3 62.2 34 48.2 17

09-SEP-10 149 8 125 6 110 4 75.95 248 63.4 64

10-SEP-10 110.05 4 100 1 72.35 5 56.7 38 43.5 27

13-SEP-10 110.5 0 148 1 137 3 98.75 69 77 53

14-SEP-10 110.5 0 211.95 14 185.2 25 153.85 117 123 36

15-SEP-10 110.5 0 211.95 0 171.2 1 133 10 110 9

16-SEP-10 110.5 0 211.95 0 171.2 0 169.95 2 150 4

17-SEP-10 110.5 0 211.95 0 180 1 139.9 2 119.95 1

20-SEP-10 - - 160.1 3 139.9 0 104.1 5 67.5 26

21-SEP-10 - - - - 120.5 6 85 9 67.45 15

22-SEP-10 - - - - 175 13 145.35 21 115.85 16

23-SEP-10 110.05 0 190 0 170.7 12 141.6 52 112.5 2

24-SEP-10 - - 229.5 2 199.8 29 172.15 25 145 3

27-SEP-10 110.05 0 229.5 0 199.8 0 172.15 0 145 0

28-SEP-10 264.05 0 249.9 0 236.55 0 233.4 0 211.05 0

29-SEP-10 301 0 168.55 0 461.1 0 169.65 0 160.45 0

30-SEP-10 301 0 168.55 0 461.1 0 169.65 0 160.45 0

01-OCT-10 301 0 168.55 0 461.1 0 169.65 0 160.45 0

04-OCT-10 301 0 168.55 0 160 1 169.65 0 160.45 0

05-OCT-10 307 0 168.55 0 160 0 169.65 0 160.45 0

06-OCT-10 307 0 168.55 0 160 0 169.65 0 160.45 0

07-OCT-10 307 0 168.55 0 160 0 169.65 0 160.45 0

C.P. = Close Premium N.C. = Number of Contracts

GRAPH 4.4:

66

0%

20%

40%

60%

80%

100%

9/2/

2010

9/9/

2010

9/16

/201

0

9/23

/201

0

9/30

/201

0

10/7

/201

0

CA 1770 N.C

CA 1770 C.P

CA 1740 N.C

CA 1710 N.C

CA 1710 C.P

CA 1680 N.C

CA 1680 C.P

CA 1650 N.C

CA 1650 C.P

The following table of net payoffs explains the profit/loss of option Holder/writer of INFOSYSTCH for the month of 2nd Sep to 07-Oct, 2010.

Call option

Buyers pay off:

as bought one lot of Infosys i.e. 828,those who buy for 1650 paid 144.55 premium per share.

Market price is 1785.95

Formula

Pay off =spot price –strike price=1785.95-1650=135.95

Interpretation:-

The buyer will get loss but the seller will get profit i.e. strike price less than the spot price and the premium is 144.55

Profit/Loss Position of Put Option Buyers/ Writers of INFOSYS

67

Spot Price Strike Price Premium Buyers(Gain/Loss) Writers (Gain/Loss)

1785.95 1650 26.55 -21990 21990

1785.95 1680 38.32 -13550 13550

1785.95 1740 57 2210 -2210

1785.95 1770 75 -11810

1785.95 1800 99 2810 -2810

Profit/Loss Position of Call Option Buyers/ Writers of INFOSYS

68


1785.95 1650 144.55 -1720 1720

1785.95 1680 123.5 -3470 3470

1785.95 1740 97 -10210 10210

1785.95 1770 71.9 -11190 11190

1785.95 1800 56.5 1440 -1440

Put options of “DR.REDDY`S”

69

Options PA 560 PA 580 PA 600 PA 620 PA 640Date C.P N.C C.P N.C C.P N.C C.P N.C C.P N.C

02-SEP-10 47.05 12 57 2 67.95 11 79.9 0 92.75 0

03-SEP-10 35.25 91 57 5 54.5 16 65.8 0 78.15 0

06-SEP-10 37.05 15 57 0 67.95 52 79.0 0 92.75 1

07-SEP-10 47.05 31 57 1 67.95 51 79.0 0 92.75 0

08-SEP-10 47.05 95 57 0 67.95 0 79.9 0 92.75 5

09-SEP-10 47.05 0 44.3 1 54.5 0 65.8 0 78.15 3

10-SEP-10 35.25 0 44.3 0 54.5 0 65.8 0 78.15 0

13-SEP-10 35.25 0 44.3 0 54.5 1 65.8 0 78.15 0

14-SEP-10 35.25 0 44.3 0 54.5 0 65.8 0 78.15 0

15-SEP-10 35.25 0 44.3 0 54.5 0 65.8 0 78.15 0

16-SEP-10 35.25 0 44.3 0 54.5 0 65.8 0 78.15 0

GRAPH 4.5:

70

0%

20%

40%

60%

80%

100%

9/2/

2010

9/4/

2010

9/6/

2010

9/8/

2010

9/10

/201

0

9/12

/201

0

9/14

/201

0

9/16

/201

0

PA 640 N.C

PA 640 C.P

PA 620 N.C

PA 620 C.P

PA 600 N.C

PA 600 C.P

PA 580 N.C

PA 580 C.P

PA 560 N.C

PA 560 C.P

Put Option:

Buyers pay off

Those who have purchased put option at a strike price of 560, the premium payable is

47.02

On the expiry date the spot market price enclosed at 638.95 and strike price is 560 .so

the buyer will lose only premium.

(Premium is 47.02 and lot size is (270*47.02) 12772

I.e. total loss =12772

seller pay off

As seller is entitled only for premium if he is in profit

So his profit is only premium

I.e. 270*47.02=12772

Profit/Loss Position Of Put Option Buyers/Writers ofz DR.REDDY

71


638.95 560 47.02 -12772 12772

638.95 580 57 -780 780

638.95 600 67.95 11600 -11600

638.95 620 79.9 24380 -24380

638.95 640 92.75 36680 -36680

72

TABLE 4.6:

Call options of “Dr.Reddy`s”

Options CA 560 CA 580 CA 600 CA 620 CA 640Date C.P N.C C.P N.C C.P N.C C.P N.C C.P N.C

02-SEP-10 72.2 1 61.7 4 52.4 6 44.2 7 37.05 0

03-SEP-10 85.95 0 73.2 3 61.7 11 51.6 11 42.7 0

06-SEP-10 72.2 0 74.8 1 111.4 1 44.2 14 88.45 0

07-SEP-10 72.2 0 60.2 0 61.75 36 100.4 0 51.6 1

08-SEP-10 84.3 5 61.7 0 52.4 0 51.6 0 42.7 3

09-SEP-10 70.2 1 61.7 1 52.4 0 44.2 13 37.05 0

10-SEP-10 72.3 1 73.8 5 52.4 1 44.2 0 37.05 1

13-SEP-10 72.2 0 72.2 0 61.7 0 44.2 0 88.45 0

14-SEP-10 72.2 0 72.2 0 61.75 1 44.2 0 42.7 0

15-SEP-10 72.2 0 72.2 0 61.75 0 44.2 0 42.7 0

16-SEP-10 72.2 0 61.7 0 111.4 0 44.2 0 42.7 0

C.P. = Close Premium

N.C. = Number of Contracts

The following table of net payoffs explains the profit/loss of

option holder/writer of DRREDDY for the month of 02-Sep to .

07-Oct, 2010.

GRAPH 4.6:

73

0%

20%

40%

60%

80%

100%

9/2/

2010

9/4/

2010

9/6/

2010

9/8/

2010

9/10

/2010

9/12

/2010

9/14

/2010

9/16

/2010

N.C

C.P

N.C

C.P

N.C

C.P

N.C

C.P

N.C

C.P

Call option

Buyers pay off’s

The lot of Dr.Reddy’s i.e. 270, those who buy for s560 paid 72.2 premiums

pershare. Market price is 638.95

Formula

Pay off =spot price –strike price

=638.95-560

=78.95

Interpretation:-

The buyer will get loss but the seller will get profit i.e. strike price less than

the spot price and the premium is 72.2

Profit/Loss Position Of Call Option Buyers/Writers Of DR.REDDY’S

74


638.95 560 72.2 2700 -2700

638.95 580 61.7 -5300 5300

638.95 600 54.4 -6180 6180

638.95 620 44.2 -10100 10100

638.95 640 37.05 -14820 14820

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FINDINGS:-

• As of the early day of the trading with open penetrating price with

Rs.1755 for two days it is stable on the third day it shoot up to Rs.1829.95 & buyers

are Bearish short it out it falls to Rs.1748 after two days. And as stood with Rs.1800

& again down by two days. For the early week it was raised in one day and falls for

two days and from then it shown appositive upwards movement in future and by the

month end it was settle down with Rs.1900.

• The future of INFOSYS shown a Bullish way till the 7th of May. And

in the 6th June it was Rs.1990; the highest price with number of contracts is 8646. And

on 26th May the players are bullish & numbers of contracts were 19275 as highest

contract with an open price Rs.1785.36 in that month.

From 5th to 9th market increases open with 625 on 5th May. The market price

rose from Rs.625 on first day to 9th May, were it stood at Rs.649 as high. As the

player in the market with an intention to short or correct the market they showed an

bearish attitude for the next 3 days, were the price fall to Rs.620. And the very next

day it shoot up to Rs.655.10 & it slowly fall down for the next 3 days from then it

showed the greedy to the investors and price rose to remaining days and at last fall

down with Slight variations

Among the open prices the price at Rs.643, the open interest stood at peak

position 9, 12,800. Before that from the open position & the trading is bullish & after

it reaches to 9, 12,800. The very next day, the players sold the Futures as to gain. The

total contract traded at this price stood 2742 which is highest for that month

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The Put option 1740, 1770 and 1800 were in-the-money option and the

remaining i.e., 1650, 1680 was out-of-the-money.

The call option 1650, 1680, 1740 & 1770 were out-of-the-money only 1800

were in-the-money.

The Profit of Holder = (Strike Price - Spot Price) - Premium *200

(Lot size) incase of Put Option.

The Profit of Holder = (Spot Price - Strike Price) - Premium * 200

(Lot size) incase of Call Option.

If it is a profit for buyer then obviously it is a loss for the holder & Vice-versa.

She Put option 600, 620, and 640 were in-the-money option and the remaining

i.e., 560, and 580 were out-of-the-money.

The call option 560 was out-of-the-money and only 580, 600, 620 and 640

were in-the-money.

The Profit of Holder = (Strike Price-Spot Price)- Premium * 400(Lot size)

incase of Put Option.

The Profit of Holder = (Spot Price-Strike Price)-Premium * 400(Lot size)

incase of Call Option.

If it is a profit for buyer then obviously it is a loss for the holder & Vice-versa.

SUGGESTIONS

77

It is better to the investors to keep their money in Infosys futures.

In a bearish market it is suggested to an investor to opt for Put Option in order to

minimize losses.

In a bullish market it is suggested to an investor to opt for Call Option in order to

maximize profits.

In a cash market the profit/loss is limited but where in futures and options an

investor can enjoy unlimited profit/loss.

It is recommended that SEBI should take measures in improving awareness about

the futures and options market as investors still don’t have much understanding

about them.

It is suggested to an investor to keep in mind the time and expiry duration of

futures and options contracts before trading. The lengthy the time, the risk is low

and more chances of profit making.

LIMITATIONS OF THE STUDY

78

The study is confined to only one month trading contract

The study does not look any Nifty Index Futures and Options and international

markets into the consideration.

This is a study conducted within a period of 45 days.

The study contains some assumption based on the demands of the .

Analysis’s

CONCLUSION

79

They would have taken more number of futures of Infosys in that

month, so that they will be in profits. Investors should choose Infosys rather

than Dr.Reddy`s. The investors in the Infosys options would have choose

more number of lots in the put option. Dr.Reddy`s options of call is more

profitable than the put option. The traders would have taken more number or

lots.

The investors who are investing in the derivative market in futures and

options should choose the blue chip companies whose companies past 3

quarters are in gradually increasing trend. The greed and fear of individual

leads to cause of fluctuations in the stock market sometimes the external

factors of economical and political mishaps.

80

BIBLIOGRAPHY

Text Books:-

1. “Securities analysis & Portfolio Management”, by R. Madhumati, Pearson

Education

2. “Investments”, by Schaum’s, TATA McGraw-Hill.

3. “International Financial Management”, by P.G.Apte, TATA McGraw-Hill.

4. “Financial Institutions and Markets”, by L.M.Bhole, TATA McGraw-Hill.

5. “Options, Futures and Other Derivatives”, by John C. hull, Education.

Web sites:

1. URL: http//www.nseindia.com

2. URL: http//www.bseindia.com

3. URL: http//www.economictimes.com

4. URL: http//www.sharekhan.com

5. URL: http//www.google.com

81

APPENDICES

Arbitrage – The simultaneous purchase and sale of a commodity or financial

instrument in different markets to take advantage of a price or exchange rate

discrepancy.

Calendar Spread – An option strategy in which a short term option is sold and a

longer term option is bought both having the same striking price. Either puts or calls

may be used.

Call Option – An option that gives the buyer right to buy a future contract at a

premium, at the strike price.

Currency Swap – A Swap in which the counter parties exchange equal amounts

of two currencies at the spot exchange rate.

Derivative – A derivative is an instrument whose value derived from the value of one

or more underlying assets, which can be commodities, precious metals, currency,

bonds, stocks, stock indices, etc. derivatives involves the trading of rights or

obligations based on the underlying assets, but do not directly transfer the property.

Double Option – An option that gives the buyer the right to buy and or sell a

Future contract, at a premium, at a strike price.

Futures Contract –A legally binding agreement for the purpose and a sell of a

commodity, index or financial instrument some time in the future.

Hedge Fund – A large pool of private money and asset managed aggressively and

often riskily on any future exchange, mostly for short term gain.

In-the-money option – An option with intrinsic value, a Call option is in the money

if its strike price is below the current price of the underlying futures contract and the

put option is in the money if it is above the underlying.

82

Margin call – A demand from a clearing house to a clearing member or from a broker

to a customer bring deposits up to a required minimum level to guarantee

performance at ruling prices.

Option – it gives the buyer the right, but not the obligation, to buy or sell stock at a

set. price on or before a given date. Investors who purchase call options but the stock

will be worth more than the price set by the option (strike price), plus the price they

paid for the option itself. Buyer of put option bet the stock price will go down below

the price set by the option.

Out-of-the-money option – An option with no intrinsic value, a call option is out of

money if its strike price is above the underlying and a put option is so if it is below

the underlying.

Premium – The price of an option contract, determined on the exchange, which the

buyer of the option pays to the option writer for the rights to the option contract.

Spread – The difference between the bid and asked prices in any market.

Stop loss orders – An order place in the market to buy or sell to close out an open

position on order to limit losses when market moves the wrong way.

Swap – An agreement to exchange on currency on index return for another, the

exchange on fixed interest payments for a floating rates payments or the exchange of

an equity index return for a floating interest rate.

Underlying – The currency, commodity, security or any other instrument that

forms the basis of a future or a option contract.

Writer – The person who originates the option contract by promising to perform the

certain obligation in return for the price of the option. Also known as the option

writer.

83

All or noting option – An option with a fixed, predetermined payoff if the underlying

instrument is at or beyond the strike price at expiration.

Average option – A path dependent option that calculates the average of the path

traversed by the asset, arithmetic or weighted. The payoff therefore the difference

between the average price of the underlying asset, over the life of option and the

exercise price of the option.

Basket option – A third party option covered warrant on a basket of underlying

stocks, currencies or commodities.

Bermuda option – Like the location of the Bermudas, this option located somewhere

between a European style options, this can be exercised only maturity and an

American style option which can be exercised any time.

Option holders choose – this option can be exercisable only on predetermined

dates.

Compound options – This is simply an option on an existing option such as a call on

a call a put on a put etc, a call on a put etc.

Cross-currency options – An out performance option stock at an exchange rate

between two currencies.

Digital options – These are options that can be structured as a “one touch” barrier,

“double no touch” barrier and: all nothing “call/puts”. The “one touch” digital

provides an immediate payoff if the currency hits your selected price barrier chosen at

outset. The “double no touch” provides a payoff upon expiration if the currency does

not touch both the upper and lower price. barrier selected at the outset. The call/put

“all or nothing” digital option provides a payoff upon expiration if your option

finishes in the money.

84

Knock-in-options – There are two kinds of known in options, 1) up and in, 2) down

and. in. with known in options, the buyer starts out without a vanilla option. If the

buyer has selected an upper price barrier and the currency hits that level; it creates the

vanilla option with maturity date And strike price agreed upon at the outset. This

would be called an up and in. the down and in option is the same as the up and in,

expect the currency has to reach a lower barrier. Upon hitting the chosen lower price

level, it creates the vanilla option.

Multi-index option – An out performance option with a payoff determined by the

deference in performance of two or more indices.

Out performance option – An option with a payoff based on the amount by which

one of two underlying instruments or indices outperform the other.

Quantity adjusting option – This is an option design to eliminate the currency risk

by fix effectively hedging it. It evolves combining an equity option and incorporating

a predetermined rate.

Secondary currency option – An option with a payoff in a difference currency than

the underling’s trading currency.

Swaption – An option to enter into a Swap contract.

Up-and-out-option – The call pays of early exercise price trigger is hit. The put

expires. Worthless if the market price of the underlying risks is above a predetermined

expiration price.

85

Financial Derivatives

Business

derivatives derivatives

study of derivatives

financial derivatives

linked derivatives

role of derivatives

derivatives bill

index derivatives vis

vis derivatives products