Trend Analysis of Fo & Op of Rel Ind Ltd 138

TREND ANALYSIS OF FUTURES AND OPTIONS WITH RESPECT OF RELIANCE INDUSTRIES

ATINTER-CONNECTED STOCK EXCHANGE OF INDIA LTD

HYDERABAD.BY

B. SHIVA KRISHNA102-07-138

Project submitted in partial fulfillment for the award of the degree of

MASTER OF BUSINESS ADMINISTRATIONBy

Aurora’s P.G College(Affiliated to Osmania University, Hyd-500007)

2007-2009

DECLARATION

I hereby declare that this Project Report titled TREND ANALYSIS OF

FUTURES OF FUTURES AND OPTIONS WITH RESPECT

RELIANCE INDUSTRIES submitted by me to the Department of Business

Management, O.U., Hyderabad, is a bonafide work undertaken by me and it is

not submitted to any other University or Institution for the award of any

degree diploma / certificate or published any time before.

Name and Address of the Student Signature of the StudentB.SHIVA KRISHNA (B. SHIVA KRISHNA)

2

POST-GRADUATE COLLEGE Ramanthapur, Hyderabad -500 013.

CERTIFICATION

This is to certify that the Project Report title TREND ANALYISIS OF

FUTURES AND OPTIONS WITH RESPECT OF RELIANCE

INDUSTRIES submitted in partial fulfillment for the award of MBA

Program of Department of Business Management, O.U. Hyderabad was carried

out by B. SHIVA KRISHNA under our guidance. This has not been submitted

to any other University or Institution for the award of any

degree/diploma/certificate.

Ms. Neetu Sachdeva Mr.C.S.Pattnaik Dr.Mohd.Zafar Sheikh Internal guide HOD Principal

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ACKNOWLEDGEMENT

My sincere thanks to Mr. K.V. Nagabhushan for granting me permission to

do my project in INTER – CONNECTED STOCK EXCHANGE

My gratitude to Mr. M. Ramasubba Rao for extending her co- operation in

course of my project.

I am very grateful to Ms. Neetu Sachdeva for her continuous support and

guidance during the course of my project.

I take great pleasure to express my deep sense of gratitude to one and all

in the company who has been directly or indirectly helpful to me in completing the

project.

4

ABSTRACT

The title of the study is “TREND ANALYSIS OF FUTURES AND

OPTIONS OF RELIANCE INDUSTRIES Ltd”.The study is confined to one

month trading of future and options of selected company. The scrip chosen for

analysis is RELIANCE INDUSTRIES LTD and the contract taken is

September 2008 ending one-month contract. The reference period of the

project covers one month (01-09-2008 to 25-09-2008) over the price

fluctuations for the above-mentioned scrip’s were analyzed.

The objective of the study is to know the various trends in derivative

market and also to analyze in detail the role of operations of futures and

options. This project is helpful to the potential investor. The main objective of

this study is to find the profit/loss position of futures buyer and also the option

writer and option holder.

In this study I found the moment of price, the pay off of the

buyers/sellers and the process of trading. The norms of the Security Exchange

Board of India (SEBI) and about other exchanges.

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CHAPTERIZATION

CONTENTS PAGE NO

LIST OF TABLES 7

LIST OF FIGURES 8

CHAPTER- 1: INTRODUCTION 9 1.1 Nature of the Problem 10 1.2 Scope of the Study 11 1.3 Objectives of study 11 1.4 Description of the Study 12

CHAPTER- 2: REVIEW OF LITERATURE 132.1 DERIVATIVES 142.2 Types of Derivatives 272.3 Futures 282.4 Options 36

CHAPTER- 3: COMPANY’S PROFILE 50 3.1 Inter Connected Stock Exchange 513.2 Industry Profile 55

3.2.1. NSE 583.2.2. BSE 60

CHAPTER- 4: ANALYSIS 624.1 Analysis on Future Market 634.2 Analysis on Option Market 66

4.2.1. Call Prices 664.2.2. Put Prices 68

CHAPTER-5: CONCLUSIONS AND SUGGETIONS 70 5.1. Limitations of Study 715.2 Conclusion 725.3. Recommendations and Suggestions 73

BIBLIOGRAPHY 74

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LIST OF TABLES Page No.

1. RELIANCE INDUSTRIES Future and Spot prices 63

2. RELIANCE INDUSTRIES Call Option prices 66

3. NET PAY OFF OF CALL OPTION HOLDER & WRITER 67

4. RELIANCE INDUSTRIES Put Option prices 68

5. NET PAY OFF OF PUT OPTION HOLDER & WRITER 69

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LIST OF FIGURES Page No.

1. Market Participants of DERIVATIVES 23

2. Types of DERIVATIVES 27

3. Pay-off profile for the Buyer of Future 33

4. Pay-off profile for the Seller of Future 34

5. Pay-off profile for the Buyer of Call Option 43

6. Pay-off profile for the Seller of Call Option 44

7. Pay-off profile for the Buyer of Put Option 47

8. Pay-off profile for the Seller of Put Option 48

9. Figure showing Spot and Future prices of 64

RELIANCE INDUSTRIES

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CHAPTER - 1

INTRODUCTION

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1.1 NATURE OF THE PROBLEM

The turnover of the stock exchange 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 Framework for

derivatives trading in India, SEBI accepted the recommendation of the committee on May

11, 1998 and approved the phase introduction of the Derivatives trading beginning with

stock index futures.

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

Because of its advantages like limited loss unlimited profit by paying the small Premiums.

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1.2 SCOPE OF THE STUDY

The Study is limited to “Derivatives” with special reference to futures and Option in the

Indian context and the Inter-Connected Stock Exchange have been Taken as a

representative sample for the study. The study can’t be said as totally perfect. Any

alteration may come. The study has only made a humble Attempt at evaluation derivatives

market only in Indian context. The study is not based on the international perspective of

derivatives markets, which exists in NASDAQ, CBOT etc.

1.3 OBJECTIVES OF THE STUDY

1. To analyze in detail role of operations of futures and options.

2. To find the profit/loss position of futures buyer and also the option writer and

option holder.

3. This project is helpful for potential investor

4. To study one month (September) market movements of RELIANCE INDUSTRIES

Futures and Options.

5. To study the pay off profile of a buyer/seller of futures or options.

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1.4 DESCRIPTION OF THE METHOD

The following are the steps involved in the study.

Selection of the scrip The scrip selection is done on a random and the scrip selected is Reliance Industries Ltd. The lot size is 75. Profitability position of the futures buyers and seller and also the option holder and option writers is studied.

Data CollectionThe data of the Reliance Industries Ltd has been collected from the “THE ECONOMIC TIMES” and the Internet. The data consist of the September Contract and period of Data collection is from 1st SEP 2008 – 29th SEP 2008.

AnalysisThe analysis consist of the tabulation of the data assessing the profitability Positions of the futures buyers and sellers and also option holder and the option Writer, representing the data with graphs and making the interpretation using Data.

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CHAPTER – 2

LITERATURE REVIEW

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2.1 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 underling 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.

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.

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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.

DefinitionContracts, 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”.

HistoryDerivatives have probably existed ever since people have been trading with another.

Forward contracting dates back at list to the twelth 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

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Bretton Woods agreement, the post-war pact that instituted a fixed exchange rate regime to

the worlds 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 at interest rates, foreign exchange and shares. In 1995 the Chicago Board of

Trade commenced trading in derivatives.

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.

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.

Functions of derivatives

Risk transfer Derivative products allow splitting of economic risks into smaller units

and transfer risk, derivatives thus facilitate the allocation of risk. Derivatives redistribute

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the risk between market players and are useful in risk management. Derivative instrument

do not involve any risk on themselves.

Essentially derivative market delivers three basic functions Hedging,

Speculation and Arbitrage. Hedgers transfer risk to another market participant Speculators

takes un-hedged risk positions so as to exploit information inefficiencies or take advantage

of risk capacity. Arbitrageurs take position mispriced instruments in order to earn risk less

return.

The economic functions of these activities are quite different.

1. Hedging and speculation generates information about the pricing of risks.

2. While arbitrages creates a consistent price systems.

Uses of derivatives

There can be a variety of uses of derivatives.

Example: A manufacture has received order for supply of his products after six months.

Price of the product has been fixed. Production of goods will have to start after four

months. He fears that, in case the price of raw material goes up in the meanwhile, he will

suffer a loss on the order. To protect himself against the possible risk, he buys the raw

material in the futures market for delivery and payment after four months at an agreed

price, say,Rs.100 per unit.

In the above example, at the end of the one year, ruling price may be more than

Rs.100 or less than Rs.100. If the price is higher (sayRs.125), the buyers is gainer for the

pays Rs.100 and gets shares worth Rs.125, and the seller is the loser for he gets Rs.100 for

shares worth Rs.125 at the time of delivery. On the other hand, in case the price is lower

(say Rs.75), the purchaser is loser, and the seller is the gainer. There is the method to cut a

part of such loss by buying a “futures” contract with an “option”, on payments of fee.

From the above example it is clear that one’s gain is another’s loss. That is why

derivatives are a ‘zero sum game’. The mechanism helps in distribution of risks among the

market players.

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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 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 glance1. 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.

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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.

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 withy regulation of every client with the

dealer/broker and risk disclosure as the corner stone.

SEBI-RBI co-ordination mechanism

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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 exchangeThe 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 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.

Regulatory frameworkRegulatory control should envisage systems for full proof regulation. Regulatory

framework for derivatives trading envisaged two-level regulation i.e. exchange-level and

SEBI-level, with considerable emphasis on self-regulatory competence of derivative

exchanges under the overall supervision and guidance of SEBI.

Regulatory role of SEBI

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SEBI will approve rules, buy-laws and regulations. New derivative contracts to be

approved by SEBI. Derivative exchanges to provide full details of proposed contract, like

economic purposes of the contract; likely contribution to the market’s development;

safeguards incorporated for investor protection and fair trading.

Market to Market settlementThere 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 practices1. Risk disclosure document with each client mandatory.

2. Sales person to pass certification exam.

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

Trading parameters1. Each order- buy/sell and open/close

2. Unique order identification number

3. Regular market lot size, tick size

4. Gross exposure limits to be specified

5. Price bands for, each derivative contract

6. Maximum permissible open position

7. Off line order entry permitted

Brokerage 1. Prices on the system shall be exclusive of brokerage

2. Maximum brokerage rates shall be prescribed by the exchange

3. Brokerage to be separately indicated in the contracts note

Margins from Clients1. Margins to be collected from all clients/trading members

2. Daily margins to be further collected

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

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Other recommendations1. 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.

2. Creation of derivative cell, a derivative advisory committee, and economic research

wing by SEBI.

Derivatives MarketThere are two types of derivative market:

1. Exchanged based market.

2. Over the counter (OTC) markets.

Exchanged based market and clearing housesThese 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 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 contract. In case of default there will be need to replace the counterparty that is also

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knows as replacement risk. The risk becomes insignificant in case of exchange-traded

derivatives.

Market participants in DERIVATIVES

Derivatives markets are essential frequented by three kinds of hedgers, speculators

and arbitrageurs. Traders who are exposed to market risk by virtue of their long/short

position under foreign currency; stocks, commodities, etc. visit derivatives market

primarily as hedgers. They are basically interested in reducing a risk that they already face.

The other category of visitors to derivatives markets in speculators. They bet that

the price of the stock or a currency will go up or will go down. Speculators can use all the

three products namely forward contracts, futures and options to take a position in the

market. A speculator who thinks that the price of Reliance share will rise can speculate by

taking a long position on Reliance option say @Rs.300, expiry three months. If on the date

of expiry, the price of Reliance is proved to be Rs.350, the speculator with a long position

can take delivery of reliance at Rs.300 and sell it at the market price of Rs.350. thus he will

realize a gain of Rs.50 per share. If reverse happens, his are marginal for all that he would

be losing is only the option premium paid upfront.

The third category of market participants is arbitrageurs. They usually lock into a

risk-less profit by entering simultaneously into transactions in two or more markets.

Consider Infosys is treated in both New York and Mumbai exchanges and suppose the

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stock price is Rs.2000 in Mumbai stock exchange and US $42 in New York stock exchange

and the dollar exchange rate is Rs.50. an arbitrageur would then jump to buy 100 shares in

Mumbai stock exchange and sell them in New York stock exchange @42 dollars per share

to make a risk free profit of Rs.10000 provided such transactions are permitted.

A wide range of participants uses derivatives instruments, such as individual

investors, institutional investors, treasury departments, banks and other financial

intermediaries, securities traders etc.

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 break down of Bretton woods system of fixed exchange

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

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All derivatives can be classified based on the following features

1. Nature of contracts

2. Underlying assets

3. Market mechanism

Nature of contract based on the nature of contract, derivatives can be classified into

three categories:

1. Forward rate contract and futures

2. Options

3. Swaps

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

assets:

1. Foreign exchange

2. Interest being financial assets

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

4. Equities

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

6. Bonds of all types

Market mechanism1. OTC products

2. Exchange traded products

Role of clearing houseA 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 derivativesIndian 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.

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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 introduction of derivatives trading through Indian stock exchanges permitted by SEBI

in 2000 AD is real landmark.

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.

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2.2 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.

FORWARDS

A forwards contract is a customized contract between two parties, where settlement takes

place on a specific date in the future 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 at a certain price.

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 give 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.

DERIVATIVES

OPTIONS FUTURES SWAPS FORWADS

INREST RATE CURRENCYCOMMODITY SECURITYPUT OPTION CALL OPTION

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SWAPS

Swaps are private between two parties to exchange cash flows in the future according to

prearranged formula. They can be regarded as portfolios of forward contracts. The two

commonly used Swaps are:

2.3 FUTURES A financial future is an agreement between two parties to buy or sell a standard quantity of

a specific asset at a future date at a price agreed between the parties through an open outcry

on the floor of an organized futures exchange. The underlying asset could as well be a

commodity such as gold, crude oil, stock market index, individual stocks, interest rates, etc.

the futures contracts are standardized in terms of quantity of underlying, quality of

underlying, the date and month of delivery, the units of the price quotation and minimum

change in price and location of settlement.

Definition of 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 of forward

contracts in the sense that the former are standardized exchange-traded contracts.

Futures are considered to be a better when compared to forward because of the

following reasons:

1. Standard volume

2. Liquidity

3. Counterparty guarantee by exchange

4. Intermediate cash flows

Organized exchanges

28

Futures are traded on organized exchanges with a designated physical location

where trading takes place. This provides a ready liquid market.

Standardization

Amount of the commodity to be delivered and the maturity date are

standardized by the exchange on which the contract is traded.

Clearing House On the trading floor of the future exchange, a future contract is agreed upon

between two parties A and B is replaced by the two contract one between A and the

clearing house and the other between the B and the clearing house.

The exchange interposes itself in every deal as a buyer to every seller and as a

seller to every buyer. This guarantees all the transactions routed through the exchange. The

clearing house protects itself from the counterparty default from imposing margin

requirements on traders.

The clearing house may subsidiary of the exchange itself or an independent

corporation.

Margins Only members of exchange can trade in futures on the exchange. A sub-set of

exchange members are “clearing members” i.e. members of the clearing house when the

clearing house is a subsidiary of the exchange. Every transaction is thus between an

exchange member and the exchange clearing house.

Since the clearing house assumes the credit risk in futures transactions, it demands

a performance bond in the form of margin to be deposited with the clearing house by each

member, who enters into the futures commitment. The amount of margin is fixed by the

exchange and it has to be complied with. The compliance could be in the form of cash or

securities such as treasury bills etc.

Market to market At the end of the trading session, all outstanding contracts are reprised by the

clearing corporation the settlement price of that session. Margin accounts of those, who

made losses, are debited and those who gained are credited.

Example

29

A trader shyam bought on 2nd December, 2002 single stock futures contract of NSE

on ACC at Rs.162, expiry date being 26th December, 2002. Suppose next day, the price on

the futures contract on ACC increases and at the end of the trading session on 3rd December

the settlement price is Rs.163. It means, shyam the trader who bought futures on ACC

made a profit of Rs.1 (as 163-162=1 and obviously, some one with the corresponding short

position lost a matching amount). This gain is credited to the margin amount of shyam

and contract is reprised at Rs.163. shyam can immediately withdraw this gain. Suppose the

reverse happens, the loss is debited to margin account and a demand is made on shyam to

make good the loss is debited to the margin account by a fresh credit.

Trading process Futures contracts are traded by a system of open-outcry on the trading floor of a

centralized and regulated exchange. The exchange member can alone take part in the

trading. Members, who trade for their own account, are called as “Floor traders” and who

trade on behalf of others, are called as “Floor brokers” while those, who trade for both are

known as “Dual traders”.

A buyer of traders in terms of negotiated price and the member of contracts

acquire a long position while the seller requires short positions.

Owing to losses, if the margin account falls below a certain level viz.,

“maintenance” margin, the trader is served with a ‘margin sell” and the trader has to

deposit the required money to bring the margin back to maintenance level within the

specific time.

If the trader fails to do so, his position to be liquidated immediately, so as to

limit the losses, the exchange or the broker may have to incur, to almost a day’s price

change.

In future market, actual derivatives are very uncommon as most of the contract is

extinguished by entering into a matching contract in the opposite direction.

However those, who have not liquidated their contracts by the end of the

‘declared last trading day’, are obliged to make or accept delivery.

TYPES OF FUTURES

1. Commodity futures

30

A future contract where the underlying asset is a commodity is referred to as a

commodity futures contract.

Evolution of commodity futuresTraders in response to the burden that volatile prices create developed price risk

instrument. Contracts, which enabled the improved management of price risk, have become

a fixture of commodity markets since sixteenth century when forward delivery contracts for

gains were first developed.

In the seventeenth century the first option appeared, fixing a price for future

delivery without the obligation of the buyer to actually take possession of the goods.

Tradable forward contracts become important after the late seventeenth century. Most of

these transactions are what is now called ‘over the counter’ i.e. directly between to parties.

While these instruments reduced the price risk, they created a new source of risk.

In the mid-nineteenth century, futures market developed an effective means of

managing price and overcoming counterparty risk. Trades in these “tradable” forward

contracts become centralized in organized commodity futures exchanges, where contract

performances were guaranteed by a clearing house collecting margins.

The first future was established in 1848, was the Chicago Board of Trade. At the end of the

nineteenth century, futures contracts in commodities such as Grains, Arabica, Coffee,

Cotton, Silver and Tin were already being traded. By the early 1980s active commodity

futures exchanges existed in Australia, Canada, France, Japan, Malaysia, New Zealand, the

United Kingdom, United States of America and India.

2. Interest Rate FuturesIn the century futures the underlying asset for the futures contract will be different

currencies and in case of interest rate futures the underlying asset will be different interest

bearing instruments like T-bills, T-bonds, deposits, etc.

Interest rate futures can be defined as follows

31

“An interest rate futures contract is an agreement to buy or sell a standard quantity

of specific interest bearing instruments, at a predetermined future date and at a price agreed

upon between the parties”.

It is known fact that money lenders stand to loss if the interest rates go down in the

future and the borrowers stand to loss if the interest go up in the future. The dislike of those

two sections of society to uncertainty in interest rate fluctuations has led to the innovations

of techniques to hedge such risks. Interest rate futures are one such method of doing the

same.

The main factors behind the growth rate of interest future are as follows

1. Enormous growth of the market for fixed income securities

2. Increased fluctuations in interest rate worldwide

Interest rate futures can be based upon both short-term (less than one year) and long term

debt obligation (more than one year).

3. Index futuresThe trading in index-based futures has commenced in June 2000

An index is representative of a set and is generally the indicator of the status of the

set. In a stock market context, index is an indicator of the broad market. For, instance by

tracking the changes of the BSE-sensex, one can effectively gauge stock market moods in

India.

An index futures contract is basically an obligation to the deliver at settlement, an

amount equal to ‘X’ times the difference between the stock index value on the expiration

date of the contract and the price at which the contract was originally struck. The value of

‘X’, which is referred to as the multiple is predetermined for the each market index.

Example futures contract on S&P 200 stock index use a multiple of 250 while the futures

contract on BSE-sensex use a multiple of 50. stock index futures are based on complex

cash instruments.

The first index futures contract was first introduced in 1982 at the Kansas City

Board of Trade and today, index futures are one of the most popular types of futures as far

as trading is concerned.

The most actively traded stock index contract is the S&P 500 of the Chicago

Mercantile Exchange. The silent features of the index futures contracts are as follows:

32

1. These contracts are cash settled; there is usually no delivery of the underlying stock or

stock certificates, as matching the physical stocks as per the index may be quite

difficult and costlier than setting the contract by cash.

2. An investor can either buy or sell an index futures contract. When an investor goes long

in the index futures contract, he will receive a cash settlement on the expiration date, if

the closing price exceeds the contract price. On the other hand, if the closing price is

less than the contract price, the investor will be required to pay the difference.

Example If the investor has bought the S&P 500 index futures at 350 and on the expiration

day the value of the contract is 360, the investor will receive $5000 [(360-350)*500]. On

the other hand if the index closes at 340, on the expiration date the buyer will be required to

the difference of $5000.

3. Since the index futures contract are listed and traded on futures exchanges,

investors can off set his position on any day prior to the expiration day.

Example An investor who has gone long on an index futures contract can offset his

position by going short on the contract and vice versa.

4. The performance of the all index futures contracts is guaranteed by the exchanges

clearing.

The index future curry the margin requirements which are applicable to the both the buyer and the seller. The purpose of maintaining margin money is to minimizethe risk of default by either party.

PAY-OFF FOR A BUYER OF FUTURES

33

CASE 1 The buyers bought the futures contract at (F); if the futures Price Goes to E1 then the buyer gets the profit of (FP).

CASE 2 The buyers gets loss when the futures price less then (F); if

The Futures price goes to E2 then the buyer the loss of (FL).

PAY-OFF FOR A SELLER OF FUTURES

LOSS

PROFIT

F

L

P

E1

E2

34

F = FUTURES PRICE

E1, E2 = SATTLEMENT PRICE

CASE 1 The seller sold the future contract at (F); if the future goes to

E1 Then the seller gets the profit of (FP).

CASE 2The seller gets loss when the future price goes greater than (F);

If the future price goes to E2 then the seller get the loss of (FL).

PRICING OF FUTURES

Pricing of futures contract is very simple. Using the cost-of-carry logic, we calculate the

fair value of a future contract. Every time the observed price deviates from the fair value,

arbitragers would enter into trades to captures the arbitrage profit. This in turn would push

the futures price back to its fair value. The cost of carry model used for pricing futures is

given below.

F

LOSS

PROFIT

E1

P

E2

L

35

F = SerT

Where: F = Futures price

S = Spot Price of the Underlying

r = Cost of financing (using continuously compounded

Interest rate)

T = Time till expiration in years

e = 2.71828

(OR)

F = S (1+r- q) t

Where: F = Futures price

S = Spot price of the underlying

r = Cost of financing (or) interest Rate

q = Expected dividend yield

t = Holding Period

2.4 OPTIONS

An option gives its owner the right to buy or sell an underlying asset at a future

date. This can be done at the price specified in the option contract. But one can use it only

if the option contract price is favorable to him. If the price trend is unfavorable, he need not

exercise the option. Instead he can go and buy or sell the asset in the market at a price

36

better than the option contract price. This means an option holder has a right but not the

obligation to exercise the contract.

Options are first traded in 1973 on an organized exchange and are now traded on

exchanges, by banks and financial institutions. The underlying asset in options includes

stocks, stock indices, foreign currencies, debt instruments, commodities and future

contracts.

Options are available on many traditional products such as equities, stock indices

commodities and foreign exchange interest rates, etc. foreign exchange markets are

particularly suited to the use of options as they have traditionally been very volatile. The

holder of an option has the right, but not obligation, to buy or sell the underlying asset at

the fixed rate (strike price) on a date in the future. The quantity of underlying asset, rate

and date are all predetermined.

Unlike under a forward contract or futures contract where the holder is obliged to buy

or sell the underlying asset, the option gives the buyer of the contract or buyer has a right to

do something and he does not have to necessarily exercise that right. As against this the

writer or seller of the option is obligated upon to honor the commitments as per the terms

of the contract should the buyer exercise it. Obviously, a buyer has to pay a cost, usually

referred to as “premium” to acquire such a right.

SEBI has permitted option trading in Indian capital market securities in the year 2001;

both buy way of trading in stock options and also index options. Options are currently

traded on the Mumbai stock exchange (BSE) and National Stock Exchange (NSE). Like

trading in stocks, options trading are regulated by SEBI. These exchanges seek to provide

competitive, liquid and orderly markets for the purpose and sale of standardized options.

Options are an important element of investing in markets, serving a function of

managing risk and generating income. Unlike the most other types of investments today,

options provide a unique set of benefits. Not only does option trading provide a chip a

defective means of hedging one’s portfolio against adverse and unexpected price

fluctuations, but it also offers a tremendous speculative dimension to trading.

GENERAL FEATURES OF OPTIONSOptions are traded both on exchanges and in the over-the-counter market. There

are two basic types of options. A call option gives the holder the right to buy the

underlying asset by a certain date for a certain price. A put option gives the holder the

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right to sell the underlying asset by a certain date in the contract is known as the expiration

date or maturity. American options can be exercised at any time up to the expiration

date. European options can be exercised only on the expiration dare itself. Most of the

options that are traded on exchanges are American. In the exchange-traded equity options

market, one contract is usually an agreement to buy or sell 100 shares. European options

are generally easier to analyze than American option are frequently deduced from those of

its European counterpart.

It should be emphasized that an option gives the holder the right to do something.

The holder does not have to exercise this right. This is what distinguishes options from

forwards and futures, where the holder is obligated to buy or sell the underlying asset. Note

that whereas it costs nothing to enter into a forward or futures contract, there is a cost to

acquiring an option.

In options markets, the exercise (strike or striking) price means the price

at which the option holder can buy and/or sell the underlying asset. If the current price of

the underlying asset exceeds the exercise price of a call option, the call is said to be in the

money. Similarly, if the current piece of the underlying asset is less than the exercise price

of a call option, it is said to be out of the money. The near the money call options are

those whose exercise price is slightly greater than current market price of the asset.

Premium is the price paid by the buyer to the seller of the option, whether put or call. A

call option when it is written against the asset owned by the option writer is called a

covered option, and the one written without owning the asset is called naked option.

Option contract illustrated:

On March 1, 2003, ‘A’ sells a call option (right to buy) on “INFOSYS”. To ‘B’ for

a price of say Rs. 300. Now ‘B’ has the right to approach ‘A’ on march 31, 2003 and he

buy 1 share of “INFOSYS” at Rs. 5000. Here:

‘B’ may find it worthwhile to exercise his right to buy only if “INFOSYS Ltd”.

Trades above Rs. 5000. If ‘B’ exercises his option, A has to necessary sell ‘B’ one share of

“INFOSYS”. At Rs. 5000 on March 31, 2003. So if the price “INFOSYS” goes above Rs.

5000 ‘B’ may exercise this option, or else the option, or else the option may lapse. Then

‘B’ loses the original option price of Rs. 300 and ‘A’ as gained it.

Basic Terms used in Option Trading Explained:

Option premium or option price:

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The buyer pays to the seller (sometimes called the writer) of the option, a fee for acquiring

the right to say or sell the underlying, known as premium. It represents the maximum that

can be lost by the buyer and the maximum profit available to the seller of the option.

In the above transaction Rs. 300 is called is the option price or option premium. In the

trading of the options, the holder (buyer) of the options is enjoying the right to buy/sell

while the writer (seller) is obliged to sell/buy depending of the action of the holder.

Exercise Price or Strike Price:

Exercise

If the option buyer decides to take delivery of the underlying asset say Example, foreign

exchange, the most notify the seller of his decision by exercising his right to delivery. This

exercise is effectively the collection of option and the resultant creation of foreign

exchange transaction, value spot. Options that are not exercised expire worthless.

Strike

It is also known as the strike or striking price. This is determined rate of exchange at which

the underlying asset is to be exchanged the option is exercisable.

Strike is usually chosen at a level close the current spot or forward rate (if available as in

the case of forex-market) of the underlying asset or at any reasonable level as perceived by

the parties. Rs. 5000 is the exercise price or strike price in the above example.

The strike price is the price at which an option can be exercised. For instance,

assume that you hold a European option on INFOSYS Company for one share. The strike

price is fixed at Rs. 5000 and the expiration date is 31st march 2003. If the prevailing

market price is say Rs. 5500, then you can exercise your option on the 31st march and buy

one share of INFOSYS for Rs. 5000.

Expiration Date:

In illustration referred above March 31st, 2003 is the expiration date i.e. the date on

which the option expires. Option quoted in exchange includes the date and the month on

which the option can exercise. This is called the expiration date.

Contract cycle:

39

The period over which the contract trades. The futures and option contract at NSE

have one month, two months and three months expiry cycles. The contracts expire on the

last Tuesday of the corresponding month.

Basis:

Basis is defined as the future price minus the spot price. In most of the times basis

shall be positive, which reflect that futures price normally exceeds spot price.

Covered & Naked Calls:

A call option position that is covered by an opposite position in the underlying

instrument (Example shares, commodities etc.) is called a covered call. Writing covered

calls involves writing call options when the shares that might have to be delivered (if

position holder exercises his right to buy), are already owned. E.g. writer writes a call on

Reliance and at the same time holds share of Reliance so that if the call is exercised by the

buyer, he can deliver the stock. Covered calls are far less risky than naked calls (where is

no opposite position in the underlying), since the most can happen is that the investor is

required to sell shares already owned at below their market value. When a physical delivery

uncovered/naked call is assigned a exercise, the writer will have to purchase the underlying

asset to meet his call obligation and his loss will be the excess of the purchase price over

the exercise price of the call reduced by the premium received for writing the call.

Intrinsic Value of Option:

The intrinsic value of an option is defined as the amount by which an option is in

the money or the immediate exercise value of the option when the underlying position is

marked-to-market.

For a call option: Intrinsic value = Spot price-Strike price

For a put option: Intrinsic value = Strike price-Spot price

The intrinsic value of an option must be a positive number or 0. if can’t be negative.

Option Holder:

Is the one who buys an option, which can be a call or a put option. He enjoys the

right to buy or sell the underlying asset at a specified price on or before specified time.

Cash-Settled Options:

40

This gives the owner the right to receive a cash payment based on the difference

between a determined value of the underlying at the time of exercise and the fixed exercise

price of the option, Nifty options shall be cash settled.

Example: a bought Nifty November call at a strike price of 1400. On expiration of

November options, the expiration level was 1430. The cash settlement will be 30 per Nifty

and for one contract, Rs.6000 (that is, 30x200, is the minimum contract size).

Cash settled options are those where, on exercise the buyers is paid the difference

between stock price and exercise price (call) or between exercise price and stock price

(put). Delivery settles options are those where the buyer takes delivery of undertaking

(calls) or offers delivery of the undertaking (puts).

Call Option & Put Option

1. Call Option:A call option gives the right but not the obligation to buy the underlying

asset at a specific price. Since the initial cash flow to buy the option is comparatively small,

investor bullish on the asset (can be a stock or any other asset for that matter) can use call

option to maximize the returns by buying into the product. Further, even in the case of the

asset moving the other way, the maximum loss for the investor is only the premium he has

paid.

Example: an investor buys one European call option on Infosys at the strike price

of Rs. 5000 at a premium of Rs. 300. if the market price of Infosys on the day of expiry is

more than Rs. 5000, the option will be exercised. The investors will earn profits once the

share price crosses Rs. 5300, (strike price + premium i.e. 5000+300). Suppose stock price

is Rs. 5800, the option will be exercised and the investor will buy 1 share of Infosys from

the seller of the option at Rs. 5000 and sell it in the market at Rs. 5800 making a profit of

Rs. 500 [(spot price – strike price )-premium].

In another scenario, if at the time of expiry stock price falls below Rs. 5000 say

suppose it touches Rs. 4800, the buyer of the call option will choose not to exercise to his

option. In this case the investor losses the premium (Rs. 300), paid which should be the

profit earned by the seller of the call option.

41

Example: Shyam, purchase a call option on ACC at a strike of R. 150 exercisable

on December 26th 2004 by paying the specified premium to the seller. On 26th December

2004 Shyam observes that the price of ACC in the cash market is Rs. 155. The option is

than obviously, worth exercising therefore, Shyam exercise the option and demands for

delivery of ACC shares. Excluding the premium, paid upfront by Shyam, the pay off from

the option is:

Spot price of ACC = Rs. 155.00

Exercise price of ACC = Rs. 150.00

Pay off = Rs. 5.00

The net gain under this call option is:

Pay off = Rs. 5.00

Less: Premium = Rs. 1.00

Net gain = Rs.4.00

On the other hand if the price of ACC on the maturity dates of the option is Rs.143,

the option has finished out of the money and thus it becomes worthless. The payoff is zero.

Therefore, Shyam will not exercise the option and he goes to the cash market and purchase

ACC shares @ Rs. 145.

Illustration 1:

An investor buys one European call option on one share of Reliance petroleum at a

premium of Rs. 2 per share on 31st July. Then strike price is Rs. 60 and the contract matures

on 30th September. The pay off for the investor by the basis of fluctuating spot prices at any

time is shown by the pay off table (table 1). It may be clear on the graph that even in the

worst case scenario; the investor would only lose a maximum of Rs. 2 per share, which

he/she had paid for the premium. The upside to it has an unlimited profits opportunity.

On the other hand the seller of the call option has a payoff chart completely reverse

of the call option buyer. The maximum loss that he can have is unlimited though the buyer

would make a profit of Rs. 2 per share on the premium payment.

Payoff from Call Buying/long (Rs)

42

S Xt C Payoff Net Profit

57 60 2 0 -2

58 60 2 0 -2

59 60 2 0 -2

60 60 2 0 -2

61 60 2 1 -1

62 60 2 2 0

63 60 2 3 1

64 60 2 4 2

65 60 2 5 3

66 60 2 6 4

A European call option gives the following payoff to the investor.

Max (S-Xt, 0). The seller gets a payoff of: max (S-Xt, 0) or min (Xt-S, 0).

Notes:

S - Stock price

Xt - Exercise price at time‘t’

C - European Call option premium

Payoff – Max (S-Xt, 0)

Payoff from Call Buying/long

Net profit - Payoff minus ‘C’

Exercising the Call Option and its implications for the buyer and the seller:

The Call Option gives the buyer a right to buy the requisite shares on a specific

price. This puts the seller under the obligation to sell the shares on that specific price. The

Call buyer exercises his option only when he/she felt it is profitable. This process is called

“exercising the option”.

The implications for a buyer are that it is his/her decision whether to exercise the

option or not. In case the investor expects prices to rise for above the strike price in the

future then he/she would surely be interested in buying call options. On the other hand, if

the seller feels that his shares are not giving to perform any better in the future, a premium

can be charged and returns from the selling the call option can be used to make up for the

desired returns.

43

PAY-OFF PROFILE FOR BUYER OF A CALL OPTION

]The Pay-off of a buyer options depends on a spot price of an underlying asset. The following graph shows the pay-off of buyers of a call option.

S = Strike price ITM = In the Money Sp = premium/loss ATM = At the Money E1 = Spot price 1 OTM = Out of the Money E2 = Spot price 2 SR = Profit at spot price E1

CASE 1: (Spot Price > Strike price)As the Spot price (E1) of the underlying asset is more than strike price (S).The buyer gets profit of (SR), if price increases more than E1 then profit also increase more than (SR)

CASE 2: (Spot Price < Strike Price)As a spot price (E2) of the underlying asset is less than strike price (S)The buyer gets loss of (SP); if price goes down less than E2 then also his loss is limited to his premium (SP)

PAY-OFF PROFILE FOR SELLER OF A CALL OPTION

OTM

LOSS

S

P E2

R PROFIT

ITM

ATM E1

44

The pay-off of seller of the call option depends on the spot price of the underlying asset. The following graph shows the pay-off of seller of a call option:

S = Strike price ITM = In The Money SP = Premium / profit ATM = At The money E1 = Spot Price 1 OTM = Out of the Money E2 = Spot Price 2 SR = loss at spot price E2

CASE 1: (Spot price < Strike price)As the spot price (E1) of the underlying is less than strike price (S). The seller gets the profit of (SP), if the price decreases less than E1 then also profit of the seller does not exceed (SP).

CASE 2: (Spot price > Strike price)As the spot price (E2) of the underlying asset is more than strike price (S) the Seller gets loss of (SR), if price goes more than E2 then the loss of the seller also increase more than (SR).

2. Put OptionA Put Option is the reverse of the Call Option. It gives the holder the right to sell an

asset at the predetermined price. When a put option is exercised, the holder/buyer of the

option sells the underlined asset and the writer/seller of the option has to accept it at the

pre-specified strike price.

ITM

PROFIT

E1

P

S

ATM E2

OTM

R

LOSS

45

Example: an investor buying one European put option on Reliance at the strike

price of Rs. 300, at a premium of Rs. 25. If the market price of Reliance, on the day of

expiry is less than RS.300, the option can be exercised as it is ‘in the money’. The

investor’s Break-even point is Rs. 275 (strike price – premium paid) i.e., investor’s make

earn profit if the market falls below Rs. 275. suppose stock price is Rs. 260, the buyer of

the put option immediately buys Reliance share in the market @ Rs. 260 and exercises his

option selling the Reliance share at Rs. 300 to the option writer thus making a net profit of

Rs. 15 [(strike price – spot price) – premium paid].

In other scenario, if at the time of expiry, market price of the Reliance is Rs. 320,

the buyer of the put option will choose not to exercise his option to sell a share can sell in

the market at a higher rate. In this case the investor losses the premium paid (i.e. Rs. 25),

which shall be the profit earned by the seller of the put option.

Example: Shyam, a stock market investor buys a put option from NSE for selling

BPCL shares at the strike price of Rs. 230, expiry date being 26 th December, 2002. -If

BPCL trades at Rs. 225 on 26th December, Shyam would exercise the option. He will

deliver the BPCL shares and demand for the payment @ Rs. 230 the pay off under the put

option is:

Strike price = Rs. 230.00

Current price = Rs. 225.00

In the money = Rs. 5.0

In otherwise means that excluding upfront premium, by exercising the put option, Shyam

realizes the gain of Rs. 5 per share.

On the other hand if the price of the BPCL shares at the maturity is Rs. 240, Shyam

will not exercise the option since, he can sell the same in the cash market at a price higher

than the strike price of the option. Thus the put option becomes worthless.

Illustration 2:

An investor buys one European put option on one share of Reliance petroleum at a

premium of Rs.2 per share on 31st July. The strike price is Rs.60 and the contract matures

on 30th September. The pay off table shows the fluctuations of net profit with a change in

spot price.

Payoff from put buying/long (Rs.)

S Xt P Payoff Net profit

46

55 60 2 5 3

56 60 2 4 2

57 60 2 3 1

58 60 2 2 0

59 60 2 1 -1

60 60 2 0 -2

61 60 2 0 -2

62 60 2 0 -2

63 60 2 0 -2

64 60 2 0 -2

The payoff for the put buyer is: max (Xt-S, 0)

The payoff for the put writer is: max (Xt-S, 0)

PAY-OFF PROFILE FOR BUYER OF A PUT OPTION

The Pay-off of the buyer of the option depends on the spot price of the underlying asset. The following graph shows the pay-off of the buyer of a call option.

47

S = Strike price ITM = In The Money SP = Premium / loss ATM = At the Money E1 = Spot price 1 OTM = Out of the Money E2 = Spot price 2 SR = Profit at spot price E1

CASE 1: (Spot price < Strike price)As the spot price (E1) of the underlying asset is less than strike price (S). The buyer gets the profit (SR), if price decreases less than E1 then profit also increases more than (SR).

CASE 2: (Spot price > Strike price)As the spot price (E2) of the underlying asset is more than strike price (S),The buyer gets loss of (SP), if price goes more than E2 than the loss of the buyer is limited to his premium (SP).

PAY-OFF PROFILE FOR SELLER OF A PUT OPTION

The pay-off of a seller of the option depends on the spot price of the underlying asset. The following graph shows the pay-off of seller of a put option.

PROFIT

ITM

R

E1 ATM

P LOSS

OTM

E2S

48

S= Strike price ITM = In The Money SP = Premium/profit ATM = At The Money E1 = Spot price 1 OTM = Out of the Money E2 = Spot price 2 SR = Loss at spot price E1

CASE 1: (Spot price < Strike price)As the spot price (E1) of the underlying asset is less than strike price (S), the seller gets the loss of (SR), if price decreases less than E1 than the loss also increases more than (SR).CASE 2: (Spot price > Strike price)As the spot price (E2) of the underlying asset is more than strike price (S), the seller gets profit of (SP), of price goes more than E2 than the profit of seller is limited to his premium (SP).

PRICING OF OPTIONS

LOSS

OTM

R

S

E1

P PROFIT

ITM ATM

E2

49

An option buyer has the right but not the obligation to exercise on the seller. The worst

that can happen to a buyer is the loss of the premium paid by him. His downside is limited

to this premium, but his upside is potentially unlimited. This optionality is precious and

has a value, which is expressed in terms of the option price. Just like in other free markets,

it is the supply and demand in the secondary market that drives the price of an option.

There are various models that help us get close to the true price of an option. Most of

these are variants of the celebrated Black- Scholes model for pricing European options.

Today most calculators and spreadsheets come with a built-in Black- Scholes options

pricing formula so to price options we don’t really need to memorize the formula. All we

need to know is the variables that go into the model.

The Black-Scholes formulas for the price of European calls and puts on a non-dividend

paying stock are:

Call optionCA = SN (d1) – Xe- rT N (d2)

Put Option

PA = Xe- rT N (- d2) – SN (- d1)

Where d1 = ln (S/X) + (r + v 2 /2) T v√T

And d2 = d1 - v√T

Where

CA = VALUE OF CALL OPTION e = 2.71828

PA = VALUE OF PUT OPTION r = ln (1 + r)

S = SPOT PRICE OF STOCK

N = NORMAL DISTRIBUTION r = ANNUAL RISK FREE RETURN

T = CONTRACT CYCLE VARIANCE (V) = VOLATILITY

50

CHAPTER - 3

COMPANY PROFILE

51

3.1 COMPANY PROFILE

INTER-CONNECTED STOCK EXCHANGE

INTRODUCTION

Inter-connected Stock Exchange of India Limited (ISE) is a national-level stock exchange, providing trading, clearing, settlement, risk management and surveillance support to its Trading Members. It has 841 Trading Members, who are located in 131 cities spread across 25 states. These intermediaries are administratively supported through the regional offices at Delhi, Kolkata, Patna, Ahmedabad, Coimbatore and Nagpur, besides Mumbai.

ISE aims to address the needs of small companies and retail investors by harnessing the potential of regional markets, so as to transform them into a liquid and vibrant market using state-of-the art technology and networking.

ISE has floated ISE Securities & Services Limited (ISS) as a wholly-owned subsidiary under the policy formulated by the Securities and Exchange Board of India (SEBI) for “Revival of Small Stock Exchanges”. The policy enunciated by SEBI permits a stock exchange to float a subsidiary, which can take up membership of larger stock exchanges, such as the National Stock Exchange of India Limited (NSE), and Bombay Stock Exchange Limited (BSE). ISS has been registered by SEBI as a Trading-cum-Clearing Member in the Capital Market segment and Futures & Options segment of NSE and Capital Market segment of BSE. Trading Members of ISE can access NSE and BSE by registering themselves as Sub-brokers of ISS. Thus, the trading intermediaries of ISS can access other markets in addition to the ISE market. ISS, thus provides the investors in smaller cities, a one-stop solution for cost-effective and efficient trading and settlement services in securities.

Complementing the stock trading function, ISE’s depository participant (DP) services reach out to intermediaries and investors at industry-leading prices. The full suite of DP services are offered using online software, accessible through multiple connectivity modes - leased lines, VSATs and internet. Operation of the demat account by a client requires just a few mouse clicks.

The Research Cell has been established with the objective of carrying out quality research on various facets of the Indian financial system in general and the capital market in particular.

It brings out a monthly newsletter titled “NISE” and a fortnightly publication titled “V share”. The Research Cell plans to expand its activities by publishing a host of value based

52

research publications, covering a number of areas, such as equities, derivatives, bonds, mutual funds, risk management, pension funds, money markets and commodities. The ISE Training Centre conducts class-room training programmes on different subjects related to the capital market, such as equities trading and settlement, derivatives trading, day trading, arbitrage operations, technical analysis, financial planning, compliance requirement, etc. Through these courses, the training centre provides knowledge to stock brokers, sub-brokers, professionals and investors to also appear for the certificate courses conducted by the stock exchanges.

It also aims to make and build the professional careers of MBAs, post graduates and graduates, with a view to enabling them to work effectively in securities trading, risk management, financial management, corporate finance disciplines or function as intermediaries (viz. stock brokers, sub-brokers, merchant bankers, clearing bankers, etc.)

MILESTONES July 6, 1996 A report on Inter-connected Market System (ICMS) submitted to the

Federation of Indian Stock Exchange (FISE).

October 26, 1996 Steering Committee was constituted by FISE at Hyderabad.

January 4, 1997 Pricewater House Coopers,the management consultancy firm, submitted a feasibility report and recommended the establishment of ICMS.

January 22, 1998 ISE incorporated as a company limited by guarantee.

November 18, 1998 SEBI grants recognition to ISE.

February 26, 1999 Commencement of trading on ISE.

December 31, 1999 Induction of 450 Dealers commences.

January 18, 2000 Incorporation of ISS as a company limited by share capital.

February 24, 2000 SEBI registers ISS for the Capital Market segment of NSE.

May 3, 2000 Commencement of trading by ISS in the Capital Market segment of NSE.

January 10 , 2001 Turnover in the Capital Market segment of NSE crosses Rs. 1000 million per day.

February 28, 2001 Turnover of Rs. 1508.80 million recorded by ISS in the Capital Market segment of NSE.

May 4, 2001 Internet trading for clients started by ISS for the NSE segment through DotEx Plaza.

May 19, 2001 ISE’s website, www.iseindia.com, launched.

February 13, 2002 SEBI registers ISS for the Futures & Options segment of NSE.

53

May 6, 2002 ISS commences trading in the Futures & Options segment of NSE.

March 12, 2003 ISS admitted as a member of the Equities segment of BSE.

April 1, 2003 DP services through CDSL launched by ISE.

June 21, 2003 First Investor Education Program under the Securities Market Awareness Campaign (SMAC) of SEBI conducted at Vashi.

January 9, 2004 Peak turnover of Rs. 3034.90 million recorded by ISS in the Capital Market segment of NSE.

May 17, 2004 First DP branch office opened at Coimbatore by ISE.

July 17, 2004 First Investor Point opened at the Vashi Railway Station Complex by ISE.

July 24, 2004 Second DP branch opened at New Delhi by ISE.

September 3, 2004 Third DP branch opened at Kolkata by ISE.

December 27, 2004 Trading in the BSE equities segment started by ISS.

September 15, 2005 Approval of ISE’s Corporatisation and Demutualisation Scheme by SEBI.

October 20, 2005 Switchover to Direct Client Dealing commences in ISS.

November 24, 2005 ISE re-registered as a “for profit” company, limited by shares.

November 24, 2005 Board of ISE reconstituted in tune with the Corporatisation and Demutualisation provisions.

MISSION ISE shall endeavor to provide flexible and cost-effective access to multiple markets to its intermediaries across the country using the latest technology.

OBJECTIVE Create a single integrated national-level solution with access to multiple markets by

providing high cost-effective service to investors across the country. Create a liquid and vibrant national-level market for all listed companies in general

and small capital companies in particular. Optimally utilising the existing infrastructure and other resources of Participating

Stock Exchanges,which are under-utilised now. Provide a level playing field to small Trading Members by offering opportunity to

participate in a national market for investment-oriented business. Provide clearing and settlement facilities to the Trading Members across the

country at their doorstep in a decentralised mode. Spread demat trading across the country.

54

BOARD OF DIRECTORS

1. Shri S. Ravi  -  Public Interest Director2. Shri K. Rajendran Nair  -  Public Interest Director3. Shri P. J. Mathew  -  Managing Director4. Shri M. K. Ananda Kumar  -  Shareholder Director, Bangalore Stock Exchange5. Shri K. D. Gupta  -  Shareholder Director, Uttar Pradesh Stock Exchange6. Shri T. N. T. Nayar  -  Shareholder Director, Cochin Stock Exchange7. Shri P. Sivakumar  -  Shareholder Director, Madras Stock Exchange8. Shri Sanjeev Puri  -  Shareholder Director, 9. Shri Maninder Singh Grewal  -  Shareholder Director10. Shri Jambu Kumar Jain  -  Trading Member Director, Gauhati Stock Exchange11. Shri Rajiv Vohra  -  Trading Member Director

3.2 INDUSTRY PROFILE

HISTORY OF THE STOCK EXCHANGE The only stock exchanges operating in the 19th century were those of Bombay set up

in 1875 and Ahmedabad set up in 1894.these were organized as voluntary non profit

making organization of brokers to regulate and protect their interests. Before the controls

on securities trading become a central subject under the constitution in 1950,it was a state

55

subject and the Bombay securities contract (control) Act of 1952 used to regulate trading in

securities. Under this Act, the Bombay stock exchange in 1972 and the Ahmedabad in

1973.

During the war boom, a number of stock exchanges were organized in Bombay,

Ahmedabad and other centers, but they were not organized. Soon after it become a central

subject, central legislation proposed on a committee headed by A.D.Gorwala went into the

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

discussion the securities contract (regulation) Act become law in 1956.

Definition of the 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.

It is an association of member brokers for the purpose of self regulation and

protecting the interest of its members. It can operate only if the government recognizes it.

Under the securities contract (regulation) act 1956, the recognition is granted under section

3 of the act by central finance ministry.

By-lawsBeside the above act, the securities contract (regulations) rules were also made in

1975 to regulate certain matters of trading of stock exchanges, which are concerned with

following subjects.

Opening/closing of stock exchanges, timing of trading, regulation of bank transfer,

regulation of carryover business, control of settlement, and other actives of stock

exchanges, fixation of margins, fixation of market prices or making prices, regulation of

taravani business (jobbing), regulation of broker trading, brokerage charges, trading rules

on exchanges, arbitration and settlement of disputes, settlement and clearing of the trading.

56

Regulations of stock exchangesThe securities contract (regulation) is the basis for operations of the stock exchange

o India. One exchange can leally without the government permission or recognition. Stock

exchanges are given monopoly in certain areas under section 19 of the above act is to

ensure that the control and regulation are facilitated. Recognition can be granted to a stock

exchange provided certain conditions are satisfied and the necessary information is

supplied to the government. Recognition can be withdrawn, if necessary. Where there is no

stock exchange, the government can license some to the brokers to perform the function of

a stock exchange in its absence.

Securities Exchange Board of India (SEBI)SEBI was set up an autonomous regulatory authority by the government of India in

1988 “to perform the interest of investors in securities and to promote the development of

and to regulate the securities the securities markets and for matters connected therewith or

incidental thereto”. It is empowered by to acts namely the SEBI Act, 1982 and the

securities contract (regulation) Act, 1956 to perform the function of protecting investor’s

rights and regulating the capital market.

There are about 24 Stock Exchanges all over India. They are as follows

Name of The Stock Exchange Year

Bombay Stock Exchange.

Ahmedabad share and stock brokers association.

Calcutta stock exchange association Ltd.

Delhi stock exchange association Ltd.

Madras stock exchange association Ltd.

Indore stock brokers association.

1875

1957

1957

1957

1957

1958

57

Bangalore stock exchange.

Hyderabad stock exchange.

Cochin stock exchange.

Pune stock exchange.

U.P. stock exchange.

Ludhiana stock exchange.

Jaipur stock exchange.

Gawhati stock exchange.

Mangalore stock exchange.

Maghad stock exchange Ltd., Patna.

Bhuvaneshwar stock exchange association Ltd.

Over the counter exchange of India, Bombay.

Saurastra Kuth stock exchange Ltd.

Vsdodard stock exchange Ltd.

Coimbatore stock exchange Ltd.

The Meerut stock exchange.

National stock exchange.

Integrated stock exchange.

1963

1943

1978

1982

1982

1983

1983-84

1984

1985

1986

1989

1989

1990

1991

1991

1991

1991

1999

3.2.1 National Stock Exchange (NSE)

The NSE was incorporated in NOVEMBER 1994 with an equity capital of

Rs.25 Crores. The International Securities Consultancy (ISC) of Hong Kong has helped in

setting up NSE. ISC has prepared the detailed business plans and installation of hardware

58

and software systems. The promotions for NSE were financial institutions, insurance

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 professionalism of the capital

market as well as provide nation wide securities trading facilities to investors.NSE is not an

exchange in the traditional sense where the brokers own and manage the exchange. A two

tier administrative setup involving a company board and a governing board of the exchange

is envisaged.

NSE is a national market for shares, PSU bonds, debentures and government

securities since infrastructure and trading facilities are provided.

The genesis of the NSE lies in the recommendations of the Pherwani

Committee (1991).It has been setup to strengthen the move towards professionalisation of

the capital market as well as provide nation wide securities trading facilities to investors.

NSE-NiftyThe NSE on April22, 1996 launched a new equity index. The NSE-50 the new

index which replaces the existing NSE-100, 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 Rs. 1, 70,000 crores. All the companies

included in the Index have a market capitalization in excess of Rs. 500 crores. 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 price 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-Madcap IndexThe NSE madcap index or the Junior Nifty comprises 50 stocks that represents

21 board Industry groups and will provide proper representation of the madcap. All stocks

59

in the index should have market capitalization of greater than Rs.200 crores and should

have traded 85% of the trading days an impact cost of less 2.5%.

The base period for the index is Nov 4, 1996 which signifies 2 years for

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

the index has been set at 1000.

Average daily turnover of the present scenario 258212(laces) and number of

average daily trades 2160(lakhs).

3.2.2 Bombay Stock Exchange (BSE)

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 evolved over the year s into its present status as the premier

stock exchange in the country. It may be noted that the stock exchange is the oldest one

in Asia, even older than the Tokyo Stock Exchange, this was founded in 1878.

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.

60

The executive director as the Chief Executive Officer (CEO) is responsible for

the day-to-day administration of the exchange. The average daily turnover of the exchange

during the year 2000-01(April-March) was Rs. 3984.19 Crores and average no. of daily

trades was 5.69 lacks.

However the average daily turnover of the exchange during the year 2000-01

has declined to Rs1244.10 Crores and average daily trades during the period to 5.17 lacks.

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

declined and the no of average daily trades during the period is also decreased.

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

capital markets by SEBI with effect from July 2, 2001, abolition of account period

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

exchanges with effect from Dec 31, 2001, etc., have adversely impacted the liquidity and

consequently there is a considerable decline in the daily turnover at the exchange. The

average daily turnover of the exchange in the present scenario is 110363(laces) and the no

of average daily trades is 1057(laces)

BSE Indices:

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

downs in Indian stock market, the exchange had introduced in 1986 an equity stock index

called BSE-SENSEX that subsequently became the barometer of the moments 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 index reflects the total market value of all 30-component stocks

from different industries related to particular base period. The total value of a company is

determined by multiplying the price of its stock by the number of shares outstanding.

Statisticians call an index of a set of combined variables (such as price number

of shares) Composite index. An Indexed number is used to represent the results of this

calculation in order to make the value easier to work with and track over a time. IT is much

61

easier to graph a chart base on indexed values then one based on actual values world over

majority of the well known indices are constructed using “Market capitalization weighted

method”. The divisor is only link to original base period value of the sensex.

New base year average=old base year average*(new market value/old market

value)

62

CHAPTER - 4

ANALYSIS

4.1 ANALYSIS ON THE FUTURE MARKET ON SELECTED SCRIP

63

RELIANCE INDUSTRIES FUTURE & SPOT PRICES

(01-09-2008 to 25-09-2008)

DATE SPOT PRICE FUTURE PRICE01-09-08 2141.65 2155.6502-09-08 2212.75 2228.9504-09-08 2152.25 2168.2005-09-08 2080.90 2098.1008-09-08 2133.20 2146.3509-09-08 2142.55 2152.4510-09-08 2082.65 2098.8511-09-08 1997.40 2011.5512-09-08 1932.65 1948.1515-09-08 1886.95 1892.2016-09-08 1928.05 1941.5517-09-08 1876.65 1881.4018-09-08 1938.25 1943.7019-09-08 2055.10 2060.4022-09-08 2039.10 2047.4023-09-08 2006.45 2015.2524-09-08 2046.10 2050.9025-09-08 2025.70 2026.90

64

1700

1800

1900

2000

2100

2200

2300

1/9/20

08

4/9/20

08

8/9/20

08

10/9/

2008

12/9/

2008

16-09

-08

18-09

-08

22-09

-08

24-09

-08

SPOT PRICE

FUTURE PRICE

FINDINGS

1. As of the early day of the trading with open penetrating price with Rs.2155.65 and the next day the price shoot up to Rs. 2228.95. But on the third day and fourth day the price has fallen to Rs. 2098.10. Again on fifth day the price shoot up to Rs. 2146.35 and it was stable on sixth day i.e. on 09-09-08. But from 10-09-08 the buyers were Bearish as the price was continuously fallen down and on 25-09-08 i.e. at the end of the SEPTEMBER month the price slowly recovered and settled down at 2026.90.

2. The future of RELIANCE INDUSTRIES showed a Bullish way till the 9 th of September. But from 10th September the buyers were Bearish till the end of the month.

65

ANALYSIS ON THE FUTURE MARKET

CALCULATION OF PROFIT/ LOSS TO BUYER AND SELLER.

Reliance Ind

BUYER SELLER

1/9/2008(buying) 2155.65 2155.65

25/9/2008 (Closing period) 2026.90 2026.90

Loss 128.75 Profit 128.75

Loss 128.75 x 75= 9656.25, Profit 128.75 x 75 = 9656.25

1. Because buyer future price will decrease so, loss also increase, seller future price also

decrease so, he can get profit. Incase buyer future will increase, he can get profit.

2. The closing price of RIL at the end of the contract period is 2026.90 and this is

considered as settlement price.

66

4.2 ANALYSIS ON THE OPTION MARKET ON SELECTED SCRIP

DATEPRICE PREMIUM

SPOT FUTURE 1950 1980 2010 204001-09-08 2141.65 2155.65 290.55 274.80 190.65 130.1002-09-08 2212.75 2228.95 290.55 274.80 190.65 150.0004-09-08 2152.25 2168.20 290.55 274.80 190.65 150.0005-09-08 2080.90 2098.10 290.55 274.80 190.65 150.0008-09-08 2133.20 2146.35 290.55 274.80 190.65 150.0009-09-08 2142.55 2152.45 290.55 274.80 190.65 150.0010-09-08 2082.65 2098.85 290.55 274.80 150.00 150.0011-09-08 1997.40 2011.55 111.35 91.55 74.45 60.1512-09-08 1932.65 1948.15 69.40 56.45 43.80 34.3515-09-08 1886.95 1892.20 43.00 33.95 25.15 18.8016-09-08 1928.05 1941.55 52.00 39.95 30.30 22.1517-09-08 1876.65 1881.40 29.60 20.60 13.25 10.5518-09-08 1938.25 1943.70 47.00 33.65 25.45 16.9019-09-08 2055.10 2060.40 119.65 95.60 70.55 55.4522-09-08 2039.10 2047.40 105.90 78.40 56.55 43.0523-09-08 2006.45 2015.25 75.25 51.80 33.65 19.7024-09-08 2046.10 2050.90 97.00 71.30 46.10 26.1525-09-08 2025.70 2026.90 64.00 38.50 13.70 2.00

1. The following table explains the market price and premiums of calls.

2. The first column explains TRADING DATE.

3. Second column explains the SPOT MARKET PRICE in cash segment on that date.

67

4.2.1 CALL PRICES

4. The third column explains the FUTURE MARKET PRICE in cash segment on that date.

5. The fourth column explains call premiums amounting 1950,1980,2010,2040

WORKING NOTES FOR CALLOPTIONS NET PAY OFF OF CALL OPTION HOLDER & WRITER

SPOT PRICE STRIKE PRICE

PREMIUM BUYERSGAIN/LOSS

SELLERSGAIN/LOSS

2025.70 1950 290.55 -16113.75 16113.75

2025.70 1980 274.80 -17182.5 17182.5

2025.70 2010 190.65 -13121.25 13121.25

2025.70 2040 130.10 8685.00 -8685.00

PUT PRICES

68

DATE PRICE PREMIUM SPOT FUTURE 1950 1980 2010 2040

01-09-08 2141.65 2155.65 20.00 29.00 30.25 38.05 02-09-08 2212.75 2228.95 9.90 11.00 15.15 15.05 04-09-08 2152.25 2168.20 14.55 9.00 20.90 29.50 05-09-08 2080.90 2098.10 25.00 37.00 43.15 54.20 08-09-08 2133.20 2146.35 12.80 21.00 23.75 38.00 09-09-08 2142.55 2152.45 8.20 15.00 22.50 25.50 10-09-08 2082.65 2098.85 18.65 27.45 32.00 42.00 11-09-08 1997.40 2011.55 41.45 54.65 68.75 85.35 12-09-08 1932.65 1948.15 70.85 89.40 102.80 129.15 15-09-08 1886.95 1892.20 101.70 118.05 147.80 155.00 16-09-08 1928.05 1941.55 58.20 130.00 99.30 120.00 17-09-08 1876.65 1881.40 96.50 101.00 146.00 180.00 18-09-08 1938.25 1943.70 55.70 185.00 85.00 110.00 19-09-08 2055.10 2060.40 10.50 15.40 21.55 33.95 22-09-08 2039.10 2047.40 9.85 16.30 23.50 35.65 23-09-08 2006.45 2015.25 8.60 18.30 29.05 43.15 24-09-08 2046.10 2050.90 1.80 4.20 8.25 19.50 25-09-08 2025.70 2026.90 0.10 0.10 0.85 11.95

NET PAY OFF OF PUT OPTION HOLDER & WRITER

SPOT PRICE STRIKE PRICE

PREMIUMBUYERSGAIN/LOSS

SELLERSGAIN/LOSS

2025.70 1950 20.00 -4177.5 4177.5

69

2025.70 1980 29.00 -1252.5 1252.5

2025.70 2010 30.25 1091.25 -1095.25

2025.70 2040 38.05 1072.5 -1072.5

OBSERVATIONS & FINDINGS

1. The call option 1950, 1980, 2010 & 1770 were out-of-the-money only

2040 were in the-money for the buyer of call option.

2. The Put option 1950, 1980 were out-of-the-money and 2010, 2040 were

in-the-money for the buyer of put option.

3. If it is a profit for buyer then obviously it is a loss for the writer &

Vice-versa.

4. The Profit of Holder = (Strike Price - Spot Price) - Premium *75

(Lot size) incase of Put Option.

5. The Profit of Holder = (Spot Price - Strike Price) - Premium * 75(Lot

size) incase of Call Option.

70

CHAPTER - 5

CONCLUSION

AND

SUGGESTIONS

5.1 LIMITATIONS OF THE STUDY

71

The following are the limitation of this study.

1. The study is conducted for a limited period of time.

2. The study is restricted to scrip’s of only one company randomly

selected from the scrip’s traded in futures and options.

3. The scrip chosen for analysis is RELIANCE INDUSTRIES LTD and

the contract taken is September 2008 ending one-month contract.

4. The reference period of the project covers one month (01-09-2008 to

25-09-2008) over the price fluctuations for the above-mentioned scrip’s

were analyzed.

5. The data collected is completely restricted to the RELIANCE

INDUSTRIES LTD of September 2008; hence this analysis cannot be

taken universal.

5.2 CONCLUSION

72

1. In bullish market the call option writer incurs more losses so the

investor is suggested to go for a call option to hold, where as the put

option holder suffers in a bullish market, so he is suggested to write a

put option.

2. In bearish market the call option holder will incur more losses so the

investor is suggested to go for a call option to write, where as the put

option writer will get more losses, so he is suggested to hold a put

option.

3. In the above analysis the market price of RELIANCE INDUSTRIES

LTD is having high volatility, so the call option writer enjoys more

losses to holders.

5.3 RECOMMENDATIONS & SUGGESITIONS

1. The prices of RELIANCE INDUSTRIES on the first ten days of

September month were Bullish; the call option writer incurs more losses

during this period. So the investor is suggested to go for a call option to

73

hold, where as the put option holder suffers in a bullish market, so he is

suggested to write a put option.

2. And the remaining days of the month were Bearish the call option

holder will incur more losses. So the investor is suggested to go for a

call option to write, where as the put option writer will get more losses,

so he is suggested to hold a put option.

3. The derivative market is newly started in India. Has it is not known by

every investor, SEBI has to take steps to create awareness among the

investors about the derivative segment.

4. In order to increase the derivatives market in India, SEBI should revise

some of their regulations like contract size, participation of FII in the

derivatives market.

5. Contract size should be minimized because small investors cannot

afford this much of huge premiums.

6. SEBI has to take further steps in the risk management mechanism.

7. SEBI has to take measures to use effectively the derivatives segment as

a tool of hedging.

BIBILOGRAPHY

BOOKS: -

74

Derivatives Dealers Module Work Book - NCFM Option, Future And Other Derivatives – JOHN C. HULL

JOURNALS: -

Economic times Times of India

WEBSITES: -

www.derivativesindia.com www.nseindia.com www.bseindia.com

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