Você está na página 1de 109

PROJECT REPORT

ON

SUBMITTED TO PUNJAB TECHNICAL UNIVERSITY, JALANDHAR

IN THE PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE


DEGREE OF

SUBMITTED TO:- SUBMITTED BY :-

VINAY KUMAR
M.B.A 4th year
ROLL NO - 80608317058
STUDENT DECLARATION

I Vinay kumar hereby declare that In Final Project Report on “ Trends


And Future Of Derivatives In India: A Detailed Study” which is submitted
in partial fulfillment of the requirements of degree of Masters Of Business
Administration to Punjab Technical University, Jalandhar is my original
work and not submitted for the award of any other degree, diploma,
fellowship or other similar titles.

Vinay Kumar
ACKNOWLEDGEMENT

This formal piece of acknowledgement may be sufficient to express the


feelings of gratitude people who have helped me in successfully completing
my Final Project Report.
I am grateful to Lect. Ruchi for giving me a chance to
do my Final Project Report on “Trends And Future Of Derivatives In
India: A Detailed Study” which required extensive study of various Brokers
and Investors that are engaged in Derivatives investment.
I feel,I shall always remain indebted to Mrs. Sarabjeet
kau r(Head Of Department, Management) without whom it is being
impossible to complete my project report.He gave his kind
supervision,guidance,timely support and all other kind of help required in
each and every moment of need.
I am deeply indebted to my dear
parents,friends whose blessings and inspirations have brought me up to this
stage of my carreer.

(VINAY KUMAR)
CONTENTS OF THE TABLE

1. PROJECT ASSIGNED.
 Introduction of the project.
 Objectives of the project.

2. CONCEPT OF STOCK MARKET.


 Introduction to stock market – a global approach.

 History of stock market.

 Features and characterstics of stock market.


 Future Plans for developing stock market.
 Various Functions performed in stock market.
 Performance of stock market in Indian market.

3.FINANCIAL DERIVATIVES MARKET.


 Introduction.
 Historical aspect.
 Products, participants and functions.

 Derivative terminology.
 Reasons behind its evolution.
 Requirements for Future and Options.
 Strength of Indian capital market.
 Importance of derivative investment.
 Instruments involved in derivative.
 Performance in India.
 Regulatory framework.

4.ANALYSIS OF THE PROJECT.


 Research Methodology.
 Graphical analysis.

5.RESULTS AND FINDINGS.


 Reasons behind less development of F &O at AMRITSAR stock

exchange.

6.SUGGESTIONS.
7.LIMITATIONS OF STUDY.
8.CONCLUSIONS.
9.BIBLOGRAPHY.
10.SAMPLE OF QUESTIONNAIRE.
INTRODUCTION OF THE PROJECT

Derivatives have vital role to play in enhancing shareholder value by ensuring access
to the cheapest source of funds. Active use of derivatives instruments allows the
overall business risk profile to be modified, thereby providing the potential to improve
earning quality by offsetting undesired risk.
Under my project report, I have studied various trends that comes in
the way of Derivatives market. Because impression is usually given that losses arose
from derivatives are extremely complex and difficult to understand financial
strategies. So after interviewing with different brokers ,investors and dealers, I have
tried to give a solution to these complexities.
i also find out that what would be the future of derivative market
in india on the basis of interviews and observations of brokers, dealers and investors.
regarding future, I have find out that derivatives can indeed be used safely and
successfully provided a sensible control and management strategy is established and
executed. inspite of that more awareness should be done and technical expertise
knowledge should be more expanded.
OBJECTIVES OF THE PROJECT

The main objectives of my final project report are as follows:-


 To study the various trends that comes in the way of Derivatives market
 To find out that what would be the future and market potential of derivative
market in india.
 To know the awareness & familiarity investors, dealers and brokers hold
regarding derivatives market.
 To know the experience of dealers, investors and brokers with derivatives till
date.
 To get knowledge about shortcomings in indian derivative market.
INTRODUCTION TO THE STOCK EXCHANGE

A stock exchange is the place where securities, shares, debentures and bonds
of joint stock companies, central & state govt., semi govt. organizations,
local bodies and foreign govt. are bought and sold. A stock exchange is the
nerve center of capital market. Changes in the capital market are brought
about by a complex set of factors, all operating on the market
simultaneously. Such changes are subject to secular trends set by the
economic progress of the nation, and governed by the factors like general
economic situation, financial and monetary policies, tax changes, political
environment, international economic and financial development etc. A stock
exchange provides necessary mobility to capital and directs the flow of
capital into profitable and successful enterprises.

The Securities Contract (Regulation) Act 1956 defines stock exchange


as:
“A body of individuals whether incorporated or not, constituted for
the purpose of assisting, regulating or controlling the business of buying,
selling, & dealing in securities.”

A stock exchange is a platform for the trade of already issued


securities through primary market. It is the essential pillar of the private
sector and corporate economy. It is the open auction market where buyers
and sellers meet and involve a competitive price for the securities.

It reflects hopes aspiration and fears of people regarding the performance of


the economy. It exerts a powerful and significant influence as a depressant
or stimulant of business activity. So, stock exchange mobilizes savings,
canalizes them as securities into those enterprises which are favored by the
investors on the basis of such criteria as –
- Future growth prospects.
- Good returns.
- Appreciation of capital.

The stock exchange serves the role of barometer, not only of


the state of health of individual companies, but also of the nation’s economy
as a whole (it measures of all the pull and pressure of securities in the
market). The trade in market is through the authorized members who have
duly registered with concerned stock exchange and SEBI.
HISTORY OF STOCK EXCHANGE

The trading of securities in India was started in early 1973. The only stock
exchange operating in the 19th century were those of Bombay set up in 1875
and in Ahemdabad set up in 1894. These were organized as voluntary non-
profit making associations of brokers to regulate and protect their interests.
Before the control on securities trading became a central subject under the
constitution in 1950. It was a state subject and Bombay securities contract
(control) act of 1925 used to regulate trading in securities. Under this act,
Bombay stock exchange was recognized in 1927 and Ahemdabad stock
exchange were organized at Bombay, Ahemdabad and other centers but they
were not recognized soon after it became a central subject, central legislation
was proposed and a committee headed by sh. A.D.GORWALA went into
bill for security regulation. On the basis securities contract act became law in
1956.
At present there were 23 recognized stock exchanges in
India. From these BSE & NSE are the two major stock exchanges and
rest 21 are the regional stock exchanges. Daily turnover of all the stock
exchange is app. 20,000cr. BSE is 129 years old. NSE is 11 years old and it
brought the screen based trading system in India
FEATURES OF THE STOCK EXCHANGE

 It is a place where listed securities are bought and sold.


 It is an association of persons known as members.
 Trading in securities is allowed under rules and regulations of stock
exchange.
 Membership is must for transacting business.
 Investors and speculators, who want to buy and sell securities, can do
so through members of stock exchange i.e. brokers.
 There are mainly three participants in stock exchange i.e.
• Issuer of security (company).
• Investor of security (Individual, HUF).
• Intermediaries and products (broker, merchant bankers and
shares, bonds, warrants, derivatives products etc.).
 It is the market as well as source for the capital. Corporate and govt.
raise resource from the market.
FUTURE PLANS OF STOCK EXCHANGE

The current market scenario in the capital market is not very encouraging,
however, in the future; the business model of ISE would be the most
preferred method of accessing multiple markets with low cost and high
credibility of an Exchange. ISE is considering several value added services
or new products which may help ISE and ISS in fulfilling the demands of
low cost users. We are considering derivative segment through NSE and DP
services initially for the participants and later for clients through CDSL and
NSDL. This futuristic concept of consolidation being pursued by ISE is now
being also explored by the Developed Countries. We think such
consolidation enables optimal utilization of existing resources, enhanced due
to economies of scale and permit product innovation, a sign o any dynamic
market. On account of this philosophy we are proposing to implement most
of the new products centrally on ISE, like, Internet trading, IPO segment,
Distribution of mutual funds units, Information dissemination, etc. We are
also planning to provide trading support to the commodities Exchanges and
also consider providing hem entry into the securities industries. The creation
of a national market has provided the brokers of the RSEs and individual
investors in the regions and opportunity approach the liquid national level
market. This market is expected to provide liquidity in small capital
companies as the other National Level markets have a higher entry norm and
may not cater to this market.

FUNCTIONS OF STOCK EXCHANGE

Stock Exchange Performs The Following Functions:


 The stock exchange provides appropriate conditions where by

purchase and sale of securities takes place at reasonable and fair


prices.
 People having surplus funds invest in the securities and these funds

used for industrialization and economic development of country that


leads to capital formation.
 The stock exchange provides a ready market for the conversion of

existing securities into cash and vice-versa.


 The stock exchange acts as the center of providing business

information relating to enterprise whose securities are traded as the


listed companies are to present their financial and other statements to
it.
 Stock exchange protects the interest of the investors through strict

enforcement of rules and regulations with respect to dealings.


Punishments (including fine, suspension or even expulsion of
membership) may be there if broker make any malpractice in dealing
with investors like charging high commissions etc.
 Stock exchange acts as the barometer of the country as it measures

all the pulls and pressures of the securities in the market.


 The stock exchange provides the linkage between the savings in the

household sector and the investment in corporate economy.

STOCK EXCHANGES OF INDIA


Name of Stock Exchange Year of Type of Organization
Establishme
nt
1. The Stock Exchange Mumbai 1875 Voluntary Non profit
org.
2. Ahmedabad Stock Exchange 1897 Voluntary Non profit
org.
3. Calcutta Stock Exchange 1908 Public ltd. Company
4. Madhya Pradesh Stock 1930 Voluntary Non profit
Exchange org.
5. Madras Stock Exchange Ltd. 1937 Company ltd. By
guarantee
6. Hyderabad Stock Exchange Ltd. 1943 Company ltd. By
guarantee
7. Delhi Stock Exchange 1947 Public ltd. Company
Association Ltd.
8. Bangalore Stock Exchange 1957 Pvt. Converted into
public ltd. company
9. Cochin Stock Exchange 1978 Public ltd. Company
10.U.P. Stock Exchange Ltd. 1982 Public ltd. Company
11.Pune Stock Exchange Ltd. 1982 Company ltd. By
guarantee
12.Ludhiana Stock Exchange 1983 Public ltd. Company
13.Guwahati Stock Exchange 1984 Public ltd. Company
14.Magadh Stock Exchange Ass. 1986 Company ltd. By
(Patna) guarantee
15.Jaipur Stock Exchange Ltd. 1983 Public ltd. Company
16.Bhubaneshwar Stock Exchange 1989 Company ltd. By
guarantee
17.SaurashtraKutch Stock 1989 Company ltd. By
Exchange Ltd. guarantee
18.Vadodara Stock Exchange Ltd. 1990 N.D
19.National Stock Exchange of 1994 N.D
India Ltd.
20.Coimbatore Stock Exchange 1996 N.D
Ltd.
21.OTC Stock Exchange of India N.D
22.Mangalore Stock Exchange Ltd. N.D
23.Interconnected Stock Exchange N.D
(ICSE)

WHO BENEFITS FROM STOCK EXCHANGE

1. Investors: - It provides them liquidity, marketability, safety etc.


of investments.
2. Company: - It provides them access to market funds, higher
rating and public interest.
3. Brokers: - They receive commission in lieu of services to
investors.
4. Economy and Country: - There is large flow of saving, better
growth more industries and higher income.
INTRODUCTION TO DERIVATIVES

Primary market is used for raising money and secondary market is used for
trading in the securities, which have been used in primary market. But
derivative market is quite different from other markets as the market is used
for minimizing risk arising from underlying assets.
The work "derivative" originates from mathematics. It refers to
a variable, which has been derived from another variable.
i.e. X = f (Y)
WHERE X (dependent variable) = DERIVATIVE PRODUCT
Y (independent variable) = UNDERLYING ASSET
A financial derivative is a product that derives value from the
market of another product. Hence derivative market has no independent
existence without an underlying asset. The price of the derivative instrument
is contingent on the value of underlying assets.
As a tool of risk management we can define it as, "a financial
contract whose value is derived from the value of an underlying
asset/derivative security". All derivatives are based on some cash product.
The underlying assets can be:
a. Any type of agriculture product of grain (not prevailing in India)
b. Price of precious and metals gold
c. Foreign exchange rates
d. Short term as well as long-term bond of securities of different type
issued by govt. and companies etc.
e. O.T.C. money instruments for example loan & deposits.
Example: Wheat farmers may wish to sell their harvest at a future date to
eliminate the risk of change in price by that date. The price of these
derivatives is driven from spot price of wheat.

DEFINITION OF DERIVATIVE
In the Indian context the Securities contracts (Regulation), Act 1956 defines
"Derivative" to include:
(1) A security derived from a debt instrument, Share, Loan whether
secured or unsecured, Risk instrument or contract for difference or
any other form of security.
A contract, which derives its value from the prices of underlying securities.
HISTORICAL ASPECT OF DERIVATIVES:

The need for derivatives as hedging tool was first felt in the
commodities market. Agricultural F&O helped farmers and PROCESSORS
hedge against commodity price risk. After the fallout of BRITAIN WOOD
AGREEMENT, the financial markets in the world started undergoing radical
changes, which give rise to the risk factor. This situation led to development
of derivatives as effective "Risk Management tools".
Derivative trading in financial market started in 1972 when "Chicago
Mercantile Exchange opened its International Monetary Market Division
(IIM). The IMM provided an outlet for currency speculators and for those
looking to reduce their currency risks. Trading took place on currency.
Futures, which were contracts for specified quantities of given currencies,
the exchange rate was fixed at time of contract later on commodity future
contracts was introduced then followed by interest rate futures.
Looking at the liquidity market, derivatives allow corporate and
institutional investors to effectively manage their portfolios of assets and
liabilities through instruments like stock index futures and options. An
equity fund e.g. can reduce its exposure to the stock market and at a
relatively low cost without selling of part of its equity assets by using stock
index futures or index options. Therefore the stock index futures first
emerged in U.S.A. in 1982.
PRODUCTS, PARTICIPANTS AND FUNCTIONS

Derivative contracts have several variants. The most common are


FORWADS, FUTURES, OPTIONS AND SWAPS.
The following three categories of Participants-Hedgers, Speculators,
and Arbitrageurs.

(1) HEDGER:
Hedgers face risk associated with the price of an asset.
They use futures or options markets to reduce the risk. Thus, they are
operation who want to eliminate the risk composing of their portfolio.
(2) SPECULATORS:
They wish to be on future movements in the price of
an asset. A speculator may buy securities in anticipation of rise in price.
If this expectation comes true he sells the securities at a higher price and
makes a profit. Usually the speculator does not take delivery of securities
sold by him. He only receives and pays the difference between the
purchase and sale prices.
(3) ARBITRAGEURS:
They are in business to take advantage of discrepancy
between price in two different markets. If for example, they see the future
price of an asset getting out of line with the cash price, they will take off
setting positions in two markets to lock in profit.
TYPES OF DERIVATIVES

The most commonly used derivative contract is forwards, futures and


options:
(1) FORWARDS:
a forward contract is a customized contract
between two entities, where settlement takes place on a specific date
in the futures at today's pre-agreed price.
(2) FUTURES:
a future contract is an agreement between two
parties to buy or sell an asset at a certain time the future at the certain
price. Futures contracts are the special types of forward contracts in
the sense that are standardized exchange traded contracts.
(3) OPTIONS:
it is of two types: call and put options.
Underlying asset, at a given price on or before a given future date.
PUTS give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a
given date.
(4) LEAPS:
Normally option contracts are for a period of 1 to
12 months. However, exchange may introduce option contracts with a
maturity period of 2-3 years. These long-term option contracts are
popularly known as Leaps or Long term Equity Anticipation
Securities.
(5) BASKETS:
Baskets options are option on portfolio of
underlying asset. Equity Index Options are most popular form of
baskets.
(6) SWAPS:
these are private agreements between two parties to
exchange cash flows in the future according to a prearrange formula.
They can be regarded as portfolios of forward's contracts. The two
commonly used swaps are:
a) INTEREST RATE SWAPS:
these entail swapping both
Principal and interest between the parties, with the cash flow in
one direction being in a different currency than those in the
opposite direction.
b) CURRENCY SWAPS:
these entail swapping both Principal
and interest between the parties, with the cash flow in one
direction being in a different currency than those in the opposite
direction.
Cash Vs Derivative Market
The basis differences between these two may be noted as follows.
a) In cash market tangible asset are traded whereas in derivatives market
contract based on tangible assets or intangible like index or rates are
traded.
b) The value of derivative contract is always based on and linked to the
underlying asset. Though, this linkage may not be on point-to point
basis.
c) Cash market contracts are settled by delivery and payment or through
an offsetting contract. the derivative contracts on tangible may be
settled through payment and delivery, offsetting contract or cash
settlement, whereas derivative contracts on intangibles are necessarily
settled in cash or through offsetting contracts.
d) The cash markets always has a net long position, whereas the net
position in derivative market is always zero.
e) Cash asset may be meant for consumption or investment. Derivatives
are used for hedging, arbitration or speculation.
f) Derivative markets are highly leveraged and therefore could be much
more riskier.
THE DERIVATIVE MARKETS PERFORM A NUMBER OF
ECONOMIC FUNCTIONS:

(1) Prices in organized derivative markets reflect the perception of


market participants about the future and lead the prices of underlying
to perceived future level. The prices of derivatives converge with the
prices of the underlying at the expiration of the derivative contract.
Thus derivatives help in discovery of future as well current prices.
(2) The derivative market helps to transfer the risks from those who have
them but may like them those who have an appetite for them.
(3) Derivatives due to their inherent nature are linked to the underlying
cash markets. With the introduction of derivative, the underlying
market, witness higher trading volumes because of participation by
more players who would not otherwise participate for lack of an
arrangement to transfer risk.
(4) Derivatives have a history of attracting many bright, creative, well-
educated people with an entrepreneurial attitude. They often energize
others to create new business, new products and new employment
opportunities, the benefits of which are immense.
(5) Derivatives market helps increase savings and investments in the
long run Transfer of risk enables market participants to expand their
volume of activities.
PARTICIPANTS IN DERIVATIVE MARKET
• Exchange, trading members, clearing members.
• Hedgers, arbitrageurs, speculators.
• Clearing, clearing bank.
• Financial institutions.
• Stock lenders and borrowers.

OBJECTIVES OF DERIVATE TRADING

(1) HEDGING:
you own a stock and you are confident about the
prospects of the company. However at the same time you feel that overall
market may not perform as good and therefore price of your stock may
also fall in line with overall marked trend.
You expect that some adverse economic or political
event might affect the market sentiments, though fundamentals of the
company will remain good, therefore, it is good to retain the stock.
In both these situations you would like to insure your portfolio against any
such market fall. Such insurance is known as hedging.
Hedging is a tool to reduce the inherent risk in an
investment. Various strategies designed to reduce investment risk using call
option, put options, short selling, and futures are used for hedging. The basic
purpose of a hedge is to reduce the risk of loss.
(2) ARBITRAGE:

The future price of an underlying asset is function of


spot price and cost of carry adjusted for any return on investment. However,
due to uncertainty about interest rates, distortions in spot prices, or
uncertainty about future income stream, prices in futures market may not
truly reflect the expected spot price in future. This imbalance in future and
spot price gives rise to arbitrage opportunities. Transaction made to take
advantage of temporary distortions in the market are known as arbitrage
transactions.

(3) SPECULATION:

you may have very strong opinion about the future


market price of a particular asset based on past trends, current
information and future expectation. Likewise you may also have an
opinion about the overall market trend. To take advantage of such
opinion, individual asset or the entire market (index) could be sold or
purchased.
Position taken either in cash market of derivative
market on the basis of personal opinion is known as speculation.
DERIVATIVE TERMINOLOGY

ASSIGNMENT:
It means allocation of an option contract, which is
exercised, to a short position in the same opinion contract, at the same strike
price, for fulfillment of the obligation, in accordance with the procedure
specified in by the relevant authority from time to time.

BADLA:
It is an indigenous mechanism of postponing the
settlement of trade. This product is peculiar to India markets. This involves
Badla financiers, stock lenders and stock traders. The long buyers and short
sellers may postpone settlement of their trade by making payments and
giving delivery by using the services of Badla financiers and stock lenders
who assume their positions for Badla charges. Counterparty risk,
unpredictable charges and high risk due to inadequate margining are
inherent limitations of Badla.

BASIS:
It is difference between spot price and future price of
the same asset. In normal markets this basis is always negative, i.e. spot
price is always less than future price. A positive basis provides for arbitrage
opportunity.
BETA:
It is a measure of the sensitivity of returns on scrip to
return on the market index. It shows how the price of scrip would move with
every percentage point change in the market index.

CONTRACT VALUE
It is the value arrived at by multiplying the strike price
of the option contract with the regular/market lot size.

EXERCISE:
It is defined as the number of future or option contracts
required be buying or selling per unit of the spot underlying position to
completely hedge against the market risk of the underlying.

MARGIN:
It is the money collected from parties to trade to insure
against the default risk. Some amount of margins is collected upfront and
some are collected shortly after the trade. Failure to pay margins may result
in mandatory closure of position.

OFFSETTING CONTRACT:
new matching contract, which offsets an existing contract,
is known as offsetting contract.
OPTION PREMIUM:
It is consideration paid by the option buyer to
option writer. The premium has two components intrinsic value and time
value. Intrinsic value is the difference between the spot price of the
underlying and exercise price of the contract. Time value represents the cost
of carrying the underlying for the option period, adjusted for any dividend
and option premium.

RISK TRANSFER:
It refers to hedging against the price risk through
futures. The holder of an asset, which he intender to sell in near future, may
transfer the inherent risk by selling futures today. The counterparty assumes
the risk in anticipation of making gain
REASON FOR STARTING DERIVATIVES

1.Counter party risk on the part of broker, in case it ask money from us but
before giving delivery of shares goes bankrupt.
2.Liquidity risk in the form that the particular scrip might not be traded on
exchange.
3.Unsystematic risk in the form that the price of scrip may go up or down
due to “Company Specific Reasons”.
4.Mutual funds may find it difficult to invest the funds raised by them
properly as the scrip in which they want to invert might not be available at
the right price.
6.Systematic risk in the form that the price of scrip may go up or down due
to reason affecting the sentiment of whole market.
THE REQUIREMENTS FOR SETTING UP FUTURE AND
OPTION TRADING ARE OUTLINED BELOW:

1. Creation of an Options Clearing Corporation (OCC) as the single


guarantor of every traded option. In case of default by a party to a
contract, the clearing house has to bear the cost necessary to carry out
the contract.
2. Creation of a strong cash market (secondary market). This is because
after the exercise of an option contract, the investors move to the
secondary market to book profits.
3. Creation of paper-less trading and a book-entry transfer system.
4. Careful selection of the securities may be listed on a National
securities exchange, have a wider capital base, be actively traded, and
so on.
5. Uniformity of rules and regulation in all the stock exchanges.
6. Standardization of the terms governing the options contracts. This
would decrease the transaction costs, For a given underlying security,
all contracts on the options exchange should have an expiry date, a
strike price, and a contract price, only the premium should be
negotiated on the floor of the exchange.
7. Large, financially sound institutions, members and a number of
market makers, who can write the options contracts. Strict capital
adequacy norms to be laid out and followed.
STRENGTH OF INDIAN CAPITAL MARKET FOR
INTRODUCTION OF DERIVATIVES

1. LARGE MARKET CAPITALIZATION:


India is one of the largest market capitalized country
in Asia with a market capitalization of more than 7,65,000 corers.
2. HIGH LIQUIDITY:
In the underlying securities the daily average traded
volume in Indian capital market today is around 7,500 crores. Which
means on an average every month 14% of the country market
capitalization gets traded, shows high liquidity.
3. TRADER GUARANTEE:
The first "clearing corporation" (CCL) guaranteeing
trades has become fully functional from July 1996 in the form of
National Securities Clearing Corporation (NSCCL) for which it does the
clearing.
4. STRONG DEPOSITORY:
A strong depository National Securities Depositories
Ltd.(NSDL), which started functioning in the year 1997, has strengthen
the securities settlement in our country.
5. A GOOD LEGAL GUARDIAN:
SEBI is acting as a good legal guardian for Indian
Capital market.
IMPORTANCE OF DERIVATIVE TRADING

1. Reduction of borrowing cost.


2. Enhancing the yield on assets.
3. Modifying the payment structure of assets to correspond to investor
market view.
4. No physical delivery of share certificate so reduction in cost by stamp
duty.
5. Increase in hedger, speculator and arbitrageurs.
6. It does not totally eliminate speculation, which is basic need of Indian
investors.

INSTRUMENTS OF DERIVATIVE TRADING


FORWARD

Derivative FUTURE

OPTION

SWAPS
FORWARD CONTRACT

"It is an agreement to buy/sell an asset on a certain future date at an agreed


price".
The two parties are:
• Who takes a long position – agreeing to buy
• Who takes a short position—agreeing to sell
The mutually agreed price is known as "delivery price" or
"forward price". The delivery price is chosen in such a way that the value of
contract for both parties is zero at the time of entering the contract, but the
contract takes a positive or negative value for parties as the price of
underlying asset moves. It removes the future price risk. If a speculator has
information or analysis, which forecast an upturn in price, and then be can
go long on the forward market instead of cash market.
The speculator would go long on the forward, wait for the price
to rise, and then take a reversing transaction to book profits. Speculator may
well be required to deposit a margin upfront. However, this is generally a
relatively small proportion of the value of assets underlying the forward
contract.
EFFECT OF CHANGE IN PRICE:

As mentioned above the value of such a contract in zero


for both the parties. But later as the price & the underlying asset changes, it
gives positive or negative value for contract.

PRICE & HOLDER & LONG HOLDER & SHORT


UNDERLYING POSITION POSITION
ASSETS
INCREASE POSITIVE VALUE NEGATIVE VALUE
DECREASE NEGATIVE VALUE POSITIVE VALUE

E.g.
A agrees to deliver 100 equity shares of Reliance to B on Sept. 30,
2002 at a Rate of Rs. 120 per share. Now if the price of share on that date is
Rs. 140 per share, than a who has short position would stand to loss of Rs.
(20*200) = 4000, long position would gain the same amount or vise versa if
price quoted is less than delivery price.
Profit/Loss = ST-E
ST = spot price on maturity date
E = delivery price
LIMITATIONS OF FORWARD CONTRACT
1. No standardization.
2. One party can breach its obligation.
3. Lack of centralization of trading.
4. Lack of liquidity.
To overcome this other type of derivation instrument known as
"Future Contracts" were introduced.

VALUATION OF FORWARD CONTRACT


The forward contract can be put under three categories for the purpose &
valuation:

VALUATION OF THOSE SECURITIES PROVIDING NO


INCOME
Shares, which neither expects to do not pay any, dividend in
future nor having arbitrage opportunities.
e.g. Here Price (F) = S0e rt
Where F = Future Price
S0 = spot price of asset
R = risk free rate of interest p.a. with continuous compounding
T = time of maturity.
If F>S0ert
In this case the investor will buy asset and take a short position in the
forward contract.
"Short position is not position of investor is of seller means contract sold is
greater then contract bought".
Investor may buy the assets, borrowing an amount equal to * * for "t" period
at risk free rate. At the time of maturity, the assets will be delivered for price
F and repayment will be equal to S0ert and there is net profit equal to F- S0ert

If F< S0ert
He will long his position in forward contract. When contract
matures: the assets would be purchased for "F" Here profit is S0ert –F
E.g.
Consider a forward contract were non-dividend shares available at
Rs, 70 matures in 3 months, Risk free rate 8% p.a. compounded
continuously.
S0ert = 70 x [e] 0.25x0.08
= 70 x 0202
= Rs. 71.41
If F = 73
Then an arbitrageur will short a contract, borrow an amount of Rs. 70 & buy
share at Rs,
Repay the loan of Rs. 70. At maturity sell it as Rs. 73 (forward contract
price) and 71.40, thus profit is (73- 71.40) 1.60
Thus he shorts his forward contract position.
SECURITIES PROVIDING A CERTAIN CASH INCOME
If there is certain cash income to be generated on securities in future to the
investor, we will determine present value of income e.g. in case of
preference share.
Present Value of Dividend = Rate & Interest (continuously compounded)
~If there is no arbitrage
Then F = (So – I) ert
~If F> (So –I)ert
Arbitrageur can short a forward contract, borrow money and buy the
asset at present and at maturity asset is sold and earns profit.
Profit = F –(So – I) ert
If
F <(So-I) ert
Arbitrageur can long a forward contract, short the asset a present and invest
the proceeding
Profit (at maturity) (So-I) ert –F
E.g.
Let us consider a 6-month forward contract on 100 shares at
Rs. 38 each risk free of interest (compounding continuously) earn is 10%
p.a. dividend is expected to a yield of Rs. 1.50 in 4 months.
Solution: divided receivable after 4 months = 100x1.50=Rs.1.50
resent Value & dividend = 150xe (4/12)(0.10)50
= Rs 50x0.9672=RS 145.88
= (3800-145.8) e(0.5)(0.10)
= 3654.92x1.05127
F = 3842.31
VALUATION & FORWARD CONTRACT PROVIDING A
KNOWN YIELD
In case of share included in portfolio companies the
index, as underlying assets, are expected to give dividend in course of time,
which may be percentage 0 their prices. It is assumed to be paid
continuously at a rate of "Y" p.a.
F = Soert
E.g.
Stock underlying an under provide a, dividend yield of 4.1% p.a.,
current value of index is 520 and risk free rate of interest is 10% p.a.
r=0.10, y = 0.04, * * = 520 T =3/12 =0.25
F = 520xe(0.10-0.40) (0.25)
= 520x01512 = Rs. 527.85
FUTURE CONTRACT

'It is an agreement between buyer and seller for the purchase and sale of a
particular assets at a specific future date; specific size, date of delivery, place
and alternative asset. It takes obligation on both parties to fulfill the contract.

FEATURES OF FUTURE CONTRACT:


1. Standardized contracts e.g. contract size.
2. Between two parties who do not necessarily know each other.
3. Guarantee for performance by a clearing corporation or clearing
house. Clearinghouse is associated with matching, processing,
registering, confirming setting, reconciling and guaranteeing the
trades on the future exchanges. Clearinghouse tries to eliminate risk of
default by either party.
4. It has some features of Badla also.

FUTURE TERMINOLOGY

SPOT PRICE:
the price at which an asset trades in the spot market.
FUTURES PRICE:
the price at which the futures contract trades in the futures
market.
CONTRACT CYCLE:
the period over which the contract trades. The index
futures contracts on the NSE have one month, and three-month expiry
cycles, which expire on the last Thursday of the month. Thus a January
expiration contract expires on the last Thursday of the January. On the
Friday following the last Thursday, a new contract having three-month
expiry is introduced of trading.
EXPIRY DATE:
it is date specified in the futures contract. This is the
last day on which the contract will be traded, at the end of which it will
cease to exist.
CONTRACT SIZE:
the amount of asset that has to be delivered less than
one contract. For instance, the contract size on NSE's futures market is
Nifties.
BASIS:
in the contract of financial futures, basis can be
defined as the futures price minus the spot price. There will be a different
basis for each delivery month for each contract. in a normal market, basis
will be positive. This reflects that futures prices normally exceed spot prices.
COST OF CARRY:
the relation between futures price and spot price can
be summarized in terms of what is known as cost of carry. This measures the
storage cost plus the interest that is paid to finance the assets less the
incomes earned on the asset.
INITIAL MARGIN:
the amount that must be deposited in the margin
account at a time a future contract is first entered into is known as initial
margin.
MARKING-TO-MARKET:
in the futures market, at the end of each trading
day, the margin account is adjusted to reflect the investor's margin gain or
loss depending upon the future's closing price.
MAINTENANCE MARGIN:
this is somewhat lower than initial margin. This is
set to ensure that the balance in the margin account never becomes negative.
If the balance amount falls below the maintenance margin, the investor
receives a margin call and is expected to top up the margin account to the
initial margin level before trading commences on the next day.
INSTRUMENTS OF FUTURE CONTRACTS

COMMODITY FUTURES
1. Trader in American Exchanges like CBOT, New York: Commodity
Exchange, Chicago Mercantile Exchange (CME), New York
Mercantile Exchange Includes: Wheat, Natural Gas, Platinum, Gold,
and Cattle etc.
2. Contract Life: Mostly for 90 days or less.
3. Maturity date is mostly non-standardized.
4. Quality specified

FINANCIAL FUTURES

1. Introduced by IMM (a division of CME) It Includes: 10 or 5 year


treasury notes (in 1976 by I:M:M), S & P 5000, Nikkie 225, Euro
Dollars, British Pound, Canadian Dollars, Mini Value line Stock
Index,
Russell 2000, Russell 3000, etc.
2. Mostly Longer time e.g. US Treasury Bond Futures are of even more
than 2 years
3. Maturity date is standardized.
4. There connot be any quality variations into these assets.
TYPE OF FUTURE CONTRACTS:

INDEX FUTURES & STOCK FUTURES

INDEX FUTURES:
Of the financial futures, Index future contracts are key
contracts, introduced in U.S. A, in 1982 by the "Commodity Futures Trading
Commission" (CFTC) by approving the Kansas Board proposal. Index
Futures began trading in India in June 2000 of Trade (KSBT)'s Futures
derive its value from the underlying index-e.g. NSE's futures. Contracts are
based on "S & P CNX NIFTY"
At present it has become the most liquid contract in the
country, the arbitrage between the futures equity market is further expected
to reduce impact cost. 80-90% of retail participation is expected in India
because.
1. Brokerage cost is lower.
2. Savings in cost is possible thorough reduced bid-ask spreads where
stocks are trade in package forms.
3. Impact cost will be much lower than dealing in individual scrip.
4. Institutional and large equity holders need portfolios hedging facility.
Index derivatives are more suited to them and more cost effective than
in individual stocks. Pension funds in the US are known-to use stock
index futures for risk hedging purpose.
5. Stock Index is difficult to manipulate as compared to individual stock
prices, more so in India, and the possibility of cornering is reduced.
6. Stock index, being an average is much less volatile than individual
stock prices. This implies lower capital adequacy and margin
requirements.
7. Index derivatives are cash settled, and hence don't suffer from
settlement delays and problems related to bad delivery & forged
certificates.

INDIVIDUAL STOCK FUTURES


The high level committee on capital market on 2001 decided to permit FII's
to participate in "Individual Stock Futures" trading e.g. in Reliance SEB!
Frame guidelines for its trading stock futures can be effectively used for
hedging: speculation and arbitrage At present there are 31 scrips in which
stock derivatives are trading. E.g. the Reliance stock traders at Rs. 1000 and
the two month futures trades at 1006. Assume that the minimum contract
value is Rs. 1,00,000. He buys 100 Individual stock futures for which he
buys a margin of Rs. 20,000. 2 months later the stock closes at Rs. 010. OR
expiration date, he makes a profit of Rs. 400 on an investment of Rs. 20,000
works out annual return of 12%.
VALUATION OF FUTURES CONTRACTS

It can be made possible on following basis:


1. Valuation of financial futures
2. Valuation of commodity futures
I. Carry type commodities
II. Non-Carry type commodities

VALUATION OF FINANCIAL FUTURES:

Valuation of financial futures is based on following assumptions


1. The markets are perfect.
2. There is no transaction cost.
3. All the assets are infinitely divisible.
4. Bid-asks spreads do not exit so that it is assumed that only one price
prevails.There is no restriction on short selling. Also short selling gets
to use the full proceeds of the sales valuations. This includes stock
index futures.
The value of futures contract on a stock index may be obtained
by using the "cost of carry model".
In this case Price of the contract is = spot price+ Carry cost-carry
returns i.e. (s + C – R)
Here: SPOT PRICE: Current Price of One Unit of Deliverable asset in
the Market.
CARRY COST: Holding cost i.e. interest Charges etc. + opportunity
cost of using funds.
CARRY RETURNS: Dividends etc.
Valuation of Stock Index futures is F = S0e(r-y) t

COMMODITY FUTURE'S VALUATION

1) CARRY TYPE OR INVESTMENT PURPOSE


COMMODITIES VALUATION
These types of commodities are held
by significant number. Of investor for futures safety as investment alone.
~If storage cost is zero then F = Soert
~If any storage cost or opportunity cost then it is regarded as negative
income. If S is the present value.
of all the storage costs that may be incurred during the life of a future
contract then F = (So + s)ert
~If the storage cost were proportional to price of commodity then would be
the same as in case of
Providing a negative yield. If S represents the storage costs p.a.
proportion of spot prices, we have
F = Soe(r+s) t E.g. Let us consider a 6 months gold futures contract of
100 gm.
Assume that the spot price is Rs. 480 per gram and that it cost Rs. 3 per
gram for the 6 monthly period to store gold and that the cost is incurred at
the end of the period. If the risk free rate of Interest is 12% p.a. compounded
continuously then R=0.12, s=480 x 100= 48000, e = 6/12 = 0.5
S=3 x 100 e-(0.12 x 0.5) = Rs. 282.53
Then F (48000 282.53)e-0.12 = Rs. 54,438.40

2) NON CARRY TYPE COMMODITITES:


Consumable goods like agricultural
product's futures price will not exceed the sum of spot price + Caring Cost-
Caring Returns, in these arbitrage arguments doesn't work investor stores
these on because of its consumption value only not for investment.
Valuation of non-carry commodity futures requires another concept. i.e.
"Convenience return" or "Convenience yield", which is the returns (in terms
of money) that the investor realizes for carrying commodity over his short
term needs. The financial assets have no convenience return. This is
different or different investor.
F= (So +s) e (r-c) t
S= P.V.
C=convenience cost
So=Spot price
PAY OF FOR FUTURES:

(a) Payoff for buyers of futures contract-long futures


Its payoff is same as payoff of a person
who holds assets. Result of holding an asset may be unlimited upside or
unlimited downside.
Profit

1220

Nifty (underlying)
Assets

Loss

INTERPRETATION
The figure shows P/L for a long futures position. The investor bought futures
when THE INDEX WAS AT 1220.

If Index His futures position shows profits


If Index His futures position shows losses
(b) Payoff for seller of futures contract-short futures
It can be explained by taking an example:
A speculator who sells a 2 months Nifty Index futures contracts when the
nifty stands at 1220 (Nifty an underlying assets)

Profit
…Nifty (underlying assets)

Loss
INTERPRETATION:
When Index moves Seller start making Profits.

When index movers. Seller starts making Loss.


FORWARD VS. FUTURES

Features Forward Future


-Operational Traded between Trade on
Mechanism two parties Exchange

-Contract Differ from Standardised


Specifications traded to trade contracts

-Counter party Exists such No such


Risks risk risk
-Liquidity Low High

-Price Not Highly


Discovery Efficient Efficient
-Example Currency Market Future Market

-Settlement At end of period Daily


COBOT WHEAT FUTURES CONTRACT SPECIFICATIONS
Trading Unit 5000 Bushels

Deliverable Grades No. 1 Northern Spring wheat at par


and No. 2 Soft. Red, No. 2 Hard Red
Winter, No. 2 Dark Northern Spring
and substitution at different
established by the exchange.
Price Quotation Cents and quarter-cents bushel
($12.50 per contract.)
Tick Size One-quarter cent per bushel ($12.50
per contract)
Daily Price Limit 20 cent per bushel ($1000 per
contract) above or below the
previous day's settlement price
(expandable to 30 cent per bushel)
No limit in the spot month (limit are
lifted two business day before the
spot month begins.)
Contract Months March, May, July, September and
December.
Contract Year Starts in July and ends in May
Last Trading day Seventh business day preceding the
last business day of the delivery
month.
Last Delivery Day Last business day of the delivery
month
Trading Hours 9.30 to 1.15 p.m (Chicago time!,
Monday through Friday, Only the
last trading day of an expiring
contract, trading that contract closes
in noon.
Ticker Symbol
W

OPTIONS
Options are fundamentally different from forward and futures. An option
gives the holder/buyers of the option the right to do something. The holder
does not have committed himself to doing something. In contrast, in a
forward or futures contract, the two parties have committed them self to
doing something. Whereas it nothing (expect margin requirement) to enter in
to a futures he purchases of an option require an up front payment.

HISTORICAL BACKGROUND OF OPTION:

Although options have exercised for a long time, they were traded OTD,
without much knowledge of valuation. Today exchange-traded options are
actively traded on stocks, stock indices, foreign currencies and futures
contracts.
The first trading is options began in Europe
and U.S. as early as the century. It was only in early, 1900s that a group of
firms set up what is known as the "put and call brokers and dealers
association" with the aim of providing a mechanism for bringing buyers and
sellers together. It someone wanted to buy an option, he or she would
contract one of the member firms. The firm would then attempt to find a
seller or writer of option either from its own client of those of other member
firms. If no seller could be found, the firm would undertake to write the
option itself in return of price. The two deficiencies in above markets were
1. No secondary market
2. No mechanism to guarantee the writer of option would honor it
In 1973, Black, Marton, Scholes invented the
Black-Scholes formula. In April 1973, CBOE was set up specially for the
purpose of trading options. The market for options develop so rapidly that
by early 80's number of share underlying the options contract sold each day
exceed the daily volume of share traded on the NYSE. Since then, there has
been no looking back.
What is option?
An options is the right, but not the obligation to buy or sell a specified
amount (and quality) of a commodity, currency, index or financial
instruments a to buy or sell a specified number of underlying futures
contracts, at a specified price on a before a give date in the future.
Thus, option like futures, also provide a mechanism
by which one can acquire a certain commodity on other assets, or take
position in order to make profits or cover risk for a price. In this type of
contract as well, there are two parties:
(a) The buyer (or the holder, or owner of options)
(b) The seller (or writer of options)
While the buyer take "long position" the seller take
"short position"
So every option contract can either be "call option" or
"put option" options are created by selling and buying and for every option
that is buyer and seller.
OPTION

BUYER SELLER

RIGHT OBLIGATION

TO BUY TO SELL TO SELL TO BUY


(CALL) (PUT) (CALL) (PUT)
OPTION TERMINOLOGY
 Buyer of an option: the buyer of an option is the one who by paying
the option premium buys the right but not the obligation exercise his
option on the seller/writer.
 Writer of an option: the writer of a call/put option is the one who
receives the option premium and is thereby obliged to sell/buy the
asset if the buyer exercise on him.
 Option price: option price is the price, which the option buyer pays to
the option seller. It is also referred as option premium.
 Expiration date: the date specified in the options contract is known as
expiration date, the exercise date, the strike date or the maturity.
 Strike price: the price specified in the options contract is knows as
strike price or the exercise price.
 American options: these are the options that can be exercised at any
time upto the expiration date. Most exchange-traded options are
Americans.
 European options: these are the options that can be exercised only on
the expiration date itself. These are easier or analyze than American
option, and properties of American options are frequently deducted
from those of its European counterpart.
 In the money option: an in the money option is an option that would
lead to a positive cash flow to the holder if it will exercise
immediately. A call option in the index is set to be in-the-money when
the current index stands at a level higher than the strike price (i.e. spot
price>strike price). If the index is much higher than the strike price,
 the call is set to deep ITM. In the case of a put, the put is ITM if the
index is below the strike price.
 At-money option: (ATM) option is an option that would lead to zero
cash flow if it were exercised immediately. An option on the index is
at-the-money when the current index equals the strike price.
 Out-of-the money option:(OTM) option is an option that would lead
to a negative cash flow it was exercised immediately. A call option on
the index is OTM when the current index stands at a level, which is
less than the strike price (spot price<strike price). If the index is much
lower than the strike price, the call is set to be deep OTM. In the case
of a put, the put is OTM if the index is above the strike price.
 Intrinsic value of an option: the option premium can be broken into
two components-intrinsic values and time value. The intrinsic value of
a call is the amount the option is ITM, if it is ITM. If the call is OTM,
its intrinsic value is zero.
 Time value of an option: it is a difference between its premium and its
intrinsic value. Both calls and puts have time value. An option that is
OTM or ATM has only time value. Usually the maximum time value
exists when the options is ATM. The longer the time to expiration, the
greater is an option's time value, all else equal. At expiration, an
option should have no time value.
TYPES OF OPTIONS
Thus the options are of two types: CALL OPTION AND PUT
OPTION.
CALL OPTION:
It gives an owner the write to buy a specified quantity
of the underling assets at a predetermined price i.e. the exercise price, or the
specific date i.e. is the date of maturity.
EXAMPLE
Suppose it is January now and the investor buys a
March option contract on Reliance Industries (RIL) Share with an exercise
price/strike price Rs. 210. With this he get a right to buy share on a
particular date in March, of course he is under no obligation.
Obviously, if at the expiry date the price in market
(spot price on expiry date) is above the exercise price he'll exercise his
option and reverse is also true.
PUT OPTION:
It gives the holder the right to sell a specific quantity of underlying
assets at an agreed price on date of maturity he gets the right to sell.
EXAMPLE
If an investor buys a March Put Option on RIL
shares with an exercise price of Rs. 210 per share the investor get the right to
sell 100 share @ 210 per share. The investor would naturally exercise his
right if on maturity date price were below 210 and stand to gain and vice-
versa. Buying out options is buying insurance. To buy a put option on Nifty
is to buy insurance: which reimburses the full extent to which-Nifty drops
below the strike price of the put option. This is attractive to many people.
AMERICAN Vs EUROPEAN OPTION
Its owner can exercise an American option at any time on or before the
expiration date.
A European style option gives the owner the right to use the
option only on expiration date and not before.

OPTION PREMIUM
A glance at the rights and obligation of buyer and seller reveals that option
contracts are skewed. One way naturally wonder as to why the seller (writer)
of an option would always be obliged to sell/buy an asset whereas the other
party gets the right? The answer is that writer of an option receives, a
consideration for
Undertaking the obligation. This is known as the price or
premium to the seller for the option.
The buyer pays the premium for the option to the seller
whether he exercise the option is not exercised, it becomes worthless and the
premium becomes the profit of the seller.
Premium/Price of an option = Intrinsic Value + Time Value
Do Nothing

Option to option holder Close out the position by write a,


matching call option or it in case of
writer.
Exercise the option.
IN-THE-MONEY AND OUT-THE-MONEY OPTIONS

Condition Call Put


So>E In the money Out of the money
So<E Out of the money In the money
So=E At the money At the money
So =spot price E = exercise price

Consideration for selling the option/Option Pricing/Option Premium


Assumption
Not transaction cost likes brokerage or commission on buying
or selling.

FACTORS AFFECTING PRICING

1. Supply and demand in secondary market


2. Exercise price
3. Risk free interest rate,
4. Volatility of underlying
5. Time to expiration
6. Dividend on underlying
Option-to-option holder in case of—he opt for expiry date.
i.e How Option Work

CALL OPTIONS Spot Nifty:1200


Buyer exercise the option
Spot Nifty: 1100 Profit: No. of option x price
Strike Price: 1150 Da Differential-Premium
Duration :3 months y paid=Rs. (200x(1200-1150)-
Da No. of option 2000=Rs.8000)
90
y1 bought=200
Premium per option:10
Total premium
paid=2000 Spot Nifty: 1000
Buyer foregoes the
option
Loss premium paid
Rs. 2000
CALL OPTION WORK

Spot Nifty:1200
Buyer exercise the option
Spot Nifty: 1100 Profit: No. of option x price
Strike Price: 1150 Differential-Premium
Da Da paid=Rs. (200x(1200-1150)-
Duration :3 months
y1 y 2000=Rs.8000)
No. of option
90
bought=200
Premium per option:10
Total premium
paid=2000

Spot Nifty: 1000


Buyer foregoes the
option
Loss premium paid
Rs. 2000

PRICING OF OPTION

AT EXPIRATION BEFORE EXPIRATION

Call option Put option Put option Call option


At expiration Before expiration At expiration Before
expiration

1 AT EXPIRATION
(a) Call option pricing at expiration:
If the price of the underlying asset were
lower than the exercise price on the expiration date, the call would expire
unexercised. This is because no one would like to buy an asset, which is
available in the market at a lower price. If an out of money call did actually
sell for a certain price, the investor can make an arbitrage profit by selling it
and earning premium.
The buyer is unlikely to exercise option, the
allowing seller to retain premium. In even of (irrational) exercise of such a
call, writer can purchase asset as S1 and give it at making a profit of (E+S1)+
premium.
On the other hand, if the call happens to be in
the money, it'll, be worth its intrinsic value, equal to excess of asset price
over the exercise price. If call price <intrinsic value then he can buy call at c,
exercise it immediately at S1 and make a profit" of S1—E—C

VALUE OF CALL OPTION

Value
E Price of share

Put option at expiration:


When at the expiration date the price of the
underlying asset is greater than exercised price, the put option will go
unexercised. This is because there is no use of using option to sell at E when
If the option were exercised, it would have resulted in a profit to seller of
option of about (E-S1) + premium.
When S1<E

Value of put option Value

Price of share
2. BEFORE EXPIRATION:
Before expiration, the options call and put are usually sold for at least
intrinsic valued (difference of E & S1).
(a) Call Option Pricing:
A call option will usually sell for at least its
intrinsic value, Minimum value of call is always is equal to its intrinsic
value. Intrinsic value = S>E
To this would be added the time value, if any longer the time expiry, greater
were time value.
P=f (E,S,T)
Y

Price of Call option

Intrinsic Value

450

E Stock Price X

In figure intrinsic value is shown, by, a 45 0 line starting at E,


equal to the excess of stock price over the exercise price.
At Stock price S2, Call Option pence is out- of-the money
i.e. zero intrinsic value then option price=S2B= only time value

(c)Put Option Pricing


It would sell for a price that is at least equal to
intrinsic value, which is excess of exercise price over stock price, when
option is in –the money.
For in the money Put Option i.e. S<E
P=Intrinsic value +Time Value
Time Value=f (Time of Maturity)
Higher the time to maturity, higher is the time value.

For out-the-money/at the money Put Option i.e. S>E, E,S = 0


P=Time Value b'coz intrinsic value = 0

B Time value
Price of put option

Value
Intrinsic B1 Time Value

Stock prices
S1 E S2
DERIVATIVES TRADING IN INDIA

The first step towards introduction of derivatives trading in India was


the promulgation of the securities laws (amendment) ordinance, 1995 which
withdrew the prohibition on options in securities. The market for derivatives,
however, did not take off, as there was no regulatory framework to govern
trading of derivatives.
SEBI set up a 24 members committee under the
Chairmanship of Dr. L.C. Gupta on 18th November, 96 to develop
appropriate regulatory framework for derivatives trading in India. The
committee submitted its report on 17th March, 98 prescribing necessary pre-
conditions for introduction of derivatives trading in India. the committee
recommended that derivatives should be declared as 'securities' so that
regulatory framework applicable to trading of 'securities' could also govern
trading of securities. SEBI also set up a group in June 1998 under the
Chairmanship of Prof. J.R. Varma, to recommend measures for risk
containment in derivatives market in India. The report, which was submitted
in October, 1998, worked out the operational details of margining system,
methodology for charging initial margins, broker net worth, deposit
requirement and real time monitoring requirements.
The SCRA was amended in Dec. 1999 to include
derivatives within the ambit of 'securities' and the regulatory framework was
developed for governing derivatives trading. The act also made it clear that
derivative shall be legal and valid only it such contract are traded on a
recognized stock exchange, thus preluding OTC derivative.
The government also rescinded in March 2002, the three decade old
notification, which prohibited forward trading in securities.
Derivatives trading commenced in India in June 2000 after
SEBI granted the final approval to this effect in May 2000.
SEBI permitted the derivative segments of two stock
exchanges. NSE and BSE, and their clearing house/corporation to
commence trading and settlement in approved derivatives contracts. To
begin with, SEBI approved trading in index futures contracts based on S & P
CNX Nifty and BSE-30 (Sensex) index. This was followed by approval, for
trading in options based on these two indexes and options on individual
securities. The trading in index options commenced in June 2001. Futures
contracts on individual stocks were launched in November 2001. Trading
and Settlement in derivatives contracts is done in accordance with the rules,
bye-laws, and regulations of the respective exchanges and their clearing
house/corporation duly approved by SEBI and notified in the official
gazette.
Thus, the following five types of Derivatives are now being traded in
the India Stock Market.
* Stock Index Futures
* Stock Index Options
* Futures on Individual Stocks
* Options on Individual Stocks
* Interest Rate Derivatives
INDEX FUTURES:
Index futures are financial contracts for which
the underlying is the cash market index like the Sensex, which is the brand
index of India. index futures contract is an agreement to buy or sell a
specified quantity of underlying index for a future date at a price agreed
upon between the buyer and seller. The contracts have standardized
specifications like market lot, expiry day, tick size and method of settlement.
INDEX OPTIONS:
Index Options are financial contracts whereby the
right is given by the option seller in consideration of a premium to the option
buyer to buy or sell the underlying index at a specific price (strike price) on
or before a specific date (expiry date).
STOCK FUTURES:
Stock Futures are financial contracts where the
underlying asset is an individual stock. Stock futures contract is an
agreement to buy or sell a specified quantity of underlying equity share for a

future date at a price agreed upon between the buyer and seller. Just like
Index derivatives, the specifications are pre-specified.
STOCK OPTIONS:
Stock Options are instruments whereby the right
of purchase and sale is given by the option seller in consideration of a
premium to the option buyer to buy or sell the underlying stock at a specific
price (strike price) on or before a specific date (expiry date).

INTEREST RATE DERIVATIVES:


The derivatives are taken on various rates of interests.

OPERATIONAL MECHANISM FOR DERIVATIVES TRADIN


1. REGISTRATION WITH BROKER:
The first step towards trading in the derivatives
market is selection of a proper broker with whom the investor would
trade. Investors should complete all the registration formalities with the
broker before commencement of trading in the derivatives market. The
investor should also ensure to deal with a broker (member of the
exchange) who is a SEBI registered broker and possesses a SEBI
registration certificate.
2. CLIENT AGREEMENT:
The investor should sign the Client
Agreement with the broker before the broker can place any order on his
behalf. The client agreement includes provisions specified by SEBI and the
derivatives segment.

3. UNIQUE CLIENT IDENTIFICATION NUMBER:


After signing the client agreement,
the investor gets a unique identification number (ID). The broker would key
this identification number in the system at the time of placing the order on
behalf of the investor. This ID is broker specific i.e. if the investor chooses
to deal with different brokers, he needs to sign the client agreement with
each one of them and resultantly, he would have different Ids.

4. RISK DISCLOSURE DOCUMENT:


As stipulated in the Bye-Laws provide his
particulars to the investor. The particulars would include his SEBI
registration number, the name of the employees who would be primarily
responsible for the client's affairs, the precise nature of his liability towards
the client in respect of the business done on behalf of the investor. The
broker must also apprise the investor about the risk associated with the
business in derivative trading and the extent of his liability. This information
forms part of the Risk Disclosure document, which the broker issues to the
client. The investor should carefully read the risk disclosure document and
understand the risks involved in the derivatives trading before committing
any position in the market. The risk disclosure document has to be signed by
the client and a copy of the same is retained by the broker for his records.
5. FREE COPY OF RELEVANT REGULATION:
The client is also entitled to a free copy of the
extracts of relevant provisions governing the rights and obligations of
clients, relevant manuals, notifications, circulars and any additions or
amendments etc. of the derivatives segment or of any regulatory authority to
the extent it governs the relationship between the broker and the client.

6. PLACING ORDER WITH THE BROKER:


The investor should place orders only
after understanding the monetary implications in the event of execution of
the trade. After the trade is executed, the investor can request for a copy of
the trade confirmation slip generated on the systems on execution of the
trade. The investor should also obtain from the broker, a contract note for the
trade executed within 24 hours. The contract note should be time (order
receipt and order execution) and price stamped. Execution prices, brokerage
and other charges, if any, should be separately mentioned in the contract
note. If desired, the investor may change an order anytime before the same is
executed on the exchange.
7. MARGINING SYSTEM IN DERIVATIVES:
The aim of margin money is to minimize
the risk of default by either counter-party. The payment of margin ensures
that the risk is limited to the previous day's price movement on each
outstanding position. The different types of margins are:

A) INITIAL MARGIN:
The basic aim of initial margin is to cover the
largest potential loss in one day. Both buyer and seller have to deposited
before the opening of the position in the futures transaction. This margin is
calculated by SPAN by considering the worst case scenario.
B) MARK TO MARKET MARGIN:
All daily losses must be met by depositing of further
collateral-known as variation margin, which is required by the close of
business, the following day. Any profits on the contract are credited to the
client's variation margin account.

7. INVESTOR PROTECTION FUND:

The derivatives segment has


established an "Investor Protection Fund" which is independent of the
cash segment to protect the interest of the investors in the derivatives
market.
8. ARBITRATION:

In case of any dispute between the members


and the clients arising out of the trading or in relation to
trading/settlement, the party thereto shall resolve such complaint, dispute
by arbitrations procedure as defined in the rules and regulations and Bye-
Laws of the respective exchanges.

REGULATORY FRAMEWORK

The trading of derivatives is governed by the provisions contained in the SC


(R) A, the SEBI Act, the rules and regulations framed there under and the
rules and bye-laws of stock exchanges.

Securities contracts (Regulation) Act, 1956


SC(R) A aims at preventing undesirable
transactions in securities by regulating the business of dealing therein and by
providing for certain other matters connected therewith. This is the principal
Act, which governs the trading of securities in India. The term "securities"
has been defined in the SC(R)A. As per Section 2(h), the 'Securities' include:

1. Shares, scrips, stock, bonds, debentures, stock or other marketable


securities of a like nature in or of any incorporated company or other
body corporate.
2. Derivative
3. Units or any other instrument issued by any collective investment
scheme to the investors in such schemes.
4. Government securities.
5. Such other instruments as may be declared by the Central Government
to be securities
6. Rights or interests in securities
"Derivative" is defined to includes:
• A security derived from a debt instrument, share, loan whether
secured or unsecured, risk instrument or contract for differences or
any other form of security.
• A contract which derives its value from the prices, or index of
price, of underlying securities.
Section 18A provides that notwithstanding anything contained in any
other law for the time being in force, contracts in derivative shall be
legal and valid if such contracts are:
Traded on a recognized stock exchange.
Settled on the clearinghouse of the recognized stock exchange, in
accordance with the rules and bye-laws of such stock exchanges.
REGULATIONS FOR DERIVATIVES TRADING

SEBI set up a 24-member committee under the Chairmanship of Dr. L.C.


Gupta to develop the appropriate regulatory framework for derivatives
trading in India. The committee submitted its report in March 1998. On May
11, 1998 SEBI accepted the recommendations of the committee and
approved the phased introduction of derivatives trading in India beginning
with stock index futures. SEBI also approved the "suggestive bye-laws"
recommended by the committee for regulations and control of trading and
settlement of derivatives contracts.
The provisions in the SC(R)A and the regulatory
framework developed there under govern trading in securities. The
amendment of the SC(R)A to include derivatives within the ambit of
'securities' in the SC(R)A made trading in derivatives possible with in the
framework of that Act.
1. Any Exchange fulfilling the eligibility criteria as prescribed in the LC
Gupta committee report may apply to SEBI for grant of recognition
under Section 4 of the SC(R)A, 1956 to start trading derivatives. The
derivatives exchange/segment should have a separate governing
council and representation of trading/clearing members shall be
limited to maximum of 40% of the total members of the governing
council. The exchange shall regulate the sales practices of its
members and will obtain prior approval of SEBI before start of
trading in any derivative contract.
2. The Exchange shall have minimum 50 members.
3. The members of an existing segment of the exchange will not
atomically become the members of derivative segment. The members
of the derivatives segment need to fulfill the eligibility conditions as
laid down by the LC Gupta committee.
4. The clearing and settlement of derivatives traders shall be through a
SEBI approved clearing corporation/house. Clearing
corporation/house complying with the eligibility conditions as laid
down by the committee have to apply to SEBI for grant of approval.
5. Derivative brokers/dealers and clearing members are required to seek
registration from SEBI. This is in addition to their registration as
brokers of existing stock exchanges. The minimum networth for
clearing members of the derivatives clearing corporation/house shall
be Rs. 300 Lakh. The networth of the member shall be computed as
follows:
• Capital + Fee reserves
• Less non-allowable assets viz.
a. Fixed assets
b. Pledged securities
c. Member's card
d. Non-allowable securities (unlisted securities)
e. Bad deliveries
f. Doubtful debts and advances
g. Prepaid expenses
h. Intangible assets
i. 30% marketable securities
6. The minimum contract value shall not be less than Rs. 2 Lakh.
Exchange should also submit details of the futures contract they
propose to introduce.
7. The initial margin requirement, exposure limits linked to capital
adequacy and margin demands related to the risk of loss on the
position shall be prescribed by SEBI/Exchanges from time to time.
8. The L.C. Gupta committee report requires strict enforcement of
"Know your customer" rule and requires that every client shall be
registered with the derivatives broker. The members of the derivatives
segment are also required to make their clients aware of the risks
involved in derivatives trading by issuing to the client the Risk
Disclosure Document and obtain a copy of the same duly signed by
the client.
9. The trading members are required to have qualified approved user and
sales person who have passed a certification programme approved by
SEBI.
DR. L.C.GUPTA COMMITTEE

The Securities and exchange board of India (SEBI) appointed a


committee with Dr. L.C. Gupta as its chairman in November, 1996 to
develop regulatory framework for derivatives trading in India.
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 recommend measures for
risk containment in the derivative market in India.
The recommendations of L.C. Gupta Committee at a glance:

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


b) SEBI to approve rules, bye-laws and regulation of the derivatives
exchange and the derivatives contracts.
c) SEBI need not be involved in framing exchange level regulations.
d) SEBI should create a special Derivatives Cell as it involves special
knowledge, and a Derivatives advisory council may be created to tap
outside experts for independent.
e) Legal restrictions on institutions, including mutual funds, on use of
derivatives should be removed.
f) Existing stock exchanges with cash trading to be allowed to trade
derivatives if they meet prescribed eligibility condition—importantly,
a separate Governing Council and at least 50 members.
g) Two categories of member-clearing members and non-clearing
members, with the latter depending on the former for settlement of
trades. This is no bring in more traders.
h) Broker members, dealers and sales persons in the derivatives market
must have passed a certificate programme to be registered with SEBI.
i) Co-ordination between SEBI and the RBI of financial derivatives
market must have passed a certificate programme to be registered with
SEBI.
j) Clearing corporation to be the center piece of the derivatives market,
both for implementing the margin system and providing trade
guarantee. In the near term, existing clearing corporation be allowed
to participate in derivatives. For the long-term, a centralized clearing
corporation has been recommended.
k) Minimum networth requirement of Rs. 3 crores for participants,
maximum exposure limits for each broker/dealer on gross basis and
capital adequacy requirements to be prescribed.
l) Mark-to-market to be collected before next day's trading starts.
m) As a conservative measure, margins for derivatives purposes not to
take into account positions in cash and futures market and across all
stock exchanges.
n) Margins to be systematically collected and not left to discretion of
brokers/dealers.
o) Much stricter regulation for derivatives as compared to cash trading.
p) Strengthen cash market with uniform settlement cycles among all SEs
and regulatory oversight.
Proper supervision of sales practices with registration of every client
with the dealer/broker and risk disclosure as the corner-stone.
J.R. VARMA COMMITTEE

After the submission of L.C. Gupta committee report and approval of the
introduction of index futures trading by SEBI the board mandated the setting
up of a group to recommend measures for risk containment in the derivative
market in India. Prof. J.R. Varma was the chairman of the group.
ASSUMPTIONS

-Volatility in India markets are high.


-Volatility is not constant & varying.
-There is no data on the volatility on Index futures.
-Even at 99% "Value At Risk" model there could be possibility of default
once in six months.
-Not efficient organized arbitragers players.
RECOMMENDATIONS

- Only traders with high net worth be allowed to traded in Derivatives.


- Imposition of VAR margin system.
- Submission of periodic reports by CC and SE to SEBI.
- Continuously refining of Margin system.
- Daily changes in the Margins be calculated and imposed.
- Proper liquid net worth.
-Online position monitoring at customer, TM, CM and Market level.
RISK MANAGEMENT

NSCCL has developed a comprehensive risk containment mechanism for the


F & O segment. The salient features of risk containment mechanism on the F
& O segment are:
1. The financial soundness of the members is the key to risk management.
Therefore, the requirements for membership in terms of capital adequacy
(net worth, security deposits) are quite stringent.
2. NSCCL charges an upfront initial margin for all the open positions of a
CM. It specifies the initial margin requirements for each futures/options
contract on a daily basis. It also follows value-at-risk (VaR) based
margining through SPAN. The CM in turn collects the initial margin
from the TMs and their respective clients.
3. The open positions of the members are marked to market based on
contract settlement price for each contract. The difference is settled in
cash on a T + 1 basis.
4. NSCCL's on-line position monitoring system monitors a CM's open
positions on a real-time basis. Limits are set for each CM based on his
capital deposits. The on-line position monitoring system generates alerts
whenever a CM reaches a position limit set up by NSCCL. NSCCL
monitors the CMs for MTM value violation, while TMs are monitored
for contract-wise position limit violation.
5. CMs are provided a trading terminal for the purpose of monitoring the
open position of all the TMs clearing and settling through him. A CM
may set exposure limits for a TM clearing and settling through him.
NSCCL assists the CM to monitor the intra-day exposure limits set up by
a CM and whenever a TM exceed the limits, it stops that particular TM
from further trading.
6. A member is alerted of his position to enable him to adjust his exposure
or bring in additional capital. Position violations result in withdrawal of
trading facility for all TMs a CM is case of a violation by the CM.
7. A separate settlement guarantee fund for this segment has been created
out of the capital of members. The fund had a balance of Rs. 648 crore at
the end of March 2002.
The most critical component of risk containment
mechanism for F & O segment is the margining system and on-line position
monitoring. The actual position monitoring and margining is carried out on-
line through Parallel Risk Management System (PRISM). PRISM uses
SPAN (r) (Standard Portfolio Analysis of Risk) system for the purpose of
computation of on-line margins, based on the parameters defined by SEBI.

MINIMUM BASE CAPITAL


A Clearing Member (CM) is required to meet
with the Base Minimum Capital (BMC) requirements prescribed by NSCCL
before activation. The CM has also to ensure that BMC is maintained in
accordance with the requirements of NSCCL at all points of time, after
activation.
Every CM is required to maintain BMC of Rs.50 lakhs with
NSCCL in the following manner:
(1) Rs.25 lakhs in the form of cash.
(2) Rs.25 lakhs in any one form or combination of the below forms:
Cash
FIXED DEPOSIT RECEIPTS (FDRs) issued by approved banks
and deposited with approved Custodians or NSCCL
BANK GUARANTEE in favour of NSCCL from approved banks in
the specified format.
APPROVED SECURITIES in demat form deposited with
approved Custodians.
Any failure on the part of a CM to meet with the
BMC requirements at any point of time, will be treated as a violation of the
Rules, Bye-Laws and Regulations of NSCCL and would attract disciplinary
action inter-alia including, withdrawal of trading facility and/ore clearing
facility, closing out of outstanding positions etc.

ADDITIONAL BASE CAPITAL


Clearing members may provide additional
margin/collateral deposit (additional base capital) to NSCCL and/or may
wish to retain deposits and/or such amounts which are receivable from
NSCCL, over and above their minimum deposit requirements, towards
initial margin and/ or other obligations.
EFFECTIVE DEPOSITS / LIQUID NETWORTH
Effective deposits

All collateral deposits made by CMs are segregated into


cash component and non-cash component.
For Additional Base Capital, cash component means cash, bank guarantee,
fixed deposit receipts, T-bills and dated government securities. Non-cash
component shall mean all other forms of collateral deposits like deposit of
approved demat securities.
At least 50% of the Effective Deposits should be in the form of cash.

Liquid Networth

Liquid Networth is computed by reducing the initial


margin payable at any point in time from the effective
deposits.
The Liquid Networth maintained by CMs at any point in
time should not be less than Rs.50 lakhs (referred to as Minimum Liquid Net
Worth).

MARGINS
NSCCL has developed a comprehensive risk containment mechanism for the
Futures & Options segment. The most critical component of a risk
containment mechanism for NSCCL is the online position monitoring and
margining system. The actual margining and position monitoring is done on-
line, on an intra-day basis. NSCCL uses the SPAN (Standard Portfolio
Analysis of Risk) system for the purpose of margining, which is a portfolio
based system

Initial Margin

NSCCL collects initial margin up-front for all the open positions of a
CM based on the margins computed by NSCCL-SPAN .A CM is in turn
required to collect the initial margin from the TMs and his respective clients.
Similarly, a TM should collect upfront margins from his clients.

Initial margin requirements are based on 99%


value at risk over a one day time horizon. However, in the case of futures
contracts (on index or individual securities), where it may not be possible to
collect mark to market settlement value, before the commencement of
trading on the next day, the initial margin may be computed over a two-day
time horizon, applying the appropriate statistical formula. The methodology
for computation of Value at Risk percentage is as per the recommendations
of SEBI from time to time.

INITIAL MARGIN REQUIREMENT FOR A MEMBER:


For client positions - shall be netted at the level of individual client
and grossed across all clients, at the Trading/ Clearing Member level,
without any setoffs between clients.
For proprietory positions - shall be netted at Trading/ Clearing
Member level without any setoffs between client and proprietory positions.
For the purpose of SPAN Margin, various
parameters are specified from time to time.
In case a trading member wishes to take additional
trading positions his CM is required to provide Additional Base Capital
(ABC) to NSCCL. ABC can be provided by the members in the form of
Cash , Bank Guarantee , Fixed Deposit Receipts and approved securities .

Premium Margin

In addition to Initial Margin, Premium Margin would be charged to


members. The premium margin is the client wise margin amount payable for
the day and will be required to be paid by the buyer till the premium
settlement is complete.

Assignment Margin

Assignment Margin is levied on a CM in addition to SPAN margin and


Premium Margin. It is required to be paid on assigned positions of CMs
towards Interim and Final Exercise Settlement obligations for option
contracts on individual securities, till such obligations are fulfilled.
The margin is charged on the Net Exercise Settlement Value payable by a
Clearing Member towards Interim and Final Exercise Settlement and is
deductible from the effective deposits of the Clearing Member available
towards margins.
Assignment margin is released to the CMs for exercise
settlement pay-in.

PAYMENT OF MARGINS
The initial margin is payable upfront by Clearing Members. Initial margins
can be paid by members in the form of Cash , Bank Guarantee, Fixed
Deposit Receipts and approved securities .

Non-fulfillment of either the whole or part of the margin


obligations will be treated as a violation of the Rules, Bye-Laws and
Regulations of NSCCL and will attract penal charges @ 0.09% per day of
the amount not paid throughout the period of non-payment. In addition
NSCCL may at its discretion and without any further notice to the clearing
member, initiate other disciplinary action, inter-alia including, withdrawal of
trading facilities and/ or clearing facility closing out of outstanding
positions, imposing penalties, collecting appropriate deposits, invoking bank
guarantees/ fixed deposit receipts, etc.
POSITION LIMITS, VIOLATIONS & PRICE SCAN RANGE

Position Limits
Clearing Members are subject to the following exposure / position limits in
addition to initial margins requirements
• Exposure Limits
• Trading Memberwise Position Limit
• Client Level Position Limits
• Market Wide Position Limits (for Derivative Contracts on Underlying
Stocks) Collateral limit for Trading Members

VIOLATIONS

PRISM (Parallel Risk Management System) is the real-time position


monitoring and risk management system for the Futures and Options market
segment at NSCCL. The risk of each trading and clearing member is
monitored on a real-time basis and alerts/disablement messages are
generated if the member crosses the set limits.
• Initial Margin Violation
• Exposure Limit Violation
• Trading Memberwise Position Limit Violation
• Client Level Position Limit Violation
• Market Wide Position Limit Violation
• Violation arising out of misutilisation of trading member/ constituent
collaterals and/or deposits
• Violation of Exercised Positions
Clearing members who have violated any
requirement and/ or limits, may submit a written request to NSCCL to either
reduce their open position or, bring in additional collateral deposits by way
of cash or bank guarantee or FDR or securities. NSCCL renders a service to
members, whereby the members can give standing instructions to debit their
account towards additional base capital.

A penalty of Rs. 5000/- is levied for each violation


and is debited to the clearing account of clearing member on the next
business day. In respect of violation on more than one occasion on the same
day, each instance is treated as a separate violation for the purpose of
calculation of penalty. The penalty is charged to the clearing member
irrespective of whether the clearing member brings in margin deposits
subsequently.

Clearing Members (CMs) and Trading Members


(TMs) are required to collect upfront initial margins from all their Trading
Members/ Constituents.

CMs are required to compulsorily report, on a daily


basis, details in respect of such margin amount due and collected, from the
TMs/ Constituents clearing and settling through them, with respect to the
trades executed/ open positions of the TMs/ Constituents, which the CMs
have paid to NSCCL, for the purpose of meeting margin
requirements.

Similarly, TMs are required to report on a daily basis details in respect of


such margin amount due and collected from the constituents clearing and
settling through them, with respect to the trades executed/ open positions of
the constituents, which the trading members have paid to the CMs, and on
which the CMs have allowed initial margin limit to the TMs.
RESEARCH METHODOLOGY & ANALYSIS

RESEARCH METHODOLOGY

Research is a procedure of logical and systematic


application of the fundamentals of science to the general and overall
questions of a study and scientific technique by which provide precise tolls,
specific procedures and technical, rather than philosophical means for
getting and ordering the data prior to their logical analysis and manipulation.
Different type of research designs is available
depending upon the nature of research project, availability of able manpower
and circumstances.
The study about " Trends and future of derivatives in
india " is descriptive in nature. So survey method is used for the study.

Sampling Procedure
The small representative selected out of large
population is selected at random is called sample. Well-selected sample may
reflect fairly, accurately the characteristic of population. The chief aim of
sampling is to make an inference about unknown parameters from a
measurable sample statistics. The statistical hypothesis relating t population.
The sample size was 60 which includes brokers,dealers and investors.
Sources of Data:
The sources of data includes primary and secondary data
sources.
Primary Sources:
Primary data is collected by structured questionnaire
administered by sitting with guide and discussing problems.
Secondary Sources:
The secondary data is data, which is collected and compiled for
the different purpose, which are used in research for this study.
The secondary data include material collected from:
 Newspaper
 Magazine
 Internet
Data collection instruments
The various method of data gathering involves the use of
appropriate recording forms. These are called 'tools' or 'instruments of data
collection.
Collection Instruments:
1. Observation
2. Interview guide
3. Interview schedule
Each tool is used for specific method of data gathering. The
tool for data collection translates the research objectives in to specific
term/questions to the response, which will provide research objective.
The instrument data collection in our study interview schedule
mainly. Every respondent was conducted personally with an interview

schedule containing questions. Interview method was used because it can be


explained more easily and clearly and takes less time to answer.
Methodology
Assumptions:
The research was based on the following assumption:
1. The methodology used for this purpose are survey and questionable
method. It is assumed that this method is more suitable for collection
of data.
2. It is assumed that the respondent have sufficient knowledge to ensure
questionable.
3. It is assumed that the respondent have filled right and correct option
according to their view.
BROKER'S PERCEPTION ABOUT DERIVATIVES (ANALYSIS)

TRADING PERIOD IN DERIVATIVES

Trading period in derivatives.

25
21
20

15 13 13 Series1
10 Series2
7 6
5

0
Less 1 year 2 year 3 year More
than 1 than 3
year year

From my sample of 60, 13 (22%) brokers and investors investing in


derivatives from last 1 year and less than this. 21(35%) are investing from
last 2 years ,7 (11%) are investing from last 3 years and only 6 (10%) have
experience of more than 3 years of investment in derivatives.
REASONS BEHIND ITS ADOPTION

Purpose for derivative Trading

30
24
25
20
15 14 Series1
15
Series2
10 7
5
0
t
en
n
g

ity
tio

em
in

id
la
dg

qu
u

na
e

ec

Li
H

a
p

M
S

k
is
R

Reasons behind adoption of derivatives are different by brokers,investors


and dealers e.g. liquidity, risk management hedging, investor
demand(speculation) etc. Out of 60 brokers,investors dealing in derivatives
14 (23%) adopt it due to characteristics of risk management, 15 (25%) due
to hedging , 24 (40%) for investor (client's) demand (speculation) and
remaining 7 (12%) due to liquidity.

EXPERIENCE WITH DERIVATIVE


Out of my sample size 60, only 23
(38%) find derivatives as quite profitable investment. 14 (23%) find that
derivatives can’t give big profits in future.17 (29%) feels that equities are
better option for onvestment than derivativies.remaining 6 (10%) have other
opinion thatonly those investors,brokers can derive good return from
derivatives those have surplus funds and patience for long period..because
derivative requires huge investment and risk also.
INVESTED AMOUNT IN DERIVATIVES

Invested amount in derivative trading.

30

25

20 Series1
15 Series2

10 Series3

0
2 lacs 2lacs-5 5 lacs-10 Any other
lacs lacs
Out of my sample size 60 ,27 (45%) investors and brokers have invested 2
lacs normally.9 (15%) invested between 2 lacs to 5 lacs.and 15 (25%)
invested between 5 lacs to 10 lacs,and remaining have invested in other
amounts. Reason behind this is that those are investing from many years are
taking the risk of investing huge amount.

TRADED PERIOD IN DERIVATIVES

Tradedperiodfor derivative
investment.

25 23
19
20
15 13 Series1
10 Series2
5
5
0
Weekly Monthly More than More than
1 month 2 months

13 (22%) investors and brokers are investing weekly in derivatives,23


( 38%) investing monthly,19 (32 %) investing after more than 1 month and
only 5 ( 8%) investing too late after 2 months.
IMPACT ON CUSTOMER BASE

Impact on customer base.

50 42
40
30 Series1
20 15 Series2
10 3
0

Increase Decrease Remain same

Out of 60 brokers and investors, 3 ( 5%) of brokers said that it doesn't


increase their customer base because introducing small savings as
investment, but derivatives increases customer base of 42 (70%) wich is
more than half.it is basically beneficial for those who are investing from last
2 or more years. In investment sector need minimum of Rs. 2,00,000 as
investment so it is basically for corporate and investment sector only not for
small investors.15 ( 25%) said their customer base remain same because
they have started just now for investing in derivatives.in future it will
increase their customer base.
RELATIONSHIP WITH CASH MARKET

relation Between derivative and cash


market.

27 28
30

20 Series1
10 5 Series2

0
Positive Negative Can't say

Out of 60 brokers,dealers 27 (45%) have the positive response toward the


relation between derivative and cash market and remaining 5 (8%) has
negative response. 28 (47%) are not able to say anything because they don’t
have proper knowledge about stock market.they are investing with the
guidance of brokers and with the support of their close relatives those are
investing for last many years.
BROKER'S PERCEPTION TOWARDS INDIAN INVESTOR

i.e. is settled in Indian investor psyche?

Relation among derivative and cash


market.
37
40
30 23
20 Series1
10
0
Yes No

out of total 37 (62%) of investors and dealers are saying it hasn't settled in
Indian investor psyche and 23 (38%) are saying it has.

DERIVATIVES AND RISK


Every broker says that there is a risk factor (up to some extent) in
derivatives also.

SHORTCOMINGS IN INDAIN DERIVATIVE SYSTEM


27 (45%) brokers,investors respond towards shortage of domestic
technical expertise. 31(52%) feel lack of awareness in investor about
derivatives and remaining 2 (3%) market failure.

RESULTS / FINDINGS
1. Brokers not dealing in derivatives at present are also not going to
adopt it in near futures.
2. Hedging & Risk Mgt. Is the most important feature of derivatives.
3. It is not for small investors.
4. It has increased brokers turnovers as well as helpful in aggregate
investment.
5. Brokers haven't adequate knowledge about options, so most by them
are dealing in futures only.
6. There is a risk factor in derivative also.
7. Most of investors are not investing in derivatives.
8.People are not aware of derivatives, even people who have invested in it,
hasn’t adequate knowledge about it. These people are interested to take it in
their future portfolio also. They consider it as a tool of risk management.
9.They normally invest in future contracts.
10.They are investing in future contract, because futures have up to home
extent similar quality as Badla.
REASON BEHIND LESS DEVELOPMENT OF F&O SEGMENT AT
L.S.E.
At L.S.E. the is become possible by L.S.E.S.L, which is working
as a broker at N.S.E. and the broker of L.S.E. (301 members) are working as
a client of LSES Ltd. Itself (in reality). So they can't trade as a broker of
their client and sub-broker concept does not exist in F&O segment.
At National Level
1. Securities and contract's regulations act has recognized "index" as a
security very later i.e. in Nov. 2001. It will take time to take position in
derivative or capital market.
2. The Limited mutual faith in the parties involved.
3. It hasn't a legalized market.
4. Commodity F & O market has not yet been come to India. this will
make easy to understand and take simple investor under investor base of
derivative trading.
5. Market failures
6. Scandals
7. Inadequate infrastructures
8. Shortage to domestic technical expertise, in India even most of people
are not aware of concept derivatives.
9. Large lot size, so small investors are not able to come under derivative
segment.
10. There are less scripts under derivatives segment.
11. High margin as compare to Badla.
12. In India there can't be a long term trading in F & O, it is only for 1 to
2 or maximum for 3 months.

SUGGESTIONS
1. LOT SIZE:
Lot size should be reduced so that the major segment of
an India society i.e. small saving class can come under F & O trading.
There is strong need for revision of lot sizes as the lot sizes of some of
the individual scrips that were worth of Rs. 200000 in starting, now same
lot size amount to a much larger value.
2. SUB BROKER:
Sub-broker concept should be added and the actual
brokers should give all rights of brokers in F & O segment also.
3. SCRIPS:
More scrips of reputed companies etc. should be
introduced in "F & O segment".
4. TRADING PERIOD:
Trading period should be increased.
5. TRAINING CLASSES OR SEMINARS:
There should be proper classes on derivatives for
investors, traders, brokers, students and employees of stock exchanges.
Because lack of knowledge is the main reason of its less development.
The first step towards it should be seminars provide to brokers & LSE
employees and secondly seminar to students.

LIMITATIONS OF THE STUDY

No study is complete in itself, however good it may and every study has
some limitations:
 Time is the main constraint of my study.
 Availability of information was not sufficient because of less
awareness among investors/brokers
 Study is based only on NSE because information and trading in BSE
is not available here.
 Sample size is not enough to have a clear opinion.
CONCLUSION

On the basis of overall study on derivatives it was found that


derivative products initially emerged as hedging devices against fluctuation
and commodity prices and commodity linked derivatives remained the soul
form of such products. The financial derivatives came in spotlight in 1972
due to growing in stability in financial market.

I was really surprised to see during my study that a layman or a simple


investor does not even know how to hedge and how to reduce risk on his
portfolios. All these activities are generally performed by big individual
investors, institutional investors, mutual funds etc.

No doubt that derivative growth towards the progress of economy is


positive. But the problems confronting the derivative market segment are
giving it a low customer base. The main problems that it confronts are
unawareness and bit lot sizes etc. these problems could be overcome easily
by revising lot sizes and also there should be seminar and general
discussions on derivatives at varied places.

BIBLIOGRAPHY
1. BOOKS AND ARTICLES
 NCFM on derivatives core module by NSEIL.
 The Indian Commodity-Derivatives Market in Operations.

2. MAGAZINES
 The Dalal Street
 LSE Bulletin
3. INTERNET SITES
 www.nseindia.com

 www.derivativeindia.com

 www.bseindia.com

 www.sebi.gov.in
SAMPLE OF QUESTIONNAIRE

Dear Respondent,

I am a student of MBA 2nd year. I am working on the project "


TRENDS AND FUTURE OF DERIVATIVES IN INDIA : A DETAILED
STUDY” You are requested to fill in the questionnaire to enable, to
undertake the study on the said project.

NAME:

OCCUPATION:

ADDRESS:

PHONE NO.:
1) For how long you have been trading in derivatives?
a) Less than 1 year b) 1 Year
c) 2 Year d) 3 Year e) More than 3 years.

2) What is your purpose for trading in derivatives?


a) Hedging b) Speculation
c) Risk Management d) Liquidity

3) How will you describe your experience with derivative till date?
a) I find these quite profitable
b) I don't find derivatives can give big profits
c) I feel that equities are better than derivatives
d) Any other __________________________________

4)What is amount of money you are investing in normally?


a) 2,00,000 b) Rs. 2,00,000 to Rs. 5,00,000
c) Rs. 5,00,000 to Rs. 10,00,000 d) Any other amount____________

5)How often do you trade?


a) Weekly b) Monthly c) More than 1 month
d) More than 2 month

6)What is your customer base with introduction of derivatives?


a) Increase b) Decrease c) Remain same

7)What according to you is relationship between derivative market and


cash market?
a) Positive b) Negative c) Can't say

8) According to you have derivatives settled in Indian investors psyche?


a) Yes b) No

9)What shortcomings do you feel in Indian derivative market?


a) Lack of awareness among the investors about derivatives.
b) Shortage of domestic technical expertise.
c) If any other___________________________

10) Which of following Media would you prefer the most for investor
education?
a) TV b) Newspaper c) Magazines

11) What suggestions do you want to make with regard to investors


education in derivatives market in India?

THANKS FOR YOUR COOPERATION