INTRODUCTION

RESEARCH PROBLEM
The turnover of the stock exchange has been tremendously increasing from Last 10 years. The number of trades and the number of investors, who are participating, have increased. The investors are willing to reduce their risk, so they are seeking for the risk management tools. There were no effective measures for the investors for hedging strategies in trading on underlying assets. Prior to this there were some manipulations for the traded derivative stocks which could not be resolved easily by the authorities. The evaluation and analysis of the incomes from the derivatives also became complex in the bearish and bullish markets. Hence, the analysis will be made on the above stated problem and measures are to be suggested to overcome the above stated problem

OBJECTIVES OF THE STUDY

To analyze the derivatives market in India. To analyze the operations of futures and options. To find the profit/loss position of futures buyer and also the option writer and option holder. To study about risk management with the help of derivatives. To study and analyze the purpose of hedging in futures and options in the derivatives market. To make suggestions to the authorities concerned regarding the effective usage of the derivatives.

SCOPE OF THE STUDY

The Study is limited to Derivatives with special reference to futures and Option in the Indian context and the data had been taken through INDIAINFOLINE LIMITED as a representative sample for the study. Any alteration may arise to the actual situations. The research study is only made as an attempt to evaluate derivatives market only in specified Organization. The study is based only on the Indian perspective of derivatives markets.

RESEARCH METHODOLOGY

The following are the steps involved in the study. Selection of the scrip:The scrip selection is done on a random and the scrip selected is HINDUSTAN PETROLEUM LTD. The lot is 200. Profitability position of and seller and also the option holder and option writers is studied.

the futures buyers

Data Collection:The data of the HINDUSTAN PETROLEUM LTD has been collected from the internet site www.nseindia.com. The data consist of the February-March Contract and period of collection is from 29rd FEBRUARY 2011 27th MARCH 2011. Data

Analysis:The analysis consist of the tabulation of the data assessing the profitability Positions of the futures buyers and sellers and also option holder and the option Writer, representing the data with graphs and making the interpretation using Data. The data for the present study is collected from primary and secondary sources. PRIMARY SOURCES: The primary sources of data collection is done by personal discussions with the assistant branch manager, relationship manager and assistant relationship manager and also through the contacts with the other staff members of the organization of indiainfoline Limited. SECONDARY SOURCES: The secondary sources of the data is collected through the official website of the National Stock Exchange of India www.nseindia.com, and through the articles collected from various news papers, journals and magazines.

LIMITATIONS OF THE STUDY

The following are the limitations of this study.

The scrip chosen for analysis is HINDUSTAN PETROLEUM LTD and the contract taken is March 2011 ending one-month contract.

The data collected is completely restricted to the HINDUSTAN PETROLEUM LTD of March 2011 hence this analysis is restricted only to the selected company, and is not applicable to any other company of same kind and nature.

As the futures and options are only taken for making the analysis and the outcome may not be applicable to other components of derivatives.

A full study of the hedging strategies may not be overviewed

REVIEW OF LITERATURE

Introduction Derivatives are financial contracts whose values are derived from the value of an underlying primary financial instrument, commodity or index, such as: interest rates, exchange rates, commodities, and equities. The International Monetary Fund defines derivatives as "financial instruments that are linked to a specific financial instrument or indicator or commodity and through which specific financial risks can be traded in financial markets in their own right. The value of financial derivatives derives from the price of an underlying item, such as asset or index. Unlike debt securities, no principal is advanced to be repaid and no investment income accrues" While some derivatives instruments may have very complex structures, all of them can be divided into basic building blocks of options, forward contracts or some combination thereof. Derivatives allow financial institutions and other participants to identify, isolate and manage separately the market risks in financial instruments and commodities for the purpose of hedging, speculating, arbitraging the price differences of the investments and adjusting portfolio risks.

The emergence of the market for derivatives products, most notable forwards, futures, options and swaps can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. The financial markets can be subject to a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, derivatives products generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivatives products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors.

The need for a derivatives market The derivatives market performs a number of economic functions: 1. They help in transferring risks from risk adverse people to risk oriented people 2. They help in the discovery of future as well as current prices 3. They catalyze entrepreneurial activity 4. They increase the volume traded in markets because of participation of risk adverse people in greater numbers 5. They increase savings and investment in the long run

Meaning of Derivatives The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived" from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities. Derivative is a product/contract which does not have any value on its own i.e. it derives its value from some underlying. As the name suggests, derivative contracts are those contracts which derives their value from the price of something else. Typically derivatives contracts derive their value from underlying cash market

Derivatives are the Investments that derive their value from underlying assets such as currencies, treasury bills, and bonds or are linked to indices such as a stock market index that can be used to speculate on market movements or to protect investments against major swings in market prices Derivatives are the financial contracts that derive their value from an underlying asset or index, such as an interest rate or foreign currency exchange rate which can be used to manage risk, reduce cost and enhance returns As the name suggests, derivative contracts are those contracts which derives their value from the price of something else. Typically derivatives contracts derive their value from underlying cash market for e.g. derivative of the Reliance, will derive its value from the cash market price of Reliance. DEFINITIONS OF DERIVATIVES Derivatives are the Investments that derive their value from underlying assets such as currencies, treasury bills, and bonds or are linked to indices such as a stock market index that can be used to speculate on market movements or to protect investments against major swings in market prices. Derivatives are the financial contracts that derive their value from an underlying asset or index, such as an interest rate or foreign currency exchange rate which can be used to manage risk, reduce cost and enhance returns. Derivatives are the Trades that are constructed or derived from another security (stock, bond, currency, or commodity) that can be both exchange and non-exchange traded (known as Over the Counter or OTC). Derivatives are the financial contracts the value of which depends on the value of the underlying instrument - commodity, bond, equity, currency or a combination. Derivatives are financial instruments whose value changes in response to an underlying variable, that require little or no net initial investment and are settled at a future date.

With Securities Laws (Second Amendment) Act, 1999, Derivatives has been included in the definition of Securities. The term Derivative has been defined in Securities Contracts (Regulations) Act, as:A Derivative includes: a. a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; b. a contract which derives its value from the prices, or index of prices, of underlying securities;

Futures Contract Futures Contract means a legally binding agreement to buy or sell the underlying

security on a future date. Future contracts are the organized/standardized contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a pre-specified date which is called the expiry date of the contract. On expiry, futures can be settled by delivery of the underlying asset or cash. Cash settlement enables the settlement of obligations arising out of the future/option contract in cash.

An Option contract Options Contract is a type of Derivatives Contract which gives the buyer/holder

of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a specified period. The buyer / holder of the option purchase the right from the seller/writer for a consideration which is called the premium. The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right. The underlying asset could include securities, an index of prices of securities etc.

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Under Securities Contracts (Regulations) Act, 1956 options on securities has been defined as "option in securities" means a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in securities; NOTE: An Option to buy is called Call option and option to sell is called Put option. As in the case of futures contracts, option contracts can be also be settled by delivery of the underlying asset or cash. However, unlike futures cash settlement in option contract entails paying/receiving the difference between the strike price/exercise price and the price of the underlying asset either at the time of expiry of the contract or at the time of exercise / assignment of the option contract.

The Index Futures and Index Option Contracts

Futures contract based on an index i.e. the underlying asset is the index, are known as Index Futures Contracts. For example, futures contract on NIFTY Index and BSE-30 Index. These contracts derive their value from the value of the underlying index. Similarly, the options contracts, which are based on some index, are known as Index options contract. However, unlike Index Futures, the buyer of Index Option Contracts has only the right but not the obligation to buy / sell the underlying index on expiry. Index Option Contracts are generally European Style options i.e. they can be exercised / assigned only on the expiry date. An index in turn derives its value from the prices of securities that constitute the index and is created to represent the sentiments of the market as a whole or of a particular sector of the economy. Indices that represent the whole market are broad based indices and those that represent a particular sector are sectoral indices. In the beginning futures and options were permitted only on S&P Nifty and BSE Sensex. Subsequently, sectoral indices were also permitted for derivatives trading subject to fulfilling the eligibility criteria.

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Derivative contracts may be permitted on an index if 80% of the index constituents are individually eligible for derivatives trading. The index is required to fulfill the eligibility criteria even after derivatives trading on the index have begun. If the index does not fulfill the criteria for 3 consecutive months, then derivative contracts on such index would be discontinued.By its very nature, index cannot be delivered on maturity of the Index futures or Index option contracts therefore, these contracts are essentially cash settled on Expiry.

GENERAL STRUCTURE OF DERIVATIVES

(CHART 1.1)

DERIVATIVES

FUTURES

OPTIONS Put Option Call Option

FORWARDS

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DIFFERENT TYPES OF DERIVATIVES

The following are the various types of derivatives. They are:

FUTURES:
A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts.

OPTIONS:
Options are of two types-calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.

FORWARDS:
A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at todays pre-agreed price.

WARRANTS:
Options generally have lives of upto one year; the majority of options traded on options exchanges having a maximum maturity of nine months. warrants and are generally traded Over-the-counter. Longer-dated options are called

LEAPS:
The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of upto three years.

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BASKETS:
Basket options are options on portfolio of underlying assets. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options.

SWAPS:
Swaps are private agreement between two parties to exchange cash flows in the future according to a pre arranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are:

Interest rate swaps:

The entail swapping only the interest related cash flows between the parties in the same currency.

Currency swaps:
These entail swapping both principal and interest between the parties, with the cashflows in one direction being in a different currency than those in the opposite direction.

Swaptions:
Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is an option to pay fixed and received floating. Although there are many types of derivatives, in Indian stock market currently we have futures and options.

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THE DERIVATIVES OFFERS THE FOLLOWING USAGES:

Speculation: One can take a view of the market and buy or sell derivatives accordingly at a fraction of a total cost. Hedging: It reduces the risk associated with market exposure by taking a counter position in the derivatives market. Arbitrage: It offers an opportunity to take an advantage of the price difference between the derivatives market and the cash market. EVOLUTION OF COMMODITIES DERIVATIVES MARKET IN INDIA The Indian experience in commodity futures market dates back to thousands of years. References to such markets in India appear in Kautialyas Arthasastra. The words, Teji, Mandi, Gali, and Phatak have been commonly heard in Indian markets for centuries. The first organized futures market was however established in 1875 under the aegis of the Bombay Cotton Trade Association to trade in cotton contracts. Derivatives trading were then spread to oilseeds, jute and food grains. The derivatives trading in India however did not have uninterrupted legal approval. By the Second World War, i.e., between the 1920s &1940s, futures trading in organized form had commenced in a number of commodities such as cotton, groundnut, groundnut oil, raw jute, jute goods, castor seed, wheat, rice, sugar, precious metals like gold and silver. During the Second World War futures trading was prohibited under Defence of India Rules. After independence, the subject of futures trading was placed in the Union list, and Forward Contracts (Regulation) Act, 1952 was enacted. Futures trading in commodities particularly, cotton, oilseeds and bullion, was at its peak during this period. However following the scarcity in various commodities, futures trading in most commodities were prohibited in mid-sixties. There was a time when trading was permitted only two minor commodities, viz., pepper and turmeric.

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Deregulation and liberalization following the forex crisis in early 1990s, also triggered policy changes leading to re-introduction of futures trading in commodities in India. The growing realization of imminent globalization under the WTO regime and nonsustainability of the Government support to commodity sector led the Government to explore the alternative of market-based mechanism, viz., futures markets, to protect the commodity sector from price-volatility. In April, 1999 the Government took a landmark decision to remove all the commodities from the restrictive list. Food-grains, pulses and bullion were not exceptions. The long spell of prohibition had stunted growth and modernization of the surviving traditional commodity exchanges. Therefore, along with liberalization of commodity futures, the Government initiated steps to cajole and incentives the existing Exchanges to modernize their systems and structures. Faced with the grudging reluctance to modernize and slow pace of introduction of fair and transparent structures by the existing Exchanges, Government allowed setting up of new modern, demutualised Nation-wide Multicommodity Exchanges with investment support by public and private institutions. National Multi Commodity Exchange of India Ltd. (NMCE) was the first such exchange to be granted permanent recognition by the Government

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STRUCTURE OF DERIVATIVE MARKETS IN INDIA Derivative trading in India takes can place either on a separate and independent Derivative Exchange or on a separate segment of an existing Stock Exchange. Derivative Exchange/Segment function as a Self-Regulatory Organization (SRO) and SEBI acts as the oversight regulator. The clearing & settlement of all trades on the Derivative Exchange/Segment would have to be through a Clearing Corporation/House, which is independent in governance and membership from the Derivative Exchange/Segment.

Everyone talks about derivatives these days. Derivative products have been around for a long time. Derivatives first came from Japanese rice markets. As early as the 1650s, dealings resembling present day derivative market transactions were seen in rice markets in Osaka, Japan. The first leap towards an organized derivatives market came in 1848, when the Chicago Board of Trade, the largest derivative exchange in the world, was established. Derivatives markets broadly can be classified into two categories, those that are traded on the exchange and they traded one to one or 'over the counter'. They are hence known as:

Exchange Traded Derivatives OTC Derivatives (Over The Counter) OTC Equity Derivatives

Traditionally equity derivatives have a long history in India in the OTC market. Options of various kinds (called Teji and Mandi and Fatak) in un-organized markets were traded as early as 1900 in Mumbai.The Securities Contract and Regulatory Authority (SCRA) however banned all kind of options in 1956. The prohibition on options in SCRA was removed in 1995. Foreign currency options in currency pairs other than Rupee were the first options permitted by RBI. The Reserve Bank of India has permitted options, interest rate swaps, currency swaps and other risk reductions OTC derivative products.

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The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived" from the value of the underlying asset.

The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities.

Derivative trading in India takes can place either on a separate and independent Derivative Exchange or on a separate segment of an existing Stock Exchange. Derivative Exchange/Segment function as a Self-Regulatory Organisation and SEBI acts as the oversight regulator. The clearing & settlement of all trades on the Derivative Exchange/Segment would have to be through a Clearing Corporation/House, which is independent in governance and membership from the Derivative Exchange/Segment.

With the amendment in the definition of 'securities' under SC(R)A (to include derivative contracts in the definition of securities), derivatives trading takes place under the provisions of the Securities Contracts (Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992..Dr. L.C Gupta Committee constituted by Sebi had laid down the regulatory framework for derivative trading in India. SEBI has also framed suggestive bye-law for Derivative Exchanges/Segments and their Clearing Corporation/House which lay's down the provisions for trading and settlement of derivative contracts.

The Rules, Bye-laws & Regulations of the Derivative Segment of the Exchanges and their Clearing Corporation/House have to be framed in line with the suggestive Bye-laws. Sebi has also laid the eligibility conditions for Derivative Exchange/Segment and its Clearing Corporation/House.The eligibility conditions have been framed to ensure that Derivative

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Exchange/Segment & Clearing Corporation/House provide a transparent trading environment, safety & integrity and provide facilities for redressal of investor grievances. Factors generally attributed as the major driving force behind growth of financial derivatives are: (a) Increased Volatility in asset prices in financial markets, (b) Increased integration of national financial markets with the international markets, (c) Marked improvement in communication facilities and sharp decline in their costs, (d) Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies, and (e) Innovations in the derivatives markets, which optimally combine the risks and returns over a large number of financial assets, leading to higher returns, reduced risk as well as transaction costs as compared to individual financial assets.

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THE COMPANY

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(THE FINANCIAL SERVICE INDUSTRY) Financial Services

The Indian financial sector is on a roll. Driven by a strong investor interest and an expanding market, the Indian stock market rose to record levels, with the popular sensex crossing 21,000 points and Nifty crossing the 6,000 mark for the first time.

The industry is also becoming more vibrant, with new types of products and services being offered to meet the needs of the booming economy. For example, in the derivatives market, the notional principal amount outstanding has more than trebled between March 2005 and June 2007 to US$ 24.09 billion from US$ 6.836 billion. The rise in the economy is also estimated to lead to a four-fold increase in India's investable wealth from US$ 250 billion in 2007 to US$ 1 trillion. Simultaneously, according to a report by Celent, an international consultancy firm, India's wealth management will rise to an estimated 42 million by 2012 from about 13 million in 2007.

Clearly, there is huge potential in this segment. Significantly, wealth management revenues are expected to account for 32-37 per cent of the total full-service financial institutions by 2012. The market is also expected to undergo a structural transformation with organized players increasing their market share.

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Stock Markets The year 2007 saw Indian stock markets scaling new peaks. It has emerged as the third best performing market in the world with a dollar return of 71.23 per cent. The popular Bombay Stock Exchange (BSE) benchmark index, sensex, also posted its highest ever absolute gain of 6500 points in over two decades. This performance of Indian stock markets has led to the total investor wealth of Bombay Stock Exchange (BSE) surging to a record high of over US$ 1.7 trillion, with an average increase of over US$ 10.18 million in every minute of trading during 2007. At the end of 2006, the total market capitalisation stood at US$ 812 billion. Simultaneously, the National Stock Exchange (NSE) has climbed to the top spot in stock futures contracts and number-two slot in the index futures segment in the world. According to Ernst & Young, India was also the fifth largest market in terms of number of IPOs and seventh largest in terms of the proceeds for the year. Indian companies raised a whopping US$ 11.48 billion through public issues in 2007, which is 83 per cent higher than US$ 6.28 billion mobilized in 2006. The robust performance of the Indian stock markets can also be seen in the huge increase in the funds mobilised by the corporate India. During 2007-08, India Inc mobilised a whopping US$ 8.13 billion through issue of shares on rights issue, which is almost an eight-fold increase over US$ 926.32 million raised in 2006-07. In fact, the mobilisation of the funds in 2007-08 was more than the combined mobilisation of the preceding 12 years. Simultaneously, a whopping US$ 13.07 billion has been raised through by India Inc through public issues, according to data compiled by Prime Database. This is almost twice that of US$ 6.25 billion mobilised in 2006-07 and the highest ever in the last six years. While initial public offerings mobilised US$ 10.34 billion (about 79.14 per cent), follow-on public issues mobilised US$ 2.53 billion.

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Private Equity The year 2007 was a watershed for private equity market, which has emerged as the most preferred mode of fund mobilization for India Inc. The capital mobilised through this route was higher than the funds mobilized through IPOs, follow-on issues and qualified institutional placements put together. India, in fact, topped the Asia private equity chart for the first time in 2007 in terms of aggregate deal value. According to Grant Thornton, a total of US$ 17.14 billion was mobilised through 386 deals by India Inc in 2007, compared to US$ 7.8 billion in 2006. Real estate, infrastructure, banking and financial services were the dominant sectors attracting about 55 per cent of the total private equity investments. The growth continues apace in 2008. During January-March 2008, private equity firms invested about US$ 3.3 billion across 97 billion, which was 22.22 per cent higher than the US$ 2.7 billion clocked in the corresponding period last year. A study by global consulting firm Boston Analytics, the average deal size has increased from US$ 8.4 billion in 2003 to US$ 36.8 billion in 2007. And driven by the robust economic growth and attractive market valuations, private equity investments are estimated to continue strongly through 2011. Structured Finance India has emerged as the fastest growing market in the Asia-Pacific region for structured finance, a process of arranging funds by banks and other entities through partly selling their loan books. It was also the second largest market for domestic issuance in the structured finance market. Within this market, Asset Backed Securities (ABS) market has been the dominant segment than Residentially Market Backed Securities (RMBS). This market has been growing at a frenetic pace ever since the RBI issued revised guidelines on securitisation in 2006.

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Mutual Funds India is also one of the fastest growing market for mutual funds industry attracting a host of global players. The combination of increasing number of fund houses (along with new schemes) and increase in the number of people parking their savings in mutual funds has resulted in total funds mobilisation increasing at a whopping 124.93 per cent during 2007-08 to stand at US$ 1.11 trillion as against US$ 485.13 billion in 2006-07. The average assets under management (AUM) of the mutual fund industry for March 2008 stood at US$ 134.76 billion as against US$ 89.86 billion at the end of 2006, representing a year on year growth of 49.96 per cent. With accelerating investor interest shown in mutual fund segment, the number of investor folios of the MFs increased to 43.7 million at the end of March 2008, from 27.9 million at the end of January 2007 (a growth rate of 54 per cent). Simultaneously, there has been an increase in the number of distributors to 72,108 (excluding 107 banks) till March 2008 from 54,000 in January 2007. Continuing the growth, the Indian mutual funds industry is expected to grow at a CAGR of 30 per cent in the next three years to become a US$ 241.79 billion industry by 2011 from US$ 118.85 billion in July 2007. This would be on the back of 25 per cent growth rate between 1999 and 2007. Consequently, market penetration in the MF industry would more than double by 2011 from about 4 per cent in 2007. Banking The burgeoning economy, surging foreign investment, financial sector reforms and a favourable demographic profile has led to the Indian banking industry emerging as one of the fastest growing in the world. The industry's business grew at a CAGR of 20 per cent from US$ 471.11 billion as of March 2002 to US$ 1175.61 billion by March 2007. Significantly, the newly licensed private sector business has grown almost twice (1.75 times) as that of banking industry as a whole, leading to their share in total banking business increasing from 9 per cent in 2001-02 to 16 per cent in 2006-07.

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This boom in the banking industry has propelled nine Indian banks to the list of top 50 Asian Banks, as per this year's Asian Banker 300 report. Similarly, seven Indian microfinance institutions find place in Forbes list of World's Top 50 Microfinance Institutions. Despite such impressive performance, the potential for further growth is huge considering the fact that India has second largest financially excluded households (about 135 million) in the world. In fact, according to Boston Consulting Group, India is the fastest growing incremental revenue pool in the world. Insurance The liberalisation of the rules for the entry of domestic and foreign players has had a favourable impact on this sector, leading to premium collections growing by 19.9 per cent in 2006-07, compared to the world average of 2.9 per cent. Consequently India became the 15th largest insurance market from 19th in 2005. This growth looks particularly impressive when seen against the fact that the combined penetration of both life and non-life is less than 2 per cent of the GDP compared to world average of 7.52 per cent. Clearly, the scope for growth is enormous. With increasing per capita income, insurance penetration and entry of new players, the Indian insurance industry is estimated to grow to US$ 50.9 billion by 2011 from around US$ 12.72 billion in 2007. The private players are likely to see a growth rate of 140 per cent during this period. Debt Market While the Indian financial sector was dominated by the stellar performance of the stock markets, the Indian debt market had its own share of excitement. India Inc increased its collections through the debt market by as much as 53.84 per cent to US$ 20 billion in 2007 from US$ 13 billion in 2006.

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FINANCIAL SERVICES (BANKING AND NON-BANKING)

Promising sub-sectors Capital markets Consumer financing Venture banking Mutual funds

Infrastructure financing (Table3.1)

India has one of the most developed financial markets in the developing world.

Tremendous scope exists for both banking and non-banking financial institutions from other countries. The insurance sector, nationalised suinmce 1971, has been opened up according to an announcenebt made in November 1998. A legislation to to this effect is expected by early 1999.

Top companies from the United Kingdom and the United States among others are

already active in India's financial markets. markets. Some of the big names are: Merrill Lynch, Oppenheimer, J.P. Morgan, Morgan Stanley, Grindlays, Standard Chartered, Hong Kong and Shanghai Banking Corporation among others.

Foreign institutional investors (FIIs) have been allowed to invest in the stocks and

securities markets with rights of full repatriation and withdrawal. Their presence has added a new dynamism to the market

India already has foreign exchange reserves of US$27 billion which is considered very

comfortable, but the country needs to use foreign skills and networks to be able to manage the huge sums for its development needs.

Local financial Institutions such as the Industrial Development Bank of India (IDBI),

Industrial Credit and Investment Corporation of India (ICICI), Industrial Finance Corporation of India, Unit Trust of India and the Shipping Credit and Investment Corporation of India have

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raised billions through the most sophisticated financial instruments including Deep Discount Bonds.

Indian firms are showing increasing liking for Global Depository Receipts (GDR) listed

in London. American institutions are trying to promote American Depository Receipts (ADR) listed in New York.

After much dithering, India has finally opened up the insurance sector to private and

foreign investors.

VOLUTION OF BROKERAGE HOUSES IN INDIA Early Years

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The equity brokerage industry in India is one of the oldest in the Asia region. India had an active stock market for about 150 years that played a significant role in developing risk markets as also promoting enterprise and supporting the growth of industry. The roots of a stock market in India began in the 1860s during the American Civil War that led to a sudden surge in the demand for cotton from India resulting in setting up of a number of joint stock companies that issued securities to raise finance. This trend was a kin to the rapid growth of securities markets in Europe and the North America in the background of expansion of railroads and exploration of natural resources and land development. Historical records show that as early as 1864, there were about 1,000 brokers with the stock markets functioning from three places in Mumbai; between 9 am to 7 pm at the junction of Meadows Street and Rampart Row, from day break till 9 am and from 7 pm to early hours of next morning at Bazargate, Bombay. Share prices rose sharply even at that time. A share of Colaba Land Company during the boom period of the 1860s rose from Rs 10,000 at par to Rs 1,20,000 and that of Backbay Shares went up from Rs 2,000 to Rs 54,000. Bombay, at that time, was a major financial centre having housed 31 banks, 20 insurance companies and 62 joint stock companies. Reports on stock markets around that time indicate that an ordinary broker in 1864 earned about Rs 200 per day, a huge sum in those days. The boom period came to an abrupt end in 1865. In Jul 1865, what was then used to be called the share mania ended with burst of the stock market bubble. Never Investors witnessed in any place a run so widely distributed nor such distress followed so quickly on the heels of such prosperity An interesting aspect is that despite the collapse of the stock market, most of the brokers met their payment commitments. In the aftermath of the crash, banks, on whose building steps share brokers used to gather to seek stock tips and share news, disallowed them to gather there, thus forcing them to find a place of their own, which later turned into the Dalal Street. A group of about 300 brokers formed the stock exchange in Jul 1875, which led to the formation of a trust in 1887 known as the Native Share and Stock Brokers Association.

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A unique feature of the stock market development in India was that that it was entirely driven by local enterprise, unlike the banks which during the pre-independence period were owned and run by the British. Following the establishment of the first stock exchange in Mumbai, other stock exchanges came into being in major cities in India, namely Ahmedabad (1894), Calcutta (1908), Madras (1937), Uttar Pradesh and Nagpur (1940) and Hyderabad (1944). The stock markets gained from surge and boom in several industries such as jute (1870s), tea (1880s and 1890s), coal (1904 and 1908) etc, at different points of time. Beginning of a new equity culture A new phase in the Indian stock markets began in the 1970s, with the introduction of Foreign Exchange Regulation Act (FERA) that led to divestment of foreign equity by the multinational companies, which created a surge in retail investing. The early 1980s witnessed another surge in stock markets when major companies such as Reliance accessed equity markets for resource mobilisation that evinced huge interest from retail investors. A new set of economic and financial sector reforms that began in the early 1990s gave further impetus to the growth of the stock markets in India. As a part of the reform process, it became imperative to strengthen the role of the capital markets that could play an important role in efficient mobilization and allocation of financial resources to the real economy. Towards this end, several measures were taken to streamline the processes and systems including setting up an efficient market infrastructure to enable Indian finance to grow further and mature. The importance of an efficient micro market infrastructure came into focus following the incidence of market abuses in securities and banking markets in 1991 and 2001 that led to extensive investigations by two respective Joint Parliamentary Committees. The Securities and Exchange Board of India (SEBI), which was set up in 1988 as an administrative arrangement, was given statutory powers with the enactment of the SEBI Act, 1992. The broad objectives of the SEBI include

To protect the interests of the investors in securities To promote the development of securities markets and to regulate the securities

markets

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The scope and functioning of the SEBI has greatly expanded with the rapid growth of securities markets in India in the last fifteen years. Following the recommendations of the High Powered Study Group on Establishment of New Stock Exchanges, the National Stock Exchange of India (NSE) was promoted by financial institutions with an aim to provide access to investors all over the country. NSE was incorporated in Nov 1992 as a tax paying company, the first of such stock exchanges in India, since stock exchanges earlier were trusts, being run on no-profit basis. NSE was recognized as a stock exchange under the Securities Contracts (Regulations) Act 1956 in Apr 1993. It commenced operations in wholesale debt segment in Jun 1994 and capital market segment (equities) in Nov 1994. The setting up of the National Stock Exchange brought to Indian capital markets several innovations and modern practices and procedures such as nationwide trading network, electronic trading, greater transparency in price discovery and process driven operations that had significant bearing on further growth of the stock markets in India. Faster and efficient securities settlement system is an important ingredient of a successful stock market. To speed the securities settlement process, The Depositories Act 1996 was passed that allowed for dematerialisation (and rematerialisation) of securities in depositories and the transfer of securities through electronic book entry. The National Securities Depository Limited (NSDL) set up by leading financial institutions, commenced operations in Oct 1996. Regulations governing selection of various types of market intermediaries as depository participations were made. Subsequently, Central Depository Services (India) Limited promoted by Bombay Stock Exchange and other financial institutions came into being.

Rapid Growth

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The last decade has been exceptionally good for the stock markets in India. In the back of wide ranging reforms in regulation and market practice as also the growing participation of foreign institutional investment, stock markets in India have showed phenomenal growth in the early 1990s. The stock market capitalization in mid-2007 is nearly the same size as that of the gross domestic product as compared to about 25 percent of the latter in the early 2000s. Investor base continued to grow from domestic and international markets. The value of share trading witnessed a sharp jump too. Foreign institutional investment in Indian stock markets showed continuous rise reaching about USD10 billion in each of these years between FY04 to FY06. Stock markets became intensely technology and process driven, giving little scope for manual intervention that has been the source of market abuse in the past. Electronic trading, digital certification, straight through processing, electronic contract notes, online broking have emerged as major trends in technology. Risk management became robust reducing the recurrence of payment defaults. Product expansion took place in a speedy manner. Indian equity markets now offer, in addition to trading in equities, opportunities in trading of derivatives in futures and options in index and stocks. Electronic Traded Funds(ETFs) are showing gradual growth. Within five years of introduction of derivatives, Indian stock markets now are ranked first in stock futures and fourth in index futures. Indian stock markets are transaction intensive and thus rank among the top five markets in this regard. Stock exchange reforms brought in professional management separating conflicts of interest between brokers as owners of the exchanges and traders/dealers. The demutualisation and corporatisation of all stock exchanges is nearing completion and the boards of the stock exchanges now have majority of independent directors. Foreign institutions took stake in Indias two leading domestic stock exchanges. While NYSE Group led consortium took stake in the National Stock Exchange, Deutsche Borse and Singapore Stock Exchange bought equity in the Bombay Stock Exchange Ltd.

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Circa1995. A group of Professionals Formed Company called Probity Research & Service Private Limited. The name was later changed to IndiaInfoline Limited. The objective was to provide unbiased and independent information to market intermediaries and investors. The quality of research soon caught the imagination of all major participants in the financial market. In a span of two to three years the client list read like the who's who of Indian financial market. The list included consulting firms like Mckinsey, companies like Hindustan Lever, Banks like Citibank, Rating agencies like CRISIL, D&B, FIs, FIIs, foreign brokers as well as leading Indian brokers. The going was smooth but not exciting! One fine morning in early1999, a colleague of the company had a crazy idea that if the company made all the research available free on the web, the number of users may well jump from 250 to 2.5million! To make it true, the business required incarnation. It meant that the company put up all the information on the web site and let go off all the revenues and profits. Worse, if the new avatar failed, there would be no comebacks'. Circa2001.The internet bubble started bursting faster than any body could have imagined. The dot com suffix, which was the tail to any business name, suddenly became the worst stigma to have. Funding disappeared completely, regardless of valuation, business model or management depth. The company also had a crash landing and was forced to drop a number of plans including one to set up a TV channel. IndiaInfoline Limited decided to narrow its focus on business where it could leverage its core competencies to the maximum. The key business lines that emerged were mutual funds, life insurance and E-Broking. The company became heavily dependant on its E-broking business for survival. The odds were against them. There was no money available for the private equity investors at any valuation. All the competitors were backed by institutions or had abundant capital. There was a core group who never lost hope. They cut all the possible costs and worked on bare bone structure. They survived against all odds and started capturing market share. Not broking alone mutual funds and life insurance business also grew strongly. The company rose from strength to strength to become the leading corporate agent in life insurance and among the top retail players in mutual fund and broking space.

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The Story took an interesting turn. The company raised capital by the way of Initial Public Offerings (IPOs).In India, investment advisory is a sunrise industry, with tremendous long term promise. The young 'Earning' and 'saving' class of population is growing very rapidly. Falling interest rates are compelling people look around for advised investment. The industry is consolidating as smaller players find it difficult to meet strict compliance standards and service customers with research and technology understandably; competition is intense. The land scape was changing every day and the road ahead is less travelled by. The India Infoline Ltd. along with its subsidiaries is a unique one stop investment which offers every thing from information and advice to execution and service to the retail customers for the entire gamut of investment products from risk free RBI Bonds to high risk, high reward equities and also mutual funds and life insurance. They also entered into portfolio management services and commodities broking, again leveraging upon their core competencies in research and technology. The company promises to continue to deliver high quality independent research and maintain high standards of integrity and compliance. The management realizes that the business is highly vulnerable to lapse in risk management. Over the years, it evolved a clear and logical risk management system, which stood the trial by fire on May 17; 2004.There are a number of opportunities on the horizon and with availability of horizon, temptations around. The management is fully conscious of the fact that with public money it is in a crucial relationship with heightened responsibilities to ensure optimum use of capital.

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THE PRODUCT LINES OF INDIAINFOLINE LIMITED

(CHART3.1)

A SEBI authorized Portfolio Manager; it offers Portfolio Management Services to clients. These services are offered to clients as different schemes, which are based on differing investment strategies made to reflect the varied risk-return preferences of clients. INDIA INFOLINE MEDIA AND RESEARCH SERVICES LIMITED The content services represent a strong support that drives the broking, commodities, mutual fund and portfolio management services businesses. Revenue generation is through the sale of content to financial and media houses, Indian as well as global. It undertakes equities research which is acknowledged by none other than Forbes as 'Best of the Web' and 'a must read for investors in Asia'. India Infoline's research is available not just over the internet but also on international wire services like Bloomberg (Code: IILL), Thomson First Call and Internet Securities where India Infoline is amongst the most read Indian brokers.

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INDIA INFOLINE COMMODITIES LIMITED. India Infoline Commodities Pvt Limited is engaged in the business of commodities broking. Our experience in securities broking empowered us with the requisite skills and technologies to allow us offer commodities broking as a contra-cyclical alternative to equities broking. We enjoy memberships with the MCX and NCDEX, two leading Indian commodities exchanges, and recently acquired membership of DGCX. We have a multi-channel delivery model, making it among the select few to offer online as well as offline trading facilities. INDIA INFOLINE MARKETING & SERVICES India Infoline Marketing and Services Limited is the holding company of India Infoline Insurance Services Limited and India Infoline Insurance Brokers Limited. (a) India Infoline Insurance Services Limited is a registered Corporate Agent with the Insurance Regulatory and Development Authority (IRDA). It is the largest Corporate Agent for ICICI Prudential Life Insurance Co Limited, which is India's largest private Life Insurance Company. India Infoline was the first corporate agent to get licensed by IRDA in early 2001. (b) India Infoline Insurance Brokers Limited India Infoline Insurance Brokers Limited is a newly formed subsidiary which will carry out the business of Insurance broking. We have applied to IRDA for the insurance broking licence and the clearance for the same is awaited. Post the grant of license, we propose to also commence the general insurance distribution business.

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INDIA INFOLINE INVESTMENT SERVICES LIMITED Consolidated shareholdings of all the subsidiary companies engaged in loans and financing activities under one subsidiary. Recently, Orient Global, a Singapore-based investment institution invested USD 76.7 million for a 22.5% stake in India Infoline Investment Services. This will help focused expansion and capital raising in the said subsidiaries for various lending businesses like loans against securities, SME financing, distribution of retail loan products, consumer finance business and housing finance business. India Infoline Investment Services Private Limited consists of the following step-down subsidiaries. a) India Infoline Distribution Company Limited (distribution of retail loan products) (b)Moneyline Credit Limited (consumer finance) (c) India Infoline Housing Finance Limited (housing finance) IIFL (ASIA) PRIVATE LIMITED IIFL (Asia) Private Limited is wholly owned subsidiary which has been incorporated in Singapore to pursue financial sector activities in other Asian markets. Further to obtaining the necessary regulatory approvals, the company has been initially capitalized at 1 million Singapore dollars.

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KEY MILESTONES OF THE COMPANY

YEAR October 18, 1995 May, 1999 April2000

MILESTONE ACHIEVED Incorporated as Probity Research and Services. Launched Internet Portal www.Indiainfoline.com. Commenced distribution on of personal financial products like Mutual Funds and RBI Bonds in Launched Online trading in shares and securities branded as www.5paisa.com.

December, 2000

Started life insurance agency business in as a corporate agent of ICICI Prudential Life Insurance.

September, 2001 August, 2004 May 17, 2005 May, 2005 December,2005

Became a depository participant of NSDL. Launched portfolio management services. Listed on NSE and BSE. Acquired NBFC license. Acquired 100% equity of Marchmont Capital Advisors Pvt Ltd through which the company had ventured into Merchant Banking.

December, 2005

DSP Merrill Lynch Capital subscribed to convertible bonds aggregating Rs.80 crores .Their current stake in India Infoline is a little over 14% as on 31st March 2007.

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December, 2005.

Bennet Coleman &Co Ltd (BCCL) invested Rs.20 crores in India-infoline by way of preferential allotment.

June, 2006. January, 2007

The company became a depository participant of CSDL. Merger of India Infoline securities Pvt Limited with India Infoline Limited.

February, 2007 April, 2007.

Entered into an alliance with Bank of Baroda e-trading. Acquired IRDA license for Insurance Broking.

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THE MANAGEMENT TEAM OF THE COMPANY

Mr.Nirmal Jain (Chairman and managing Director) Nirmal jain is the founder and Chairman of India Infoline Limited. He holds an MBA degree from IIM Ahmedabad, and is a Chartered Accountant (All India Rank2) and a cost Accountant. He has an impeccable professional and academic track record. He started his career in 1989 with Hindustan Lever Limited. During his stint with Hindustan Lever Limited, he handled a variety of responsibilities, including exports and trading in agro-commodities with Rs3bn annual turnover. His work set new standards for equity research in India. In1995, he founded his own independent financial research company, now known as India Infoline Ltd.

Mr.Venkatraman (Executive Director) R Venkatraman is the co-promoter and Executive Director of India Infoline Limited. He holds a B.Tech degree in Electronics and Electrical Communications Engineering from IIT Kharagpur and an MBA from IIM Bagalore. He has held senior managerial positions in various divisions of ICICI Limited, Including ICICI Securities Ltd, their investment banking joint venture with J P Morgan of USA and with BZW and Taib Capital Corporation Limited. He has also held the position of Assistant Vice President with G E Capital Services India Limited in their private equity division.

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THE BOARD OF DIRECTORS

Mr. Sat Pal Khatter (Non Executive Director) Mr Sat Pal Khatter joined the Board with effect from April20, 2001. Mr Sat Pal Khattar is a lawyer by profession. He was the founding partner of a firm of solicitiors in Singapore named Khattar Wong and at present is a Consultant in the said firm. He is also a director of a number of public companies in Singapore and India.

Mr. Sanjiv Ahuja (Independent Director) Mr Sanjiv Ahuja joined the Board with effect from August 28,2002. Mr Ahuja graduated from National University of Singapore with a degree in Computer Science and is also a Certified Public Accountant. He started his own investment advisory and consulting company in 2001, named Centennial Management consultants Private Limited. At present, he is also an Executive Director with Corporate Brokers International Private Limited and also a board member of the Singapore Indian Chamber of Commerce and Industry, a post he has held since 2002. Mr. Nilesh Vikamsey (Independent Director) Mr Nilesh Shivji Vikamsey joined the Board with effect from February 11, 2005. Mr Vikamsey qualified as Chartered Accountant in 1985 and has been a member of the Institute of Chartered Accountants of India since 1985. In 1985, Mr Vikamsey was inducted as partner in M/s Khimji Kunverji& Co., Chartered Accountants and was in charge of the audit department till 1990 and

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thereafter also handles assignments related to financial services, consultancy, investigations, mergers and acquisitions, valuations etc. Mr. Kranti Sinha (Independent Director) Mr Kranti Sinha joined the Board with effect from January 27, 2005. Mr Sinha graduated from the Agra University with a masters degree. He is currently the Managing Director of the Global Institute for Financial and Eductaion Services (India) Private Limited (a sholly owned subsidiary of The Global Institute, LLC, USA). Mr Sinha is also on the Board of Directors of Hindustan Motors Limited, L& T Limited & LICHFL Care Homes Limited.

INDIA INFOLINE TODAY

The company is a one stop investment shop where customers can meet all their advisory, investing and borrowing needs under one roof. We provide advice, offer a wide range of products to choose from, execute the orders and complete the value chain by providing constant service to all our customers.

REGULATORS OF THE COMPANY

Stock and Exchange Board of India (SEBI). Reserve Bank of India (RBI). Association of Mutual Funds in India (AMFI). Insurance Regulatory Development Authority (IRDA). Forward Market Commission (FMC).

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THE VISION OF THE COMPANY

The companys vision is to be the most respected financial services company in India. Having a vision gives an organization a sense of direction. It helps all employees of the organization to channelize their efforts in the same direction towards a common organizational goal and acts as a cornerstone to resolve conflicts. At India Infoline, they are convinced that even as a number of their peer companies are focused on emerging as the biggest and the best in the financial services space in India, there is an even more critical opportunity available in emerging as the most respected. The company needs to be most respected by their stakeholders, their customers, their employees and by society in general. Needless to emphasize, it is imperative for all of them to align our personal goals and values to the organizations vision.

THE KEY COMPETITORS OF INDIAINFOLINE LIMITED

KARVY STOCK BROKERING LIMITED SHAREKHAN SECURITIES LIMITED INDIA BULLS SECURITIES LIMITED MOTILAL OSWAL SECRITIES LIMITED KOTAK SECURITIES LIMITED ICICI DIRECT

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DATA ANALYSIS & INTERPRETATION

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FUTURES CONTRACT
Futures Contract means a legally binding agreement to buy or sell the underlying security on a future date. Future contracts are the organized/standardized contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a pre-specified date which is called the expiry date of the contract. On expiry, futures can be settled by delivery of the underlying asset or cash. Cash settlement enables the settlement of obligations arising out of the future/option contract in cash. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. FUTURES FUNCTIONALITY Futures are derivative contracts to buy or sell a specified quantity or underlying assets at an agreed price, on or before a specified time. They are standardized forward contracts, which are traded on the exchanges mainly BSE & NSE. Since they are traded on the exchange on electronic platform, it provides them transparency, liquidity, anonymity of trades, and also eliminates the counter party risk due to guarantee Provided by the exchange. Derivative market is a leverage market since Investor/Trader has to pay only fraction of total value of the contract as a margin to his broker, who in turn has to pay to the exchange, For example if Rs. 100/- is required to be deployed in cash market for taking a delivery the same stock if available in derivatives market can be bought by paying an average margin of around15%.

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Currently in India we have three types of contracts available for trading i.e. for current month, next month and far month. On last Thursday of each month these contracts expires and then they are settled at a closing price of underlying cash market. In India contracts are settled in cash. Further day to day mark to market difference is also debited/credited to the client and brokers account by the Exchange. Example: say an investor has a bullish view on Reliance and hence buys a Reliance in a futures market at a start of current month at Rs.750/- wherein price in cash market is Rs.747/-.He has to pay 15% margin on Rs.750/- i.e. approx 112.5 per share to his broker as a margin, unlike entire Rs.747/- for buying the same share in cash market. Now say for e.g. on the next day the price of the Reliance in the futures market moves uptoRs.760/- then he will be credited Rs.10/- in his account (760-750). Supposing next day price falls by Rs.5/- to Rs.755/-he will be debited by Rs.5/- in his account. Thus, on a daily basis his account will be debited/credited to the extent of difference in price compared to previous day. On the last day of the contract the difference will be settled bytaking the closing price in the cash market for Reliance.In the similar manner if investor has a bearish view on Reliance he can short sell in futures market unlike in cash market where he can sell only if he has shares in his hand. ARRIVAL OF FUTURE PRICE A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts.

The pricing of the futures depends on cash market price and the cost of carry. The Cost of carry is the sum of all costs incurred if a similar position is taken in cash market and carried to maturity of the futures contract less any revenue which may result in this period. Generally the cost comprises interest while revenue comprises of dividend. Say for e.g. the interstate is 12% and the dividend declared by the company is say0.50ps. on the stock that is quoting at Rs.100/in cash market then the theoretical value of this stock in the futures market should be 100 + 1 0.50 = 100.50.

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Although generally by definition futures prices should be higher than the cash prices to the extent of the interest element (assuming no dividend). However, many a times it is not so and it may be significantly higher or lower than the cash price because of built-in market expectations for that stock in futures prices. BASIS The difference between spot price and futures price is known as basis. Although the spot price and futures price generally move in line with each other, the basis is never constant. It gradually decreases with time and on expiry since futures and cash prices becomes equal basis becomes zero.

AN OPTION CONTRACT
Options Contract is a type of Derivatives Contract which gives the buyer/holder of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a specified period. The buyer / holder of the option purchase the right from the seller/writer for a consideration which is called the premium. The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right. The underlying asset could include securities, an index of prices of securities etc. Options are of two types-calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.

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OPTIONS AND THEIR FUNCTIONS Options are derivative contracts where the person gets aright (but not obligation) to buy or sell a specified quantity of the underlying asset at an agreed price (strike price) on or before the specified future date (expiration date) at an agreed Price (premium). Example Suppose an investor is bullish on Reliance at the start of the current month when the price is Rs.750/- say for e.g. he is expecting a price of Rs.850/- by end of the month. Although he is expecting an upward price movement, he wants to limit his downside risk and hence he buys an option contract of Rs.750/- (strike price) for a price of say Rs.30/- (premium)By paying Rs.30/what he gets is right (not an obligation) to buy Reliance at any time before the month end at Rs.750/-only, irrespective of cash market price. Obviously he will exercise his right if cash market price is higher than Rs.750/- any time before expiry of the contract. Since he has already incurred Rs.30/- as a cost for buying this right his break even point is Rs.780/- so if Reliance moves to Rs.850/- he makes Rs.80/- (850-750-30) on an investment of Rs.30/- (cost of buying an option). Now suppose that Reliance moves down to Rs. 650/- in this case since it makes more sense to buy Reliance from the cash market, he will not exercise his right to buy at Rs.750/- and hence he loses the premium amount of Rs.30/-. At the same time he avoids the downside risk of Rs.100/- which otherwise he would have taken had he bought the Reliance from the cash market at Rs.750/-. Thus, options in a way, are like an insurance contract whereby paying certain premium, option buyer passes on his risks to option seller. The risk of option buyer is limited while that of an option seller is unlimited. In a similar manner, option buyer has unlimited gain potentials while option seller has a limited income potential to the extent of premium income only. The different types of Options

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There are basically two types of option contracts. (a) Call Options (b) Put Options CALL OPTIONS: A call option gives the holder (option buyer), the right to buy a specified quantity of the underlying asset at a strike price on or before expiration date. The seller however, has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy. PUT OPTIONS: A Put Option gives the holder (i.e. the buyer), the right to sell a specified quantity of the underlying asset at a strike price on or before an expiry date. The seller of the put option however has the obligation to buy the underlying asset at the strike price if the buyer decides to exercise his option to sell. The different style of Options Broadly there are two styles of options, namely American style option and European style option. An American style option is one, which can be exercised by the buyer on or before the expiration date, i.e anytime between the time of purchase and the time of its expiry. The European kind of option is one, which can be exercised by the buyer on the expiration day only and not anytime before that. In India, stock options are of the American style while index options are of the European style. FACTORS THAT DETERMINE OPTION PRICES (PREMIUM) There are two types of factors that affect the value of the option (premium): Quantifiable factors, they are strike price, underlying asset price, the volatility of the underlying asset, the time to expiration and the risk free interest rate: Non-quantifiable factors, they are market participants varying estimates of the underlying assets future volatility and future performance. Difference between Futures and Options

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The significant differences between them are as under: In case of futures, both the parties have an obligation to buy/sell the underlying asset. Whereas in the case of options the buyer enjoys the right and not the obligation, to buy or sell the underlying asset. In case of Futures the risk/return profile of both buyers and sellers is equal whereas in case of options the buyer has limited risk and unlimited gain potential and seller of the option has a unlimited risk and limited gain potential. Future prices are mainly affected by the prices of underlying asset while option prices are affected by not only the prices of underlying asset, but also by volatility and time to expiry. Trading of Futures & Option before the expiry date Once the position is taken in futures, it can be squared off by taking a reverse position any time before the expiry of the contract. Similarly once the position is taken in the option contract; it can be squared off by taking a reverse position any time before the expiry. Various derivative Strategies and their utilization Option strategies are various combinations of futures and options in such a manner that it offers optimal risk to reward ratio based on the view of a market player for e.g. an investor having a moderately bullish view on a market can buy a stock or futures and correspondingly sell call of higher price at some premium and thus not only participate in rally but also earn some premium income. This is called a covered call writing. Bullish and bearish option spread, Strangle, straddle are few of other option strategies which can be utilized bythe market players. Index Futures and its utilization Index futures are the futures on index. Currently on NSE we have 3 types of index futures. They are Nifty futures, CNX IT futures and Bank Nifty futures. While Nifty future is future on cash Nifty CNX IT and Bank Nifty are futures on IT and bank index respectively. An investor can utilize these futures as a hedging tool or for a trading based on his view about that index. The Uses/Advantages of Derivatives

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Versatility: The major advantage of derivatives is their versatility. An investor can use derivative in a most Conservative to most risky manner as his risk profile dictates. High Leverage: Derivative contracts enable the investor to take an exposure to the full value of underlying shares for a fraction of its value in the form of margin. High Liquidity: Derivative contracts offers very high liquidity compared to cash market.

CONCEPT OF BASIS IN FUTURES MARKET

BASIS: The difference between spot price and futures price is known as basis. Although the spot price and futures price generally move in line with each other, the basis is never constant. It gradually decreases with time and on expiry since futures and cash prices becomes equal basis becomes zero.

Basis is defined as the difference between cash and futures prices: Basis = Cash prices - Future prices. Basis can be either positive or negative (in Index futures, basis generally is negative). Basis may change its sign several times during the life of the contract. Basis turns to zero at maturity of the futures contract i.e. both cash and future prices converge at maturity.

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(Chart 4.1) Life of the contract Operators in the derivatives market

Hedgers - Operators, who want to transfer a risk component of their portfolio. Speculators - Operators, who intentionally take the risk from hedgers in pursuit of profit. Arbitrageurs - Operators who operate in the different markets simultaneously, in pursuit of profit and eliminate mis-pricing.

PRICING FUTURES
Cost and carry model of Futures pricing

Fair price = Spot price + Cost of carry - Inflows FPtT = CPt + CPt * (RtT - DtT) * (T-t)/365 FPtT - Fair price of the asset at time t for time T. CPt - Cash price of the asset. RtT - Interest rate at time t for the period up to T. DtT - Inflows in terms of dividend or interest between t and T. Cost of carry = Financing cost, Storage cost and insurance cost. If Futures price > Fair price; Buy in the cash market and simultaneously sell in the futures market.

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If Futures price < Fair price; Sell in the cash market and simultaneously buy in the futures market. This arbitrage between Cash and Future markets will remain till prices in the Cash and Future markets get aligned.

Set of assumptions

No seasonal demand and supply in the underlying asset. Storability of the underlying asset is not a problem. The underlying asset can be sold short. No transaction cost; No taxes. No margin requirements, and so the analysis relates to a forward contract, rather than a futures contract.

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INDEX FUTURES AND COST AND CARRY MODEL In the normal market, relationship between cash and future indices is described by the cost and carry model of futures pricing. Expectancy Model of Futures pricing

(Chart4.2) S - Spot prices. F - Future prices. E(S) - Expected Spot prices.

Expectancy model says that many a times it is not the relationship between the fair price and future price but the expected spot and future price which leads the market. This happens mainly when underlying is not storable or may not be sold short. For instance in commodities market.

E(S) can be above or below the current spot prices. (This reflects markets expectations) Contagion market- Market when Future prices are above cash prices. Backwardation market - Market when future prices are below cash prices.

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RELATIONSHIP BETWEEN FORWARD & FUTURE MARKETS

Analyze the different dimensions of Forward and Future Contracts: (Risk; Liquidity; Leverage; Margining etc....) Assign value to each factor to arrive at the contract price. (Perception plays a crucial role in price determination)

Any substantial difference in the Forward and Future prices will trigger arbitrage. RISK MANAGEMENT THROUGH FUTURES

Risk managing through Futures

Basic objective of introduction of futures is to manage the price risk. Index futures are used to manage the systemic risk, vested in the investment in securities.

SOME SPECIFIC USES OF INDEX FUTURES

Portfolio Restructuring - An act of increasing or decreasing the equity exposure of a portfolio, quickly, with the help of Index Futures. Index Funds - These are the funds which imitate/replicate index with an objective to generate the return equivalent to the Index. This is called Passive Investment Strategy.

SPECULATION IN THE FUTURES MARKET

Speculation is all about taking position in the futures market without having the underlying. Speculators operate in the market with motive to make money. They take:

o o

Naked positions - Position in any future contract. Spread positions - Opposite positions in two future contracts. This is a conservative speculative strategy.

54

Speculators bring liquidity to the system, provide insurance to the hedgers and facilitate the price discovery in the market. ARBITRAGEURS IN FUTURES MARKET Arbitrageurs facilitate the alignment of prices among different markets through operating in them simultaneously. MARGINING IN FUTURES MARKET
o o

Whole system dwells on margins: Daily Margins Initial Margins Compulsory collection of margins from clients including institutions. Collection of margins on the Portfolio basis not allowed by L. C. Gupta committee.

Daily Margins

Daily margins are collected to cover the losses which have already taken place on open positions.

o o

Price for daily settlement - Closing price of futures index. Price for final settlement - Closing price of cash index. Daily margins should be received by CC/CH and/or exchange from its members before the market opens for the trading on the very next day. Daily margins would be paid only in cash.

Initial Margins

Margins to cover the potential losses for one day. To be collected on the basis of value at risk at 99% of the days. Different initial margins on:

55

o o

Naked long and short positions. Spread positions.

Naked positions Short positions 100 [exp (3st) - 1] Long positions 100 [1 - exp (3rd)] Where (st)2 = l(st-1)2 + (1-l)(rt2)

st is todays volatility estimates. st-1 is the volatility estimates on the previous trading day. l is decay factor which determines how rapidly volatility estimates change and is taken as 0.94 by Prof. J. R. Verma. rt is the return on the trading day [log(It/It-1)] Because volatility estimate st changes everyday, Initial margin on open position will change every day. (For first 6 months of futures trading, minimum initial margin on naked positions shall be 5%)

Spread positions

Flat rate of 0.5% per month of spread on the far month contract. Min. margin of 1% and maximum margin of 3% on spread positions. A calendar spread would be treated as open position in the far month contract as the near month contract approaches maturity. Over the last five days of trading of the near month contract, following percentages of the spread shall be treated as naked position in the far month contract:

o o o o o

100% on the day of expiry 80% one day before the expiry 60% two days before the expiry 40% three days before the expiry 20% four days before the expiry

56

Liquid assets and Brokers net worth

o

Liquid assets Cash, fixed deposits, bank guarantee, government securities and other approved securities. 50% of Liquid assets must be cash or cash equivalents. Cash equivalents means cash, fixed deposits, bank guarantee and government securities.

o o

Liquid net-worth = Liquid asset - Initial margin Continuous requirement for a clearing member: Minimum liquid net-worth of Rs. 50 Lacs. The mark to market value of gross open position shall not exceed 33.33 times of members liquid net worth.

Basis for calculation of Gross Exposure:

For the purpose of the exposure limit, a calendar spread shall be regarded as an open position of one third of the mark to market value of the far month contract. As the near month contract approaches expiry, the spread shall be treated as a naked position in the far month contract in the same manner.

Margining in Futures market Initial Margin (Value at risk at 99% of the days) Daily Margin Special Margins

57

(Chart4.3)

Striking an intelligent balance between safety and liquidity while determining margins is a million dollar point.

Position limits in Index Futures Customer level

No position limit. Disclosure to exchange, if position of people acting in concert is 15% or more of open interest.

Trading member level

15% of open interest or 100 crore whichever is higher. To be reviewed after 6 months of futures trading.

Clearing member level

No separate position limit. However, C.M. should ensure that his own positions (if C.M. is a T.M. also) and the positions of the T.Ms. clearing through him are within the limits specified above for T.M.

Market level

58

No limit. To be reviewed after 6 months of trading in futures.

Expected advantages of derivatives to the cash market

o o

Higher liquidity Availability of risk management products attracts more investors to the cash market. Arbitrage between cash and futures markets fetches additional business to cash market. Improvement in delivery based business. Lesser volatility Improved price discovery.

Reasons for making a contract click

Risk in the underlying market. Presence of both hedgers and speculators in the system. Right product specifications. Proper margining.

Futures

Multiple indices trading on the same exchange even the same index with different contract designs Dedicated funds o o o

Future funds Options funds Hybrid funds

59

CONTRACT SPECIFICATIONS FOR FUTURES & OPTIONS

(Table4.1)
Parameter Index Futures 6 Indices Index Options 6 Indices OPTIDX Symbol of Underlying Index DD-MMMYYYY CE / PE Strike Price Futures on Individual Securities 225 securities FUTSTK Symbol of Underlying Security DDMMMYYYY Options on Individual Securities 225 securities OPTSTK Symbol of Underlying Security DD-MMMYYYY CA / PA Strike Price Mini Index Futures S&P CNX Nifty FUTIDX MINIFTY Mini Index Options S&P CNX Nifty OPTIDX MINIFTY

Underlying

Security Descriptor : Instrument FUTIDX Underlying Symbol Expiry Date Option type Strike Price Trading Cycle Expiry Day Strike Price Intervals Permitted Lost Size Price Steps Symbol of Underlying Index DD-MMMYYYY -

DD-MMMYYYY -

DD-MMMYYYY CE / PE Strike Price

3 month trading cycle the near month (one), the next month (two) and the far month (three) Last Thursday of the expiry month. If the last Thursday is a trading holiday, then the expiry day is the previous trading day. Depending on Depending Depending underlying on on price underlying underlying Underlying Underlying Underlying price 20 price Specific Specific Specific Underlying 20 Specific Rs. 0.05 Rs. 0.05 Rs. 0.05 Rs. 0.05 Rs. 0.05 Rs. 0.05 Upper Upper Upper Operating Operating Operating Operating Range + 99% Operating Range +99% Operating Range +99% range of of base price range of of base price range of of base price 10% of the or Rs.20, 20% of the or Rs.20, 10% of the or Rs.20, base price whichever is base price whichever is base price whichever is higher; Lower higher; higher; Operating Lower Lower Range Operating Operating Rs. 0.05 Range Range Rs. 0.05 Rs. 0.05

Price Bands

60

(STATISTICS)

Settlement Statistics (2007-2008) Monthly Settlement Statistics of Derivatives Traded For The Year 2007-2008

(Table 4.2) Month/Year Index / Stock Futures MTM Settlement 4162.90 3251.10 3794.50 4935.20 11299.00 5300.00 15924.00 16248.00 14125.00 39768.00 Final Settlement 41.96 94.92 72.59 71.64 107.60 103.42 222.61 282.38 77.17 105.11

(All figures in Rs. Crores) Index / Stock Options Premium Settlement 385.58 294.13 367.07 498.15 599.84 569.62 918.41 615.11 478.38 777.95 Exercise Settlement 188.36 211.43 92.24 247.67 143.88 583.62 669.84 327.17 203.60 767.43 Total

Apr-2010 May-2010 Jun-2010 Jul-2010 Aug-2010 Sep-2010 Oct-2010 Nov-2010 Dec-2010 Jan-2011

4778.80 3851.58 4326.39 5752.66 12150.33 6556.65 17734.85 17472.66 14884.14 41418.49

61

INTEREST RATE DERIVATIVES CLEARING AND SETTLEMENT

National Securities Clearing Corporation Limited (NSCCL) is the clearing and settlement agency for all deals executed on the Derivatives (Futures & Options) segment. NSCCL acts as legal counter-party to all deals on NSE's F&O segment and guarantees settlement. A Clearing Member (CM) of NSCCL has the responsibility of clearing and settlement of all deals executed by Trading Members (TM) on NSE, who clear and settle such deals through them. 1. Settlement Procedure & Settlement Price Daily Mark to Market Settlement and Final settlement for Interest Rate Futures Contract

Daily Mark to Market settlement and Final Mark to Market settlement in respect of admitted deals in Interest Rate Futures Contracts shall be cash settled by debiting/ crediting of the clearing accounts of Clearing Members with the respective Clearing Bank.

All positions (brought forward, created during the day, closed out during the day) of a F&O Clearing Member in Futures Contracts, at the close of trading hours on a day, shall be marked to market at the Daily Settlement Price (for Daily Mark to Market Settlement) and settled.

All positions (brought forward, created during the day, closed out during the day) of a F&O Clearing Member in Futures Contracts, at the close of trading hours on the last trading day, shall be marked to market at Final Settlement Price (for Final Settlement) and settled.

Daily Settlement Price shall be the closing price of the relevant Futures contract for the Trading day.

62

Final settlement price for an Interest rate Futures Contract shall be based on the value of the notional bond determined using the zero coupon yield curve computed by National Stock Exchange or by any other agency as may be nominated in this regard.

Open positions in a Futures contract shall cease to exist after its expiration day.

Daily Settlement Price Daily settlement price for an Interest Rate Futures Contract shall be the closing price of such Interest Rate Futures Contract on the trading day. The closing price for an interest rate futures contract shall be calculated on the basis of the last half an hour weighted average price of such interest rate futures contract. In absence of trading in the last half an hour, the theoretical price would be taken or such other price as may be decided by the relevant authority from time to time. Theoretical daily settlement price for unexpired futures contracts shall be the futures prices computed using the (price of the notional bond) spot prices arrived at from the applicable ZCYC Curve. The Zero Coupon Yield Curve (ZCYC) shall be computed by the Exchange or by any other agency as may be nominated in this regard from the prices of Government securities traded on the Exchange or reported on the Negotiated Dealing System of RBI or both taking trades of same day settlement(i.e. t = 0). In respect of coupon bearing notional bond, the present value shall be obtained as the sum of present value of the principal payment discounted at the relevant zero coupon yield and the present values of the coupons obtained by discounting each notional coupon payment at the relevant zero coupon yield for that maturity. For this purpose the notional coupon payment date shall be half yearly and commencing from the date of expiry of the relevant futures contract. For computation of futures prices from the price of the notional bond (spot prices) thus arrived, the rate of interest may be the relevant MIBOR rate or such other rate as may be specified from time to time.

63

FINAL SETTLEMENT PRICE FOR MARK TO MARKET SETTLEMENT OF INTEREST RATE FUTURES CONTRACTS Final settlement price for an Interest rate Futures Contract on zero coupon notional bond and coupon bearing bond shall be based on the price of the notional bond determined using the zero coupon yield curve computed as explained above. In respect of notional T-bill it shall be 100 minus the annualised yield for the specified period computed using the zero coupon yield curve.

SETTLEMENT VALUE IN RESPECT OF NOTIONAL T-BILL

Since the T-bills are priced at 100 minus the relevant annualised yield, the settlement value shall be arrived at using the relevant multiplier factor. Currently it shall be 91/365 SETTLEMENT SCHEDULE

Settlement schedule for Interest Rate Futures Contracts

Product Interest Rate Futures Contracts Settlement Daily Mark-to-Market Settlement

(Table 4.3) Schedule Pay-in: T+1 working day on or after 11:30 a.m Pay-in: T+1 working day on or after 12:00 p.m (T is trading day)

Interest Rate Futures Contracts

Final Settlement

Pay-in: T+1 working day on or after 11:30 a.m Pay-in: T+1 working day on or after 12:00 p.m (T is trading day)

64

Interest Rate Derivatives - Risk Containment Margins

Initial Margins Computation of Initial Margin Exposure Limits Trading Member wise/ Custodial Participant wise Position Limit

Initial Margins Initial margin shall be payable on all open positions of Clearing Members, upto client level, at any point of time, and shall be payable upfront by Clearing Members in accordance with the margin computation mechanism and/ or system as may be adopted by Clearing Corporation from time to time. Presently, the initial margins would be based on the zero coupon yield curve computed at the end of the day as explained above with trades of same day settlement (t =0). However, in case of large deviation between the yields generated using only t = 0 trades and all trades, initial margins revised accordingly may be computed and collected by the Clearing corporation from the members at its discretion. Initial Margin shall include SPAN margins and such other additional margins, that may be specified by Clearing Corporation from time to time.

Computation of Initial Margin Clearing Corporation will adopt SPAN (Standard Portfolio Analysis of Risk) system or any other system for the purpose of real time initial margin computation. Initial margin requirements shall be based on 99% value at risk over a one day time horizon. Provided, however, in the case of futures contracts, 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.

65

ANALYSIS

The Objective of this analysis is to evaluate the profit/loss position of the futures and options. The aim of conducting the analysis is to determine whether the Investor who

brought the derivatives of the company has incurred Profit or loss. The other cause of conducting the analysis is to find out the nature of the

behavior of the derivatives of the company along the period of observation.

This analysis is based on sample data taken of HINDUSTAN PETROLEUM

LIMITED Scrip. LIMITED. The lot Size of HINDUSTAN PETROLEUM LIMITED is 200shares. The time period in which this analysis done is from 29Feburary to 27March2011. This analysis considered the MARCH contract of HINDUSTAN PETROLEUM

66

DATA OF HINDUSTAN PETROLEUM LIMITED THE FUTURES AND SPOT PRICE MOVEMENTS
(TABLE 4.4) DATE 29-02-2011 03-03-2011 04-03-2011 05-03-2011 06-03-2011 07-03-2011 10-03-2011 12-03-2011 13-03-2011 14-03-2011 17-03-2011 18-03-2011 19-03-2011 24-03-2011 25-03-2011 26-03-2011 27-03-2011 (* Amount in Rs.) SOURCE: The sources of the above data is collected from the official website of National Stock Exchange of India www.nseindia.com If the call option writer bought 1 lot of shares on 29-02-2011 he has to buy at a price of Rs 300.30 and if he intends to sell it on the last day of trading in the month i.e, on 27-03-08 his investment would be priced at 255.05 Rs per share and hence he bears a loss of 45.95 Rs per share and the net loss incurred will be 45.95 * 200 = 1950 Rs. SPOT PRICE* 300.30 288.95 282.35 285.10 281.55 281.45 285.45 287.00 279.00 270.10 270.35 253.20 262.25 254.05 257.00 263.90 255.05 FUTURE PRICE* 299.00 288.00 279.20 286.40 279.10 285.80 286.00 278.40 268.70 271.00 252.45 259.00 254.00 257.00 263.45 263.50 255.00

67

CHART REPRESENTING THE FUTURES AND SPOT PRICE MOVEMENTS

Price of Future and Option

310 300 290 280 270 260 250 240 230 220

Future Price Option Price

Average of Traded Dates

(Graph 4.1) Note: The dates for the above graph is in Month/Day/Year format

INTERPRETATIONS
The future price of HINDUSTAN PETROLEUM LIMITED is moving along with the market price. If the buy price of the future is less than the settlement price, than the buyer of a future gets profit. If the selling price of the future is less than the settlement price, then the seller incurs loss.

68

CALL OPTION AT DIFFERENT STRIKES

(TABLE 4.5) PRICE* DATE 29-02-2011 03-03-2011 04-03-2011 05-03-2011 06-03-2011 07-03-2011 10-03-2011 12-03-2011 13-03-2011 14-03-2011 17-03-2011 18-03-2011 19-03-2011 24-03-2011 25-03-2011 26-03-2011 27-03-2011 SPOT 300.30 288.95 282.35 285.10 281.55 281.45 285.45 287.00 279.00 270.10 270.35 253.20 262.25 254.05 257.00 263.90 255.05 FUTURE 299.00 288.00 279.20 286.40 279.10 285.80 286.00 278.40 268.70 271.00 252.45 259.00 254.00 257.00 263.45 263.50 255.00 280 38.75 29.75 24.85 25.25 21.55 21.65 21.50 16.60 8.15 10.35 3.85 5.70 2.95 0.75 0.90 0.15 0.00 300 16.50 11.10 7.90 10.00 6.75 7.80 7.00 5.05 5.40 4.65 1.20 2.70 0.25 0.15 0.15 0.10 0.00 PREMIUM* 310 9.00 16.90 13.25 5.00 10.35 9.70 9.20 2.80 3.60 3.00 0.75 1.15 0.40 0.10 0.00 0.00 0.00 320 6.00 6.00 5.00 10.55 10.40 3.00 7.20 6.70 4.35 2.35 1.85 0.40 0.60 0.20 0.00 0.00 0.00

(* Amount in Rs.)

SOURCE:

The sources of the above data is collected from the official website of National

69

Stock Exchange of India www.nseindia.com

INTERPRETATIONS BASED ON CALL OPTIONS AT DIFFERENT STRIKES

BUYERS PAY OFF :( AT Rs280 STRIKE PRICE) As brought 1 lot of HINDUSTAN PETROLEUM LIMITED that is 200, those who brought at strike price at 280 paid Rs.38.75 as premium per share. FORMULA: PAY OFF PRICE = SPOT PRICE STRIKE PRICE We Know, Settlement price =255.05 Rs Pay off Price = Spot price 255.05 Rs - Strike price 280.00Rs Pay Off Price = -24.95 Rs Since the payoff price is negative, the buyer is at aloss of Rs.24.95 pershare And he will lose the premium amount Net loss for the buyer = 38.75 Rs. X 200shares (1Lot) = 7750 Rs.

SELLERS PAY OFF: It is in the money for the buyer so it is in out of the money for seller; hence his loss is also increasing. The profit for the seller is only the premium amount Strike price - Spot price Rs.280.00 - Rs.255.05 = 38.75Rs. X 200Shares (1Lot)

70

=7750Rs. BUYERS PAY OFF :( AT Rs300 STRIKE PRICE) If 1 lot of HINDUSTAN PETROLEUM LIMITED is brought that is 200 shares, at strike price of 300, the buyer paid Rs.16.50 as premium per share. FORMULA: PAY OFF PRICE = SPOT PRICE STRIKE PRICE We Know, Settlement price =255.05 Rs Pay off Price = Spot price 255.05 Rs - Strike price 300.00Rs Pay Off Price = - 44.95 Rs Since the payoff price is negative, the buyer is at loss of Rs.44.95 per share And he will lose the premium amount, Net loss for the buyer = 16.50 Rs. X 200shares (1Lot) = 3300 Rs.

SELLERS PAY OFF:

It is in the money for the buyer so it is in out of the money for seller; hence his loss is also increasing. The profit for the seller is only the premium amount Strike price - Spot price X 1 Lot = Sellers Payoff Rs.300.00 - Rs.255.05 = 44.95Rs. X 200Shares (1Lot) = 3300Rs.

71

BUYERS PAY OFF :( AT Rs310 STRIKE PRICE) If 1 lot of HINDUSTAN PETROLEUM LIMITED is brought that is 200 shares, at strike price of 310, the buyer paid Rs.9.00 as premium per share. FORMULA: PAY OFF PRICE = SPOT PRICE STRIKE PRICE We Know, Settlement price =255.05 Rs Pay off Price = Spot price 255.05 Rs - Strike price 310.00Rs Pay Off Price = - 55 Rs Since the payoff price is negative, the buyer is at loss of Rs.55 per share And he will lose the premium amount Net loss for the buyer = 9.00 Rs. X 200shares (1Lot) = 1800 Rs.

SELLERS PAY OFF: It is in the money for the buyer so it is in out of the money for seller; hence his loss is also increasing. The profit for the seller is only the premium amount Strike price - Spot price X 1 Lot = Sellers Payoff Rs.310.00 - Rs.255.05 = 9.00Rs. X 200Shares (1Lot) =1800Rs.

72

BUYERS PAY OFF :( AT Rs320 STRIKE PRICE) If 1 lot of HINDUSTAN PETROLEUM LIMITED is brought that is 200 shares, at strike price of 320, the buyer paid Rs.6.00 as premium per share. FORMULA: PAY OFF PRICE = SPOT PRICE STRIKE PRICE We Know, Settlement price =255.05 Rs Pay off Price = Spot price 255.05 Rs - Strike price 320.00Rs Pay Off Price = - 64.95 Rs Since the payoff price is negative, the buyer is at loss of Rs.64.95 per share And he will lose the premium amount Net loss for the buyer = 6.00 Rs. X 200shares (1Lot) = 1200 Rs.

SELLERS PAY OFF: It is in the money for the buyer so it is in out of the money for seller; hence his loss is also increasing. The profit for the seller is only the premium amount Strike price - Spot price X 1 Lot = Sellers Payoff Rs.320.00 - Rs.255.05 = 6.00Rs. X 200Shares (1Lot) =1200Rs

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PUT OPTION AT DIFFERENT STRIKES

(TABLE 4.6) PRICE* DATE SPOT 29-02-2011 03-03-2011 04-03-2011 05-03-2011 06-03-2011 07-03-2011 10-03-2011 12-03-2011 13-03-2011 14-03-2011 17-03-2011 18-03-2011 19-03-2011 24-03-2011 25-03-2011 26-03-2011 27-03-2011 300.30 288.95 282.35 285.10 281.55 281.45 285.45 287.00 279.00 270.10 270.35 253.20 262.25 254.05 257.00 263.90 255.05 FUTURE 299.00 288.00 279.20 286.40 279.10 285.80 286.00 278.40 268.70 271.00 252.45 259.00 254.00 257.00 263.45 263.50 255.00 280 16.65 19.15 20.90 18.60 18.65 15.00 13.35 3.00 20.05 19.00 29.95 22.80 28.30 23.55 16.85 17.00 0.00 300 26.00 29.85 32.40 29.80 30.35 26.15 24.25 27.80 34.20 33.30 47.35 39.05 46.15 42.85 36.00 36.85 0.00 310 31.60 36.10 39.10 36.35 37.25 32.90 30.95 35.15 42.35 41.55 56.75 48.15 55.70 52.80 45.95 46.85 0.00 320 37.70 42.90 46.40 43.55 44.75 40.35 38.40 43.20 51.05 50.40 66.40 57.60 65.45 62.80 55.95 56.85 0.00 PREMIUM*

(* Amount in Rs.) SOURCE: The sources of the above data is collected from the official website of National Stock Exchange of India www.nseindia.com

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CHART REPRESENTING THE PAY OFFS BASED ON THE PUT OPTIONS

9000 8000 7000 6000 5000 4000 3000 2000 1000 0 7750
Strike price

Pay off Price

3300 1800 280 300 Strike Price

(Graph 4.2)

310

1200 320

Buyers' pay off Sellers' P ay off

75

INTERPRETATIONS BASED ON PUT OPTIONS AT DIFFERENT STRIKES

BUYERS PAY OFF: (AT Rs280 STRIKE PRICE) Those who have purchase put option at a strike price of 280, the premium payable is 16.65Rs. On the expiry date the spot market price enclosed at Rs. 255.05 Net pay off = Strike Price Rs 280.00 - Spot Price Rs.255.05 = 24. 95Rs

Deduct Premium Amount already Paid i.e., Rs 24.95 - 16.65Rs = 8.30Rs. Total Profit = 8.30Rs X 200(1Lot Shares) = 1660Rs.

SELLERS PAY OFF: As Seller is entitled only for premium if he is in profit, he will get the same as the Profit amount. Pay off = Spot price Rs.280 - Strike price 255.05Rs. Pay off = -24.95Rs Net Loss Incurred = Rs.16.65 Rs.24.95 Net Loss Incurred = Rs.8.30 X 200(1Lot Shares) Net Loss Incurred =1660Rs.

76

BUYERS PAY OFF: (AT Rs300 STRIKE PRICE)

Those who have purchase put option at a strike price of 300, the premium payable is 26.00Rs. On the expiry date the spot market price enclosed at Rs. 255.05 Net pay off = Strike Price Rs.300.00 - Spot Price Rs.255.05 = 44.95Rs Deduct Premium Amount already Paid i.e., Rs 44.95 26.00Rs =18.95Rs. Total Profit = 18.95Rs X 200(1Lot Shares) = 3790Rs.

SELLERS PAY OFF: As Seller is entitled only for premium if he is in profit, he will get the same as the profit amount. Pay off = Spot price Rs.300 - Strike price 255.05Rs. Pay off = 44.95Rs Net Loss Incurred = Rs 44.95 26.00Rs X 200(1Lot Shares) = Rs.18.95 X 200(1Lot Shares) =3790Rs.

77

BUYERS PAY OFF: (AT Rs310 STRIKE PRICE) Those who have purchase put option at a strike price of 310, the premium payable is 31.60Rs. On the expiry date the spot market price enclosed at Rs. 255.05 Net pay off= Strike Price Rs. 310.00 - Spot Price Rs.255.05 = 54.95Rs Deduct Premium Amount already Paid i.e., Rs 31.60 54.90Rs = 23.35Rs. Total Profit = 23.35Rs. X 200(1Lot Shares) = 4670Rs.

SELLERS PAY OFF: As Seller is entitled only for premium if he is in profit, he will get the same as the profit amount. Pay off = Spot price Rs.310 - Strike price 255.05Rs. Pay off = 54.95Rs Net Loss Incurred = Rs 54.95 26.00Rs X 200(1Lot Shares) = Rs.23.35 X 200(1Lot Shares) = 4670Rs.

78

BUYERS PAY OFF: (AT Rs320 STRIKE PRICE)

Those who have purchase put option at a strike price of 320, the premium payable is 37.70Rs. On the expiry date the spot market price enclosed at Rs. 255.05 Net pay off=Strike Price Rs 320.00 - Spot Price Rs.255.05 = 64.95Rs Deduct Premium Amount already Paid i.e., Rs 37.7 0 64.90Rs =27.25Rs. Total Profit = 27.22Rs. X 200(1Lot Shares) = 5450Rs.

SELLERS PAY OFF: As Seller is entitled only for premium if he is in profit, he will get the same as the profit amount Pay off = Spot price Rs.320 - Strike price 255.05Rs Pay off = 64.95Rs Net Loss Incurred = Rs 64.95 37.70Rs X 200(1Lot Shares) = Rs.27.25 X 200(1Lot Shares) = 5450Rs.

79

CHART REPRESENTING THE PAY OFFS BASED ON THE PUT OPTIONS

6000 5000 5450 5 450 4670 4 670 3790 3 790 Strike P rice Buy ers P ay off P rice sellers P ay off P rice

Pay off prices

4000 3000 2000 1000 0 1 280 2 1660 1 6 60

300 3

310 4

320

S trike P rice
(Graph 4.3)

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TABLE SHOWING THE PRICE MOVEMENTS OF THE FUTURE PRICE

(TABLE 4.7) DATE 29-02-2011 03-03-2011 04-03-2011 05-03-2011 06-03-2011 07-03-2011 10-03-2011 12-03-2011 13-03-2011 14-03-2011 17-03-2011 18-03-2011 19-03-2011 24-03-2011 25-03-2011 26-03-2011 27-03-2011 (* Amount in Rs.) SOURCE: The sources of the above data is collected from the official website of National Stock Exchange of India www.nseindia.com FUTURE PRICE* 299.00 288.00 279.20 286.40 279.10 285.80 286.00 278.40 268.70 271.00 252.45 259.00 254.00 257.00 263.45 263.50 255.00

81

(Graph 4.4)

Representation of Future Price on Traded dates Future prices

310 300 290 280 270 260 250 240 230 220
11 11 11 13 -0 320 08 11 00 320 08 11 00 320 08 21 00 320 08 27 10 320 11 11 /2 0 /2 0 3/ 20 -2 0

Closing Prices

4/ 3

29 -0 2

6/ 3

10 /

Trading Dates

INTERPRETATIONS:
From the above graph we could Interpret that the Future Prices of M/S. HINDUSTAN PETROLEUM LTD is not constant and is fluctuating and the price on the first traded date i.e, on 29/02/2011 is more than that of the last traded date i.e, on 27/03/2011.

82

SUGGETIONS & CONCLUSIONS

83

FINDINGS
In the call option as the amount of the strike price increases the amount of the premium to be paid decreases. (This is clear from the table 4.5). In the put option as the amount of the strike price increases the amount of the premium to be paid also increases. (This is clear from the table 4.6). In the short sellings the futures turn out to be a cheaper option for the investors of M/S.HINDUSTAN PETROLEUM LTD. The settlement price will be considered as the final price in calculating the future and options prices and the closing price of the equities will be considered as the spot price in the evaluation of F&Os. The future price of M/S.HINDUSTAN PETROLEUM LTD is moving along with the market

price. If the buy price of the future is less than the settlement price, then the buyer of a future gets profit.

If the selling price of the future is less than the settlement price, then the seller incurs loss.

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SUGGESTIONS

The investors need to continuously monitor and assess the effectiveness of the hedging strategies and ensure that they are in synchronization with the under lying asset profile.

It is suggested that the regulatory authorities allow short selling by institutional investors in the Cash market as a means of physical settlement in the F&O segment.

An introduction to short selling will help the deepening of the market (Derivatives) in terms of availability of products/stocks.

If the physical settlement comes into existence the allegations of manipulation of the stocks in the derivatives segment could be easily resolved.

It would be suggestive that the derivatives accounting be made mandatory for corporate investors to look at the derivatives exposure of the companies on the basis of accounting prudence.

The authorities should revise some of their regulations with respect to the contract size, and should encourage the participation of Foreign Institutional Investors (FIIs) in the derivatives market to encourage the active functioning of the derivatives market in India

To encourage the participation of the small investors measures like minimization of the Contract size should be taken care of.

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SUMMARY Derivative is a product/contract which does not have any value on its own i.e. it derives its value from some underlying. As the name suggests, derivative contracts are those contracts which derives their value from the price of something else. Typically derivatives contracts derive their value from underlying cash market Derivatives are the Investments that derive their value from underlying assets such as currencies, treasury bills, and bonds or are linked to indices such as a stock market index that can be used to speculate on market movements or to protect investments against major swings in market prices Derivatives are the financial contracts that derive their value from an underlying asset or index, such as an interest rate or foreign currency exchange rate which can be used to manage risk, reduce cost and enhance returns

Derivatives market is an innovation to cash market. Approximately its daily turnover exceeds to the turnover of cash market by 6 times in the average daily turnover of the NSE derivative segments. In cash market the profit/loss of the investor depends on the market price of the underlying asset. The investor may incur huge profits or he may incur huge profits or he may incur huge loss. But in derivatives segment the investor the investor enjoys huge profits with limited downside. In cash market the investor has to pay the total money, but in derivatives the investor has to pay premiums or margins, which are some percentage of total money. The main purpose of trading upon the derivatives is mostly for hedging purpose. In derivative segment the profit/loss of the option writer is purely dependent on the fluctuations of the underlying asset.

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CONCLUSIONS

Through the observations it could be concluded that the price of the future stock of HINDUSTAN PETROLEUM LIMITED is fluctuating throughout the traded dates that was analyzed.

The analysis made on the basis of HINDUSTAN PETROLEUM LIMITED showed that, the call option writers gain more amount of profit than the put option writers due to relatively low volatility.

Investors are unable to closely match the hedge transactions with the underlying exposures, there by causing ineffectiveness in derivatives trading.

It may turn out that some times going short calls via futures would be profitable while at other times, it (Going short in cash market) would be feasible in derivatives. If Derivatives are judiciously used, with the intention of mitigating the underlying assets, it can act as a boon, but if used for speculative purposes, can often have disastrous results. In bullish market the call option writer incurs more losses so the investor is suggested to go for a call option to hold, where as the put option holder suffers in a bullish market, so he is suggested to write a put option. In bearish market the call option holder will incur more losses so the investor is suggested to go for a call option to write, where as the put option writer will get more losses, so he is suggested to hold a put option.

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DERIVATIVES GLOSSARY

Spot price: The price at which the underlying asset is currently trading in the market. Strike price: The agreed price of the underlying asset at which the contract is entered. Expiry date: The date on which the option expires. If an option has not been exercised prior to its expiration, it ceases to exist after the expiration date, that is, the option holder will not longer have any right and the option, no value. Premium: The amount per share paid by the option buyer to obtain the right to buy or sell a specified quantity of the underlying share at an agreed price that an option confers. Futures price: The agreed price of the underlying asset at which the futures contract is traded. Index Futures market

Contract Size: The value of the contract at a specific level of Index. It is Index level * Multiplier. Multiplier: It is a pre-determined value, used to arrive at the contract size. It is the price per index point. Tick Size: It is the minimum price difference between two quotes of similar nature. Contract Month: The month in which the contract will expire. Expiry Day: The last day on which the contract is available for trading. Open interest: Total outstanding long or short positions in the market at any specific point in time. As total long positions for market would be equal to total short positions, for calculation of open Interest, only one side of the contracts is counted.

Volume: No. of contracts traded during a specific period of time. During a day, during a week or during a month. Long position: Outstanding/unsettled purchase position at any point of time. Short position: Outstanding/ unsettled sales position at any point of time. Open position: Outstanding/unsettled long or short position at any point of time.

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Physical delivery: Open position at the expiry of the contract is settled through delivery of the underlying. In futures market, delivery is low. Cash settlement: Open position at the expiry of the contract is settled in cash. These contracts are designated as cash settled contracts. Index Futures fall in this category. Alternative Delivery Procedure (ADP): Open position at the expiry of the contract is settled by two parties - one buyer and one seller, at the terms other than defined by the exchange. World wide a significant portion of the energy and energy related contracts (crude oil, heating and gasoline oil) are settled through Alternative Delivery Procedure.

Portfolio Restructuring: An act of increasing or decreasing the equity exposure of a portfolio, quickly, with the help of Index Futures. Index Funds: These are the funds which imitate/replicate index with an objective to generate the return equivalent to the Index. This is called Passive Investment Strategy.

Naked positions: Position in any future contract. Spread positions: Opposite positions in two future contracts. This is a conservative speculative strategy. Hedge Terminology

Long hedge: When you hedge by going long in futures market. Short hedge: When you hedge by going short in futures market. Cross hedge: When a futures contract is not available on an asset, you hedge your position in cash market on this asset by going long or short on the futures for another asset whose prices are closely associated with that of your underlying.

Hedge Contract Month: Maturity month of the contract through which hedge is accomplished. Hedge Ratio: Number of future contracts required to hedge the position.

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ACRONYMS
F&O NMCE SRO OTC SCR EFT TM CM SCM MTM IM LEAPS BSE NSE IPO ABS RMBS FIIs GDR ADR : : : : : : : : : : : : : : : : : : : : FUTURES & OPTIONS National Multi Commodity Exchange of India Ltd Self-Regulatory Organization Over The Counter Securities Contract and Regulatory Authority Electronic funds transfer Trading Member Clearing Member Self-clearing Member Mark to Market Margin Initial Margin Long-Term Equity Anticipation Securities Bombay Stock Exchange National Stock Exchange Initial Public Offering Asset Backed Securities Residentially Market Backed Securities Foreign institutional investors Global Depository Receipts American Depository Receipts

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FERA SEBI FMC VaR

OPTIDX FUTIDX

: : : : : : : : : : :

Foreign Exchange Regulation Act Securities and Exchange Board of India Forward Market Commission Value at Risk
Option Index Future Index

NSCCL CM TM ZCYC SPAN

National Securities Clearing Corporation Limited Clearing Member Trading Members Zero Coupon Yield Curve Standard Portfolio Analysis of Risk

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BIBLIOGRAPHY

BOOKS: TITLE OF THE BOOK Financial Institutions & Markets Financial Management; 2ND Edition Financial Markets and Services Security Analysis & Portfolio Management Derivatives Core Module Work book AUTHOR Meir Kohn Prasanna Chandra Gordan and Natrajan Donald E Fischer & Ronald R Jordan Advisors of National Stock Exchange of India NSE Press PUBLISHER Oxford University Press Tata Mc Graw Hill Tata Mc Graw Hill Prentice Hall Of India

WEBSITES: www.derivativesindia.com www.sebiindia.com www.indianinfoline.com www.nseindia.com www.bseindia.com www.5paisa.com NEWS PAPERS:

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The Economic Times Business Line

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