Escolar Documentos
Profissional Documentos
Cultura Documentos
2007-2009
DECLARATION
Mrs.shethal Thomas Faculty towards partial fulfillment of the requirements for the M.B.A
course of M.G University. This has not been submitted in part or full towards any other degree or
diploma.
Place: Ettumanoor
Date:…………. JIBIN.P.JOHN
ACKNOWLEDGEMENT
First of all I thank Almighty God for his mercy and love which kept me in good health and
sound mind and helped me to complete the organizational study successfully.
At the very out set, I express heart full thanks to , Rtd. Brigadier Joseph Mathew, Dean
and Principal in charge and also express my gratitude to our Professor & Head of the
Department, Dr.Sibu C Chithran ,M B A ,M Phil ,P H D.
INTRODUCTION
General introduction
The liberalization of the Indian economy has ushered in an era of opportunities for
the Indian corporate sector. however, these opportunities are accomplished by challenges. The
corporate are now required to operate at global capacities to be able to reap the benefits of
economies of scale and be competitive. To operate at global capacities, huge investments are
called for and the main source of fund in the public at large. Therefore, the corporate now started
tapping the capital market in a big way. The response is also encouraging.
As the Indian nation integrates with world economy era, small tremors in the world
market starts affecting the Indian economy. As an example, interest rates have been south bound
in the world and the same has happened in the Indian market too. fixed income rates have fallen
drastically due to fall in the real income of people. To overcome this fall , investors have been
continuously seek to increase the yield of their of their investments. But, it is a time-tested fact
that, the yields on investment in equity shares are maximum, the accompanying risks are also
maximum. Therefore, it is absolutely essential that efforts should be made to reduce this factor.
The reduction of risk can be achieved through the process of ‘hedging’ using
‘derivatives’ financial instrument. A hedge is any act that reduced the price risk of an existing or
anticipated position in the cash market. Basically, there are two type of hedging with futures
:long hedge and short hedge.
Financial derivatives are a kind of risk management instrument. A derivative's
value depends on the price changes in some more fundamental underlying assets. Many forms of
financial derivatives instruments exist in the financial markets. Among them, the three most
fundamental financial derivatives instruments are: forward contracts, futures, and options. If the
underlying assets are stocks, bonds, foreign exchange rates and commodities etc., then the
corresponding risk management instruments are: stock futures (options), bond futures (options),
currency futures (options) and commodity futures (options) etc. In risk management of the
underlying assets using financial derivatives, the basic strategy is hedging, i.e., the trader holds
two positions of equal amounts but opposite directions, one in the underlying markets, and the
other in the derivatives markets, simultaneously. This risk management
strategy is based on the following reasoning: it is believed that under normal circumstances,
prices of underlying assets and their derivatives change roughly in the same direction with
basically the same magnitude; hence losses in the underlying assets (derivatives) markets can be
offset by gains
in the derivatives (underlying assets) markets; therefore losses can be prevented or reduced by
combining the risks due to the price changes. The subject of this book is pricing of financial
derivatives and risk management by hedging.
Introduction of derivatives in the Indian capital market is the beginning of a new era ,
which is truly exciting. Derivatives, worldwide are recognized risk management products. These
products have a long history in India, in the unorganized sector , especially in currency and
commodity markets. The availability of these products on organized exchanges ha provided the
market participants with broad based risk management tools.
This study mainly covers the area of hedging and speculation. The main aim of the
study is to prove how risks in investing in equity shares can be reduced and how to make
maximum return to the other investment.
IMPORTANCE OF THE STUDY
Primary Objectives
Secondary objective
• To find out extant to which loss can be reduced by applying hedging strategies.
• To determine whether the hedger enjoys better returns from the use of hedgers.
A) While applying the strategies , transaction cost and impact cost are not taken into
consideration.so,it will reflect in the profit calculation on each month of the study.
B) data were collected only on the basis of NSE trading
C) Hedging strategy is applied on historical data. so the direction of each trend in the stock
market is known before hand for the period selected. As a result, some bias could have
LITERATURE REVIEW
REVIEW OF LITURATURE
Financial derivatives are so effective in reducing risk because they enable financial
Institutions to hedge that is, engage in a financial transaction that reduces or eliminates
risk. When a financial institution has bought an asset, it is said to have taken a
long position, and this exposes the institution to risk if the returns on the asset are
uncertain. Conversely, if it has sold an asset that it has agreed to deliver to another party at a
Future date, it is said to have taken a short position, and this can also expose the
Institution to risk. Financial derivatives can be used to reduce risk by invoking the following
basic principle of hedging :Hedging risk involves engaging in a financial transaction
that offsets a long position by taking an additional short position, or offsets a short
position by taking an additional long position. In other words, if a financial institution has
bought a security and has therefore taken a long position, it conducts a hedge by
contracting to sell that security (take a short position) at some future date. Alternatively,
if it has taken a short position by selling a security that it needs to deliver at a future date, then it
conducts a hedge by contracting to buy that security (take a long position)at a future date. We
look at how this principle can be applied using forward and futures
PARTICIPANTS OF DERIVATIVE
Though the use of derivative products, it is possible to partially or fully transfer price
risks by locking in asset prices. as instrument of risk management , these generally do not
influence the fluctuations in the underlying asset prices.
DEFINATIONS
According to JOHN C. HUL “ A derivatives can be defined as a financial instrument whose
value depends on (or derives from) the values of other, more basic underlying variables.”
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. contract which derives its value from the prices, or index of prices, of underlying
securities.
Derivatives were developed primarily to manage, offset or hedge against risk but some were
developed primarily to provide the potential for high returns.
Growth of derivative is affected by a number of factors, some of the important factors are
started below.
1. Increased volatility in asset prices in financial markets
2. Increased integration of national financial markets with the international markets.
3. Marked improvement in communication facilities and sharp decline in their costs.
4. Development of more sophisticated risk management tools, providing economic agents,
a wider choice of risk management strategies.
5. Innovation in the derivative markets, which optimally combine the risk and returns,
reduced risk as well as transaction costs as compared to individual financial assets.
TYPE OF DERIVATIVES
DERIVATIVES
COMMODITY FINANCIAL
COMMODITY DERIVATIVE
These deals with commodities like suger, gold, wheat, pepper etc..thus, futures or options
on gold, suger,pepper, jute etc are commodity derivatives.
FINANCIAL DERIVATIVE
Futures or options or swaps on currencies, gift edged securities, stocks and shares,
stock market indices, cost of living indices etc are financial derivatives.
Another way of classifying derivatives.
DERIVATIE
BASIC COMPLEX
BASIC DERIVATIVES
COMPLEX DERIVATIVE
Other derivative, such as swaps are complex
Derivative
FUTURES FORWARDS OPTIONS COMPLEX
Forward contract
VT = K -ST,(short position)
VT VT
0 K ST 0 K ST
LONG POSITION SHORT POSITION
Future contract
Future same as a forward contract, an agreement to buy or sell at a specified future time a
certain amount of an underlying asset at a specified price. Futures have evolved from
standardization of forward contracts. Futures differ from forward contracts in the following
respects:
Options
Options-an agreement that the holder can buy from, or sell to, the seller of the option at
a specified future time a certain amount of an underlying asset at a specified price. But the holder
is under no obligation to exercise the contract. The holder of an option has the right, but not the
obligation, to carry out the agreement according to the terms specified in the agreement. In an
options contract, the specified price is called the exercise price or strike price, the specified date
is called the expiration date, and the action to perform the buying or selling of the asset
according to the option contract is called exercise.
According to buying or selling an asset, options have the following types:
call option:- is a contract to buy at a specified future time a certain amount of an underlying
asset at a specified price.
put option:- is a contract to sell at a specified future time a certain amount of an underlying
asset at a specified price.
According to terms on exercise in the contract, options have the following types:
Where ST denotes the price of the underlying asset at the expiration date
t =T
VT VT
0 K ST O K ST
COMPLEX DERIVATIVE
Using futures and option it is possible to build number of complex derivative. it is designed to
suit the particular need and circumstances of a client.
Weather derivative
This is a new tool for risk management. This is a contract between 2 parties that stipulates how
payment will be exchanged between parties depending on certain meteorological conditions
souring the contract period. They are based on data such as temperature, rainfall, snowfall etc,
the primary objective of this derivative is to initiate the volume risks, which will influence the
balance sheet and profit and loss figures.
FUCTION OF DERIVATIVES
1. Risk management: it involves structuring of financial contracts too produce grains or
losses that counter balance the losses or gains arising from movements in financial prices.
Thus risks are reduced and profit is increased of a financial enterprises.
2. Price discovery: this represents the ability to achieve and disseminate price information
without price information investors ;consumers an producers cannot make decision.
Derivatives are well suited for providing price information.
3. Transactional efficiency: transitional efficiency is the product of liquidity. Inadequate
liquidity results in high transaction costs. These incases investment and causes
accumulation of capital. Derivatives increases market liquidity, as a result transitional
costs are lowered, and the efficiency in doing business is increased.
RISK OF DERIVATIVE
there are 4 inherent risk associated with derivatives. These risk should clearly understood before
establishing position in derivatives market.
A) Credit risk: the exposure to the possibility of loss resulting from a counter party’s failure
C) Legal risk: an auction by a court or by a regulatory body that could invalidate a financial
contract.
CHAPTER – 3
METHODOLOGY OF STUDY
REVIEW ABOUT RESERCH METHODOLOGY
Methods of study
In dealing with any real life problem it is often found that data at hand are inadequate and
hence it becomes necessary to collect data that are appropriate. There are several ways of
collecting the appropriate data which Considerably in context of money costs, time and other
resources at the disposal of the researcher
The main methods used to study about banks for the primary data are,
●Survey method
● Observational method
● Bank report
● journals
● magazines
● website
● Annual reports
● Attitude test
●projective techniques
● linkert scale
SOURCES OF DATA
In dealing with any real life problem it is often found that data at hand are hand
inadequate, and hence it becomes necessary to collect data are appropriate. There are several
ways of collecting the appropriate data which considerable in context of many costs, time and
other resources at the disposal of the researcher.
There are two source of collecting data a) internal source and b) external
source. Internal source of collecting data is a collecting of data from the concerned company.
External source of data is collecting from the market. This can be again divided into Primary
data and secondary data.
The researcher has selected both the internal and external source
of data for the study. Data for any research can be obtained through primary and secondary
sources. But for the conducted study the researcher fully depend on secondary data.
● Direct observation
● Personal interviews
● Bank publications
● Journals
● Magazines
● Website
● Annual report
Interview
Observation
Published sources
Data is also collected from published sources like company profile, company
journal, leaflet, internet, etc..
Limitation of the techniques used
The varies techniques used for the study involves projective technique involving
of thematic appreciation test, sentence completion test etc…attitude test, linkert scale etc
STUDY PLAN.
INDUSTRY PROFILE
Introduction
In general, the financial market divided into two parts, Money market and capital market.
Securities market is an important, organized capital market where transaction of capital is
facilitated by means of direct financing using securities as a commodity. Securities market can
be divided into a primary market and secondary market.
PRIMARY MARKET
The primary market is an intermittent and discrete market where the initially listed shares are
traded first time, changing hands from the listed company to the investors. It refers to the process
through which the companies, the issuers of stocks, acquire capital by offering their stocks to
investors who supply the capital. In other words primary market is that part of the capital
markets that deals with the issuance of new securities. Companies, governments or public sector
institutions can obtain funding through the sale of a new stock or bond issue. This is typically
done through a syndicate of securities dealers. The process of selling new issues to investors is
called underwriting. In the case of a new stock issue, this sale is called an initial public offering
(IPO). Dealers earn a commission that is built into the price of the security offering, though it
can be found in the prospectus.
SECONDARY MARKET
The secondary market is an on-going market, which is equipped and organized with a
place, facilities and other resources required for trading securities after their initial offering. It
refers to a specific place where securities transaction among many and unspecified persons is
carried out through intermediation of the securities firms, i.e., a licensed broker, and the
exchanges, a specialized trading organization, in accordance with the rules and regulations
established by the exchanges.
A bit about history of stock exchange they say it was under a tree that it all started in
1875.Bombay Stock Exchange (BSE) was the major exchange in India till 1994.National Stock
Exchange (NSE) started operations in 1994.
NSE was floated by major banks and financial institutions. It came as a result of Harshad Mehta
scam of 1992. Contrary to popular belief the scam was more of a banking scam than a stock
market scam. The old methods of trading in BSE were people assembling on what as called a
ring in the BSE building. They had a unique sign language to communicate apart from all the
shouting. Investors weren't allowed access and the system was opaque and misused by brokers.
The shares were in physical form and prone to duplication and fraud.
NSE was the first to introduce electronic screen based trading. BSE was forced to follow suit.
The present day trading platform is transparent and gives investors prices on a real time basis.
With the introduction of depository and mandatory dematerialization of shares chances of fraud
reduced further. The trading screen gives you top 5 buy and sell quotes on every scrip.
A typical trading day starts at 10 ending at 3.30. Monday to Friday. BSE has 30 stocks which
make up the Sensex .NSE has 50 stocks in its index called Nifty. FII s Banks, financial
institutions mutual funds are biggest players in the market. Then there are the retail investors and
speculators. The last ones are the ones who follow the market morning to evening; Market can be
very addictive like blogging though stakes are higher in the former.
ORIGIN OF INDIAN STOCK MARKET
The origin of the stock market in India goes back to the end of the eighteenth century when long-
term negotiable securities were first issued. However, for all practical purposes, the real
beginning occurred in the middle of the nineteenth century after the enactment of the companies
Act in 1850, which introduced the features of limited liability and generated investor interest in
corporate securities.
An important early event in the development of the stock market in India was the formation of
the native share and stock brokers 'Association at Bombay in 1875, the precursor of the present
day Bombay Stock Exchange. This was followed by the formation of associations/exchanges in
Ahmedabad (1894), Calcutta (1908), and Madras (1937). In addition, a large number of
ephemeral exchanges emerged mainly in buoyant periods to recede into oblivion during
depressing times subsequently.
Stock exchanges are intricacy inter-woven in the fabric of a nation's economic life. Without a
stock exchange, the saving of the community- the sinews of economic progress and productive
efficiency- would remain underutilized. The task of mobilization and allocation of savings could
be attempted in the old days by a much less specialized institution than the stock exchanges. But
as business and industry expanded and the economy assumed more complex nature, the need for
'permanent finance' arose. Entrepreneurs needed money for long term whereas investors
demanded liquidity – the facility to convert their investment into cash at any given time. The
answer was a ready market for investments and this was how the stock exchange came into
being.
Stock exchange means any body of individuals, whether incorporated or not, constituted for the
purpose of regulating or controlling the business of buying, selling or dealing in securities. These
securities include:
(i) Shares, scrip, stocks, bonds, debentures stock or other marketable securities of a like nature in
or of any incorporated company or other body corporate;
The exchange makes buying and selling easy. For example, you don't have to actually go to a
stock exchange, say, BSE - you can contact a broker, who does business with the BSE, and he or
she will buy or sell your stock on your behalf.
Market Basics
Electronic trading
Electronic trading eliminates the need for physical trading floors. Brokers can trade from their
offices, using fully automated screen-based processes. Their workstations are connected to a
Stock Exchange's central computer via satellite using Very Small Aperture Terminus (VSATs).
The orders placed by brokers reach the Exchange's central computer and are matched
electronically.
Exchanges in India
The Stock Exchange, Mumbai (BSE) and the National Stock Exchange (NSE) are the country's
two leading Exchanges. There are 20 other regional Exchanges, connected via the Inter-
Connected Stock Exchange (ICSE). The BSE and NSE allow nationwide trading via their VSAT
systems.
Index
An Index is a comprehensive measure of market trends, intended for investors who are
concerned with general stock market price movements. An Index comprises stocks that have
large liquidity and market capitalization. Each stock is given a weight age in the Index equivalent
to its market capitalization. At the NSE, the capitalization of NIFTY (fifty selected stocks) is
taken as a base capitalization, with the value set at 1000. Similarly, BSE Sensitive Index or
Sensex comprises 30 selected stocks. The Index value compares the day's market capitalization
vis-à-vis base capitalization and indicates how prices in general have moved over a period of
time.
Execute an order
Select a broker of your choice and enter into a broker-client agreement and fill in the client
registration form. Place your order with your broker preferably in writing. Get a trade
confirmation slip on the day the trade is executed and ask for the contract note at the end of the
trade date.
Need a broker
As per SEBI (Securities and Exchange Board of India.) regulations, only registered members can
operate in the stock market. One can trade by executing a deal only through a registered broker
of a recognized Stock Exchange or through a SEBI-registered sub-broker.
Contract note
A contract note describes the rate, date, time at which the trade was transacted and the brokerage
rate. A contract note issued in the prescribed format establishes a legally enforceable relationship
between the client and the member in respect of trades stated in the contract note. These are
made in duplicate and the member and the client both keep a copy each. A client should receive
the contract note within 24 hours of the executed trade. Corporate Benefits/Action.
Split
A Split is book entry wherein the face value of the share is altered to create a greater number of
shares outstanding without calling for fresh capital or altering the share capital account. For
example, if a company announces a two-way split, it means that a share of the face value of Rs
10 is split into two shares of face value of Rs 5 each and a person holding one share now holds
two shares.
Buy Back
As the name suggests, it is a process by which a company can buy back its shares from
shareholders. A company may buy back its shares in various ways: from existing shareholders on
a proportionate basis; through a tender offer from open market; through a book-building process;
from the Stock Exchange; or from odd lot holders.
A company cannot buy back through negotiated deals on or off the Stock Exchange, through spot
transactions or through any private arrangement.
Settlement cycle
The accounting period for the securities traded on the Exchange. On the NSE, the cycle begins
on Wednesday and ends on the following Tuesday, and on the BSE the cycle commences on
Monday and ends on Friday. At the end of this period, the obligations of each broker are
calculated and the brokers settle their respective obligations as per the rules, bye-laws and
regulations of the Clearing Corporation. If a transaction is entered on the first day of the
settlement, the same will be settled on the eighth working day excluding the day of transaction.
However, if the same is done on the last day of the settlement, it will be settled on the fourth
working day excluding the day of transaction.
Rolling settlement
The rolling settlement ensures that each day's trade is settled by keeping a fixed gap of a
specified number of working days between a trade and its settlement. At present, this gap is five
working days after the trading day. The waiting period is uniform for all trades. In a Rolling
Settlement, all trades outstanding at end of the day have to be settled, which means that the buyer
has to make payments for securities purchased and seller has to deliver the securities sold. In
India, we have adopted the T+5 settlement cycle, which means that a transaction entered into on
Day 1 has to be settled on the Day 1 + 5 working days, when funds pay in or securities pay out
takes place.
Derivatives
Derivatives are used to lower funding costs by borrowers, to efficiently alter the
proportions of fixed to floating rate debt, to enhance the yield on assets, to quickly modify the
assets payoff structure to correspond to the firm's market view, to avoid taxes and skirt
regulations, and perhaps most importantly, to transfer market risk (hedge)- where the term
market risk is used to connote the possibility of losses sustained due to an unforeseen price or
volatility change. A firm may execute a derivative transaction to alterits market risk profile by
transferring to the trade's counter party a particular type of risk. The price that the firm must pay
for this risk transfer is the acceptance of another type of risk and/or a cash payment to the
counter party.
The term "derivative" indicates that it has no independent value, i.e. its value is entirely
"derived" from the value of the cash asset. A derivative contract or product, or simply
“derivative", is to be sharply distinguished from the underlying cash asset, i.e. the asset brought /
sold in the cash market on normal delivery terms. A general definition of "derivative" may be
suggested here as follows: "Derivative" means forward, future or option contract of pre-
determined fixed duration, linked for the purpose of contract fulfillment to the value of specified
real or financial asset or to index of securities. Derivatives offer organizations the opportunity to
break financial risks into smaller components and then to buy and sell those components to best
meet specific risk management objectives.
As both forward contracts and futures contracts are used for hedging, it is important to
understand the distinction between the two and their relative merits. Forward contracts are
private bilateral contracts and have well established commercial usage. They are exposed to
default risk by counter-party. Each forward contract is unique in term of contract size, expiration
date and the asset type/ quality. The contract price is not transparent, as it is not publicly
disclosed.Since the forward contract is not typically tradable, it has to be settled by delivery of
the asset on the expiration date. In contrast, futures contracts are standardized tradable contracts.
They are standardized in terms of size, expiration date and all other features. They are traded on
specially designed exchanges in a highly sophisticated environment of stringent financial
safeguards. They are liquid and transparent. Their market prices and trading volumes are
regularly reported. The futures trading system has effective safeguards against defaults in the
form of Clearing Corporation guarantees for trades and the daily cash adjustment (mark to
market) to the accounts of trading members based on daily price change. Futures are far more
cost-efficient than forward contracts for hedging.
EVOLUTION OF DERIVATIVE
FORWARD TRADING
It is not clearly established when and where the first forward market came into existence.
there are reports that forward trade exited in India as for back as 2000 BC and in Roman times
forward training is believed to have been existence in the 12 th century in Japan.
The first organized forward market came into existence in late 19th and early 20th century in
Kolkata(jute & jute goods)and in Mumbai (cotton)
FUTURES TRADING
The Dojima rice market can be considerd as the first future market in the sense of an
organized exchange.the first futures in the western hemisphere were developed in united states in
Chicago.first they were started as spot markets and gradually evolved into futures trading.
First stage was starting of agreements to buy grain in future a predetermined price with
the intention of actual delivery. Gradually these contracts become transferable and during.
American civil war, it become commonplace to sell and resell agreements instead of taking
delivery of physical produce. Traders found that the agreements were easier to but and sell. This
is how modern futures contract came into being.
OPTION TRADING
Options trading are of more recent origin. It is estimated that they existing in Greece and Rome
as early as 400 BC. Option trading in agriculture products and shares came in us from the
1860s.chicago started the first option market board of trade (CBOT)in 1973.standard maturities ,
standard strike price, standard delivery arrangement were evolved. The risk of default laws
removed by introducing a clearing house and margin system. The introduction of trade option
opened the way for the evaluations of more complex derivative.
SWAP TRADING
The first swap transaction took place between world bank and IBM (international business
machine) they were currency swap’s. interest rates swap also commenced 1981
OTHER DERIVATIVE
Other derivative like forward rate agreement (FRA).range forward contract and they like evolved
in second half of 1980s.
CHAPTER – 5
COMPANY PROFILE
PROFILE OF THE COMPANY
INTRODUCTION
Mr. C.J. George and Mr. Ranajit Kanjilal founded Geojit as a partnership firm. In
1993, Mr.Ranajit Kanjilal retired from the firm and Geojit became the proprietary concern of Mr.
C .J. George. In 1994, it became a Public Limited Company named Geojit Securities Ltd. The
Kerala State Industrial Development Corporation Ltd. (KSIDC), in 1995, became a co-promoter
of Geojit by acquiring a 24 percent stake in the company, the only instance in India of a
government entity participating in the equity of a stock broking company. The year 1995 also
saw Geojit being listed on the leading regional stock exchanges. Geojit listed at The Stock
Exchange, Mumbai (BSE) in the year 2000. Company’s wholly owned subsidiary, Geojit
Commodities Limited, launched Online Futures Trading in agri-commodities, precious metals
and energy futures on multiple commodity exchanges in 2003. This was also the year when the
company was renamed as Geojit Financial Services Ltd. (GFSL). The Board consists of
professional directors; including a Kerala Government nominee. With effect from July 2005, the
company is also listed at The National Stock Exchange (NSE). Company is a charter member of
the Financial Planning Standards Board of India and is one of the largest Depository
Participant(DP) brokers in the country.
On 31st December 2007, the company closed its commodities business and surrendered its
membership in the various commodity exchanges held by Geojit Commodities Ltd. Global
banking major BNP Paribas took a stake in the year 2007 to become the single largest
shareholder. Consequently, Geojit Financial Services Limited was renamed as Geojit BNP
Paribas Financial Services Ltd.
BNP Paribas is the Eurozone’s leading bank in terms of deposits, and one of the
10 most important banks in the world in terms of net banking income, equity capital and market
value. Furthermore, it is one of the 6 strongest banks in the world according to Standard &
Poor's. With a presence in 85 countries and more than 205,000 employees, 165,200 of which in
Europe, BNP Paribas is a global-scale European leader in financial services. It holds key
positions in its three activities: Retail banking, Investment Solutions and Corporate & Investment
Banking. The Group benefits from its four domestic markets: Belgium, France, Italy and
Luxembourg. BNP Paribas also has a significant presence in the United States and strong
positions in Asia and the emerging markets.
BNP Paribas has been operating in India since 1860 in a number of businesses such as
Investment Banking (CIB), Private banking (BNP Paribas Wealth Management), Life Insurance
(SBI Life) and Asset Management (Sundaram BNP Paribas), Infrastructure Funding (Srei BNP
Paribas), Retail Financing (Sundaram BNP Paribas Home Finance), Car Contract Hiring (Arval),
Institutional Broking (BNP Paribas Securities India) and Securities Services (Sundaram BNP
Paribas Securities Services and BNP Paribas Sundaram Global Securities Operations).
Geojit BNP Paribas today is a leading retail financial services company in India with a growing
presence in the Middle East. The company rides on its rich experience in the capital market to
offer its clients a wide portfolio of savings and investment solutions. The gamut of value-added
products and services offered ranges from equities and derivatives to Mutual Funds, Life &
General Insurance and third party Fixed Deposits. The needs of over 460 000 clients are met via
multichannel services - a countrywide network of 500 offices, phone service, dedicated
Customer Care centre and the Internet.
Geojit BNP Paribas has membership in, and is listed on, the National Stock Exchange (NSE) and
the Bombay Stock Exchange (BSE). In 2007, global banking major BNP Paribas joined the
company’s other major shareholders - Mr. C.J.George, KSIDC (Kerala State Industrial
Development Corporation) and Mr.Rakesh Jhunjhunwala – when it took a stake to become the
single largest shareholder.
Strategic joint ventures and business partnerships in the Middle East has provided the company
access to the large Non-Resident Indian(NRI) population in the region. Now, as a part of the
BNP Paribas global network, Geojit BNP Paribas is well positioned to further expand its reach to
NRIs in 85 countries. Barjeel Geojit Securities is the joint venture with the Al Saud group in the
United Arab Emirates that is headquartered in Dubai with branches in Abu Dhabi, Ras Al
Khaimah, Sharjah and Muscat. Aloula Geojit Brokerage Company headquartered in Riyadh is
the other joint venture with the Al Johar group in Saudi Arabia. The company also has a business
partnership with the Bank of Bahrain and Kuwait, one of the largest retail banks in Bahrain and
Kuwait.
At the forefront of the many fruitful associations between Geojit BNP Paribas and BNP Paribas
is their joint venture, namely, BNP Paribas Securities India Private Limited. This JV was created
exclusively for domestic and foreign institutional clients. An industry first was achieved when
Geojit BNP Paribas became the first broker in India to offer full Direct Market Access(DMA) on
NSE to the JV’s institutional clients.
A strong brand identity and extensive industry knowledge coupled with BNP Paribas’
international expertise gives Geojit BNP Paribas a competitive advantage.
Geojit BNP Paribas has proven expertise in providing online services. In the year 2000, the
company was the first stock broker in the country to offer Internet Trading. This was followed by
integrating the first Bank Payment Gateway in the country for Internet Trading, and many other
industry firsts. Riding on this experience, and harnessing BNP Paribas Personal Investors’
expertise as the leading online broker in Europe, is helping the company to rapidly expanding its
business in this segment. Presently, clients can trade online in equities, derivatives, currency
futures, mutual funds and IPOs, and select from multiple bank payment gateways for online
transfer of funds. Strategic B2B agreements with Axis Bank and Federal Bank enables the
respective bank’s clients to open integrated 3-in-1 accounts to seamlessly trade via a
sophisticated Online Trading platform.
Further, deployment of BNP Paribas’ state-of-the-art globally accepted systems and processes is
already scaling up the sales of Mutual Funds and Insurance.
Certified financial advisors help clients to arrive at the right financial solution to meet their
individual needs. The wide range of products and services on offer includes -
Equities | Derivatives | Currency Futures | Custody Accounts | Mutual Funds | Life Insurance &
General Insurance | IPOs | Portfolio Management Services | Property Services | Margin Funding |
Loans against Shares
A growing footprint
With a presence in almost all the major states of India, the network of 500 offices across 300
cities and towns presently covers Andhra Pradesh, Bihar, Chattisgarh, Goa, Gujarat, Haryana,
Jammu & Kashmir, Karnataka, Kerala, Madhya Pradesh, Maharashtra, New Delhi, Orissa,
Punjab, Rajasthan,Tamil Nadu & Pondicherry, Uttar Pradesh, Uttarakhand and West Bengal.
OVERSEAS JOINT VENTURES
• Barjeel geojit securities, LLC Dubai, is a joint venture of geojit with al
Saud group belonging to sultan bin saud AL Qassemi having diversified
interests in the area of equity markets, real estates and trading. Barjeel geojit
is a financial intermediary and the first licensed brokerage company in USA.
It has facilities for off-line and on-line trading in Indian capital market and
also in US, European and far-eastern capital markets. it also provides
depository services and deals in Indian and international funds. An associate
company, global financial investments S.A.O.G provides similar services in
Oman.
• Aloua geojit brokerage company, is geojit’s recently promoted joint
venture in Saudi Arabia with the al johar group. Saudi is home to the world’s
single largest NRI population. The new venture is expected to start
operations in the latter half of 2008. The Saudi national and the NRI would
be able to invest in the Saudi capital market. The NRI would also be able to
invest in the Indian stock market and in Indian mutual funds. This joint
venture makes geojit the first Indian stock broking company to commence
domestic retail brokerage operations in any foreign country.
2002
• 1st in India to launch an integrated internet trading system for Cash & Derivatives
segments.
2003
• Geojit Commodities Limited, wholly owned subsidiary, launched Online Futures Trading
in agri-commodities, precious metals and in energy futures on multiple commodity
exchanges.
• National launch of online futures trading in Rubber, Pepper, Gold, Wheat and Rice.
• Company renamed as Geojit Financial Services Ltd.
2004
• National launch of online futures trading in Cardamom.
2005
• NSE Listing.
• Geojit Credits, a subsidiary, registers with RBI as a Non-Banking Financial Company
(NBFC).
• National launch of online futures trading in Coffee.
2006
• Charter member of the Financial Planning Standards Board of India.
2007
• BNP Paribas takes a stake in the company’s equity, making it the single largest
shareholder.
• Establishes Joint Venture in Saudi Arabia to serve the Saudi national and the NRI.
2008
• BNP Paribas Securities India (P) Ltd. – a Joint Venture with BNP Paribas S.A. for
Institutional Brokerage.
• 1st brokerage to offer full Direct Market Access execution in India for institutional
clients.
2009
• Launch of Property Services division.
• Launch of online trading in Currency Derivatives.
Consequent to BNP Paribas becoming the largest stakeholder in Geojit Financial Services,
company is renamed as Geojit BNP Paribas Financial Services Ltd.
BOARD OF DIRECTORS
MANAGEMENT
Name Designation
Mr. C. J. George Managing Director
Mr. Satish Menon Director (Operations)
Mr. A. Balakrishnan Chief Technology Officer
Mr. K. Venkitesh National Head - Distribution
Mr. Stefan Groening Director (Planning and Control)
Mr. Jean-Christophe G Director (Marketing)
Mr. Binoy .V.Samuel Chief Financial Officer
Mrs. Jaya Jacob Alexander Chief of Human Resources
We believe that sound corporate governance is critical to enhance and retain investor trust.
Accordingly, we always seek to attain our performance rules with integrity. The Board extends
its fiduciary responsibilities in the widest sense of the term. Our disclosures always seek to attain
the best practices in international corporate governance. We are also responsible to enhance long
term shareholder value and respect minority rights in all our business decisions.
Because the principles described in this Code are general in nature, Officers should also review
the Company’s other applicable policies and procedures.
Officers should sign the acknowledgment form at the end of this Code and return the form to the
HR department indicating that they have received, read and understood, and agree to comply
with the Code. The signed acknowledgement form should be available with officers concerned.
Each year, as part of their annual review, Officers will be asked to sign an acknowledgement
indicating their continued understanding and adherence of the code.
D. Related parties: As a general rule, Officers should avoid conducting Company’s business
with a relative, or have business in which a relative is associated in any significant role. A
relative means and includes spouse, children, parents, grandparents, grandchildren, aunts,
uncles, nieces, nephews, cousins, step relationships, and in-laws. Subject to the rules and
regulation, the Company discourages the employment of relatives of Officers in key
positions or assignments within the same department. Further, the Company prohibits the
employment of such individuals in positions that have a financial dependence or
influence (e.g. an auditing or control relationship, or a supervisor/subordinate
relationship). Every employee drawing a monthly salary of Rs.10,000/- or more shall
disclose whether he is a relative or not of any of our directors.
E. Payments or gifts from others: Under no circumstance the Officers shall accept any offer,
payment, promise to pay, or authorisation to pay any money, gift, or anything of value
from customers, vendors, consultants, etc., that is perceived as intended, directly or
indirectly, to influence any business decision, any act or failure to act, any commitment
of fraud, or opportunity for the commitment of any fraud. Inexpensive gifts, infrequent
business meals, celebratory events and entertainment, provided that they are not
excessive or create an appearance of impropriety, do not violate this policy. Questions
regarding whether a particular payment or gift violates this policy are to be directed to
Finance Department. Gifts given by the Company to suppliers or customers should be
appropriate to the circumstances and should never be of a kind that could create an
appearance of impropriety. The nature and cost must always be accurately recorded in the
Company’s books and records.
F. Corporate opportunities: Officers may not exploit for their own personal gain,
opportunities that are discovered through the use of corporate property, information or
position, unless the opportunity is disclosed fully in writing to the Company’s Board of
Directors and the Board declines to pursue such opportunity.
G. Interested Contracts: Except with the consent of the Board of Directors of the Company,
any of the Director or his relative or a firm in which a director or his relative is a partner,
any other partner in such a firm, or a private company of which the director is a member
or director shall enter into any contract Whistle Blower Policy: Employees who came
across any unethical or improper practice (not necessarily a violation of law) shall be free
to approach the Audit Committee without necessarily informing their supervisors. All
officers are requested to inform their subordinates about their this right through an
effective manner. For any clarification in this regard please contact Finance Department /
Secretarial Department / Legal Department.
The Company will take appropriate action against any Officer whose actions are found to
violate the Code or any other policy of the Company. Disciplinary actions may include
immediate termination of employment at the Company’s sole discretion. Where the
Company has suffered a loss, it may pursue its remedies against the individuals or entities
responsible. Where laws have been violated, the Company will cooperate fully with the
appropriate authorities.
J. Whistle Blower Policy: Employees who came across any unethical or improper practice
(not necessarily a violation of law) shall be free to approach the Audit Committee without
necessarily informing their supervisors. All officers are requested to inform their
subordinates about their this right through an effective manner. For any clarification in
this regard please contact Finance Department / Secretarial Department / Legal
Department.
The Company will take appropriate action against any Officer whose actions are found to violate
the Code or any other policy of the Company. Disciplinary actions may include immediate
termination of employment at the Company’s sole discretion. Where the Company has suffered a
loss, it may pursue its remedies against the individuals or entities responsible. Where laws have
been violated, the Company will cooperate fully with the appropriate authorities.
➢ Derivatives – an overview
➢ Futures contract
➢ Hedging in futures
➢ Speculating in futures
➢ Arbitrage in futures
➢ Options
➢ Options strategies
➢ Derivatives products
➢ Open interest
➢ Futures price = spot price + cost of carry
DERIVATIVES
The word “DERIVATIVES” is derived from the word itself derived of a
underlying asset. It is a future image or copy of a underlying asset which may be shares, stocks,
commodities, stock indices, etc.
Derivatives is a financial product (shares, bonds) any act which is concerned with lending and
borrowing (bank) does not have its value borrow the value from underlying asset/ basic
variables.
Derivatives is derived from the following products:
A. Shares
B. Debuntures
C. Mutual funds
D. Gold
E. Steel
F. Interest rate
G. Currencies.
Derivatives is a type of market where two parties are entered into a contract one is bullish and
other is bearish in the market having opposite views regarding the market. There cannot be a
derivatives having same views about the market. In short it is like a INSURANCE market where
investors cover their risk for a particular position.
Derivatives are financial contracts of pre-determined fixed duration, 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.
Derivatives are risk shifting instruments. Initially, they were used to reduce exposure to changes
in foreign exchange rates, interest rates, or stock indexes or commonly known as risk hedging.
Hedging is the most important aspect of derivatives and also its basic economic purpose. There
has to be counter party to hedgers and they are speculators. Speculators don’t look at derivatives
as means of reducing risk but it’s a business for them. Rather he accepts risks from the hedgers
in pursuit of profits. Thus for a sound derivatives market, both hedgers and speculators are
essential.
Derivatives trading has been a new introduction to the Indian markets. It is, in a sense promotion
and acceptance of market economy, that has really contributed towards the growing awareness of
risk and hence the gradual introduction of derivatives to hedge such risks.
Initially derivatives was launched in America called Chicago. Then in 1999, RBI introduced
derivatives in the local currency Interest Rate markets, which have not really developed, but with
the gradual acceptance of the ALM guidelines by banks, there should be an instrumental product
in hedging their balance sheet liabilities.
The first product which was launched by BSE and NSE in the derivatives market was index
futures
BACKGROUND
Consider a hypothetical situation in which ABC trading company has to import a raw material
for manufacturing goods. But this raw material is required only after 3 months. However in 3
months the prices of raw material may go up or go down due to foreign exchange fluctuations
and at this point of time it can not be predicted whether the prices would go up or come down.
Thus he is exposed to risks with fluctuations in forex rates. If he buys the goods in advance then
he will incur heavy interest and storage charges. However, the availability of derivatives solves
the problem of importer. He can buy currency derivatives. Now any loss due to rise in raw
material prices would be offset by profits on the futures contract and vice versa. Hence the
company can hedge its risk through the use of derivatives
PURPOSE
The primary purpose of futures market is to provide an efficient and effective mechanism for
management of inherent risks, without counter-party risk.
It is a derivative instrument and a type of forward contract The future contracts are affected
mainly by the prices of the underlying asset. As it is a future contract the buyer and seller has
to pay the margin to trade in the futures market
It is essential that both the parties compulsorily discharge their respective obligations on the
settlement day only, even though the payoffs are on a daily marking to market basis to avoid
default risk. Hence, the gains or losses are netted off on a daily basis and each morning starts
with a fresh opening value. Here both the parties face an equal amount of risk and are also
required to pay upfront margins to the exchange irrespective of whether they are buyers or
sellers. Index based financial futures are settled in cash unlike futures on individual stocks which
are very rare and yet to be launched even in the US. Most of the financial futures worldwide are
index based and hence the buyer never comes to know who the seller is, both due to the presence
of the clearing corporation of the stock exchange in between and also due to secrecy reasons
EXAMPLE
The current market price of INFOSYS COMPANY is Rs.1650.
There are two parties in the contract i.e. Hitesh and Kishore. Hitesh is bullish and kishore is
bearish in the market. The initial margin is 10%. paid by the both parties. Here the Hitesh has
purchased the one month contract of INFOSYS futures with the price of Rs.1650.The lot size of
infosys is 300 shares.
Suppose the stock rises to 2200.
Profit
20
2200
10
0
1400 1500 1600 1700 1800 1900
-10
-20
Loss
Unlimited profit for the buyer(Hitesh) = Rs.1,65,000 [(2200-1650*3oo)] and notional profit for
the buyer is 500.
Unlimited loss for the buyer because the buyer is bearish in the market
20
10
0
1400 1500 1600 1700 1800 1900
-10
-20
Loss
Unlimited profit for the seller = Rs.75,000.[(1650-1400*300)] and notional profit for the seller is
250.
Unlimited loss for the seller because the seller is bullish in the market.
Finally, Futures contracts try to "bet" what the value of an index or commodity will be at some
date in the future. Futures are often used by mutual funds and large institutions to hedge their
positions when the markets are rocky. Also, Futures contracts offer a high degree of leverage, or
the ability to control a sizable amount of an asset for a cash outlay, which is distantly small in
proportion to the total value of contract
MARGIN
Margin is money deposited by the buyer and the seller to ensure the integrity of the contract.
Normally the margin requirement has been designed on the concept of VAR at 99% levels.
Based on the value at risk of the stock/index margins are calculated. In general margin ranges
between 10-50% of the contract value.
PURPOSE
The purpose of margin is to provide a financial safeguard to ensure that traders will perform on
their contract obligations.
TYPES OF MARGIN
INITIAL MARGIN:
It is a amount that a trader must deposit before trading any futures. The initial margin
approximately equals the maximum daily price fluctuation permitted for the contract being
traded. Upon proper completion of all obligations associated with a traders futures position, the
initial margin is returned to the trader.
OBJECTIVE
The basic aim of Initial margin is to cover the largest potential loss in one day. Both buyer and
seller have to deposit margins. The initial margin is deposited before the opening of the position
in the Futures transaction.
MAINTENANCE MARGIN:
It is the minimum margin required to hold a position. Normally the maintenance is lower than
initial margin. This is set to ensure that the balance in the margin account never becomes
negative. If the balance in the margin account falls below the maintenance margin, the investor
receives a margin call to top up the margin account to the initial level before trading
commencing on the next level.
ILLUSTRATION
On MAY 15th two traders, one buyer and seller take a position on June NSE S and P CNX nifty
futures at 1300 by depositing the initial margin of Rs.50,000with a maintenance margin of 12%.
The lot size of nifty futures =200.suppose on MAY 16th
The price of futures settled at Rs.1950. As the buyer is bullish and the seller is bearish in the
market. The profit for the buyer will be 10,000 [(1350-1300)*200]
Loss for the seller will be 10,000[(1300-1350)]
Net Balance of Buyer = 60,000(50,000 is the margin +10,000 profit for the buyer)
Net Balance of Seller = 40,000(50,000 is the margin -10,000 loss for the seller)
Net balance of Buyer =70,000(50, 000 is the margin +20,000 profit for the buyer)
Net Balance of Seller = 30,000(50,000 is the margin -20,000 loss for the seller)
As the sellers balance dropped below the maintenance margin i.e. 12% of 1400*200=33600
While the initial margin was 50,000.Thus the seller must deposit Rs.20,000 as a margin call.
Now the nifty futures settled at Rs.1390.
Net balance of Buyer =68,000(70,000 is the margin -2000 loss for the buyer)
Net Balance of Seller = 52,000(50,000 is the margin +2000 profit for the seller)
Therefore in this way each account each account is credited or debited according to the
settlement price on a daily basis. Deficiencies in margin requirements are called for the broker,
through margin calls. Till now the concept of maintenance margin is not used in India.
ADDITIONAL MARGIN:
In case of sudden higher than expected volatility, additional margin may be called for by the
exchange. This is generally imposed when the exchange fears that the markets have become too
volatile and may result in some crisis, like payments crisis, etc. This is a preemptive move by
exchange to prevent breakdown.
CROSS MARGINING:
This is a method of calculating margin after taking into account combined positions in Futures,
options, cash market etc. Hence, the total margin requirement reduces due to cross-Hedges.
MARK-TO-MARKET MARGIN:
It is a one day market which fluctuates on daily basis and on every scrip proper evaluation is
done. E.g. Investor has purchase the SATYAM FUTURES. and pays the Initial margin.
Suddenly script of SATYAM falls then the investor is required to pay the mark-to-market
margin also called as variation margin for trading in the future contract
HEDGERS :
Hedgers are the traders who wish to eliminate the risk of price change to which trhey are already
exposed.It is a mechanism by which the participants in the physical/ cash markets can cover their
price risk. Hedgers are those persons who don’t want to take the risk therefore they hedge their
risk while taking position in the contract. In short it is a way of reducing risks when the investor
has the underlying security.
PURPOSE:
“TO REDUCE THE VOLATILITY OF A PORTFOLIO, BY REDUCING THE RISK”
Figure 1.1
Hedgers
STRATEGY:
The basic hedging strategy is to take an equal and opposite position in the futures market to the
spot market. If the investor buys the scrip in the spot market but suddenly the market drops then
the investor hedge their risk by taking the short position in the Index futures
HEDGING AND DIVERSIFICATION:
Hedging is one of the principal ways to manage risk, the other being diversification.
Diversification and hedging do not have have cost in cash but have opportunity cost. Hedging is
implemented by adding a negatively and perfectly correlated asset to an existing asset. Hedging
eliminates both sides of risk: the potential profit and the potential loss. Diversification minimizes
risk for a given amount of return (or, alternatively, maximizes return for a given amount of risk).
Diversification is affected by choosing a group of assets instead of a single asset (technically, by
adding positively and imperfectly correlated assets).
ILLUSTRATION
Ram enters into a contract with Shyam that he sells 50 pens to Shyam for Rs.1000. The cost of
manufacturing the pen for Ram is only Rs. 400 and he will make a profit of Rs 600 if the sale is
completed.
COST SELLING PRICE PROFIT
400 1000 600
However, Ram fears that Shyam may not honour his contract. So he inserts a new clause in the
contract that if Shyam fails to honour the contract he will have to pay a penalty of Rs.400. And if
Shyam honours the contract Ram will offer a discount of Rs 100 as incentive.
Shyam defaults Shyam honors
400 (Initial Investment) 600 (Initial profit)
400 (penalty from Shyam (-100) discount given to Shyam
- (No gain/loss) 500 (Net gain)
Finally if Shyam defaults Ram will get a penalty of Rs 400 but Ram will recover his initial
investment. If Shyam honors the bill the ram will get a profit of 600 deducting the discount of
Rs.100 and net profit for ram is Rs.500. Thus Ram has hedged his risk against default and
protected his initial investment.
Now let’s see how investor hedge their risk in the market
Example:
Say you have bought 1000 shares of XYZ Company but in the short term you expect that the
market would go down due to some news. Then, to minimize your downside risk you could
hedge your position by buying a Put Option. This will hedge your downside risk in the market
and your loss of value in XYZ will be set off by the purchase of the Put Option.
Therefore hedging does not remove losses .The best that can be achieved using hedging is the
removal of unwanted exposure, i.e.unnessary risk. The hedging position will make less profits
than the un-hedged position, half the time. One should not enter into a hedging strategy hoping to
make excess profits for sure; all that can come out of hedging is reduce risk.
ILLUSTRATION:
With a market price of ACC Rs.600 the investor buys the 50 shares of ACC.Now the investor
excepts that price will fall by 100.So he decided to buy the put Option b y paying the premium
of Rs.25. Thus the investor has hedge their risk by purchasing the put Option. Finally stock falls
by 100 the loss of investor is restricted t the premium paid of Rs.2500 as investor recovered
Rs.75 a share by buying ACC put.
HEDGING STRATEGIES:
Under this investor takes a long position on the security and sell some amount of
Nifty Futures. This offsets the hidden Nifty exposure that is inside every long- security position.
Thus the position LONG SECURITY, SELL NIFTY is a pure play on the performance of the
security, without any extra risk from fluctuations of the market index. Finally the investor has
“HEDGED AWAY” his index exposure.
EXAMPLE:
LONG SECURITY, SELL FUTURES
Here stock futures can be used as an effective risk –management tool. In this case the
investor buys the shares of the company but suddenly the rally goes down. Thus to maximize the
risk the Hedger enters into a future contract and takes a short position. However the losses
suffers in the security will be offset by the profits he makes on his short future position.
As the fall in the price of the security will result in a fall in the price of Futures. Now the Futures
will trade at a price lower then the price at which the hedger entered into a short position.
Finally the loss of Rs.40 incurred on the security hedger holds, will be made up the profits made
on his short futures position.
This is one of the simplest ways to take on hedge. Here the investor buys 100 shares of
HLL.The spot price of HLL is 232 suddenly the investor worries about the fall of price.
Therefore the solution is buy put options on HLL.
The investor buys put option with a strike of Rs.240. The premium charged is Rs.10.Here the
investor has two possible scenarios three months later.
1) IF PRICE RISES
Thus loss he suffers on the stock will be offset by the profit the investor earns on the put
option bought.
2) IF PRICE RISES:
Thus the investor has a limited loss(determined by the strike price investor chooses) and an
unlimited profit.
Here the investor are holding the portfolio of stocks and selling nifty futures. In the case
of portfolios, most of the portfolio risk is accounted for by index fluctuations. Hence a
position LONG PORTFOLIO+ SHORT NIFTY can often become one-tenth as risky as the
LONG PORTFOLIO position.
Let us assume that an investor is holding a portfolio of following scrips as given below on
1st May, 2001.
SPECULATORS:
If hedgers are the people who wish to avoid price risk, speculators are those who are willing to
take such risk. speculators are those who do not have any position and simply play with the
others money. They only have a particular view on the market, stock, commodity etc. In short,
speculators put their money at risk in the hope of profiting from an anticipated price change.
Here if speculators view is correct he earns profit. In the event of speculator not being covered,
he will loose the position. They consider various factors such as demand supply, market
positions, open interests, economic fundamentals and other data to take their positions.
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:
• Naked positions - Position in any future contract.
• Spread positions - Opposite positions in two future contracts. This is a conservative
speculative strategy.
Speculators bring liquidity to the system, provide insurance to the hedgers and facilitate the price
discovery in the market.
Figure 1.2
Speculators
ILLUSTRATION:
Here the Speculator believes that stock market will going to appreciate.
Current market price of PATNI COMPUTERS = 1500
Strategy: Buy February PATNI futures contract at 1500
Lot size = 100 shares
Contract value = 1,50,000 (1500*100)
Margin = 15000 (10% of 150000)
Market action = rise to 1550
Future Gain:Rs. 5000 [(1550-1500)*100]
Market action = fall to 1400
Future loss: Rs.-10000 [(1400-1500)*100]
Thus the Speculator has a view on the market and accept the risk in anticipating of profiting from
the view. He study the market and play the game with the stock market
TYPES:
POSITION TRADERS:
These traders have a view on the market an hold positions over a period of as days until their
target is met.
DAY TRADERS:
. Day traders square off the position during the curse of the trading day and book the profits.
SCALPERS:
Scalpers in anticipation of making small profits trade a number of times throughout the day.
Thus because of leverage provided security futures form an attractive option for speculator.
Under this strategy the speculator is bullish in the market. He could do any of the following:
BUY STOCK
This shows that investor can earn more in the call option because it gives 25% returns over a
investment of 2months as compared to 6.6% returns over a investment in stocks
Finally on the day of expiration the spot and future price converges the investor makes a profit
because the speculator is bearish in the market and all the future stocks need to sell in the market.
ARBITRAGEURS:
Arbitrage is the concept of simultaneous buying of securities in one market where the price is
low and selling in another market where the price is higher.
Arbitrageurs thrive on market imperfections. Arbitrageur is intelligent and knowledgeable person
and ready to take the risk He is basically risk averse. He enters into those contracts were he can
earn risk less profits. When markets are imperfect, buying in one market and simultaneously
selling in other market gives risk less profit. Arbitrageurs are always in the look out for such
imperfections.
In the futures market one can take advantages of arbitrage opportunities by buying from lower
priced market and selling at the higher priced market.
JM Morgan introduced EQUITY DERIVATIVES FUND called as ARBITRAGE FUND where
the investor buys the shares in the cash market and sell the shares in the future market.
ARBITRAGEURS IN FUTURES MARKET
Arbitrageurs facilitate the alignment of prices among different markets through operating in them
simultaneously.
Figure 1.3
Arbitrageurs
Example:
Current market price of ONGC in BSE= 500
Current market price of ONGC in NSE= 510
Lot size = 100 shares
Thus the Arbitrageur earns the profit of Rs.1000(10*100)
STRATEGIES:
BUY SPOT, SELL FUTURES:
In this the investor observing that futures have been overpriced, how can the investor
cash in this opportunity to earn risk less profits. Say for instance ACC = 1000 and One month
ACC futures = 1025.
This shows that futures have been overpriced and therefore as an Arbitrageur, investor can make
risk less profits entering into the following set f transactions.
• On day one, borrow funds, buy security on the spot market at 1000
• Simultansely, sell the futures on the security at1025
• Take delivery of the security purchased and hold the security for a month
• on the futures expiration date, the spot and futures converge . Now unwind the position
• Sa y the security closes at Rs.1015. Sell the security
• Futures position expires with the profit f Rs.10
• The result is a risk less profit of Rs.15 on the spot position and Rs.10 on the futures
position
• Return the Borrow funds.
Finally if the cost of borrowing funds to buy the security is less than the arbitrage profit
possible, it makes sense for the investor to enter into the arbitrage. This is termed as cash – and-
carry arbitrage.
INTRODUCTION TO OPTIONS
It is a interesting tool for small retail investors. An option is a contract, which gives the buyer
(holder) the right, but not the obligation, to buy or sell specified quantity of the underlying
assets, at a specific (strike) price on or before a specified time (expiration date). The underlying
may be physical commodities like wheat/ rice/ cotton/ gold/ oil or financial instruments like
equity stocks/ stock index/ bonds etc.
MONTHLY OPTIONS :
The exchange trade option with one month maturity and the contract usually expires on last
Thursday of every month.
Investors often face a problem when hedging using the three-monthly cycle options as the
premium paid for hedging is very high. Also the trader has to pay more money to take a long or
short position which results into iiliquidity in the market.Thus to overcome the problem the BSE
introduced WEEKLY OPTIONS
WEEKLY OPTIONS:
The exchange trade option with one or weak maturity and the contract expires on last Friday of
every weak
ADVANTAGES
TYPES OF OPTION:
CALL OPTION
A call option gives the holder (buyer/ one who is long call), the right to buy specified quantity of
the underlying asset at the strike price on or before expiration date. The seller (one who is short
call) however, has the obligation to sell the underlying asset if the buyer of the call option
decides to exercise his option to buy. To acquire this right the buyer pays a premium to the
writer (seller) of the contract.
ILLUSTRATION
Suppose in this option there are two parties one is Mahesh (call buyer) who is bullish in the
market and other is Rakesh (call seller) who is bearish in the market.
The current market price of RELIANCE COMPANY is Rs.600 and premium is Rs.25
1. CALL BUYER
Here the Mahesh has purchase the call option with a strike price of Rs.600.The option will be
excerised once the price went above 600. The premium paid by the buyer is Rs.25.The buyer will
earn profit once the share price crossed to Rs.625(strike price + premium). Suppose the stock has
crossed Rs.660 the option will be exercised the buyer will purchase the RELIANCE scrip from
the seller at Rs.600 and sell in the market at Rs.660.
Profit
30
20
10
0
590 600 610 620 630 640
-10
-20
-30
Loss
Unlimited profit for the buyer = Rs.35{(spot price – strike price) – premium}
Limited loss for the buyer up to the premium paid.
2. CALL SELLER:
In another scenario, if at the tie of expiry stock price falls below Rs. 600 say suppose the stock
price fall to Rs.550 the buyer will choose not to exercise the option.
Profit
30
20
10
0
590 600 610 620 630 640
-10
-20
-30
Loss
Profit for the Seller limited to the premium received = Rs.25
Loss unlimited for the seller if price touches above 600 say 630 then the loss of Rs.30
Finally the stock price goes to Rs.610 the buyer will not exercise the option because he has the
lost the premium of Rs.25.So he will buy the share from the seller at Rs.610.
Thus from the above example it shows that option contracts are formed so to avoid the unlimited
losses and have limited losses to the certain extent
PUT OPTION
A Put option gives the holder (buyer/ one who is long Put), the right to sell specified quantity of
the underlying asset at the strike price on or before a expiry date. The seller of the put option
(one who is short Put) however, has the obligation to buy the underlying asset at the strike price
if the buyer decides to exercise his option to sell.
ILLUSTRATION
Suppose in this option there are two parties one is Dinesh (put buyer) who is bearish in the
market and other is Amit(put seller) who is bullish in the market.
The current market price of TISCO COMPANY is Rs.800 and premium is Rs.2 0
1) PUT BUYER(Dinesh):
Here the Dinesh has purchase the put option with a strike price of Rs.800.The option will be
excerised once the price went below 800. The premium paid by the buyer is Rs.20.The buyer’s
breakeven point is Rs.780(Strike price – Premium paid). The buyer will earn profit once the
share price crossed below to Rs.780. Suppose the stock has crossed Rs.700 the option will be
exercised the buyer will purchase the RELIANCE scrip from the market at Rs.700and sell to the
seller at Rs.800
Profit
20
10
0
600 700 800 900 1000 1100
-10
-20
Loss
Unlimited profit for the buyer = Rs.80 {(Strike price – spot price) – premium}
Loss limited for the buyer up to the premium paid = 20
In another scenario, if at the time of expiry, market price of TISCO is Rs. 900. the buyer of the
Put option will choose not to exercise his option to sell as he can sell in the market at a higher
rate.
profit
20
10
0
600 700 800 900 1000 1100
-10
-20
Loss
Unlimited loses for the seller if stock price below 780 say 750 then unlimited losses for
the seller because the seller is bullish in the market = 780 - 750 = 30
Limited profit for the seller up to the premium received = 20
Thus Put option also indicates two positions as follows:
LONG POSITION
If the investor expects price to fall i.e. bearish in the market he takes a long position by buying
Put option.
SHORT POSITION
If the investor expects price to rise i.e. bullish in the market he takes a short position by selling
Put option
Option seller or Has the obligation to sell Has the obligation to buy
option writer the underlying asset (to the the underlying asset (from
option holder) at the the option holder) at the
specified price specified price.
For instance, as the price of the underlying asset rises, the premium of a call will increase and the
premium of a put will decrease. A decrease in the price of the underlying asset’s value will
generally have the opposite effect
Volatility:
Volatility is simply a measure of risk (uncertainty), or variability of an option’s underlying.
Higher volatility estimates reflect greater expected fluctuations (in either direction) in underlying
price levels. This expectation generally results in higher option premiums for puts and calls alike,
and is most noticeable with at- the- money options.
RIGHT OR OBLIGATION :
Futures are agreements/contracts to buy or sell specified quantity of the underlying assets at a
price agreed upon by the buyer & seller, on or before a specified time. Both the buyer and seller
are obligated to buy/sell the underlying asset.
In case of options the buyer enjoys the right & not the obligation, to buy or sell the underlying
asset.
RISK
Futures Contracts have symmetric risk profile for both the buyer as well as the seller.
While options have asymmetric risk profile. In case of Options, for a buyer (or holder of the
option), the downside is limited to the premium (option price) he has paid while the profits may
be unlimited. For a seller or writer of an option, however, the downside is unlimited while profits
are limited to the premium he has received from the buyer.
PRICES:
The Futures contracts prices are affected mainly by the prices of the underlying asset.
While the prices of options are however, affected by prices of the underlying asset, time
remaining for expiry of the contract & volatility of the underlying asset.
COST:
It costs nothing to enter into a futures contract whereas there is a cost of entering into an options
contract, termed as Premium.
STRIKE PRICE:
In the Futures contract the strike price moves while in the option contract the strike price
remains constant .
Liquidity:
As Futures contract are more popular as compared to options. Also the premium charged is high
in the options. So there is a limited Liquidity in the options as compared to Futures. There is no
dedicated trading and investors in the options contract.
Price behaviour:
The trading in future contract is one-dimensional as the price of future depends upon the price of
the underlying only. While trading in option is two-dimensional as the price of the option
depends upon the price and volatility of the underlying.
PAY OFF:
As options contract are less active as compared to futures which results into non linear pay off.
While futures are more active has linear pay off .
OPTION STRATAGIES:
Profit
20
10
0
1490 1500 1510 1520 1530 1540
-10
-20
Loss
Profit
20
10
0
3000 3500 4000 4500 5000 5500 6000 6500 7000
-10
-20
Loss
OPTION PAYOFF
Profit
Loss
OPTION PAYOFF
Profit
Loss
5). STRADDLE:
In this strategy the investor purchase and sell the call as well as the put option of the same strike
price, the same expiration date, and the same underlying. In this strategy the investor is neutral in
the market.
This strategy is often used by the SPECULATORS who believe that asset prices will move in
one direction or other significantly or will remain fairly constant.
TYPES:
LONG STRADDLE:
Here the investor takes a long position(buy) on the call and put with the same strike price and
same expiration date. In this the investor is beneficial if the price of the underlying stock move
substantially in either direction. If prices fall the put option will be profitable an if the prices rises
the call option will give gains. Profit potential in this strategy is unlimited ,While the loss is
limited up to the premium paid. This will occur if the spot price at expiration is same as the strike
price of the options.
SHORT STRADDLE:
This strategy is reverse of long straddle. Here the investor write(sell) the call as well as the put in
equal number for the same strike price an same expiration. This strategy is normally used when
the prices of the underlying stock is stable but the investor start suffering losses if the market
substantially moves in either direction .
Detailed example of a long straddle
Current market price of BAJAJ AUTO is Rs.600
Here the investor buys one month call of strike price 600 at 20 ticks per contract and two
month put of strike price 600 for 15 ticks per contract.
Premium Paid = 35 ticks
Lot size = 400 shares
Lower Break- Even- Point = 600 – 35 = 565
Higher Break- Even- Point = 600 + 35 = 635
i. AT BREAK- EVEN- POINT:
If the stock is at 565 or at 635, this option strategy will be at Break- Even- Point. At 565 the 600
call will have no intrinsic value an expire worthless but the 600 put will have an intrinsic value
of 35.
At 635 the 600 call will have an intrinsic value of 35, while the put 600 will expire worthless.
ii. BELOW STRIKE PRICE AND BELOW LOWER BEP:
If the stock price goes to 550 then the 600 call will have no intrinsic value and expire worthless
while 600 put will have an intrinsic value of 50.
iii. ABOVE STRIKE PRICE AND ABOVE LOWER BEP:
If the stock price touches 650 the 600 call will have an intrinsic value of 50, while 600 put will
have no intrinsic value an will expire worthless.
iv. BETWEEN LOWER BEP AND HIGHER BEP:
If the stock prices goes to 6oo then the both call and put option will expire worthless which
results in the loss of 35(premium).
The pay-off table:
BAJAJ AUTO AT 550 600 618 635 650
EXPIRATION (BELOW (At the (BETWEEN (At BEP) (ABOVE
STRIKE strike) STRIKE & STRIKE
AN D HIGHERBEP AN D
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20
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10
550 560 570 580 590 600 610 620 630 640 650
-10
-20
-30
-40
Loss
6. STRANGLE:
In this strategy the investor is neutral in the market which involves the purchase of a higher call
and a lower put that are slightly out of the money with different strike price and with the
different expiration date. The premiums are lower as compared to straddle also the risk is more
involved as compare to straddle which not leads to the profit.
TYPES
1) LONG STRANGLE:
Here the investor purchases a higher call and a lower put with different strike price and with
the different expiration date. A long strangle strategy is used to profit from a volatile price an
loss from stable prices.
1) SHORT STRANGLE:
In this the investor sells a higher call and a lower put with different strike price and with the
different expiration date. A short strangle strategy is used to profit from a stable prices an loss
starts when price is volatile.
If the stock is at 3915 or at 4085, this option strategy will be at Break- Even- Point. At 3915 the
4050 call will have no intrinsic value and expire worthless but the 3950 put will have an
intrinsic value of 35
At 4085 the 4050 call will have an intrinsic value of 35, while the put 400 will have no intrinsic
value and expire worthless.
ii. BELOW STRIKE PRICE AND BELOW LOWER BEP:
If the stock price goes to 3900 then the 4050 call will have no intrinsic value and expire
worthless while 3950 put will have an intrinsic value of 50.
iii. ABOVE STRIKE PRICE AND ABOVE LOWER BEP:
If the stock price touches 4100 the 4050 call will have an intrinsic value of 50, while 3950 put
will have no intrinsic value and will expire worthless.
iv. BETWEEN LOWER BEP AND HIGHER BEP:
If the stock prices goes to 4000 then the both call and put option will expire worthless and
limited profit up to the premium received.
v. AT STRIKE PRICE:
If the price is settled at 4050 then 4050 call and 3950 put will have limited profit upto the
premium received
20
10
0
3900 3925 3950 3975 4000 4025 4050 4075 4100
-10
-20
Break – Even - Point
Loss
7) COVERED CALL:
Under this strategy investors buys the shares which shows that they are bullish in the market
but suddenly they are scared about the market falls thus they sells the call option. Here the seller
is usually negative or neutral on the direction of the underlying security. This strategy is best
implemented in a bullish to neutral market where a slow rise in the market price of the
underlying stock is anticipated.
Thus if price rises he will not participate in the rally. However he has now reduced loss by the
amount of premium received, if prices falls.Finally if prices remains unchanged obtains the
maximum profit potential.
EXAMPLE:
If the stock closes at 300, the 300 call option will not exercised and seller will receive the
premium.
If the stock ends at 275, the 300 call option expires worthless equilant to the premium received
results into no profit no loss.
If the stock ends above 300, the 300 call option is exercised and call writer receives the
premium results into the maximum profit potential.
The payoff diagram of a covered call with long stock + short call = short put
Profit
:
50 Break- Even-
25
0
250 275 300 325 350
-25
-50
Loss
8) COVERED PUT:
Here the writer sell stock as well as put because he overall moderate bearish on the market
and profit potential is limited to the premium received plus the difference between the original
share price of the short position and strike price of the put. The potential loss on this position,
however is substantial if price increases above the original share price of the short position. In
this case the short stock will suffer losses which will be offset by the premium received.
Profit
:
Lower
Loss
9) UNCOVERED CALL:
This strategy is reverse of the covered call. There is no opposite position in the naked call. A call
option writer (seller) is uncovered if the shares of the underlying security represented by the
option is not owned by the option writer.
The object of an uncovered call writer is to realize income by writing (selling) option without
committing capital to the ownership of the underlying shares.
This shows that the seller has one sided position in the contract for this the seller must deposit
and maintain sufficient margin with the broker to assure that the stock can be purchased for
delivery if option is exercised.
• If the market price of the stock rises sharply the calls could be exercised, while as far as
the obligation is concerned the seller must buy the stock more than the option strike
price, which results in a substantial loss.
• The rise of buying uncovered calls is similar to that of selling stock although, as an
option writer, the risk is cushioned somewhat by the amount of premium received.
ILLUSTRATION:
Net premium: 6
Therefore the option will not be assigned because the seller has no stock position and price
decline has no effect on the profit of the premium received.
Suppose the price settled at Rs.75 the option assigned and the seller has to cover the position
at a net loss of Rs.400 [1000 (loss on covering call)- 600(premium income)]
Finally the loss is unlimited to the increase in the stock price and profit is limited to the
declining stable stock price.
Under this strategy the investor purchases the stock along with the put option because the
investor is bearish in the market. This strategy enables the holder of the stock to gain
protection from a surprise decline in the price as well as protect unrealized profits. Till the
option expires, no matter what the price of underlying is, the option buyer will be able to sell
the stock at strike price of put option.
SCENARIO
Here the investor pays an additional margin of Rs.10 along with the price of Rs.210
combining a share with a put option is referred as a Protective Put.
• AT BREAK-EVEN-POINT:
Previously if the price rises to 200 the investor will gain but now the investor pays an margin of
Rs.10. If price rises to Rs.210 then only the investor will gain.
Finally uncertainty is the biggest curse of the market and a protective put helps override the
uncertainty in the markets. Protective put removes the uncertainty by limiting the investor loss at
Rs.10. In this case no matter what happens to the investor is protected by the loss of Rs.10. The
put option makes the investor life by telling the investor in advance how much it stands to loss.
This is also referred to as PORTFOLIO INSURANCE because it helps the investor by insuring
the value of investment just like any other asset for which the investor would purchase insurance.
profit
:
20
Break- Even-
10
0
180 190 200 210 220
-10
-20
Loss
PRICING OF AN OPTION
DELTA
A measure of change in the premium of an option corresponding to a change in the price of
the underlying asset.
Change in option premium
Delta = --------------------------------
Change in underlying price
ILUSTRATION
The investor has buys the call option in the future contract for the strike price of Rs.19. The
premium charged for the strike price of 19 at 0.80 The delta for this option is 0.5.Here if the
price of the option rises to 20.A rise of 1. then the premium will increase by 0.5 x 1.00 = 0.50. The
new option premium will be 0.80 + 0.50 = Rs 1.30.
Here in the money call option will increase the delta by 1.which will make the value more and
expensive while at the money option have the delta to 0.5 and finally out the money call option
will have the delta very close to 0 as the change in underlying price is not likely to make them
valuable or cheap and reverse for the put option
Delta is positive for a bullish position (long call and short put) as the value of the position
increases with rise in the price of the underlying. Delta is negative for a bearish position (short
call and long put) as the value of the position decreases with rise in the price of the underlying.
Delta varies from 0 to 1 for call options and from –1 to 0 for put options. Some people refer to
delta as 0 to 100 numbers.
ADVANTAGE
The delta is advantageous for the option buyer because it can tell him much of an option and
accordingly buyer can expect his short term movements by the underlying stock. This can help
the option of an buyer which call/put option should be bought.
GAMMA
A measure of change in the delta that may occur corresponding to the rise or fall in the price of
the underlying asset.
Gamma = change in option delta
__________________
change in underlying price
The gamma of an option tells you how much the delta of an option would increase or decrease
for a unit change in the price of the underlying. For example, assume the gamma of an option is
0.04 and its delta is 0.5. For a unit change in the price of the underlying, the delta of the option
would change to 0.5 + 0.04 = 0.54. The new delta of the option at changed underlying price is
0.54; so the rate of change in the premium has increased. suppose the delta changed to 0.5-0.04 =
0.46 thus the rate of premium will decreased .
In simple terms if delta is velocity, then gamma is acceleration. Delta tells you how much the
premium would change; gamma changes delta and tells you how much the next premium change
would be for a unit price change in the price of the underlying.
Gamma is positive for long positions (long call and long put) and negative for short positions
(short call and short put). Gamma does not matter much for options with long maturity. However
for options with short maturity, gamma is high and the value of the options changes very fast
with swings in the underlying prices
THETA:
ADVANTAGE
Theta is always positive for the seller of an option, as the value of the position of the seller increases
as the value of the option goes down with time.
DISADVANTAGE
Theta is always negative for the buyer of an option, as the value of the option goes
down each day if his view is not realized.
In simple words theta tells how much value the option would lose after one day, with all the
other parameters remaining the same.
VEGA
The extent of extent of change that may occur in the option premium, given a change in the
volatility of the underlying instrument.
Change in an option premium
Vega = -----------------------------------------
Change in volatility
ILLUSTRATION
Suppose the Vega of an option is 0.6 and its premium is Rs15 when volatility of the
underlying is 35%. As the volatility increases to 36%, the premium of the option
would change upward to Rs15.6.
Vega is positive for a long position (long call and long put) and negative for a short position (short
call and short put).
ADVANTAGE
Simply put, for the buyer it is advantageous if the volatility increases after he has
bought the option.
DISADVANTAGE
For the seller any increase in volatility is dangerous as the probability of his option getting in the
money increases with any rise in volatility.
In simple words Vega indicates how much the option premium would change for a unit change in
annual volatility of the underlying.
SENSEX OPTIONS:
A financial derivative product enabling the investor to buy or sell call or put options (to
be exercised on a future date) on the underlying sensex at a premium decided by the market
forces
Useful primarily for Hedging the Sensex based portfolios and also for expressing the views
on the market.
STOCK FUTURES:
A financial derivative product enabling the investor to buy or sell underlying stock on a
future date at a price decided by the market forces
Available on ____ individual stocks approved by SEBI
Useful primarily for Hedging, Arbitrage and for expressing the views on the market.
STOCK OPTIONS:
A financial derivative product enabling the investor to buy or sell call options(to be
exercised at a future date) on the underlying stock at a premium decided by the market
forces
Available on ____ individual stocks approved by SEBI
Useful primarily for Hedging, Arbitrage and for expressing the views on the market.
CONTRACT SPECIFICATIONS
PARTICULARS SENSEX FUTURES AND STOCK FUTURES AND
OPTIONS OPTIONS
Underlying Asset Sensex Corresponding stock in the
cash market
Contract Multiplier 50 times the sensex Stock specific E.g. market
(futures) lot of RIL is 600, Infosys
100 times the sensex is 100 & so on
(options)
Contract Months 3 nearest serial months 1, 2 and 3 months
(futures)
1, 2 and 3 months(options)
Tick size 0.1 point 0.01*
Price Quotation Sensex point Rupees per share
Trading Hours 9:30a.m. to 3:30p.m. 9:30a.m. to 3:30p.m.
Settlement value In case of sensex options In case of stock options
the closing value of the the closing value of the
sensex on the expiry day respectative in the cash
segment of BSE
Exercise Notice Time In case of sensex options In case of stock options
Specified time (exercise Specified time (exercise
session) on the last trading session) on the last trading
day of the contract. All in day of the contract. All in
the money options would the money options would
deem to be exercised deem to be exercised
unless communicated unless communicated
otherwise by the otherwise by the
participant. participant.
Last Trading Day Last Thursday of the Last Thursday of the
contract month. If it is a contract month. If it is a
holiday, the immediately holiday, the immediately
preceding business day preceding business day
Final Settlement On the last trading day, the The difference is settled in
closing value of the cash on the expiration day
Sensex would be the final on the basis of the closing
settlement price of the value of the respectative
expiring futures/option underlying scrip in the
contract. cash market on the
expiration day
INDEX OPTIONS
An index option provides the buyer of the option, the right but not the obligation to buy or sell the
underlying index, at a pre-determined strike price on or before the date of expiration, depending on the
type of option.
Index option offer investors an opportunity to either capitalize on an expected market move or hedge
price risk of the physical stock holdings against adverse market moves.
NSE defines the characteristics of the futures contract such as the underlying security, market lot,
and the maturity date of the contract. The futures contracts are available for trading from
introduction to the expiry date.
CONTRACT SPECIFICATIONS
Strike Price Interval S&P CNX Nifty Options Rs. 10/-2. Options on individual Between
Rs.2.50 and Rs. 100.00
securities : depending on the price
of underlying
Trading Cycle Maximum of three month trading Maximum of three month trading
cycle- near month(one), the next cycle- near month(one), the next
month (two)and the far month month (two)and the far month
(three). New series of contract will (three). New series of contract
be introduced on the next trading will be introduced on the next
day following expiry of near month trading day following expiry of
contract near month contract.
Expiry Date The last Thursday of the expiry The last Thursday of the expiry
month or the Previous trading day if month or the Previous trading day
the last Thursday of the month is a if the last Thursday of the month
trading holiday is a trading holiday
Settlement Price S&P CNX Nifty Futures / Daily Final settlement price shall be the
settlement price will be the closing closing value of the underlying
value of the underlying index security on the last trading day
Index Options The settlement price
shall be closing value of underlying The settlement price shall be
index closing on individual security
price of underlying security.
OPEN INTEREST(OPTIONS)
Open Interest is a crucial measure of the derivatives market. The total number of options
contracts outstanding in the market at any given point of time. In short Sum of all positions taken
by different traders reflects the Open Interest in a contract. Opposite positions taken by a trader
in a contract reduces the open interest. However, opposing positions taken (in the same contract)
by two different traders are added to the open interest.
Assuming that the market consists of three traders only following table indicates how Open
Interest changes on different day’s trades in PATNI COMPUTERS with a call American option
at a strike price of Rs. 180
OPEN INTEREST(FUTURES)
The total number of net outstanding futures contracts is called as open interest i.e. long minus
short contracts. A decline in open interest of the near term futures indicates a short-term
weakness whereas an increase in the open interest in the long term futures indicate that the
markets may bounce back after some time provided this trend persists for a long time
If open interest and market volumes increases but the market is bullish this shows that
there has been buying positions in the market, which results into the positive open
interest.
If open interest and volumes increases but the market is in the bearish phase this shows
that there has been selling positions made by the investor which results into the negative
open interest
If open interest remains constant and volumes are increasing and market is also bullish
this shows that there has been intra day trading in the market.
If both open interest and prices are increasing, this shows that the buyers have entered in
the market unfolding. Expect the uptrend to continue.
If on the other hand, open interest is increasing while prices decline, sellers are expecting
for the price rise in a technically weak market. As open interest is growing while prices
decline, buyers are obviously the more aggressive party.
In the event of open interest declining while prices are also slipping, liquidation by long
positions is the implication, therefore suggesting a technically strong market overall. In
other words, the market is strong as open interest declining suggests no new aggressive
shorts, as this would entail an increase in open interest.
When open interest is declining and prices are increasing, short covering is the most
likely cause suggesting that overall the market is weak - i.e. attracting new buyers would
be required for a technically strong market and consequently open interest would rise.
ILLUSTRATION
Suppose there are only two brokers Mr. A and Mr. B in the market. A buys and B sells contracts
on Index futures on a specific day. At the end of the day , we may say that open interest in the
market is 10 contracts and volume for the day is 10 contracts.
Now, if next day a new trader Mr. C comes from Mr. A, open interest at the endo f the 2 day of
trading remains same 10 contracts and volume for the day is again 10 contracts. Understand that
on the second day, Mr. C assumes Mr. A’s position on first day of trading. But for the market as
a whole, at the end of the 2nd day all only 10 contracts remain open.
COST OF CARRY
The relationship between futures and spot prices can be summarized in terms of what is know as
the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset
less the income earned on the asset.
Cost of carry gives us an idea about the demand-supply forces in the futures market. It basically
indicates the annualized interest cost which players are willing to pay (receive) for buying
(selling) a futures contract.
In the Indian markets the cost of carry marketing varies between a negative 35% per annum to a
positive 35 % per annum. It can even be higher or lower than the 35% figure but that would be
an extraordinary event. We all know that at expiry the futures price closes at the cash price of the
security or an index.
The cost-of-carry model in financial futures, thus, is
Futures price = Spot price + Carrying cost — Returns (dividends, etc.)
EXAMPLE
Suppose the RELIANCE share is trading at Rs.400 in the spot market. While RELIANCE
FUTURES is trading at Rs.406.Thus in this circumstances the normal strategy followed by
investors is buy the RELIANCE in the spot market and sell in the futures. On expiry, assuming
RELIANCE closes at Rs 450, you make Rs.50 by selling the RELIANCE stock and lose Rs.44
by buying back the futures, which is Rs 6 in a month. Thus Futures prices are generally higher
than the cash prices, in an overbought market.
CASH PRICE HIGHER THAN THE FUTURES PRICE
Here cash price exceeds the futures price which indicates that the cost of carry is positive and
this market is termed as oversold market. This may be due to the fact that the market is cash
settled and not delivery settled, so the futures price is more a reflection of sentiment, rather than
that of the financing cost.
EXAMPLE
Now let us assume that the RELIANCE share is trading at Rs.406 in the spot market. While
RELIANCE FUTURES is trading at Rs.400.Thus in this circumstances the normal strategy
followed by investors is buy the RELIANCE FUTURES and sell the RELIANCE in the spot
market. So at expiry if Reliance closes at Rs 450, the investor will buy back the stock at a loss of
Rs 44 and make Rs 50 on the settlement of the futures position. This is applied when the cost of
carry is high.
Thus the arbitrageur can apply this strategy and make the profits
VOLATILITY
Volatility is one of the most important factors in an option’s price. It measures the amount by
which an underlying asset is expected to fluctuate in an given period time. It significantly
impacts the price of an option’s premium and heavily contributes to an option’s time value.
In basic terms, volatility is merely a term used to describe how fast a stock, future or index
changes with respect to change in the price. It can be viewed as the speed of change in the
market, although the investor may prefer to think of it is as market confusion. The more confused
a market is the better the chance an option of ending up “in the money”. A stable market moves
slowly. Volatility measures the speed of change in the price of the underlying instrument or the
option. Higher the volatility the more the chance an option of becoming profitable by expiration
Higher the price volatility of the underlying stock of the put option, higher would be the
premium.
Lower the price volatility of the underlying stock of the call option, lower would be the
premium.
TYPES OF VOLATILITY
HISTORICAL VOLATILITY:
This (also called statistical volatility) measures price movement in terms of past.
Historical volatility is calculated by using the standard deviation of underlying asset price
changes from close to close of trading for a given period - month, half yearly, annualized
IMPLIED VOLATILITY:
It is the option market predication of volatility of the underlying instrument over the life
of the option. It helps in determining what strategies are to be used.When implied
volatility is high, the market price of the option will be greater than their theoretical price.
Example
Stock Price: Rs 280
Strike Price: Rs 260
Annual volatility: 50%
Days to expiry 20 days
Interest rate 12% annual
The price of the Option applying Black-Scholes Model comes to Rs 26.28. But the actual price
of that Option in the market might be (say) Rs 29.50. This means that the market is imputing
another volatility to that option going forward. Now instead of providing the volatility figure
yourself, you can provide the Option price instead. Now if the investor work backwards and find
out what is the volatility that would support the price of Rs 29.50, that volatility comes to 65 per
cent.
While the value of a call option is an increasing function of the value of its underlying, it is also
an increasing function of the volatility of its underlying. That is, the more uncertain the
underlying, the more the option is worth.
From the above scenario it is possible that the players are expecting the scrip to increase another
possibility is that the market is mis-pricing the option and could fall. It could also be possible
that the market is anticipating some development, which could push the stock higher. If you
believe that volatility would rise and the underlying then you may go in for a bull strategy or if
you are an aggressive player you could sell the option with a belief to buy them at a later date.
Most traders, however, use a general rule of thumb: Buy options in low volatility and sell options
during periods of high volatility.
If you see low implied volatilities, you should buy the At the Money (ATM) option and sell an
Out of the Money (OTM) option. You can also create a similar position using puts. In this case,
you should buy ATM and sell In the Money (ITM) put options. If you see high implied
volatilities, you should buy an In the Money (ITM) Call and sell an ATM call. You will find that
both the calls are expensive, but the ATM will be in most circumstances more expensive than the
others. Thus, by selling the ATM call, you can realize a good price.
Finally implied volatility can increase or decrease even without price changes ion the
underlying security. This is because implied volatility is the level of expected volatility i.e. it is
also based not on actual prices of the security, but expected price trends. Implied voltility also
declines, as the option gets closer to expiration, as changes in volatility become less significant
with fewer trading days
ILLUSTRATION
Let's choose the strike price 165 in Satyam for the June contracts. Satyam is one of the most
actively traded contracts in the NSE F&O segment.
The IV for the call is 97.66 per cent and that of put is 99.40 per cent on April 25, 2005 Since the
IV is high, it is a premium-selling time. (a good time to sell calls and puts)
# On May 25, the investor `short straddle' the Satyam by selling the 165 call and put for Rs 27.
# The inflow in this strategy is Rs 54 (2X27).
# The underlying spot has been trading within a range of 157-177.
# However, the call IV has ranged from 99.40 - 63.36 and that of put has ranged from 97.66-
46.01
# On May 29, 2003 the IV of call and put are low, hence the investor can square off positions.
# The respective IV was 63.36 for call and 46.01 for put. The underlying Satyam was Rs 169.50.
# The call closed at Rs 11.45 and the put closed at Rs 9.50.
# Square-off position by buying call and put of the same strike. Your outflow would be 20.95
(11.45+9.50). Hence, your net profits would be Rs 33.05 (54-20.95).
Here the strategy has “limited profit and unlimited losses”. Here the Profit is limited to the
premiums received. Losses would be unlimited if you are wrong on the stock outlook and the
volatility outlook.
CHAPTER – 6
FINDINGS,SUGGESTIONS
AND CONCLUSIONS
FINDINGS
The following findings are made on the basis of data analysis from the previous
Chapter.
1. The study reveals the effectiveness of risk reduction using hedging strategies. It has
found out that risk cannot be avoided. But can only be minimized.
2. Through the study. it has found out that, the hedging provides a safe position on an
underlying security. The loss gets shifted to a counter party. Thus the hedging covers the
loss and risk. Sometimes, the market performs against the expectation. This will trigger
losses. so the hedger should be a strategic and positive thinker.
3. The anticipation of the hedger regarding the trend of the movement in the prices of the
underlying security plays a key role in the result of the strategy applied.
4. It has been found that, all the strategies applied on historical data of the period of the
study were able to reduce the loss that rose from price risk substantially.
5. If the trader is not sure about the direction of the movement of the profits of the current
position, he can counter position in the future contract and reduces the level of risks.
6. The trader can effectively use the strategy for return enhancement provided he has the
correct market anticipation.
7. In general, the anticipation of the strategies purely for return enhancement is a risky
affair, because, if the anticipation about the performance of the market and the underlying
goes wrong, the position taker would end up in higher losses.
SUGGEESTIONS
• If an investor wants to hedge with portfolios, it must consist of scrips from different
industries, since they are convenient and represent true nature of the securities market as
a whole.
• The hedging tool to reduce the losses that may arise from the market risk. Its primary
objective is loss minimization, not profit maximization .The profit from futures or shares
will be offset from the losses from futures or shares, as the case may be. as a result, a
hedger will earn a lower return compared to that of an unhedger. But the unhedger faces a
high risk than a hedger.
• The hedger will have to be a strategic thinker and also one who think positively. He
should be able to comprehend market trends and fluctuations. Otherwise, the strategies
adopted by him earn him earn losses.
• The hedging tool is suitable in the short term period. They can be specifically adopted by
the investor, who are facing high risks and has sufficient liquid cash with them. Long
term investor should beware from the market, because of the volatile nature of the
market.
• A lot more awareness needed about the stock market and investment pattern, both in spot
and future market. The working of BSE Training Institute and NSE Institutes are
apprehensible in this regard.
CONCLUSION
CHAPTER – 7
BIBLIOGRAPHY
BIBLIOGRAPHY
BOOKS
Websites
• www.nseindia.com
• www.bseindia.com
• www.capitaline.com
• www.geojit.com
• www.derivativeindia.com
• www.capitalmarket.com
• www.indiabulls.com