UNDERSTANDING DERIVATIVES MARKET IN INDIA

Submitted By
JIGNA A. SHAH

UNDER THE GUIDANCE OF

PROF. ARUN CHANDARANA

A PROJECT SUBMITTED IN PART COMPLETION OF

MMS TO THE

Chetana’s R. K. Institute of Management &

Research

Bandra (East), Mumbai – 400 051

July 2011
UNDERSTANDING DERIVATIVES MARKET IN INDIA

July 2011
 DECLARATION

This is to declare that the study presented by me to Chetana’s R.

K. Institute of Management and Research, in part completion of
the M.M.S under the title

“Understanding Derivatives Market in India” had been done

under the guidance of Prof. Arun Chandarana.

Signature of the Student

Jigna A. Shah
 ACKNOWLEDGEMENTS

There are many people who helped me in doing this project. I can never
express in words how much I am grateful to Zodiac Broking Pvt. Ltd for
their continuous support. Mr. Jaimesh Seth and Mrs. Sweta Madam helped
me in gathering right information for my derivatives. I would extend
sincere thanks to them for providing me with all the facilities, valuable
guidance and encouragement to complete the project well in time.

I essentially feel a sense of gratitude towards my project guide Mr. Arun

Chandarana and other faculties for providing me all the guidance needed
and solving queries. I am whole heartedly indebted to them.

Finally I would like to mention that many persons have directly or

indirectly contributed in successful completion of this project. This has
been wonderful experience for me and I would like to thank all of them for
the same.

JIGNA SHAH
 CERTIFICATE

This is to certify that the study presented by JIGNA A. SHAH to

the Chetana’s R. K. Institute of Management and Research, in part
completion of the MMS under the title

“Understanding Derivatives Market in India” has been done

under the guidance of Prof. ARUN CHANDARANA.

The project is in the nature of original work that has not so far
been submitted for any Diploma of Chetana’s R. K. Institute of
Management & Research or any other University/ Institute.
References of work and related sources of information have been
given at the end of each chapter.

Signature of the Guide Signature of the Director

Prof. Arun Chandarana Dr. Firdous Shroff

CERTIFICATE

fromcompany
 EXECUTIVE SUMMARY

Everyone talks about derivatives these days. Derivative products have been around for a long
time. Do you know derivatives first came about in Japanese rice markets? Yes, as early as the
1650s, dealings resembling present day derivative market transactions were seen in rice markets
in Osaka, Japan. The first leap towards an organized derivatives market came in 1848, when the
Chicago Board of Trade, the largest derivative exchange in the world, was established.

Today, equity and commodity derivative markets are rapidly gaining in size in India. Starting
from a controlled economy, India has moved towards a world where prices fluctuate every day.
This has increased risk for investors. Risk is a characteristic feature of most commodity and
capital markets. A derivative is widely used instrument in India for hedging purposes. In India,
the emergence and growth of derivatives market is relatively a recent phenomenon. Since its
inception in June 2000, derivatives market has exhibited exponential growth both in terms of
volume and number of traded contracts. The market turn-over has grown from Rs.2365 crore in
2000-2001 to Rs. 11010482.20 crore in 2008-2009. Within a short span of eight years,
derivatives trading in India has surpassed cash segment in terms of turnover and number of
traded contracts. In terms of popularity too, these markets are catching on like a forest fire. So,
what are these markets all about? What are the products that they trade in? Why do people feel
the need to trade in such products and how one can minimize risks with use of these instruments?
This are the questions thrown by everyone. Therefore, understanding the basic fundamentals of
Derivatives plays an important role.

This project covers the basic fundamentals of derivatives instruments like futures, forwards and
options. Understanding these basic concepts will help investing in any one of the above
instruments. This project covers some aspects on how derivatives started trading in India, how
futures and options works and some basic terminologies associated with these instruments

Also, as mentioned above that price fluctuates on a daily basis, some space has been given for
strategies to minimize risk. Although these strategies cannot completely reduce risk, but if used
widely can reduce risk to large extent.

Nothing is perfect in this world and so the derivatives trading in India are no exception. Some
suggestions have been given from my side on how to increase awareness and trading process.
 TABLE OF CONTENT
1. Introduction 1-2

1.1 Company Profile 1

1.2 Definition and purpose of project 1
1.3 Scope and objective of project 2
1.4 Outline of project report 2

2. Review of Literature 3

3. Research Methodology 4

3.1 Research Design 4

3.2 Company Fundamental analysis 5
3.3 Company Valuation analysis 5

4. Introduction to derivatives 5-11

4.1 The definition of a derivative 5

4.2 Factors driving the growth of derivatives 6
4.3 Functions performed by derivatives market 6
4.4 About futures, forwards, options and swaps 7
4.5 History of Derivatives Markets in India 8
4.6 Derivatives in India: Chronology 9
4.7 Participants in Derivatives Markets 9
4.8 Exchange Traded v/s Over the counter Derivatives 10

5. Introduction to Forward Contracts 12-13

5.1 Definition 12
5.2 Limitations of Forward Markets 12
5.3 Terminating a position prior to expiration 12

6. Introduction to Futures 14-21

6.1 Introduction 14
6.2 Futures Terminology 14
6.3 How futures work 15
6.4 Difference between Cash segment and Futures 16
6.5 Future Payoffs 18
6.6 Futures in India 19
7. Introduction to Options 22 - 45

7.1 What are Options 22

7.2 Options v/s Stocks 23
7.3 Understanding Calls and Puts 24
7.4 Participants in the options market 24
7.5 Terminologies involved 24
7.6 Understanding payoffs for call and put options 27
7.7 Pricing Options 29
7.8 Strategies 31
- Bullish Speculation 31
- Neutral 35
- Bearish Speculation 40

8. Suggestions 46

9. Limitations of project 47
 LIST OF FIGURES

Figure 6.1 Payoff for buyer of Nifty Future 18

Figure 6.2 Payoff for seller of Nifty Future 19
Figure 7.1 Payoff for buyer of Call Option 27

Figure 7.2 Payoff for writer of call option 28

Figure 7.3 Payoff for buyer of put option 28

Figure 7.4 Payoff for seller of put option 29

Figure 7.5 Profits/losses for a buyer of calls at various strikes (Bullish speculation) 32

Figure 7.6 Profits/losses for a writer of puts at various strikes (Bullish speculation) 33

Figure 7.7 Payoff for a bull spread created using call options 34

Figure 7.8 Profit and risks by using Long Strangle 38

Figure 7.9 Profit and risks by using Short Strangle 40

Figure 7.10 Payoff for seller of call option at various strikes (Bearish speculation) 42

Figure 7.10 Payoff for buyer of call option at various strikes (Bearish speculation) 42
 LIST OF TABLES

Table 7.1 One month calls and puts trading at different strikes 32

Table 7.2 Expiration day cash flows for a Bull spread using two-month calls 35

Table 7.3 Expiration day cash flows for a Bear spread using two-month calls 44