‘STUDY OF DERIVATIVES’

LUDHIANA STOCK EXCHANGE LIMITED

LUDHIANA

TRAINING REPORT SUBMITTED IN THE PARTIAL

FULFILMENT FOR THE DEGREE OF
“BACHELOR OF BUSINESS ADMINISTRATION”
YEAR 2008-2009

Angel broking

SUBMITTED TO SUBMITTED BY
PUNJABI UNIVERSITY SIMRANDEEP SINGH
PATIALA 6329

RIMT-INSTITUTE OF MANAGEMENT AND COMPUTER TECHNOLOGY,

MANDIGOBINDGARH

i
 ACKNOWLEDGEMENT

“Our personalities are based on the foundation of education imparted by our

teachers who are next to god.”
I acknowledge our deepest sense of gratitude and sincere feeling of
indebtedness to my major advisor, Mr. Shammi Kholi, under whose guidance I
was able to complete my project.
Without their immaculate and intellectual guidance, sustained efforts and
encouraging attitude, it would have been difficult to achieve the results in such a
short span of time.
I am grateful to Mr. H.S. Sidhu (Managing Director) of LSE for permitting me to
take the training at LSE Ltd. I also want to express our sincere gratitude to Mr.
J.S. Arneja (Senior Manager &Training In charge) and all the staff members of
LSE for spending time and valuable information they have shared with me and
helped me in my project to be a success. The acknowledgement would not be
completed without expressing my thanks to the faculty of my college for showing
me the right path and guided me to solve my problems.

I extent my gratitude to our Director Mr. B.S. Bhatia and all the related
teachers. The help and cooperation they offered at each stage of my study is
ineffable. Their valuable suggestions and constant encouragement made this
study interesting and useful.

Finally, I would like to acknowledge the support I got from my parents and God. It
was their blessing that kept me motivated throughout till the completion of the
project.

Simrandeep Singh

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 STUDENT DECLARATION

I here by Declare that study of ‘Study of Derivatives’ Has been exclusively

done by us for the degree of BACHELOR OF BUSINESS ADMINISTRATION
And not for any other degree, Diploma or fellowship. This is our own study done
under the guidance of manager of the company.

I hereby declare that the contents of this report are true and best to my
knowledge.

Place: LUDHIANA

(SIMRANDEEP SINGH)

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 PREFACE

One should always work with an objective in its mind. To accomplish that
objective efficient management of material, time and financial resources is very
important. Above this coordination is must that determines the degree of
success.
Awareness at each level of life is necessary for a human being keeping all this is
view in this report on “Study of Derivatives’’. The rounded encouraging support
by Mr. JS Arneja towards this report has created in me confidence regarding the
approval of the subject matter.
I feel that it was a great opportunity for me to spend time in LSE and getting
myself aware of the ups and downs of capital market.
So would like to say that this report is a result of an assignment, to improve
myself and gain confidence.

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 CONTENTS

CHAPTER 1 INTRODUCTION TO ORGANISATION

1 . STOCK EXCHANGE

2 . LUDHIANA STOCK EXCHANGE

3 . LSE SECURITIES LIMITED

CHAPTER 2 PROJECT OBJECTIVES

A LEARNING OBJECTIVES

1 INTRODUCTION TO DERIVATIVES

2 TYPES OF DERIVATIVES

3 ECONOMIC UTILITY OF DERIVATIVES

4 OBJECTIVES OF DERIVATIVES

5 INSTRUMENTS OF DERIVATIVE TRADING

6 RISK MANAGEMENT

7 MARGIN

B ANALYSIS OF DERIVATIVES

CHAPTER 3 RESEARCH METHODOLOGY

CHAPTER 4 DATA ANALYSIS AND INTERPRETATION

CHAPTER 5 SUGGESTIONS AND CONCLUSIONS

BIBLIOGARPHY AND ANNEXURES

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 LIST OF TABLES

Table No. Title Of Table Page No.

TABLE 1.1 LIST OF VARIOUS STOCK EXCHANGES IN INDIA 5

TABLE 1.2 BOARD OF DIRECTORS ( LSE) 8

TABLE 1.3 BOARD OF DIRECTORS (LSE SECURITIES) 15

TABLE 1.4 SETTLEMENT CYCLE SCHEDULE 19

TABLE 1.5 SCHEDULE OF ANNUAL LISTING FEE 23

TABLE 1.6 ACHIEVEMENTS OF LUDHIANA STOCK EXCHANGE 30

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 LIST OF DIAGRAMS

Fig. No. Title of the Diagram Page No

FIGURE 1.1 SOURCES OF FUND FOR THE YEAR 2005-06 28

OF LSESL
FIGURE 1.2 SOURCES OF FUND FOR THE YEAR 2004-05 29
OF LSESL
FIGURE 2.1 PAYOFF INDEX FUTURES (BUYER) 50

FIGURE 2.2 PAYOFF INDEX FUTURES (SELLER) 51

FIGURE 2.3 PAY OFF CALL OPTION (BUYER) 55

FIGURE 2.4 SELLER CALL OPTION 56

FIGURE 2.5 PUT OPTION BUYER 57

FIGURE 2.6 PAY OFF PUT OPTION (SELLER) 58

FIGURE 4.1 TRADING PERIOD IN DERIVATIVES 81

FIGURE 4.2 PURPOSE FOR DERIVATIVE TRADING 82

FIGURE 4. 3 SEGMENT HAVING LARGE TURNOVER 83

FIGURE 4. 4 AMOUNT INVESTED IN DERIVATIVES 84

FIGURE 4. 5 TRADED PERIOD FOR DERIVATIVE INVESTMENT 85

FIGURE 4. 6 IMPACT ON CUSTOMER BASE 86

FIGURE 4. 7 RELATIONSHIP WITH CASH MARKET 87

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FIGURE 4. 8 ACCEPTANCE BY INDIAN INVESTORS 88

FIGURE 4. 9 SHORT COMING IN INDIAN DERIVATIVE SYSTEM 89

FIGURE 4.10 WHICH TOOL OF DERIVATIVE IS BETTER 90

viii
1
 STOCK EXCHANGE

A “STOCK EXCHANGE” is a platform where buyers and sellers of securities

issued by government, financial institutions, corporate houses, etc meet and
where the trading of these corporate securities takes place. This is a market of
speculations. If the speculation of investor becomes wrong then the investor
loses. Nobody knows what will happen even after a second.
A stock exchange refers to that segment of the capital market where the
securities issued by corporate entities are trade. It is an open auction market
where buyers and sellers meet and evolve a competitive price for the securities.
It reflects hopes, aspirations and fears of people regarding the performance of
the economy. It provides necessary mobility to capital and directs the flow of
capital into profitable and successful enterprises.
Since buying and selling of different types of securities takes place in stock
exchange. The prices of particular securities reflect their demand and supply. In
fact, stock exchange is said to be a barometer of economic and financial health.
The stock exchanges are the nerve center of capital market. The stock exchange
discharges three essential functions in the process of capital formation not in
raising resources for the corporate sector.
It provides place for sale and purchase of securities i.e. shares, bonds etc.
It provides linkages between the savings of household sector and investment in
corporate sector or economy.
It provides market quotation for share, debentures and bonds and serves as a
role of barometer, not only of the state of health of individual companies, but also
of the economy as a whole.
Therefore, by providing market place quotations of the price of shares and bonds
or sort of collective judgment. Simultaneously reached by many buyers and
sellers in the market, the stock exchanges serve the role of barometer, not only
of the state of health of individual companies but also of the nation’s economy as
a whole.

2
 FEATURES OF STOCK EXCHANGE

o It is the place where listed securities are bought and sold.

o It is an association of persons known as members.

o Trading in securities is allowed under rules and regulations of stock

exchange.

o Membership is must for transacting business.

o Investors and speculators, who want to buy and sell securities, can do so
through members of stock exchanges i.e. brokers.

3
 FUNCTIONS OF STOCK EXCHANGE

The stock exchange provides appropriate conditions where purchase and sale of
securities takes place at reasonable and fair prices. The bargained prices of
buyers and sellers are recorded, on the basis of which each investor is able to
evaluate the securities held by him and thus knows the worth of his holdings at a
particular time.The stock exchange provides a ready market for the conversion of
existing securities into cash and vice versa.
People having surplus funds invest in securities and these funds are securities
and these funds are used for industrialized and economic development of the
country that leads to capital formation.
Stock exchange protects the investor of investors through strict enforcement of
rules and regulations with respect of dealings. Punishment (including fine,
suspension) may be there if brokers adopt any malpractice in dealing with
investor like charging excessively high commission etc.
The stock exchange acts as the center of providing business information relating
to the enterprise whose securities are traded as the listed companies are to
present their financial and other statements to it.

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 HISTORY OF STOCK EXCHANGE

The trading in securities in India was started in the early of 1973. The stock
exchange operating in the 19th century was those of Bombay set up in 1875 and
Ahmedabad set up in 1894. These were organized as voluntary non-profit
making associations of brokers to regulate and protect their interests. Before the
control on securities trading becomes a control on securities trading became a
central subject under the constitution in 1950. It was a state subject and the
Bombay securities contact (control) act, 1925 used to regulate trading in
securities. Under this act, Bombay stock exchange was securities in 1927 and
Ahmedabad stock exchange in 1927 and Ahmedabad stock exchange in 1937.
During the war boom, a number of stock exchanges were organized at Bombay,
Ahmedabad and other centers but they were not recognized soon after it became
a central subject, central legislation was proposed and a committee headed by
sh. A.D. GORWALA went into bill for securities regulation. On the basis
securities regulation. On the basis securities contracts (control) at became law in
1956. At present there are 23 recognized stock exchanges in India. Number of
Investors is increasing day by day.
The stock exchange is a double auction market. Quite distinct from the common
market in which only one seller and many buyers in a stock exchange a number
of potential buyers and potential sellers co-exist all competing both among
themselves and with one another in making bids, counter-bids, offers and
counter-offers.

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WHO BENEFITS FROM STOCK EXCHANGE?

o INVESTORS: It provides them liquidity, marketability, safety etc. of

Investment.

o COMPANIES: It provides them access to market funds, higher rating and

public interests.

o BROKERS: They receive commission in lien of their services to investors.

o ECONOMY AND COUTRY: There is large of saving, better growth moves

industries, higher income.

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 LIST OF VARIOUS STOCK EXCHANGES IN INDIA

TABLE 1.1

S. Name of stock exchange Years of Type of organization

No. establishment
1 Bombay Stock exchange 1875 Voluntary Non-profit
organization
2 Ahmedabad Stock 1897 Voluntary Non-profit
exchange organization
3 Calcutta Stock exchange 1908 Public limited company
4 M.P. Stock exchange, 1930 Voluntary Non-profit
Indore organization
5 Madras Stock exchange 1937 Co. limited by guarantee
6 Hyderabad Stock exchange 1943 Co. limited by guarantee
7 Delhi Stock exchange 1947 Public limited company
8 Bangalore Stock exchange 1957 Pvt. converted into public
ltd. co.
9 Cochin stock exchange 1978 Public limited company
10 U.P. Stock exchange, 1982 Public limited company
Kanpur
11 Pune Stock exchange 1982 Co. limited by guarantee
12 Ludhiana Stock exchange 1983 Public limited company
13 Jaipur Stock exchange 1983 Public limited company
14 Guahati Stock exchange 1984 Public limited company
15 Kannaar Stock exchange 1985 Public limited company
16 Magadh Stock exchange 1986 Co. limited by guarantee

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17 Bhuvneshwar Stock 1989 Co. limited by guarantee
exchange
18 Saurashtra stock exchange, 1989 Co. limited by guarantee
Kutch.

19 Vadora Stock exchange 1990 N.D.

20 Meerut Stock exchange 1991 N.D.
21 O.T.C.I. 1993 Pure demutulised

(Over the counter exchange

of India), Mumbai
22 National Stock exchange 1995 Pure demutualised
23 Coimbtoor tock exchange 1996 N.D.
24 Sikkam Stock exchang 1997 N.D.

PROFILE OF LUDHIANA STOCK EXCHANGE ASSOCIATION LTD.

ESTABLISHMENT

Ludhiana stock exchange was established in 1983 with 220 members by Sh.
S.P. Oswal and Sh. B.M. Munjal leading industrialist to fulfill vital need of having
a stock exchange in this region. Since its inception LSEAL has grown
phenomenally switched from manual trading to screen based training on
November 18th 1996 and number of listed companies increased from 160 in 90’s
to 437 as on 31st march of which 286 are regional and 131 are non regional.
LSEAL has played on important role in generating capital for the companies in
states of Punjab, Haryana, Himachal Pradesh and J.K.

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GOVERNING COUNCIL, COMMITTEES AND ADMINISTRATION

The Council of Management of the Exchange consists of eleven members, out of

which two are Government Nominees; six are Public Representatives and one
Managing Director who is also Ex-officio member of the Board. At every Annual
General Meeting, one third of the elected the Executive Directors retire by
rotation. Administration of the Exchange is managed by the Managing Director
who is assisted by a Company Secretary and a team of Executives, Assistants,
Technicians and sub-staff. The Exchange has four Statutory Committees namely
Disciplinary Committee, Arbitration Committee, Defaults Committee and Investor
Services Committee. In addition, it has advisory and standing committees to
assist the administration.

BOARD OF DIRECTORS

Sh. Harjit Singh Sidhu Managing Director

Prof. Rajinder Bhandari Public Representative
Sh. D.K. Malhotra Public Representative
Sh. G.S. Bains Public Representative
Sh. B.B. Tandon Public Representative
Sh. Sunil Malhotra Public Representative
Sh. Yash Mahajan Public Representative
Sh. S.C. Aggarwal SEBI Nominee
Sh. Sanjeev kumar Gupta Director

Sh. Manmohan Juneja SEBI Nominee

Sh. D.P. Gandhi Director

TABLE 1.2

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CORPORATE GOVERNANCE
Although the Ludhiana Stock Exchange is not a listed Company, yet it has
followed a model of corporate governance, which is evident from the composition
of the Statutory Committees, the Investor Services Committee and Audit
Committee. The Investor Services Committee comprises of four public
Representatives and one broker member. It is headed by Sh. D.K. Malhotra, a
legal expert. Statutory Committees are represented by brokers and non-brokers
in 20:80 ratios.

OPERATIONS OF LUDHIANA STOCK EXCHANGE

TURNOVER
Ludhiana Stock Exchange is one of the leading Stock Exchanges among the
Regional Stock Exchanges of the country, and has been providing trading
platform for the investors situated in Punjab, J&K, and Himachal Pradesh &
Chandigarh. At present, it has 344 listed companies and among them, 220 are
listed as regional companies. It had been generating significant amount of the
business in the secondary market. It recorded a peak turnover of Rs.9154 crores
during the year 2000-2001. The structural changes that took place in the recent
past in the Capital Market of the country had a negative impact on the trading
volume of the regional Stock Exchanges. There has been a significant reduction
of turnover during the financial year 2001-2002, but the reduction in turnover of
the Exchange has been more than adequately compensated by substantial rise
in the turnover of LSE Securities Limited, a subsidiary of Ludhiana Stock
Exchange.

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LISTING

Listing is one of the major functions of a Stock Exchange wherein the securities
of the Companies are enlisted for trading purpose. Any Company incorporated
under Companies Act, 1956, coming out with an IPO, has to mandatory list its
shares on a Stock Exchange.
The Listing Department of Ludhiana Stock Exchange deals with listing of
securities, further listing of issues like bonus and rights issues, post-listing
compliance of the companies, which are already listed with Ludhiana Stock
Exchange. The Companies desirous of listing its securities on the Exchange
have to sign a Listing Agreement with the Stock Exchange. After getting the
listing approval, the Company has to ensure and report compliance of the post
listing requirements. The listing section of the LSE monitors the post-listing
compliance of all the listed companies and follows up with the companies, which
are found deficient in compliance.

TRADING ON BIGGER STOCK EXCHANGES

The exchange acquired the membership of NSE and BSE: through its
subsidiary, the LSE securities LTD, with the objective of providing an enabling
mechanism to its member brokers to trade on NSE and BSE as a sub brokers of
LSE securities Limited.
Trading at NSE and BSE was commenced through the subsidiary route from
September 200 and December 2000 respectively.

END OF AN ERA

The management of the stock Exchange apprehended that the smaller regional
stock exchanges would not be able to meet the challenges imposed by
expansion of bigger stock exchanges like NSE and BSE and might end up losing
their business to VSAT counters of the bigger stock exchanges. In order to

11
prepare for such an eventuality, stock exchanges set up a broking armed in the
name of LSE Securities Ltd (a subsidiary company of stock exchange) in January
2000 and built infrastructure and IT based sophisticated systems to enable its
members and investors to trade on NSE and BSE through the subsidiary route.

LSEAL HAS:-

OWN BUILDING
LSEAL has its own six stories ultra modern building at Feroze Gandhi market at
Ludhiana. It started its operation on 16th Aug, 1983.

OWN BULLETIN

LESAL is continuously publishing LSEAL Bulletin at the interval of quarter. It is

also publishing LSE annual report which provides information to the various
members and investors of stock exchanges.

SCREEN BASED TRADING

It was started at LSE on Nov. 18, 1996. The requisite software is developed by
CMC Ltd. This screen Based Trading is based on VECTOR (Versatile Engine for
Centralized Trading and on line reporting System) this system displays funds
with respect of opening prices of the stock exchanges as well as the last traded
prices.

ON LINE TRADING THROUGH VSAT

LSEAL has chalked out an ambitious program to expand online trading through
V-SAT to untie other than Ludhiana and plans to take the trading facility to
doorstep of investors in this year. The Board of Directors of LSE have approved
the plan for expansion of online trading through VSAT with the object of broad
base business opportunities to the investor and members, the exchange has set
up 30 trading terminals at remote sites and union territory of Chandigarh. Trading
through V-SAT has been smoothly conducted in October 1999.

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SETTLEMENT GUARANTEE FUND

It provides guarantee to all genuine based trading system of the stock exchange
and was implemented a settlement guarantee fund with effect from 6 th April,
1998.

SETTLEMENT AND CLEARING

There is T+2 settlement cycle prevailing in the market. Members are given scrip
wise delivery notes. The members are required to deposit scrip’s sold by them to
the clearing house on the second working day following the day of transaction.
Purchasing members are required to make the payment against the delivery also
on aforesaid day.

DEPOSITORY SYSTEM

LSE commence trading in demat shares from November 16, 1998 by becoming a
participant of NSDL. The exchange has set up in-house DP services to facilitate
trading and settlement in demat securities.

INVESTOR GRIEVANCES CELL

LSE has made special arrangement to handle investors complaints and

grievance so its premises for providing information relating to Capital market.
This center has a well equipped library.
The exchange introduced a computer based stock. Tel system for providing on
line real time information through a fully automatic system, to the investors and
members of the general public such as prices of the scrip’s, book closures, new
listings, new issuers etc. Centre is also equipped with a screen for providing ‘live’
rates of trading at NSE and BSE

DEPOSITORY PARTICIPANT SERVICE

The company is the DP of NSE and is the only depository in the region having on
line real time connectivity with NSDL. DP operation of the company not only

13
benefited the investors of the region but has also proved to be a source of
income for the company.

14
 PROFILE OF LSE SECURITIES LTD.

OBJECTIVE OF THE COMPANY

LSE Securities Limited is a subsidiary of the Ludhiana Stock Exchange, which

was formed with an objective to enhance business and investment opportunities
for the investors and members of Ludhiana Stock Exchange at large, through
innovative products by encompassing a variety of activities related to the capital
market. The company has a paid –up capital of Rs.5.65 crores, preference
capital of Rs 7.90 lacs & the authorized capital of the company is Rs 8 crores.
INTRODUCTION OF LSE SECURITIES LTD.
LSE Securities Ltd., was incorporated in January, 2000 with a view to revive the
capital market in the region and for taking full advantage of the emerging
opportunities being provided by expansion of bigger stock exchanges like NSE
and BSE. The company since its inception has marched forward rapidly and
achieved many milestones in a short span of its existence.

GOVERNMENT COUNCIL

The Council of the management of the Company comprises of 12 directors of

which 5 are broker members and 5 non-brokers. The non broker members are
independent Directors of eminent status from the field of finance, law and
management and remaining two are Executive Officer of the holding company
(Ludhiana Stock Exchange) and Chief Executive officer of the company, who are
on the board of the company as ex-officio Directors. Thus the council of
management has representation of sub-brokers as well as professionals and
subject specialists representing various fields of business activities. Operations
of the company are run in a professional, transparent and fair manner keeping in
view of the interest of investors as well as other stakeholders.

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CORPORATE MEMEBERSHIP OF NSE & BSE

SEBI, at the initiative of LSEAL, permitted smaller Stock Exchanges, to trade on

bigger Stock Exchanges through their subsidiary companies. The Ludhiana
Stock Exchange floated its subsidiary company, the LSE Securities Limited, with
the objective of obtaining trading rights on bigger Stock Exchanges. It has
obtained corporate membership of both NSE and BSE in the year 2000.

TRADING AT NSE AND BSE

The LSE Securities Ltd.Commenced trading operations in Capital Market

Segments of BSE and NSE in September, 2000 and December, 2000
respectively. The total turnover of the company at NSE is growing by leaps and
bounds ever since in incorporation. There was encouraging response from the
sub-brokers specially at NSE counters. During the financial year 2005-06
turnover had been Rs 8613 crores as against Rs 7987 crores during the financial
year 2004-05 in Capital Market segment of NSE. The total turnover during the
financial year 2005-06 had been Rs 4920 crores as against Rs 3833 crores
during the financial year 2004-05 in Capital Market segment of BSE.

F&0 SEGMENT OF NSE

LSE Securities Ltd. Commenced trading operations in Future and Options

Segment of NSE in February 2002. The Company became the first subsidiary of
any Regional Stock Exchange which commenced trading in “F&O” Segment of
NSE. Response to trading facilities in the “F&O” segment of NSE has been very
encouraging and volumes generated in this segment soon exceeded those in
“Capital Market” segment.

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TRADING THROUGH V-SATs

The LSE Securities Limited has also provided facility to its sub-brokers for trading
on NSE and BSE through VSAT counters, which are located outside Stock
Exchange Building. Presently, 17 sub-brokers of the company have been trading
through VSAT on NSE and 10 on BSE.

CERTIFICATION IN FINANCIAL MARKET

In order to provide professional services to the investors of LSE Securities

Limited through its sub-brokers, the company motivated its sub-brokers and its
staff to qualify the certification in financial markets conducted by NSE. All trading
terminals for Capital Market Segment and F&O segment are being operated by
the persons after having qualified the said certification.

BOARD OF DIRECTORS

Sh. A.K ARORA Chairman

Sh. Vijay Singhania Vice Chairman
Sh. Harjit Singh Sidhu Director
Sh. Lalit Kishore Director
Sh Sukhjiwan Rai Director
Sh. Anurag Arora Director
Sh. Ashwani Kumar Public Representative
Sh. M.A. Zahir Public Representative
Sh. P.C. Garg Public Representative
Sh. Ajay Chaudhry Public Representative

Sh. Vinay Shrivastav Public Representative

TABLE 1.3

DEPARTMENTS OF LSE

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The main aim of LUDHIANA STOCK EXCHANGE is to ensure the safety and
security to the investments of the investors and to provide the proper services
under the prescribed guidelines of SE 131. So to maintain the proper system of
working of exchange, there are so many different departments in which particular
functions are performed, assigned to those departments. Following in the list of
various departments of LSE:-
OPERATIONAL DEPARTMENTS
1. Margin Section
2. Clearing House
3. Market Surveillance
4. Computer Section and information System Department
SERVICE DEPARTMENTS
1. Legal Department
2. Secretarial Department.
3. I.G.C. (Investor Grievance Cell)
4. Listing Section
5. Accounting Section
6. Membership Department/Personnel Department

All the section perform specific functions. There is no duplication of work;

even then all the sections are interconnected with each other. There is an
organized network of recording of activities performed there. But before studying
the inter dependence of section) here is the details of all department i.e. actually
what function is performed by each and every section.

MARGIN SECTION

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Margin Section is an important section. This section apart from dealing in the
regulating the trading of brokers keeps a check on excessive trading in
speculation. Margin is the amount, which is collected from brokers for the safety
of transactions. As the transactions are to be finalized on basis, in the mean time
the rates may fluctuate which may lead to default. So to make the transaction
safe, daily margins are collected from brokers. When a member gets registered
in the exchange and with Securities Exchange Board of India (SEBI), then before
starting trading he is supposed to deposit some amount fixed by SEBI as
security. Now as SEBI’s rolling settlement prevails. Ultimately margin is the
difference between the limit and trade done by the member. The security
deposited by a member is called Base Minimum Capital. If any member wants to
trade beyond his trading limit, he can do so by depositing Additional Base
Minimum Capital.

TYPES OF MARGINS

As we have discussed earlier margins, collected from members to

avoid the losses and to provide security to the investors. There are different
types of margins, which are imposed given as follows:-

MARK TO MARKET MARGIN

The exchange collects this margin on daily basis, broker-wise
100% notional loss of each member for every scrip, calculated as the difference
of his buying or selling price and closing of that scrip at the end of the day. This is
also called loss margin. The margin is payable in cash or in bank guarantee.

VALUE AT RISK OR VAR MARGIN

19
 For the scrips in the compulsory rolling settlement at 99% VAR
based margin system would be introduced w.e.f. July, 02, 2001. the computation
of this margin is done by a software developed by CHICAGO Stock Exchange.

ADDITIONAL MARGIN
Thus margin is 12% would be levied over and above the VAR
margin. This margin is collected from brokers on T+1 basis.

SPECIAL MARGIN
The brokers will be required to deposit margin as per the
percentage prescribed by stock exchange in this regard from time to time.

PAYMENT OF MARGIN
The broker's shall be required to deposit margin demanded from
them by 11:00AM on T+I day. That is on next trading day. The margin
brokers shall be collected by way of cheques drawn on the prescribed banks,
demand draft or by way of direct debit to the bank account to broker.

CLEARING HOUSE

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Clearing house takes care of pay-in and pay-out securities. At this time there is
weekly trading system (Monday to Friday) prevails. And securities are settled by
rolling settlement. Means pay-in and pay-out of securities is settled on T+3 Basis
would commence form 1stApril, 2002. SEBI decide the following activity schedule
for exchanges for the T+3 rolling settlement.

SETTLEMENT CYCLE SCHEDULE

Sr. Day Description of Activity Trade

No.
1 T Trade Date
2 T+2 Securities and funds pay-in and pay-out
3 T+3 Auction of shortage in delivery

TABLE 1.4
T - TRADING PERIOD.

PAY IN/PAYOUT OF SECURITIES

On trading day brokers buy and sold the securities or scrips and pay-In and pay
out of securities will be completed on T+2 basis e.g. if broker buy/sell shares on
Monday then pay in of securities will be on Wednesday, 10:30A.M. And pay out
of scrips will also on Wednesday up to 2:00 P.M., in this way pay-in/pay-out of
securities cycle will be completed.

AUCTION OF UNDELIVERED SCRIPS

21
In case if broker fails to deliver the scrips on T+2 delivery day. Then it is
responsibility of clearing house to settle the undelivered scrips. Then, auction will
start. In above example, auction of pending securities will be conducted on
Thursday. In auction price of securities may will fluctuate 20% high or low of that
trading day. In this way trade in auction is settled.

CLOSE OUT

In case the shares of particular scrips is not available on the date of

auction. Then it is obligation of solicitor (exchange) to give monetary benefit to
initiator (buyer) against the default of defaulter of securities in this manner
settlement schedule has completed.

COMPUTER SECTION

The growing technicalities and increase in workload has enhanced

the importance of computer section in Ludhiana stock exchange. This
department mainly referred to as EDP i.e. electronic data processing section.
This section is the backbone of entire stock exchange would come to halt if this
department becomes inactive.
It prepares several reports namely: -
o Scrip wise statement of each member for each settlement period
o Sub broker wise delivery bill receive order (after payout)
o Downloading of delivery order.
o Downloading of receiving order.
o And broker on sub broker wise final settlement.
o HDFC bank entries.
o Scrip wise statement
Computer facilitates easily updating all automatically adopting of
new rates, once we feed new limits the whole calculation to be done through

22
computer will change. Rates are updated either daily or month wise as per the
requirements.

MANUAL OPERATIONS

It has reduced manual work. It has also eliminated approximately

the need to keep check the physical reports, which is a time consuming as well
as space consuming and requires a lot of attention.

VOLUME AND TRANSPARENCY

This system is very much transparent, as each individual involved

knows every relevant tilling . Also volume of shares being traced is very high and
increasing continuously.

LINKING CHAIN
This section acts as a linkage, which links each and every
department of the LSE with another and hence helps in working as a whole.
CHECK AND CONTROL OVER SCRIPS AND MEMBERS

This section also helps in maintaining check and control over

defaulting members and scrips. In case the member crosses his limit of trading
according to his deposited amount, the computer section switches off his terminal
and same step is taken in case of defaulted scrips.

MARKET SURVEILLANCE AND MONITORING SECTION

23
 The main task of this section is to see the market sanctity and
maintenance so that the investors are not cheated. So market surveillance
entails scientifically identifying points in a stock price movement or trading
volumes, which don't match with the company's fundamentals. So the price and
volume trends in stock exchange are checked for abnormalities scientifically.

INVESTORS GRIEVANCE SECTION

LSE has a separate investor's grievance cell, which receives
complaints from investors and follows up the complaints with companies and
member broker to ensure their satisfactory redressal. For providing better
services to the investors the stock exchange has maintained investor protection
fund. In this fund Rs. 500 is collected from each member annually. Apart from
this one percent of the total listing fee collected and ten percent interest covered
on company deposits is also transferred to the investor protection fund.
One more fund investor service fund has been set up. 20% of the
listing fee is transferred to it. The funds of it are used for maintenance of investor
service center, holding of seminars for investor/brokers benefit, and publication of
LSE Bulletin.
Rationale Behind Establishing Investors’ Grievance Cell

o To safeguard the investor’s interest through investors grievance section.

o To participate as monitoring authority in the public and right issue of the
company.
o To ensure that the company listed at the LSE compiles with all the listing
requirements.
o To keep a record of the inquiry base of the listed companies, their annual
financial results and any subsequent increase in the equity base.
o

LISTING SECTION

24
 This department plays an important role in the Stock Exchange. as
it helps the company to raise money from the capital market. Presently it is
mandatory for Regional Company to get itself listed at LSE. In order to get listed
company should have minimum capital of Rs. 3 crores and at least 25% of its
equity should be offered to the public for the listing company is also required to
make a deposit 1 % issue price with the stock Exchange and it can not be
released before the expiry of six months provided there is a compliance of pre-
listings and post-listing requirements of the company. Company has also to
comply with the conditions enunciated in listing clause.
The schedule of annual Listing fee and up front listing fee payable triennially is
given below:
Paid up capital Annual Listing Fee (Rs.)
Upto 1 crores 8400
1 to 5 crores 16800
5 to 10 crores 28000
10 to 20 crores 56000
20 to 30 crores 84000
Above 50 crores 140000

TABLE 1.5

Companies which have paid up capital of more than Rs. 50 crores will pay
additional fee of Rs. 2800 for every increase of Rs. 5 crores or part there of. The
annual listing fees referred to above are applicable only if the exchange is a
Regional Stock Exchange otherwise the fees will be 50% of the fees indicated
above.

ACCOUNTS SECTION

Most of the work in account section LSE is done manually, although help is taken
through computers for the purpose of making Trial Balance, Income and

25
 Expenditure statement and Balance Sheet. The annual report of LSE is generally
published in August every year. Some of the important polices of LSE are
o The company follows accrual system of accounting recognizes income
and expenditure accordingly.
o Depreciation is provided on written down, value method in accordance
with and din the manner specified in schedule XIV of the Companies Act
1956.
o Fixed costs are stated at historical costs less depreciation.
o Stock/Inventory (stationery) is valued at cost.
o Interest on funds borrowed which is attributable to construction of fixed
assets and other indirect expenditure during construction is included under
work in progress.
The company has the procedure of receiving shares, scrips of various
companies as securities against the performance of the contract. No accounting
entries in such transaction are made in respect of defaulting members by
crediting security account and debiting member's investment a/c. The shares in
such cases are valued at prices on the date of transfer deeds.

Functions of Accounts Section:-

The account section performs the following function.

o To make and receive payments to the outside agencies, these agencies
include companies listed at LSE and brokers working at LSE.
o To disburse personnel expenses.
o To keep the records of all incoming and outgoing money depreciation of
financial statements at the end of financial year.
o To get their accounts audited from the third party.
o
Sources of funds of LSE:
-

26
 o Membership fee from brokers at the beginning.
o Initial listing fee from companies i.e. Rs. 1,000/-
o Annual listing fee from companies.
o Annual fee from brokers (Rs. 5000) and their authorized representatives.
(Rs. 500 each) as broker member is allowed to have maximum 4 authorized
representatives.
o Interest income from deposits of companies for listing, which are made at
1% of issue amount and minimum capital for this purpose is Rs. 4/- crores. Such
deposits are retained until there is no dispute against the company subject to the
minimum of 6 months,
o Annual computer fee from brokers (Rs. 5000)
o Library charges from brokers (Rs. 200) p.a.)
o Brokers contribution to investor protection fund (Rs. 500 p.a)
o Fines and penalties form brokers.
o Maintenance charges Rs. 13.50 per sq. feet, per quarter from those
members having rooms and those not having rooms all those not having rooms
are charges at till rate of Rs. 1500/- pa.
o Water and electricity charges Rs. 750 per quarter, whose area is less than
200 sq. feet and 900/- per quarter which is having area of more than 200 sq. feet.
The members who are not having rooms are charged at the rate of Rs. 300/-
(p.a.)
o Interest earned affixed deposits.
Billing of members is done on annual basis for annual fees and other
above- mentioned charges. On 1st April of each year and they are to make
payment in 180 days up to 30 September. Beyond it, they are charged interest
on due amount @ 12% p.a. still in case of nonpayment, broker member is served
a show cause notice for 60 days on 1st April next year. If member fails to, comply
with notice then he can be expelled.

Application Of Funds Of LSE:-

27
 1. 5% of listing fees to SEBI each year.
2. 20% for providing services to investors out, or listing fee annually to
investor service fund.
3. Administrative expenses (I) Electricity Charges. (II) Security Charges
(III) Telephone Charges (IV) VSAT Charges (V) Printing and stationary
Salaries
4. 1% of listing is transferred annually to investor protection fund.

SECRETARIAL DEPARTMENT

Duties and responsibilities of personnel department are mentioned as under

which are discharge by the secretarial departments.
o Recruitment of staff.
o Maintain employee record e.g. attendance leave, overtime etc.
o Maintain employee service book up to date and other detail as per the
requirements to auditors at the time of inspection (From date of joining
registration)
o Employee welfare scheme like loans.
o Other activities like staff farewell party and Diwalipuja.
Although the LSE, has not a separate personnel
departments in its organizing chart. All activities relating personnel are carried
out by the secretarial departments, which has the additional charge of personnel.

LEGAL SECTION

28
 When two broker or outside clients do not settle their claims in between
themselves and move to court, the legal section comes into the picture to fight for
the cause of investors and against the defaulting members. Legal section also
assist the member investor to settle their disputes through the arbitration
committee investors grievance committee.
Disciplinary committee, defaulting committee, so that there
maybe settled at the earlier without incurring heavy due on amount regarding
court fee, advocate fee etc. The objective of the legal section is to make effective
the bylaws and regulation of the stock exchange and to see that the guidelines,
circular and any amendments in rules made by the SEBI are enforced at
appropriate time so that the future complications may be reduced or avoided. As
the name legal section suggests it is clearly mentioned and understood that each
of every matter involving legality is to be solved by the legal department.

PERSONNEL DEPARTMENT

Ludhiana stock exchange does not have a personnel department in its

Organization chart. This department carries out all activities relating to the
recruitment of the personnel, whenever and wherever a vacancy arises,
maintenance of attendance register. This department also deals with the
appointment or removal of floor clerks or authorized representatives of brokers.
These departments also maintain records of leaves and overtime of employees.

MEMBERSHIP DEPARTMENT

29
This department deals with membership of exchange. The trade in market is
done through the authorized members who are registered with concerned stock
exchange and SEBI.
There are two types of members in stock exchanges.
o Corporate members
o Individual member
Following are the requirements to be an individual member of exchange.
Age Limit: To be member of stock exchange there is age limit Minimum
age is 21 yrs Maximum age is 60 yrs.
Qualification: To be member minimum qualification Matriculation is plus
person has three-year experience interview. Including written
test and membership department deal with all above
requirements of members.

Following requirements are for corporate members:-

1. Company must be registered u/s 322 of the company Act i.e. Directors
with unlimited liability.
2. Two copies of MOA & AOA.
3. Qualification & Proof of age of at least two directors, who will deal in
securities.

SOURCES OF FUND FOR THE YEAR 2005-06

OF LSESL

30
 1
2
3
4
5

FIGURE 1.1

SOURCES:-
(1) Membership Fee = 0.82%
(2) Listing Fee = 13.27
(3) Interest on deposits = 29.03%
(4) Profit on sale of fixed assets = 3.23%
(5) Other income = 53.65

SOURCES OF FUND FOR THE YEAR 2004-05

OF LSESL

31
 1
2
3
4
5

FIGURE 1.2

SOURCES:-
1) Turnover Charge BSE = 5.10%
2) Turnover Charge NSE = 47.18%
3) Interest on Bank deposits = 31.90%
4) Depository Income = 8.99%
5) Other income = 6.83%
________
100

ACHIEVEMENTS OF LUDHIANA STOCK EXCHANGE

32
 TABLE 1.6
Oct 1981 Incorporation of Stock Exchange
Aug 1983 Commencement of operations
Aug 1983 Shifting of operation to own building
Nov 1996 Online Screen Trading
April 1998 Modified carry forward system
(MCTS) and settlement gurantee
fund.
Nov 1998 Trading and settlement in demat
scrips
Sep 1999 Trading at remote sites through VSAT
counters
Jan 2000 Introduction of rolling settlement
Aug 2000 Commencement of online real time
depository services
Dec 2000 Trading on N.S.E. in C.M. segment
(Through NSEL)
Sep 2000 Trading on B.S.E. in CM segment
(Through LSEL)
July 2001 Introduction of Compulsory rolling
settlement
January 2002 Complete shift of trading CM segment
from ISE To LSE securities Ltd.
Feb 2002 Trading in F&O segment of N.S.E.
April 2002 Rolling settlement cycle prevailing at
LSE on T+3 basis
April 2003 Rolling settlement cycle prevailing at
LSE on T+2 cycle
Oct 2003 Incorporation of LSE commodities
trading services Ltd., a subsidiary of
LSE. Securities Ltd.
March 2004 Introduction of MCX (Multi Commodity
Exchange of India) MCX offers 14
different commodities such as steel,
kapas, rubber, blackpepper, oil soil
seeds, precious metal etc.

33
34
 OBJECTIVES

A LEARNING OBJECTIVES
It includes

1 INTRODUCTION TO DERIVATIVES

2 TYPES OF DERIVATIVES

3 ECONOMIC UTILITY OF DERIVATIVES

4 OBJECTIVES OF DERIVATIVES

35
 5 INSTRUMENTS OF DERIVATIVE TRADING

6 RISK MANAGEMENT

7 MARGIN

B ANALYSIS OF DERIVATIVES MARKET

INTRODUCTION TO DERIVATIVES

Primary market is used for raising money and secondary market is used
for trading in the securities, which have been used in primary market. But
derivative market is quite different from other markets as the market is used for
minimizing risk arising from underlying assets.

The work “derivative” originates from mathematics. It refers to a variable,

which has been derived from another variable.
i.e. X = f(Y)
Where X (dependent variable) = DERIVATIVE PRODUCT

36
 Y (independent variable) = UNDERLYING ASSET

A financial derivative is a product that derives value from the market of

another product. Hence derivative market has no independent existence without
an underlying asset. The price of the derivative instrument is contingent on the
value of underlying assets.

As a tool of risk management we can define it as, a financial contract

whose value is derived from the value of an underlying asset/derivative
security”. All derivatives are based on some cash product. The underlying
assets can be :

a. Any type of agriculture product of grain (not prevailing in India)

b. Price of precious and metals gold
c. Foreign exchange rates
d. Short term as well as long-tern bond of securities of different type issue4d
by govt. and companies etc.
e. O.T.C. money instruments for examples loan & deposits.

Example : Wheat farmers may wish to sell their harvest at a future date to
eliminate the risk of change in price by that date. The price of these derivatives is
driven from spot price of wheat.

DEFINITION OF DERIVATIVE

In the Indian context the securities contracts (Regulations), Act 1956

defines “Derivative” to include:

37
 1. A security derived from a debt instrument, Share, Loan whether secured
or unsecured, Risk instrument or contract for difference or any other form
of security.

A contract which derives its value from the prices of prices of underlying
securities.

HISTORICAL ASPECT OF DERIVATIVES

The need for derivatives as hedging tool was first felt in the commodities
market. Agricultural F&O helped farmers and PROCESSORS hedge against
commodity price risk. After the fallout of BRITAIN WOOD AGREEMENT, the
financial markets in the world stared undergoing radical changes, which give rise
to the risk factor. This situation led to development of derivatives as effective
“Risk Management tools”.

38
 Derivatives trading in financial market started in 1972 when “Chicago
Mercantile Exchange opened its international Monetary Market Division (IIM).
The IMM provided an outlet for currency speculators and for those looking to
reduce their currency risks. Trading took place on currency. Futures, which were
contracts for specified quantities of given currencies, the exchange rate was fixed
at time of contract later on commodity future contracts was introduced then
followed by interest rate futures.

Looking at the liquidity market, derivatives allow corporate and institutional

investors to effectively manage their portfolio of assets and liabilities through
instruments like stock index futures and options. An equity fund e.g. can reduce
its exposure to the stock market and at a relatively low cost without selling of part
of its equity assets by using stock index futures or index options. Therefore the
stock index futures first emerged in U.S.A. in 1982.

PRODUCTS, PARTICIPANTS, AND FUNCTIONS

Derivatives contracts have several variants. The most common are

FORWARDS, FUTURES, OPTIONS AND SWAPS.

The following three categories of Participants-Hedgers, Speculators, and

Arbitrageurs.

39
 1. Hedger :- Hedgers face risk associated with the price of an asset. They
use futures or options markets to reduce the risk. Thus, they are operation
who want to eliminate the risk composing of their portfolio.

2. Speculators : They wish to be on future movements in the price of an

asset. A speculator may buy securities in anticipation of rise in price. If this
expectation comes true he sells the securities at a higher price and makes
a profit. Usually the speculator does not take delivery of securities sold by
him. He only receives and pays the differences between the purchase and
sale prices.

3. Arbitrageurs : They are in business to take advantage of discrepancy

between price in two different markets. If for example, they see the future
price of an asset getting out of line with cash price, they will take off
setting positions in two markets to lock in profit.

TYPES OF DERIVATIVES

The most commonly used derivatives contract is forwards, futures and

options:

1. Forwards : A forward contract is a customized contract between two

entities, where settlement takes place on a specific date in the futures at
today’s pre-agreed price.

40
2. Futures : A future contract is an agreement between two parties to buy or
sell an asset at a certain time the future at the certain price. Futures
contracts are the special types of forward contracts in the sense that are
standardized exchange traded contracts.
3. Options : It is of two types : call and put options.
Underlying asset, at a give price on or before a given future date. PUTS
give the buyer the right but not the obligation to sell a give quantity of the
underlying asset at a given price on or before a given date.
4. Leaps : Normally option contracts are for a period of 1 to 12 months.
However, exchange may introduce option contracts with a maturity period
of 2-3 years. These long-term option contract are popularly known as
Leaps pr Long term Equity Anticipation Securities.
5. Baskets : Baskets options are option on portfolio of underlying asset.
Equity Index Options are most popular form of baskets.

6. Swaps : These are private agreements between two parties to exchange

cash flows in the future according to a prearrange formula. They can be
regarded as portfolios of forward’s contracts. The two commonly used
swaps are:
a) Interest rate swaps : These entail swapping both Principal and
interest between the parties , with the cash flow in one direction
being in a different currency than those in the opposite direction.

41
 b) Currency swaps : These entail swapping both Principal and
interest between the parties, with the cash flow in one direction
being in a different currency than those in the opposite direction.

THE DERIVATIVES MARKETS PERFORM A NUMBER OF ECONOMIC

FUNCTIONS:

1. Price Discovery: - Prices in organized derivatives markets reflects the

perception of market participants about the future and lead the prices of
underlying to perceived future level. The prices of derivatives converge
with the prices of the underlying at the expiration of the derivative contract.
Thus derivatives help in discovery of future as well current price.
2. Transfer of risk: - The derivative market helps to transfer to the risks from
those who have them but may like them those who have an appetite for
them. We can also term the derivative market as the insurance company,
whereby certain players assumes the risk by receiving premium amount.
3. Increased volume in the cash market :- Derivatives due to their inherent
nature are linked to the underlying cash markets. With the introduction of
derivative, the underlying market, witness higher trading volumes because
of participation by more players who would not otherwise participate for
lack of an arrangement to transfer risk.

4. New Entrepreneurial activities :- Derivatives have a history of attracting

many bright, creative, well-educated people with an entrepreneurial, new
products and new employment opportunities, the benefits of which are
immense.
5. Increase in saving :- Derivatives market helps increase savings and
investments in the long run Transfer of risk enables market participants to
expand their volume of activities.

42
 6. Trading in controlled environment :- The introduction of the derivatives
has shifted the trading in speculative dealings in controlled market and the
counter party risk has been eliminated.

Participants in derivative market

1. Exchange, trading members, clearing members.

2. Hedgers, arbitrageurs, speculators.
3. Clearing, clearing bank.
4. Financial institutions.
5. Stock lenders and borrowers.

REASON FOR STARTING DERIVATIVES

1. Counter party risk on the part of broker, in case it ask money from us but
before giving delivery of shares goes bankrupt.
2. Liquidity risk in the form that the particular scrip might not be traded on
exchange.
3. Unsystematic risk in the form that the price of scrip may go up or down
due to “Company Specific Reasons”.
4. Mutual funds may find it difficult to invest the funds raised by them
properly as the scrip in which they want to invert might not be available at
the right price.

OBJECTIVES OF DERIVATIVE TRADING

1. Hedging: You own a stock and you are confident about the prospects of
the company. However at the same time you feel that overall market may
not perform as good and therefore price of your stock may also fall in line
with overall marked trend.

43
 You except that some adverse economic or political vent affect the marker
sentiments, though fundamentals of the company will remain good,
therefore, it is good to retain the stock.
In both these situations you would like to insure portfolio against any such
market fall. Such insurance is known as hedging.
Hedging is a tool to reduce the inherent risk in an investment. Various
strategies designed to reduce investment risk using call option, put
options, short selling, and futures are used for hedging. The basic purpose
of a hedge is to reduce the risk of loss.

2. Arbitrage: - The future price of an underlying asset is function of spot

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

3. Speculations: - You may have very strong opinion about the future
market price of a particular asset based on past trends, current
information and future expectation. Likewise you may also have opinion
about the overall marker trend. To take advantage of such opinion,
individual asset or the entire market (index) could be sold or purchased.

44
THE REQUIREMENTS FOR SETTING UP FUTURE AND OPTION TRADING
ARE OUTLINES BELOW:

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

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

45
 STRENGTH OF INDIAN CAPITAL MARKET FOR INTRODUCTION OF
DERIVATIVES

1. Large Market Capitalization: India is one of the largest market

capitalized country in Asia with a market capitalization of more than
7,65,000 crores.
2. High Liquidity: In the underlying securities the daily average traded
volume in Indian capital market today is around 7,500 crores. Which
means on an average every month 14% of the country market
capitalization gets traded, shows high liquidity.
3. Trader Guarantee: The first “clearing corporation” (CC) guaranteeing
trades has become fully functional from July 1996 in the form of National
Securities Clearing Corporation (NSCCL) for which it does the clearing.
4. Strong depository : A strong depository National Securities Depositories
Ltd. (NSDL), which started functioning in the year 1997, has strengthen
the securities settlement in our country.
5. A good Legal Guardian : SEBI is acting as a good legal guardian for
Indian Capital Market.

46
 IMPORTANCE OF DERIVATIVES TRADING

1. Reduction of borrowing cost.

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

47
 INSTRUMENTS OF DERIVATIVE TRADING

Forward

Derivative Future

Option

FORWARD CONTRACTS

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

price”.
The two parties are :

1. Who takes a long position - agreeing to buy

2. Who takes a short position – agreeing to sell

The mutually agreed price is known as “delivery price” or “forward

price”. The delivery price is chosen in such a way that the value of contract for
both parties is zero at the time of entering the contract, but the contract takes a
positive or negative value for parties as the price of underlying asset moves. It
removes the future price risk. It a speculator has information or analysis, which
forecast an upturn in price, and then be can go long on the forwards market
instead of cash market.

48
 The speculator would go long on the forward, wait for the price to rise, and
then take a reversing transaction to book profits. Speculator may well be required
to deposit a margin upfront. However, this is generally a relatively small
proportion of the value of assets underlying the forward contract.

Effect of change in price :

As mentioned above the value of such a contract in zero for both the
parties. But later as the price & the underlying asset changes, it gives positive or
negative value for contract.

Price & Underlying Holder & long position Holder & Short Position
Assets
Increase Positive Value Negative Value
Decrease Negative Value Positive Value

E.g. A agrees to deliver 100 equity shares of Reliance to B on Sept. 30,

2002 at a Rate of Rs. 120 per share. Now if the price of share on that is Rs. 140
per share, than a who has short position would stand to loss of Rs. (20*200) =
4000, long position would gain the same amount or vise versa if price quoted is
less than delivery price.
Profit/Loss = ST-E
ST = spot price on maturity date
E = delivery price

Limitations of forward contract

1. No standardization.
2. One party can breach its obligation.
3. Lack of centralization of trading.
4. Lack of Liquidity.
.
FUTURE CONTRACT

49
It is an agreement between buyer and seller for the purchase and sale of a
particular assets at a specific future date; specific size, date of delivery, place
and alternative asset. It makes obligation on both parties to fulfill the contract.

Features of Future Contract

1. Standardized contracts e.g. contract size.

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

FUTURE TERMINOLOGY

Spot Price : The price at which an asset trades in the spot market.
Future Price : The price as which the futures contract trades in the futures
market.
Contract cycle : The period over which the contract trades. The index futures
contracts on the NSE have one moth, and three-month expiry cycles, which
expire on the last Thursday of one month. Thus a January expiration contract
expires on the last Thursday of the January. On the Friday following the last
Thursday, a new contract having three-month expiry is introduced of trading.
Expiry Date : It is date specified in the futures contract. This is the last day on
which the contract will be traded, at the end of which it will cease to exist.

Basis : In the contract of financial futures, basis can be defined as the futures
price minus the spot price. There will be a different basis for each delivery month

50
for each contract. In a normal market, basis will be positive. This reflects that
futures prices normally exceed spot prices.
Initial margin : The amount that must be deposited in the margin account at a
time a future contract is first entered into is known as initial margin.
Marketing-to-market : In the futures market, at the end of each trading day, the
margin account is adjusted to reflect the investor’s margin gain or loss depending
upon the future’s closing price.
Maintenance margin : This is somewhat lower than initial margin. This is set to
ensure that the balance in the margin account never becomes negative. If the
balance amount falls below the maintenance margin, the investor receives a
margin call and is expected to top up the margin account to the initial margin
level before trading commences on the next day.

TYPE OF FUTURE CONTRACTS

Index Futures : Of the financial futures, index future contracts are key contracts,
introduced in U.S.A., in 1982 by the “Commodity Futures Trading Commission”
(CFTC) by approving the Kansas Board proposal. Index Futures began trading in
India in June 2000 of Trade (KSBT)’s Futures derive its value from the underlying
index-e.g. NSE’s futures. Contracts are based on “S & P CNX NIFTY”
At present it has become the most liquid contract in the country, the arbitrage
between the futures equity market is further expected to reduce impact cost. 80-
90% of retail participation is expected in India because

51
TREND OF BULLISH MARKET

– 15th
– Feels the market will rise
– Buys 200 nifty contracts with expiry date - 31th at 1220 costing
Rs. 244000 (200*1220)
– 31st
– Nifty July futures has risen to 1310
– Sells off his position at 1310
– Makes a profit of Rs. 18000 (200*90)

PAYOFF INDEX FUTURES (BUYER)

Profit

0 1220 Index
FIGURE 2.1

Loss
57

52
TREND OF BEARISH MARKET

F 15th
– feels the market will fall
– Sells 200 Nifties July Contract
– Nifty July contract is trading at 1220
– His position is worth Rs. 244000 (200*1220)
F 31st
– Suppose Nifty July futures has fallen to 1150
– Squares off his position at 1150
– Makes a profit of Rs. 14000 (200*70)

PAYOFF INDEX FUTURES (SELLER)

Profit

0 1220
FIGURE 2.2
Index

Loss
53 59
FORWARD VS. FUTURES

Features Forward Future

-Operational Traded between Trade on
Mechanism two parties Exchange

-Contract Differ from Standardized

Specifications traded to trade Contracts

-Counter party Exists such No such

Risks risk risk
-Liquidity Low High

-Price Not Highly

Discovery Efficient Efficient

-Settlement At end of period Daily

Margin No such margin Margin required
for trading

54
 OPTIONS

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

Historical background of Option:

Although options have exercised for a long time, they were traded OTD, without
much knowledge of valuation. Today exchange-traded options are actively traded
on stocks, stock indices, foreign currencies and futures contracts.

The first trading is options began in Europe and U.S. as early as the
century. It was only in early, 1990s that a group of firms set up what is known as
the “put and call brokers and dealers association” with the aim of providing a
mechanism for bringing buyers and sellers together. It someone wanted to buy
an option, he or she would contract one of the member firms. The firm would
then attempt to find a seller or writer of option either from its own client of those
of other member firms. I”f no seller could be found, the firm would undertake to
write the option itself in return of price. The two deficiencies in above markets
were
1. No secondary market
2. No mechanism to guarantee the writer of option would honor it
In 1973, Black, Marton, Scholes invented the Black-Scholes formula. In April
1973, CBOE was set up specially for the purpose of trading options. The market
for options develop so rapidly that by early 80’s number of share underlying the

What is Option ?

55
An options is the right, but not the obligation to buy to sell a specified amount
(and quality) of a commodity, index or financial instruments a to buy of sell a
specified number of underlying futures contracts, at a specified price on a before
a give date in the future.
Thus, option like futures, also provide a mechanism by which one can acquire a
certain commodity on other assets, or take position in order to make profits or
cover risk for a price. In this type of contract as well, there are two parties:
a. The buyer (or the holder, or owner of options)
b. The seller (or writer of options)
While the buyer take “long position” the seller take “short position”
So every option contract can either be “call option” or “put option” options are
created by selling and buying and for every option that is buyer and seller.

TYPES OF OPTION CONTRACTS

1. Index Options :- Index options are also financial exchange traded

contracts with the underlying assets as the index, whereby the buyer of
the options acquire the right to buy or sell predefined quantity of the index
for a consideration paid to the seller or the writer of the option. All option
contracts are also standardized and the clearing house or the cooperation
guarantees the performance of the contracts.
2. Stock Options :- These are the stock exchange traded contracts
whereby, buyer of the option gets the right to buy the contracts stocks for
a consideration paid to the seller of the option. He does not have any
obligation, but on the other hand the writer (seller) of the option is under
the obligation to honour the contract since he has received the premium in
lieu of the obligations. Stock options are similar to index options, but with
a basic difference is that the underlying assets are individual

3. TYPES OF OPTIONS

56
Call Option :
It gives an owner the write to buy a specified quantity of the underlying assets at
a predetermined price i.e. the exercise price, or the specific date i.e. is the date
of maturity.

Call Option (Buyer)

Why call option ?

If u think market will rise
Example
.Buy a call with a strike of Rs .2340(NIFTY) at a premium of Rs. 50
Maximum Profit Potential : Unlimited.
Maximum Risk Potential : Limited to Rs. 50
Break Even : Rs.2390

Pay off call option (Buyer)

2340
0
50 index

loss
FIGURE 2.3

Call option (Seller)

57
Why sell Option : If u think market will remain neutral or slightly bearish .

Example
Sell a call with a strike price of Rs.2340(Nifty) at a premium of Rs.50
Maximum Profit Potential : Rs.50
Maximum Risk Potential : Unlimited
Break Even : Rs. 2390
Desired Movement :Market will not go down

Seller call option

0 1250 index

loss

FIGURE 2.4

Put Option

58
It gives the holder the right to sell a specific quantity of underlying asses at an
agreed price on date of maturity he gets the right to sell.

Why Buy a Put Option (Buyer)

If u think market will fall

Example
Buy a Put with a strike of Rs.2360(Nifty) at a premium of Rs.25
Maximum Profit Potential : Substantial
Maximum Risk Potential.
Break Even : 2335
Desired Movement : Bearish

Put Option Buyer

Profit

0 2360
index

loss
FIGURE 2.5

Put Option seller

59
Why Sell a Put Option
If u think market will remain neutral or moderately bullish
Example

Sell a put with a strike of Rs.2360(Nifty) at a premium of Rs.50

Maximum Profit Potential : Rs 50
Maximum Risk Potential : Substantial
Break Even : Rs. 2310
Desired Movement : Market will not go down

Pay off put option (seller)

profit

0 2360

index

loss

FIGURE 2.6

OPTION TERMINOLOGY

60
1. Buyer of an option : The buyer of an option is the one who by paying the
option premium buys the right but not the obligation exercise his option on
the seller/writer.
2. Writer of an option : The writer of a call/put option is the one who
receives the option premium and is thereby obliged to sell/buy the asset if
the buyer exercise on him.
3. Option price : Option price is the price, which the option buyer pays to
the option seller. It is also referred as option premium.
4. Expiration date : The date specified in the options contract is known as
expiration date, the exercise date, the strike date or the maturity.
5. Strike Price : The price specified in the options contract is known as
strike price or the exercise price.
6. American options : these are the options that can be exercised at any
time upto the expiration date. Most exchange-traded options are
Americans.
7. European options: These are the options that can be exercised only on
the expiration date itself. These are easier or analyze than American
option, and properties of American options are frequently deducted from
those of its European counterpart.
8. In the money option : An in the money option is an option that would
lead to a positive cash flow to the holder if it will exercise immediately. A
call option in the index is set to be in-the-money when the current index
stands at a level higher than the strike price (i.e. spot price>strike price). If
the index is much higher than the strike price, the call is set to deep ITM.
In the case of a put, the put is ITM if the index is below the strike price.
9. At-money option : (ATM) option is an option that would lead to zero cash
flow if it were exercised immediately. An option on the index is at-the-
money when the current index equals the strike price.

61
 10. Out-of-the money option : (OTM) options is an option that would lead to
a negative cash flow it was exercised immediately. A call option on the
index is OTM when the current index stands at a level, which is less than
the strike price (spot price<strike price). If the index is much lower than the
strike price, the call is set to be deep OTM. In the case of a put, the put is
OTM if the index is above the strike price.

AMERICAN VS EUROPEAN OPTION

Its owner can exercise an American option at any time on or before the expiration
date.
A European style option gives the owner the right to use the option only on
expiration date and not before.

Option Premium

A glance at the rights and obligations of buyer and seller reveals that option
contracts are skewed. One way naturally wonder as to why the seller (writer) of
an option would always be obliged to sell/buy an asset whereas the other party
gets the right. The answer is that writer of an option receives, a consideration for
Undertaking the obligation. This is known as the price or premium to the seller for
the option.
The buyer pays the premium for the option to the seller shelter he exercise the
option is not exercised, it becomes worthless and the premium becomes the
profit of the seller.

62
Factors Affecting Pricing

1. Supply and demand in Secondary market

2. Exercise price
3. Risk free interest rate
4. Volatility of underlying
5. Time to expiration
6. Dividend on underlying

63
 RISK MANAGEMENT

NSCCL have developed a comprehensive risk containment mechanism for the F

& O Segment. The salient features of risk containment mechanism of the F & O
segment are :

1. The financial soundness of the members is the key to risk management.

Therefore, the requirements for membership in term of capital adequacy
(net worth, security deposits) are quite stringent.
2. NSCCL charges an upfront initial margin for all the open positions of a
CM. It specifies the initial margin requirements for each futures/options
contract on a daily basis. It also follows value-at-risk (VAR) based
margining through SPAN. The CM in turn collects the initial margin form
the TMs and their respective clients.
3. The open positions of the members are marked based on contract
settlement price for each contract. The difference is settled in cash on T +
1 basis.
4. NSCCL’s on-line position monitoring system monitors a CM’s open
positions on a real-time basis. Limits are set for each CM based on his
capital deposits. The on-line position monitoring system generates alters
whenever a CM reaches a position limit set up by NSCCL. NSCCL
monitors the CMs for MTM value violation, while TMS are monitored for
contract-wise position limit violation.
5. CMs are provided a trading terminal for the purpose of monitoring the
open position of all the TMs clearing and setting through him. A CM may
set exposure limits for a TM clearing and settling through him. NSCCL
assists the Cm to monitor the intra-day exposure limits set up by a CM
and whenever a TM exceed the limits, it stops that particular TM from
further trading.

64
 6. A member is altered of his position to enable him to adjust his exposure or
bring in additional capital. Position violates result in withdrawal of trading
facility for all TMs a CM is case of violation by the CM.
The most critical component of risk containment mechanism for F & O
segment is the margining system and on-line position monitoring. The actual
position monitoring and margining is carried out on-line through Parallel Risk
Management System (PRISM). PRISM uses SPAN (r) (Standard Portfolio
Analysis of risk) System for the purpose of computation of on-line margins,
based on the parameters defined by SEBI.

MINIMUM BASE CAPITAL

A clearing Member (CM) is required to meet with the Base Minimum Capital
(BMC) requirements prescribed by NSCCL before activation. The CM has also to
ensure that BMC is maintained in accordance with the requirements of NSCCL at
all points of time, after activation.

Every CM is required to maintain BMC of Rs. 50 lakhs with NSCCL in the

following manner :

1. Rs.25 lakhs in the form of cash.

2. Rs. 25 lakhs in any one form or combination of the below forms:
Cash
Fixed Deposit Receipts (FDRs) issued by approved banks and deposited
with approved Custodians or NSCCL.
Bank Guarantee in favour of NSCCL from approved banks in the specified
format.
Approved securities in demat form deposited with approved Custodians.

Any failure on the part of a CM to meet with the BMC requirements

65
at any point of time, will be treated as a violation of the Rules, Bye-Laws and
Regulations of NSCCL and would attract disciplinary action inter-alia including,
withdrawal of trading facility and /or clearing facility, closing out of outstanding
positions etc.

Additional Base Capital

Clearing members may provide additional margin/collateral deposit

(additional base capital) to NSCCL and/or may wish to retain deposits and/or
such amounts which are receivable from NSCCL, over and above their minimum
deposit requirements, towards initial margin and / or other obligations.

66
 MARGINS

NSCCL has developed a comprehensive risk containment mechanism for the

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

Initial Margin

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

Initial margin requirements are based on 99% value at risk over a one day
time horizon. However, in the case of futures contracts (on index or individual
securities), where it may not be possible to collect mark to market settlement
value, before the commencement of trading on the next day, the initial margin
may be computed over a two-day time horizon, applying the appropriate
statistical formula. The methodology for computations of Value at Risk
percentage is as per the recommendations of SEBI from time to time.

67
Initial margin requirement for a member:

For client positions – shall be netted at the level of individual client and
grossed across all clients, at the Trading/Clearing Member level, without any
setoffs between clients.

For proprietary positions – shall be netted at Trading/Clearing Member

level without any setoffs between client and proprietary positions.

For the purpose of SPAN Margin, various parameters are specified from
time to time.

In case a trading member wishes to take additional trading positions his

CM is required to provide Additional Base Capital (ABC) to NSCL. ABC can be
provided by the members in the form of Cash, Bank Guarantee, Fixed Deposit
Receipts and approved securities.

Premium Margin

In Addition to Initial Margin, Premium Margin would be charged to members. The

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

Payment of Margins

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

Non-fulfillment of either the whole or part of the margin obligations will be treated
as a violation of the Rules, Bye-Laws and Regulations of NSCCL and will attract

68
penal charges @ 0.09% per day of the amount not paid throughout the period of
non-payment. In addition NSCCL may at its discretion and without any further
notice to the clearing member, initiate other disciplinary action, inter-alia
including, withdrawal of trading facilities and / or clearing facility closing out of
outstanding positions, imposing penalties, collecting appropriate deposits,
invoking bank guarantees / fixed deposit receipts etc
DERIVATIVES TRADING IN INDIA

The first step towards introduction of derivatives trading in India was the
promulgation of the securities laws (amendment) ordinance, 1995 which
withdrew the prohibition on options in securities. The market for derivatives,
however, did not take off, as there was no regulatory framework to govern trading
of derivatives.

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

Gupta on 18th November, 1996 top develop appropriate regulatory framework for
derivatives trading in India. The committee submitted its report on 17th March,
1998 prescribing necessary pre-conditions for introduction of derivatives trading
in India. The committee recommended that derivatives should be declared as
‘securities’ so that regulatory framework applicable to trading of ‘securities’ could
also govern trading of securities. SEBI also set up a group in June 1998 under
the Chairmanship of Prof. J.R. Varma, to recommend measures for risk
containment in derivatives market in India. The report, which was submitted in
October, 1998, worked out the operational details of margining system,
methodology for changing initial margins, broker net worth, deposit requirement
and real time monitoring requirements.

The SCRA was amended in Dec, 1999 to include derivatives within the
ambit of ‘securities’ and the regulatory framework was developed for governing
derivatives trading.

69
 Derivatives trading commenced in India in June 2000 after SEBI granted
the final approval to this effect in May 2000.

SEBI permitted the derivative segments of two stock exchanges. NSE and
BE, and their clearing house/corporation to commence trading and settlement in
approved derivatives contracts. To begin with, SEBI approved trading in index
futures contracts based on S&P CNX Nifty and BSE-30 (Sensex) index. This was
followed by approval, for trading in options based on these two indexes and
options on individual securities. The trading in index options commenced in June
2001. Futures contracts on individual stocks were launched in November 2001.
Trading and Settlement in derivatives contracts is done in accordance with the
rule, bye-laws, and regulations of the respective exchanges and their clearing
house/corporation duly approved by SEBI and notified in the official gazette.

Thus, the following four types of Derivatives are now being traded in the
India Stock Market.

• Index Futures
• Index Options
• Stocks Future
• Stock Options

Index Futures : Index futures are financial contracts for which the underlying is
the cash market index like the Sensex, which is the brand index of India. Index
futures contract is an agreement to buy or sell a specified quantity of underlying
index for a future date at a price agreed upon between the buyer and seller. The
contracts have standardized specifications like market lot, expiry day, tick size
and method of settlement.

70
Index Options : Index Options are financial contracts whereby the right is given
by the option seller in consideration of a premium to the option buyer to buy or
sell the underlying index at a specific price (strike price) on or before a specific
date (expiry date).

Stock Futures : Stock Futures are financial contracts where the underlying asset
is an individual stock. Stock futures contract is an agreement to buy or sell a
specified quantity of underlying equity share for a future date at a price agreed
upon between the buyer and seller. Just like Index derivatives, the specifications
are pre-specified.

Stock Options : Stock Options are instruments whereby the right of purchase
and sale is given by the option seller in consideration of a premium to the option
buyer to buy or sell the underlying stock at a specific price (strike price) on or
before a specific date (expiry date).

OPERATIONAL MECHANISM OF DERIVATIVES

1. Registration with broker : The first step towards trading in the

derivatives market is selection of a proper broker with whom the investor
would trade. Investors should complete all the registration formalities with
the broker before commencement of trading in the derivatives market. The
investors should also ensure to deal with a broker (member of the
exchange) who is a SEBI registered broker and possesses a SEBI
registration certificate.
2. Client Agreement : The investor should sign the Client Agreement with
the broker before the broker can place any order on his behalf. The client
agreement includes provisions specified by SEBI and the derivatives
segment.
3. Unique Client Identification Number : After signing the client
agreement, the investors gets a unique identification number (ID). The

71
 broker would key this identification number in the system at the time of
placing the order on behalf of the investors. This ID is broker specific i.e. if
the investors chooses to deal with different brokers, he needs to sign the
client agreement with each one of them and resultantly, he would have
different Ids.
4. Risk Disclosure Documents : As stipulated in the Bye-Laws provide his
particulars to the investors. The particulars would include his SEBI
registration number, the name of the employees who would be primarily
responsible for the client’s affairs, the precise nature of his liability towards
the client in respect of the business done on behalf of the investor. The
broker must also apprise the investor about the risk associated with the
business in derivative trading and the extent of his liability. This
information forms part of the Risk Disclosure document, which the broker
issues to the client. The investor should carefully read the risk disclosure
document and understand the risks involved in the derivatives trading
before committing any position in the market. The risk disclosure
document has to be sign3ed by the client and a copy of the same is
retained by the broker for his records.
5. Free Copy of Relevant Regulations : The client is also entitled to a free
copy of the extracts or relevant provisions governing the rights and
obligations of clients, relevant manuals, notifications, circulars and any
additions or amendments etc. of the derivatives segment or of any
regulatory authority to the extent it governs the relationship between the
broker and the client.
6. Placing order with the broker : The investor should place orders only
after understanding the monetary implications in the event of execution of
the trade. After the trade is executed, the investor can request for a copy
of the trade confirmation slip generated on the systems on execution of
the trade. The investor should also obtain from the broker, a contract note
for the trade executed within 24 hours. The contract note should be time
(order receipt and order execution) and price stamped. Execution prices,

72
 brokerage and other charges, if any, should be separately mentioned in
the contract note. If desired, the investors may change an order anytime
before the same is executed on the exchange.
7. Margining System in Derivatives : The aim of margin money is to
minimize the risk of default by either counter-party. The payment of
margin ensures that the risk is limited to the previous day’s price
movement on each outstanding position. The different types of margins
are:
a) Initial Margin : The basic aim of initial margin is to cover the
largest potential loss in one day. Both buyer and seller have to
deposited before the opening of the position in the futures
transaction. This margin is calculated by SPAN by considering the
worst case scenarion.
b) Mark to market margin : All daily losses must be met by
depositing of further collateral-known as variation margin, which is
required by the close of business, the following day. Any profits on
the contract are credited to the client’s variation margin account.
8. Investors Protection Fund: The derivatives segment has established an
“Investors Protection Fund” which is independent of the cash segment to
protect the interest of the investors in the derivatives market.
9. Arbitration : In case of any dispute between the members and the clients
arising out of the trading or in relation to trading/settlement, the party
thereto shall resolve such complaint, dispute by arbitrations procedure as
defined in the rules and regulations and Bye-Laws of the respective
exchanges.

73
 REGULATORY FRAMEWORK

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

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

Securities contracts (Regulation) Act, 1956

SC(R) A aims at preventing undesiarable transactions in securities by regulating

the business of dealing therein and by providing for certain other matters
connected therewith. This is the principal Act, which governs the trading of
securities in India. The term “securities” has been defined in the SC(R)A. As per
Section 2(h), the ‘Securities’ include:

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

securities of a like nature in or of any incorporated company or other body
corporate.
2. Derivative
3. Units or any other instrument issued by any collective investment scheme
to the investors in such schemes.
4. Government securities.
5. Such other instruments as may be declared by the Central Government to
be securities.
6. Rights or interests in securities
“Derivative” is defined to includes:
• A security derived from a debt instrument, share, loan whether secured or
unsecured, risk instrument or contract differences or any other form of
security.
• A contract which derives its value from the prices, or index of price, of
underlying securities.

74
 Section 18A provides that notwithstanding anything contained in any other
law for the time being in force, contracts in derivative shall be legal and
valid if such contracts are:
Traded on a recognized stock exchange.
Settled on the clearing house of the recognized stock exchange, in accordance
with the rules and bye-laws of such stock exchanges.

75
76
 RESEARCH METHODOLOGY

Research is a procedure of logical and systematic application of the

fundamentals of science to the general and overall questions of a study and
scientific technique by which provide precise tools, specific procedures and
technical, rather than philosophical means for getting and ordering the data prior
to their logical analysis and manipulations.

Different type of research design is available depending upon the

nature of research project, availability of able manpower and circumstances.
The study about “ANALYSIS OF DERIVATIVES MARKET” is
exploratory as well as descriptive in nature .Discussion with experts, internet
surfing, and journals were studied to explore more about the concerned objective
and better understanding of the problem. After that questionnaire was prepared
to meet the desired objective

77
Sources of Data:

The source of data includes primary and secondary data sources.

Primary Sources

Primary data is data collected for first time specially for the
purpose for which study is being conducted i.e. the problem under study..

Secondary Sources

The secondary data is data, which is collected and compiled for the
different purpose, which are used in research for this study. The secondary data
include material collected from:

- Newspaper
- Magazine.
- Internet.

Data Collection Instruments

The various methods of data gathering involves the use of

appropriate recording forms. These are called ‘tools’ or ‘instruments of data
collection. Data was collected through structured questionnaire administered by
sitting with guide and discussing problems

Sampling Technique
The small representative selected out of large population is
selected at random is called sample. Well-selected sample may reflect fairly,
accurately the characteristic of population. The chief aim of sampling is to make
an inference about unknown parameters from a measurable sample statistics.

78
Sampling technique used was Snowball sampling was used for the purpose of
data collection as reference was taken form sample to reach other sample.

Sample Size : Sample size refers to the number of items to be selected from the
universe to constitute a sample. Due to constraints of cost and time, the sample
size selected for the research is 25 investors and 35 brokers

Sampling Unit : The sampling unit was the person who had an account and
was investing in stock market and broker who were trading in stock market
.

79
 LIMITATIONS OF THE STUDY

No study is complete in itself, however, good it may and every

study has some limitations:
• Time is the main constraint of my study.
• Availability of information was not sufficient because of less awareness
among investors / brokers.
• Sample size is not enough to have a clear opinion.

80
81
 1. TRADING PERIOD IN DERIVATIVES

25

20

No.of brokers 15
and investors
10
Series1
5

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

FIGURE 4.1

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

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

82
 2. REASONS BEHIND ITS ADOPTION

purpose

liquidity
12% hedging
25%

speculation
risk
40%
management
23%

Reasons behind adoption of derivatives are different by brokers, investors and

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

83
3. In which segment you have larger turnover?

• Capital Market Segment (20)

• F & O Segment.
• Equal in both above (15)
• Can’t Say.

segment having large turnover

4
11%
6 CM SEGMENT
17% 17
49% EQUAL IN F&O & CM
F& O Segment
Can't Say
8
23%

FIGURE 4.3

Out of 35 informants, 17 have largest turnover in the capital segment i.e. 49%
and 23% have equal turnover in CM & F&O segment. No informants have its
largest turnover in F & O segment because the investor are very less aware
about the derivatives and they do not know about the derivative trading as they
much know about the CM Segment.

84
 4. INVESTED AMOUNT IN DERIVATIVES

Amout invested in derivatives

30 27
25

20
No. of brokers 15
15
and investors
10 9 9 Series1

0
2 LACS 2 LACS - 5 LACS - Any Other
5 LACS 10 LACS
Amount

FIGURE 4.4

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

85
86
 5 TRADED PERIOD IN DERIVATIVES

Traded period for Derivative Investment

25
20

No. of brokers 15
and investors 10

5 Series1

0
Weekly Monthly More More
than 1 than 2
month months
Traded Period

FIGURE 4.5

13 (22% investors and brokers are investing weekly in derivatives, 23 (38%)

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

87
 6 IMPACT ON CUSTOMER BASE

25

20

15
No. of brokers
10
Series1

0
Increase Decrease Remain
same
Impact

FIGURE 4.6

Out of 35 brokers , 3 (5%) of brokers said that it does not increase their customer
base because introducing small savings as investment, but derivatives increase
customer base of 24 (70%) which is more than half. It is basically beneficial for
those who are investing from last 2 or more years. In investment sector need
minimum of Rs. 2,00,000 as investment so it is basically for corporate and
investment sector only not for small investors. 8 (25%) said their customer base

88
remains same because they have started just now for investing in derivatives in
future it will increase their customer base.

7. RELATIONSHIP WITH CASH MARKET

30

25

20
No of brokers
15
and investors
Series1
10

0
Positive Negative Can't Say
Relation

FIGURE 4.7

Out of 60 brokers, investors 27 (45%) have the positive response towards the
relation between derivative and cash market and remaining 5 (8%) has negative
response. 28 (47%) are not able to say anything because they do not have
proper knowledge about stock market. They are investing with the guidance of

89
brokers and with the support of their close relatives those are investing for last
many years.

8. DERIVATIVES AND RISK

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

SHORTCOMINGS IN INDIAN DERIVATIVE SYSTEM

Short coming in indian derivative system

35 31
30 27
25
No. of brokers 20
and investors 15
10
Series3
5 2
0
domestic lack of market
technical awareness failure
expertise in investors
short comings

FIGURE 4.9

90
 27 (45%) brokers, investors respond towards shortage of domestic
technical expertise. 31 (52%) feel lack of awareness in investors about
derivatives and remaining 2 (3%) market failure.

9.. Which tool of derivative according to you is better?

a) Index future
b) Stock future
c) Index option
d) Stock option

8
13%
7
Index Future
12%
Stock Future
30 Index Option
50%
Stock Option
15
25%

FIGURE 4.10

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 I got mix view on this question. But most of the informants i.e. 50%
are in the favour of index future and rests are having some different different
attraction .

RESULTS / FINDINGS

 Brokers not dealing in derivatives at present are also not going to

adopt it in futures.
 Hedging and Risk Management is the most important feature of
derivatives?
 It is not for small investors.
 It ahs increased brokers turnovers as well as helpful in aggregate
investment.
 Brokers haven’t adequate knowledge about options, so most of them
are dealing in futures only.
 There is a risk factor in derivative also.
 Most of the investors are not investing in derivatives.
 People are not aware of derivatives, even people who have invested
in it, has not adequate knowledge about it. These people are
interested to take it in their future portfolio also. They consider it as a
tool of risk management.
 They normally invest in future contracts.
 They are investing in future contract, because futures have up to
some extent quality at Badla.

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REASONS BEHIND LESS DEVELOPMENT OF F & O SEGMENT
.
 Securities and contract’s regulations act has recognized index as a
security very later i.e. in Nov. 2001. It will take time to take position
in derivative or capital market.
 The Limited mutual faith in the parties involved.
 It hasn’t a legalized market.
 Commodity F & O Market has not yet been come to India. This will
make easy to understand and take simple investor under investor
base of derivative trading.
 Market failures
 Scandals.
 Inadequate infrastructures.
 Shortage to domestic technical expertise, in India even most of the
people are not aware of concept derivatives.
 Large lot size, so small investors are not able to come under
derivative segment.
 There are less scripts under derivatives segment.
 High margin as compared to Badla.
 In India there cannot be a long term trading in F & O, it is only for 1 to
2 or maximum for 3 months.

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94
 SUGGESTIONS

1. LOT SIZE:
Lot size should be reduced so that the major segment of an Indian
society i.e. small saving class can come under F & O trading. There is strong
need for revision of lot sizes as the lot sizes of some of the individual scrips that
were worth of Rs. 200000 in starting, now same lot size amount to a much larger
value.

2. SUB BROKERS
Sub-broker concept should be added and the actual brokers should
give all rights of brokers in F & O segment also.

3. SCRIPS:
More scrips of reputed companies etc. should be introduced in
“F & O Segment”.

4. TRADING PERIOD
Trading period should be increased.

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5. TRAINING CLASSES OR SEMINARS
There should be proper classes on derivatives for investors,
traders, brokers, students and employees of stock exchanges. Because lack of
knowledge is the main reason of its less development. The first step towards it
should be seminars provided to brokers and LSE employees and secondly
seminar to students.

CONCLUSION

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

derivative products initially emerged as hedging devices against fluctuation and
commodity prices and commodity linked derivatives remained the soul form of
such products. The financial derivatives came in spotlight in 1972 due o growing
instability in financial market.
I was really surprised to see during my study that a layman or a
simple investor does not even know how to hedge and how to reduce risk on his
portfolios. All these activities are generally performed by big individual investors,
mutual funds etc.
No doubt that derivative growth towards the progress of economy is
positive. But the problem confronting the derivative market segment are giving it
a low customer base. The main problem that it confronts are unawareness and
bit lot sizes etc. these problems could be overcome easily by revising lot sizes
and also there should be seminar and general discussions on derivatives at
varied places.

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“We view them as time bombs both for the parties that deal in them
and the economic system. In our view derivatives are financial
weapons of mass destruction (WMD), carrying dangers that, while
now latent, are potentially lethal.”
Warren Buffet.

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 BIBLIOGRAPHY

BOOKS

• NCFM on derivatives core modules by NSEIL.

• H.S.SIDHU Indian Capital Market 1996, 1st Edition
• The Indian Commodity-Derivatives Market in Operations.
• Indian Securities Market – A Review.

MAGAZINES & NEWSPAPER:

• NSE News.
• ECONOMICS TIME
INTERNET SITES:

• www.nseindia.com - historical data – business growth.

• www.bseindia.com
• www.derivativesindia.com
• “Derivatives in India: Frequently Asked Questions”,
http://www.mayin.org/ajayshah/PDFDOCS/ShahThomas2000_dfq.
pdf

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 QUESTIONNAIRE

Dear Respondent,

I am a student of MBA . I am working on the project “STUDY OF

DERIVATIVES ”. You are requested to fill in the questionnaire to enable, to

undertake the study on the said project

NAME:

OCCUPATION:

ADDRESS:

PHONE NO:

1) For how long you have been trading on derivatives?

a) Less than 1 year b) 1 Year

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 c) 2 Year d) 3 year e) More than 3 year.

2) What is your purpose for trading in derivatives?

a) Hedging b) Speculation

c) Risk Management d) Liquidity

3) . In which segment you have larger turnover ? (BROKERS ONLY)

a ) Capital Market Segment

b) F & O Segment.
c) Equal in both above
d) Can’t Say.

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

a) 2, 00,000

b) 2, 00,000 to Rs. 5, 00,000

c) Rs. 5, 00,000 to Rs. 10, 00,000

d) Any other amount______________

5) How often do you trade?

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

d) More than 2 month

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

a) Increase b) Decrease c) Remains same.

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

cash market?

a) Positive b) Negative c) Can’t say.

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

a) Lack of awareness among the investors about derivatives.

b) Shortage of domestic technical expertise.
c) If any other ___________________________

9) . Which tool of derivative according to you is better?

a) Index future
b) Stock future
c) Index option

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 d) Stock option

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

education in derivatives market in India?

_____________________________________________________________

_____________________________________________________________

102