Share Khan Limited

Master of Business Administration
EXECUTIVE SUMMARY
New ideas and innovations have always been the hallmark of progress made by mankind. At every stage of development, there have been two core factors that drive man to ideas and innovation. These are increasing returns and reducing risk, in all facets of life. The financial markets are no different. The endeavor has always been to maximize returns and minimize risk. A lot of innovation goes into developing financial products centered on these two factors. It has spawned a whole new area called financial engineering. Derivatives are among the forefront of the innovations in the financial markets and aim to increase returns and reduce risk. They provide an outlet for investors to protect themselves from the vagaries of the financial markets. These instruments have been very popular with investors all over the world. Indian financial markets have been on the ascension and catching up with global standards in financial markets. The advents of screen based trading, dematerialization, rolling settlement have put our markets on par with international markets. As a logical step to the above progress, derivative trading was introduced in the country in June 2000. Starting with index futures, we have made rapid stride and have four types of derivative products- index future, index option, stock future and stock options. Today, there are 50 stocks on which one can have futures and options, apart from the index futures and options. This market presents a tremendous opportunity for individual investors. The markets have performed smoothly over the last four years and have stabilized. The time is ripe for investors to make full use of the advantage offered by this market. We have tried to present in a lucid and simple manner, the derivatives market, so that the individual investor is educated and equipped to become a dominant player in the market.
Gujarat Technological University, Ahmedabad
Financial Derivatives And Its Benefits
Industrial Profile
(Sharekhan pvt Ltd.)

Product Profile
INTRODUCTION OF SHAREKHAN LTD
Industrial Profile: Sharekhan Ltd

The Company
Sharekhan Limited is a retail financial services provider with a focus on equities, derivatives and commodities brokerage execution on the National Stock Exchange of India Ltd. (NSE), Bombay Stock Exchange Ltd. (BSE), National Commodity and Derivatives Exchange India (NCDEX) and Multi Commodity Exchange of India Ltd. (MCX), Sharekhan provides trade execution services through multiple channels - an Internet platform, telephone and retail outlets and is present in 225 cities through a network of 615 locations. The company was awarded the 2005 Most Preferred Stock Broking Brand by Awwaz Consumer Vote.
Corporate profile
Particulars Name Of Trading Member Clearing No. Regd. Office BSE Sharekhan Ltd. Cash:748 Cash:10229 Derivative: T748 Derivative:F10229 A-206, Phoenix House, Phoenix Mills Compound, Senapati Bapat Marg, Lower Parel Mumbai, Maharashtra 400013 Ph: 022-267482000 Cash INB-001073351 Cash: INB/INF231073330 Derivative: INF- 001073351 Derivative:MAPIN 100008375 Mr.Mitesh Prajapati (Email: miteshprajapati@branch.sharekhan.com) Mr. Kashyap Chokhwatia (-Sr. Clint Relation) 100008375 100008989 NSE
SEBI Registration & Trading Member Branch In charge (Vapi) Main contact person In Regd. Off. Unique Identification No. Mutual Fund PMS DP Website E-Mail Address
ARN 20669 INP00000066 NSDL-IN-DP-NSDL-233-2003 CDSL-IN-DP-CDSL-271-2004 www.sharekhan.com Info@sharekhan.com
The Business Challenges

Easily access customer portfolio information in a secure contact centre environment. Seamlessly integrate with back-end applications and streamline customer data to contact Centre agents. Easily manage upgrades and technology issues to accommodate growing customer base.
The Solution
Sharekhan selected Aspect EnsemblePro from the Aspect Software Unified IP Contact Centerproduct line, a unified contact centre solution delivering advanced multichannel contact capabilities,Because it provided the best total value over other solutions evaluated. It enabled Sharekhan to meet Customer service needs for inbound call handling, voice self service, predictive outbound dialling, call Blending, call monitoring and recording, and creating outbound marketing campaigns, among other Capabilities. The Results Increased agent efficiency and productivity Enabled company to execute proactive customer service calls and expand services offered to customers Enhanced call monitoring for improved service quality The company was awarded the 2005 Most Preferred Stock Broking Brand by Awwaz Consumer Vote.
VAPI BRANCH:
Address: Royal Fortune, D-101, E -101, First Floor, Vapi - Daman Road, Vapi - 396 191. Telephone No: 0260 - 6452931 to 36 Email:miteshprajapati@branch.sharekhan.com Contact Person: Mr. Mitesh Prajapati
Sharekhan Services
Sharekhan is one of India's leading financial services companies. We provide a complete life-cycle of investment solution in Equities, Derivatives, Commodities, IPO, Mutual Funds, Depository Services, Portfolio Management Services and Insurance. We also offer personalized wealth management services for High Net worth individuals. With a physical presence in over 300 cities of India through more than 800 "Share Shops", and an online presence through Sharekhan.com, India's premier online destination, we reach out to more than 800,000 trading customers.
Product offered by Sharekhan:
Features of Classic Account

that enables you to invest effortlessly Online trading account for investing in Equities and Derivatives via sharekhan.com Integration of: Online trading + Bank + Demat account Instant cash transfer facility against purchase & sale of shares Make IPO bookings
You get Instant order and trade confirmations by e-mail Streaming Quotes Personalised Market Scan with your own customized stock ticker! Single screen interface for cash and derivatives Your very own Portfolio Tracker!
Features OF Sharekhan Trade Tiger

A single platform for multiple exchange BSE & NSE (Cash & F&O), MCX, NCDEX, Mutual Funds, IPOs
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Multiple Market Watch available on Single Screen Multiple Charts with Tick by Tick Intraday and End of Day Charting powered with various Studies Graph Studies include Average, Band- Bollinger, Know SureThing, MACD, RSI, etc
Apply studies such as Vertical, Horizontal, Trend, Retracement & Free lines can save his own defined screen as well as graph template, that is, saving the layout for future use User-defined alert settings on an input Stock Price trigger Tools available to guage market such as Tick Query, Ticker, Market Summary, Action Watch, Option Premium Calculator, Span Calculator Shortcut key for FAST access to order placements & reports
Online fund transfer activated with 12 Banks
Features of Dial-n-Trade
that enable you to trade effortlessly TWO dedicated numbers for placing your orders with your cell phone or landline. Toll free number: 1-800-22-7050. For people with difficulty in accessing the toll-free number, we also have a Reliance number (Your Local STD Code) 30307600 which is charged at as a local call. Simple and Secure Interactive Voice Response based system for authentication
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No waiting time. Enter your TPIN to be transferred to our telebrokers You also get the trusted, professional advice of our telebrokers After hours order placement facility between 9.00 am and 9.30 am (timings to be extended soon) Reliable service, wherever you are
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Need of Study Research Objective Research Design Sources of Data collection Benefit of Study
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NEED OF THE STUDY

A financial derivative in India is a growing subject in Indian capital market. Trading in financial derivatives started in National Stock exchange (NSE) in June 2000,with tools like future and option. My research in this field is still in its initial stage and there is lot of potential scope in the field of derivatives Derivatives and its products (types) studied in this project have appeared as the most efficient tools to facilitate an efficient risk management system as they are designed and traded on the basis of future price movement expectations of underlying assets, thereby arranging some kind of insurance or protection from points associated with trading in financial assets Derivatives are recognized as the best and most cost-efficient way of meeting the felt need for risk hedging in certain types of commercial and financial operations. Countries not providing such globally accepted risk hedging facilities are disadvantaged in today's rapidly integrating global economy.
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RESEARCH OBJECTIVE
To understand different types of derivatives product available in market. To understand how derivates are useful as a tool in risk management To understand impact of derivatives product (future and option) in financial market. To understand future and option and their strategies of the trading in real market To understand various determinants of option value.
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RESEARCH DESIGN
The study is based on descriptive research design having protection against bais and maximizes reliability and also has structured or well thought out instrument for collection of data, from various websites, referred journal, articles and books.
SOURCE OF DATA COLLECTION

Secondary source
Stock Exchange : National Stock Exchange From Web dealers: Ms. Shruti Mistri, share khan. Report studied( mentioned in literature review) Books referred Websites surfed
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BENEFITS OF THE STUDY

How useful are derivatives?
Derivatives are important financial instrument and perform a wide variety of functions. These functions range from hedging and insuring against adverse change to ensuring market efficiency. From an investors point of view, derivatives offer a huge number of opportunities, whether he is risk-taker or risk averse. Derivatives, especially index futures and stock options. Some of the important advantages are as follow:
Hedging Risk
Derivatives are use to hedge risks. They can be used as hedging devices by retail investors, portfolio manages and borrowers hedging against interest rate rise. Index futures can be used to hedge a portfolio against adverse movement in the stock market. Through the process of hedging, the buyer of the instrument implicitly transfers the risk to those who want to assume it for a consideration.
Expanding portfolio
Derivatives enable banks, traders or investors to be on price movement without having to deal with actual assets, if the value of the underlying goes up or down, the difference is simply settled in cash. Derivatives are more flexible than the underlying products. the value is based on the price of the underlying product, and most contract are settled in cash term so investor could gamble.
Power to leverage
Derivatives allow investor to take position of a large value by making a small investment. In futures, one takes a position by paying a margin in the range of 25-30%. In case of an option, one pays a premium that is a very small amount relative to the spot price and takes position in the markets.
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Power to defer
The cash markets have a daily settlement mechanism. A speculator wanting to take a position in a stock has to either take delivery or square off his position the same day. Thus he is unable to take a position beyond a day. With futures, one can take a position on a stock today, while the settlement takes place at a future date. In this aspect, futures are similar to the erstwhile Badla system as it enables carry forward of positions.
Power to lend or borrow from the markets

With futures, one can lend or borrow funds from the market. This will become more effective when actual deliveries are introduced in the derivatives markets. In case you need money for short-term requirements, you can sell your stocks in the cash market and buy futures. You get the liquidity for some time and then you can get your stock back when the futures are settled.
Benefits to End Users As a result of the numerous studies of derivatives activities, there is now broad agreement in both the private and public sectors that derivatives provide numerous and substantial benefits to end users. Corporations, governmental entities, and financial institutions all benefit from derivatives through lower funding costs and more diversified funding sources. In todays global capital market, currency and interest rate swaps, for example, give firms the ability to borrow in the cheapest capital market, domestic or foreign, without regard to the currency in which the debt is denominated or the form in which interest is paid, i.e., fixed- or floating-rate. A major lender to McDonalds, for example, uses interest rate swaps to lower its own financing costs and hence increase its capacity to lend to McDonalds franchisees. By using derivatives, institutional investors and portfolio managers may enhance asset yields. For example, asset swaps enable institutions to exchange cash flows on particular assets for other cash flows, possibly based on a different rate of interest or exchange rate. In cases where securities trade poorly because of some undesirable feature, derivatives can be used to neutralize the undesirable feature,
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thereby creating a synthetic instrument with a higher yield than a traditional instrument of the same credit quality. Asset swaps are popular, for example, when the issuer of a security experiences deterioration in its credit standing, hence causing the demand for its securities on the secondary market to dry up. Derivatives, moreover, provide an efficient method for end users to better hedge and manage their exposures to risk from price and interest rate fluctuations. Interest rate swaps, for example, help banks of all sizes to manage better the asset/liability mismatches inherent in funding long-term assets, such as mortgages, with short-term liabilities that reprice more frequently, such as certificates of deposit. Airlines and oil refiners can use commodity swaps to hedge their exposure to fluctuating fuel prices. Finally, derivatives provide an effective, low-cost means for corporations and institutional investors effectively to manage their portfolios of assets and liabilities. A fully-invested equity fund, for example, can reduce its market exposure quickly and at a relatively low cost without selling off part of its equity assets by using an equity swap calling for the exchange of payments based on the total return on the S&P 500 index in return for a receipt based on a floating rate, such as the London Interbank Offer Rate (LIBOR).
Benefits to Dealers
Participation in derivatives activity benefits derivatives dealers in several important ways. For example, dealing has increased both the average credit quality and the diversity of credit risk to which dealers are exposed. Dealing also provides a profitable and stable earnings stream that has helped banks rebuild their capital bases and diversify their sources of earnings. Finally, improvements in risk management techniques that first developed in derivatives have spilled over into and improved the management of risks in the traditional lines of businesses of dealers. Banks taking deposits and making loans, for example, have begun to make use of risk management systems originally developed for derivatives for their balance sheet asset/liability management. This improved risk management, in turn, has improved the safety and profitability of these institutions.
Benefits for the Economy

The innovation and growth in derivatives activity over the past fifteen years has yielded substantial benefits to the U.S. economy. By facilitating the access of U.S. corporations to international capital markets, enabling them to lower their cost of funds and diversify their funding sources, derivatives have improved the competitive position of U.S. firms in an increasingly competitive global economy.
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By providing U.S. firms with new and more effective tools for managing their exposure to interest rates, foreign exchange rates, and commodity prices, derivatives have also reduced the likelihood of financial distress due to volatile prices and interest rates, helping to stabilize employment. With these incidental risk exposures under control, management is better able to focus on its core businessimproving the quality and reducing the cost of its product. Similarly, by providing investors and issuers with a wider array of tools for managing risks and raising capital, derivatives improve the allocation of credit and the sharing of risk in the economy, reducing the cost of capital formation and stimulating economic growth. Finally, since world markets for trade and finance have become increasingly integrated and accessible, derivatives have strengthened important linkages between markets, increasing market liquidity and efficiency.
Benefits of Derivatives to Indian capital markets

India's financial market system will strongly benefit from smoothly functioning index derivatives markets. The reasons in support of this statement are as follow: Internationally, the launch of derivatives has been associated with substantial improvements in market quality on the underlying equity market. Liquidity and market efficiency on India's equity market will improve once the derivatives commence trading. Many risks in the financial markets can be eliminated by diversification. Index derivatives are special insofar as they can be used by investors to protect themselves from the one risk in the equity market that cannot be diversified away, i.e. a fall in the market index. Once investors use index derivatives, they will suffer less when fluctuations in the market index take place. Foreign investors coming into India would be more comfortable if the hedging vehicles routinely used by them worldwide are available to them. So, the foreign funds inflow through FIIs in Indian capital markets will be more making it easier for the corporate to tap the funds at a cheaper rate. The launch of derivatives is a logical next step in the development of human capital in India. Skills in the financial sector have grown tremendously in the last few years, thanks to the structural changes in the market, and the economy is now ripe for derivatives as the next area for addition of skills. The launch of futures trading has been a milestone on Indian bourses although its full impact is yet not visible due to certain roadblocks. It is the right time, as far as India is concerned, as for launch of derivatives in the country. As the markets are become more volatile and complex, there is a need to hedge these risks and hence for instruments, which allow fund managers to manage risk, better.
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So, this is definitely the appropriate time. As our Indian market lacks infrastructure available, therefore our futures market is not perfect, as it must be. For example, as we lack a system of electronic fund transfer in the banking sector and we don't even have the short-term yield curve, which can be used to calculate the fair price for the index future. As market becomes deep, the need for these deficiencies to go will be stronger. As our market is on retail basis therefore we requires great protection against counterparty risk. It is the regulators that have nurtured the entire derivative initiative and have played a very positive role. They may extend the support, guidance and advice while derivatives have been introduced. Even the regulatory framework, which has been designed, puts the Indian derivatives market best in the world. However, volumes in derivatives markets are still too small to have an impact on the cash market. The derivatives market, which gives better price discovery, can have a positive impact on the cash market. It would increase the liquidity even in the cash market where arbitrage takes place between the futures and the cash market. Here, derivatives would no doubt increase the liquidity and depth. Within index futures Indian bourses would be launching sectoral index futures like InfoTech or FMCG index. Among other products, we would like to bring futures on foreign exchange and fixed income instruments.
Derivative users Hedgers

Hedgers wish to eliminate or reduce price risk to which they are already exposed. To hedge is to enter into transaction that protects a business or assets against change in the underlying commodity. The instrument bought a hedge, tend to have the opposite value movement to the underlying asset. Financial and commodity markets are used to transfer risk form an individual or corporation to someone more willing and table to bear that risk. To begin with, suppose a leading trader buys a large quantity of wheat that would take two weeks to reach him. Now, he fears that the wheat prices may fall in the coming two weeks and so wheat may have to be sold at lower prices. The trader can sell futures (or forward) contracts with matching price, to hedge. Thus, if wheat prices do fall, the trader would lose money on the inventory of wheat but will profit from the futures contract, which would balance the loss.
Speculator
Speculators willing take price risk from price changes in the underlying. In contract to hedgers, speculators buy or sell derivatives contracts in an attempt to
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earn profits. They are willing to assume the risk of price fluctuation, hoping to profits from them. Assume that a call option, with exercise price of Rs. 35 and due in one month, on this share is available in the market at 50 paisa (per share). Buying this option would require Rs. 50 (a call is for 100 shares) only. Now, if the price of the share is either less than, or equal to, Rs. 35, the call shall not be exercised and the loss would be Rs. 50 or 100% of the investment. If, on the other hand, the price rules at Rs. 40, then a gain of 100*(Rs. 40-Rs. 35) = Rs. 500 would be made, which works out to be 900% of the investment! With no option or other derivative available, the investor would be required to invest Rs. 3200 (for 100 shares) and would make a profit of Rs. 800 i.e. only 24% of the amount invested.
Arbitrageurs
Arbitrageur profits from price differentials existing in two markets by simultaneously operating in two different markets. An Arbitrageurs makers risk less profits by exploiting the price differential on the same instrument or similar assets, often by trading on different exchanges. He buys the instrument at the lower price and promptly makes a resale at the higher price. Arbitrage plays a role in ensuring markets efficiency, in that it helps so eliminate pricing anomalies. Arbitrageurs are on the lookout for market inefficiencies and quickly look to eliminate them. All class of investors is required for healthy functioning of the market. Hedger and investor provide the economic substance to any financial market. Without them, the markets would lose their purpose and become mere tools of gambling. Speculators provide liquidity and depth to the market. Arbitrageurs bring price uniformity and help price discovery. Futures and options with various expiration dates are traded in the market, there are likely to be several arbitrage opportunities in trading. Thus, if a trader believes that the price differential between the futures contracts on the same underlying asset with differing maturities is more or less than what he/she perceives them to be, then appropriate positions, in them, may be taken to make profits. The existence of well-functioning derivatives markets alters the flow of information into the prices. This is because in a purely cash market, speculators, feed information into the sport prices. In contrast, the presence of a derivatives market, besides a cashmarket, ensures that a major part of the transformation of information into prices takes place at the derivatives market, due to lower transaction costs involved in such a market, and then it gets transmitted to the spot markets.
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Review of literature Introduction to derivative Risk Management Taxation Issues
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REVIEW OF LITERATURE Report Studied:

Mitesh B. Buddhdev, Trading Strategies & accounting Procedures in Derivatives, March 2007 The project provides significant knowledge of trading strategies and accounting procedures in derivates and also impact of derivatives in financial market. The project reveled importance of accounting in derivatives. It consists of all the accounting entry made at each stage for all action in futures and option contract. Each transaction is accounted with its complete effects from inception to financial year end. It also provides information of reports generation for all the elements of transactions from view point of client. It also recognizes the basic strategies and their usage in real stock market where besides price, various factors have influence. Thus in outline, project report establishes knowledge of different strategies and accounting standard of derivatives Books of national certification in financial market in dealer module were referred Book for national certification in financial market in option and trading strategies were referred
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History of Derivatives
Derivative instruments have been in existence for over two thousand years. Olive farmers in ancient Greece used them. Farmers, who were unwilling to accept the risk of low prices for their crops, when harvested month later, would enter into forward rate agreement. In such case, a price was agreed for delivery on a specific date between the farmer and buyer. This reduced uncertainty for both the grower and purchased of olives. In the middle ages, forward contracts, particularly for wheat, were traded in a kind of secondary market in Europe. A futures market was established in Osakas rice markets in Japan in 17th century. In Amsterdam, tulip bulb options were traded in 17th century. In Calcutta, forward contracts in frozen potato have been in existence for a long time. In addition, an organized derivatives trading has been prevalent in agricultural commodities like pepper, trading in commodity futures took off in 19th century after Chicago board of trade (CBOT) Started regulating trading. The last 25 years have witness an explosive growth in traded volumes, Varity of derivatives products and range of uses and users.
Development of derivatives market 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-member committee under the Chairmanship of Dr. L.C. Gupta on November 18, 1996 to develop appropriate regulatory framework for derivatives trading in India. SEBI also set up a group in June 1998 under the Chairmanship of Prof. J.R.Varma, to recommend measures for risk containment in the derivatives market in India. The report, which was submitted in October 1998, worked out the operational details of margining system, methodology for charging initial margins, the operational details of margining system, methodology for charging initial margins, broker net worth, deposit requirement and real-time monitoring requirements. The government also rescinded in March 2000, the three-decade old notification, which prohibited forward trading in securities. Derivatives trading commenced in India in June 2000 after SEBI granted the final approval to this effect in May 2001. SEBI permitted the derivative segments of two stock exchanges, NSE and BSE, and their clearing house/corporation to commence
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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 the individual securities. The derivatives trading on NSE commenced with S&P CNX Nifty Index futures on June 12, 2000. Single stock futures were launched on November 9, 2001. Trading and settlement in derivative contracts is done in accordance with the rules, bylaws, and regulations of the respective exchanges and their clearing house/corporation duly approved by SEBI and notified in the official gazette. Index futures recorded a total trading value of Rs. 35, 22,264 million and the near month index futures contract recorded the highest trading value of Rs. 28, 97,754 million during the month. The movement of Nifty as compared to Nifty futures in the month of February 2008. The stock futures recorded a total trading value of Rs. 42,18,381 million during February 2008. The near month contract expiring on February 28,2008 recorded the highest trading volume of Rs. 34,60,707 million. The index options recorded a total national trading value of Rs. 11, 02,514 million during the month with the near option contract recording the highest national trading value of Rs.5.14,602 million for call option and Rs.4,06,304 million for put options. The total trading value of stock options during the month was Rs.1,49,011 million. The option expiring on February 28, 2008 recorded the highest national trading value of Rs.1,15,917 million for call options and Rs. 20,437 million for put options.
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The table below indicates the growth witnessed in the derivatives market
Futures
Product Contract 28-Feb-2008 Index Futures 27-Mar-2008 24-Apr-2008 29-May-2008 28-Feb-2008 27-Mar-2008 24-Apr-2008 29-May-2008 No. of 11,566,086 2,467,094 30,814 217 11,256,571 3,222,316 12,575 139 Trading 2,897,75 4 617,635 6,825 50 3,460,70 7 754,809 2,831 35 Open interest (No. as at end of month)** 262,096 852,977 11,328 86 251,514 1,375,110 4,441 118 Open (No of contract as at end Of month) 315,578 149,984 1,846 2 277,697 183,779 15,314 71,435 25,887 18 19,482 3,048 3 -
Stock Futures
Option
Produc t Interest Contract 28-Feb-2008 27-Mar-2008 24-Apr-2008 29-May-2008 28-Feb-2008 27-Mar-2008 24-Apr-2008 29-May-2008 28-Feb-2008 27-Mar-2008 24-Apr-2008 29-May-2008 28-Feb-2008 27-Mar-2008 24-Apr-2008 29-May-2008 No. of 1,880,368 302,874 1,921 2 1,561,626 357,262 15,524 379,565 47,855 63 77,026 5,802 4 Trading 514,602 84,172 536 1 406,304 92,686 4,214 115,917 11,395 16 20,437 1,245 1 -
Call Index Put
Call Stock Put
Source: - www.sharekhan.com
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Distribution of F& O Volume:February 2008
Index option 12%
Stock option 2% Index future 39%
Stock future 47%
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Derivatives defined
A derivative is a financial instrument that derives its value from an underlying asset. This underlying asset can be stocks, bonds, currency, commodities, metals and even intangible, pseudo assets like stock indices. Simply we can say that derives some thing from someone. e.g. we derived price of curd from price of milk. It is derivatives. In the Indian context the Security Contract Act, 1956 defines derivative to include: 1) A security derived from a debt instrument, shares, and loans whether secured or unsecured, risk instrument or contract for any other from of security. 2) A contract which derives its value from of security.
What is a derivative instrument?

It is a contract whose value depends on or derives from the value of an underlying asset [say a share, forex, commodity or an index]. In its broadest sense a derivative attempts to hedge against the variability of any economic variable. Thus exposures or perceived risks to a firm arising from the variation in interest rates, exchange rates, commodity prices and equity prices can be hedged through an appropriate derivative structure. Such a derivative structure covers a wide variety of financial contracts viz. Futures, Forwards, Options, Swaps and different variations thereof. These contracts can be traded on the various exchanges in a standardized manner or by custom designed for individual requirements. The four important types of derivatives are based on the following: I) II) III) IV) Bonds which vary in price according to interest rates Currencies Equities including stock indices Commodities like metals, oil and agricultural produce
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The need for a derivatives market

The derivatives market performs a number of economic functions: They help in transferring risks from risk averse people to risk oriented people. They help in the discovery of future as well as current prices. They increase the volume traded in markets because of participation of risk adverse people in greater numbers. They increase savings and investment in the long run.
Types of Derivatives
Derivatives are complex instrument and come in various forms. Apart from the standard instruments, which are traded on Over the Counter (OTC) markets, derivatives can also be tailored made to suit the specific requirements of the user. Some of the most important and widely used derivatives are as follows:
Forward
A forward contract is an agreement in which two parties agree to under take an exchange of the underling asset at some future date at pre-determined price. A forward contract is customized contact between two parties, where settlement take place on a specific date the settlement date and price are agreed in advance by the parties concerned.
Features of forward contract: They are bilateral contract and hence exposed to counter-party risk. Each contract is custom designed and hence is unique in term of contract size, expiration date and the assets type and quality. The contract price is generally not available in public domain. The contract price has to be settled by delivery of the assets on expiration date. In the case the party wishes to reverse the contract it has to compulsorily go to the same counter-party. Forward contact is popular in the foreign exchange market and agriculture sector where commodity prices fluctuate a great deal. If the forward contract is close before the scheduled closing date, a penalty may be charged. The draw back of forward contract is lack standardization which prevents trading on an exchange and the risk of default.
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Futures
Futures are agreements between two parties to undertake a transaction at an agreed price on a specific future date. Futures contract are exchanged based instrument, which are traded on a regulated exchange. In general, future contract are related to various underlying assets such as commodities, market indices, interest rate and so on. In the futures, there is an agreement to buy or sell a specified quantity of financial instrument commodity on a designed future date a price agreed upon by the buyer and seller today. e.g. if you buy 100 company X futures at 100 Rs. for march 31 delivery it means that on 31 march, you would pay the seller Rs.10000 and get return 100 shares of company X. In general there is no physical delivery of the underlying assets but the settlement is done by paying or receiving the difference of the actual price on March 31 and contracted price. Now suppose on the 31 march price of company X was 150 .you would get Rs. 5000 and if the price of company x was Rs. 70 then you would to pay Rs.3000. The standardized item in any futures contract is as follows. Quantity of the underlying The date and month of delivery The unit of price quotation and minimum change in price Location of settlement
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In general most futures contract is not held to expiry, and so delivery does no take place. Open positions are closed out on the last day of trading at a price determined by the spot/cash market price of the underlying asset. The price is called exchange delivery settlement price or EDSP.
Option
The buyer of an option has the right but not the obligation to buy or sell an agreed amount of a commodity on or before a specified future date. An option to buy is know as a call option while an option to sell is knows as a put option. The rate at which the buyer of the option has the right to buy or sell is the strike or exercise price. An option which can be exercised at any time before it expires is described as an American style option. One, which can only be exercised on the expiry date, is called a European style option. Buying an option protects against downside risk and at the same times gives upside potential. You establish the worst possible rate at which you will / sell a commodity or stock but still have the possibility of improving on this rate. The buyer hence, has the best of both worlds.
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SWAPS
A Swaps can be defined as an exchange of obligation by two parties for instance I an interest rate Swap(IRS), one company arrange with another to exchange interest rate payment. There are many types of Swaps like Assets Swap, Currency swaps and so on. The most important one is an interest rate Swaps (IRS) and Currency Swaps. Interest Rate swap(IRS): One company may be paying fixed rate of interest but prefer floating rates. Another company may be paying a floating rate but would find a fixed rate advantageous. Thus it makes sense for both the companies to enter into an IRS agreement. An important advantage of IRS is that different firms can access funds at varying rates and terms. They may not always find these terms beneficial, they enter into Swap agreement. IRS enables them to access sources of funding at better rates than what they would be able to achieve on a direct basis.
Currency swaps:
These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.
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CAPS
An interest rate cap is a contract which allows the purchaser to set the upper limit for interest rates payable. The buyer of the cap receives compensation if interest rate rises above the agreed level. Capping is use in the long term borrowing.
Floors and collars

Buyers of a cap have to pay premium, which can be a large cash payment. To reduce this some buyer simultaneously sells a floor. Hence, they receive a premium if the interest rate falls below an agreed level; they have to compensate the floor buyer. The combination of selling a Floor at a low strike rate and buying a cap at a higher strike rate is called a collar.
Warrants
Options generally have lives of up to one year; the majority of options traded on options exchanges have a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter.
Baskets
Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average or a basket of assets. Equity index options are a form of basket options. Derivatives can be of different types like futures, options, swaps, caps, floor, Collars etc. The most popular derivative instruments are futures and options.
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Risk Management
Four Steps in Risk Management
1. Understand the nature of various risks. 2. Define a risk management policy for the organization and quantifying maximum risk that organization is willing to take if quantifiable. 3. Measure the risks if quantifiable and enumerate otherwise. 4. Build internal control mechanism to control and monitor all the risks.
Step 1 - Understand Risks

Risks can be classified into three categories. Price or Market Risk Counterparty or Credit Risk Operating Risks
Price Risks This is the risk of loss due to change in market prices. Price risk can increase further due to Market Liquidity Risk, which arises when large positions in individual instruments or exposures reach more than a certain percentage of the market, instrument or issue. Such a large position could be potentially illiquid and not be capable of being replaced or hedged out at the current market value and as a result may be assumed to carry extra risk. Counterparty Risks This is the risk of loss due to a default of the Counterparty in honoring its commitment in a transaction (Credit Risk). If the Counterparty is situated in another country, this also involves Country Risk, which is the risk of the Counterparty not honoring its commitment because of the restrictions imposed by the government though counterparty itself is capable to do so.
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Dealing Risk Dealing Risk is the sum total of all unsettled transactions due for all dates in future. If the Counterparty goes bankrupt on any day, all unsettled transactions would have to be redone in the market at the current rates. The loss would be the difference between the original contract rate and the current rates. Dealing risk is therefore limited to only the movement in the prices and is measured as a percentage of the total exposure. Settlement Risk Settlement risk is the risk of Counterparty defaulting on the day of the settlement. The risk in this case would be 100% of the exposure if the corporate gives value before receiving value from the Counterparty. In addition the transaction would have to be redone at the current market rates. Operating Risks Operational risk is the risk that the organization may be exposed to financial loss either through human error, misjudgment, negligence and malfeasance, or through uncertainty, misunderstanding and confusion as to responsibility and authority. Following are the different kinds of operating risks: Legal Legal risk is the risk that the organization will suffer financial loss either because contracts or individual provisions thereof are unenforceable or inadequately documented, or because the precise relationship with the counterparty is unclear. Legal Regulatory Errors & Omissions Frauds Custodial Systems
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Regulatory Regulatory risk is the risk of doing a transaction, which is not as per the prevailing rules and laws of the country. Errors & Omissions Errors and omissions are not uncommon in financial operations. These may relate to price, amount, value date, currency, buy/sell side or settlement instructions. Frauds Some examples of frauds are: Front running Circular trading Undisclosed Personal trading Insider trading Routing deals to select brokers
Custodial Custodial risk is the loss of prime documents due to theft, fire, water, termites etc. This risk is enhanced when the documents are in transit. Systems Systems risk is due to significant deficiencies in the design or operation of supporting systems; or inability of systems to develop quickly enough to meet rapidly evolving user requirements; or establishment of a great many diverse, incompatible system configurations, which cannot be effectively linked by the automated transmission of data and which require considerable manual intervention.
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Step 2 - Define Risk Policy

Decide the basic risk policy that the organization wants to have. This may vary from taking no risk (cover all) to taking high risks (open all). Most organizations would fall somewhere in between the two extremes. Risk and reward go hand in hand. Cost Center vs. Profit Center A cost centre approach looks at exposure management as insurance against adverse movements. One is not looking for optimization of cost or realization but meeting certain budgeted or targeted rates. In a profit centre approach, the business is taking deliberate risks to make money out of price movements.
Step 3- Risk Measurement

There are a number of different measures of price or market risk which are mainly based on historical and current market values Examples are Value at Risk (VAR), Revaluation, Modeling, Simulation, Stress Testing, Back Testing, etc.
Step 4- Risk Control

Control of Price Risk Position limits are established to control the level of price or market risk taken by the organization. Diversification is used to reduce systematic risk in a given portfolio. Control of Credit Risk Credit limits are established for each counterparty for both dealing risk and settlement risk separately depending upon the risk perception of the counterparty.
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Control of Operating Risk Establishment of an effective and efficient internal control structure over the trading and settlement activities, as well as implementing a timely and accurate management information system (M.I.S.).
Tools to control operating risks

Comprehensive Systems and Operations Manuals Proper Organizations structure and adequate personnel
Separation of trading function from settlement, accounting and risk control functions. Strict enforcement of authority and limits Written confirmation of all verbal dealings Voice recording
Legally binding agreements with counterparties ensuring proposed transactions are not ultra virus. Contingency Planning Internal Audits Daily reconciliation Ethical standards and codes of conduct Dealing discipline
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Taxation Issues
Taxation of Derivative Transactions in Index Futures

This Note seeks to provide information on the taxation aspects of index futures transactions. The contents of this Note should not be treated as advice or guidance or authoritative pronouncements. Readers are advised to consult their tax advisors before taking any action relating to their tax computations or planning. This Note is not intended for any such purpose. In the absence of special provisions, the current provisions, which are inadequate to handle the complexities involved, are reviewed in this Note. It is expected that the Central Board of Direct Taxes (CBDT) will shortly provide guidelines for taxation aspects of Derivative transactions.
Definition of Speculative Transactions

Section 43(5) defines speculative transactions as those which are periodically or ultimately settled otherwise than by actual delivery or transfer. By this definition all index futures transactions will qualify prima facie as speculative transactions, as delivery of such futures is not possible. Exceptions are provided to this definition to cover cases where contracts are entered into in respect of stocks and shares by a dealer or investor to guard against loss in holdings of stocks and shares through price fluctuations. Another exception is provide for contracts entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member.
The CBDT has issued a Circular No 23 dated 12th September 1960 on this area. The important provisions of this Circular are summarized below:
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Hedging sales can be taken to be genuine only to the extent the total of such transactions does not exceed the ready stock, the loss arising from excess transactions should be treated as total stocks of raw material or merchandise in hand. If forward sales exceed speculative losses. Hedging transactions in connected, though not the same, commodities should not be treated as speculative transactions. It cannot be accepted that a dealer or investor in stocks or shares can enter into hedging transactions outside his holdings. By this interpretation, transactions in index futures will not be covered under the definition of hedging. Speculation loss, if any carried forward from earlier years, could first be adjusted against speculation profits of the particular year before allowing any other loss to be adjusted against those profits.
Deemed Speculation
As per Explanation to Section 73, where any part of the business of a company consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this Section, be deemed to be carrying on a speculation business to the extent to which the business consists of purchase and sale of such shares. The CBDT has issued a Circular No 23 dated 12th September 1960 on this area. The important provisions of this Circular are summarized below: Company whose Gross Total Income consists mainly of Income chargeable under the heads Interest on Securities, Income from House Property, Capital Gains and Income from Other Sources Company whose principal business is Banking Company whose principal business is granting of loans and advances
Most brokers and dealers are currently caught within the mischief of this explanation, especially after the wave of corporatization of brokers businesses. The Explanation however does not cover index futures.
Speculation Losses Cannot be set off

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Losses from speculation business can be set off only against profits of another speculation business. If speculation profits are insufficient, such losses can be carried forward for eight years, and will be set off against speculation profits in these future years.
Possibility of Speculation treatment

In view of the above provisions, it appears that the possibility of the Income Tax department treating index futures transactions to be speculative and taxed accordingly, is high as far as assesses carrying on business are concerned, unless a clarification is issued by the Central Board of Direct Taxes. Another possible view (as far as non-business assesses are concerned) could be that gains and losses from index futures be treated as short term capital gains. This view can gain support from the fact that such assesses are not covered within the ambit of Sections 43 and 73 referred to above.
Possible Arguments:
It is possible to argue that index futures transactions are not speculative transactions. Some lines of argument are explored below. 1. Section 43(5) speaks of purchase and sale of any commodity, including shares and stocks. Index futures are not commodities. Further, index futures are also not stocks and shares. Hence, section 43(5) does not apply to futures transactions. The question of examining the provisos (exceptions) does not arise. 2. Exceptions to speculative transactions as provided in Section 43(5) also include hedging transactions undertaken in respect of stocks and shares. Proviso (b) to Section 43(5) sates a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations. It however remains to be seen whether index futures can be covered under stocks and shares. To our mind, it appears that if index futures are considered to be part of stocks and shares as per the wording of Section 43(5), then the proviso will also become applicable and hence hedging contracts through the mechanism of index futures will not be considered speculative. On the other hand, if index futures are not part of stocks and shares, then neither Section 43(5) nor the proviso apply and hence the entire gamut of index futures transactions will remain out of the purview of speculative transactions.
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3. Explanation to Section 73 speaks of purchase and sale of shares of other companies. Index futures are not shares. Hence, this Explanation does not apply to futures transactions. It is believed and understood that foreign exchange forward transactions are currently not being caught within the mischief of Sections 43 and 73. This lends more comfort to the possibility of index futures also being left out of this net, though only experience will indicate the stand the Income tax department will take.
Other Possible Controversies:

1. The Income tax department may take a stand that profits and losses accrue on a day to day basis, in view of the daily settlement procedure. This could be contrary to the accounting guidelines, which (as it currently appears) may advocate profit (loss) recognition at the expiry of the contract. 2. It appears currently that accounting guidelines will require recognition of unrealized losses at financial year-end, but not unrealized profits. The Income tax department may not agree with this conservative treatment
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Data Analysis & Interpretations Introduction to Futures Introduction to Options Option Strategies Swaps
Actions of Investors to Market Fluctuations Investors Reactions Swot analysis
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INTRODUCTION TO FUTURE
Future, as the name indicates, is a trade whose settlement is going to take place in the future. However, before we take a look at futures, it will be beneficial for us to take a look at forward rate agreements
What is a forward rate agreement?

A forward rate agreement is one in which a buyer and a seller enter into a contract at a specified quantity of an asset at a specified price on a specified date. An example for this is the exporters getting into forward rate agreements on currencies with banks. But there is always a risk of one of the parties defaulting. The buyer may not pay up or the seller may not be able to deliver. There may not be any redressal for the aggrieved party as this is a negotiated contract between two parties.
What is a future?
A future is similar to a forward rate agreement, except that it is not a negotiated contracted but a standard instrument. A future is a contract to buy or sell an asset at a specified future date at a Specified price. These contracts are traded on the stock exchanges and it can Change many hands before final settlement is made. The advantage of a future is that it eliminates counterparty risk. Since there is an exchange involved in between, and the exchange guarantees each trade, the buyer or seller does not get affected with the opposite party defaulting.
Futures Forwards
There are two kinds of futures traded in the market- index futures and stock Futures. There are three types of futures, based on the tenure. They are 1, 2 or 3-month future. They are also known as near and far futures depending on the tenure.
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What are Index futures?

Index futures are futures contract on the index itself. One can buy a 1, 2 or 3- month index future. If someone wants to take a call on the index, then index futures are the ideal instruments for him. Let us try and understand what an index is. An index is a set of numbers that represent a change over a period of time. A stock index is similarly a number that gives a relative measure of the stocks that constitutes the index. Each stock will have a different weight in the index. The Nifty comprises of 50 stocks. BSE Sensex comprises of 30 stocks. For example, Nifty was formed in 1995 and given a base value of 1000. The value of Nifty today is 1550. What it means in simple terms is that, if Rs 1000 was invested in the stocks that form in the index, in the same proportion in which they are weighted in the index, and then Rs 1000 would have become Rs 1550 today. There are two popular methods of computing the index. They are price weighted method like Dow Jones Industrial Average (DJIA) or the market capitalization method like Nifty or Sensex.
What is Stock Future?

Stock future means dealing in specific scrip. E.g. if you buy or sell Reliance future it called stock future. National Stock exchange fixed lot size for each and every stock future. It means one can buy or sell that size of lot. Lit is given below
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Permitted Lot Sizes of Contracts

No. 1 2 Underlying S&P CNX Nifty CNX IT Symbol NIFTY CNXIT Market Lot 50 50
Derivatives on Individual Securities 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Associated Cement Co. Ltd. Andhra Bank Arvind Mills Ltd. Bajaj Auto Ltd. Bank of Baroda Bank of India Bharat Electronics Ltd. Bharat Heavy Electricals Ltd. Bharat Petroleum Corporation Ltd. Canara Bank Cipla Ltd. Dr. Reddy's Laboratories Ltd. GAIL (India) Ltd. Grasim Industries Ltd. Gujarat Ambuja Cement Ltd. HCL Technologies Ltd. Housing Development Corporation Ltd. HDFC Bank Ltd. Hero Honda Motors Ltd. Hindalco Industries Ltd. Hindustan Lever Ltd. ACC ANDHRABANK ARVINDMILL BAJAJAUTO BANKBARODA BANKINDIA BEL BHEL BPCL CANBK CIPLA DRREDDY GAIL GRASIM GUJAMBCEM HCLTECH Finance HDFC HDFCBANK HEROHONDA HINDALC0 HINDLEVER 188 2300 4300 200 700 950 138 75 550 800 1250 400 750 85 1100 650 75 200 400 1595 1000 1300
Hindustan Petroleum Corporation Ltd. HINDPETRO
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23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50
ICICI Bank Ltd. I-FLEX Solutions Ltd. Infosys Technologies Ltd. Indian Petrochemicals Corps. Ltd. Indian Oil Corporation Ltd. ITC Ltd. Mahindra & Mahindra Ltd. Maruti Udyog Ltd. Mastek Ltd. Mahanagar Telephone Nigam Ltd. National Aluminium Co. Ltd. Oil & Natural Gas Corp. Ltd. Oriental Bank of Commerce Punjab National Bank Polaris Software Lab Ltd. Ranbaxy Laboratories Ltd. Reliance Energy Ltd. Reliance Industries Ltd. Satyam Computer Services Ltd. State Bank of India Shipping Corporation of India Ltd. Syndicate Bank Tata Power Co. Ltd. Tata Tea Ltd. Tata Motors Ltd. Tata Iron and Steel Co. Ltd. Union Bank of India Wipro Ltd.
ICICIBANK I-FLEX INFOSYSTCH IPCL IOC ITC M&M MARUTI MASTEK MTNL NATIONALUM ONGC ORIENTBANK PNB POLARIS RANBAXY REL RELIANCE SATYAMCOMP SBIN SCI SYNDIBANK TATAPOWER TATATEA TATAMOTORS TISCO UNIONBANK WIPRO
75 150 200 1100 600 300 312 400 1600 1600 1150 225 1200 600 2800 800 138 75 600 132 1600 1900 200 275 412 382 2100 600
Source: www.nseindia.c om
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What are the terminologies used in a Futures contract?

The terminologies used in a futures contract are Spot Price: The current market price of the scrip/index Future Price: The price at which the futures contract trades in the futures market Tenure: The period for which the future is traded Expiry date: The date on which the futures contract will be settle Basis : The difference between the spot price and the future price Contact size: the amount of assets will be delivered under one contract. For instances contract size of NSEindex future is 200 Nifties. Initial margin: The amount that must be deposited in the margin account at the time of the future contract it is known as initial margin. Mark-to-market: in the future market, at the end of each day, the margin account is adjusted to reflect the investors gain or loss depending upon future closing price. This is called mark-to-market.
Why are index futures more popular than stock futures?

Globally, it has been observed that index futures are more popular as compared to stock futures. This is because the index future is a relatively low risk product compared to a stock future. It is easier to manipulate prices for individual stocks but very difficult to manipulate the whole index. Besides, the index is less volatile as compared to individual stocks and can be better predicted than individual stock.
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How is the future price arrived at?

Future price is nothing but the current market price plus the interest cost for the tenure of the future. This interest cost of the future is called as cost of carry. If F is the future price, S is the spot price and C is the cost of carry or opportunity cost, then F=S+C F = S + Interest cost, since cost of carry for a finance is the interest cost Thus, F=S (1+r) T Where r is the rate of interest and T is the tenure of the futures contract. The rate of interest is usually the risk free market rate.
Example:
The spot price of Reliance is Rs 300. The bank rate prevailing is 10%. What will be the price of one-month future?
Solution
The price of a future is F= S (1+r) T The one-month Reliance future would be the spot price plus the cost of carry. Since the bank rate is 10 %, we can take that as the market rate. This rate is an annualized rate and hence we recalculate it on a monthly basis. F=300(1+0.10) (1/12) F= Rs 302.39
Example:
The shares of Infosys are trading at 3000 rupees. The 1-month future of Infosys is Rs 3100. The returns expected from the Govt. security funds for the same period is 10 %. Is the future of Infosys overpriced or under priced?
Solution
The 1-month Future of Infosys will be F= 3000(1+0.10) (1/12) F= Rs 3023.90 But the price at which Infosys is traded is Rs 3100. Thus it is overpriced by Rs 76.
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Pay-Off Profile of Future

Payoff profile for a buyer of Futures:
The payoff profile for Futures is linear. As the spot price increases, the profit from having bought a Future increases. Similarly, as spot price decreases, the profit from having sold Futures increases and is a mirror image of the profit from buying. The point where the spot price and the Futures price are same is the breakeven point.
Payoff for a writer of future:

The payoff for a person who sells a future contact is similar to the payoff for a person who shorts assets. He has a potentially unlimited upside as well as potentially unlimited downside. From the diagram we can able to understand that when the index moves down the short future position starts making profit, and when the index moves up, it starts making losses.
Payoff profile for writer of future

Profit
1220 0 Nifty
Loss
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What happens if dividend is going to be declared?

Dividend is an income to the seller of the future. It reduces his cost of carry to that extent. If dividend is going to be declared, the same has to be deducted from the cost of carry Thus the price of the future in this case becomes, F= S (1+r-d) T Where d is the dividend.
Example:
The spot price of Reliance is Rs 300. The bank rate prevailing is 10%. What will be the price of one-month future? Reliance will be paying a dividend of 50 paise per share
Solution:
Since Reliance is paying 50 paisa per share and the face value of reliance is Rs 10, the dividend rate is 5%. So while calculating futures, F=300(1+0.10-0.05) (1/12) F= Rs. 301.22
What happens if dividend is declared after buying a future?

If the dividend is declared after buying a one-month future, the cost of carry will be reduced by a pro rata amount. For example, if there is a one-month future ending June 30th and dividend is declared on June 15th, then dividend benefit will be reduced from the cost of carry for 15 days. Since the seller is holding the shares and will transfer the shares to the buyer only after a month, the dividend benefit goes to the seller. The seller will enjoy the benefit to the extent of interest on dividend. Thus net cost of carry = cost of carry dividend benefits
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Example:
The spot price of Reliance is Rs 300. The bank rate prevailing is 10%. Reliance declares a dividend of 5%. What will be the price of one-month future?
Solution:
The benefit accrued due to the dividend will be reduced from the cost of the future. One month future will be priced at F= 300(1+0.10) (1/12) F = 302.39 Cost of Carry = Rs 302.39-Rs 300 = Rs 2.39 The interest benefit of the dividend is available for 15 days, ie 0.5 months. Dividend for 15 days = 300(1+0.05) (0.5/12) Dividend Benefit = Rs300.61- Rs 300= Rs0.61 Therefore, net cost of the carry is, Rs2.39-Rs0.61 = Rs 1.78 Therefore the price of the future is Rs 300+Rs 1.78 = Rs 301.78 In practice, the market discounts the dividend and the prices are automatically adjusted. The exchange steps into the picture if the dividend declared is more than 10 % of the market price. In such cases, there is an official change in the price. In other cases, the market does the adjustment on its own.
What happens in case a bonus/ stock split is declared on the stock in which have futures positions?
If a bonus is declared, the settlement price is adjusted to reflect the bonus. For example, if you have 200 Reliance at Rs 300 and there is a 1:1 bonus, then the position becomes 400 Reliance at Rs 150 so that the contract value is unaffected.
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Comparison of spot price and future price
Future prices lead the spot prices. The spot prices move towards the future Prices and the gap between the two are always closing with as the time to settlement decreases. On the last day of the future settlement, the spot price equals the future price.
The futures price can be lower than the spot price too. This depends on the fundamentals of the stock. If the stock is not expected to perform well and the market takes a bearish view on them, then the futures price can be lower than the spot price. Future prices can fall also due to declaration of dividend.
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What happens if buy an index future and there is a dividend declared on a stock that comprises the index?
Practically speaking, the index is corrected for these things in case there is a dividend declared for such a stock. Theoretically, dividend is adjusted in the following manner: 1. The contribution of the stock to the index is calculated. The index, as discussed earlier, is a market capitalization index. 2. Then the number of shares in the index is calculated. This is obtained by dividing the contribution to the index by the market price. 3. The dividend on the index is the dividend on the number of shares of the stock in the index. 4. The interest earned on the dividend is calculated and reduced from the cost of carry to obtain the net cost of carry.
Example:
The index is at 1000. There is a dividend of Rs 5 per share on HLL. HLL contributes to 15 % of the index. The market price of HLL is Rs 150. What will be the cost of the 1-month future if the bank rate is 10%?
Solution:
The future will be priced at F= 1000(1+0.10) (1/12) F= 1008 The weight of HLL in the index is 15% i.e. 0.15*1000=150. The market price of HLL is Rs 150 Therefore, the number of shares of HLL in the index=1 The dividend earned on this is Rs 5 Dividend benefit on Rs 5 is 5(1+0.10) (1/12) Dividend benefit = Rs 0.04 Cost of the future will be Rs 1008-Rs 0.05= Rs 1007.95 But in practice, the market discounts the dividends and price adjustment is made accordingly.
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What happens in the real world?

In the real world, derivatives are highly volatile instruments and there have been lots of losses in the various financial markets. The classic examples have been Long Term Capital Markets (LTCM) and Barings. As a result, the regulators have decided that a minimum of Rs 2 lacs should be the contract size. This is done primarily to keep the small investors away from a volatile market till enough experience and understanding of the markets is acquired. So the initial players are institutions and high net worth individuals who have a risk taking capacity in these markets. Because of this minimum amount, lots are decided on the market price such that the value is Rs 2 lacs. As a result one has to buy a minimum of 200 Nifties or in case of Sensex, 50. Similarly minimum lots are decided for individual stocks too. Thus you will find different stock futures having different market lots. The lots decided for each stock was such that the contract value was Rs 2 lakhs. This was at the point of introduction of these instruments. However the lot size has remained the same and has not been adjusted for the price changes. Hence the value of the contract may be slightly lower in case of certain stocks. Trading, i.e. Buying and Selling take place in the same manner as the stock markets. There will be an F & O terminal with the broker and the dealer will enter the orders for you. Another fact of the real world is that, since the future is a standard instrument, you can close out your position at any point of time and need not hold till maturity.
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How is the trading done on the exchange?

Buying of futures is margin based. You pay an up front margin and take a position in the stock of your choice. Your daily losses/ gains relative to the future price will be monitored and you will have to pay a mark to market margin. On the final day settlement is made in cash and is the difference between the futures price and the spot price prevailing at that time For example, if the future price is Rs 300 and the spot price is Rs 330, then you will make a cash profit of Rs 30. In case the spot price is Rs 290, you make cash loss of Rs 10. Thus futures market is a cash market. In future, there is a possibility that the futures may result in delivery. In such a scenario, the future market will be merged with the spot market on the expiration day and it will follow the T+ 3 rolling settlement prevalent in the stock markets
How does the mark to market mechanism work?

Mark to market is a mechanism devised by the stock exchange to minimize risk. In case you start making losses in your position, exchange collects money to the extent of the losses up front. For example, if you buy futures at Rs 300 and its price falls to Rs 295 then you have to pay a mark to market margin of Rs 5. This is over and above the margin money that you pay to take a position in the future.
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INTRODUCTION TO OPTIONS
What are options?
As seen earlier, futures are derivative instruments where one can take a position for an asset to be delivered at a future date. But there is also an obligation as the seller has to make delivery and buyer has to take delivery. Options are one better than futures. In option, as the name indicates, gives one party the option to take or make delivery. But this option is given to only one party in the transaction while the other party has an obligation to take or make delivery. The asset can be a stock, bond, index, currency or a commodity but since the other party has an obligation and a risk associated with making good the obligation, he receives a payment for that. This payment is called as premium. The party that had the option or the right to buy/sell enjoys low risk. The cost of this low risk is the premium amount that is paid to the other party. Thus we have seen an option is a derivative that gives one party a right and the other party an obligation to buy /sell at a specified price for a specified quantity. The buyer of the right is called the option holder. The seller of the right (and buyer of the obligation) is called the option writer. The cost of this transaction is the premium. For example, a railway ticket is an option in daily life. Using the ticket, a passenger has an option to travel. In case he decides not to travel, he can cancel the ticket and get a refund. But he has to pay a cancellation fee, which is analogous to the premium paid in an option contract. The railways, on the other hand, have an obligation to carry the passenger if he decides to travel and refund his money if he decides not to travel. In case the passenger decides to travel, the railways get the ticket fare. In case he does not, they get the cancellation fee. The passenger on the other hand, by booking a ticket, has hedged his position in case he has to travel as anticipated. In case the travel does not materialize, he can get out of the position by canceling the ticket at a cost, which is the cancellation fee.
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Benefits of Options Trading

Besides offering flexibility to the buyer in form of right to buy or sell, the major advantage of options is their versatility. They can be as conservative or as speculative as one's investment strategy dictates.
Some of the benefits of Options are as under:

High leverage as by investing small amount of capital (in form of premium), one can take exposure in the underlying asset of much greater value. Pre-known maximum risk for an option buyer Large profit potential and limited risk for option buyer One can protect his equity portfolio from a decline in the market by way of buying a protective put wherein one buys puts against an existing stock position. This option position can supply the insurance needed to overcome the uncertainty of the marketplace. Hence, by paying a relatively small premium (compared to the market value of the stock), an investor knows that no matter how far the stock drops, it can be sold at the strike price of the Put anytime until the Put expires. E.g. An investor holding 1 share of Infosys at a market price of Rs 3800/-thinks that the stock is over-valued and decides to buy a Put option' at a strike price of Rs. 3800/- by paying a premium of Rs 200/If the market price of Infosys comes down to Rs 3000/-, he can still sell it at Rs 3800/by exercising his put option. Thus, by paying premium of Rs 200, his position is insured in the underlying stock.
Please note:
All or part of your investments using Bullish Strategies has greater risk of loss in falling market. Investments using Neutral Strategies have greater risk of loss in volatile markets Investments using Bearish Strategies have greater risk of loss in rising markets.
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Lot of jargons about options.

There are some basic terminologies used in options. These are universal terminologies and mean the same everywhere. a.) Option holder: The buyer of the option who gets the right b.) Option writer: The seller of the option who carries the obligation c.) Premium: The consideration paid by the buyer for the right d.) Exercise price: The price at which the option holder has the right to buy or sell. It is also called as the strike price. e.) Call option: The option that gives the holder a right to buy f.) Put option: The option that gives the holder a right to sell g.) Tenure: The period for which the option is issued h.) Expiration date: The date on which the option is to be settled i.) American option: These are options that can be exercised at any point till the expiration date j.) European option: These are options that can be exercised only on the expiration date k.) Covered option: An option that an option writer sells when he has the underlying shares with him. l.) Naked option: An option that an option writer sells when he does not have the underlying shares with him m.) In the money: An option is in the money if the option holder is making a profit if the option was exercised immediately n.) Out of money: An option is in the money if the option holder is making a loss if the option was exercised immediately o.) At the money: An option is in the money if the option holder evens out if the option was exercised immediately
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Call option
A call option gives the holder a right to buy shares. The option holder will make money if the spot price is higher than the strike price. The pay off assumes that the option holder will buy at the strike price and sell immediately at the spot price. But if the spot price is lower than the strike, the option holder can simply ignore the option. It will be cheaper to buy from the market. The option holder loss is to the extent of premium he has paid. But if the spot price increases dramatically then he can make wind fall profits. Thus the profits for an option holder in a call option are unlimited while losses are capped to the extent of the premium. Conversely, for the writer, the maximum profit he can make is the premium amount. But the losses he can make are unlimited.
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Payoff profile for a buyer of Call Options:

In Options, in case of a call, it is an Option to buy an asset at strike price. The maximum profit for the buyer of a Call Option is theoretically unlimited and maximum loss is limited to the extent of Option premium. Buy a call Stock value 520 Spot price 480 485 490 500 510 520 530 540 550 560
Net Gain/Loss
25 20 15 10 5 0 -5 -10 -15 -20 -25 Net Gain/Loss 480 485 490 495 500 510 520 530 540 550 560
540 0 0 0 0 0 0 0 0 10 20
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Put option
The put option gives the right to sell. The option holder will make money if the spot price is lower than the strike price. The pay off assumes that the option holder will buy at spot price and sell at the strike price But if the spot price is higher than the strike, the option holder can simply ignore the option. It will be beneficial to sell to the market. The option holder loss is to the extent of premium he has paid. But if the spot price falls dramatically then he can make wind fall profits. Thus the profit for an option holder in a put option is unlimited while losses are capped to the extent of the premium. This is a theoretical fallacy as the maximum fall a stock can have is till zero, and hence the profit of a option holder in a put option is capped. Conversely, the maximum profit that an option writer can make in this case is the premium amount. But in the above pay off, we had ignored certain costs like premium and brokerage. These are also important, especially the premium. So, in a call option for the option holder to make money, the spot price has to be more than the strike price plus the premium amount. If the spot is more than the strike price but less than the sum of strike price and premium, the option holder can minimize losses but cannot make profits by exercising the option. Similarly, for a put option, the option holder makes money if spot is less than the strike price less the premium amount. If the spot is less than the strike price but more than the strike price less premium, the option holder can minimize losses but cannot make profits by exercising the option
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Payoff profile for a buyer of Put Options:

Put Option is an Option to sell an asset at the strike price. As with any long position, the loss is limited to the premium paid with an unlimited potential for profit. However, since spot prices cannot be negative, the unlimited gain would be limited to X, the strike price, since the maximum gain can be X when the spot price touches zero. Stock price 520 Spot price 480 485 490 500 510 520 530 540 550 560 Buy a put 500 20 15 10 0 0 0 0 0 0 0
Net Gain/Loss (price fall Situation)

25 20 15 10 5 0 -5 -10 -15 -20 -25 Net Gain/Loss 480 485 490 500 510 520 530 540 550 560
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Example: He call option for Reliance is selling at Rs 10 for a strike price of Rs 330. What will be the profit for the option holder if the spot price touches a) Rs. 350 b) Rs.337
Solution
a. The option holder can buy Reliance at a price of Rs 330. He has also paid a premium of Rs 10 for the same. So his cost of a share of Reliance is Rs 340. He can sell the same in the spot market for Rs 350. He makes a profit of Rs 10 b. The option holder can buy Reliance at a price of Rs 330. He has also paid a premium of Rs 10 for the same. So his cost of a share of Reliance is Rs 340. He can sell the same in the spot market for Rs 337 He makes a loss of Rs 3. But he has reduced his losses by exercising the option. Had he not exercised the option, he would have made a loss of Rs 10, which is the premium that he paid for the option.
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Should one always buy an option?

This is not always the case. The writer of the option too can make money. Basically, the option writers and option holders are people who are taking a divergent view on the market. So if the option writer feels the markets will be bearish, he can write call options and pockets the premium. In case the market falls, the option holder will not exercise the option and the entire premium amount can be a profit. But if the option writer is bullish on the market, then he can write put options. In case the market goes up, the option holder will not exercise the option and the premium amount is a profit for the option writer. The other area that an option writer makes money is the spot price lying in the range between the strike price and the strike plus premium For example, if you write a call option on Reliance for a strike prices of Rs 300 at a premium of Rs 30. If the spot price is Rs 320, then the option holder will exercise the option to reduce losses and buy it at Rs 300. But you have already got the premium of Rs 30. So in effect, you have sold the stock at Rs. 330, which is Rs 10 above the spot price! This profit increases even more if you calculate the opportunity cost of Rs 30 as this amount is received up front. Let us look at a typical pay off table for a call option, for the buyer as well as writer. Let us assume a call option with a strike price of Rs 200 and a premium of Rs 10
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Table Pay off Table for buyer and writer of an option
In the above pay off table, if we take 200 as the median value, we see that the writer has made money 5 out of 7 occasions. He has made money even when the option is exercised, as long as the spot price is below the strike price plus the premium. Thus writers also make money on options, as the buyer is not at an advantage all the time.
What are the options that are currently traded in the market?
The options that are currently traded in the market are index options and stock options on the 30 stocks. The index options are European options. They are settled on the last day. The stock options are American options. There are 3 options-1, 2, 3 month options. There can be a series of option within the above time span at different strike prices. Another lingo in option is near and far options. A near option means the option is closer to expiration date. A Far option means the option is farther from expiration date. A 1month option is a near option while a 3-month option is a far option. In option trading, what gets quoted in the exchange is the premium and all that people buy and sell is the premium.
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We said we could have different option series at various strike prices. How is this strike price arrived at?
The strike bands are specified by the exchange. This band is dependent on the market price.
Thus if a stock is trading at Rs. 100 then there can be options with strike price of Rs 105,110,115, 95, 90 etc.
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Calculation of option premium.

In practice, it is the market that decides the premium at which an option is traded. There are mathematical models, which are used to calculate the premium of an option. The simplest tool is the expected value concept. For example, for a stock that is quoting at Rs 95. There is a 20 % probability that it will become Rs 110. There is a 30 % probability that it will become Rs 105. There is 30% probability that the stock will remain at Rs.95 and a 20 % probability that it will fall to Rs 90. If the strike price of a call option is to be Rs 100, then the option will have value when the spot goes to Rs 105 or Rs 110. It will be un- exercised at Rs 95 and Rs 90. If it is Rs105 and Rs 110, the money made is Rs 10 and 15 respectively. The expected returns for the above distribution is 0.20*15+0.30*10=Rs 6.
Thus this the price that one can pay as a premium for a strike price of Rs 100 for a stock trading at Rs 95. Rs 6 will also be the price for the seller for giving the option holder this opportunity. This is a very simple thumb calculation. Even then, one would require a lot of background data like variances and expected price movements. There are more advanced probabilistic models like the Black Scholes model and the Binomial Pricing model that calculates the options. One need not go deep into those and it would suffice to say that option calculators are readily available. Please visit www.indiainfoline.com/stok/ to use an option calculator based on Black Scholes Model.
What happens when one decided to exercise the option?

When the option holder decides to exercise the option, the option will be assigned to the option writer on a random basis, as decided by the software of the exchange. The European options are also the similarly decided by the software of the exchange. The index options are European options. In future, there is a possibility that the options may result in delivery. In such a scenario, the option market will be merged with the spot market on the expiration day and it will follow the T+ 3 rolling settlement prevalent in the stock markets
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OPTION STRATEGIES
There are the various strategies about derivatives that limit your losses. In derivatives trading the amount exposed is very high hence it is advisable for you to have the knowledge of such strategies of derivatives. There are basically two types of strategies in derivatives: (1) Spread Strategies (2) Combination Strategies
Spread Strategies:
Spread strategies involve dealing in only one type of option i.e. call option or put options. Spread means the different between the two strike prices of the scrip of the same expiry period. For example, Satyam call options with strike price Rs. 220 and Rs. 230 of August, in this case the spread id of Rs. 10. There are various spread strategies that we will see in the latter stage of this content. The examples of spread strategies are as follows (1) (2) (3) Bull Spread strategies with call options Bull Spread strategies with put options Butterfly Spread strategies
Combination Strategies
Spread Strategies involve either call or put option but combination strategies involve trading of dealing with call and put option simultaneously. There are various types of combination strategies. The examples of combination strategies are as follows: (1) Straddle Strategy (2) Strip strategy (3) Strap Strategy
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Options as Hedging Tool

Hedging: Long Stock Long Put
Hedging represents a strategy by which an attempt is made to limit the losses in one position by simultaneously taking a second offsetting position. Typically, a hedge strategy strives to prevent large losses without significantly reducing the gains. Very often, options in equities are employed to hedge a long or short position in the underlying common stock. Such options are called covered options in contrast to the uncovered or naked options, discussed earlier. This strategy viz. Long Stock Long Put involves buying a stock and simultaneously buying a Put Option. An example will demystify the nitty-gritty. Consider an investor who buys a share for Rs 100. To guard against the risk of loss from a fall in its price, he buys a put for Rs 16 for an exercise price of, say, Rs 110. He would, obviously exercise the option only if the price of the share were to be less than Rs. 110. The following table gives the profit/ loss for some selected values of the share price on maturity of the option. Share Price 70 80 90 100 110 120 130 140 Exercise Price 110 110 110 110 110 110 110 110 Profit on Profit/ loss on exercise (i) share held (ii) 24 -30 14 -20 4 -10 -6 0 -16 10 -16 20 -16 30 -16 40 Net Profit (i) + (ii) -6 -6 -6 -6 -6 4 14 24
For instance, at a share price of Rs. 80, the put will be exercised and the resulting profit would be Rs. 14, equal to Rs. 110 Rs. 80, or Rs. 30 minus the put premium of Rs. 16. With a loss of Rs. 20 incurred for the reason of holding the share, the net loss equals to Rs. 6.
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The profits resulting from the strategy of holding a long position in the stock and long put are shown in the following figure. In all the figures that follow now, the dashed lines depict the relationship between the profit and stock prices for the stock in question, on the one hand, and profit and the option on the other hand. The solid line in each case depicts the relationship between profit and stock prices for the whole portfolio. It may further be noted that the profit/ loss shown is on a per share basis.
Profit 50 40 30 20 10 0 10 20 30 40 Loss Hedging: Long Stock Long Put E Profit on exercise of Put
Profit/ loss on Long Stock
Profit/ loss on hedging Stock Price
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Hedging: Short Stock Long Call

Unlike an investor with a ling position in stock, a short seller of stock anticipates a decline in stock prices. By shorting the stock now and buying it at a later date at a lower price in the future, the investor intends to make a profit. Any price increase can bring losses because of an obligation to purchase at a later date. To minimize the risk involved, the investor can buy a call option with an exercise price equal to or close to the selling price of the stock Let us take a hypothetical case of an investor who shorts a share at Rs. 100 and buys a call option for Rs. 4 with a strike price of Rs. 105. The conditional payoffs resulting from some selected prices of the share are shown in the next table. Share Price 90 95 100 105 110 115 120 Exercise Price 105 105 105 105 105 105 105 Profit on Profit/ loss on exercise (i) share held (ii) -4 15 -4 10 -4 5 -4 0 1 -5 6 -10 11 -15 Net Profit (i) + (ii) 11 6 1 -4 -4 -4 -4
The following figure illustrates the strategy.
50 40 30 20 10 0 10 20 30 40 Hedging: Short Stock Long call E Stock Price Profit/ Loss in hedging Profit/ Loss on Call Option Profit/Loss on Short Stock
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Hedging: Long Stock Short Call

In the previous two strategies, the investor takes Long positions in the Option- be it Call or Put. Hedging can also be undertaken by writing (taking a Short position) Call as well as Put Options in appropriate circumstances. One of such strategies is to write a covered call option when the investor has already taken a long position in the underlying individual stock. If the common stock is not expected to witness a significant change, either way, in the near future, then the strategies of writing calls and puts may be usefully employed to minimize the risk. The following paragraph shows-How? Take for an example, if an investor has bought a share for Rs. 100, he can employ this strategy by writing a call option with the strike price of, say Rs. 105, with the premium of Rs. 3. The profit/ loss occurring at some prices of the underlying share, is indicated in the following table. Share Price 90 95 100 105 110 115 120 Exercise Price 105 105 105 105 105 105 105 Profit on Profit/ loss on exercise (i) share held (ii) 3 -10 3 -5 3 0 3 5 -2 10 -7 15 -12 20 Net Profit (i) + (ii) -7 -2 3 8 8 8 8
The following chart explains the same phenomena graphically.
50 40 30 20 10 0 10 20 30 40 Hed in Lo Stock Short Call g g: ng Pro Lo o fit/ ss n h g ed ing Profit/ Loss on C all O ption E Stock Price Profit/ Loss on Long Stock
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Hedging: Short Stock Short Put

Exactly adverse strategy is to be adopted when the investor short sells the share. He can hedge by writing a Put Option. Thus, by undertaking to be a buyer, the investor hopes to reduce the magnitude of loss that would be from an increase in the stock price, by limiting the profit that could be made when the stock price declines. Suppose, an investor shorts a share at Rs. 100 and write a put option for Rs.3, having an exercise price of Rs. 100. Clearly, the buyer of the put will exercise the option only if the share price does not exceed the exercise price. The table giving conditional payoff is given below: Share Price 90 95 100 105 110 115 120 Exercise Price 100 100 100 100 100 100 100 Profit on Profit/ loss on exercise (i) share held (ii) -7 10 -2 5 3 0 3 -5 3 -10 3 -15 3 -20 Net Profit (i) + (ii) 3 3 3 -2 -7 -12 -17
For the pictorial presentation of this strategy, see the next page.
Profit 50 40 30 20 10 0 10 20 30 40 Loss Hedging: Short Stock Short Put E Stock Price Profit/ Loss on Hedging Profit/ Loss on Put Option Profit/ Loss on Short Stock
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Determinants of Option value:

Volatility: Option premium deflects the personal belief of both buyer and sellers. Buyer of option thrives on changes in stock prices and gladly pay premium for option on volatile stocks. The more stock price fluctuates in the future, the better their chances, for making money and the buyers losses are limited to the amount of the premium. On the other hand, seller detests volatility, since it can only work against them. As a result, option seller usually demands much higher prices for writing options on volatile stocks. The willingness of buyer to pay higher premium combined with the reluctance of seller to write them produces higher premium on option of more volatile stocks. Expiration date: the expiration date of the option also affects the premium. The odds of a stock making a profitable move increase with time. The option buyer resembles a brand jumper. The longer the run, the better the chances of making a good jump. Because buyers benefit from the extended periods of time and sellers suffer buyers or seller agree to higher premiums for longer lasting options. For this reasons, options are a wasting asset. As time goes on, value of the option decreases, and decline usually occurs at a faster and faster pace. Striking Price: striking prices add a further complication to the analysis of option. This striking price remains the same during the entire life of the option contract. The nearer this striking price is to the market price of the underlying stock, the greater the buyers chances of making money on the option. In effect the striking price serves as a hurdle placed in front of an investor sprinting after profits. Higher hurdles or striking prices make it more difficult for option buyer to finish the race on time. In fact, many of the runners fall flat on their faces. Dividends: A dividend also affects option premiums. Generally speaking, firm paying high dividend seldom increases very much in price. So prospective call buyers avoid options on these stocks. Since options writers collect these dividends in addition to their premium income, they naturally prefer to write option on high dividend stocks. Buyers and seller compromise and agree to lower premiums for high-dividend paying stocks. Interest Rates: Interest rates have the opposite impact on premium. At higher interest rates, options writers sacrifice considerable income by holding stocks instead of bonds. As a result, they usually demand and get higher premiums for writing options during times of high interest rates.
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Swot Analysis
Strength
Local financial market knowledge Knowledge and access of local investor communities and investing culture. Powerful Online access and tools offering users complete control over portfolio and assets investing Sales and support presences in broader user base and geographical are area Leading market share Established brand
Weakness
Limited internet access in many regions
Opportunity
Emerging economy [India] offering huge potentials for M&A, IPO, Capital raising, mutual fund business Recent volatility and depressed assets prices in financial markets have drawn more attention of new investors Recent investment losses are making people reconsider portfolio reshuffling [generating more brokerage/sales business] Growing young generation entering workforce and more young people having disposable income to invest for long-term
Threats
Prolonged recession would drive average investors away from financial markets, impacting brokerage business Recent and upcoming job losses curbing peoples risk-taking and turning them to more traditional savings habits.
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Global players with established technology solutions and mature business models entering Indian market e.g. Goldman, Merill
Findings Conclusion Suggestions Annexure Bibliography Webography
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FINDINGS
The result of the study is a good understanding of different strategies in derivates. These strategies are effectively used for hedging loss or gaining risk-free return by arbitrage and provide good knowledge of when to use these strategies in most effective way according to different market situation. The study show how strategy works according to fundamental changes. The understanding of payoff patterns of futures and options ha s contributed to knowledge of implementation of strategies. The second part of the study reveled importance of derivatives in transferring risk, called hedging, which is a protection against losses is resulting from unforeseen price or volatility changes Finally, it recognizes the basic strategies and their usage in real stock market where beside price, various factors also have influence. The study also shows the determinants of option value.
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CONCLUSION
The Indian Capital Market has undergone qualitative changes in the last decades due to phenomenal growth of derivatives. Derivates are used for variety of purposes, but most important are hedging and arbitrages. This study attempts to simplify the concept of these basis strategies with the knowledge of market condition and payoff strategies so that investor can make out opportunities for reducing the loss and gain fair returns.
Thus the study provides significant knowledge of impact of derivates products in financial market.
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SUGGESTIONS
There should be the rapid development of derivates product in financial as well as commodity market all over the world but with some consciousness The main development may be like this: Introducing more innovative types of risk hedging contracts. Increasing the scope of current derivates product in emerging markets so as to include more individual stock as well as all types indices. Introducing adequate risk management and internal monitoring techniques to curb unnecessary speculation so to protect the interest of small investors. Introduce a barometer to compete with global cues and recession period.
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Annexure
Equity Derivatives in India - An Overview Derivatives Markets
Derivatives markets broadly can be classified into two categories, those that are traded on the exchange and the traded one to one or over the counter. They are hence known as Exchange Traded Derivatives OTC Derivatives (Over The Counter)
OTC Equity Derivatives

Traditionally equity derivatives have a long history in India in the OTC market. Options of various kinds (called Teji and Mandi and Fatak) in un-organized markets were traded as early as 1900 in Mumbai The SCRA however banned all kind of options in 1956.
Derivative Markets today

The prohibition on options in SCRA was removed in 1995. Foreign currency options in currency pairs other than Rupee were the first options permitted by RBI. The Reserve Bank of India has permitted options, interest rate swaps, currency swaps and other risk reductions OTC derivative products. Besides the Forward market in currencies has been a vibrant market in India for several decades. In addition the Forward Markets Commission has allowed the setting up of commodities futures exchanges. Today we have 18 commodities exchanges most of which trade futures.
e.g. The Indian Pepper and Spice Traders Association (IPSTA) and the Coffee Owners Futures Exchange of India (COFEI). In 2000 an amendment to the SCRA expanded the definition of securities to included Derivatives thereby enabling stock exchanges to trade derivative products. The year 2000 will herald the introduction of exchange traded equity derivatives in India for the first time.
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Equity Derivatives Exchanges in India

In the equity markets both the National Stock Exchange of India Ltd. (NSE) and The Stock Exchange, Mumbai (BSE) have applied to SEBI for setting up their derivatives segments. The exchanges are expected to start trading in Stock Index futures by mid-May 2000.
BSE's and NSEs plans

Both the exchanges have set-up an in-house segment instead of setting up a separate exchange for derivatives. BSEs Derivatives Segment, will start with Sensex futures as its first product. NSEs Futures & Options Segment will be launched with Nifty futures as the first product.
Product Specifications BSE-30 Sensex Futures

Contract Size - Rs. 50 times the Index Tick Size - 0.1 points or Rs. 5 Expiry day - last Thursday of the month Settlement basis - cash settled Contract cycle - 3 months Active contracts - 3 nearest months
Product Specifications S&P CNX Nifty Futures Contract Size - Rs. 200 times the Index Tick Size - 0.05 points or Rs. 10 Expiry day - last Thursday of the month Settlement basis - cash settled Contract cycle - 3 months Active contracts - 3 nearest months
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Membership
Membership for the new segment in both the exchanges is not automatic and has to be separately applied for. Membership is currently open on both the exchanges. All members will also have to be separately registered with SEBI before they can be accepted.
Membership Criteria NSE Clearing Member (CM)

Net worth - 300 lakh Interest-Free Security Deposits - Rs. 25 lakh Collateral Security Deposit - Rs. 25 lakh In addition for every TM he wishes to clear for the CM has to deposit Rs. 10 lakh.
Trading Member (TM)

Net worth - Rs. 100 lakh Interest-Free Security Deposit - Rs. 8 lakh Annual Subscription Fees - Rs. 1 lakh
BSE Clearing Member (CM)

Net worth - 300 lacs Interest-Free Security Deposits - Rs. 25 lakh Collateral Security Deposit - Rs. 25 lakh Non-refundable Deposit - Rs. 5 lakh Annual Subscription Fees - Rs. 50 thousand
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In addition for every TM he wishes to clear for the CM has to deposit Rs. 10 lakh with the following break-up. Cash - Rs. 2.5 lakh Cash Equivalents - Rs. 25 lakh Collateral Security Deposit - Rs. 5 lakh
Trading Member (TM)

Net worth - Rs. 50 lakh Non-refundable Deposit - Rs. 3 lakh Annual Subscription Fees - Rs. 25 thousand
The Non-refundable fees paid by the members are exclusive and will be a total of Rs.8 lakhs if the member has both Clearing and trading rights.
Membership Strength
The current membership strength of the exchanges is 1057 and 92.05% of the members are the corporate members. The composition of members at the end of the February month is presented in the following table. There are 19 registered professional clearing members at the end of February 2008. constitution CM WDM CM & CM WDM Segment WDM & Segments F&O Segments Corporate 1016 8 48 Individuals 100 0 0 Firms 130 0 0 Total 1246 8 48 CM & Total F&O Segments 810973 3040 3144 8711057
Trading Systems
NSEs trading system for its futures and options segment is called NEAT F&O. It is based on the NEAT system for the cash segment. BSEs trading system for its derivatives segment is called DTSS. It is built on a platform different from the BOLT system though most of the features are common.
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Settlement and Risk Management systems

Systems for settlement and risk management are required to satisfy the conditions specified by the L.C. Gupta Committee and the J.R. Verma committee. These include upfront margins, daily settlement, online surveillance and position monitoring and risk management using the Value-at-Risk concept.
Certification Programs
The NSE certification programme is called NCFM (NSEs Certification in Financial Markets). NSE has outsourced training for this to various institutes around the country. The BSE certification programme is called BCDE (BSEs Certification for the Derivatives Exchange). BSE conducts its own training run by its training institute. Both these Programmes are approved by SEBI.
Rules and Laws

Both the BSE and the NSE have been give in-principle approval on their rule and laws by SEBI. According to the SEBI chairman, the Gazette notification of the Bye-Laws after the final approval is expected to be completed by May 2000. Trading is expected to start by mid-June 2000.
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BIBLIOGRAPHY
Apte, P. G.(2002) International Financial Management, Tata McGraw Hill Chandra P.(2001) Financial Management: Theory and Practice, Tata McGraw Hill Basis of Derivatives : the stock exchange of Mumbai, India Info line Somnathan T.V.(2003) Derivatives, Tata McGraw Hill
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WEBOGRAPHY
www.bseindia.com www.nseindia.com www.rbi.org.in www.sebi.gow.in www.kotaksecurities.com www.angeltrade.com
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Actions of Investors to the Market Fluctuations

Q:1 A Trading member Mr. Manojbhai took proprietary positions in a November expiry contract. He bought 3000 trading units at 1210 and sold 2400 at 1220. If the initial margin per unit for the November contract is rs. 100 per unit, then the total initial margin payable by Mr. Manojbhai would be? Ans: He bought 3000 trading unit at 1210 and sold 2400 at 1220 so his earning from this trade is 24000. And hence close of that is 1220 so his total earnings from this trade is 30000. Q:2 The following are the details of trading member Ratanlals proprietary and client position: Proprietary: He buys 600 units @ 1020 and sells 1800 units @ 1025 Client A: He buys 2000 units @ 1015 Client B: He buys 1600 units @ 1016 and sells 800 units @ 1022 The settlement price of the day is 1023. What is MTM profit/loss for Ratanlal? Ans: Proprietor makes 1800 profit on buying ((1023-1020)*600=1800) and on selling makes 3600 profit On Buying ((1025-1023)*1800=3600) Client A makes 16000 profit On Buying ((1023-1015)*2000=16000) makes 800 loss on selling ((1022-1023)*800=800) so total profit is 31800(1800+3600+16000+11200-800) Q:3 What is the outstanding position on which initial margin will be calculated if Mr. Madanlal buys 800 which @ 1060 and sells 400 units @ 1055? Ans: 400 units(Buying 800-selling 400) Q:4 What will be MTM profit/loss of Mr. Ramesh if he buys 800 @ 1040 and sells @ 1045? The settlement price of the day was 1035? Ans: He buys at 1040 and sells at 1045 so 5rupee profit on this trade and value of that trade is 4000.
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Q:5 What is the outstanding position on which initial margin will be charged if no proprietary trading is done and the details of client trading are: Client 1: Buys 1000 units @ 1260 Client 2: Buys 800 units @ 1255 and Sells 1200 units @ 1260. Ans: 600 units (Total buying=1000+800=1800 and selling=1200, so 1800-1200) Q:6 The May futures contract on LNT. Closed at Rs.3940 yesterday. It closes today at Rs.3898.60. The spot closes at Rs.3800. Raju has a short position of 3000 in the May futures contract. He sells 2000 units of May expiring put options on LNT with a strike price of Rs.3900 for a premium of Rs.110 per unit. What is his net obligation to/from the clearing today? Ans: Pay out of 220000 Q:7 Kantaben sold a February Nifty futures contract for Rs.536500 on 15th January. Each Nifty future contract is for delivery of 100 Nifties. On 25th January, the index closed at 5415. How much profit/loss did she make? Ans: Her Loss of this particular trade is 5000 because ((5365-5415) =50*100) Q:8 Santosh is bullish about Company NTPC and buys ten one-month NTPC futures contracts at Rs.2,96,000. On the last Thursday of the month, NTPC closes at Rs.271. What will be his profit/loss? Ans: His Buying is 296 and he sell at 271 so difference is 25 and lot size of NTPC is 1000 So loss of this particular trade is (25*1000) = 25000. Q:9 Rajiv is bearish about Company IDBI and sells twenty one-month IDBI futures contracts at Rs.3,04,000. On the last Thursday of the month, IDBI closes at Rs.134. What will be his Profit/loss? Ans: He sold IDBI twenty future so value will be (304/2=152) so his selling rate is 152 and close of IDBI IS 134. So his profit from this trade is 18 and lot size is 2000 so his profit from this trade is 36000.
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Q:10 Chetan is bullish about index. Spot Nifty stands at 5200. He decides to buy one three-month Nifty call option contact with a strike of 5260 at a premium of Rs.60 per call. Three months later, the index closes at 5240. What will be his payoff position? (Contract size 100) Ans: Pay off his position is 60 rupee so payoff is 6000. Q:11 Suppose the Company PQR trades at 1000 in the cash market and two month PQR futures trade at 1030. If transactions costs involved are 0.4%. What is the arbitrage return possible? Ans: Return 1030/1000=3% (For 2 months) Minus transactions costs of 0.4% The net return=3% - 0.4% = 2.6% (For 2 months) The return per month is 1.3% Q:12 Mr. Amar buys 600 units @ 1040 and sells 400 units @ 1030. The settlement price is 1030. What is his MTM profit/loss? Ans: buying 600*1040=624000 and selling 400*1030=412000, Settlement price is 1030 So 200*1030=206000 Therefore, 624000-(412000+206000) =6000. Q:13 Deepak is bullish about the index. Spot Nifty stands at 2250. He decides to buy one three-month Nifty call option contract with a strike of 2290 at Rs.20 per call. Three months later the index closes at 2230.What will be his payoff position? Ans: He Buy Call at 20 Rupee so call calculation is (Spot prize Strike prize=Value) So (2330-2290-20)*100=2000 payoff Q:14 Satish is bullish about the index. Spot Nifty stands at 2225. He decides to buy one three-month Nifty call option contract with a strike of 2260 at Rs.20 a call. Three month later the index closes at 2235. What will be his payoff? Ans: Call value is 20 so he to pay 2000 for this call. Q:15 On 15th January Mr. Kajaria bought a January Nifty futures contract which cost him Rs.240000. Each Nifty futures contract is for delivery of 100 Nifties. On 25th January, the index closed at 2360. How much profit/loss did he make? Ans: Total cost 240000/100 units=2400 per Nifty futures. Indexed closed at 2360. So he made loss i.e.(2400-2360)*100=-4000.
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Reactions of Investors
1. Name: Mitesh k. Shah Script Name: Prajind (168) Reaction: Yesterday he bought this security on 182 but he wants to do doubling on this script on the rate 162 so buying value will be decreases. 2. Name: Rajesh Patel Script Name: Nifty Fresh Buying 5363 Reactions: Lots of volatility in future market so he wants to buy and particular in this Script he wants do intraday. Profit or loss. 3. Name: Amit Desai Script Name: Nifty at 5385 Reactions: He wants to sell 250 nifty on the same day and wants to pay margin and go for long position. 4. Name: Kishor Pardiwala Script Name: Reliance capital Reactions: He wants to sell a lot a relcapital on1946 (1 lot=550) was weak because of global weakness after some day. He made awesome profit. 5. Name: Hardik Upadhyay Script Name: Ibulls(692) Reactions: He short this position on713 of 200unit and square up at 692 so his earning form this trade 21 so profit form this trade is 4200. 6. Name: Vijay Tandel Script Name: JP ASSOCIATES LOT Reactions: He short this position on193 and changes in this script is 7 rupee so he pay margin and go for long position but next day again script value is 197 so he decides to make a loss on this script. So he made a loss.
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7. Name: Bharat Desai Script Name: RNRL(113) Reaction: He takes a delivery for this trade. 8. Name: Deepal Desai Script Name: INDIA Cement(204) Reactions: She bought this delivery on 296 but due t0 weakness in market she books loss on this trade and take a fresh position from this amount. 9. Name: Balukesh Patni Script Name: Essar oil 189 Reactions: He took this position on 348. He wants to do doubling in this script. 10. Name: Bhavin Desai Script Name: Walchandnagar(7134) Reactions: He took this share on 6120 the moment in this script is so volatile and all time high of this script is 12367. But he want more profit on this script so he go for long but for weakness in market script comes to 7134 than he take profit in this script.
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Master of Business Administration

Gujarat Technological University, Ahmedabad

Financial Derivatives And Its Benefits

Master of Business Administration

(Sharekhan pvt Ltd.)

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Gujarat Technological University, Ahmedabad

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Industrial Profile: Sharekhan Ltd

ARN 20669 INP00000066 NSDL-IN-DP-NSDL-233-2003 CDSL-IN-DP-CDSL-271-2004 www.sharekhan.com Info@sharekhan.com

Gujarat Technological University, Ahmedabad

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Master of Business Administration

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Master of Business Administration

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Product offered by Sharekhan:

Features of Classic Account

Gujarat Technological University, Ahmedabad

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Features OF Sharekhan Trade Tiger

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Online fund transfer activated with 12 Banks

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NEED OF THE STUDY

Gujarat Technological University, Ahmedabad

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Master of Business Administration

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SOURCE OF DATA COLLECTION

Gujarat Technological University, Ahmedabad

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BENEFITS OF THE STUDY

Gujarat Technological University, Ahmedabad

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