Derivatives

INTRODUCTION

Derivatives are products whose value is derived from one or more variables called bases. These bases can be underling asset such as foreign currency, stock or commodity, bases or reference rates such as LIBOR or US treasury rate etc. Example, an Indian exporter in anticipation of the riceipt of dollar denominated export proceeds may wish to sell dollars at a future date to eliminate the risk of exchange rate volatility by the data. Such transactions are called derivatives, with the spot price of dollar being the underling asset. Derivatives thus have no value of their own but derive it from the asset that is being dealt with under the derivative contract. A financial manager can hedge himself from the risk of a loss in the price of a commodity or stock by buying a derivative contract. Thus derivative contracts acquire their value from the spot price of the asset that is covered by the contract. The primary purposes of a derivative contract is to transfer risk from one party to another i.e. risk in a financial sense is transfer from a party that is willing to take it on. Here, the risk that is being dealt with is that of price risk. The transfer of such a risk can therefore be speculative in nature or act as a hedge against price movement in a current or anticipated physical position. Derivatives or derivative securities are contracts which are written between two parties (counterparties) and whose value is derived from the value of underlying widelyheld and easily marketable assets such as agricultural and other physical (tangible) commodities or currencies or short term and long-term and long term financial instruments or intangible things like commodities price index (inflation rate), equity price

Derivatives index or bond piece index. The counterparties to such contracts are those other than the original issuer (holder) of the underlying asset. Derivatives are also known as deferred delivery or deferred payment instruments. In a sense, they are similar to securitized assets, but unlike the latter, they are not the obligations which are backed by the original issuer of the underlying asset or security. It is easier to take a short position in derivatives than in other possible to combine them to match specific requirements, i.e., they are more easily amenable to financial engineering. The values of derivatives and those of their underlying assets are closely related. Usually, in trading derivatives, the taking or making of delivery of underlying assets is not involved; the transactions are mostly settled by taking offsetting positions in the derivatives themselves. There is, therefore, no effective limit on the quantity of claims which can be traded in respect of underlying assets. Derivatives are off balance sheet instruments, a fact that is said to obscure the leverage and financial might they give to the party. They are mostly secondary market instruments and have little usefulness in mobilizing fresh capital by the companies (warrants, convertibles being the exceptions). Although the standardized, general, exchange-traded derivatives are being contracts which are in vogue and which expose the users to operational risk, counterparty risk, liquidity risk, and legal risk. There is also an uncertainty about the regulatory status of such derivatives. There are bewilderingly complex varieties of derivatives already in existence, and the markets are innovating newer and newer ones continuously: plain, simple or straightforward, composite, joint or hybrid, synthetic, leveraged, mildly leveraged, customized or OTC-traded, standardized or organized-exchange traded. Although we are not going to discuss all of them, the names of certain derivatives may be noted here: futures, options, range forward and ratio range forward options, swaps, warrants,

Derivatives convertible bonds, credit derivatives, captions, swaptions, futures options, the ratio swaps, periodic floors, spread lock one and two, treasury-linked swaps, wedding bands three and six, inverse floaters, index amortizing swaps, and so on; because of their complexity, derivatives have become a continuing pain for the accounting person and a true mindbender for anyone trying to value them. The turnover of the stock exchanges has been tremendously increasing from last 10 years. The number of trades and the number of investors, who are participating, have increased. The investors are willing to reduce their risk, so they are seeking for the risk management tools. Mutual funds, FIIs and other investors who are deprived of hedging (i.e. risk reducing) opportunities will now have a derivatives market to bank on. While derivatives markets flourished in the developed world, Indian markets remain deprived of financial derivatives to the beginning of this millennium. While the rest of the world progressed by leaps and bounds on the derivatives front, Indian market lagged behind. Having emerged in the markets of the developed nations in the 1970s, derivatives markets grew from strength to strength. The trading volumes nearly doubled in every three years making it a trillion-dollar business. They became so ubiquitous that, now, one cannot think of the existence of financial markets without derivatives. Two broad approaches of SEBI is to integrate the securities market at the national level, and to diversify the trading products, so the more number of traders including banks, financial institutions, insurance companies, mutual funds, primary dealers etc., choose to transact through the exchanges. In this context the introduction of derivatives trading through Indian Stock Exchanges permitted by SEBI exchange in the year 2000 is a real landmark. Prior to SEBI abolishing the BADLA system, the investors had this system as a source of reducing the risk, as it has many problems like no strong margining system,

Derivatives unclear expiration date and generating counter party risk. In view of this problem SEBI abolished the BADLA system. After the abolition of the BADLA system, the investors are seeking for a hedging system, which could reduce their portfolio risk. SEBI thought the introduction of the derivatives trading, as a first step it has set up a 24 member committee under the chairmanship of Dr.L.C.Gupta to develop the appropriate regulatory framework for derivative trading in India, SEBI accepted the recommendations of the committee on May 11, 1998 and approved the phased introduction of the derivatives trading beginning with stock index futures. The Board also approved the suggestive bye-laws recommended for regulation and control of trading and settlement of derivatives contracts. However the securities contracts (regulation) act, 1956 (SCRA) needed amendment to include derivatives in the definition of securities to enable SEBI to introduce trading in derivatives. The government in the year 1999 carried out the

necessary amendment. The securities Laws (Amendment) bill 1999 was introduced to bring about the much needed changes. In December 1999 the new framework has been approved derivatives have been accorded the status of securities. The ban imposed on trading in derivatives way back in 1999 under a notification issued by the central Government has been revoked. Thereafter SEBI formulated the necessary

regulations/bye-laws and started in India at NSE in the same year and BSE started in the year 2001. In this module we are covering the different types of derivatives products and their features, which are traded in the stock exchanges in India.

Derivatives

NATURE OF THE PROBLEM:

The turnover of the stock exchanges has been tremendously increasing from last 10 years. The number of trades and the number of investors, who are

participating, have increased. The investors are willing to reduce their risk, so they are seeking for the risk management tools. Prior to SEBI abolishing the BADLA system, the investors had this system as a source of reducing the risk, as it has many problems like no strong margining system, unclear expiration date and generating counter party risk. In view of this problem SEBI abolished the BADLA system. After the abolition of the BADLA system, the investors are seeking for a hedging system, which could reduce their portfolio risk. SEBI thought the introduction of the derivatives trading, as a first step it has set up a 24 member committee under the chairmanship of Dr.L.C.Gupta to develop the appropriate regulatory framework for derivative trading in India, SEBI accepted the recommendations of the committee on May 11, 1998 and approved the phased introduction of the derivatives trading beginning with stock index futures. There are many investors who are willing to trade in the derivative segment, because of its advantages like limited loss and unlimited profit by paying the small premiums.

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NEED FOR THE STUDY

The emergence of derivatives market in the late 20 th century is the most notable development in the realm of financial markets. The derivative products serve as instruments of risk management for risk-averse investors by locking-in the asset prices to hedge against uncertainty.

This study on financial derivatives is an attempt to bring out the pricing principles and practices followed in the derivatives market of India which introduced derivatives barely 7 years ago. The study majorly focuses on the option contracts which are most commonly used risk management instruments. The study is focused mainly on the various factors influencing the options premium and also to study the practical implication of Black-Scholes model of options pricing. It is also an attempt to know the investors perception towards derivatives markets.

The study is also to focus on how the traders insure themselves using the derivatives. At the same time, to how in reality an investor uses it as a tool for speculation.

Derivatives it act as a risk hedging tool for the investors. The objective is to help the investor in selecting the appropriate derivatives instrument to attain the maximum return and to construct the portfolio in such a manner to meet the investor needs and to decide how best to reach the goals from the securities available.

Derivatives

OBJECTIVES OF THE STUDY:

To analyze the derivatives market in India. To analyze the operations of futures and options. To find out the profit/loss position of the option writer and option holder. To study about risk management with the help of derivatives. To analyze & evaluate the causes for fluctuations in the futures and options stocks. To evaluate how futures and options contracts are used to speculate or hedge based on anticipated prices of stocks. demonstrate a knowledge of the regulatory framework for financial derivatives; demonstrate a knowledge of the operations of derivatives exchanges, and be able to compare and contrast Exchange Traded and Over The Counter (OTC) instruments; demonstrate a detailed knowledge of the different types of forwards, futures, swaps, options and other financial derivatives, the principal differences between them, and where and how they are traded. demonstrate a detailed understanding of the variables (inputs) which influence the value of such derivatives, and the relationship of financial derivatives to their underlying assets; present the alternative derivatives strategies that would be appropriate for different market circumstances, and describe the advantages and disadvantages of each; demonstrate the uses of all financial derivatives, either alone, or in conjunction with underlying assets, to realise investment, hedging and trading objectives;

Derivatives

SCOPE OF THE STUDY:

The study is limited to Derivatives with special reference to futures and options in the Indian context and the Hyderabad stock exchange has been taken as a representative sample for the study. The study cant be said as totally perfect. Any alteration may come. The study has only made a humble attempt at evaluating

derivatives market only in Indian context. The study is not based on the international perspective of derivatives markets, which exists in NASDAQ, NYSE etc.

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LIMITATIONS OF THE STUDY:

The following are the limitations of this study:

The scrip chosen for analysis is ONGC and the contract taken is August and September 2005. The data collected is completely restricted to the ONGC of August and September 2005. Hence this analysis cannot be taken as universal. The analysis of options is limited to call options.
The study is limited only to the Indian derivatives market segment in NIFTY The legalities in the entire process are difficult to analyze because of the time of work. In this study limited to all companys in sector wise

Derivatives

Classification of derivatives: Forwards (currencies, stocks, swaps etc.,)

Forward contract is different from a spot transaction, where payment of price and delivery of commodity take place immediately the transaction is settled. In a forward contract the sale/purchase transaction of an asset is settled including the price payable not for deliver/settlement at spot, but at a specified future date. India has a strong dollar-rupee forward market with contracts being traded for one, two, Six-month expiration. Daily trading volume on this forward market is around $500 million a day. Indian users of hedging services are also allowed to buy derivatives involving other currencies on foreign markets.

Futures (Currencies, Stocks, Indices, Commodities):

A future contract has been defined as a standardized exchange-traded agreement specifying a quantity and price of a particular type of commodity (soyabeans, gold, oil etc.,) to be purchased or sold at a pre-determined date in the future. On contract date, delivery and physical possession take place unless the contract has been closed out. Futures are also available on various financial products and indices today. A future contract is thus a forward contract, which trades on an exchange. S&P CNX Nifty futures are traded on National Stock Exchange. This provides them transparency, liquidity, anonymity of trades and also eliminates the counter party risks due to the guarantee provided by national securities clearing corporation Ltd.

Options (Currencies, Stocks, Indexes etc):

Options are the standardized financial contracts that allow the buyer (holder) of the options, i.e., the right at the cost of option premium not the obligation, to buy (call

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Derivatives options) or sell (put options) a specified asset at a set price on or before a specified date through exchanges under stringent financial security against default. Risk management in derivatives: Derivatives are high-risk instruments and hence the exchanges have put a lot of measures to control this risk. The most critical aspect of risk management is the daily monitoring of price and position and the margining of those positions. NSE used the SPAN (Standard Portfolio Analysis of Risk). SPAN is a system that has origins at the Chicago mercantile exchange, one of the oldest derivative exchanges in the world. The objective of SPAN is to monitor the positions and determine the maximum loss that a stock can incur in a single day. This loss is covered by the exchange by imposing mark to market margins. SPAN evaluates risk scenarios, which are nothing but market conditions. The specific set of market conditions evaluated, are called the risk scenarios, and these are defined in terms of; a) How much the price of the underlying instrument is expected to change over one trading day, and b) How much the volatility of that underlying price is expected to change over one trading day. Based on the SPAN measurement, margins are imposed and risk covered. Apart from this, the exchange will have a minimum base capital of Rs.50 lakhs and brokers need to pay additional base capital if they need margins about the permissible limits

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TYPES OF DERIVATIVES:

Derivative products initially emerged as hedging devices against fluctuations in commodity prices, and commodity-linked derivatives remained the sole form of such products for almost three hundred years. Financial derivatives came into spotlight in the post-1970 period due to growing instability in the financial markets. However, since their emergence, these products have become very popular and by 1990s, they accounted for about two-thirds of total transactions in derivative products, in recent years, the market for financial derives has grown tremendously in terms of variety of instruments depending on their complexity and also turnover. In this class of equity derivatives the world over, futures and options on stock indices have gained more popularity than on individual stocks, especially among institutional investors, who are maor users of indexlinked derivatives. Even small investors find these useful due to high correlation of the popular indices with various portfolios and ease of use. The lower costs associated with index derivatives vis--vis derivative products based on individual securities is another reason for their growing use.

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

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

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Derivatives

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

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

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

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

SWAPS:
Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts.

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Derivatives

RESEARCH METHOLOLGY:Research design Data sources Secondary data : : : Analytical research. Secondary data. It is collected from the company records, company brouchers & Financial tools : Strike price model.

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DESCRIPTION OF THE METHOD SELECTION OF THE SCRIPS

The scrips are selected on a random basis and from five different sectors. The profitability position of the futures and options is studied. The scrips taken for the study for both futures and options are GMR Infrastructure Ltd, Hindustan Unilever Ltd, Ranbaxy Laboratories Ltd, Reliance Communications Ltd and Tata Motors Ltd.

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DATA COLLECTION
The mode of data collection is secondary. The data is collected from the business newspapers and internet. Two types of data are used in this research namely secondary and the primary data. The secondary data includes historical data of stock prices and the futures andoption prices for a period of 45 months was collected from the site of National Stock Exchange of India (www.nseindia.com).

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THE GROWTH OF DERIVATIVES MARKET

Over the last three decades, the derivatives markets have seen a phenomenal growth. A large variety of derivative contracts have been launched at exchanges across the world. Some of the factors driving the growth of financial derivatives are:

Increased volatility in asset prices in financial markets, Increased integration of national financial markets with the international markets, Marked improvement in communication facilities and sharp decline in their costs, Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies, and

Innovations in the derivatives markets, which optimally combine the risks and returns over a large number of financial assets leading to higher returns, reduced risk as well as transactions costs as compared to individual financial assets.

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Derivatives

DEFINITION:
Derivative is a product whose value is derived from the value of an underlying asset in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. Securities Contracts (Regulation) Act, 1956 (SC(R) A) defines derivative to include:1. A security derived from a debt instrument, share, and loan whether secured or unsecured, risk instrument or contract for differences or any other form of security. 2. A contract, which derives its value from the prices, or index of prices, of underlying securities.

The above definition conveys: i. That derivative is financial products and derives its value from the underlying assets. ii. Derivative is derived from another financial instrument/contract called the underlying. In this case of nifty index is the underlying.

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Derivatives

PARTICIPANTS/USES OF DERIVATIVES:

Figure:1.1

1. Hedgers use for protecting (risk-covering) against adverse movement. Hedging is a mechanism to reduce price risk inherent in open positions. Derivatives are widely used for hedging. A hedge can help lock in existing profits. Its purpose is to reduce the volatility of a portfolio, by reducing the risk.

2. Speculators to make quick fortune by anticipating/forecasting future market movements. Speculators wish to bet on future movements in the price of an asset. Futures and options contracts can give them an extra leverage; that is, they can increase both the potential gains and potential losses in a speculative venture. Speculators on the other hand arte those classes of investors who willingly take price risks to profit from price changes in the underlying.

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3. Arbitrageurs to earn risk-free profits by exploiting market imperfections. Arbitrageurs profit from price differential existing in two markets by simultaneously operating in the two different markets. Arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets.

FUNCTIONS OF DERIVATIVES MARKET: The following are the various functions that are performed by the derivatives markets. They are: Prices in an organized derivatives market reflect the perception of market participants about the future and lead the prices of underlying to the perceived future level. Derivatives market helps to transfer risks from those who have them but may not like them to those who have an appetite for them.

The two commonly used swaps are:

Interest rate swaps: Currency swaps:

REGULATORY FRAMEWORK
The trading of derivatives is governed by the provisions contained in the SCRA, the SEBI Act, the rules and regulations framed there under and the rules and bye-laws of stock exchanges.

Regulations for derivatives trading

SEBI set up a 24-member committee under the chairmanship of Dr.L.C.Gupta to develop the appropriate regulatory framework for derivatives trading in India. The

committee submitted its report in March 1998. On May 11, 1998 SEBI accepted the 20

Derivatives recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with tock index futures. SEBI also approved the suggestive bye-laws recommended by the committee for regulation and suggestive bye-laws recommended by the committee for regulation and control of trading and settlement of derivatives contracts. 1. The provisions in the SC(R)A and regulatory framework developed there under govern trading in securities. 2. The amendment of the SC(R)A to include derivatives within the ambit of securities in the securities in the SC(R)A made trading in derivatives possible within the framework of that Act. 3. Any Exchange fulfilling the eligibility criteria as prescribed in the L.C. Gupta committee report may apply to SEBI for grant of recognition under section 4 of the SC(R) A, 1956 to start trading derivatives. The derivatives

exchange/segment should huge a separate governing council and representation of trading/clearing members shall be limited to maximum of 40% of the total members of the governing council. The exchange shall regulate the sales practice of its members and will obtain prior approval of SEBI before start of trading in any derivative contact. 4. The Exchange shall have minimum 50 members. 5. The members of an existing segment of the exchange will not automatically become the members of the derivative segment need to fulfill the eligibility conditions as laid down by the L.C.Gupta committee. 6. The clearing and settlement of derivatives trades shall be through a SEBI approved clearing corporation/house. Clearing corporations/houses complying

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Derivatives with the eligibility conditions a s laid down by the committee have to apply SEBI for grant of approval. 7. Derivative brokers/dealers and clearing members are required to seek registration from SEBI. This is in addition to their registration a brokers of existing stock exchanges. The minimum net worth for clearing members of the derivatives clearing corporation/house shall be Rs.300 lakhs. The net worth of the member shall be computed as follows: Capital+Free reserves Less non-allowable assets viz, (a) Fixed assets (b) Pledged securities (c) Members card (d) Non-allowable securities (unlisted securities) (e) Bad deliveries (f) Doubtful debts and advances (g) Prepaid expenses (h) Intangible assets (i) 30% marketable securities The trading members are required to have qualified approved user and sales person who have passed a certification programme approved by SEBI.

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

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Derivatives 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 month Active contracts 3 nearest months Membership Criteria National Stock Exchange (NSE)

Clearing Member (CM)

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

Trading Member (TM)

Net worth Rs.100 lakhs Interest-Free Security Deposit Rs.8 lakhs Annual Subscription fees Rs.1 lakh

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Membership Criteria Mumbai Stock Exchange (BSE) Clearing Member (CM)

Net worth 300 lakhs Interest-Free Security Deposit Rs.25lakhs Collateral Security Deposit Rs.25 lakhs Non-refundable Deposit Rs.5 lakhs Annual Subscription Fees Rs.50,000. In addition for every TM he wishes to clear for the CM has to deposit Rs.10 lakhs with the following break-up. i. Cash Rs.25 lakhs ii. Cash Equivalents Rs.25 lakhs iii. Collateral Security Deposit Rs.5 lakhs

Trading Member (TM)

Net worth Rs.50 lakhs Non-refundable deposit Rs.3 lakhs Annual Subscription Fees Rs.25 thousant The Non-refundabel fee paid by the members is exclusive and will be a total of Rs.8 lakhs if the member has both clearing and trading rights.

Trading systems
NSEs trading system for its futures and options segment is called NEAT F&O. It is bsed on the NEAT system for the cash segment.

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Derivatives BSEs trading system for its derivatives segment is called DTs. It is built on a platform different from the BOLT system though most of the features are common. FORWARD CONTRACTS A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes along position agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same rice. Other contract details like delivery date, the parties to the contract negotiate price and quantity bilaterally. The forward contracts are normally traded outside the exchanges.

The salient features of forward contracts are: They are bilateral contracts and hence exposed to counter-party risk. Each contract is custom-designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. The contract price is generally not available in public domain. On the expiration date, the contract has to be settled by delivery of the asset. If the party wishes to reverse the contract, it has to compulsorily go to the same counter-party, which often results in high prices being charged.

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FUTURES
INTRODUCTION: Futures markets were designed to solve the problems that exist in forward markets. Futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or which can be used for reference purposes in settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 90 of futures transactions are offset this way.

The standardized items in a futures contract are: Quantity of the underlying Quality of the underlying The date and month of delivery The units of price quotations and minimum price changes Location of settlement

FUTURES MARKET
The Chicago Board of Trade was the earliest one found, in 1848 and currently is the largest futures exchange in the world. The method of trading futures in the organized exchanges is similar in some ways to and different in other ways from the way stocks are traded. As with the stocks and in other ways from the way stocks are traded. As with the 26

Derivatives stocks and options, customers can pace market, limit and stop orders. Further more once an order is transmitted to an exchange floor, it must be taken to a destined spot for execution by a member of exchange, just as it is done for stocks and options. This spot is known as pit because of its shape, which is circular with a set of interior descending steps on which members stand.

In futures market, there are floor brokers. They execute customers orders. In doing so they, (or their phone clerks) each keep a file of any stop or limit orders that cannot be executed, alternatively, members can be floor traders (those with very short holding periods, of less than a day, are known as locals or scalpers), they execute orders for their own personal accounts in an attempt to make profits by buying low and selling high.

SETTLEMENT OF FUTURES Mark to market settlement

There is a daily settlement for mark to market. The profits/losses are computed as the difference between the trade price (or the previous days settlement price, as the case may be) and the current days settlement price. The party who have suffered a loss are required to pay the mark to market loss amount to exchange which is in turn passed on to the party who has made a profit/. This is known as daily mark to market settlement. Theoretical daily settlement price for unexpired futures contracts, which are not traded during the last half an hour on a day, is currently the price computed as per the formula detailed below: F = S*RT Where:

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Derivatives F=theoretical futures price S=value of the underlying index/stock R=rate of interest (MIBOR Mumbai I Inter Offer Rate) T=time to expiration Rate of interest may be the relevant MIBOR rate or such other rate as may be specified. After daily settlement, all the open positions are reset to the daily settlement price. the pay-in and payout of the mark-to-market settlement is on T+1 days (T = Trade day).

Final settlement:
On the expiry of the futures contracts, exchange marks all positions to the final settlement price and the resulting profit / loss is settled in cash. The final settlement of the futures contracts is similar to the daily settlement process except for the method of computation of final settlement price. The final settlement profit/loss is computed as the difference between trade price (or the previous days settlement price, as the case may be), and the final settlement price of the relevant futures contract. Final settlement loss/profit amount is debited/credited to the relevant brokers clearing bank account on T+1 day (T = expiry day). This is then passed on the client from the broker. Open positions in futures contracts cease to exist after their expiration day.

DISTINCTION BETWEEN FUTURES AND FORWARDS

Forward contracts are often confused with futures contracts. The confusion is primarily because both serve essentially the same economic functions of the allocating risk in the presence of future price uncertainty. However futures are a significant improvement over the forward contracts as they eliminate counter party risk and offer more liquidity.

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TERMS USED IN FUTURES CONTRACT:

Spot price: the price at which an asset trades in the spot market. Futures price: the price at which the futures contract trades in the futures market. Contract cycle: the period over which a contract trades. The index futures contracts on the NSE have one-month, tow-months ad three-month expiry cycle, which expires on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three-month expiry is introduced for trading. Expiry date: it is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist. Contract size: the amount of asset that has to be delivered less than one contract. For instance, the contract size on NSEs futures market is 200 Nifties. Cost of carry: the relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.

OPTIONS: INTRODUCTION
Options on stocks were first traded on an organized stock exchange in 1973. Since then there has been extensive work on these instruments and manifold growth in the field has taken the world markets by storm. This financial innovation is present in cases of stocks, stock indices, foreign currencies, debt instruments, commodities, and futures contracts. An option is a type of contract between two people where one grants the other party the right to buy a specific asset at specific priced within a specific time period. 29

Derivatives Alternatively, the contract may grant the other person the right to sell a specific asset at a specific price within a specific period of time. The person who has received the right, and thus has a decision to make, is known as the option buyer because he or she must pay for this right. The person who has sold the right, and thus must respond to the buyers decision is known as the option writer.

TYPES OF OPTION CONTRACT

The two most basic types of option contracts are call option and put option. Currently such options are traded on many exchanges around the world. Furthermore, many of these contracts are created privately (that is off exchange or over the counter), typically involving institutions banking firms and their clients.

CALL OPTION:
The most prominent type of option contract is call option for stocks. It gives the buyer the right to buy (call away) a specific number of shares of a specific company from the option writer at a specific purchase price at any time up to and including a specific date. An investor buys a call options when he seems that the stock price moves upwards. A call option gives the holder of the option the right but not the obligation to buy an asset by a certain date for a certain price.

PUT OPTION:
A second type of option for stocks is the put option. It gives the buyer the right to sell (put away) a specific number of shares of a specific company to the option writer at a specific selling price at any time up to and including a specific date. An investor buys a put option when he seems that the stock price moves downwards. A put option gives the 30

Derivatives holder of the option right but not the obligation to sell an asset by a certain date for a certain price.

Options clearing house:

The Options Clearing House (OCC), a company that is jointly owned by several exchanges, generally facilitates trading in these options. It does so by maintaining a computer system that keeps track of all those options by recording the position of all those investors in each one. Although the mechanics are complex, the principles are simple. As soon as a buyer and a writer decide to trade a particular option contract and the buyer pass the agreed upon premium the OCC steps in becoming the effective writer as buyer is concerned the effective buyer as far as the seller is concerned. Thus at this time all directs links between original buyer and seller is served.

TRADING ON EXCHANGES:
There are two types of exchanged-based mechanisms for trading options contracts. The focal point for trading either involves specialists or market makers.

COMMISSIONS:
A commission must be paid to stockbroker whenever an option is either written, bought, sold. The size of the commission has been reduced substantially since the options began trading on organize exchanges in 1973. Furthermore this typically smaller than the commission that would be paid if the underlying stock had been purchased instead of option. This is probably because that clearing and settlement are easier with the options than stock. However, the investor should be aware that exercise an option will typically result in the buyers having to pay commission equivalent to the commission that would be incurred if the stock itself were being bought or sold.

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PARTIES IN AN OPTION CONTRACT: 1. Buyer of the Option:

The buyer of an option is one who by paying option premium buys the right but not the obligation to exercise his option on seller/writer.

Writer/Seller of the Option:

The writer of a call/put options is the one who receives the option premium and is there by obligated to sell/buy the asset if the buyer exercises the option on him.

OPTION VALUATION USING BLACK AND SCHOLES:

The Black and Scholes Option Pricing Model didnt appear overnight, in fact, Fisher Black started out working to create a valuation model for stock warrants. This work involved calculating a derivative to measure the discount rate of a warrant varies with time and stock price. The result of this calculation held a striking resemblance to a well known the transfer equation. Soon after this discovery, Myron Scholes joined Black and the result of their work is a startling accurate option-pricing model. Black and Scholes cant take all credit for their work; in fact their model is actually an improved version of a previous model developed by A.James Boness in Ph.D dissertation at the University of Chicago. Black and Scholes improvement son the Boness model come in the form of a proof that the risk-free interest rate is the correct discount factor and with the absence of assumptions regarding investors risk preferences. THE MODEL: C=SN (d1)-Ke (-r t) N (d2) C=theoretical call premium

32

Derivatives S=current stock price T=time until option expiration K=option striking price R=risk free interest rate N=cumulative standard normal distribution E=exponentil terms (2.1783) d1=in(s/k) + (r + s2/2) T D2=d1 St

In order to understand the model itself, we divide it into two parts. The first part SN (d1) derives the expected benefit from acquiring a stock outright. This is found by multiplying stock price(s) by the change in the call premium with respect to a change in the underlined stock price [N (d1)]. The second part of the model, ke (-r t) N (d2), gives the resent value of paying the exercise price on the expiration day. The fair market value of the call option is then calculated by taking the difference between these two parts.

SOME TERMS USED IN OPTIONS CONTRACT Index options:

These options have the index as the underlined. Some options are European while others are American. Like index, futures contracts, index options. Contracts are also cash settled.

Stock options:
Stock options are options on individual stocks. Options currently trade on over 500 stocks in the United States. A contract gives the holder the right to buy or sell shares at the specified price.

33

Derivatives

American options:
American options are options that can be exercised any time up to the expiration date. Most exchange traded options are American.

European options:
European options are options that can be exercised only on the expiration date itself. European options are easier to analyze that American option are frequently deduced from those of its European counterpart.

In-the-money options:
An in-the-money option is an option that would lead to a positive cash flow to the holder if it were exercised immediately. A call option on the index is said to be in the money when the current index stands at a level higher than the strike price. If the index is much higher than the strike price the call is said to be deep in the money.

At-the-money option:
An at-the-money option is an option that would lead to zero cash flow if it were exercised immediately. An option in the index is at the money when the current index equal that strike price (i.e. spot price=strike price)

Out-of-the-money option:
An out-of-the-money option is an option that would lead to a negative cash flow. call option on the index is out of the money when the current index stands at a level, which is less than the strike price (i.e. spot price-strike price). A

34

Derivatives

LOT SIZES OF DIFFERENT COMPANIES

CODE ACC ANDHRA BANK ARVIND MILLS BAJAJ AUTO BANKBARODA BANKINDIA BEL BHEL BPCL CANBK CIPLA CNXIT DIGITALEQUIP DRREDDY GAIL GRASIM GUJAMBCEMENT HCL TECH HDFC LOT SIZE 1500 4600 4300 400 1400 3800 550 600 550 1600 200 10 400 200 1500 350 110 1300 600 COMPANY NAME ASSOCIATES CEMENT COS LTD ANDHRA BANK ARVIND MILLS LTD BAJAJ AUTOMOBILES LTD BANK OF BARODA BANK OF INDIA BHARAT ELECTRICALS LTD BHARAT HEAVY ELECTRICALS LTD BHARAT PETROL CORPORATION LTD CANARA BANK CIPLA LTD IT INDEX DIGITAL GLOBAL LTD DR. REDDYS LABORATORIES LTD GAS AUTHOURITY OF INDIA GRASIM INDUSTRIES LTD GUJARAT AMBUJA CEMENT LTD HINDUSTAN CORPORATION LTD HOUSING DEDVELOPMENT FINANCE CORPORATION HDFC BANK HEROHONDA 800 400 HDFC BANK HERO HONDA MOTORS LTD

35

Derivatives HINDALCO HINDLEVER HINDPETROL I-FLEX ICICIBANK INFOSYSTECH IOC IPCL ITC L&T M&M MARUTI MASTEK MTNL NATIONALALAM NIFTY NIIT 300 2000 650 300 1400 50 600 1100 300 500 625 400 1600 1600 1150 200 1500 HINDUSTAN ALUMINIUM COMPANY HINDUSTAN LEVER LTD HINDUSTAN PETROLEUM CORPORATION I-FLEX ICICI BANKING CORPORATION LTD INFOSYS TECHNOLOGIES LTD INDIAN OIL CORPORATION INDIAN PETROLEUM CHEMICALS LTD INDIAN TOBACCO COMPANY LARSEN AND TURBO MAHENDRA AND MAHENDRA LTD MARUTI UDYOG LTD MASTEK MAHANAGAR TELECOM NIGAM LTD NATIONAL ALUMINIUM COMPANY NATIONAL INDEX FOR FIFTY STOCKS NATIONAL INSTITUTE OF INFORMATION TECHNOLOGY ONGC ORIENT BANK PNB POLARIS 300 1200 1200 1400 OIL AND NATURAL GAS CORPORATION ORIENTAL BANK PUNJAB NATIONAL BANK POLARIS SOFTWARE COMPANY LTD.

RANBAXY

400

RANBAXY LABORATORIES LTD

36

Derivatives RELIANCE REL SATYAMCOMPU SBI SCI SYNDIBANK TATAMOTORS TATAPOWER TATA TEA TISCO UNION BANK WIPRO Table:1.1 550 600 1200 500 1600 7600 825 50 900 4200 200 800 RELIANCE INDUSTRIES LTD RELIANCE COMPUTERS SERVICES LTD SATYAM COMPUTERS LTD STATE BANK OF INDIA SHIPPPING CORPORATION OF INDIA SYNDICATE BANK TATA MOTORS TATA POWER COMPANY LTD TATA TEA LTD TATA IRON&STEEL COMPANY LTD UNION BANK OF INDIA WESTERN INDIA-VEG PRODUCTS LTD

37

Derivatives

COMPANY PROFILE
About IIFL
The IIFL (India Infoline) group, comprising the holding company, India Infoline Ltd (NSE: INDIAINFO, BSE: 532636) and its subsidiaries, is one of the leading players in the Indian financial services space. IIFL offers advice and execution platform for the entire range of financial services covering products ranging from Equities and derivatives, Commodities, Wealth management, Asset management, Insurance, Fixed deposits, Loans, Investment Banking, Gold bonds and other small savings instruments. IIFL recently received an in-principle approval for Securities Trading and Clearing memberships from Singapore Exchange (SGX) paving the way for IIFL to become the first Indian brokerage to get a membership of the SGX. IIFL also received membership of the Colombo Stock Exchange becoming the first foreign broker to enter Sri Lanka. IIFL owns and manages the website, www.indiainfoline.com, which is one of Indias leading online destinations for personal finance, stock markets, economy and business.

IIFL has been awarded the Best Broker, India by FinanceAsia and the Most improved brokerage, India in the AsiaMoney polls. India Infoline was also adjudged as Fastest Growing Equity Broking House - Large firms by Dun & Bradstreet. A forerunner in the field of equity research, IIFLs research is acknowledged by none other than Forbes as Best of the Web and a must read for investors in Asia. Our research is available not just over the Internet but also on international wire services like Bloomberg, Thomson First Call and Internet Securities where it is amongst one of the most read Indian brokers.

A network of over 2,500 business locations spread over more than 500 cities and towns across India facilitates the smooth acquisition and servicing of a large customer base. All 38

Derivatives our offices are connected with the corporate office in Mumbai with cutting edge networking technology. The group caters to a customer base of about a million customers, over a variety of mediums viz. online, over the phone and at our branches.

History & Milestones

1995 Commenced operations as an Equity Research firm 1997 Launched research products of leading Indian companies, key sectors and the economy Client included leading FIIs, banks and companies. 1999 Launched www.indiainfoline.com 2000 Launched online trading through www.5paisa.com Started distribution of life insurance and mutual fund 2003 Launched proprietary trading platform Trader Terminal for retail customers 2004 Acquired commodities broking license Launched Portfolio Management Service 2005 Maiden IPO and listed on NSE, BSE 2006 Acquired membership of DGCX Commenced the lending business 2007 Commenced institutional equities business under IIFL formed Singapore subsidiary, IIFL (Asia) Pte Ltd 39

Derivatives 2008 Launched IIFL Wealth Transitioned to insurance broking model 2009 Acquired registration for Housing Finance SEBI in-principle approval for Mutual Fund Obtained Venture Capital license 2010 Received in-principle approval for membership of the Singapore Stock Exchange Received membership of the Colombo Stock Exchange.

Board of directors
Mr. Nirmal Jain Chairman, India Infoline Ltd

Mr. Nirmal Jain is the founder and Chairman of India Infoline Ltd. He is a PGDM (Post Graduate Diploma in Management) from IIM (Indian Institute of Management) Ahmadabad, a Chartered Accountant and a rank-holder Cost Accountant. His professional track record is equally outstanding. He started his career in 1989 with Hindustan Lever Limited, the Indian arm of Unilever. During his stint with Hindustan Lever, he handled a variety of responsibilities, including export and trading in agro-commodities. He contributed immensely towards the rapid and profitable growth of Hindustan Levers commodity export business, which was then the nations as well as the Companys top priority.

He founded Probity Research and Services Pvt. Ltd. (later re-christened India Infoline) in 1995; perhaps the first independent equity research Company in India. His work set new standards for equity research in India. Mr. Jain was one of the first entrepreneurs in India 40

Derivatives to seize the internet opportunity, with the launch of www.indiainfoline.com in 1999. Under his leadership, India Infoline not only steered through the dotcom bust and one of the worst stock market downtrends but also grew from strength to strength. Mr. R. Venkataraman Managing Director, India Infoline Ltd. Mr. R Venkataraman, Co-Promoter and Managing Director of India Infoline Ltd, is a B.Tech (electronics and electrical communications engineering, IIT Kharagpur) and an MBA (IIM Bangalore). He joined the India Infoline Board in July 1999. He previously held senior managerial positions in ICICI Limited, including ICICI Securities Limited, their investment banking joint venture with J P Morgan of US, BZW and Taib Capital Corporation Limited. He was also the Assistant Vice President with G E Capital Services India Limited in their private equity division, possessing a varied experience of more than 19 years in the financial services sector Mr. Nilesh Vikamsey Independent Director, India Infoline Ltd. Mr. Nilesh Vikamsey Board Member since February 2005 - is a practicing Chartered Accountant for 25 years and Senior Partner at M/s Khimji Kunverji & Co., Chartered Accountants, a member firm of HLB International, a world-wide organisation of professional accounting firms and business advisers, ranked amongst the top 12 accounting groups in the world. Mr. Vikamsey headed the audit department till 1990 and thereafter also handled financial services, consultancy, investigations, mergers and acquisitions, valuations and due diligence, among others. He is elected member of the Central Council of Institute of Chartered Accountant of India (ICAI), the Apex decision making body of the second largest accounting body in the world, 20102013.

41

Derivatives He is on the ICAI study group member for the introduction of the Accounting Standard 30 on financial instruments recognition and management. Convener of the Study group Formed by ASB of ICAI to formulate comments on various Exposure Drafts, Discussion Papers and other matters pertaining to IFRS originating from IASB, Representative of the Institute of Chartered Accountants of India on the Committee for Improvement in Transparency, Accountability and Governance(ITAG) of South Asian Federation of Accountants (SAFA), Member of Executive Committee & IFRS Implementation Committee of WIRC of Institute of Chartered Accountant of India (ICAI), Accounting and Auditing Committee of Bombay Chartered Accountant Society (BCAS) and also on its Core Group, member of Review, Reforms & Rationalisation Committee, IPR Committee of Bombay Chamber of Commerce and Industry (BCCI), Member of Legal Affairs Committee of Bombay Chamber of Commerce and Industry(BCCI), Corporate Members Committee of The Chamber of Tax Consultants (CTC), Regular Contributor to WIRC Annual Referencer on Bank Branch Audit, Study/ Sub Group formed by ICAI for Considering Developments on Fair Value Accounting (AS 30) post Sub Prime crisis, Sub Group formed by ICAI for approaching the Government and Regulatory Authorities for Convergence with IFRS. He is also a Vice Chairman of Financial Reporting Review Board Accounting Standard Board and Member of Accounting Standard Board and various other Standing and Non Standing Committees. Mr. Vikamsey is also a Director of Miloni Consultants Private Limited, HLB Offices and Services Private Limited, Trunil Properties Private Limited, BarKat Properties Private Limited and India Infoline Investment Services Limit

DATA ANALYSIS & INTERPRETATION

42

Derivatives

DESCRIPTION OF THE METHOD:

The following are the steps involved in the study. 1. Selection of the scrip: The scrip selection is done on a random basis and the scrip selected is ONGC. The lot size of the scrip is 500. Profitability position of the option holder and option writer is studied. 2. Data collection: The data of the ONGC has been collected from the The Economic Times and the Internet. The data consists of the August contract and the period of data collection is from 3rd August 2011 to 3rd September 2011. 3. Analysis: The analysis consists of the tabulation of the data assessing the profitability positions of the option holder and the option writer, representing the data with graphs and making the interpretations using the data.

LOT SIZES OF SELECTED COMPANIES FOR ANALYSIS

43

Derivatives

CODE

LOT SIZE

COMPANY NAME

Associates Cement Co. Ltd. ACC 188 Infosys Technologies Ltd. INFOSYS 200 Hindustan UniLever Ltd. HLL 1000 Ranbaxy laboratories Ltd. RANBAXY 800 Satyam Computer services SATYAM Table:4.1 The following tables explain about the trades that took place in futures and options between 01/05/2009 and 13/05/2009. The table has various columns, which explains various factors involves in derivatives trading. 600 Ltd.

Date the day on which trading took place

Closing premium premium for the day

Open interest No. of Options that did not get exercised

44

Derivatives Traded quantity No. of futures and options traded on that day

N.O.C No. of contacts traded on that day

Closing price the price of the futures at the end of the trading day

FUTURES OF ACC CEMENTS

45

Derivatives Date Open. High Rs. Low Rs. Close Rs Open Int (000) N.O.C

dd/mm/yyy Rs

20/04/2011 19/04/2011 18/04/2011 17/04/2011 16/04/2011 Table:4.2

795.95 809.00 815.00 791.00 756.00

809.40 819.00 827.45 816.70 793.95

791.35 783.10 815.00 785.00 756.00

794.5 790.15 818.00 809.95 789.15

3452 3943 3810 4600 4385

7502 15759 7738 17265 10335

830 820 810 800 790 780 770 760 750 740 730 720 20/04/2011 19/04/2011 18/04/2011 17/04/2011 16/04/2011 Open. Rs Close Rs

Figure:4.1

INTERPRETATION
46

Derivatives

The price gradually rose from 789.15 on first day to 18th April, where it stood at 818.00 as high. As the players in the market with an intention to short or correct the market, the players showed a bearish attitude for the next day where the price fell to 790.15. Later the players become a bullish.

At 809.95 the open interest stood at peak position of 4600000, but later the next day players sold their futures as to gain. The total contracts traded at this price stood 17265 which is higher than the week days

By the end of the trading week most of the players closed up their contracts to make loss. As the price was high, the open interest was high and the no. of contracts trades rose to 7502.

There always exit an impact of price movements on open interest and contracts traded. The futures market also influenced by cash market, Nifty index futures, and news related to the underlying asset or sector (industry), FIIs involvement, national and international affairs etc.

FUTURES OF INFOSYS
47

Derivatives

Date

Open

High Rs.

Low Rs.

Close Rs

Open. int (000)

N.O.C

dd/mm/yyy Rs.

20/04/2011 19/04/2011 18/04/2011 17/04/2011 16/04/2011 Table:4.3

2061.00 2046.50 2076.00 2102.65 2100.00

2082.00 2060.50 2090.00 2110.00 2125.00

2055.50 2021.25 2062.15 2055.50 2095.00

2061.75 2045.95 2070.30 2073.90 2118.80

3335 3397 3625 4215 3698

10842 13041 11886 26534 17017

2140 2120 2100 2080 Open Rs. 2060 2040 2020 2000 20/04/2011 19/04/2011 18/04/2011 17/04/2011 16/04/2011 Close Rs

Figure:4.2

48

Derivatives

INTERPRETAION

After the market quite relived by the fall in the discount on the Nifty in the futures and the options segment, which was used by the players to short the market shown appositive upward movement in futures and options segment and cash market during the first day of the week.

The futures of INFOSYS shown a bullish way till 17th of the April whose impact shown on the open interest at 4215 with 26534 contracts traded. The players at this point did not sell or close up their contracts as a hope of increase or go up in the market for a next day. Even the cash market was down on this day for this underlying at Rs. 2076.00.

The market for INFOSYS for last day of the trading week shown a decline in the opening price Rs. 15.05 when compare with the week high price. The open interest closed at 3335000 with lowest 10842 contracts traded on the last trading day of the week.

49

Derivatives

FUTURES OF THE HLL

Date

Open.

High Rs.

Low Rs.

Close Rs

Open. int N.O.C (000)

dd/mm/yyy Rs.

20/04/2011 19/04/2011 18/04/2011 17/04/2011 16/04/2011 Table:4.4

205.10 203.55 208.10 211.50 205.70

209.80 205.50 211.80 212.85 211.45

204.25 201.10 205.25 208.35 204.70

206.20 204.15 206.00 208.75 211.10

8742 9112 9143 9205 9232

2568 2740 2020 2454 3765

214 212 210 208 206 204 202 200 198 20/04/2011 19/04/2011 18/04/2011 17/04/2011 16/04/2011 Open. Rs. Close Rs

Figure:4.3

50

Derivatives

INTERPRETATION

HLL contracts traded in the futures stood at peak for the week i.e. 3765. There was a good buying in both the futures and options and cash market for this stock.

The last trading day of the week showed a high strike price or exercising price for the HLL futures i.e. Rs. 206.20 because of the huge correction done by the FII flows.

51

Derivatives

FUTURES OF RANBAXY

Date

Open

High Rs.

Low Rs.

Close Rs

Open. int N.O.C (000)

dd/mm/yyy Rs

20/04/2011 19/04/2011 18/04/2011 17/04/2011 16/04/2011 Table:4.5

345.00 336.00 339.50 341.80 337.00

345.50 344.75 344.80 342.00 342.25

342.05 335.10 339.00 337.25 337.00

344.10 342.45 341.40 338.00 339.30

5698 6578 6731 6770 6731

1366 305.4 3008 1679 2370

346 344 342 340 338 336 334 332 330 20/04/2011 19/04/2011 18/04/2011 17/04/2011 16/04/2011 Open Rs Close Rs

Figure:4.4

52

Derivatives

INTERPRETATION

The week showed a buy for RANBAXY stock futures. Since beginning of the trading day of the week the figures has been representing a continuous bullish market for RANBAXY. The pharmacy sector is considered to be one of the eye watches for investors for investing.

On the last but one, trading day the RANBAXY stock futures has rose to peak level where the price stood at 451.35 an increase of 11.73% over the first trading day price 403.95. The open interest rose 52.16% to 9512000 and the contract traded, 19314 from 7645 of weeks beginning.

At the end of the week the price of the RANBAXY has rose to Rs.458.90 this is all time record of that week at this stage open interest has also gone up to 9512000, this was great boom in pharmacy sector, because FIIs were interested to invest in this sector.

53

Derivatives

FUTURES OF SATYAM COMPUTERS

Date

Open

High Rs.

Low Rs.

Close Rs

Open. int N.O.C (000)

dd/mm/yyy Rs

20/04/2011 19/04/2011 18/04/2011 17/04/2011 16/04/2011 Table:4.6

463.00 450.00 462.00 474.55 487.90

477.00 462.00 468.80 483.00 494.50

461.35 445.55 460.10 456.00 476.90

474.75 449.50 462.95 457.95 480.95

6226 8991 11072 13645 13043

16486 11286 11984 15747 11543

500 490 480 470 Open Rs 460 450 440 430 20/04/2011 19/04/2011 18/04/2011 17/04/2011 16/04/2011 Close Rs

Figure:4.5

INTERPRETATION
54

Derivatives The above table indicates decrease in the price from the 3 rd day about 23 Rs.

Call and Put Options of ACC Cements

Date/ Option s C.P. O.I. * CA 700 CA 720 CA 740 CA 760 CA 780 CA 800 CA 820 CA 840 89.8 0 66.3 5 45.9 0 35.4 0 22.9 5 13.6 5 7.50 2 7 38 114 25 69 64 161 44 87 17 21 91.3 5 71.8 0 50.5 0 39.0 0 22.8 5 14.1 0 8.50 6 21 29 136 49 177 17 63 57 88 59.0 0 47.0 0 27.5 0 15.1 0 7.30 15 49 4.05 23 61 45 151 42 52 15 16 58 11 34.0 0 20.1 0 10.9 5 6.35 83 204 79 241 28 60 56 23 37 91 17 12 17 N.C C.P. . 7 O.I. * N.C C.P. . O.I. * N.C C.P. . O.I. * N. C 16/04/2011 17/04/2011 18/04/2011 19/04/2011

55

Derivatives Date/ Option s C.P. O.I. * PA 720 PA740 3.35 PA 760 PA 780 PA 800 PA 820 Table:4.7 17.4 5 26 98 16.2 0 7 20 13.2 5 8.40 26 36 24 95 6.85 14 11 11.2 0 21.5 5 39.0 0 26 47 33 107 23 63 7.50 17 13 24 45 2.85 7.50 17 14 15 31 2.45 18 6 4.35 26 33 2.05 13 N.C C.P. . 10 1.00 O.I. * 14 N.C C.P. . 7 O.I. * N.C C.P. . O.I. * N. C 16/04/2011 17/04/2011 18/04/2011 19/04/2011

C.P. = Close premium O.I = Open interest N.C. = No. of contracts The following table of net payoff explains the profit/loss of option holder/writer of ACC for the week 16/04/2011-20/04/2011.

56

Derivatives

Profit/loss position of Call option buyer/writer of ACC

Spot Price Strike Price Premium Whether Exercised 788 788 788 788 788 788 788 Table:4.8 700 720 740 760 780 800 820 89.80 66.35 45.90 35.40 22.95 13.65 7.50 NO YES YES NO NO NO NO Buyer Gain/Loss -562.5 618.75 787.5 -2775 -8598.5 -9618.75 -14812.5 Writers Gain/Loss 562.5 -618.75 -787.5 2775 8598.5 9618.75 14812.5

57

Derivatives

Profit/Loss position of Put option buyer/writer of ACC

Spot Price Strike Price Premium Whether Exercised 788 788 788 788 Table:4.9 720 740 760 780 2.05 3.35 7.50 16.20 YES YES YES NO Buyer Gain/Loss 24731.25 16743.75 7687.5 -3075 Writers Gain/Loss -24731.25 -16743.75 -7687.5 3075

INTERPRETATION

The Call Options 700, 760,780,800 and 820 were out-of-the-money option and the remaining 720 and 740 were in the money option.

The Put Options 720,740 and 760 were in-the-money option and the remaining i.e.780 was out-of-the-money option.

Profit of the holder = (spot price strike price) premium * 375 (lot size) in case of Call Option

Profit of the holder = (spot price strike price) premium * 375 (lot size) in case of Put Option

If it is a profit for the holder than obviously it is loss for the holder and vice-versa. 58

Derivatives

Call and Put Options of INFOSYS

Date/ Options C.P. O.I.* N.C. C.P.O.I.* N.C. C.P. O.I.* N.C. C.P. N.C. C.P.O.I.*N.C. O.I.* CA 1950 176.50 7 8 CA 1980 145.95 31 30 CA 2010 117.95 351 267 CA 2040 90.55 362 100 CA 2070 65.10 189 63 102.00 27 76.55 251 57.90 107 39.25 63 28 102.0 7 26 79.95 13 26 83.05 26 10 16/04/2011 17/04/2011 18/04/2011 19/04/2011 20/04/2011

319 71.25 101 249 271 50.45 108 105 193 33.90 109 65 1194 22.55 466 344 193 12.15 88 86 215 5.65 95 150 83 67 3.60 69 19 3.05 80 32

55.20 334 56.70 117 242 242 37.10 399 36.95 150 104 100 22.45 208 20.95 69 73 193

CA 2100 45.40 1092 24.80 327 340 CA 2130 29.25 205 81 CA 2160 19.35 159 85 CA 2190 12.30 67 66 CA 2220 9.00 73 98 CA 2250 6.20 33 29 Table:4.10 13.65 86 8.3093 6.3068 4.5077

14.85 601 11.30 437 370 358 8.36 87 5.70 94 3.90 66 3.00 80 66 4.4587 54 54 47 12

115 3.9595 25 20 2.5066 1.3080

Date /

16/04/2011

17/04/2011

18/04/2011

19/04/2011

20/04/2011

59

Derivatives Opti ons C. P. PA 3.1 O.I N. .* 80 C. 25 C. P. 3.1 0 51 34 3.6 0 14 1 75 11 6 34 4.5 5 7.0 0 94 12 6 21 8 69 35 1 21 1 24 12 8 44 29 7 9.0 5 14. 15 25. 40 36. 90 52. 20 31 23 20 0 67 33 6 16 8 11 7 28 5 91 48 13 7 73 46 89 50 10 O.I N. .* 79 C. 15 C. P. 2.9 0 2.8 0 4.3 0 5.8 5 7.8 5 12. 15 20. 60 34. 05 52. 60 28 72 24 50 19 3 65 24 9 77 87 80 13 4 72 13 41 4.9 0 7.7 0 12. 75 19. 60 28. 50 42. 25 65. 75 27 76 19 16 9 55 81 12 3 43 3 31 3 96 12 5 67 11 3 82 47 27 1. 25 2. 25 3. 25 3. 30 8. 35 17 .0 33 .6 45 .0 26 12 19 41 17 1 55 11 3 67 74 90 12 3 64 38 24 46 11 O.I N. .* 77 C. 37 C. P. O.I N. .* C. C. P. O.I N. .* C.

1830 5 PA 3.4

1890 0 PA 5.2

1920 0 PA 5.6

1950 5 PA 6.7

1980 5 PA 10.

2010 40 PA 14.

2040 45 PA 19.

2070 70 PA 30.

2100 45

60

Derivatives The following pay-off for explain the profit/loss of option holder/writer of INFOSYS for the week 16/04/2011-20/04/2011..

Profit/Loss position of Call Option Buyer/Writer of INFOSYS

SPOT PRICE 2040 2040 2040 2040 2040 2040 2040 2040 2040 2040 2040 Table:4.11

STRIKE PRICE 1950 1980 2010 2040 2070 2100 2130 2160 2190 2220 2250

PREMIUM

WHETHER

BUYER

WRITER

EXERCISED GAIN/LOSS GAIN/LOSS 176.50 145.95 117.95 90.55 65.10 45.40 29.25 19.35 12.30 9.00 6.20 NO NO NO NO NO NO NO NO NO NO NO -8650 -8595 -8795 -9055 -9510 -10540 -11925 -13935 -16230 -18900 -21620 8650 8595 8795 9055 9510 10540 11925 13935 16230 18900 21620

61

Derivatives

Profit/Loss position of Put Option Buyer/writer of INFOSYS

SPOT PRICE 2040 2040 2040 2040 2040 2040 2040 2040 2040 Table:4.12 STRIKE PRICE 1830 1890 1920 1950 1980 2010 2040 2070 2100 3.15 3.40 5.20 5.65 6.75 10.40 14.45 19.70 30.45 PREMIUM WHETHER BUYER WRITER

EXERCISED GAIN/LOSS GAIN/LOSS YES YES YES YES YES YES NO NO NO 20685 14660 11480 8435 5325 1960 -1445 -4970 -9045 -20685 -14660 -11480 -8435 -5325 -1960 1445 4970 9045

Findings: The Call options all were in out-of-money option. The Put option1830, 1890,1920,1950,1980 and 2010 were in-the-money options and the remaining 2040, 2070 and 2100 were out of option. Profit of the holder = (spot price strike price) premium*100 (lot size) in case call option Profit of the holder = (spot price-spot price)-premium*100 (lot Size) in case of put option. If it is profit for the holder than obviously it will be loss for the holder and vice-versa.

62

Derivatives

Call and Put Option of HLL

Date / Opti ons

16/04/2011

17/04/2011

18/04/2011

19/04/2011

20/04/2011

C. P. CA 200 CA 205 CA 210 CA 215 CA 220 CA 225 13. 80 9.2 0 4.8 0 2.6 5 1.6 0 0.7 5

O.I N. .* 23 8 10 8 39 6 78 26 3 62 C. 12 0 65

C. P. 11. 55 6.2 5 3.7 0 2.1 5

O.I N. .* 23 1 10 5 38 5 10 8 28 4 37 7 66 21 3 68 34 C. 45

C. P. 8. 50 4. 65 2. 65 1. 40 0. 75 .5 0

O.I N. .* 14 8 98 18 C. 67

C. P. 6. 95 3. 90

O.I N. .* 17 3 11 6 47 5 12 9 28 6 86 30 11 10 9 13 C. 10 7 44

C. P. 7. 45 3. 80 1. 80 0. 55 0. 40 1. 05

O.I N. .* 10 8 11 2 47 0 12 2 27 8 88 17 13 11 3 19 33 C. 57

41 7 12 6 28 7 40

15 2 44

1. 75 1. 00

25 5 32

97

1.2 5

31

0. 60

25

0.8 0

2. 10

Date/ 16/04/2011

17/04/2011

18/04/2011 63

19/04/2011

20/04/2011

Derivatives Opti ons C. P. PA 200 PA 205 PA 210 Table:4.13 O.I N. .* C. 34 C. P. O.I N. .* C. 16 C. P. O.I N. .* C. 18 C. P. O.I N. .* C. 30 C. P. O.I N. .* C. 17

1.3 85 5 2.7 11 0

1.3 90 5

1.8 90 0

2.1 86 0

1.0 88 5

11

2.2 16 0 4.5 9 0

3.2 18 0

10

4.0 17 0

14

2.7 32 0

29

12

5.0 17 5

26

8.5 14 5

5.9 26 0

13

The following table of net payoff explains the profit/loss of option holder/writer of HLL for the week 16/04/2011-20/04/2011...

Profit/Loss position of Call Option Buyer/Writer of HLL

64

Derivatives SPOT PRICE 207 207 207 207 207 207 Table:4.14 STRIKE PRICE 200 205 210 215 220 225 13.80 9.20 4.80 2.65 1.60 0.75 PREMIUM WHETHER BUYER WRITER

EXERCISED GAIN/LOSS GAIN/LOSS NO NO NO NO NO NO -6800 -7200 -7800 -10650 -14600 -18750 6800 7200 7800 10650 14600 18750

65

Derivatives

Profit/Loss position of Put Option Buyer/Writer of HLL

SPOT PRICE 207 207 Table:4.15 STRIKE PRICE 200 205 1.35 2.70 PREMIUM WHETHER BUYER WRITER

EXERCISED GAIN/LOSS GAIN/LOSS YES NO 5650 -700 -5650 700

INTERPRETATION The Call Options all were out-of-the-money options

The Put Options200 was in-the-money option and 205was out-of-the-money option.

Profit of the holder = (spot price-strike piece)-premium*1000(lot size) in case of Call option.

Profit of the holder = (strike price-spot price) - premium*1000(lot size) in case of Put option.

If it is profit for the holder then obviously it will be loss for the holder and vice-versa.

Call and Put Options of RANBAXY

66

Derivatives Date / Opti ons C. P. CA 330 CA 340 CA 350 CA 360 CA 370 CA 400 0. 60 22 6 8. 90 5. 65 3. 35 10 2 11 5 10 3 11 51 63 8. 45 4. 80 3. 00 1. 25 12 2 12 3 10 5 44 9 5 22 54 O.I N. .* C. C. P. O.I N. .* C. . C. P. 15. 00 8.7 5 4.7 0 2.4 5 1.7 0 12 4 13 0 10 6 42 9 16 42 61 O.I N. .* 28 C. 8 C. P. 16. 65 8.3 5 4.1 0 2.2 0 12 4 13 3 10 2 9 23 32 8. 40 3. 60 1. 75 11 8 12 9 10 3 8 15 29 O.I N. .* 26 C. 8 C. P. O.I N. .* C. 16/04/2011 17/04/2011 18/04/2011 19/04/2011 20/04/2011

Table:4.16 The following tables of net payoff explain the following Profit/Loss of option holder/writer of RANBAXY for the week 16/04/2011-20/04/2011...

Profit/Loss position of Call Buyer/Writer of RANBAXY

67

Derivatives SPOT PRICE 340 340 340 340 Table:4.17 STRIKE PRICE 340 350 360 400 8.90 5.65 3.35 0.60 PREMIUM WHETHER BUYER WRITER

EXERCISED GAIN/LOSS GAIN/LOSS NO NO NO NO -7120 -12520 -18680 -48480 7120 12520 18680 48480

68

Derivatives Profit/Loss position of Put option Buyer/Writer of RANBAXY

SPOT PRICE 340 Table:4.18

STRIKE PRICE 330

PREMIUM

WHETHER

BUYER

WRITER

EXERCISED GAIN/LOSS GAIN/LOSS 4.60 NO -4320 4320

INTERPRETATION The Call options all were in the out-of-the-money options.

The Put option also was in the out-of-the-money options..

Profit of the holder = (spot price- strike price) premium* 800 (lot size) in case of call option.

Profit for the holder = (strike price-spot price) premium* 800(lot size) in case of Put option.

If it is a profit of the holder then obviously it will be loss for the holder and viceversa.

69

Derivatives

Call and Put Option of the SATYAM COMPUTERS

Da te/ Op ti

16/04/2011

17/04/2011

18/04/2011

19/04/2011

20/04/2011

C. P. CA 44 0 CA 35. 45 0 CA 28. 46 0 CA 22. 47 0 CA 15. 48 0 CA 11. 75 20 05 00

O.I N. .* C.

C. P.

O.I N. .* C.

C. P.

O.I N. .* C.

C. P. 18. 35

O.I N. .* 50 C. 21

C. P. 32. 25

O.I N. .* 44 C. 18

44

26

18. 10

51

63

21. 65

61

36

12. 85

15 2

28 2

26. 50

91

26 3

88

35

13. 40

12 0

25 8

15. 20

13 3

11 3

7.5 5

30 2

56 9

18. 25

18 5

70 1

11 5

72

8.8 5

18 5

30 6

10. 45

20 5

12 3

4.2 5

32 5

33 4

12. 10

26 6

97 1

16 1

31 0

6.3 5

29 2

43 5

7.1 5

32 9

17 1

2.8 0

44 6

35 3

6.3 5

41 8

85 5

55

10

4.0

96

11

4.2

13

66

2.0

14

61

2.9

17

13

70

Derivatives 49 0 CA 7.8 50 0 CA 5.0 51 0 CA 3.0 52 0 Table:4.19 0 26 44 1.5 0 39 29 1.3 0 41 6 9.6 0 4 8 0.2 5 40 11 0 31 58 2.0 5 34 12 1.9 0 37 17 1.0 0 33 13 0.8 0 36 22 5 19 4 30 0 2.9 5 32 6 31 0 2.9 5 35 8 12 0 1.4 0 43 0 18 6 1.6 5 44 2 32 8 40 1 0 2 5 0 5 3 0 5 6

71

Derivatives
Date 16/04/2011 Opt 17/04/2011 18/04/2011 19/04/2011

C.P. PA 420 PA 430 PA 440 PA 450 PA 460 PA 470 PA 480 PA 490 PA 500 6.85 5.15 3.75

O.I.* N.C. C.P. 2.25

O.I.* N.C. C.P. 10 6

O.I.* N.C.

C.P. 4.10

O.I.* N.C. 14 11

6.30

13

12

38

13

6.55

44

38

6.00

48

17

8.30

64

80

60

73

10.10 58

82

8.05

58

30

13.30 56

77

104

78

15.10 92

183

12.65 100

57

18.45 97

159

10.50 36

42

19.55 22

45

20.15 21

14.85 35

189

28.40 28

41

17.05 11

25

24.90 9

13

72

Derivatives The following table of net payoff explains profit/loss of option holder/writer of SATYAM COMPUTERS for the week 16/04/2011-20/04/2011...

Profit/Loss position of Call Option Buyer/Writer of SATYAM COMPUTERS

SPOT PRICE 448 448 448 448 448 448 448 448 Table:4.20

STRIKE PRICE 450 460 470 480 490 500 510 520

PREMIUM

WHETHER

BUYER

WRITER

EXERCISED GAIN/LOSS GAIN/LOSS 35.00 28.05 22.20 15.75 11.40 7.85 5.00 3.00 NO NO NO NO NO NO NO NO -22200 -24030 -26520 -28650 -32040 -35910 -40200 -22200 22200 24030 26520 28650 32040 35910 40200 22200

73

Derivatives

Profit/Loss position of Put Option Buyer/Writer of TATA CONSULTANCY SERVICES

SPOT PRICE 448 448 448 448 448 448 448 Table:4.21

STRIKE PRICE 440 450 460 470 480 490 500

PREMIUM

WHETHER

BUYER

WRITER

EXERCISED GAIN/LOSS GAIN/LOSS 3.75 5.15 6.85 10.50 14.85 17.05 24.90 YES NO NO NO NO NO NO 2550 -4290 -11310 -19500 -28110 -35430 -46140 -2550 4290 11310 19500 28110 35430 46140

INTERPRETATION

The Call Options all were out-of-the-money option All Put Option 440 was in-the-money option and remaining 450,460,470,480,490 and 500 were out-of-the-money options.

Profit of the holder = (spot price-strike price)-premium*600 (lot size) in case of Call Option.

Profit of the holder = (strike piece-spot price)-premium*600 (lot size) in case of Put Option. 74

Derivatives If it is a profit for the holder then obviously it will be loss for the holder and viceversa.

Conclusion and suggetions:

The above analysis Futures and Options of ACC, INFOSYS, HLL, RANBAXY and SATYAM COMPUTERS had shown a positive market in the week.

The major factors that will influence the futures and options market, FII involvement, News related to the underlying asset, National and International markets, Researchers view etc.

In a bearish market it is suggested to an investor to opt for Put Option in order to minimize losses.

In a bearish market it is suggested to an investor to opt for Call Option in order to minimize profits.

In a cash market the profit/loss is limited but where in futures and options an investor can enjoy unlimited profit/loss.

It is recommended that SEBI should take measures in improving awareness about the futures and options market as it is launched very recently.

75

Derivatives It is suggested to an investor to keep in mind the time and expiry duration of futures and options contracts before trading. The lengthy the time, the risk is low and profit making. The fever time may be high risk and chances of loss making.

At present futures and options are traded on NSE. It is recommended to SEBI to take actions in trading of futures and options in other regional exchanges.

At present scenario the derivatives market is increased to a great position. Its daily turnover reaches to the equal stage of cash market. The average daily turnover of NSE in derivatives market is 400000 (vol.).

The derivatives are mainly used for hedging purpose.

76

Derivatives

TITLE

AUTHOR

PUBLICATION

Securities Analysis and Portfolio Management R. Madhumati Pearson Education

Investments

Schaums

TATA McGraw-Hill

International Financial Management

P.G.Apte

TATA McGraw-Hill

Financial Institutions and Markets

L.M.Bhole

TATA McGraw-Hill

Options, Futures and Other Derivatives

John C. hull

Pearson Education

77

Derivatives

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www.rediff/money/derivatives.htm www.appliederivatives.com www.derivativesreview.com

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