![INTRODUCTION 1.1 A STUDY ON DERIVATIVES: The only stock exchanges operating in the 19 the century were those of Bombay set up in 1875 and Ahmedabad set up in 1894. These were organized as voluntary non-profit-making association of brokers to regulate and protect their interests. Before the control on securities trading became a central subject under the constitution in 1950, it was a state subject and the Bombay securities contracts (control) Act of 1925 used to regulate trading in securities. Under this Act, The Bombay stock exchange was recognized in 1927 and Ahmedabad in 1937. During the war boom, a number of stock exchanges were organized even in Bombay, Ahmedabad and other centers, but they were not recognized. Soon after it became a central subject, central legislation was proposed and a committee headed by A.D.Gorwala went into the bill for securities regulation. On the basis of the committee's recommendations and public discussion, the securities contracts (regulation) Act became law in 1956. 1.1.1 OBJECTIVES OF STUDY: To study various trends in derivative market. Comparison of the profits/losses in cash market and derivative market. To find out profit/losses position of the option writer and option holder. To study in detail the role of the future and options. To study the role of derivatives in Indian financial market. To study various trends in derivative market. Comparison of the profits/losses in cash market and derivative market. To find out profit/losses position of the option writer and option holder. To study in detail the role of the future and options. To study the role of derivatives in Indian financial market. 1.1.2 NEED OF THE STUDY Different investment avenues are available investors. Stock market also offers good investment opportunities to the investor alike all investments, they also carry certain risks. The investor should compare the risk and expected yields after adjustment off tax on various instruments while talking investment decision the investor may seek advice from expartry and consultancy include stock brokers and analysts while making investment decisions. The objective here is to make the investor aware of the functioning of the derivatives. Derivatives act as a risk hedging tool for the investors. The objective if to help the investor in selecting the appropriate derivates instrument to the attain maximum risk and to construct the portfolio in such a manner to meet the investor should decide how best to reach the goals from the securities available. To identity investor objective constraints and performance, which help formulate the investment policy? The develop and improvement strategies in the with investment policy formulated. They will help the selection of asset classes and securities in each class depending up on their risk return attributes. 1.1.3 SCOPE OF THE STUDY The study is limited to “Derivatives” with special reference to futures and options in the Indian context; the study is not based on the international perspective of derivative markets. The study is limited to the analysis made for types of instruments of derivates each strategy is analyzed according to its risk and return characteristics and derivatives performance against the profit and policies of the company. 1.1.4 LIMITATION OF THE STUDY The subject of derivates if vast it requires extensive study and research to understand the dept of the various instrument operating in the market only a recent plenomore. But various international examples have also been added to make the study more comfortable. There are various other factors also which define the risk and return preferences of an investor how ever the study was only contained towards the risk maximization and profit maximization objective of the investor. The derivative market is a dynamic one premiums, contract rates strike price fluctuate on demand and supply basis. Therefore data related to last few trading months was only consider and interpreted. 1.2 DEFINITION OF STOCK EXCHANGE:
Stock exchange means any body or individuals whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities.
It is an association of member brokers for the purpose of self-regulation and protecting the interests of its members. It can operate only if it is recognized by the Government under the securities contracts (regulation) Act, 1956. The recognition is granted under section 3 of the Act by the central government, Ministry of Finance. BYLAWS: Besides the above act, the securities contracts (regulation) rules were also made in 1957 to regulate certain matters of trading on the stock exchanges. There are also bylaws of the exchanges, which are concerned with the following subjects. Opening/closing of the stock exchanges, timing of trading, regulation of blank transfers, regulation of badla or carryover business, control of the settlement and other activities of the stock exchange, fixation of margins, fixation of market prices or making up prices, regulation of taravani business (jobbing), etc., regulation of brokers trading, brokerage charges, trading rules on the exchange, arbitration and settlement of disputes, settlement and clearing of the trading etc. 1.2.1 REGULATION OF STOCK EXCHANGES: The securities contracts (regulation) act is the basis for operations of the stock exchanges in India. No exchange can operate legally without the government permission or recognition. Stock exchanges are given monopoly in certain areas under section 19 of the above Act to ensure that the control and regulation are facilitated. Recognition can be granted to a stock exchange provided certain conditions are satisfied and the necessary information is supplied to the government. Recognition can also be withdrawn, if necessary. Where there are no stock exchanges, the government can license some of the brokers to perform the functions of a stock exchange in its absence. 1.2.2 SECURITIES AND EXCHANGE BOARD OF INDIA(SEBI): SEBI was set up as an autonomous regulatory authority by the Government of India in 1988
to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto.
It is empowered by two acts namely the SEBI Act, 1992 and the securities contract(regulation)Act, 1956 to perform the function of protecting investor's rights and regulating the capital markets. 1.2.3 BOMBAY STOCK EXCHANGE This stock exchange, Mumbai, popularly known as
BSE
was established in 1875 as
The Native share and stock brokers association
, as a voluntary non-profit making association. It has an evolved over the years into its present status as the premiere stock exchange in the country. It may be noted that the stock exchanges the oldest one in Asia, even older than the Tokyo Stock exchange which was founded in 1878. The exchange, while providing an efficient and transparent market for trading in securities, upholds the interests of the investors and ensures redressed of their grievances, whether against the companies or its own member brokers. It also strives to educate and enlighten the investors by making available necessary informative inputs and conducting investor education programmes. A governing board comprising of 9 elected directors, 2 SEBI nominees, 7 public representatives and an executive director is the apex body, which decides the policies and regulates the affairs of the exchange. The Executive director as the chief executive officer is responsible for the day today administration of the exchange. The average daily turnover of the exchange during the year 2000-01(April-March) was Rs 3984.19 crs and average number of daily trades 5.69 laces.However the average daily turnover of the exchange during the year 2001-02 has declined to Rs. 1244.10 crs and number of average daily trades during the period to 5.17 laces.The average daily turn over of the exchange during the year 2002-03 has declined and number of average daily trades during the period is also decreased. The Ban on all deferral products like BLESS AND ALBM in the Indian capital markets by SEBI i.e. July 2, 2001, abolition of account Period settlements, introduction of compulsory rolling settlements in all scrip’s traded on the exchanges i.e. Dec 31,2001, etc., have adversely impacted the liquidity and consequently there is a considerable decline in the daily turn over at the exchange. The average daily turn over of the exchange present scenario is 110363 (Laces) and number of average daily trades 1057(Laces) BSE INDICES: In order to enable the market participants, analysts etc., to track the various ups and downs in the Indian stock market, the Exchange has introduced in 1986 an equity stock index called BSE-SENSEX that subsequently became the barometer of the moments of the share prices in the Indian stock market. It is a
Market capitalization-weighted
index of 30 component stocks representing a sample of large, well-established and leading companies. The base year of Sensex is 1978-79. The Sensex is widely reported in both domestic and international markets through print as well as electronic media. Sensex is calculated using a market capitalization weighted method. As per this methodology, the level of the index reflects the total market value of all 30-component stocks from different industries related to particular base period. The total market value of a company is determined by multiplying the price of its stock by the number of shares outstanding. Statisticians call an index of a set of combined variables (such as price and number of shares) a composite Index. An Indexed number is used to represent the results of this calculation in order to make the value easier to work with and track over a time. It is much easier to graph a chart based on Indexed values than one based on actual values world over majority of the well-known Indices are constructed using “Market capitalization weighted method
. In practice, the daily calculation of SENSEX is done by dividing the aggregate market value of the 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to the original base period value of the SENSEX. The Divisor keeps the Index comparable over a period of time and if the reference point for the entire Index maintenance adjustments. SENSEX is widely used to describe the mood in the Indian Stock markets. Base year average is changed as per the formula New base year average = Old base year average*(New market Value/old market value) 1.2.4 NATIONAL STOCK EXCHANGE The NSE was incorporated in Nov 1992 with an equity capital of Rs. 25 crs. The International securities consultancy (ISC) of Hong Kong has helped in setting up NSE. ISC has prepared the detailed business plans and installation of hardware and software systems. The promotions for NSE were financial institutions, insurances companies, banks and SEBI capital market ltd, Infrastructure leasing and financial services ltd and stock holding corporation ltd. It has been set up to strengthen the move towards professionalisation of the capital market as well as provide nation wide securities trading facilities to investors. NSE is not an exchange in the traditional sense where brokers own and manage the exchange. A two tier administrative set up involving a company board and a governing aboard of the exchange is envisaged. NSE is a national market for shares PSU bonds, debentures and government securities since infrastructure and trading facilities are provided. NSE - NIFTY: The NSE on April 22, 1996 launched a new equity Index. The NSE-50. The new Index which replaces the existing NSE-100 Index is expected to serve as an appropriate Index for the new segment of futures and options. “Nifty
means National Index for Fifty Stocks. The NSE-50 comprises 50 companies that represent 20 broad Industry groups with an aggregate market capitalization of around Rs. 1,70,000 crs. All companies included in the Index have a market capitalization in excess of Rs 500 crs each and should have traded for 85% of trading days at an impact cost of less than 1.5%. The base period for the index is the close of prices on Nov 3, 1995, which makes one year of completion of operation of NSE’s capital market segment. The base value of the Index has been set at 1000. NSE - MIDCAP INDEX: The NSE midcap Index or the Junior Nifty comprises 50 stocks that represents 21 board Industry groups and will provide proper representation of the midcap segment of the Indian capital Market. All stocks in the Index should have market capitalization of greater than Rs. 200 crs and should have traded 85% of the trading days at an impact cost of less 2.5%. The base period for the index is Nov 4, 1996, which signifies two years for completion of operations of the capital market segment of the operations. The base value of the Index has been set at 1000. Average daily turn over of the present scenario 258212 (Lacs) and number of average daily trades 2160 (Lacs). At present, there are 24 stock exchanges recognized under the securities contract (regulation) Act, 1956. They are List of Stock Exchanges recognized under the securities contract (regulation) Act, 1956 NAME OF THE STOCK EXCHANGEYEARBombay stock exchange, Ahmedabad share and stock brokers associationCalcutta stock exchange association Ltd, Delhi stock exchange association Ltd, Madras stock exchange association Ltd, Indoor stock brokers association, Bangalore stock exchange, Hyderabad stock exchange, Cochin stock exchange, Pune stock exchange Ltd, U.P stock exchange association Ltd, Ludhiana stock exchange association Ltd, Jaipur stock exchange Ltd, Gauhathi stock exchange Ltd, Mangalore stock exchange Ltd, Maghad stock exchange Ltd, Patna, Bhubaneshwar stock exchange association Ltd, Over the counter exchange of India, Bombay, Saurasthra kutch stock exchange Ltd, Vsdodara stock exchange Ltd, Coimbatore stock exchange Ltd, The meerut stock exchange Ltd, 1National stock exchange Ltd, Integrated stock exchange, 1875195719571957195719581963194319781982198219831983-841984198519861989198919901991199119911991,1999 1.3 DERIVATIVES MEANING: The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. Derivatives are risk management instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, share, bonds, currency, interest etc. Annual turnover of the derivatives is increasing each year from 1986 onwards, Year Annual turnover 1986 146 millions 1992 453 millions 1998 1329 millions 2002 & 2003 it has reached to equivalent stage of cash market Derivatives are used by banks, securities firms, companies and investors to hedge risks, to gain access to cheaper money and to make profits Derivatives are likely to grow even at a faster rate in future they are first of all cheaper to world have met the increasing volume of products tailored to the needs of particular customers, trading in derivatives has increased even in the over the counter markets. In Britain unit trusts allowed to invest in futures & options .The capital adequacy norms for banks in the European Economic Community demand less capital to hedge or speculate through derivatives than to carry underlying assets. Derivatives are weighted lightly than other assets that appear on bank balance sheets. The size of these off-balance sheet assets that include derivatives is more than seven times as large as balance sheet items at some American banks causing concern to regulators 1.3.1 DEFINITION: Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R) A) defines “derivative” to include- 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. A contract, which derives its value from the prices, or index of prices, of underlying securities. Derivatives are the securities under the SC(R)A and hence the trading of derivatives is governed by the regulatory framework under the SC(R)A. 1.3.2 PARTICIPANTS IN THE DERIVATIVES MARKET The following three broad categories of participants who trade in the derivatives market: Hedgers Speculators and Arbitrageurs Hedgers: Hedgers face risk associated with the price of an asset. They use futures or options markets to reduce or eliminate this risk. Speculators: 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. Arbitrageurs: Arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. For example, they see the futures price of an asset getting out of line with the cash price; they will take offsetting positions in the two markets to lock in a profit. 1.3.4 FUNCTIONS OF THE DERIVATIVES MARKET: The derivatives market performs a number of economic functions. 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, due to their inherent nature, are linked to the underlying cash markets. With the introduction of derivatives, the underlying market witnesses higher trading volumes because of participation by more players who would not otherwise participate for lack of an arrangement to transfer risk. Speculative trades shift to a more controlled environment of derivatives market. In the absence of an organized derivatives market, speculators trade in the underlying cash markets. An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new entrepreneurial activity. Derivatives markets help increase savings and investment in the long run. Transfer of risk enables market participants to expand their volume of activity. 1.3.5 TYPES OF DERIVATIVES The most commonly used derivatives contracts are forwards, futures and options. Here various derivatives contracts that have come to be used are given briefly: Forwards Futures Options Warrants LEAPS Baskets Swaps Swaptions Forwards: A forward contract is customized contract between two entities, where settlement takes place on a specific date in the future at today’s 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 exchange-traded contracts. 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 two lives of up to one year, the majority of options traded on options exchanges having a minimum 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. The two commonly used swaps are: Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency. 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. Swaptions: Swaptions are options to buy or sell that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions markets has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is an option to pay fixed and receive floating. 1.3.6 DERIVATIVES INSTRUMENTS IN INDIA The first derivative product to be introduced in the Indian securities market is going to be
INDEX FUTURES
. In the world, first index futures were traded in U.S. on Kansas City Board of Trade (KCBT) on Value Line Arithmetic Index (VLAI) in 1982. Organized exchanges began trading options on equities in 1973, where as exchange traded debt options did not appear until 1982, on the other hand fixed income futures began trading in 1975, but equity related futures did not begin until 1982. 1.3.7 DERIVATIVES SEGMENT IN BSE & NSE On June 9,2000 BSE & NSE became the first exchanges in India to introduce trading in exchange traded derivative product with the launch of index futures on sense and Nifty futures respectively. Index futures was follows by launch of index options in June 2001, stock options in July 2001 and stock futures in Nov 2001.Presently stock futures and options available on 41 well-capitalized and actively traded scripts mandated by SEBI. Nifty is the underlying asset of the Index Futures at the Futures & Options segment of NSE with a market lot of 200 and the BSE 30 Sensex is the underlying stock index with the market lot of 50. This difference of market lot arises due to a minimum specification of a contract value of Rs. 2 lakhs by Securities Exchange Board of India. A contract value is contracting Index laid by its market lot. For e.g. If Sensex is 4730 then the contract value of a futures Index having Sensex as underlying asset will Be 50 x 4730 = Rs. 2,36,500. Similarly if Nifty is 1462.7, its futures contract value will be 200 x 1462.7 = Rs.2, 92,540/-. Every transaction shall be in multiple of market lot. Thus, Index futures at NSE shall be traded in multiples of 200 and at BSE in multiples of 50 1.3.8 CONTRACT PERIODS: At any point of time there will always be available near three months contract periods. For e.g. in the month of June 2009 one can enter into either June Futures contract or July Futures contract or August Futures Contract. The last Thursday of the month specified in the contract shall be the final settlement date for that contract at both NSE as well BSE. Thus June 29, July 27 and August 31 shall be the last trading day or the final settlement date for June Futures contract, July Futures Contract and August Futures Contract respectively. When one futures contract gets expired, a new futures contract will get introduced automatically. For instance, on 30th June, June futures contract becomes invalidated and a September Futures Contract gets activated. 1.3.9 SETTLEMENT: Settlement of all Derivatives trades is in cash mode. There is Daily as well as Final Settlement. Outstanding positions of a contract can remain open till the last Thursday of that month. As long as the position is open, the same will be marked to Market at the Daily Settlement Price, the difference will be credited or debited accordingly and the position shall be brought forward to the next day at the daily settlement price. Any position which remains open at the end of the final settlement day (i.e., last Thursday) shall be closed out by the Exchange at the Final Settlement Price which will be the closing spot value of the underlying (Nifty or Sensex, or respective stocks as the case may be). 1.3.10 Regulation for Derivatives Trading SEBI set up a 24-member committee under 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 recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with stock index futures. SEBI also approved the “suggestive bye-laws” recommended by the committee for regulation and control of trading and settlement of derivatives contracts. The provisions in the SC(R) A and the regulatory framework developed there under govern trading in securities. The amendment of the SC(R) A to include derivatives within the ambit of ‘securities’ in the SC(R) A made trading in derivatives possible within the framework of the Act. 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 have 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 practices of its members and will obtain approval of SEBI before start of trading in any derivative contract The exchange shall have minimum 50 members. The members of an existing segment of the exchange will not automatically become the members of derivative segment. The members of the derivative segment need to fulfill the eligibility conditions as laid down by the L C Gupta committee. The clearing and settlement of derivatives trades shall be through a SEBI approved clearing corporation / house. Clearing corporation / houses complying with the eligibility conditions as laid down by the committee have to apply to SEBI for grant of approval. Derivative brokers/dealers and clearing members are required to seek registration from SEBI. The minimum contract value shall not be less than Rs. 2 Lakh. Exchanges should also submit details of the futures contract they propose to introduce. The trading members are required to have qualified approved user and sales person who have passed a certification programme approved by SEBI. While from the purely regulatory angle, a separate exchange for trading would be a better arrangement. Considering the constraints in infrastructure facilities, the existing stock (cash) exchanges may also be permitted to trade derivatives subject to the following conditions. Trading should take place through an on-line screen based trading system. An independent clearing corporation should do the clearing of the derivative market. The exchange must have an online surveillance capability, which monitors positions, price and volumes in real time so as to deter market manipulation price and position limits should be used for improving market quality. Information about trades quantities, and quotes should be disseminated by the exchange in the real time over at least two information-vending networks, which are accessible to investors in the country. The exchange should have at least 50 members to start derivatives trading. The derivatives trading should be done in a separate segment with separate membership; That is, all members of the cash market would not automatically become members of the derivatives market. The derivatives market should have a separate governing council which should not have representation of trading by clearing members beyond whatever percentage SEBI may prescribe after reviewing the working of the present governance system of exchanges. The chairman of the governing council of the derivative division / exchange should be a member of the governing council. If the chairman is broker / dealer, then he should not carry on any broking or dealing on any exchange during his tenure. No trading/clearing member should be allowed simultaneously to be on the governing council both derivatives market and cash market. FUTURES 2.1 FUTURES Futures contract is a firm legal commitment between a buyer & seller in which they agree to exchange something at a specified price at the end of a designated period of time. The buyer agrees to take delivery of something and the seller agrees to make delivery. 2.2 STOCK INDEX FUTURES Stock Index futures are the most popular financial futures, which have been used to hedge or manage the systematic risk by the investors of Stock Market. They are called hedgers who own portfolio of securities and are exposed to the systematic risk. Stock Index is the apt hedging asset since the rise or fall due to systematic risk is accurately shown in the Stock Index. Stock index futures contract is an agreement to buy or sell a specified amount of an underlying stock index traded on a regulated futures exchange for a specified price for settlement at a specified time future. Stock index futures will require lower capital adequacy and margin requirements as compared to margins on carry forward of individual scrips. The brokerage costs on index futures will be much lower. Savings in cost is possible through reduced bid-ask spreads where stocks are traded in packaged forms. The impact cost will be much lower in case of stock index futures as opposed to dealing in individual scrips. The market is conditioned to think in terms of the index and therefore would prefer to trade in stock index futures. Further, the chances of manipulation are much lesser. The Stock index futures are expected to be extremely liquid given the speculative nature of our markets and the overwhelming retail participation expected to be fairly high. In the near future, stock index futures will definitely see incredible volumes in India. It will be a blockbuster product and is pitched to become the most liquid contract in the world in terms of number of contracts traded if not in terms of notional value. The advantage to the equity or cash market is in the fact that they would become less volatile as most of the speculative activity would shift to stock index futures. The stock index futures market should ideally have more depth, volumes and act as a stabilizing factor for the cash market. However, it is too early to base any conclusions on the volume or to form any firm trend. The difference between stock index futures and most other financial futures contracts is that settlement is made at the value of the index at maturity of the contract. 2.3 FUTURES TERMINOLOGY Contract Size The value of the contract at a specific level of Index. It is Index level * Multiplier. Multiplier It is a pre-determined value, used to arrive at the contract size. It is the price per index point. Tick Size It is the minimum price difference between two quotes of similar nature. Contract Month The month in which the contract will expire. Expiry Day The last day on which the contract is available for trading. Open interest Total outstanding long or short positions in the market at any specific point in time. As total long positions for market would be equal to total short positions, for calculation of open Interest, only one side of the contracts is counted. Volume No. Of contracts traded during a specific period of time. During a day, during a week or during a month. Long position Outstanding/unsettled purchase position at any point of time. Short position Outstanding/ unsettled sales position at any point of time. Open position Outstanding/unsettled long or short position at any point of time. Physical delivery Open position at the expiry of the contract is settled through delivery of the underlying. In futures market, delivery is low. Cash settlement Open position at the expiry of the contract is settled in cash. These contracts Alternative Delivery Procedure (ADP) - Open position at the expiry of the contract is settled by two parties - one buyer and one seller, at the terms other than defined by the exchange. World wide a significant portion of the energy and energy related contracts (crude oil, heating and gasoline oil) are settled through Alternative Delivery Procedure. 2.4 Pay off for futures: A Pay off is the likely profit/loss that would accrue to a market participant with change in the price of the underlying asset. Futures contracts have linear payoffs. In simple words, it means that the losses as well as profits, for the buyer and the seller of futures contracts, are unlimited. Pay off for Buyer of futures: (Long futures) The pay offs for a person who buys a futures contract is similar to the pay off for a person who holds an asset. He has potentially unlimited upside as well as downside. Take the case of a speculator who buys a two-month Nifty index futures contract when the Nifty stands at 1220. The underlying asset in this case is the Nifty portfolio. When the index moves up, the long futures position starts making profits and when the index moves down it starts making losses . Pay off for seller of futures: (short futures) The pay offs for a person who sells a futures contract is similar to the pay off for a person who shorts an asset. He has potentially unlimited upside as well as downside. Take the case of a speculator who sells a two-month Nifty index futures contract when the Nifty stands at 1220. The underlying asset in this case is the Nifty portfolio. When the index moves down, the short futures position starts making profits and when the index moves up it starts making losses. OPTIONS 3.1 OPTIONS An option agreement is a contract in which the writer of the option grants the buyer of the option the right to purchase from or sell to the writer a designated instrument at a specific price within a specified period of time. Certain options are shorterm in nature and are issued by investors another group of options are long-term in nature and are issued by companies. 3.2 OPTIONS TERMINOLOGY: Call option: A call is an option contract giving the buyer the right to purchase the stock. Put option: A put is an option contract giving the buyer the right to sell the stock. Expiration date: It is the date on which the option contract expires. Strike price: It is the price at which the buyer of a option contract can purchase or sell the stock during the life of the option Premium: Is the price the buyer pays the writer for an option contract. Writer: The term writer is synonymous to the seller of the option contract. Holder: The term holder is synonymous to the buyer of the option contract. Straddle: A straddle is combination of put and calls giving the buyer the right to either buy or sell stock at the exercise price. Strip: A strip is two puts and one call at the same period. Strap: A strap is two calls and one put at the same strike price for the same period. Spread: A spread consists of a put and a call option on the same security for the same time period at different exercise prices. The option holder will exercise his option when doing so provides him a benefit over buying or selling the underlying asset from the market at the prevailing price. These are three possibilities. In the money: An option is said to be in the money when it is advantageous to exercise it. ,[object Object], 3. At the money: IF the option holder does not lose or gain whether he exercises his option or buys or sells the asset from the market, the option is said to be at the money. The exchanges initially created three expiration cycles for all listed options and each issue was assigned to one of these three cycles. January, April, July, October. February, March, August, November. March, June, September, and December. In India, all the F and O contracts whether on indices or individual stocks are available for one or two or three months series and they expire on the Thursday of the concerned month. 3.3 CALL OPTION: An option that grants the buyer the right to purchase a designated instrument is called a call option. A call option is a contract that gives its owner the right, but not the obligation, to buy a specified price on or before a specified date. An American call option can be exercised on or before the specified date only. European options can be exercised on the specified date only. 3.4 PUT OPTION: An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. This is the opposite of a call option, which gives the holder the right to buy shares. A put becomes more valuable as the price of the underlying stock depreciates relative to the strike price. For example, if you have one Mar 09 Taser 10 put, you have the right to sell 100 shares of Taser at $10 until March 2008 (usually the third Friday of the month). If shares of Taser fall to $5 and you exercise the option, you can purchase 100 shares of Taser for $5 in the market and sell the shares to the option's writer for $10 each, which means you make $500 (100 x ($10-$5)) on the put option. Note that the maximum amount of potential proft in this example ignores the premium paid to obtain the put option. 3.5 FACTORS DETERMINIG OPTION VALUE: Stock price Strike price Time to expiration Volatility Risk free interest rate Dividend 3.6 DIFFERENCE BETWEEN FUTURES & OPTION: FUTURES1) Both the parties are obligated to perform. 2) With futures premium is paid by either party.3) The parties to futures contracts must perform at the settlement date only. They are not obligated to perform before that date.4) The holder of the contract is exposed to the entire spectrum of downside risk and had the potential for all upside return.5) In futures margins to be paid. They are approximate 15-20% on the current stock price.OPTIONS1) Only the seller (writer) is obligated to perform.2) With options, the buyer pays the seller a premium.3) The buyer of an options contract can exercise any time prior to expiration date.4) The buyer limits the downside risk to the option premium but retain the upside potential.5) In options premiums to be paid. But they are very less as compared to the margins. 3.7 Advantages of option trading: Risk management: put option allow investors holding shares to hedge against a possible fall in their value. This can be considered similar to taking out insurance against a fall in the share price. Time to decide: By taking a call option the purchase price for the shares is locked in. This gives the call option holder until the Expiry day to decide whether or exercised the option and buys the shares. Likewise the taker of a put option has time to decide whether or not to sell the shares. Speculations: The ease of trading in and out of option position makes it possible to trade options with no intention of ever exercising them. If investor expects the market to rise, they may decide to buy call options. If expecting a fall, they may decide to buy put options. Either way the holder can sell the option prior to expiry to take a profit or limit a loss. Trading options has a lower cost than shares, as there is no stamp duty payable unless and until options are exercised. Leverage: Leverage provides the potential to make a higher return from a smaller initial outlay than investing directly however leverage usually involves more risks than a direct investment in the underlying share. Trading in options can allow investors to benefit from a change in the price of the share without having to pay of the share. 3.8 Summary of options Call option buyerCall option writer (seller)Pays premiumRight to exercise and buy the shareProfits from rising pricesLimited losses, potentially unlimited gainReceives premiumObligation to sell shares if exercisedProfits from falling prices or remaining neutralPotentially unlimited losses, limited gainPut option buyerPut option writer (seller)Pays premiumRight to exercise and sell sharesProfits from falling pricesLimited losses, potentially unlimited gainReceives premiumObligation to buy shares if exercisedProfits from rising prices or remaining neutral Potentially unlimited losses, limited gain ABOUT SHAREKHAN 4.1 SHAREKHAN Sharekhan is one of India's largest and leading financial services companies. It is an online stock trading company of SSKI Group (S.S. Kantilal Ishwarlal Securities Limited) which has been a provider of India-based investment banking and corporate finance service for over 80 years. SSKI caters to most of the prominent financial institutions, foreign and domestic, investing in Indian equities. It has been valued for its strong research-led investment ideas, superior client servicing track record and exceptional execution skills. The key features of sharekhan are as follows: ,[object Object]](https://image.slidesharecdn.com/derivatives-091208062317-phpapp02/85/project-on-derivatives-1-320.jpg)
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Project On Derivatives
- 2. There are instant credit and money transfer facilities.
- 3. You can trade from any net enabled PC.
- 4. After hour orders facilities.
- 5. You can go for online orders over the phone.
- 6. Timely advice and research reports
- 9. Multiple Market Watch available on Single Screen
- 10. Multiple Charts with Tick by Tick Intraday and End of Day Charting powered with various Studies
- 11. Graph Studies include Average, Band- Bollinger, Know Sure Thing, MACD, RSI, etc
- 12. Apply studies such as Vertical, Horizontal, Trend, Retracement & Free lines
- 13. User can save his own defined screen as well as graph template, that is, saving the layout for future use
- 14. User-defined alert settings on an input Stock Price trigger
- 15. Tools available to gauge market such as Tick Query, Ticker, Market Summary, Action Watch, Option Premium Calculator, Span Calculator
- 16. Shortcut key for FAST access to order placements & reports
- 18. Commodities Beat: a summary of the days trading activity.
- 19. Traders Corner: Under commodity trading calls, there are two types of trading calls:
- 20. Rapid Fire: (short-term calls for 1 day to 5 days updated daily)
- 21. Medium-term Plays: (medium-term calls for 1 month to 3 months updated weekly or in between if needed)
- 22. Sharekhan Xclusive: the commodity research reports and analyses (periodical).
- 24. Settlement Price is 163.75
- 32. On the expiry date the spot market price enclosed at 155.95.
- 42. Already Premium Received 21.1
- 44. Taken Spot price on 11th june 09 is 138.Such as Call option is sold on 11th June
- 51. On the expiry date the spot market price enclosed at 155.95.
- 65. Already Premium Received
- 67. Settlement Price is 639.65
- 75. On 18th May 09 the spot price enclosed is 662.8 .here this put option sold on 18th may 09.
- 85. Already Premium Received 94.1
- 86. So, he can get profit up to Rs 24840Because it is positive, in the money Contract, hence seller gets more profit, incase Spot price decrease in below strike price seller can get loss in premium. Punjab national bank minting money On 12th may 09 so its volumes are increasing. On 12th may 09 Punjab touched an intraday high of Rs 549.50 and an intraday low of Rs 508.40. At 1:45 pm, the share was quoting at Rs 547.20, up Rs 28.10, or 5.41%. So from may 12th Onwards there is a drastic increase in Share price of PNB. So that the call option values also starts increasing and put option values decreased from 12th may onwards. On 12th May there is drastic increase in total turnover in lacs from 6316.87 on 11th May 09 to 12456.74 on 12th May 09. Traded quantity increased from 12,09,101 on may 11th 09 to 23,09,184 on 12th may 09. So the share price of PNB started increasing from 12th may 09. On 20th may 09 PNB announced it will disinvest 26% stake in PNB Housing Finance to Dawnay Day. So the share price decreased from 20th may onwards. Then call option values started decreasing, put options values started increasing. PNB MAY FUTURES:- InstrumentSymbolDateExpiryOpenHighLowCloseLTPSettle PriceNo. of contracts Turnover in lacsOpen IntFUTSTKPNB4-May-0928-May-09484.9502.9481.5498.85497.15498.8529478725.531602000FUTSTKPNB5-May-0928-May-09499518489.3499.75500499.7531199415.691594800FUTSTKPNB6-May-0928-May-09503.3514.45498502.75504.7502.7532769949.451744200FUTSTKPNB7-May-0928-May-09509.85523507.25519.85522.25519.8524237491.641746000FUTSTKPNB8-May-0928-May-09523.8527.45506.5523.2525523.230509465.211978800FUTSTKPNB11-May-0928-May-09525.5528.6505.4515.45516.4515.4525978045.322088600FUTSTKPNB12-May-0928-May-09515.8549.95512.2547.25547.3547.25389912452.472382600FUTSTKPNB13-May-0928-May-09548568.8542554.75551.05554.75381612752.892509800FUTSTKPNB14-May-0928-May-09543563.8536556.7556.5556.7321510710.82779200FUTSTKPNB15-May-0928-May-09558.1582.9555.2572.95575.7572.95359512325.32811000FUTSTKPNB18-May-0928-May-09658.9687658.9682.5685.05682.538154.262803800FUTSTKPNB19-May-0928-May-09719.7747674689.3686.2689.3460119195.662431800FUTSTKPNB20-May-0928-May-09680710670.2680.5683.1680.5268311095.092452200FUTSTKPNB21-May-0928-May-09680698663.2668.4663.2668.4333513711.662196600FUTSTKPNB22-May-0928-May-09655.25680.7647.25663.1660.8663.1315812590.171813200FUTSTKPNB25-May-0928-May-09664666638.15644.05642.1644.05335013020.471587000FUTSTKPNB26-May-0928-May-09648659.5630634.4633.25634.420598012.991307400FUTSTKPNB27-May-0928-May-09648664645.3661.5660661.519417661.761109400FUTSTKPNB28-May-0928-May-09661668.4653.6664.5664.5664.319997934.09663000 Future Market BUYER SELLER 12/05/09(buying) 547.25 547.25 28/05/09(Closing Period) 664.5 664.5 Profit = 117.25 Loss =117.25 Profit 145.2*300=35175 Loss 117.25*300=35175 Because buyer Future price will increase so, profit also increases.Seller Future price also increases so he can get loss. Incase seller Future will decreases, he can get profit. The closing Price of PNB at the end of contract period is 664.5 and this is considered as settlement price. 5.2.3 PNB JUNE MONTH ANALYSIS PNB JUNE EQUITY TABLE:- SymbolSeriesDate Prev CloseOpen PriceHigh PriceLow PriceLast PriceClose PriceAverage PricePNBEQ1-Jun-09670.8684.4684.4658.55667663.5668.62PNBEQ2-Jun-09663.5674674.4633.3648.3646.3648.03PNBEQ3-Jun-09646.3650.1664.45641658657.2651.67PNBEQ4-Jun-09657.2649.8665623.35660.9661.65647.62PNBEQ5-Jun-09661.65666670648.3652.05654.25661PNBEQ8-Jun-09654.25650659.85595.35598606.45618.81PNBEQ9-Jun-09606.45601.05624.9590.1615.1610.85612.97PNBEQ10-Jun-09615.1612638.5612632.1636628.5PNBEQ11-Jun-09636638638606614612.65615.23PNBEQ12-Jun-09612.65614632590.2592.9593602.32PNBEQ15-Jun-09593583617.9583613.95611.4606.93PNBEQ16-Jun-09611.4605634.85598.2629.8630.85625.96PNBEQ17-Jun-09630.85634.85647605612600633.88PNBEQ18-Jun-09600618.7640612619617.2627.16PNBEQ19-Jun-09617.2639.7645.85624.05645642.05634.12PNBEQ22-Jun-09642.05646.85659.8645645648.7652.44PNBEQ23-Jun-09648.7635647620.3621625.15630.16PNBEQ24-Jun-09625.15628631.8620.1623623.7626.18PNBEQ25-Jun-09623.7640647.7626631631.45633.5PNBEQ26-Jun-09631.45633.15667620.7649655.2646.17PNBEQ29-Jun-09655.2655.55689.9655676.95680.05675.28PNBEQ30-Jun-09680.05683694673.5679677.75684.69 Interpretation:- This analysis is useful to know where to buy and sell the options such as Call and Puts. Open Price=684 On 1st June 09 Low Price=583 On 15th June 09 High Price= 694 On 30th June 09 Close price=677 On 30th June 09 In the above graph I calculated Break Even point for GMRINFRA Stock for June Month. Break Even Point(BEP) = (High Price + Low Price)/2 = (694+583)/2 = 638 Again I found margin of safety (MOS) (1) Margin of safety (mos) = opening share value – BEP =684-638 =46 So here margin of safety is Positive value. So here investor gets more profits and longs. (2) Margin of safety (mos) =high share price –BEP =694-638 =56 So here margin of safety is Positive value. So here investor gets more profits and longs. So at this point investor can sell their Call options to get more profits. (3) Margin of safety (mos) =Low share value – BEP =583-638 =-55 So here margin of safety is negative. So here investor gets more losses and shorts. Investor can sell their Put Option at this point to incur more profits. PNB JUNE PUT OPTION(Strike Price=640):- InstrumentSymbolOptionDateExpiryStrike PriceSettle PriceOPTSTKPNBPA1-Jun-0925-Jun-0964037.85OPTSTKPNBPA2-Jun-0925-Jun-0964043.1OPTSTKPNBPA3-Jun-0925-Jun-0964036.4OPTSTKPNBPA4-Jun-0925-Jun-0964033.7OPTSTKPNBPA5-Jun-0925-Jun-0964034.45OPTSTKPNBPA8-Jun-0925-Jun-0964058.95OPTSTKPNBPA9-Jun-0925-Jun-0964054.1OPTSTKPNBPA10-Jun-0925-Jun-0964041.05OPTSTKPNBPA11-Jun-0925-Jun-0964050.25OPTSTKPNBPA12-Jun-0925-Jun-0964061.4OPTSTKPNBPA15-Jun-0925-Jun-0964045.5OPTSTKPNBPA16-Jun-0925-Jun-0964032.6OPTSTKPNBPA17-Jun-0925-Jun-0964039.95OPTSTKPNBPA18-Jun-0925-Jun-0964036.25OPTSTKPNBPA19-Jun-0925-Jun-0964021.1OPTSTKPNBPA22-Jun-0925-Jun-0964011.4OPTSTKPNBPA23-Jun-0925-Jun-0964021.15OPTSTKPNBPA24-Jun-0925-Jun-0964019OPTSTKPNBPA25-Jun-0925-Jun-096400 OBSERVATION