INTRODUCTION

A derivative is a security whose value depends on the value of to

gather more basic underlying variable. These are also known as contingent

claims. Derivative securities have been very successful innovation in capital

market.

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, financial markets are

marked by a very high degree of volatility. Through the use of derivative

products, is possible to partially or fully transfer price risks by a locking-in

asset prices. As instruments of risk management, these generally do not

influence the fluctuation 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 investor.

Derivatives are risk management instruments, which drive their value

form underlying asset. Underlying asset can be bullion, index; share, currency,

bonds, interest etc.

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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 expertly 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.

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OBJECTIVES

To study the various trends in derivatives in derivative market.

To study the role of derivatives in Indian financial market.

To study in detail the role of futures and options.

To find out profit/loss of the option holder and option writer.

To study about risk management with the help of derivatives.

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.

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METHODOLOGY

To achieve the objective of studying the stock market data has been

collected.

Research methodology carried for this study can be two types

1. Primary data

2. Secondary data

PRIMARY DATA

The data, which is being collected for the first time and it is the original

detain this project the primary data has been taken from NSE staff and guide

of the project.

SECONDARY DATA

The secondary information is mostly taken from websites, books, &

journals etc.

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LIMITATION OF THE STUDY

The subject of derivative if vast it requires extension study and research to

understand the debt 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

preference of an investor however the study was only contained towards

the risk minimization 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.

Data related to last few trading months was only consider and interpreted.

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INTRODUCTION TO DERIVATIVES

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 price. By their very nature, the financial markets are

marked by a 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 defined:

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.

For example: wheat farmers may wish to sell there heaviest at a future date to

eliminate the risk of a change in prices by that date. Such a transaction is an

example of a derivative. The price of this derivative is driven by the spot price

of wheat which is the “underlying”. In the Indian context the Securities

Contracts (Regulation) Act, 1956(SC®A) defines “derivatives” to include…

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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.

Derivatives are securities under the SC® A and hence the regulatory

framework under the SC® A governs the trading of derivatives.

Definitions

“A Derivative can be defined as a financial instrument whose value

depends on (or derives from) the value of other, more basic underlying

variables.”

- John C. Hull

“A Derivative is simply a financial instrument (or even more simply an

agreement between two people) which has a value determined by the price

of something else.”

- Robert L. McDonald

Derivatives are financial instruments whose value is derived from its

underlying it may be stock, commodity, gold, Index, etc.

Derivatives give an opportunity to buy or sell the underlying at a future date

but at a pre-specified price decided at the date of entry of the contract.

Functions

The following are the various functions that are performed by the derivatives

markets. They are…

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1. Prices in an organized derivatives market reflect the perception of market

participants about the future and lead the prices of the underlying asset to

the perceived future level.

2. Derivatives markets help to transfer risks from those who have them but

may not like them to those who want them.

3. Derivatives market helps increase savings and investments in the long run.

4. Derivatives trading act as catalyst for new entrepreneurial activity.

Advantages

1. Transactional efficiency-greater liquidity and lower cost.

2. Price discovery-dissemination of price information

3. Risk management-transfer of risks.

Characteristics of derivatives

1. Their value is derived from an underlying instrument such as stock index,

currency, etc.

2. They are vehicles for transferring risk.

3. They are leveraged instruments

Participants

There are three broad categories of participants participating in the

derivative segment

They are

Hedgers: Hedgers are investors who would like to reduce risk. Hedges

seek to protect themselves against price changes in a commodity in which

they have an interest.

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Speculators: Speculators bet on the future price movements of an asset.

Derivatives give them an extra leverage that they can increase both the

potential gains and losses. Speculators are major players in the markets,

without whom the market probably would ever exist.

Arbitrageurs: These are specialized in making purchase and sales in

different markets at the same time and there by make profits by the

differences in the prices between two countries i.e. they take the advantage

of the discrepancy between prices in two different markets.

Functions

The following are the various functions that are performed by the

derivatives markets. They are:

Prices in an organized market reflect the perception of market participants

about the future and lead the prices of the underlying asset to the perceived

future level.

Derivatives market help to transfer risks from those who have them but

may not like them to those who want them.

Derivatives markets help increase savings and investments in the long run.

Derivatives trading act as a catalyst for new entrepreneurial activity.

ADVANTAGES

Risk management:

Risk management is not about the elimination of risk rather it is about

the management of risk. Financial derivatives provide a powerful tool for

limiting risk that individual an organizations face in ordinary conduct of

their business. Successful risk management with derivatives requires are

thorough understandings of principles that govern the pricing of financial

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derivatives. Used correctly, derivatives can save costs and increased

returns.

Trading Efficiency:

Derivatives allow for the free trading of individual risk components,

there by improving market efficiency. Traders can use a position in one or

more financial derivatives as a substitute for a position in the underlying

instruments. In many instances traders find financial to more attractive

instrument than the underlying security is reason being the greater amounts

of liquidity in the market afford by the financial derivatives and lowered

transaction costs associated with a trading a financial derivative as

compared to the cost of trading the underlying instrument.

Speculation:

Serving as a speculative tool is not the only use, and probably not the

most important use, of financial derivatives. Financial derivatives are

considered to be risky. However, these instrument acts as a powerful

instrument for knowledgeable traders to expose themselves to properly

calculated and well understood risks in pursuit of a reward i.e. profit.

Types of Derivatives

Following are the various types of derivatives:

Forwards

A forward contract is a customized contract between two entities, where

settlement takes place on a specific date on the future at today’s pre-agreed

price.

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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 contract are

special types of forward contracts in the sense that the former or

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 lives up to one year, the majority of the options

traded on options exchanges having a maximum maturity of 9 months.

Longer- dated options are called warrants and are generally trade 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 portfolio of underlying assets. The

underlying asset is usually a moving average of a basket of asset. Equity

index options are a form of basket options.

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Swaps

Swaps are private agreements between two parties to exchange cash flows

in the future according to her pre-arranged 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.

Swap options

Swap options are options to buy or sell a swap that will become

operative at the expiry of the options. Thus a swap option is an option on

a forward swap. Rather than have calls and puts, the swap options market

has receiver swap options and payer swap options. A receiver swap option

is an option to receive fixed and pay floating. A prayer swap option is an

option to pay fixed and receive floating.

Forwards

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

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party wishes to reverse the contract, it has to compulsorily go to the same

counter party, which often results in high prices being charged.

Forward contracts are very useful in hedging and speculation.

Limitations of forward markets

Forward markets world-wide are afflicted by several problems:

Lack of centralization of trading

Liquidity, and

Counter party risk is a very serious issue.

The basic problem is that of too much flexibility and generality.

Futures

Defined futures: A future contract is on by which one party agrees to

Buy from/Sell to the other party at a specified future time, on a asset at a

price agreed at the time of the contract and payable on maturity date. The

agreed price is known as the strike price. The underlying asset can be a

commodity, currency debt or equity securities etc.

The standardized items on a futures contract are:

Quantity of the underlying

Quality of the underlying

The date and the month of delivery

The units of price quotation and minimum price change

Distinctive future

Trade on an organized exchange

Standardized contract terms

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More liquid

Requires margin payments

Follows daily settlement

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.

Multiplier: It is pre-determined value, used to arrive as the contract size.

It is price per index point.

Contract cycle: The period over which a contract trades. The index

futures contracts on the NSE have one-month, two-months and three-

months expiry cycles, which expire on the last Thursday of the month.

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 under one

contract. For instance, the contract size on NSE’s futures market is 200

Nifties.

Basis: In the context of financial futures, basis is the differences of futures

price minus the spot price. There will be a different basis for each delivery

month for each contract. In a normal market, basis will be positive. This

reflects that futures prices normally exceed spot prices

Cost of carry: The relationship between futures prices and spot prices can

be summarized in terms what is known as the cost of carry. This measures

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the storage cost plus the interest that is paid to finance the asset less the

income earned on the asset.

Open Interest: Total outstanding long or short positions in the market at

any specific time. As total long positions for market would be equal to

short positions, for which calculation of open Interest, only one side of the

contract is counted.

Initial margin: the amount that must be deposited in the margin account

at the time a futures contract is first entered into is known as initial margin.

Making-to-market: In the futures market, at the end of each trading day,

the margin account is adjusted to reflect the investor’s gain or loss

depending upon the futures closing price. This is called marking-to-

market.

Maintenance margin: This is somewhat lower than the initial margin.

This is set to ensure that the balance in the margin account never becomes

negative. If the balance in the account falls below the maintenance margin,

the investor receives a margin call and is expected to top up the margin

account to the initial margin level before trading commences on the next

day.

Cash settled: Open position at the expiry of the contract is cash settled.

Physical delivery: Open position at the expiry of the contract is settled

through delivery of the underlying asset. In the futures market, the

physical delivery of the underlying is very rare.

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Parties in futures contracts

There are two parties in the future contract, the buyer and the seller. The

buyer of the contract is one who is LONG on the futures contract and the

seller of the contract is one who is SHORT on the futures contract.

The payoff for the buyer and seller of the futures contracts:

Pay-off for a buyer of futures:

P

E2 F E1

Options

Introduction: Option is a type of a contract between two persons where one

grants the other the right to buy a specific asset at a price within a specified

period of time. Alternatively the contract may grant the other person the right

to sell a specific asset at a price with in a specific period of time. In order to

have this right, the option buyer has to pay the seller of option premium.

The assets on which options can be derived are stocks, commodities, indexes,

etc., and if the underlying asset is the non-financial asset the options are Non-

financial options like Commodity options.

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Properties of options

Options have several unique properties that set them apart from other

securities. The following are the properties of options.

Limited loss

High leverage

Limited life

Distinctive features

Exchange traded with notation.

Exchange defines the product same as futures.

Strike price is fixed, price moves

Price is always positive

Nonlinear payoff

Only short at risk

The purchase of an option requires an up-front payment.

Elementary option strategies

Pay-off profile for buyer of a call option:

The pay-off of buyer of the option depends on the spot price of the

underlying asset. The following graph shows the pay-off of buyer of a call

option.

R S ITM

E2 E1

O T M ATM

P

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S = strike price ITM = In-the-MoneySP = Premium/profit ATM = At-the-MoneyE1 = Spot price 1 OTM = Out-of the MoneyE2 = Spot price 2 SR = Profit at Spot price E2

Case1: (Strike price > Strike price)

As the spot price [E1] of the underlying asset is more than strike price [S].

The buyer gets the profit increases more than [E1] then the profit also

increase more than SR.

Case 2: (Strike price < Strike price)

As the spot price [E2] of the price underlying asset is less than strike price

[S]. The buyer gets loss of [SP], if price goes down less than [E2] then also

his loss is limited to his premium [SP].

Pay-off profile for seller of a call option:

The pay-off of seller of the call option depends on the spot price of the

underlying asset.

The following graph shows the pay-off of seller of a call option.

P ATM

ITM E1 E2

S O T M

R

S = Strike price ITM = In-the-MoneySP = Premium/profit ATM = At-the-MoneyE1 = Spot price 1 OTM = Out-of the MoneyE2 = Spot price 2 SR = Profit at Spot price E2

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Case1: (Strike price < Strike price)

As the spot price [E1] of the underlying asset is more than strike price [S].

The seller gets the profit of [SP], if price decreases less than [E1] then also

profit of the seller does not exceed [SP].

Case 2: (Strike price > Strike price)

As the spot price [E2] of the price underlying asset is more than strike

price [S]. The seller gets loss of [SR], if price goes more less than [E2]

then also the loss of the seller increases more than [SR].

Pay-off profile for buyer of a put option:

The pay-off of seller of the call option depends on the spot price of the

underlying asset.

The following graph shows the pay-off of seller of a put option.

R ITM

E1 E2

S O T M

ATM P

S = Strike price ITM = In-the-MoneySP = Premium/profit ATM = At-the-MoneyE1 = Spot price 1 OTM = Out-of the MoneyE2 = Spot price 2 SR = Profit at Spot price E2

Case1: (Strike price < Strike price)

As the spot price [E1] of the underlying asset is less than strike price [S].

The buyer gets the profit of [SR], if price decreases less than [E1] then

also profit increases more than [SR].

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Case 2: (Strike price > Strike price)

As the spot price [E2] of the underlying asset is more than strike price [S].

The buyer gets loss of [SP], if price goes more than [E2] then the loss of

the buyer is limited to his premium [SP].

Pay-off profile for seller of a put option:

The pay-off of seller of the call option depends on the spot price of the

underlying asset.

The following graph shows the pay-off of seller of a call option.

P ATM ITM

E1 E2

S

S = Strike price ITM = In-the-MoneySP = Premium/profit ATM = At-the-MoneyE1 = Spot price 1 OTM = Out-of the MoneyE2 = Spot price 2 SR = Profit at Spot price E2

Case1: (Strike price < Strike price)

As the spot price [E1] of the underlying asset is less than strike price [S].

The seller gets the loss of [SR], if price decreases less than [E1] then also

loss exceeds more than [SR].

Case 2: (Strike price > Strike price)

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As the spot [E2] of the price underlying asset is more than strike price [S].

The seller gets profit of [SP], if price goes more than [E2] then the profit

of the seller is limited to his premium [SP].

Factors affecting the price of an option:

The following are the various factors, which affect the price of an option

they are…

Stock price:

The pay-off from a call option is the amount by which the stock price

exceeds the strike price. Call options therefore become more valuable as

the stock price increases and vice versa. The pay-off from a put option is

the amount by which the strike price exceeds the stock price.

Put option therefore become more valuable as the stock price increases and

vice versa.

Strike price:

In the case of a call, as the strike price increases, the stock price has to

make a larger upward move for the option to go In-the-money. Therefore,

for a call as the strike price increases options become less valuable and

strike price decreases, options become more valuable.

Time to expiration:

Both put and call American options become more valuable as the time to

expiration increases.

Volatility:

The volatility of a stock price is a measure of uncertain about futures stock

price movements. As volatility increases, the change of that the stock will

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do very well or very poor increases. The value of both calls and puts

therefore increases as volatility increase.

Risk free interest rate:

The put option prices decline as the risk-free rate increase where as the

prices of calls always increase as the risk-free interest increases.

Dividends:

Dividends have the effect of reducing the stock price on the ex-dividend

date. This has a negative effect on the value of call options and a positive

affect on the value of put options.

Option terminology

Strike price: The price specified in the options contract is known as the

strike price or the exercise price.

Option price: Option price is the price, which the option buyer pays to the

option seller. It is also referred to as the option premium.

Expiration date: The date specified in the options contract is known as

the expiration date, the exercise date, the strike date or the maturity.

In-the-money option: An in-the-money (ITM) 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 (i.e. spot

price - strike price). If the index is much higher than the strike price, the

call is said to be deep ITM. In the case of a put, the put is ITM if the index

is below the strike price.

At-the-money option: An at-the-money (ATM) option is an option that

would lead to zero cash flow, if it were exercised immediately. An option

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on the index is at-the-money when the current index equals the strike price

(i.e. spot price = strike price).

Out-of-the-money option: An out-of-the-money (OTM) option is an

option that would lead to a negative cash flow, if it were exercised

immediately. A 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). If the index is much lower than the strike price, the

call is said to be deep OTM. In the case of a put, the put is OTM if the

index is above the strike price.

Intrinsic value of an option: The option premium can be broken down

into two components – intrinsic value and time value. The intrinsic value

of a call is the amount the option is ITM, if it is ITM. If the call is OTM,

its intrinsic value is zero.

Time value of an option: The time value of an option is the difference

between its premium and its intrinsic value. Both calls and puts have time

value. An option that is OTM or ATM has only time value. Usually, the to

expiration, the greater is an option’s time value, all else equal. At

expiration, an option should have no time value.

Futures and Options

Futures…

Futures price: Agreed-upon price at maturity.

Long position: Agree to purchase.

Short position: Agree to sell.

Profit or loss is unlimited to both buyer and seller of the Futures.

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Stock Futures: The underlying to these contracts are the individual stocks

like Satyam, Infosys, HCL, HPCL, Wipro, etc..

Index Futures: The underlying to these contracts are indices like S&P

(Standard and Poor’s), CNX, Nifty, Sensex…

Implied cost of carry:

(Future Price – spot price) / spot price

It indicates the notional cost the investor would have incurred in carrying

the stock.

Options…

Option class: All listed options of a particular type (call or put) on a

particular underlying instrument. E.g.: Infosys calls or Infosys puts.

Option series: All options of a given class with the same expiration date

and strike price.

Open interest: The total number of options contract outstanding in the

market at any given point of time.

Covered option: If an investor takes a position in options and also on its

underlying then his position is covered.

E.g.: If investor buys a put on Reliance and also possesses Reliance shares

then his position is covered. This is protective in nature.

Naked option: If the investor takes a position only in option with out

possessing its underlying then its naked option.

E.g.: If investor buys either a put or call option on Reliance with out

possessing the underlying then it is a naked option. This is speculative in

nature.

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Buy call Option Buy Put Option Sell Call Option

Sell Put Option

A right to buy A right to sell A duty to buy

A duty to

At set strike At set strike At set strike At set strikeFor an expiry For an expiry For an

expiryFor an

Paying a price Paying a price Receive a price

Receive a

Sans a duty Sans a duty Sans a right Sans a rightSettle in cash Settle in cash Settle in

cashSettle in

Particulars Futures OptionsContract Size Standardized StandardizedProfits Unlimited Unlimited to buyer

Losses Unlimited Limited to BuyerType of Trade Exchange traded Exchange tradedCounter party Risk Does not exist Does not existPrice Margin is paid, No cost Premium is paid,

This is the price of the Right.

Derivatives are the contracts for a limited time period say one month, two

months, and three months. The last Thursday of the month is expiry day for

those contracts. The proceeding day to last Thursday of the month only

trading will starts and new contracts will exist.

One month trading contract is called “Near month contract”,

Two month trading contract is called “Middle month contract”, and

Three months trading contract is called “Far month contract”.

At any point of time there would be three contracts of varying maturities. The

maximum maturity of the month contract will be one (1) month and the

maximum of a far month contract will be three (3) months.

An example on PUT option:

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X buys one April month put option on NIFTY at the strike price of

Rs.1470/- of Infosys at a premium of Rs.35/-.

1). If on the date of expiry the market price is less than 1470, the put

option will be economically viable and hence exercised.

2). The investor will earn profits once the share price falls below Rs.

1435/- (strike price – premium [i.e. 1470-35).

3). Suppose price of NIFTY is at 1430 on expiry date, the investor who

will get a profit of Rs.5/-, will exercise the put option.

[(Strike price – spot price) - premium][(1470 = 1430) - 35].Long on PUT (buyer’s perspective)

Pay-off on NIFTY long put for different spot pricesStrike Price – 1470/- Premium – 35/-Spot Price

Premium Strike Price

Profit/Loss Exercised

1380 35 1470 55 Yes1390 35 1470 45 Yes1400 35 1470 35 Yes1410 35 1470 25 Yes1420 35 1470 15 Yes1430 35 1470 5 Yes1440 35 1470 -15 Yes

1450 35 1470 -25 Yes

1460 35 1470 -35 Yes1470 35 1470 -35 Indifferent1480 35 1470 -35 No1490 35 1470 -35 No

An example on CALL option:

Y buys one April month call option on NIFTY at the strike price of

Rs.1500/- of Infosys at a premium of Rs.35/-.

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1). If on the date of expiry the market price is more than 1500, the call

option will be economically viable and hence exercised.

2). The investor will earn profits once the share price exceeds more than

the Rs. 1535/- (strike price + premium [i.e. 1500+35]).

3). Suppose price of NIFTY is at 1540 on expiry date, the investor who

will get a profit of Rs.5/-, will exercise the call option.

[Spot price – Strike price) - premium]

[(1540 - 1500) - 35].

Long on Call (buyer’s perspective)

Pay-off on Nifty long can for different spot PricesStrike Price – 1500/- Premium – 35/-Spot Price

Premium Strike Price

Profit/Loss Exercised

1450 35 1500 -35 No

1460 35 1500 -35 No

1470 35 1500 -35 No

1480 35 1500 -35 No

1490 35 1500 -35 No1500 35 1500 -35 Indifferent1510 35 1500 -25 Yes1520 35 1500 -15 Yes1530 35 1500 -5 Yes

1540 35 1500 5 Yes1550 35 1500 15 Yes1560 35 1500 25 Yes

Protective PUT

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Long on STOCK + Long on PUT

Instead of buying the stock, I can also buy a future, in which case my out

flow will be limited to the margin.

If price of the stock goes up by more than the premium paid then profits

are unlimited.

If price of the stock goes down then maximum loss is confined to the (spot

price – strike price + premium paid)

Down side is limited and upwards unlimited.

Example:

If the HCL technologies price is Rs, 140/-.

Buy at Rs.130/- of April put @ 5/-

At Time TPrice Long Stock Long Put Profit / Loss100 -40 25 -15

110 -30 15 -15

120 -20 5 -15

130 -10 -5 -15140 0 -5 -5

150 10 -5 5160 20 -5 15170 30 -5 25180 40 -5 35

Covered call:

Long on stock + short on call

Instead of buying the stock, buyer can also buy a future, in which case my

outflow will be limited to the margin.

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If price of the stock goes down, the loss on stock is partially offset by

premium receipt on call, if the price of the stock goes up, loss on call is

offset by the gain in the stock.

Example:

TISCO Company’s share price is Rs.860/-Sell at Rs.900/- of April call of Rs.@20/-

At Time T

Price Long stock Short call Profit / Loss820 -40 20 -20840 -20 20 0860 0 20 20

880 20 20 40

900 40 20 60920 60 20 60

940 80 20 60

Example

Illustration

Two parties, Jack and Jill enter into a contract to buy and sell 100

shares of Infosys at Rs 3500 each, two months down the line from the date

of contract. Assuming that Jack is the buyer and Jill is the seller. In the

given example, both the parties concerned have determined product,

quantity of the product, price of the product and time of the delivery in

advance. Delivery and payments will take place as per the terms of this

contract on the designated date and place. This is a simple example of

forward contract.

Forward contracts are being used in India on large scale in the foreign

exchange market to cover the currency risk.

29

Forward contracts being negotiated by the parties on one to one basis,

offer the tremendous flexibility to them to articulate the contract in terms

of price, quantity, quality, delivery time and place. However, forward

contracts suffer from poor liquidity and default risk.

Limitations

Limitations of forward markets

Forward markets world-wide are afflicted by several problems:

Lack of centralization of trading,

Illiquidity, and

Counterparty risk

In the first two of these, the basic problem is that of too much flexibility

and generality.

The forward market is like a real estate market in that any two consenting

adults can form contracts against each other. This often makes them design

terms of the deal which are very convenient in that specific situation, but

makes the contracts non-tradable.

Counterparty risk arises from the possibility of default by any one party to

the transaction. When one of the two sides to the transaction declares

bankruptcy, the other suffers. Even when forward markets trade

standardized contacts, and hence avoid the problem of illiquidity, still the

counterparty risk remains a very serious issue.

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Distinctive Future

Distinction between futures and forwards contracts

Forward contracts are often confused with futures contracts. The confusion

is primarily because both serve essentially the same economic functions of

allocating risk in the presence of future price uncertainty. However futures

are a significant improvement over the forward contracts as they eliminate

counterparty risk and offer more liquidity.

Distinction between futures and forwards

Futures ForwardsTrade on an organized exchange OTC in nature

Standardized contract terms Customized contract terms

Hence more liquid hence less liquid

Requires margin payments No margin payment

Follows daily settlements Settlement happens at end of period

The date and the month of delivery

The units of price quotation and minimum price change

Location of settlement

Future Terminology

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.

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Contract cycle: The period over which a contract trades. The index

futures contracts on the NSE have one-month, two-months and three-

months expiry cycles which expire 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 under one

contract. For instance, the contract size on NSE’s futures market is 200

Nifties.

Basis: In the context of financial futures, basis can be defined as the

futures price minus the spot price. There will be a different basis for each

delivery month for each contract. In a normal market, basis will be

positive. This reflects that futures prices normally exceed spot prices.

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.

Initial margin: The amount that must be deposited in the margin account

at the time a futures contract is first entered into is known as initial margin.

Marking-to-market: In the futures market, at the end of each trading day,

the margin account is adjusted to reflect the investor’s gain or loss

32

depending upon the futures closing price. This is called marking-to-

market.

Maintenance margin: This is somewhat lower than the initial margin.

This is set to ensure that the balance in the margin account never becomes

negative. If the balance in the margin account falls below the maintenance

margin, the investor receives a margin call and is expected to top up the

margin account to the initial margin level before trading commences on

the next day.

Types of futures

Stock index futures

Stock index futures are most popular financial futures, which have

been used to hedge or manage the systematic risk by the Investors of the

stock market. They are called Hedgers, who own portfolio of securities

and are exposed to 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 at

a specified time in future.

Stock index futures will require lower capital adequacy and margin

requirement as compared to margins on carry forward of individual

scrip’s. The brokerage cost 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 incase of stock

33

index futures as opposed to dealing in individual scrips. The market is

conditioned to think in terms of the index and therefore, would refer 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 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

contracts traded. 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 are 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.

Example: If BSE Sensex is at 6800 and each point in the index equals to

Rs.30, a contract struck at this level could work Rs. 204000(6800x30). If

at the expiration of the contract, the BSE Sensex is at 6850, a cash

settlement of Rs.1500 is required ((6850-6800) x30).

Stock Futures

With the purchase of futures on a security, the holder essentially makes a

legally binding promise or obligation to buy the underlying security at

some point in the future (the expiration date of the contract). Security

34

futures do not represent ownership in a corporation and the holder is

therefore not regarded as a shareholder.

A futures contract represents a promise to transact at some point in the

future. In this light, a promise to sell security is just as easy to make as a

promise to buy security. Selling security futures without previously

owning them simply obligates the trader to sell certain amount of the

underlying security at some point in the future. It can be done just as easily

as buying futures, which obligates the trader to buy a certain amount of the

underlying security at some point in future.

Example: If the current price of the ACC share is Rs.170 per share. We

believe that in one month it will touch Rs.200 and we buy ACC shares. If

the price really increases to Rs.200, we made profit of Rs.30 i.e. a return of

18%. If we buy ACC futures instead, we get the same position as ACC in

the cash market, but we have to pay the margin not the entire amount. In

the above example if the margin is 20%, we would pay only Rs.34 initially

to enter into the futures contract. If ACC share goes up to Rs.200 as

expected, we still earn Rs.30 as profit.

Pricing futures

Stock index futures began trading on NSE on the 12 th June 2000. Stock

futures were launched on 9th November 2001. The volumes and open,

interest on this market has been steadily growing. Looking at the futures

prices on NSE’s market, have you ever felt the need to know whether the

quoted prices are a true reflection of the price of the underlying

index/stock? Have you wondered whether you could make risk-less profits

by arbitraging between the underlying and futures markets? If so, you need

35

to know the cost-of-carry to understand the dynamics of pricing that

constitute the estimation of fair value of futures.

The cost of carry model

We use fair value calculation of futures to decide the no-arbitrage limits on

the price of a futures contract. This is the basis for the cost-of-carry where

the price of the contract is defined as:

F=S+C

Where:

F=Futures price

S=Spot price

C=Holding costs or carry costs

This can also be expressed as:

F=S (1 + r)T

Where:

r=Cost of financing

T=time till expiration

If F < S(1 + r)T or F > S(1 + r)T , arbitrage opportunities would exist i.e.,

whenever the futures price moves away from the fair value, there would be

chances for arbitrage.

We know what the spot and futures prices are, but what are the

components of holding cost? The components of holding cost vary with

contracts on different assets. At times the holding cost may even be

36

negative. In the case of commodity futures, the holding cost is the cost of

financing plus cost of storage and insurance purchased etc. In the case of

equity futures, the holding cost is the cost of financing minus the dividends

returns.

Pricing futures contracts on commodities

Let us take an example of future contracts on a commodity and work

out the price of the contract. The spot price of silver is Rs.7000/kg. If the

cost of financing is 15% annually, what should be the futures price of 100

gms of silver one month down the line? Let us assume that we’re on 1 st

January 2002. How would we compute the price of a silver futures price is

nothing but the spot price plus the cost-of-carry. Let us first try to work out

the components of the cost-of-carry model.

1. What is the spot price of silver? The spot price of silver,

S=Rs.7000/kg.

2. What is the cost of financing for a month? (1 + 0.15) 30/365.

3. What are the holding costs? Let us assume that the storage cost=0.

In this case the fair value of the futures price, works out to be = Rs.708.

F = S (1 + r )T + C = 700(1.15)30/365 = Rs.708

If the contract was for a three-month period i.e. expiring on 30 th march,

the cost of financing would increase the futures price. Therefore, the

futures price would be

F = 700(1.15)30/365 = Rs.724.5 On the other hand, if the one-month contract

was for 10,000 kg. Of silver instead of 100 gms, then it would involve a

non-zero storage cost, and the price of the futures contract would be

Rs.708 plus the cost of storage.

37

Pricing equity index futures

A futures contract on the stock market index gives its owner the right and

obligation to buy or sell the portfolio of stocks characterized by the index.

Stock index futures are cash settled; there is no delivery of the underlying

stocks.

The main differences between commodity and equity index futures are that:

There are no costs of storage involved in holding equity.

Equity comes with a dividend stream, which is a negative cost if you are

long the stock and positive costs if you are short the stock.

Therefore, Cost of carry = Financing cost – Dividends. Thus, a crucial aspect

of dealing with equity futures as opposed to commodity futures is an accurate

forecasting of dividends. The better the forecast of dividend offered by a

security, the better is the estimate of the futures price.

Pricing index futures given expected dividend amount

The pricing of index futures is also based on the cost-of-carry model, where

the carrying cost is the cost of financing the purchase of the portfolio

underlying the index, minus the present value of dividends obtained from the

stocks in the index portfolio.

Illustration

Nifty futures trade on NSE as one, two and three-month contracts. Money

can be borrowed at a rate of 15% per annum. What will be the price of a new

two-month futures contract on Nifty?

1. Let us assume that M&M will be declaring a divident of Rs.10 per

share after 15 days of purchasing the contract.

38

2. Current value of Nifty is 1200 and Nifty trades with a multiplier of

200.

3. Since Nifty is traded in multiples of 200, value of the contract is 200 *

1200 = Rs. 240,000.

4. If M&M has a weight of 7% in Nifty, its value in Nifty is Rs.16,800

i.e.(240,000 * 0.07).

5. If the market price of M&M is Rs.140, then a traded unit of Nifty

involves 120 shares of M&M i.e.(16,800/140).

6. To calculate the futures price, we need to reduce the cost-of-carry to

the extent of dividend received.

The amount of dividend received is Rs. 1200 i.e(120 * 10). The dividend

is received 15 days later and hence compounded only for the remainder of 45

days. To calculate the futures price we need to compute the amount of

dividend received per unit of Nifty.

Hence we divide the compounded dividend figure by 200.

Thus, futures price

F= 1200(1.15)60/365 – (120x10(1.15)45/365)/200 = Rs.1221.80

Pricing index futures given expected dividend yield

If the dividend flow throughout the year is generally uniform, i.e. if there are

few historical cases of clustering of dividends in any particular month, it is

useful to calculate the annual dividend yield

F=S (1 + r – q )T

Where:

F=futures price

S=spot index value

R=cost of financing

Q=expected dividend yield

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T=holding period

Example: A two-month futures contract trades on the NSE. The cost of

financing is 15% and the dividend yield on Nifty is 2% annualized. The spot

value of Nifty is 1200. What is the fair value of the futures contract?

Fair value = 1200(1 + 0.15 – 0.02)60/365 = Rs. 1224.35

Definition

Option is a contract between two persons where one grants the other

the right to buy a specific asset at a specific price within a stipulated time

period. Alternatively the contract may grant the other person the right to sell a

specific asset at a specific price within a specific time period. In order to have

this right, the option buyer has to pay the seller of the option premium.

The assets on which the option can be derived are stocks, commodities,

indexes, etc. If the underlying asset is the financial asset, then the options are

financial options like stock options, currency options, index options etc, and if

the underlying is the non-financial asset the options are non-financial options

like commodity options.

Properties of options:

Options have several unique properties that set them apart from other

securities. The following are the properties of options:

Limited Loss

High Leverage Potential

Limited Life

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Characteristics of Options

The following are the main characteristics of options:

1. Options holders do not receive any dividend or interest.

2. Options yield only capital gains.

3. Options holder can enjoy a tax advantage.

4. Options are traded on O.T.C and in all recognized stock exchanges.

5. Options holders can control their rights on the underlying asset.

6. Options create the possibility of gaining a windfall profit.

7. Options holders can enjoy a much wider risk-return combinations.

8. Options can reduce the total portfolio transaction costs.

Illustration

On 1 July 2000, S sells a call option to L for a price of Rs.3.25. Now L has

the right to come to S on 31 Dec 2000 and buy 1 share of Reliance at Rs.500.

Here, Rs.3.25 is the “option price”, Rs.500 is the exercise price” and 31 Dec

2000 is the “expiration date” L does not have to buy 1 share of Reliance on 31

Dec 2000 at Rs.5000 from S (unlike a forward/futures contract which is

binding on both sides). It is only if Reliance is above exercising the option, S

is obliged to live up to his end of the deal: i.e. S stands ready to sell a share of

Reliance to L at Rs.500 on 31 Dec 2000. Hence, at option expiration, there are

two outcomes that are possible: an option could be profitably exercised, or it

could be allowed to die unused. If the option lapses unused, then L has lost the

original option price (Rs.3.25) and S has gained it. When L and S enter into a

futures contract, there is not payment (other than initial margin). In contrast,

41

the option has positive price, which is paid in full on the date that the option is

purchased. Options come in two varieties – European and American. In a

European option, the holder of the option can only exercise his right (if he

should so desire) on the expiration date. In an American option, he can

exercise this right anytime between purchase date and the expiration date. The

price of an option is determined on the secondary market. An option always

has a non-negative value: i.e., the value of an option is never negative.

History of options

Options made their first major mark in financial history during the tulip-

bulb mania in seventeenth century Holland. It was one of the most spectacular

get rich quick binges in history. The first tulip was brought into Holland by a

botany professor from Vienna. Over a decade, the tulip became the most

popular and expensive item in Dutch gardens. The more popular they became,

the more Tulip bulb prices began rising. That was when options came into the

picture. They were initially used for hedging. By purchasing a call option on

tulip bulbs, a dealer who was committed to a sales contract could be assured of

obtaining a fixed number of bulbs for a set price. Similarly, tulip-bulb growers

could assure themselves of selling their bulbs at a set price by purchasing put

options. Later, however, speculators who found that call options were an

effective vehicle for obtaining maximum possible gains on investment

increasingly used options. As long as tulip prices continued to skyrocket, a call

buyer would realize returns far in excess of those that could be obtained by

purchasing tulip bulbs themselves. The writers of the put options also

prospered as bulb prices spiraled since writers were able to keep the premiums

and the options were never exercised. The tulip-bulb market collapsed in 1636

42

and a lot speculators lost huge sums of money. Hardest hit were put writers

who were unable to meet their commitments to purchase Tulip bulbs.

Parties in an options contract

The following are the parties in an option contract.

Buyer of the option: The buyer of an option is one who by paying the option

premium buys the right but not the obligation to exercise his option on seller

or writer.

Writer/seller of the option: The writer or seller of a call option/put option 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.

Types of options

The options are classified in to various types on the basis of various variables.

The following are the various types of options:

I. On the basis of the underlying asset:

On the basis of the underlying asset the options are divided into two types:

INDEX OPTIONS

Underlying assert as the index.

STOCK OPTIONS:

A stock option gives the buyer of the options the right to buy/sell stock at

a specified price. Stock options are options on the individual stocks, there

are currently more than 50 stocks, that are trading in this segment.

II. On the basis of the market movement:

On the basis of the market movement the options can be divided into two

types. They are:

43

CALL OPTION

An investor buys a call option 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.

Illustration

An investor buys 100 European call options on Infosys at the strike price

of Rs3500 when the current price of the stock is Rs3400 at a premium of

Rs100.

If the stock price, on the day of expiry is more than Rs3600 (Strike Price +

Cost incurred in form of premium paid), lets us say Rs3800, the buyer of the

call option will decide to exercise his option to buy the 100 Infosys shares. If

the buyer sells the shares in the market immediately, he will earn Rs200 per

share as profit (or Rs20, 000 in the whole of transaction). The seller of the call

will have the obligation to deliver the stock. In another scenario, if at the time

of expiry stock price falls below Rs3500 say suppose it touches Rs3000, the

buyer of the call option will choose to not to exercise his option. In this case

the investor loses the premium paid which shall be the profit earned by the

seller of the call option.

PUT OPTION

A put option is bought by an investor when he thinks that the stock price

moves downwards. A put option gives the holder of the option the right but

not the obligation to sell an asset by a certain date for a certain price

44

Illustration

An investor buys 100 European put options on Reliance at the strike price of

Rs300 when the current price of the stock is Rs280 at a premium of Rs15. If

the stock price, on the day of expiry is less than Rs300 (Strike Price + cost

incurred in form of premium paid), say Rs270, the buyer of the Put option will

decide to exercise his option to sell the 100 Reliance shares. He will buy 100

shares of Reliance from the market @ Rs270/share and sell the same at

Rs300 / share, he will earn Rs15 per share (taking premium paid into

consideration), as profit or Rs1,500 in the whole of transaction. The seller of

the put will have the obligation to buy the stock. In another scenario, if at the

time of expiry stock price rises above Rs300 (strike price), say suppose it

touches Rs320, the buyer of the put option will choose to not to exercise his

option to sell as he can sell in the market at a higher rate. In this case the

investor loses the premium paid which shall be the profit earned by the seller

of the put option.

III. On the basis of exercise of option:

On the basis of the exercising of the option, the options are classified into two

categories:

AMERICAN OPTION

American options are options that are exercised at any time up to the

expiration date most exchanged-traded options are American

EUROPEAN OPTION

45

European options are options that can be exercised only on the

expiration date itself. European options are easier to analyze than American

options.

PLAYERS IN OPTION MAKET

In the option markets, the players fall into four categories:

The Exchanges

Financial Institution

Market Makers

Individual(Retail) Investors

What follows is a brief overview of each group along with insights into their

trading objectives and strategies.

The Exchanges

The exchange is a place where market makers and traders gather to buy

and sell stocks, options, bonds, futures, and other financial instruments. Since

1973 when the Chicago Board Options Exchange first began trading options, a

number of other players have emerged. At first, the exchanges each

maintained separate listings and therefore didn’t trade the same contracts. In

recent years this has changed.

Now that BSE and NSE both these exchanges list and trade the same

contracts, they compete with each other. Nevertheless, even though a stock

may be listed on multiple exchanges, one exchange generally handles the bulk

of the volume. This would be considered the dominant exchange for that

particular option.

The competition between exchanges has been particularly valuable to

professional traders who have created complex computer programs to monitor

46

price discrepancies between exchanges. These discrepancies, though small,

can be extraordinarily profitable for traders with the ability and speed to take

advantage. More often than not, professional traders simply use multiple

exchanges to get the best prices on their trades.

Deciding between the two would be simply a matter of choosing the

exchange that does the most trading in this contract. The more volume the

exchange does, the more liquid the contract. Greater liquidity increases the

likelihood the trade will get filled at the best price.

Financial Institutions

Financial institutions are professional investment management

companies that typically fall into several main categories: mutual funds, hedge

funds, insurance companies, stock funds. In each case, these money managers

control large portfolios of stocks, options, and other financial instruments.

Although individual strategies differ, institutions share the same goal – to

outperform the market. In a very real sense, their livelihood depends on

performance because the investors who make up any fund tend to a fickle

group. When fund don’t perform, investors are often quick to move money in

search of higher returns.

Where individual investors might be more likely to trade equity

options related to specific stocks, fund managers often use index options to

better approximate their overall portfolios. For example, a fund that invests

heavily in a broad range of tech stocks will use NSE Nifty Index options rather

than separate options for each stock in their portfolio. Theoretically, the

performance of this index would be relatively close to the performance of a

47

subset of comparable high tech stocks the fund manager might have in his or

her portfolio.

Market Makers

Market makers are the traders on the floor of the exchanges who create

liquidity by providing two-sided markets. In each counter, the competition

between market makers keeps the spread between the bid and the offer

relatively narrow. Nevertheless, it’s the spread that partially compensates

market makers for the risk of willingly taking either side of a trade.

For market makers, the ideal situation would be to “scalp” every trade. More

often than not, however, market makers don’t benefit from an endless flow of

perfectly offsetting for trading techniques that characterize how different

market makers trade options. The same market makers depending on trading

conditions may employ any or all of these techniques.

Day Traders

Premium Sellers

Spread Traders

Theoretical Traders

Day traders

Day traders, on or off the trading screen, tend to use small positions to

capitalize on intra day market movement. Since their objective is not to hold a

position for extended periods, day traders generally don’t hedge options with

the underlying stock. At the same time, they tend to be less concerned about

delta, gamma, and other highly analytical aspects of option pricing.

Premium Sellers

48

Just like the name implies, premium sellers tend to focus their efforts

selling high priced options and taking advantage of the time decay factor by

buying them later at a lower price. This strategy works well in the absence of

large, unexpected price swings but can be extremely risky when volatility

skyrockets.

Spread Traders

Like other market makers, spread traders often end up with large

positions but they get there by focusing on spreads. In this way, even the

largest of positions will be somewhat naturally hedged. Spread traders employ

a variety of strategies buying certain options and selling others to offset the

risk. Floor traders primarily use some of these strategies like reversals,

conversions, and boxes because they take advantage of minor price

discrepancies that often only exist for seconds. However, spread traders will

use strategies like butterflies, condors, call spreads, and put spreads that can be

used quite effectively by individual investors.

Theoretical Traders

By readily making two-sided markets, market makers often find

themselves with substantial option positions across a variety of months and

strike prices. The same thing happens to theoretical traders who use complex

mathematical models to sell options that are overpriced and buy options that

are relatively under priced. Of the four groups, theoretical traders are often the

most analytical in that they are constantly evaluating their position to

determine the effects of changes in price, volatility, and time.

Individual (Retail)

49

As option volume increases, the role of individual investors becomes

more important because they account for over 90% of the volume. That’s

especially impressive when you consider that option volume in February 2000

was 56.2 million contracts – an astounding 85% increase over February 1999

The psychology of the Individual Investor

From a psychological standpoint, individual investors are in interesting

group because there are probably as many strategies and objectives as there

are individuals. For some, options are a means to generate additional income

through relatively conservative strategies such as covered calls. For others,

options in the form of protective puts provide an excellent form of insurance

to lock in profits or prevent losses from new positions. More risk tolerant

individuals use options for the leverage they provide. These people are willing

to trade options for large percentage gains even knowing their entire

investment may be on the line.

In a sense, taking a position in the market automatically means that

you are competing with countless investors from the categories described

above. While that may be true, avoid making direct comparisons when it

comes to your trading results. The only person you should compete with is

yourself. As long as you are learning, improving, and having fun, it doesn’t

matter how the rest of the world is doing.

Pricing options

Option pricing

There are two main approaches that are used to replicate an option

position and, thus, price an option. The most commonly used is an analytical

50

formula known as the Black Scholes model. The second widely –used

approach is a methodology known as the binomial model from Ross, Cox and

Rubinstein. The binomial option-pricing model is more like process than a

formula, in that it is a series of steps that can be used to price an option.

Although the two pricing models appear to be very different, mathematicians

have proven their equivalency through calculations.

The Black-Scholes option pricing formulae

The black-scholes option pricing model has been one of the most influential

formulas in finance since its initial publication in 1973. In 1997, Myron

Scholes and Robert Merton won the Nobel prize in Economics for their work

in developing the formula. Unfortunately, Fischer Black, the other major

contributor, passed away before the announcement of the Nobel awards.

Although it has its limitations, the formula is widely used.

Black and Scholes start by specifying a simple and well-known

equation that models the way in which stock prices fluctuate. This equation

called Geometric Brownian Motion, implies that stock returns will have

lognormal distribution, meaning that the logarithm of the stock’s return will

follow the normal (bell shaped) distribution. Black and Scholes then propose

that the option’s price is determined by only two variables that are allowed to

change: time and the underlying stock price. The other factors – the volatility,

the exercise price, and the risk-free rate do affect the option’s price but they

are not allowed to change. By forming a portfolio consisting of a long position

in stock and a short position in calls, the risk of the stock is eliminated. This

hedged portfolio is obtained by setting the number of shares of stock equal to

the approximated change in the call price for a change in the stock price. This

51

mix of stock and calls must be revised continuously, a process known as delta

hedging.

.

Black and Scholes then turn to a little-known result in a specialized field of

probability known as stochastic calculus. This result defines how the option

price changes in terms of combination of options and stock should grow in

value at the risk-free rate. The result boundary condition on the model that

requires the option price to converge to the exercise valued at expiration. The

end result is the Black and Scholes model.

The original Black-Scholes model is based on the following assumptions:

1. The option is European style.

2. The evolution of share prices follows a continuous random process.

3. The model is based on a lognormal distribution of stock prices.

4. No commissions or taxes are charged.

5. Short-selling is permitted and the proceeds of such a sale are immediately

available for use.

6. Stock prices move in smooth increments (there are no stock market

crashes or bubbles).

7. We can borrow or lend at the risk-free interest rate and this rate is

constant.

8. Markets are efficient and there are no arbitrage possibilities.

9. The stock pays no dividends during the life of the options.

52

10. Robert Merton later modified the last assumption and introduction a

variable to the original model accounting for continuous stock dividend

payments.

11. Development of the mathematics behind the formula is beyond the

scope of this reference manual. The equations below show the formula for

pricing a European call and put option, respectively. These equations apply

for a stock that pays a continuous dividend.

Where:

C= is the call option price

P=is the put option price

S=is the stock price

X=is the strike price

R=is the risk-free interest rate (continuously compounded)

Q=is the dividend yield (continuously compounded)

T= is the time to maturity (in years)

E=is the operator for the exponential function (equal to approximately 2.718)

N(*) is the operator for the cumulative normal distribution function

53

THE COMPANY PROFILE

The birth of Karvy was on a modest scale in 1981. It began with the

vision and enterprise of a small group of practicing Chartered Accountants

who founded the flagship company …Karvy Consultants Limited. We started

with consulting and financial accounting automation, and carved inroads into

the field of registry and share accounting by 1985. Since then, we have

utilized our experience and superlative expertise to go from strength to

strength…to better our services, to provide new ones, to innovate, diversify

and in the process, evolved Karvy as one of India’s premier integrated

financial service enterprise.

Thus over the last 20 years Karvy has traveled the success route,

towards building a reputation as an integrated financial services provider,

offering a wide spectrum of services. And we have made this journey by

taking the route of quality service, path breaking innovations in service,

versatility in service and finally totality in service.

KARVY is a premier integrated financial services provider and ranked among

the top five in the country in all its business segments, services over 16 million

individual investors in various capacities, and provides investor services to

54

over 300 corporate, comprising the who is who of Corporate India. KARVY

covers the entire spectrum of financial services such as Stock broking,

Depository Participants, Distribution of financial products like mutual funds,

bonds, fixed deposit, Merchant Banking & Corporate Finance, Insurance

Broking, Commodities Broking, Personal Finance Advisory Services,

placement of equity, IPOs, among others. Karvy has a professional

management team and ranks among the best in technology, operations, and

more importantly, in research of various industrial segments.

Quality Policy

To achieve and retain leadership, Karvy shall aim for complete

customer satisfaction, by combining its human and technological resources, to

provide superior quality financial services. In the process, Karvy will strive to

exceed Customer's expectations. 

Quality Objectives  

As per the Quality Policy, Karvy will: 

Build in-house processes that will ensure transparent and harmonious

relationships with its clients and investors to provide high quality of

services.

Establish a partner relationship with its investor service agents and

vendors that will help in keeping up its commitments to the customers.

Provide high quality of work life for all its employees and equip them

with adequate knowledge & skills so as to respond to customer's needs.

55

Continue to uphold the values of honesty & integrity and strive to

establish unparalleled standards in business ethics.

SECTOR OF KARVY

1. KARVY CONSULTANTANTS LIMITED: Deals in

Registrar and Transfer Agent.

We have traversed wide spaces to tie up with the world’s largest transfer

agent, the leading Australian company, Computer share Limited. The

company that services more than 75 million shareholders across 7000

corporate clients and makes its presence felt in over 12 countries across 5

continents has entered into a 50-50 joint venture with us.

With our management team completely transferred to this new entity,

we will aim to enrich the financial services industry than before. The future

holds new arenas of client servicing and contemporary and relevant

technologies as we are geared to deliver better value and foster bigger

investments in the business. The worldwide network of Computer share will

hold us in good stead as we expect to adopt international standards in addition

to leveraging the best of technologies from

around the world.

KARVY SECURITIES LIMITED

Deals in distribution of various investment products, viz., equities,

mutual funds, bonds and debentures, fixed deposits, insurance policies for the

investor.

56

3. KARVY INVESTOR SERVICE LIMITED

Deals in issue management, investment banking and merchant

banking.

4. KARVY STOCK BROKING LIMITED

Deals in buying and selling equity shares and debentures on the

National Stock Exchange(NSE), the Hyderabad Stock Exchange(HSE) and the

over The Counter Exchange of India(OTCEI).

PRODUCTS & SERVICES

With greater choices comes greater value. KARVY offers you more

choices by providing a wide array of products and personalized services, so

you can take charge of your financial future with confidence.

So whether you are a new investor or a seasoned one, we have the resources

and advice you would need to make smart, well-researched investments. You

have the option to choose the level support you would like from us:

Invest Independently – If you are an independent investor and prefer calling

your own shots, you can access our extensive Market Research section for

relevant, in-depth resources and support.

SERVICES

Take our advice – If you are new to the world of investing, or are unable

to do your own research due to time constraints, our highly experienced

team of advisors will help you. get started and meet your financial goals.

Day Trading – If you thrive on the thrill of riding the market wave on a

daily basis, we offer our Day Traders the resources you would need to

strategize, buy and sell conveniently.

57

KARVY’s products and services are geared towards meeting your

individual financial requirements. To find out more about a product / service,

click on it from the menu on the left.

DEPOSITORY SERVICES

We offer Depository facilities to facilitate a seamless transaction

platform as a part of our value-added services for our clients. KARVY is a

depository participant with the Central Depository Services (India) Ltd.

(CDSL) and National Securities Depository Ltd. (NSDL) for trading and

settlement of dematerialized shares

WEALTH MANAGEMENT SERVICES

It is our aim to empower clients by helping them to diversify their

investments. To this end, KARVY has added a range of products such as

Mutual Funds, Insurance and online facilities to its offerings.

We meet our clients on an individual basis and analyze important

factors such as your risk appetite, investment horizon and your existing

investments before making our recommendations as to what clients should

invest in. The fund and scheme selection is then done after conducting in-

depth research on parameters like risk adjusted returns, rolling returns,

volatility and portfolio churn. We are also in close contact with fund houses as

well as insurance agencies and are therefore always cognizant with new

offerings and occurrences in the market and like to keep our clients updated on

the same. Our clients can pick from Mutual Funds, IPOs, and Insurance

products.Our Wealth Management Services include Portfolio Management

Services (PMS)

58

PRODUCTS

EQUITIES

Our experienced trading consultants and advanced trading tools will

provide the support you need to achieve your long-term goals via the stock

markets. We trade on the BSE, NSE and CN and our website has facilities

such as live stock tickers, news updates, and more, to help our clients stay in

the know. We also provide NRI specific services to meet the needs of our

clients who live abroad

COMMODITIES

Indian markets have recently thrown open a new avenue for investors

and traders to participate: COMMODITY DERIVATIVES. For those who

want to diversify their portfolios beyond shares, bonds and real estate,

commodities are the best option.

Commodities actually offer immense potential to become a separate asset class

for market-savvy investors, arbitrageurs and speculators. They are also easy to

understand as far as fundamentals of demand and supply are concerned.

Historically, pricing in commodities futures has been less volatile compared

with equity and bonds, thus providing an efficient portfolio diversification

option.

KARVY now offers to investors a platform to trade in COMMODITY

FUTURES. As a member of the Multi Commodity Exchange of India Ltd. and

of the National Commodity and Derivative Exchange, we offer futures trading

in 10 commodities (gold, silver, castor, soya, canola/mustard oil, crude palm

59

oil, RBD palmolein and cotton) – NCDEX and in gold, silver and castor seed,

rubber through MCX.

MARKET RESEARCH

Information is power. At KARVY, it is also at your fingertips!

KARVY is powered by a top-notch research team that penetrates and

investigates the market to provide you with reliable, relevant information that

helps you make intelligent investment decisions. Our commitment to keeping

you updated on the latest market conditions stems from our desire to give you

the option to invest in ways that are the most suitable to you.

To explore our research reports in the category of your interest, please

select it from the list on your right.

Market Musing

Company Reports

Theme Based Reports

Weekly Notes

IPOs / FPO

Sector Reports

Stock Stance

Pre-quarter/Updates

Commodity

Research Recommendation Card

Pivot Points

INVESTOR HANDBOOK

60

Registrars and Transfer Agent

(Share transfers and communications regarding share certificates,

dividends and change of address)

Purva Sharegistry (India) Pvt. Ltd.

9,ShivShaktiIndustrialEstate, GroundFloor, SitaramMiill Compound,

JR Boricha Marg, Lower Parel, Mumbai-400 011.

Tel No.: 23016761,

Fax No.: 22626407

E-Mail: busicomp@vsnl.com

Listing of Equity Shares on Stock Exchange at

Bombay Stock Exchange Limited,

Mumbai (BSE) Phiroze Jeejeebhoy Towers,

Dalal Street, Mumbai – 400 001

PORTFOLIO MANAGEMENT SERVICES

KARVY PMS will help you achieve your objective of preserving and

growing capital by conducting a thorough analysis of your investment needs,

returns expected and risk taking ability. Our focus is to craft a basket of

Stocks, Bonds, and Mutual Funds through strong research and corporate

interface, keeping in mind your risk-profile in specific relation with the ever.

Investment Philosophy

61

We focus on a Bottom – Up approach to stock picking. The stock selection

process starts with fundamental analysis of companies and includes

management meeting and plant visits to get a first hand feel of the company,

rather than depending solely on quantitative analysis. The investment process

is fairly rigorous and includes qualitative as well as quantitative criteria and

builds upon the decade long experience of KARVY in Indian equity markets.

Who is it for?

Our offering is ideal for high net-worth customers -

Who are investing in Indian equities

Who desire to create wealth over longer period

Who appreciate a high level of personalized service

Benefits of being with KARVY PMS

Portfolio Management with a difference Every investor, whether individual or

corporate, has unique needs based on their objectives and risk profiles. We

recognize the difference and design tailored investment advice to achieve

specific investment objectives.

Professional Management- We offer professional management of your

equity portfolio with an aim to deliver consistent returns while

controlling risk.

Continuous Monitoring- We recognize that portfolios need to be

constantly monitored and periodically churned to optimize the results.

Risk Control- The portfolios are managed through a strong research

driven investment process with complete transparency and highest

standards of service.

62

Transparency- You will get regular account statements and

performance reports on a monthly basis/ That's not all; web-enabled

access ensure that you are just a click away from all information relating

to your investment.

Hassle Free Operation- Our Portfolio Management Service relieves

you from all the administrative hassles of your investments. We provide

periodic reporting on the performance and other aspects of your

portfolio.

Dedicated Relationship Manager- Our Relationship Managers

specialize in providing personal investment management services to

achieve your investment objective.

Infrastructure

A corporate office and 3 divisional offices in CBD of Mumbai which

houses state-of-the-art dealing room, research wing & management and

back offices.

All of 107 branches and franchisees are fully wired and connected to hub

at corporate office at Mumbai. Add on branches also will be wired and

connected to central hub

Web enabled connectivity and software in place for net trading.

60 operative ID’s for dealing room

State of the Art accounting and billing system, on line risk management

system in place with 100% redundancy back up.

Milestones of Karvy

63

ANALYSIS AND INTERPRETATION GRAPH

DEC-2011 TO JAN-2012 FEATURES INDEX NIFTY-50

64

DATE DAY OPEN HIGH LOW CLOSE13-Dec-11 MON 4069.00 4110.85 4060.20 4081.5014-Dec-11 TUE 4098.60 4098.60 4021.90 4069.7015-Dec-11 WED 4095.00 4167.75 4095.00 4138.6016-Dec-11 THU 4136.75 4165.35 4109.83 4144.3520-Dec-11 MON 4144.70 4197.00 4060.85 4179.4021-Dec-11 TUE 4184.25 4230.15 4126.40 4178.5522-Dec-11 WED 4179.10 4300.05 4179.10 4274.3023-Dec-11 THU 4271.00 4289.80 4193.35 4279.7024-Dec-11 FRI 4282.45 4357.10 4221.60 4287.8527-Dec-11 MON 4287.55 4338.30 4231.65 4272.0028-Dec-11 TUE 4278.10 4347.00 4142.90 4156.9529-Dec-11 WED 4166.65 4224.20 4112.55 4200.1030-Dec-11 THU 4208.80 4244.15 4172.00 4206.8031-Dec-11 FRI 4204.40 4236.40 4115.90 4218.9003-Jan-12 MON 4065.00 4065.00 4825.75 4935.7504-Jan-12 TUE 4937.95 4013.15 4880.30 4913.2005-Jan-12 WED 4907.75 4908.75 4677.00 4705.3006-Jan-12 THU 4705.00 4705.00 4977.10 4208.8007-Jan-12 FRI 4203.35 4203.35 4448.50 4899.3011-Jan-12 MON 4093.05 4328.05 4891.60 4203.4012-Jan-12 TUE 4208.00 4357.20 4995.80 4033.4512-Jan-12 WED 4035.05 4399.25 4065.05 4383.3513-Jan-12 THU 4380.95 4380.95 4071.00 4274.1017-Jan-12 MON 4279.55 4391.60 4225.25 4280.8018-Jan-12 TUE 4272.00 4359.00 3957.75 4005.2519-Jan-12 WED 4329.00 4406.90 4150.00 4389.9020-Jan-12 THU 4412.25 4412.25 4045.00 4270.0521-Jan-12 FRI 4340.00 4393.00 4216.00 4278.1524-Jan-12 MON 4152.50 4268.50 4128.00 4156.7525-Jan-12 TUE 4248.70 4253.60 4072.00 4133.25

TABLE - 1

DECEMBER III RD WEEK GRAPH

DATE DAY OPEN HIGH LOW CLOSE

65

13-Dec-11 MON 4110.00 4141.50 4097.00 4120.3014-Dec-11 TUE 4080.00 4127.00 4047.10 4118.3015-Dec-11 WED 4147.00 4178.95 4123.00 4162.9516-Dec-11 THU 4150.00 4179.95 4121.00 4156.4020-Dec-11 MON 4149.10 4236.00 4060.00 4220.1021-Dec-11 TUE 4185.65 4227.00 4155.00 4178.20

1ST MONDAY: OPEN=4611.00

HIGH=4236.00

LOW=4047.00

CLOSE=4178.00

INTERPRETATION:

DECEMBER 3RD WEAK

CLOSE

HIGH

LOW

OPEN

3950

4000

4050

4100

4150

4200

4250

MON TUE WED THU MON THU

13-12-2011 14-12-2011 15-12-2011 16/12/2011 20/12/2011 21/12/2011

DATE & DAY

NIF

TY

SH

AR

E V

AL

UE

BEP

66

In the above graph I calculated BEP:

Breakeven point (BEP) =HIGH VALUE+LOW VALUE/2

=4236.00+4047.00/2

=8283.00

=4141.50

In this graph I observed the following fluctuations. In the period of (13-12-

2011 to 21-12-2011) in these I found as BEP was 4141.00 values. Here I

observed as value share is a lose of point of Nifty-50 value was (4141.00-

4047.00=94) so here share value is decrease. Due to UN expected change in

market, politics and lack of expects of investors. Here I observed as there is a

change of Nifty-50 share value. That is period of (20-12-2011) is go’s to share

value high (4141.00-4236.00=95) so here share value is increased. And it is

good signal of investment to the buyers. So here investors get more longs.

DEC-2011 TO JAN-2012 FUTURES

67

DATE DAY OPEN HIGH LOW CLOSE13-Dec-11 MON 4110.00 4141.50 4097.00 4120.3014-Dec-11 TUE 4080.00 4127.00 4047.10 4118.3015-Dec-11 WED 4147.00 4178.95 4123.00 4162.9516-Dec-11 THU 4150.00 4179.95 4121.00 4156.4020-Dec-11 MON 4149.10 4236.00 4060.00 4220.1021-Dec-11 TUE 4185.65 4227.00 4155.00 4178.2022-Dec-11 WED 4205.00 4292.75 4203.10 4264.4523-Dec-11 THU 4170.00 4296.00 4170.00 4288.2524-Dec-11 FRI 4307.80 4331.90 4214.25 4272.8027-Dec-11 MON 4263.10 4336.00 4226.10 4264.4028-Dec-11 TUE 4279.00 4321.65 4141.10 4160.6029-Dec-11 WED 4150.35 4225.00 4115.10 4203.6030-Dec-11 THU 4205.35 4542.40 4171.25 4224.7531-Dec-11 FRI 4110.40 4342.60 4166.40 4060.4003-Jan-12 MON 4984.80 4993.80 4831.60 4947.6504-Jan-12 TUE 4931.00 4045.00 4887.00 4931.7505-Jan-12 WED 4862.00 4927.25 4700.00 4730.3506-Jan-12 THU 4691.00 4691.00 4916.00 4197.8507-Jan-12 FRI 4925.00 4997.50 4420.00 4894.0011-Jan-12 MON 4080.00 4337.00 4930.00 4166.9012-Jan-12 TUE 4272.00 4359.00 4957.75 4005.2512-Jan-12 WED 4329.00 4406.90 4150.00 4389.9013-Jan-12 THU 4412.25 4412.25 4045.00 4270.0517-Jan-12 MON 4340.00 4393.00 4216.00 4278.1518-Jan-12 TUE 4152.50 4268.50 4128.00 4156.7519-Jan-12 WED 4248.70 4253.60 4072.00 4133.2520-Jan-12 THU 4329.00 4406.90 4150.00 4389.9021-Jan-12 FRI 4412.25 4412.25 4045.00 4270.0524-Jan-12 MON 4340.00 4393.00 4216.00 4278.1525-Jan-12 TUE 4152.50 4268.50 4128.00 4156.75

TABLE - 2

DECEMBER IV TH WEEK GRAPH

68

DATE DAY OPEN HIGH LOW CLOSE22-Dec-11 WED 4185.65 4227.00 4155.00 4178.2023-Dec-11 THU 4205.00 4292.75 4203.10 4264.4524-Dec-11 FRI 4170.00 4296.00 4170.00 4288.2527-Dec-11 MON 4307.80 4331.90 4214.25 4272.8028-Dec-11 TUE 4263.10 4336.00 4226.10 4264.4029-Dec-11 WED 4279.00 4321.65 4141.10 4160.60

2ND MONDAY: OPEN=4185.00

HIGH=4336.00

LOW=4141.00

CLOSE=4160.00

INTERPRETATION:

DECEMBER 4TH WEEK

BEP

OPEN

HIGH

LOW&

CLOSE

4000

4050

4100

4150

4200

4250

4300

4350

4400

WED THU FRI MON TUE WED

22/12/2011 23/12/2011 24/12/2011 27/12/2011 28/12/2011 29/12/2011

DATE & DAY

NIF

TY

SH

AR

E V

AL

E

69

In the above graph I calculated BEP.

BREAKEVEN POINT (BEP) = HIGH VALUE+LOW VALUE/2

=4336.00+4141.00/2

=8477.00/2

=4238.50

In this graph I observed the following fluctuations. In the period of (22-12-

2011 to 29-12-2011).In these I found as BEP was 4238.00. Here I observed as

value share is a high rate so Nifty-50 value was (4238.00-4336.00=98.00)

share value is increased. So it is a good signal of investor to long to the shares.

and I observed share value is loss of point Nifty-50 was (4238.00-

4141.00=97.00) this value are investor in most loss so this is un expected

changes in market and politics and lack of expects of investors.

DEC-2011 TO JAN-2012 CONTRACT AND SWAPS

70

DATE DAY OPEN HIGH LOW CLOSE13-Dec-11 MON 4099.00 4130.00 4088.10 4109.7514-Dec-11 TUE 4051.05 4130.00 4041.00 4109.9015-Dec-11 WED 4130.00 4171.00 4115.15 4151.4516-Dec-11 THU 4138.00 4169.00 4112.35 4148.1020-Dec-11 MON 4140.00 4227.00 4056.95 4211.2021-Dec-11 TUE 4130.00 4217.00 4130.00 4174.5522-Dec-11 WED 4200.00 4287.00 4192.10 4261.6523-Dec-11 THU 4249.70 4290.00 4175.00 4284.6024-Dec-11 FRI 4320.00 4333.00 4212.00 46269.6527-Dec-11 MON 4250.00 4333.00 4227.40 4264.8528-Dec-11 TUE 4271.00 4317.00 4141.00 4161.3029-Dec-11 WED 4199.00 4222.90 4115.00 4202.3530-Dec-11 THU 4220.00 4240.00 4170.00 4224.2531-Dec-11 FRI 4210.60 4228.80 4140.80 4020.6003-Jan-12 MON 4017.70 4017.70 4834.60 4951.5004-Jan-12 TUE 4945.00 4049.00 4885.00 4933.1005-Jan-12 WED 4901.00 4927.10 4700.00 4728.9506-Jan-12 THU 4680.00 4680.00 4920.40 4204.2507-Jan-12 FRI 4900.00 4999.00 4400.00 4885.6511-Jan-12 MON 4105.00 4329.00 4925.00 4157.6612-Jan-12 TUE 4319.00 4348.00 4942.20 4996.2512-Jan-12 WED 4875.00 4395.00 4069.80 4374.9013-Jan-12 THU 4265.00 4281.00 4026.55 4252.9017-Jan-12 MON 4298.70 4376.00 4200.00 4261.0018-Jan-12 TUE 4250.00 4265.00 4102.15 4132.0019-Jan-12 WED 4200.00 4243.00 4045.00 4083.6020-Jan-12 THU 4329.00 4406.90 4150.00 4389.9021-Jan-12 FRI 4412.25 4412.25 4045.00 4270.0524-Jan-12 MON 4340.00 4393.00 4216.00 4278.1525-Jan-12 TUE 4152.50 4268.50 4128.00 4156.75

TABLE - 3

JANUARY I ST & 2 ND WEEK GRAPH

71

DATE DAY OPEN HIGH LOW CLOSE30-Dec-11 THU 4279.00 4321.65 4141.10 4160.6031-Dec-11 FRI 4150.35 4225.00 4115.10 4203.603-Jan-12 MON 4205.35 4542.40 4171.25 4224.754-Jan-12 TUE 4110.40 4342.60 4166.40 4060.405-Jan-12 WED 4984.80 4993.80 4831.60 4947.656-Jan-12 THU 4931.00 4045.00 4887.00 4931.75

TABLE – 7

3RD MONDAY : OPEN=4279.00

HIGH=4831.00

LOW=4542.00

CLOSE=4931.00

INTERPRETATION:

JANUARY 1 ST & 2 ND WEEK

CLOSE

LOW

HIGH

OPEN

BEP

3400

3600

3800

4000

4200

6400

4600

THU FRI MON TUE WED THU

30/12/2011 31/12/2011 03-01-2012 04-01-2012 05-01-2012 06-01-2012

DATE AND DAY

NIF

TY

SH

AR

E V

AL

UE

72

In the above graph I calculated BEP.

BREAKEVEN POINT (BEP) = HIGH VALUE+LOW VALUE/2

=4542.00+4831.00/2

=9373.00/2

=4686.50

In this graph I observed the following fluctuations in the period of (30-12-

2011 to 06-01-2012) in this period I found as BEP rate was 4686.00 values. So

here I observed has value share is high rate so Nifty-50 value was (4686.00-

4542.00 = 144.00). so here share value is decreased so it is a bad signal of

investor so here investor get more losses and more longs. And I observed as

share value is profit of point to Nifty-50 was (4686.00-4931.00=245). So here

share value increased here investor gets more profits and more gains. So this is

unexpected change in market and politics and lack of experts to investors.

DEC-2011 TO JAN-2012 FORWORDS

73

DATE DAY OPEN HIGH LOW CLOSE13-Dec-11 MON 4085.00 4110.60 4010.30 4090.8014-Dec-11 TUE 4070.05 4105.00 4035.00 4100.6515-Dec-11 WED 4123.70 4155.00 4110.00 4139.6016-Dec-11 THU 4129.95 4157.90 4110.00 4136.2520-Dec-11 MON 4134.00 4215.00 4050.00 4201.6521-Dec-11 TUE 4130.05 4208.00 4121.00 4162.4522-Dec-11 WED 4200.00 4275.00 4180.10 4250.6523-Dec-11 THU 4200.00 4279.70 4175.00 4272.3524-Dec-11 FRI 4299.00 4318.95 4205.00 4261.1027-Dec-11 MON 4270.00 4320.05 4215.00 4255.2028-Dec-11 TUE 4280.05 4307.90 4140.00 4155.7029-Dec-11 WED 4145.15 4214.00 4115.00 4191.3530-Dec-11 THU 4198.00 4231.00 4167.00 4214.2531-Dec-11 FRI 4210.30 4220.00 4140.80 4040.9003-Jan-12 MON 4000.00 4000.00 4835.00 4947.9504-Jan-12 TUE 4921.05 4044.50 4882.05 4927.7505-Jan-12 WED 4900.00 4923.00 4175.90 4740.1506-Jan-12 THU 4700.00 4700.00 4950.00 4195.90

07-Jan-12 FRI 4058.00 4058.00 4305.00 4896.5511-Jan-12 MON 4110.00 4329.00 4910.00 4158.3512-Jan-12 TUE 4315.00 4340.00 4949.00 4994.1512-Jan-12 WED 4195.00 4399.60 4150.05 4377.8513-Jan-12 THU 4200.00 4297.00 4029.70 4258.8517-Jan-12 MON 4349.00 4389.90 4200.10 4262.4018-Jan-12 TUE 4218.05 4249.95 4100.00 4119.1519-Jan-12 WED 4155.00 4234.00 4049.00 4066.0020-Jan-12 THU 4329.00 4406.90 4150.00 4389.9021-Jan-12 FRI 4412.25 4412.25 4045.00 4270.0524-Jan-12 MON 4340.00 4393.00 4216.00 4278.1525-Jan-12 TUE 4152.50 4268.50 4128.00 4156.75

TABLE - 4

JANUARY III RD WEEK GRAPH:

74

DATE DAY OPEN HIGH LOW CLOSE7-Jan-12 FRI 4931.00 4045.00 4887.00 4931.7510-Jan-12 MON 4862.00 4927.25 4700.00 4730.3511-Jan-12 TUE 4691.00 4691.00 4916.00 4197.8512-Jan-12 WED 4925.00 4997.50 4420.00 4894.0013-Jan-12 THU 4080.00 4337.00 4930.00 4166.9017-Jan-12 MON 4272.00 4359.00 4957.75 4005.25

TABLE – 8

4TH MONDAY: OPEN=3931.00

HIGH=4420.00

LOW=4045.00

CLOSE=4005.00

INTERPRETATION:

In the above graph I calculated BEP.

JANUARY 3 RD WEEK

CLOSELOW

HIGHOPEN

BEP

0

1000

2000

3000

4000

4500

6000

6000

FRI MON TUE WED THU MON

07-01-2012 10-01-2012 11-01-2012 12-01-2012 13-01-2012 17-01-2012

DATE & DAY

NIF

TY

SH

AR

E V

AL

UE

75

BREAKEVEN POINT (BEP) = HIGH VALUE+LOW VALUE/2

=4045.00+4420.00/2

=8465.00/2

=4232.00

In this graph I observed fluctuations in the period of (07-01-2012 to 17-01-

2012) in this graph I found as BEP was 4232.00 share value .Here I observed

as a value share is high rate so Nifty-50 value was (4232.00-4420.00=188.00)

so here share value is increased so it is good signal of investors so here

investors gets more profits and more longs and I observed share value is Nifty-

50 was (4232.00-4045.00 = 187). so here share value decreased so here

investors gets more loss and more shorts. So this is unexpected changes in

market and politics and lack of experts of investors.

JANUARY IV TH WEEK GRAPH:

76

DATE DAY OPEN HIGH LOW CLOSE18-Jan-12 TUE 4272.00 4359.00 3957.75 4005.2519-Jan-12 WED 4329.00 4406.90 4150.00 4389.9020-Jan-12 THU 4412.25 4412.25 4045.00 4270.0521-Jan-12 FRI 4340.00 4393.00 4216.00 4278.1524-Jan-12 MON 4152.50 4268.50 4128.00 4156.7525-Jan-12 TUE 4248.70 4253.60 4072.00 4133.25

TABLE – 9

5TH MONDAY: OPEN =4272.00

HIGH =4412.00

LOW =3957.00

CLOSE=4133.00

INTERPRETATION

JANUARY 4 TH WEEK

CLOSE

HIGH

LOW

OPENBEP

3700

3800

3900

4000

4100

4200

4300

4400

4500

TUE WED THU FRI MON TUE

18-01-2012 19-01-2012 20-01-2012 21-01-2012 24-01-2012 25-01-2012

DATE & DAY

NIF

TY

SH

AR

E V

AL

UE

77

In the above graph I calculated BEP.

BREAKEVEN POINT (BEP) = HIGH VALUE+LOW VALUE/2

=4412.00+ 3957.00/2

=8369.00/2

=4184.00

In this graph I observed fluctuations in the period of (18-01-2012 to 25-01-

2012) in this graph I found as BEP was 4184.00 share value .Here I observed

as a value share is high rate so Nifty-50 value was (4184.00-3957.00=227.00)

so here share value is decreased so here investors gets more losses and more

shorts .so this is unexpected change in the market and politics and lack of

expects of investors .and I observed share value is Nifty-50 was (4184.00-

4412.00 = 228.00). So here share value increased so here investors gets more

profits and more longs.

FINDINGS

78

Derivatives market is an innovation to cash market. Approximately its

daily turnover reaches to the equal stage of cash market. The average

daily turnover of the NSE derivative segments

In cash market the profit/loss of the investor depend the market price

of the underlying asset. The investor may incur Hugh profit or he may

incur Hugh profits or he may incur Hugh loss. But in derivatives

segment the investor the investor enjoys Hugh profits with limited

downside.

In cash market the investor has to pay the total money, but in

derivatives the investor has to pay premiums or margins, which are

some percentage of total money.

Derivatives are mostly used for hedging purpose.

In derivative segment the profit/loss of the option writer is purely

depend on the fluctuations of the underlying asset.

SUGGESTIONS

79

The investors can minimize risk by investing in derivatives. The use of

derivative equips the investor to face the risk, which is uncertain.

Though the use of derivatives does not completely eliminate the risk,

but it certainly lessens the risk .

It is advisable to the investor like to invest in the derivatives market

because of the greater amount of liquidity offered by the financial

derivatives and the lower transaction costs associated with the trading of

financial derivatives.

The derivative products give the investor an option or choice whether

the exercise the contract or not.

Option gives the choice to the investor to either exercise his right or

not.

If on expiry date the investor finds that the underlying asset in the

option contract is traded at a less price in the stock market then,

he has the full liberty to get out of the option contract and go ahead and

buy the asset from the stock market.

So in case of high uncertainty the investor can go for option.

However, these instruments act as a powerful instrument for

knowledge traders to expose them to the properly calculated and well

understood risks in pursuit of reward i.e profit.

80

CONCLUSION

Derivative have existed and evolved over a long time, with roots in

commodities market .In the recent years advances in financial markets

and technology have made derivatives easy for the investors.

Derivatives market in India is growing rapidly unlike equity

markets .Trading in derivatives require more than average understanding

of finance. Being now markets. Maximum numbers of investors have not

yet understood thee full implications of the trading in derivatives. SEBI

should take actions to create awareness in investors about the derivative

market.

Introduction of derivative implies better risk management. These markets

can greater depth, stability and liquidity to India capital markets.

Successful risk management with derivatives requires a through

understanding 0 principles that govern the pricing of financial derivatives.

In order to increase the derivatives market in India SEBI should revise

some of their regulation like contract size ,participation of Fill in the

derivative market. Contract size should be minimized because small

investor cannot afford this much of huge premiums.

Derivatives are mostly used for hedging purpose.

In derivative market the profit and loss of the option writer /option holder

purely depends on the fluctuations of the underlying.

81

BIBLIOGRAPHY

TEXT BOOKS

S.No Name of the

Author

Title of Book Publisher Year EDITION

1 IM PANDEY FINANCIAL

MANAGEMENT

VIKAS

PUBLISHING

HOUSE. PVT.LTD.

2008 9TH

EDITION

3RD

EDITION

6TH

EDITION

2 R MAHAJAN FUTURES & OPTIONS VISION BOOKS

PVT.LTD

2011

3 DONALD E.

FISCHER &

J. JORDAN

RONALD

SECURITY ANALYSIS

AND PORTFOLIO

MANAGEMENTPRENTICE HALL 1995

MAGAZINES:

BUSINESS TODAY

BUSINESS WORLD

WEB SITES

www.karvystock.com

www.derivativesindia.com

www.nseindia.com

www.bseindia.com

www.hseindia.com

82