Study Reports on Online Trading Derivatives

8/12/2019 Study Reports on Online Trading Derivatives

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STUDY REPORTS ON ONLINE TRADING

DERIVATIVES

ONLINE TRADING IN DERIVATIVES

CONTENTS

Chapter I Introduction

Need for the study

Objectives of the study

Methodology

Limitations

Chapter II Stock markets in India Financial Markets

Money Markets

Capital Markets

Stock Markets

erivative Markets

Chapter -III !heoretical frame"ork of derivative market.

Chapter -IV #ractical aspects of derivative market$

Chapter V Summary % Suggestions

ANNEXURE &uestionnaire

'ibliography


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CHAPTER-I

IN!(O)C!ION

N** FO( S!)+

O',*C!I-*S

M*!.OOLO/+

LIMI!0!IONS


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Introducton !

In our present day economy1 finance is defined as the provision of money at the

time "hen it is re2uired$ *very enterprise1 "hether big1 medium or small1 needs finance

to carry on its operations and to achieve its targets in fact3 finance is so indispensable

today that it is rightly said that it is the lifeblood of an enterprise$

!he term 4o"nership securities5 also kno"n as 4capital stock 4 represents shares$

Shares are the most universal forms of raising long6term funds from the market$ *very

company1 e7cept a company limited by guarantee1 has a statutory right to issued shares$

!he capital of a company is divided into a number of e2ual parts kno"n as shares$

0ccording to Fare"ell $j1 a share is1 8the interest of a shareholder in the company1

measured by a sum of money1 for the purpose of liability in the first place1 and if interest

in the second1 but also consisting a series of mutual covenants entered into by all the

shareholders interest5$ Section 9:;?@< defines it as 8 a share

in the share capital of a company1 and includes stock e7cept "here a distinction bet"een

stock and shares e7pressed or implied$

Share market is of t"o types$ !hey arecash market

andderivative market

.

Ca"h #ar$et"are the secondary markets "here trading in e7isting securities is

done$ Listing of ne" issues for investment and disinvestments by saversAinvestors takes

place$ It imparts li2uidity or encash ability to stocks and shares$ Stock e7change is a

market in "hich securities are bought and sold and it is an essential component of a

developed capital markets$


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!he securities contracts :(egulation= 0ct1 >?@


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erivative contracts have several variants$ !he most common variants are

for"ards1 futures1 options and s"aps$ !he follo"ing three broad categories of

participants hedgers1 speculators1 and arbitrageurs trade in the derivatives market$

.edgers face risk associated "ith the price of an asset$ !hey use futures or options

markets to reduce or eliminate this risk$ Speculators "ish to bet on future movements in

the price of an asset$ Futures and options contracts can give them an e7tra leverage3 that

is1 they can increase both the potential gains and potential losses in a speculative

venture$ 0rbitrageurs and in business to take advantage of a discrepancy bet"een prices

in t"o different markets$ If1 for e7ample1 they see the futures price of an asset getting out

of line "ith the cash price1 they "ill take offsetting positions in the t"o markets to lock in

a profit$

erivative products initially emerged as hedging devices against fluctuations in

commodity prices1 and commodity6linked derivatives remained the sole form for such

products for almost three hundred years$ Financial derivatives came into spotlight in the

post6>?GE period due to gro"ing instability in the financial markets$

.o"ever1 since their emergence1 these products have become very popular and by

>??Es1 they accounted for about t"o6thirds of total transactions in derivative products$ In

recent years1 the market for financial derivatives has gro"n tremendously in terms of

variety of instruments available1 their comple7ity and also turnover$

In the class of e2uity derivatives the "orld over1 futures and options on stock indices

have gained more popularity than on individual stocks1 especially among institutional

investors1 "ho are major users of inde76linked derivatives$ *ven small investors find

these useful due to high correlation of the popular inde7es "ith various portfolios and

ease of use$ !he lo"er costs associated "ith various portfolios and ease of use$ !he

lo"er costs associated "ith inde7 derivatives vis6H6vis derivative products based on

individual securities is another reason for their gro"ing use$

!he first step to"ards introduction of derivatives trading in India "as the promulgation of

the Securities La"s :0mendment= Ordinance1 >??@1 "hich "ithdre" the prohibition on

option in securities$


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!he market for derivatives1 ho"ever1 did not take off1 as there "as no regulatory

frame"ork to govern trading of derivatives$ S*'I set up a 9;6member committee under

the Chairmanship of r$L$C$/upta$ on November >1>??< to develop appropriate

regulatory frame"ork for derivatives trading in India$

!he committee submitted its report on March >G1>?? prescribing necessary pre6

conditions for introduction of derivatives trading in India$ !he committee recommended

that derivatives should be declared as 4securities5 so that regulatory frame"ork applicable

to trading of 4securities5 could also govern trading of securities$ S*'I also set up a group

in ,une >?? under the Chairmanship of #rof$,$($-arma$1 to recommend measures for

risk containment in derivatives market in India$ !hese instruments can be used to

speculate or to manage risk in the e2uity markets$

erivatives are products "hose values are derived from one of more basic variables

called bases$ !hese bases can be underlying assets such as foreign currency1 stock or

commodity1 bases or reference rates such as LI'O( or )S !reasury (ate etc$ For

e7ample1 an Indian e7porter in anticipation of the receipt of dollar6denominated e7port

proceeds may "ish to sell dollars at a future date to eliminate the risk of e7change rate

volatility by the date$ Such transactions are called derivatives1 "ith the spot price of dollar

being the underlying asset$

erivatives thus have no value of their o"n but derive it from the asset that is being dealt

"ith under the derivative contract$ For instance1 look at an ashtray$ It has no value of its

o"n but gains its importance only "hen one smokes and gain if one "ants to collect that

ash at one place instead of dirtying the "hole room "ith cigarette ash and its stubs$ 0

smoker can hedge against the risk of ste"ing the cigarette stubs and ash all around the

room$

Similarly a financial manager can hedge himself from the risk of a loss in the price of a

commodity or stock by buying a derivative contract$ !hus derivative contracts ac2uire

their value from the spot prices of the assets that are concerned by the contract$

!he primary purpose of a derivative contract is to transfer 8riskD from one party to another

i$e$ risk in a financial sense in transferred from a party that "ants to get rid of it to another


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party that is "illing to take it on$ .ere1 the risk that is being dealt "ith is that of price risk$

!he transfer of such a risk can therefore be speculative in nature or act as a hedge

against price movement in a current or anticipate physical position$

0 derivative is an instrument "hose value is derived from the value of one or more

underlying "hich can either in the form of commodities1 precious meat1 currencies1

bonds1 stock and stock indicesD$ 0s the price of the "heat derivatives "ould be

determined or based on the prices of "heat itself$

/iven the fast change and gro"th in the scenario of the economic and financial sector

have brought a much broader impact on derivatives instrument$ 0s the name signifies1

the value of this product is derived of based on the prices of currencies1 interest rate :i$e$

bonds=1 share and share indices1 commodities1 etc$ Not going into very back1 financial

derivatives just came into e7istence in the early >?E5s$ .ere the principal instruments1

clubbed under the general term derivatives1 include

>$ Futures % For"ards

9$ Options1

J$ S"aps

;$ Karrants

@$ *7otic and are the modern tools of financial risk management$

0ll pricing of derivatives is done by arbitrage1 and by arbitrage alone$ .ere1 there is a

relationship bet"een the price of the spot and the price in the futures$ If this relationship

is violate1 then an arbitrage opportunity is available1 and "e people e7ploit this

opportunity1 the price reverts back to its economic value$ !herefore1 arbitrage is the basic

re2uirement for pricing$ !he role of li2uidity i$e$ the lo" transaction costs is in making

arbitrage check up and convenient$ erivative markets in 'rail are some of the largest

markets in the "orld even first derivative dealing "ere started in )S0$ Ke can even

kno" that as the prices of the for"ard contacts are based on future therefore it can even

be termed as derivative instrument$


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erivative contracts have several variants$ !he most common variants are

for"ards1 futures1 options and s"aps$ 0 brief note on the various derivative that are used

are as follo"sB

&or'ard"$ 0 for"ard contract is a customied contract bet"een to" entities1

"here settlement takes place on a specific date in future at today5 pre agreed price$

&uture"$ 0 future contract is an agreement bet"een t"o parties to buy

Or sell an asset at a certain time in the future at a certain price$ Future contracts are

Special types of for"ard contracts means that the former are standardied e7change

!raded contracts$

Opton"$ Options are of t"o types1

Calls option$ Calls give the buyer the right but not the obligation to buy a

/iven 2uantity of the underlying asset1 at a given price on or before a given future

ate$

Puts Option. #uts Option give the buyer the right1 but not obligation to sell a

/iven 2uantity of the underlying asset at a given price on or before a given date$

(arrant") Longer dated options are called "arrants and are generally

!raded over the counter$

S'ap") S"aps are private agreements bet"een t"o parties to e7change

cash flo"s in the future according to a pre6 arranged formula$ !hey can be regarded as

portfolios of for"ard contracts$

Need *or Stud+!


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0lthough financial derivatives have e7isted for a considerable period of time they

have become major forces in financial market only since the early >?GEs$ !he >?GEs

constituted a "atershed in financial history1 partly because the fi7ed e7change rate

regime :the 'retton Koods Systems= that had operated since the >?;Es1 broke do"n$

!hese developments established the conte7t in "hich financial derivatives could develop1

flourish and became a major force in "orld financial markets$ Khen the 'reton Kood

Systems collapsed in the early >?GEs1 a regime of fi7ed e7change rates gave "ay to

financial environment in "hich e7change rates "ere constantly changing in response to

pressure of demand and supply$ !he fact that currency prices move constantly and often

substantially1 in the ne" situation meant that businesses face ne" risks$

Currency derivatives developed in response to the need to manage these risks$ In other

"ords the ne" system of variable e7change rates generated a need to find techni2ues to

reduce the risks arising and simultaneously created opportunities for speculations$ !hus

financial derivatives develop as a vehicle for these t"o forms of economic activities$

Khen an investor feels the market "ill fall1 he can hedge this position by selling$ Say1

Nifty futures against his portfolio$

!rading in derivatives in India "as introduced in ,une 9EEE on NS* market$ !he S*'I

governs this market buy providing the necessary rules and regulations$ erivatives allo"

us to manage risks more efficiently by unbundling the risks and allo" either hedging or

taking only :or more if desired= risk at a time$

uring the present period1 banks have increased their e7posure to O!C derivative

instruments at such a faster rate that supervisory authorities the "orld over are getting

"orried about the risks such e7posures involve for the banks$ !he e7plosive gro"th in

derivatives has been the result both of intense competition amongst major international

banks :as the role have been changed to profitability= and the need of the corporate

"orld1 indeed the "hole 8realD economy1 to hedge e7posures in volatile markets$ 0s the

increase of players entering market "hich decrease the margins$ erivatives provide

their important economic functionsB


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:>= (isk management

:9= #rice discovery3 and

:J= !ransactional efficiency

!he risk "hich are generally seen in derivatives are generally of four typesB

:>= Credit risk

:9= Market risk

:J= Legal risk

:;= Operations risk

!his should be the follo"ing measure to reduce disasters "ith derivativesB 6

0t the level of e7changes1 position limits and surveillance procedures should be

sound$

0t the level of clearing houses1 margin re2uirements should be stringently enforced1

even "hen dealing is "ith large institutions$

0t the level of individual companies "ith positions in the market1 modern risk

measurement systems should be established alongside the creation of capabilities in

trading in derivatives$ !he basic idea1 "hich should be steadfastly used "hen thinking

about returns1 is that risk also merits measurement$

,ut 'h+ are der%at%e" "uch a . ht n Indan #ar$et/

!he derivatives products inde7 futures1 inde7 options1 stock futures and stock

options provide a carry for"ard facility for investors to take a position :bullish or

bearish= on an inde7 or a particular stock for a period ranging from one to three

months$

!he current daily settlement in the cash market has left no room for speculation$ !he

cash market has turned into a day market1 leading to increasing attention to

derivatives$

)nlike the cash market of full payment or delivery1 you don5t need many funds to buy

derivatives products$ 'y paying a small margin1 one can take a position in stocks or

market inde7$


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!hey provide a substitute for the infamous '0L0 system$

!he derivatives volume is also picking up in anticipation of reduction of contract sie from

the current (s$9EE1 EEE to (s$>EE1 EEE$

*verything "orks in a rising market$ )n2uestionably1 there is also a lot of trading

interest in the derivatives market$

O0ect%e" o* the "tud+!

!o study the process of derivative market

!o make a comparative study "ith cash market$

!o analye risks and benefits of derivative market

!o analye through 2uestionnaire ho" investors are benefited inerivative market$

1ethodo2o.+!

Facts e7pressed in 2uantity form can be termed as 8dataD$ ata maybe classified either

asB

i$ #rimary data

ii$ Secondary data

3 Pr#ar+ Data!

#rimary data is the first hand information that a researcher gets from various

sources like respondents1 analogous case situations and research e7periments$ #rimary

data is the data that is generated by the researcher for the specific purpose of research

situation at hand$


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For this project the primary data "ill be collected from the personnel$ !his data

can also be obtained through a 2uestionnaire1 based upon "hich some statistical

techni2ues are applied$

3 Secondar+ Data!

Secondary data is already published data collected for some purpose other than

the one confronting the researcher at a given point of time$ !he secondary data can be

gathered from various sources like statistics1 libraries1 research agencies etc$ In this

case the secondary information is to be collected from ne"spapers like 8'usiness lineD

and business magaines like 8'usiness !odayD and Internet$

L#taton"!

!he project may suffer from the follo"ing limitationsB

!he re2uired data may not be available due to "hich it cannot be accurate$

Some of the important information is included because of time constraint$

It "as deliberately difficult to collect the data from the clients1 as they are apparently

busy


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Chapter II

Stoc$ #ar$et" n Inda

Financial Markets

Money Markets

Capital Markets

Stock Markets

erivative Markets


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&INANCIAL 1AR4ETS!

Financial markets are in the forefront in developing economics$ !he vibrant

financial market enhances the efficiency of capital formation$ Kell6developed financial

markets enlarge the range of financial services$ !hus1 financial markets bridge one set of

financial intermediaries "ith another set of players$

!he main functions of the financial markets areB

!o facilitate creation and allocation of credit and li2uidity$

!o serve as intermediaries for mobiliation of savings$

!o provide financial convenience1 and

!o cater to the various credits needs of the business houses$

!ypes of Financial marketsB


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On the basis of the maturity period of the financial assets1 the market can be divided intoB

1one+ #ar$et!

0 money market is a mechanism through "hich short6term funds are loaned

and borro"ed and through "hich a large part of the financial transaction of a particular

country of the "orld are cleared$

!he money market is divided into J sectors namely organied sector1 unorganied sector

and Cooperative sector$

Or.an5ed "ectoris comparatively "ell developed in terms of organied relationships

and specialiation of functions$ It consists of the (eserve 'ank of India1 various

scheduled and non6scheduled commercial banks$ !he development banks1 other

financial institutions like LIC1 )!I1 discount and finance house of India limited are all a

part of the organied sector$

The unor.an5ed "ectoris more dominate in India$ !he only link bet"een the organied

and unorganied sectors is through commercial banks$ It consists of the indigenous

bankers1 Moneylenders1 Nidhis and Chit funds$


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The cooperat%e "ectorconsists of the state cooperative banks1 primary agricultural

credit societies1 Central Cooperative banks1 and State Land evelopment bank

FIN0NCI0L S+S!*M

FINANCIAL

INSTITUTIONS

FINANCIAL

MARKETS

FINANCIAL

INSTRUMENTS

FINANCIAL

SERVICES

MONEY

MARKET

CAPITAL

MARKET

Unorganized Organized

Term ending

In!"r#$"ion!

S"o$% Mar%e"

Ind#!"ria Se$#ri"ie!

Mar%e"

Gi" Edged

Se$#ri"ie! Mar%e"

Se$ondar&

Mar%e"

Primar& Mar%e"S"o$% E'$(ange!


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)(oe!ae de*"

Mar%e" !egmen" Ca+i"a mar%e"

Se men"

F#"#re! O+"ion! In"ere!" ra"e

Ca P#"

Ca!( Segmen" Deri,a"i,e Segmen"


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Capta2 #ar$et!

Capital market is an organied mechanism for effective and efficient transfer of money

capital of financial resources form the investing class i$e$1 a body of individual or

institutional savers1 to the entrepreneur class i$e$1 a body of individual or institutions

engage in industry1 business or service in the private and public sectors of the economy$

&uncton" o* capta2 #ar$et!

!he capital market is directly responsible for the follo"ing activities$

Mobiliation of National savings for economic development

Mobiliation and import of foreign capital and foreign investment capital plus skill to fill

up the deficit in the re2uired financial resources to maintain e7pected rate of

economic gro"th$

#roductive utiliation of resources

irection the flo" to funds of high yields and also strives for balance and diversified

industrialiation$

Con"ttuent" o* capta2 #ar$et!

!he capital market comprises of mutual funds1 development banks1 specialied

financial institutions1 investment institutions1 state level development banks1 lease


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companies1 financial service companies1 commercial banks and other specialied

institutions set up for the gro"th of capital market like S*'I1 C(ISIL$

In"tru#ent" Capta2 #ar$et!

!he follo"ing instruments are being used for raising resources$

*2uity shares

#reference shares

Non6voting e2uity shares

Cumulative convertible preference Shares Company fi7ed deposits1 banks1 and

debentures1 global depository receipts$

!he capital market is divided into t"o parts namely ne" issues market and Stock market$

Stoc$ 1ar$et!

Stock markets are the secondary markets "here trading in e7isting securities is done$

Listing of ne" issues for investment and disinvestments by saversAinvestors takes place$

It imparts li2uidity or encash ability to stocks and shares$

Stock e7change is a market in "hich securities are bought and sold and it is an essential

component of a developed capital markets$

!he securities contracts :(egulation= 0ct1 >?@


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established for the purpose of assisting1 regulating and controlling of business in buying1

selling and dealing in securitiesD$

0 stock e7change1 thus imparts marketability and li2uidity to securities1 encourage

investments in securities and assists corporate gro"th$ Stock e7changes are organied

and regulated markets for various securities issued by corporate sector and other

institutions$

Character"tc"!

0n organiation in the form of an association or company

0 governing body to supervise and control its activities

0 frame"ork of rules and regulations

0 common meeting place for purchasers and sellers

Only members are allo"ed to conduct business in a stock e7change$

&uncton"!

*nsures li2uidity of capital

#rovides ready market for securities

irects flo" of capital into profitable channels

*valuation of financial conditions and prospects of listed firms

Facilitates speculation

#romotes and mobilies savings

#romotes industrial gro"th and economic development

#latform for public debt

Clearing house of business information


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,ene*t"!

!he benefits of stock e7change can be studied under the follo"ing headingsB

>$ 0dvantages to the companiesB

(eady market for securities

Increase in price

Increase in good"ill

0gent bet"een companies and the investors

9$ 0dvantage to the Investors

Safety of investment and 'est use of capital

More collateral value

#ublication of price list of securities

#o"erful hedge against inflation

J$ 0dvantage to the societyB

.elpful in industrialiation

Increase in rate of capital formation

Savings are encouraged

Inventive for efficiency

/overnment can raise funds for important projects

#rovides a mirror to reflect general economic condition

!here are stock 9J e7changes in India$ !hey are National Stock *7change1

'ombay Stock *7change1 'an galore Stock *7change1 0hmedabad Stock *7change1

Calcutta Stock *7change1 elhi Stock *7change1 .yderabad Stock *7change1

Madhya#radesh Stock *7change1 Madras Stock *7change1 Cochin Stock *7change1


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)ttar#radesh Stock *7change1#une Stock *7change1 Ludhiana Stock *7change1

/u"ahati Stock *7change1 Mangalore Stock *7change1 -adodara Stock *7change1

(ajkot Stock *7change1 'hubanesh"ar Stock *7change1 Coimbatore Stock *7change1

,aipur Stock *7change1 Merrut Stock *7change1 #atna Stock *7change1 over the

counter e7change of India$

!he most prominent among these are 'ombay Stock *7change and National Stock

*7change1

,o#a+ Stoc$ E6chan.e!

!he Stock *7change1 Mumbai1 popularly kno"n as 7,SE8 "as established in >G@ as

7The Nat%e Share and Stoc$ ,ro$er" A""ocaton8$ It is the oldest one in 0sia1 even

older that the !okyo Stock *7change1 "hich "as established in >G$ It is a voluntary

nonprofit making 0ssociation of #ersons :0O#= and is currently engaged in the process

of converting itself into de mutilated and corporate entity$ It has evolved over the years

into its present status as the premier Stock *7change in the country$ It is the first Stock

*7change in the Country to have obtained permanent recognition in >?@< from the /ovt$

of India under the Securities Contracts :(egulation= 0ct1 >?@


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It "as incorporate in November >??9 "ith an e2uity capital of (s$9@ Cores and promoted

among others by I'I1 ICICI1 LIC1 /IC and its subsidiaries1 commercial banks including

State 'ank of India$ It has a satellite based state6of the art net"orking and fully automate

screen based trading$ It lists companies "ith paid up capital of (s$>E core or more$

Stren.th"!

!ransparency and National reach$

*2ual access to all members

/overnment patronage

Institutional patronage

#rovides avenue for investment trading

.i6tech infrastructure

FIIs more comfortable "ith screen based trading

Specialiing in derivatives Futures % Options

(ea$ne""e"!

No track record$

Screen based trading is a ne" concept

Short run concentration in Mumbai

'ack up infrastructure like communication not in place$

#rohibitive costs of entry for small brokers$

)ntested systems for large volumes of trade$

,SE5s established system1 its net"ork of brokers and sub brokers$

)neven track record of computeriation in India$

National Stock *7change operates t"o segments namely "holesale debt market and

capital market$

9) (D1 "e.#ent!


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!he KM segment or the money market as it is commonly referred as1 is a facility for

institutions and corporate bodies to enter into high value transactions in instruments such

as government securities1 treasury bills1 public sector nits :#S)= bonds1 commercial

paper certificates of deposit$ On the KM segment1 there are t"o types of entities$

!rading members "ho can either trade on their account or on behalf of their clients

including participants Khile participants are the organiations directly responsible for

settlement of trades "ho settle trades e7ecuted on their o"n account and on behalf of

those clients "ho are not direct participants$

:) Capta2 1ar$et Se.#ent!

!he CM segment covers trading in e2uities1 convertible debentures and retail trade in

debt instruments like non6convertible debentures$ Securities of medium1 and large

companies "ith nation"ide investors base including securities traded on other stock

e7changes are traded the NSF$ !he CM segment has t"o sub segments namely Cash

Segment and erivatives Segment$

Ca"h 1ar$et Se.#ent!

Spot trading takes place in this market "ith no for"ard transactions$ 'uying and selling of

scripts is done "ith various motives like investments1 speculation and hedging$ !he

settlement cycle in this segment is ! 9 days for payment and receipt of funds and

delivery$


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Der%at%e" 1ar$et Se.#ent!

!rading in derivatives is done in this segment$ 0 derivative security is a financial contract

"hose value is derived from the value of an under6lying asset$ !he underlying asset can

be e2uity1 fore71 commodity or any other asset$

!he securities contract :(egulation= 0ct1 >?@< :SC0= defines 8derivativeD to include6

0 security derived from a debt instrument1 share1 and loan "hether secured or

unsecured1 risk instrument or contract for differences or any form of security$

0 contract1 "hich derives its value from the prices1 or inde7 of prices1 of underlyingsecurities$ !he derivatives are securities under the SC0 and hence the trading of

derivatives is governed by the regulatory frame"ork under the SC0

&uncton"!

9) Prce d"co%er+! !he markets indicate "hat is likely to happen and thus assist in

better price discovery of the future as "ell as current prices$

:) R"$ tran"*er! erivatives instruments do not themselves involve risk they redistribute

the risk bet"een the market participants$

;) 1ar$et co#p2eton! Kith the introduction of derivatives the underlying market

"itnesses higher trading volumes$

I#portance!

#rovide enhanced yield on assets$

(educe finding costs by borro"ers

Modify payment structure of assets to correspond to investors market vie"s1

(eflects the perception of market participants about future price of assets$

Increase trading volumes by increasing confidence of investors

Speculative trades shifts to amore controlled environment$


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0cts as a catalyst for ne" entrepreneurial activity$

.elps to increase savings and investment in the long run and promotes economic

development as it depends on the rate of savings and investment$

.elps to transfer the market risk i$e$ called hedging "hich is a protection against losses

resulting from unforeseen price and volatility changes$ !hus derivatives are a very

important tool of risk management$

C(a+"er -IIITheoretca2 *ra#e'or$ o* der%at%e #ar$et.

NS*

De*" Ca+i"a

Ca!( Mar%e" Segmen" Deri,a"i,e Mar%e"

Segmen"F#"#re!O+"ion! In"ere!" ra"e

CaP#"


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&UTURES!

0 Future contract is a contract to buy or sell a stated 2uantity of a commodity

or a financial claim at a specified price at a future specified date$ !he parties to the

Future have to buy or sell the asset regardless of "hat happens to its value during the

intervening period or "hat shall be the price of the date for "hich the contract is finalied$

&uture De2%er+ Contract!


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Khere the physical delivery of the asset is slated for a future date and the payment to be

made as agreed it is future delivery contract$

.o"ever in practice all Future are settled by the himself then it "ill be settled by the

e7change at a specified price and the difference is payable by or to the party$ !he basic

motive for a Future is not the actual delivery but the heading for future risk or speculation$

Futures can be of t"o typesB

>$ Co##odt+ &utureB

!hese include a "ide range of agricultural products and other commodities like oil1

gas including precious metals like gold1 silver$

9$ &nanca2 &utureB

!hese include financial claims such as shares1 debentures1 treasury bonds1 and

share inde71 foreign e7change$ Futures are traded at the organied e7changes only$

!he e7change provides the counter6party guarantee through its clearinghouse and

different types of margins system$ Some of the centers "here Futures are traded are

Chicago board of trade1 !okyo stock e7change$

&UTURE TER1INOLOG


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Contract S5eB !he amount of asset that has to be delivered under on contract$ For

*7B !he contract sie on NS*5S Futures market is 9EE niftys$

Inta2 1ar.nB !he amount that must be deposited in the margin account at the time

a Futures contract is first entered in to be kno"n as initial margin$

1ar$n. to 1ar$etB 0t the end of each trading day1 the margin account is adjusted to

reflect the investor5s gain or loss depending upon the Futures closing price$ !his is

called Marking to Market$

1antenance 1ar.nB !his is set to ensure that the balance in the margin account

never becomes negative$ If the balance in the margin account falls belo" the

maintenance margin1 the investor receives a margin call and is e7pected to top up the

margin account to the initial margin level before trading commences on the ne7t day$

Tradn. In &uture ContractB

$ !he customer "ho desired to buy or sell Future has to contact a broker or a

brokerage firm$

$ Customers are re2uired by the future e7change to establish a margin deposit "ith

the respective1 broker before the transaction is e7ecuted$ !his is called initial margin1

"hich is bet"een @69EP of the value of the future contract$

$ !he margin deposit is regulated by the future e7change depending on the volatility

in the price of future$

$ Khen the contract values moves in response to the change in the rate1 gains are

credited and losses are debited to the margin account$


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$ If the account falls belo" a particular level kno" as maintenance level1 the trade

receives a margin call and must make up1 the account e2ual to initial margin failing

"hich his account is li2uidates

$ !hose "ho have held the positions are re2uired to li2uidate the position prior to the

last trading day of the contract or the position is settled but the e7change$

$ 0t the end of the settlement period or at the time of s2uaring off a transaction1 the

difference bet"een the trading price and settlement prices is settled by the cash

payment$

$ No carry for"ard of a Future contract is allo"ed beyond the settlement period$

Future1 as a techni2ue of risk management provide several services to the investor and

speculators as follo"sB

0= Future provides a hedging facility to counter the e7pected movement in prices$

'= Futures help indication the future price movement in the market$

C= Future provides an arbitrage opportunity to the speculators$

#ay off for FuturesB

0 pay off is the likely profitAloss "ould accrue to a market participant "ith change in the

price of the underling asset$ Futures contract have linear pay offs$ It means the losses as

"ell as profits for the buyer and the seller of a Future contract are unlimited$

#ay off for buyer of FuturesB Long Futures


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!he pay off for a person "ho buys a Futures contract is similar to the pay off for a

person "ho held on asset$ .e has a potentially unlimited upside as "ell as a potentially

unlimited do"nside$

*$g$B 0n investor buys nifty Futures "hen the inde7 is at >J9E if the inde7 goes up1 his

Future position starts making profit$ If the inde7 falls his Future position starts sho"ing

losses$

#rofit

E >J9E Nifty

Loss

#ay off for seller of FuturesB Short Futures


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!hey pay off for a person "ho sells a Future contract is similar to the pay off for a

person "ho shorts an asset$ .e has potentially unlimited upside as "ell as a potentially

unlimited do"nside$

*$g$B 0n investor sells nifty Future "hen the inde7 is at >J9E$ If the inde7 goes do"n1 his

Future position starts making profit$ If the inde7 rises1 his Futures position starts sho"ing

losses$

#rofit

>J9E

E Nifty

Loss

ivergence of Futures and Spot #ricesB !he basis the difference bet"een the Future

price and the current price is kno"n as the basis$

!hus basis Q F6S Khere FQ Future #rice SQ Spot #rice


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In a normal market the Future price "ould be greater then spot price and therefore1 the

basis "ill be positive1 "hile in an inverted market1 the basis is negative since the spot

price e7ceeds the future price in such a market$

!he price of Future referred to the rate at "hich the Futures contract "ill be entered

into$

!he basic determinants of future prices areB

>= Spot rate 9= Other Carrying costs

!he cost of carrying depends upon theB

>= !ime involved 9= (ate of Interest J= Storage Cost1 obsolescence1 insurance cost

and other costs incurred till the delivery date$

/enerally longer the time of maturity1 the greater the carrying costs$ 0s the delivery

month approaches1 the basis declines until the spot and Futures prices are

appro7imately the same$ !he phenomenon is kno"n as convergence$

#rice Futures #rice


35/88

Spot price

!ime

-aluation of Future #ricesB

!he valuation of Futures is done using the cost of carry model$ !he assumptions for

pricing future contracts as follo"sB

$ !he markets are perfect$

$ !here are no transaction costs$

$ 0ll the assets are infinitely divisible$

$ 'id60sk spreads do not e7ist so that is assumed that only one price prevails$

$ !here are no restrictions on short selling$ 0lso short sellers get to use the full

proceeds of the sales$

Stock Inde7 FuturesB

0 stock inde7 represents the change in the value of a set of stocks1 "hich constitute

the inde7$


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0 stock inde7 number is the current relative value of a "eighted average of the prices

of a pre6defined group of e2uities$

NS* @E1 NIF!+B

!.* NS* @E inde7es called NIFI!+ "as launched by the national stock e7change of

India Limited :NS*= in 0pril >????@

"hen one year of operations of its capital market segment "as completed$ !he base

value of the inde7 has been set to >EEE$

!he inde7 is based on the prices of shares of @E companies chosen from among the

companies traded on the NS*1 each "ith a market capitaliation of at least (s$@EE crores

and having a high degree of li2uidity$

!he methodology used for the computation of this inde7 is market capitaliation "eight

age as follo"ed by the S % # Nifty1 "hich is maintained by IISL i$e$1 India Inde7 services1

and products limited1 a company set up by NS* and C(ISIL "ith technical assistance

from standard % poor5s$

In the market capitaliation "eighted method1

Current Market Capitaliation

Inde7 Q 6666666666666666666666666666666666666666 R 'ase -alue

'ase Market Capitaliation


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Khere Current market capitaliation Q Sum of :Current marketing #rice R Outstanding

Shares= of all securities in the inde7$

'ase market capitaliation Q Sum of :Market #rice R Issue Sie= of all securities as

on base date$

.eading using Futures contractB

.eading is the process of reducing e7posure to risk$ !hus a hedge is any act that

reduces the price risk of a certain position in the cash market$ Future act as a hedge

"hen a position is taken in them1 "hich is opposite to that of the e7isting or anticipated

cash position$

In a short hedger sells Future contract "hen they have taken a long position on the

cash asset1 apprehending that prices "ould fall$ 0 loss in the cash market "ould result

"hen the prices do fall1 but a gain "ould occur due to the short position in the Future$

In a long hedge the hedger buys Futures contract "hen they have taken a short

position on the cash asset$ !he long hedger faces the rise that prices may risk$ If a price

rise does not take place1 the long hedger "ould incur a loss in the cash good but "ould

realie gains on the long Futures position$

Khen the asset "hose price is to be hedge does not e7actly match "ith the asset

underlying the Futures contract so held is called as cross hedge$ .edge ration is the

number of future contacts to buy or sell per unit of the spot good position$ Optimal hedge

ration depends on the e7tent and nature of relative price movements of the Futures

prices and the cash good prices$

.ence the points to be noted areB


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>$ (eliable relationship e7ists bet"een price change of spot asset and price change of

Future contract$

9$ Choice of data depends on the hedging horion$ For a daily hedge1 daily price

changes can be taken$ 'ut for longer periods take "eekly1 bimonthly or monthly

charges do not take too lies tonic data like > year1 as it "ould give a distorted

estimate of relation bet"een current and futures prices$

.edging using Inde7 FuturesB

>$ Khen the markets are e7pected to go up

a= Long stock short inde7 FuturesB 'uy selects li2uid securities1 "hich move "ith the

inde7 and sell them at a later date$

b= .ave funds long inde7 FuturesB 'uy the entire inde7 portfolio in their correct

proportions and sell it at a later date$

9$ Khen the markets are e7pected to do do"n$

a= Short stock long inde7 FuturesB Sell selects li2uid securities1 "hich move "ith the

inde7 and buy them at a later date$

b= .ave portfolio1 short inde7 FuturesB Sell the entire inde7 portfolio in their correct

proportions and buy them at a later date$

*ven "hen a stock picker carefully purchases stock his estimate may go "rong

because the entire market moves against the estimate even though the underlying idea

"as correct$ .ence "hen a long position is adopted a"ay his inde7 e7posure$

Speculation using inde7 FuturesB

>$ 'ullish Inde7 Long inde7 FuturesB


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Khen you think the market inde7 is going to rise you can make a profit by adopting a

position on the inde7$ !his could be after a good budget or good corporate results$ )sing

inde7 Futures an investor can 4buy5 or 4sell5 the entire inde7 b trading on one single

security$

.ence id you buy inde7 Future you gain if the inde7 rises and lose if the inde7 falls$

J$ 'earish Inde7 short inde7 FuturesB

Khen you think the market inde7 is going to fall you can make a profit buy adoption a

position on the inde7$ !his could be after a bad budget or bad corporate results1

instability$ )sing inde7 Futures an investor can 4buy5 or 4sell5 the entire inde7 by

trading on one single security$

.ence if you sell inde7 Futures you gain if the inde7 falls you lose if the inde7

rises$ !o prevent large price movement occurring because of 8speculative e7cessesD

and to allo" the market to digest any information "hich is likely to affect the Futures

prices in a significant "ay for most Futures contract there are limits1 :both minimum

and ma7imum=1 on the daily movements of their prices$

*very Future contract has a minimum limit on trade6to6trade price changes1 "hich is

called a tick say @ pays or >E pays$ Normally trading on a contract stops one the

contract is limit up or limit do"n$ .o"ever e7changes ay change the limits "hen they

feel appropriate$


40/88

OPTIONS!

Options are contracts1 "hich provide the holder the right to sell or buy a specified

2uantity of an underlying asset at an affi7ed price on or before the e7piration of the

option date$ Options provide a right and not the obligation to buy or sell$

>= !he call optionB 0 call option provides the holder a right to buy specified assets at

specified on or before a specified date$

9= !he put optionB 0 put option provides to the holder a right to sell specified assets

at specified price on or before a specified date$

Options may also be classified asB

>= 0merican OptionsB In the 0merican option1 the option holder can e7ercise the right

to buy or sell1 at any time before the e7piration or on the e7piration date$

9= *uropean OptionsB In the *uropean option1 the right can be e7ercised only on the

e7piry date and not before$ !he possibility of early e7ercise of right makes the

0merican option to be more valuable that the *uropean option to the option holder$

J= Naked Option and covered OptionsB 0 call option is called a covered option is

called a covered option if it is coveredA"ritten against the assets o"ned by the

option "riter$ In case of e7ercised of the call option "riter can deliver the asset or

the price differential$ On the other hand1 if the option is not covered by physical

asset1 if is kno"n as naked option$


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Option !erminologyB

Inde7 OptionB !hese Options have inde7 as the underlying

Stock OptionsB !hese Options are on individual stocks

'uyer of an optionB Is the one "ho by paying the option premium buys the right but not

the obligation$ !o e7ercise his option on the sellerA"riter$

Kriter of an optionB Is the one "ho receives the option premium and is thereby

obliged to sellAbuy the asset is the buyer e7ercises on him$

Option #riceB I s the #rice1 "hich the option buyer pays to the option seller$

*7piration #riceB !he date specified in the Options contract is kno"n an e7piration

date1 the e7ercise date1 the strike date or the maturity$

Option premiumB !he buyer of the option has to but the right from the seller by paying

an option premium$ !he premium is one6time non6refundable amount for a"aiting the

right$ In case1 the right is not e7ercised later1 the option "riter does not refund the

premium$

In6the6money optionB If the actual price of the asset is more than the strike price of a call

option1 then the call is said to be in the money$ In the case of put option1 if the strike price

is more than the actual price them the put is said to be in the money$


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0t the money optionB If the spot price is e2ual to the strike price the option is called at

the money$ It "ould lead to ero cash flo" if it "ere e7ercised immediately$

Out of the money optionB If the actual price is less than the strike price the call option is

said to be out of money$ In the case of put option if the strike price is less then the actual

price1 then the put is said to be of money$

Option payoffsB

!he optionally characteristics of Options results in a non6Linear payoff for Options$ It

means that the losses for the buyer of an option are limited1 ho"ever the profits are

potentially unlimited$ For a "rite the payoff is e7actly the opposite$ .is profits are limited

to the option premium1 ho"ever is losses are potentially unlimited$


43/88

>$ #ay off profile for buyer of call optionB

!he profitAloss that the buyer makes on the option depends on the spot

price of underlying$ .igher the spot price them the strike price1 more is the profit he

makes$ .is loss is limited to the premium he paid for buying an option$ *$g$B 0n

investor buys Nifty Option "hen the inde7 is at >99E$ If the inde7 goes up1 he profits$

If the inde7 falls he looses$

#rofit

Net pay off on call :#rofitA Loss=

E >99E

#remium

Nifty

Loss


44/88

9$ #ay off profile "riter of call optionB

!he profitAloss that the buyer makes on the option depends on the spot of

the underlying$ Khatever is the buyer5s profit is the seller5s loss$ .igher the spot price1

more is he loss he makes$ I f upon e7piration the spot price of the underlying is less than

the strike price1 the buyer lets his option e7pire une7ercised and the "riter gets to keep

the premium *$g$B 0n investor seller nifty Options "hen the inde7 is at >99E$ If the inde7

goes up1 he looses$

#rofit

#remium E >99E Nifty

Loss


45/88

J$ #ayoff profile for buyer of put optionB

!he profitAloss that the buyer makes on the option depends on the spot price

of the underlying$ If upon e7piration1 the spot price is belo" the strike price1 he makes a

profit$ Lo"er the spot price more is the profit he makes$ .is loss in this case is the

premium he paid for buying the option$ *7B 0n investor buys nifty Options "hen the inde7

is at >99E1 if the inde7 goes up he looses$

#rofit

E >99E

#remium Nifty

Loss


46/88

;$ #ayoff profile for "riter of put optionB

!he profitAloss that the seller maker on the option depends on the spot price of theunderlying$ If upon e7piration the spot prices happen to be belo" the strike price1 the

buyer "ill e7ercise the option on the "riter$ If upon e7piration the spot price of the

underlying is more than the strike price1 the buyer lets his option e7pire un6e7ercised and

the "riter gets to keep the premium$ *$g$B 0n investor sells nifty Options "hen the inde7

is >99E$ If the inde7 goes up he profits$

#rof

E

>99E Nifty

Loss

ifferences bet"een Futures and OptionsB


47/88

F)!)(*S O#!IONS

>$ It involves obligations it involves rights

9$ No premium is payable #remium is payable

J$ Linear payoff Non6Liner payoff

;$ #rice is ero3 strike price moves Strike price is fi7ed1 price moves

@$ 'oth long and short at risk only short at risk


48/88

depends upon a number of factors relating to the underlying asset and the financial

market$

*ffect of ifferent factors on the valuation of Options

SL$No$ Factor Call Option #ut Option

-alue -alue

>$ Increase in value of underlying asset Increases ecreases

9$ *7tent of volatility in value of asset Increases ecreases

J$ Increase in strike price ecreases Increases

;$ Longer e7piration time Increases ecreases

@$ Increases in rate of Interest Increases ecreases


49/88

$ Out of the @ basic variables re2uired ; are mentioned in the option contract$

-olatility1 "hich is not mentioned1 can be estimated on the basis of historical

ata$

$ !he model is not affected by the risk perception of the investor$

$ !he model does not depend on the e7pected return on the share$

LimitationsB

$ !he basic assumption that a risk less hedge can be set up in unrealistic$

$ !he transaction costs are bound to be there is the form of brokerage and "ill

ilute the return$

$ !he estimation of the proper volatility in put remains a serious problem$

$ !he model also helps to calculate the value of put option1 through I "as

eveloped primarily to values the call Options$

Opton" o**er a nu#er o* ad%anta.e") The+ are a" *o22o'"B

$ Fle7ibilityB Options offer fle7ibility to the buyer in form of right to buy or sell

'ut not the obligation$

$ -ersatilityB Option can be as conservative or as speculative as one5s investment

Strategy dictates$

$ LeveragesB Options give high leverage by investing small amount of capital in the form

of premium one can take e7posure in the underlying asset of much greater value$

$ (iskB #re6kno"n ma7imum risk for an option buyer$

$ #rofitB Large profit potential for limited risk to the option buyer$

$ InsuranceB *2uity portfolio can be protected from a decline in the market by "ay of

buying a protective put$ !his option position supplies the needed insurance to over come

the uncertainty of the market place$

$ Seller #rofitsB Selling put options is like selling insurance to anyone "ho feels like

earning revenues by selling insurance can set himself up to do so in the inde7 Options

market$


50/88

Inde6 Opton"B

0n inde7 option provides the buyer of the option1 the right but not the obligation to

buy or sell the underlying inde71 at a pre6determined strike price on or before the date of

e7piration1 depending on the type of option$

,ene*t" o* Inde6 Opton!

.elp to capitalie on an e7pected market move$

.edge price risk of the physical stock holdings against adverse market moves$

iversified e7posure to the market as a "hole "ith a single trading decision$

#redetermined ma7imum risk for the buyer$

.igh leverage i$e$1 large percentage gains from relatively small1 favorable percentage

moves in the underlying inde7$

S!(0!*/I*S FO( IN* O#!IONSB

I$ 'ullish vie" of the marketB

>$ 'uy a callB It is e7ercised if the inde7 is above the strike price$ !he profit is unlimited$

It is e2ual to the value of inde7 minus break6even point$

Khere '*# Q premium paid strike price$ !he ma7imum loss is limited to the premiumpaid$

9$ Sell a putB It is e7ercised if the inde7 is belo" the strike price1 the profit is limited to

the premium received and the loss is e2ual to the difference '*# and the inde7$

II$ 'ullish vie" but not sureB


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'ull call spreadB It contains of the purchase of a lo"er strike price call and the sale of

higher strike price call1 of the same month$ It is e7cursed if the inde7 is above the strike

prices$ !he ma7imum profit is limited to the difference bet"een the t"o strike prices

minus the net premium paid the loss is limited to the net premium paid$

III$ 'earish vie" of the marketB

>$Sell a callB It is e7ercised it the inde7 is above strike price the ma7imum profit is limited

to the premium received$ !he ma7imum loss is unlimited and e2uals to the value of the

inde7 minus break6even point$

9$'uy a putB It is e7ercised if the inde7 is belo" the strike price$ !he ma7imum profit is

e2ual to the difference bet"een '*# ad inde7es$

I-$ 'ear vie" but not sure

'ear put spreadB It contains of selling one put option "ith lo"er strike price and purchase

another put option "ith a higher strike price$ It is e7ercised if the inde7 is belo" the strike

price$ !he ma7imum price is limited to the deference bet"een the t"o strike prices plus

the net premium paid$

-$ Neutral vie" of the marketB

>$ Long straddleB !he purchase of a call and put "ith the same strike price1 the same

e7piration date and the same underlying$ Ma7imum risk is limited to the premium paid

and the ma7imum profit is unlimited$

9$ Long StrangleB !he purchase of a higher call and a lo"er put that are both slightly out

of the money and have the same e7piration date and are on the same underlying$

Ma7imum risk is limited to the premium paid and the ma7imum profit is unlimited$


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-I$ .igh -olatility but direction unkno"nB

>$ Short StraddleB !he sale of a call and put "ith the same strike price1 same e7piration

date and the same underlying$ Ma7imum risk is unlimited and the profit is limited to

the premium paid$

9$Short StrangleB !he sale of a higher call and lo"er put "ith the same e7piration date

and the same underlying$ Ma7imum risk is limited and the ma7imum profit is limited to

the premium paid$

!he difference bet"een straddle and strangle is the strike price of the options$ !he

strangle has strikes "hich are slightly out of the money$ !he advantage of this strategy is

that premiums "ill be less than that of a straddle as premiums for out of money Options

are lo"er$ !he disadvantage is that inde7 needs to move even further for the position to

become profitable$ !hough strangle is cheaper than the straddle1 it also carries much

more risk stock Options$

Stoc$ Opton"!

0 stock option is a contact1 "hich conveys to its holder the right1 but not the obligation1 to

buy or sell shares of the underlying security at a specified price on or before a given

date$ 0fter this given date1 the option ceases to e7ist$

!he caller of an option is1 in turn1 obligated to the sell shares to the call option buyer or

buy shares from the put option buyer at the specified price "ithin the time period the

option$


53/88

'enefits of Stock OptionsB

#rotect stock holdings from a decline in market price by buying a put$

Increase income against current stock holdings by "riting a covered call$

Fi7 buying price of a stock1 by buying a call$

#osition for a buy market move6even "hen you don5t kno" "hich "ay prices "ill

move by buying a straddle or strangle$

'enefit from a stock price5s rise or fall "ithout incurring the lost of buying or selling the

stock outright by "riting Options$

Strategies for Options of StocksB

>$ 'uy a CallB "hen the market vie" is bullish a call is bought$ It is e7ercised if the stock

prince is above strike$ Ma7imum profit is unlimited e2ual to the price of the stock 6

'*#$ Ma7imum loss is limited to premium paid$

9 Short stock Long CallB It5s taken to offset a short stock position5s upside risk$ It is

e7ercised if the stock price is above strike$ Ma7imum profit is e2ual to the difference

bet"een the '*# and the stock price ma7imum loss is limited to the premium paid$

9$ Covered CallB selling call "hen you are long on the stock does it$ It is e7ercised if the

stock is above the strike price$ #rofit is limited to the premium paid loss is e2ual to

the difference bet"een the '*# and the stock price$

;$'uy a putB Khen the market vie" is bearish a put is purchased$ It is e7ercised if the

stock price is belo" strike$ Ma7imum profit is e2ual to the difference bet"een '*# and

stock price is belo" strike$ Ma7imum profit is e2ual to the difference bet"een '*# and

stock price$ Ma7imum loss is limited to the premium paid$

@$ #rotective #utB buying put "hen you are long on the stock does it$ It helps to protect

unrealied profits of the stock$ Its is e7ercised it the stock price is belo" the strike

price$ #rofit is unlimited "hile the loss is limited to the premium paid$


54/88

is the put and the original share price of the short position$ Ma7imum loss is

unlimited$

G$ )ncovered #utB If a put is sold "ithout corresponding short stock position it is called

as uncovered put$ It is taken "hen there is a bearish vie" of the market$ It is

e7ercised if the stock price is belo" the strike price$ Ma7imum profit is limited to the

premium received "hile the loss is e2ual to the difference bet"een '*# and stock

price$

Chapter -IV

#ractical aspects of erivative Market $

FO

OPTION

/UY SELLPUT

SELL

CALL

/UY

FUTURE


55/88

&UTURES = OPTIONS TRADING S


56/88

the regular lot sie and ticks sie for each of the contracts traded on this segment from

time to time$

Khen any order enters the trading system it is an active order$ It tries to find a match on

the other side of the book$ If it finds a match1 a trade is generated$

If it does not find a match1 the order becomes passive and goes and sits in the

respective outstanding order book in the system$

*N!I!I*S IN !.* !(0IN/ S+S!*MB

>$Tradn. 1e#er"B they are member of NS*$ !hey can trade either on their o"n

account or on behalf of their clients including participants$ !he e7change assigns a

trading members I to each trading member "ho can have more than one use$ 'ut the

ma7imum number of users allo"ed for each trading member is notified by the e7change

from time to time$

9$C2earn. #e#er"!!hey are members of NSCCL and carry out risk management

activities and confirmationU in2uiry of trades through the trading system$

;)Partcpant"! !hey are clients of trading members like the financial institutions$ !hese

clients may trade through multiple trading members but settle through a single clearing

member$

Corporate .ierarchyB

In F % I trading soft"are1 a trading member has the facility of defining a hierarchy

amongst users of the system$

>= Corporate ManagerB !he term is assigned to a user placed at the highest level in a

trading firm$ Such a user can perform at the functions such as order and trade related


57/88

activities1 receiving report for all branches of the trading member firm and also

dealers of the firm$ .e can only define e7posure limits for the branches of the firm$

9= 'ranch ManagerB !he term is assigned to a user "ho is placed under the corporate

manager$ .e can perform and vie" order and trade related activities for all dealers

under that branch$

J= ealerB ealers are users at the lo"est level of the hierarchy$ 0 dealer can perform a

vie" order and trade relates activities only for oneself and does not have access to

information on other dealers under either the same branch or other branches$

-S0! Net"ork ConnectivityB

-S0! -ery small 0perture !erminalB

-S0! is the most important component in on line trading$ NS* offers its services "ith

over JEE -S0!S to ?@E members spread all over the country$

(e2uirementsB

!he cost of a leased line is around J$@ lakhs$ For installation it re2uires a dish antenna

of >$ meters diameter$ NS* Server !rading is done on Mainframe$ 'ack office on

mainframe on )ni7 servers "ith oracle database$ System re2uirements include 'randed

#entium or higher II1 III1 I- processors an *ICON car :K0N Interface=1 "hich is

around one lakh1 provided by .CL Comet Server; nodes "ith #entium or higher

processor$ Kindo"s N! Operating System for all servers and nodes$

ConnectivityB

-S0!s are connected through INS0!6J' satellite$ NS* and 'S* used leased lines in

Mumbai for providing services to corporate members each line costs > lakh per year$

-S0!s are connected through INS0!6J' and in turn are connected to NS* .ub in

Mumbai$ Kith more than JEEE -S0!s spread across to country$ NS* is considered to be

the top >E on the "orld in providing services through -S0!s$

MaintenanceB


58/88


59/88

!hey thrive on market imperfections$ 0n arbitrageur profits by trading a given

commodity1 or other item that sells for different prices in different market$ !hey take

advantage of discrepancy bet"een prices in t"o different markets$ !hey make

simultaneous purchase of securities in one market "here the price thereof is lo" and

sale in a market "here the price is comparatively higher$ 0rbitrage may be :a= over

space or :b= overtime$

T+pe o* Der%at%e"!

!he most commonly used derivatives contracts are for"ards1 Futures 0nd Options$

For"ardsB 0 for"ard contract is a customied contract bet"een t"o

*ntities "here settlement takes place on a specific date in the future at today5s pre

agreed price$

FuturesB 0 Futures contract is an agreement bet"een t"o parties to buy or sell an

asset at a certain time in the future in the future at certain price$ !hese are

standardied e7change traded contracts$

OptionsB 0n Option gives the holder of the option the right to do some6!hing$ !he

holder does not have to e7ercise this right$ Options may be call option or put Options$

epending on this maturity the Options may be classified as

Karrants longer dated Options having maturity of one year and are generally traded

over the counter$

L*0#S6 long6term *2uity 0nticipation securities are Options having maturities of up to

three years$

'0ST*!S6 Option on portfolios of underlying asset$ !hey underlying asset is usually

a moving average or a basket of assets like inde7 Options$

SK0#SB !hese are private agreements bet"een t"o parties to e7changer cash flo"s

in the future according to a pre6arranged formula$

a= Interest rates to s"apsB !hese entail s"apping only the interest related cash flo"s

bet"een the parties in the same currency$

b= Currency S"apsB !hese entail s"apping both principal and interest bet"een the

parties1 "ith the cash flo"s in one direction being the different currency than those in

the opposite direction$


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S%# CN Nifty

S%# CN Nifty is a "ell6diversified @E stock inde7 accounting for 9; sectors of the

economy$ It is used for a variety of purposes such as benchmarking fund portfolios1 inde7

based derivatives and inde7 funds$

S%# CN Nifty is o"ned and managed by India Inde7 Services and #roducts Ltd :IISL=1

"hich is a joint venture bet"een NS* and C(ISIL$ IISL is India5s first specialied

company focused upon the inde7 as core products$ IISL have a consulting and licensing

agreement "ith Standard % #oor5s :S%#=1 "ho are "orld leaders in inde7 services$

!he average total traded value for the last si7 months of all Nifty stocks is

appro7imately GGP of the traded value of all stocks on the NS*$

Nifty stocks represent about P of the total market capitaliation as on 0ugust

J>19EE;$

Impact coast of the S%# CN Nifty for a portfolio sie of (s$@ million is E$>EP

S%# CN Nifty is professionally maintained and is idea for derivatives trading$

Tradn. n N*t+

!he National Stock *7change o India Limited :NS*= commenced trading in derivatives

"ith inde7 futures on ,une >919EEE$ !he futures contracts on NS* are based on S%#

CN Nifty$ !he *7change later introduced trading on inde7 options based on Nifty on

,une ;19EE>$

!he turnover in the derivatives segment has sho"n considerable gro"th in the last

year1 "ith NS* turnover accounting for $

Future details on inde7 based derivatives are available under the erivatives :F%O=

section of the "ebsite$

Ad%anta.e"!

erivatives market is mainly useful for short6term investment "here there can be a

profit$ !his is because3 one need not pay >EEP at the time of buying$ !hey can pay it in

the form of M0(/IN1 "hich depends upon market volatile position$ Market values

increases per market volatile position$ !he other advantage is as mentioned above


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NIF!+ can be traded$ !his is the best part of erivative market "hich is even the sense7

can be bought and speculated$ !he sense7 is NIF!+$ It is tradable$ !his opportunity is

not available is cash market$

E).)! -

0 person bought >EE (eliance shares "orth (s$@E1 EEE:(s$@EE #er Share$ Margin of >E6

9EP has been paid and he can start hedging or speculating$ .e need not pay >EEP of

"hatever he bought$

D"ad%anta.e!

0s this is on contract1 "hich is for a fi7ed period of time$ !he contract ends

after certain period like > month1 9 months and J months$ !here it is only shot term or for

a limited time$

O#!IONSB

Options is said to be the '*S!1 as the risk is limit$ 0dvantage can be sho"n as

follo"sB

(isk 666666666666666666666Limited

#rofit 666666666666666666666)nlimited

*$g$B

If the market price is in do"n"ards then1 put buy$ If the market price is in up"ards then1

call buy$

In case of put buy there is an amount paid kno" as #(*MI)M$ !he premium depends

upon the strike price$ #remium is the amount paid "hich is e7pected increase amount of

money on the scrip$

*$g$B 6


62/88

If the market price of scrip is (s$@EE and the strike of price is decided as (s$@E>$ !he

e7tra (e$> :@E>6@EE= is said to be premium$

Strike #riceB #rice taken from the three strike up"ards and three strikes do"n"ards of

the market price$

&UTURES!

In this there is >EE percent risk involved$ It depends upon the time values "here the

interest is calculated$ !he interest rate depends upon the market values of the scrip$ !he

time values can be said asB

*$g$B

!he number of days bet"een the present day and the last day :contract ending day= is

called as time value$

ANAL


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0/*#articulars

L*SS!.*N

9E +*0(S

9>6JE J>6;E ;>6@E @E60bove !O!0L

No$ Ofresponses

NIL

>> 99 >; J @E

#ercentage NIL 112 332 142 52>EEP

0ge of the traders play an important role in their trading decision and outlook$ Most of

the traders lie in the middle6age bet"een J>6;E and ;>6@E1 "hich is ;;P and 9P

respectively$ !he market improves if the a"areness is created "ell among the age group

9>6JE1 the market may improve due to rapid speculation of that age grouped people$

9) Educatona2 ,ac$.round !

#articulars 0rts Commerce Science !otal #ercentage

Non6graduates 9 E E 9 ;P

E

@>E

>@

9E

9@

JEJ@

;E

;@

less than

9E yerars

9>6JE

years

J>6;E

years

;>6@E

years

more

than @E

years

noo

*re

"pon"e

no of responses percentage


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/raduates >J >E J> G J;P

!otal >@ >? >< @E >EEP

>

?

9>

9?

:>

Art" Co##erce Scence

Non-.raduate"

Graduate"

Po"t Graduate"

Tota2

*ducational backgrounds of the traders play an important role in there trading decision$

?


65/88

!otal @E >EEP

Sharekhanltd$ has many shareholders "ho also trade in the sock markets$ 'ut the

number of clients "ho are not members is close to t"o6thirds i$e$1


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67/88

>

?

9>

9?

:>

:?

Ca"h Se.#ent

& = O Se.#ent

,oth Ca"h and & = O

Se.#ent

!rading in cash segment is relatively more than the F%O segment and is also more

popular because of its simplicity$ !his can be seen from the fact that ;9P of traders trade

in the cash segment "hile only 9EP of traders trade in the F%O segment$ .ence there is

a need to increase a"areness about derivatives1 "hich is relatively a ne" concept "ith

advanced strategies$

?) Other ,ro$n. co#pane" !

#articulars No$ Of responses #ercentage

Came from other broking

company to trade .ear

>> 99P

!rading Started in SCSL J? GP

!otal @E >EEP


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>

?

9>

9?

:>

:?

;>

;?

@>

@?

Ca#e *ro#

other ro$n.co#pan+ to

trade Hear

Tradn. Startedn SCSL

!he percentage of traders1 "ho have already traded through some other brokers

before shifting to is 99P "hich sho"s that the services provided by Share khan lid$1 are

superior to the previous brokers$ Moreover there are GP of traders1 "ho have started

their trading activities by ShareThanLtd "ith $1 "hich speaks of its reputation as the best

broker in .yderabad$

) E6perence o* In%e"tor"!


Less than > year < >9P

>6@ years >? JP

E years > JE years G >;P

!otal @E >EEP


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!he study reveals the only >9 P of its clients have joined in the past > year$ .ence the

marketing activities of the company have to be more aggressive to "iden its clients in the

"ake of ne" brokers and sub brokers coming up in the city$ 0ggressive publicity has to

be done in order to stand against the ne" coming brokers$

B) ,a"" *or "e2ecton o* "crp"!


*arning #er Share ; P

Company Image >E 9EP

#rofitability >> 99P

no o* re"pon"e"

E

@

>E

>@

9E

Less than

> year

>6@ years E years More than

>E years

Series>


70/88

0ll !hree G >;P

#rofitability and

Company Image

@ >EP

*arnings #er Share

0nd Image

G >;P

*arnings #er Share and

#rofitability

J


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!he study reveals that investors use varied parameters to make their

investment decisions1 profitability and image of the company are the t"o prominent

parameters used by most investors$ !he investors also use a combination of more than

one parameter$ Mostly one can rely on company image along "ith profitability but in

order to be updated "ith the latest information once has to follo" the media1 "hich gives

the e7act information time to time$

) Source" o* In*or#aton!

#articulars No$ Of (esponses #ercentage

Ne"s #apers >< J9P

0nnual (eports >; 9PShare khan revie" @ >EP

0ll three G >;P

Ne"s #aper %

0nnual (eports

@ >EP

Ne"s Channels J EEP

J9P

9IP>EP

>;P

>EP EP


72/88

In combination "ith other sources of information by Share khan1 the study reveals that

ne"spapers and annual reports are the most popular sources of information$ 'oth of

"hich used by G

) &a%ora2e "crp" *or n%e"t#ent!


INFOS+S >9 9;P

N!#C @ >EP

!ISCO G >;P

(IL >E 9EP

0ndhra 'ank @ >EP

Miscellaneous >> 99P

!otal @E >EEP

>

:

@

9>

9:

IN&OS


73/88


74/88

9:)Cate.or+ o* Der%at%e"!


Futures 9J JEP

Options 9G GEP

!otal @E >EEP

:9

::

:;

:@

:?

:

:B

&uture"

Opton"

Options are less risky than futures because the ma7imum loss is limited to the

premium paid and the profit potential is unlimited$ !his is supported by the study "hich

reveals that GEP of the investor trade is more in options than in futures$ 0s futures are

>EEP risk1 people are not going for futures though it ahs >EEP profit1 as risk involved ismore$ Options are encouraged much$ In the same "ay if futures are also encouraged

then improvement of it can be seen$ 'ut some changes he to make as the risk involved

in this is very high$

9;)Cate.or+ o* contract!


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#articulars No$ Of responses #ercentages

> Month Contract J G;P

J Months Contract @ >EP!otal @E >EEP

!rading in futures and options is done in contracts "ith three different e7piry dates$ Out

of "hich trading in one6month contracts is more popular because of the relatively

predictable fluctuations of the near future$ It is very difficult to speculate on prices t"o

months and three months later1 "hich accounts for the lo" percentages of trades of >;P

and >EP in these contracts$ One6month contracts "orks out "ell here as everything

closes in one "ill kno" their status in that particular area$ So1 one6month contracts are in

"ell used$ !"o month and !hree month are also good but risk is involved "hich most of

the clients do not "ant to face$

9@)4no'2ed.e o* "trate.e"!


No kno"ledge E EP+es :only basic J< G9P

E

>E

9E

JE

;E

> Month Contract 9 Months

Contract

J Months

Contract

Series>


76/88

Strategies=

+es :advances Strategies

0lso=

>; 9P

!otal @E >EEP

Tno"ledge of trading strategies of futures and options is very important for profitable

trading in this segment$ G9P people have kno"ledge on only the basic strategies1 "hich

are easy to understand1 and implement of "hich 9P have the kno"ledge of the more

comple7 and advanced trading strategies$ Kith the basic kno"ledge people are

speculating "ell1 if they are given a better training classes by Share khan for the

advanced strategies they "ill go in deep further strategies$

9?)In%e"tor ratn.!


/ood 9 @J 9EEP

E

>E

9E

JE

;E

No kno"ledge +es :only basic

Strategies=

+es :advances

Strategies also


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#eople are -ery happy "ith the performance of Share khan$ !hey say it is good at most

of the times and best at times$ If Share khan follo"s some ne" strategies like

maintenance of the people "hich means the operator should have not more ;6@ people

so that every one can involve easily in speculation$ 0nd some ne" counters "here the

clients can take the help in the areas they are uneducated$ Ne" counters to e7plain and

understand the strategies etc$

9)Rea"on" *or tradn. n Share $han!


Lo" 'rokerage >9 9;P

/ood facilities and

Service

>@ JEP

Cooperative %

isciplined

Mgt$

>> 99P

(egular !rading 9 ;P

E

@

>E>@

9E

9@

JE

/ood 'etter 'est

Series>


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79/88

CHAPTER - V

SU11AR?E1 the number had gone up to 9J by the end of 9EE


81/88

Options margining "orkB

In the case of futures1 both short and long are charged initial margin1 and after this1

both sides pay daily mark6to6mark margin$ !his is not ho" options "ork$ In the options

market1 the long pays up the full price of the options on the same day1 and the short puts

up initial margin$ 0fter this1 the long is relieved of all responsibilities to his position1 and

the short pays daily mark6to6market margin$

!he initial margin of the option short is the largest loss that he can suffer "ith a one6

day price change that goes against his$ !his is calculated using theoretical option6pricing

formulas$

erivatives allo" a shifting of risk from a person "ho does not "ant to dear the risk to a

person "ho "ants to dear the risk$ !he only investment decision that can be made is

"hether to be in a certain area of business or not$ For e7ample1 if a garment e7porter

dislikes currency risk1 the only choice that he faces :in a "orld before derivatives= is

"hether to be in garment e7port or not$ Khich derivatives1 he has the ability and choice

to insure against currency e7posure$ 0nd he is able to do this by trading this e7posure

"ith others in the economy that is e2uipped to deal "ith it$

'oth futures and options markets have a significant impact upon the informational

efficiency of financial markets$ In the case of futuresB

>$ !he simplest and most direct effect is that the launch of derivatives market is

correlated "ith improvements in market efficiency in the underlying market$ !his

improved market efficiency means that the market prices of individual securities are

more informative$

9$ Once futures markets appear1 a certain de6linking of roles in the t"o markets is

observed$ !he cash market caters to relatively non6speculative orders1 and the

futures markets takes over the major brunt of price discovery$ !he futures market is

better suited for this role1 because of high li2uidity and leverage$ Khenever ne"s


82/88


83/88

SUGGESTIONS!

!o succeed trade in futures and options1 a thorough understanding of concepts

and trading strategies is important1 sharekhanltd May put in some special efforts

to educate its clients$

sharekhanltd May conduct seminars for its clients and prospective clients for

derivative market$


84/88

ANNEXURE

)UESTIONNAIRE

),I,ILOGRAPH$ 0geB 6666666666666666666666666666666666666666666

9$ &ualificationsB 6666666666666666666666666666666666666666666

J$ 0re you a Member := or a Client := of sharkhanltd

TRADING DETAILSB

;$In "hich e7changes do you trade in

NS* :=1 'S* :=1 .S* :=1 0ny Other 666666666666

@$In "hich segments do you trade in

Cash Market :=1 Futures and Options :=1 Mutual Funds :=


86/88

If yes1 NamesB VVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVV

G$Since ho" many years have you been trading VVVVVVVVVVVVVV +ears

$ On "hat basis do you select scrip for trading

*#S :=1 Company image :=1 #rofitability := O(

0ny other VVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVV

?$ From "here do you gather information about the scrip5s

Ne"s papers := 0nnual reports := Share khan revie" :=

>E$"hich "ould you recommend as the three most favorable scrips for

Investment

VVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVV6

III.DERIVATIVE TRADING DETAILS

>>$ +ou primarily use derivates for

Speculation := 0rbitrage := .edging :=

>9$ o you invest more in Futures := or Options :=

>J$ o you invest more in Inde7 futures := or Stock Futures :=

>;$ o you invest more in Call Option := or #ut Option :=

>@$ .o" do you rate sharekhanltd in providing brokering facilities in .yderabad

/ood := 'etter := 'est :=

>


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NCFM :NS* Certification in Financial Markets=

Documents

Study Reports on Online Trading Derivatives