TOpic 4 Derivatives Market in India

8/6/2019 TOpic 4 Derivatives Market in India

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Indian Derivatives Market


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INTRODUCTION- RISK

MANAGMENT

Risk management is a discipline that helps bringing risks to

manageable extent .

One risk does not get transformed into undesirable risk.

PLAYERS:

Hedgers, Speculators and Arbitrageurs - Market Role

Hedgers and investors provide the economic substance to any

financial market. Without them the markets would lose their purpose

and become mere tools of gambling.

(E.g. Banks)

Speculators provide liquidity and depth to the market.

Arbitrageurs


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DERIVATIVES

Derivatives are financial contracts whose value/price is dependent on the

behavior of the price of one or more basic underlying assets (often simply

known as the underlying). These contracts are legally binding agreements,

made on the trading screen of stock exchanges, to buy or sell an asset in

future.

The asset can be a share, index, interest rate, bond, rupee dollar exchange

rate, sugar, crude oil, soybean,cotton, coffee and what have you.

A very simple example of derivatives is curd, which is derivative of milk. The

price of curd depends upon the price of milk which in turn depends upon the

demand and supply of milk.


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HISTORY OF DERIVATIVES AND

THE MARKET IN INDIAAccording to Mr. Asani Sarkars research work, Derivatives markethas been in existence in India since 1875

He also mentions that in early 1900s India had the largest FuturesIndustry

In 1952, Indian Government banned the options and futurestrading

But, by 2000 various reforms assisted in lifting all such bans andthe derivatives market is booming since then

The exchange traded derivative market is the largest in terms ofnumber of contracts made

In 2004, the daily trading value was 30 billion USD

The commodities eligible for futures trading was 8 and in 2004 itwas increased to 80


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Current Scenario

` Indias experience with the launch of equity derivativesmarket has been extremely positive. The derivatives

turnover on the NSE has surpassed the equity market

turnover. The turnover of derivatives on the NSE

increased from Rs. 23,654 million (US $ 207 million) in2000-01 to Rs. 110,104,821 million (US $ 2,161 bn) in

2008-09. The average daily turnover in this segment of

the markets on the NSE was Rs. 453,106 mn in 2008-09.


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FORWARDS

` A forward contract is a customized contract betweenthe buyer and the seller where settlement takes placeon a specific date in future at a price agreed today.The rupee-dollar exchange rate is a big forward

contract market in India with banks, financialinstitutions, corporate and exporters being themarket participants.


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Features of forward contract

` It is a negotiated contract between two partiesand hence exposed to counter party risk.

eg: Trade takes place between A&B@ 100 to buy &sell x commodity.After 1 month it is trading atRs.120. If A was he buyer he would gain Rs. 20& B Loose Rs.20. In case B defaults you areexposed to counter party Risk i.e. you will nowentitled to your gains. In case of Future, theexchange gives a counter guarantee even if thecounter party defaults you will receive Rs.20/- asa gain.


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Features of forward contract

` Each contract is custom designed and hence unique interms of contract size, expiration date, asset type, assetquality etc.

` A contract has to be settled in delivery or cash onexpiration date.

` In case one of the two parties wishes to reverse a

contract, he has to compulsorily go to the other party.The counter party being in a monopoly situation cancommand the price he wants.


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FUTURES

` Futures are exchange-traded contracts to buy or sell anasset in future at a price agreed upon today. The asset can

be share, index, interest rate, bond, rupee-dollar exchange

rate, sugar, crude oil, soybean, cotton, coffee etc.


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The standard Feature in any

futures contract

Obligation to buy or sellStated quantityAt a specific price

Stated date (Expiration Date)Marked to Market on a daily basis` For example: when you are dealing in March 2002

Satyam futures contract, you know that the marketlot, ie the minimum quantity you can buy or sell, is1,200 shares of Satyam, the contract would expiry

on March 28, 2002, the price is quoted per share,the tick size is 5 paise per share or (1200*0.05) =Rs60 per contract/ market lot, the contract would besettled in cash and the closing price in the cashmarket on expiry day would be the settlement price.


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Motives behind using Futures

` Hedging: It provides an insurance against an increase in

the price.

` The futures market has two main types of foreseeable

risk:

- price risk

- quantity risk


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Interest Rate Futures

` An interest rate futures contract is an agreement to buyor sell a standard quantity of specific interest bearing

instruments, at a predetermined future date and a price

agreed upon between parties


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DIFFERENCE BETWEEN FORWARD

AND FUTURE CONTRACT.

` Customised vs Standardised contract:

` Counter Party Risk

` Liquidity

` Squaring off:


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FUTURES TERMINOLOGY

` COST OFCARRY` INITIALMARGIN

` MARKING TO MARKET

` MAINTENANCE MARGIN


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OPTIONS

` Options contracts grant their purchasers theright but not the obligation to buy or sell aspecific amount of the underlying at aparticular price within a specified period.


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OPTIONS Terminology

` Commodity options

` StockOptions

` Buyer of an option

` Writer of an option

` Call option

` Put option

` Option price


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OPTIONS Terminology

` Expiration date` Strike Price

` American option

` European option


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Pay-off for Options

` Buyer of call options : long call` Writer of call options : short call

` Buyer of put options : long put

` Writer of call options : short put


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Buyer of call options : long call


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Writer of call options : short call


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Buyer of put options : long put


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Writer of call options : short put


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Long Straddle


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Short Straddle


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Long Strangle


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Short Strangle


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Distinguishing Options & Futures

Documents

TOpic 4 Derivatives Market in India