Derivatives Sridhar

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A STUDY ON TRADING ON DERIVATIVES AND OPERATIONS OF

FUTURES AND OPTIONS WITH SPECIAL REFERENCE TO INDIA

INFOLINE, HYDERABAD.

By

BAJJURI SRIDHAR

Reg. No. 5131

Of

VISHWA VISHWANI INSTITUTE OF SYSTEMS AND

MANAGEMENT

Under the Guidance of

M. MADANA MOHAN

Associate Professor

A PROJECT REPORT

Submitted to the

FACULTY OF BUSINESS MANAGEMENT

In partial fulfillment of the requirements

For the award of the

POST GRADUATE DIPLOMA IN MANAGEMENT

July 2010

VISHWA VISHWANI INSTITUTE OF SYSTEMS & MANAGEMENT


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DECLARATION

I Bajjuri Sridhar, Reg. No. 5131 hereby declare that this summer project titled A

STUDY ON TRADING ON DERIVATIVES AND OPERATIONS OF FUTURES

AND OPTIONS WITH SPECIAL REFERENCE TO INDIA INFOLINE AT

THARNAKA, HYDERABAD is an original work carried out by me, under the

guidance ofM. Madana Mohan, Associate Professor. The report submitted by me is a

bonafied work carried by me of my own efforts and it has not been submitted to any

other University or published any time before.

Signature of the student

(BAJJURI SRIDHAR)

Date:

Place: Hyderabad



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BONAFIDE CERTIFICATE

Certified that this summer project titled A STUDY ON TRADING ON

DERIVATIVES AND OPERATIONS OF FUTURES AND OPTIONS WITH

SPECIAL REFERENCE TO INDIA INFOLINE AT THARNAKA,

HYDERABAD is the bonafied work ofBAJJURI SRIDHAR, who carried out the

research under my supervision, certified further, that to the best of my knowledge the

work reported here is does not form part of any other thesis or dissertation on the basis

of which a degree or award was conferred on an earlier occasion on this or any

candidate.

Signature of the Faculty Guide

(M. MADANA MOHAN)

Date:Place: Hyderabad



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ACKNOWLEDGEMENT

It is a great sense of satisfaction and a matter of privilege to me to work at India

infoline, tharnaka, Hyderabad. I wish to express my heartiest thanks to trading

Organization Division for providing me the opportunity to undergo training in the

esteemed organization. Under such a nice environment, systematic work approach and

target oriented task management of this division provided me with the much-desired

training experience.

I sincerely record my appreciation to all, who have contributed in preparing this report

with suggestions and critical evaluation.

I Express My deep sense of gratitude to the Marketing manager of India Infoline Mr.

Vishwanath, Who extended support to me for successfully completion of the project.

I express my deep sense of gratitude to the officers of India Infoline Mr. Venkat Rao

(Relationship Manager), Mr. Sunil Kumar (Sales Manager), who provides me the

complete information for completing the project well in time.

I am very much grateful to our faculty Guide (VVISM, Hyderabad) Prof. M. Madana

Mohan for his valuable guidance provided me for completion of project.I am thankful to the other Employees at INDIA INFOLINE Ltd., Tharnaka. For

providing me all the information and help I required for the completion of this project.

Last but not the least I want to thanks my college, VVISM, Hyderabad that provided

me this opportunity to interact so closely with this organization.

(BAJJURI SRIDHAR)



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ABSTRACT

DERIVATIVES MARKET (FUTURES AND OPTIONS) WITH SPECIALREFERENCE TO INDIA INFOLINE are the cooperative sector company and one of

the best brokage company in India.

This report contains trading performance during the period of May 28 to July 1.The

study covers the derivative market in recent days.

To know the liquidity, Solvency, Earning, Market position and profitability of the

company (ICICI, SBI, YES BANK).

Financial performance of the Saras Bhilwara dairy in the current year is quite

impressive. Sales of the current year increase as comparison to last year due to

awareness of the product. Gross profits, Net profit, operating profit of the company are

high as comparison to all other company in the industry. Liquidity position and solvency

condition is sounder of the company.While in turnover, companys debtor turnover is

also in good positions that indicate speed of their collection.

Methodology is a systematic and objective process of identifying and formulating the

problem by setting objectives and methods for collecting, editing, calculating,

evaluating, analyzing, interpreting and presenting data in order to find justified

solutions. The Current Position is analyzed and new ideas are suggested to improve the

current condition.



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TABLE OF CONTENTS

CHAPTERNO. TITLE PAGE NO.

I

ABSTRACT

5

IILIST OF TABLES

7

IIILIST OF FIGURES

8

CHAPTER1 INTRODUCTION 9

OBJECTIVES, NEED, SCOPE, LIMITATIONS13-15

CHAPTER 2 METHODOLOGY 16

CHAPTER 3

3.1 COMPANY OVERVIEW 16

3.2 INDUSTRY OVERVIEW 18

LITERATURE REVIEW 22

CHAPTER 4 DATA ANALYSIS AND INTERPRETATION 49

CHAPTER 5FINDINGS, RECOMMENDATIONS &

CONCLUSION

72-74

GLOSSARY75

BIBLIOGRAPHY80

APPENDIX81

LIST OF TABLES

TABLE NO. TITLE PAGE NO.

TABLE 1 THE PRICE MOVEMENTS OF ICICI

FUTUTRES

51

TABLE 2 CALL OPTIONS PRICES OF ICICI 53



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TABLE 3 PUT OPTIONS PRICES IF ICICI 55

TABLE 4THE PRICE MOVEMENTS OF SBI

FUTUTRES

58

TABLE 5 CALL OPTIONS PRICES OF SBI 61

TABLE 6 PUT OPTIONS PRICES IF SBI 63

TABLE 7THE PRICE MOVEMENTS OF YES

FUTUTRES

66

TABLE 8 CALL OPTIONS PRICES OF YES 68

TABLE 9 PUT OPTIONS PRICES IF YES 70

LIST OF FIGURES

GRAPH

NO.

CONTENTS PAGE NUMBERS

Graph.1 Graph showing the price movements of ICICI

Futures

52

Graph.2 Graph showing the price movements of ICICI Spot &

Futures

57

Graph.3 Graph showing the price movements of SBI 59



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Futures

Graph.4 Graph showing the price movements of SBI Spot &

Futures

64

Graph 5 Graph showing the price movements of YES BANK

Futures

67

Graph 6 Graph the price movements of YES BANK Spot &

Futures

72

Graph 5.1 NSE scrips 81

Graph 5.2 NSE and BSE scrips 82

Graph 5.3 Buy order form 83

Graph 5.4 Sell order form 84

Graph 5.5 Trade book 85

CHAPTER NO. 1

1.1 INTRODUCTION

Derivatives are products whose value is derived from one or more variables called

bases. These bases can be underling asset such as foreign currency, stock orcommodity, bases or reference rates such as LIBOR or US treasury rate etc. Example,

an Indian exporter in anticipation of the riceipt of dollar denominated export proceeds

may wish to sell dollars at a future date to eliminate the risk of exchange rate volatility

by the data. Such transactions are called derivatives, with the spot price of dollar being

the underlying asset.



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Derivatives thus have no value of their own but derive it from the asset that is being

dealt with under the derivative contract. A financial manager can hedge himself from

the risk of a loss in the price of a commodity or stock by buying a derivative contract.

Thus derivative contracts acquire their value from the spot price of the asset that is

covered by the contract.

The primary purposes of a derivative contract is to transfer risk from one

party to another i.e. risk in a financial sense is transfer from a party that is willing to

take it on. Here, the risk that is being dealt with is that of price risk. The transfer of

such a risk can therefore be speculative in nature or act as a hedge against price

movement in a current or anticipated physical position.

Derivatives or derivative securities are contracts which are written between two

parties (counterparties) and whose value is derived from the value of underlying

widely-held and easily marketable assets such as agricultural and other physical

(tangible) commodities or currencies or short term and long-term and long term

financial instruments or intangible things like commodities price index (inflation rate),

equity price index or bond piece index. The counterparties to such contracts are those

other than the original issuer (holder) of the underlying asset.

Derivatives are also known as deferred delivery or deferred payment instruments. In

a sense, they are similar to securitized assets, but unlike the latter, they are not the

obligations which are backed by the original issuer of the underlying asset or security.

It is easier to take a short position in derivatives than in other possible to combine them

to match specific requirements, i.e., they are more easily amenable to financial

engineering.

The values of derivatives and those of their underlying assets are closely related.

Usually, in trading derivatives, the taking or making of delivery of underlying assets is

not involved; the transactions are mostly settled by taking offsetting positions in the



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derivatives themselves. There is, therefore, no effective limit on the quantity of claims

which can be traded in respect of underlying assets. Derivatives are off balance sheet

instruments, a fact that is said to obscure the leverage and financial might they give to

the party. They are mostly secondary market instruments and have little usefulness in

mobilizing fresh capital by the companies (warrants, convertibles being the exceptions).

Although the standardized, general, exchange-traded derivatives are being contracts

which are in vogue and which expose the users to operational risk, counterparty risk,

liquidity risk, and legal risk. There is also an uncertainty about the regulatory status of

such derivatives.

There are bewilderingly complex varieties of derivatives already in existence,

and the markets are innovating newer and newer ones continuously: plain, simple or

straightforward, composite, joint or hybrid, synthetic, leveraged, mildly leveraged,

customized or OTC-traded, standardized or organized-exchange traded. Although we

are not going to discuss all of them, the names of certain derivatives may be noted here:

futures, options, range forward and ratio range forward options, swaps, warrants,

convertible bonds, credit derivatives, captions, swaptions, futures options, the ratio

swaps, periodic floors, spread lock one and two, treasury-linked swaps, wedding bands

three and six, inverse floaters, index amortizing swaps, and so on; because of their

complexity, derivatives have become a continuing pain for the accounting person and a

true mind-bender for anyone trying to value them.

The turnover of the stock exchanges has been tremendously increasing from last

10 years. The number of trades and the number of investors, who are participating,

have increased. The investors are willing to reduce their risk, so they are seeking for

the risk management tools. Mutual funds, FIIs and other investors who are deprived of

hedging (i.e. risk reducing) opportunities will now have a derivatives market to bank

on.

While derivatives markets flourished in the developed world, Indian markets

remain deprived of financial derivatives to the beginning of this millennium. While the

rest of the world progressed by leaps and bounds on the derivatives front, Indian market



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lagged behind. Having emerged in the markets of the developed nations in the 1970s,

derivatives markets grew from strength to strength. The trading volumes nearly

doubled in every three years making it a trillion-dollar business. They became so

ubiquitous that, now, one cannot think of the existence of financial markets without

derivatives.

Two broad approaches of SEBI is to integrate the securities market at the

national level, and to diversify the trading products, so the more number of traders

including banks, financial institutions, insurance companies, mutual funds, primary

dealers etc., choose to transact through the exchanges. In this context the introduction

of derivatives trading through Indian Stock Exchanges permitted by SEBI exchange in

the year 2000 is a real landmark.

Prior to SEBI abolishing the BADLA system, the investors had this system as a

source of reducing the risk, as it has many problems like no strong margining system,

unclear expiration date and generating counter party risk. In view of this problem SEBI

abolished the BADLA system.

After the abolition of the BADLA system, the investors are seeking for a

hedging system, which could reduce their portfolio risk. SEBI thought the introduction

of the derivatives trading, as a first step it has set up a 24 member committee under the

chairmanship of Dr.L.C.Gupta to develop the appropriate regulatory framework for

derivative trading in India, SEBI accepted the recommendations of the committee on

May 11, 1998 and approved the phased introduction of the derivatives trading

beginning with stock index futures. The Board also approved the suggestive bye-

laws recommended for regulation and control of trading and settlement of derivatives

contracts.

However the securities contracts (regulation) act, 1956 (SCRA) needed

amendment to include derivatives in the definition of securities to enable SEBI to

introduce trading in derivatives. The government in the year 1999 carried out the

necessary amendment. The securities Laws (Amendment) bill 1999 was introduced to



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bring about the much needed changes. In December 1999 the new framework has been

approved derivatives have been accorded the status of securities. The ban imposed on

trading in derivatives way back in 1999 under a notification issued by the central

Government has been revoked. Thereafter SEBI formulated the necessary

regulations/bye-laws and started in India at NSE in the same year and BSE started in

the year 2001. In this module we are covering the different types of derivatives

products and their features, which are traded in the stock exchanges in India.

NATURE OF THE PROBLEM:

The turnover of the stock exchanges has been tremendously increasing from last 10

years. The number of trades and the number of investors, who are participating, have

increased. The investors are willing to reduce their risk, so they are seeking for the risk

management tools.

Prior to SEBI abolishing the BADLA system, the investors had this

system as a source of reducing the risk, as it has many problems like no strong

margining system, unclear expiration date and generating counter party risk. In view of

this problem SEBI abolished the BADLA system.

After the abolition of the BADLA system, the investors are seeking for a

hedging system, which could reduce their portfolio risk. SEBI thought the introduction

of the derivatives trading, as a first step it has set up a 24 member committee under the

chairmanship of Dr.L.C.Gupta to develop the appropriate regulatory framework for

derivative trading in India, SEBI accepted the recommendations of the committee on

May 11, 1998 and approved the phased introduction of the derivatives trading

beginning with stock index futures.

SCOPE OF THE STUDY

Introduction of derivatives in the Indian capital market is the beginning of a new era,

which is truly exciting. Derivatives, worldwide are recognized risk management



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products. These products have a long history in India, in the unorganized sector,

especially in currency and commodity markets. The availability of these products on

organized exchanges has provided the market participants with broad based risk

management tools.

The project covers the derivatives market and its instruments. For better

understanding various strategies with different situations and actions have been

given. It includes the data collected in the recent days and also the market in the

derivatives in the recent days.

The study is limited to Derivative Market With reference to the Indian context

and `the India Infoline has been taken as representative sample for the study.

The study cannot be said as totally perfect, any alteration may come.

The study has only made humble attempt at evaluating the Derivatives Markets

only in Indian Context.

OBJECTIVES OF THE STUDY

To find the different types of derivatives and also to know the derivative market in

India.

To analyze the recent developments in the derivative market taking into accounts the

trading in past years.

To find the trading on derivatives and their use in the stock markets and operations of

futures and options

To know the outcome of Derivative market prices of Futures and Options.

NEED OF THE STUDY

It helps the researcher to construct a diversified portfolio.

Provide an insight on return and risk analysis.



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Different kinds of investors to invest in derivative and to face high risk and get

high returns.

Studying the performance of investing derivative for few months considering

their analysis.

LIMITATIONS

Despite of the training my level best, there were still some limitation which I think

remains there to draw fruitful conclusion. There were some practical problem which

come across and could not be properly death with

The advisory services being promised by the brokers would be of little use to

investors looking for an insight into the market.

Customers are not willing to open the demat account because of high price to

open demat account.

And India infoline charging more price to open demat account compared to

other stock broking companies.

There is confusion to buy put option or call option in derivative shares

It is difficult to estimate the futures

CHAPTER NO 3

RESEARCH METHODOLOGY

METHODOLOGY OF THE STUDY

The data collection methods include both primary and secondary collection methods.

ACTUAL COLLECTION OF DATA

Data Collection from secondary Sources



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Secondary data were gathered from numerous sources. While preparation of this project

report, the secondary data have been collected through:

Data was generated from general library research sources, textbooks, trade

journals, articles from newspaper, treasury management, brochures, by india

infoline trading terminal and Internet web site

www.nseindia.com

www.indiainfoloine.com

www.bseindia.com

www.google.com

www.commodityindia.com

CHAPTER 4

4.1 COMPANY PROFILE

Date of Establishment 1995

Revenue112.862 (USD in Millions)

Market Cap 26304.8769 (Rs. in Millions)

Corporate Address75 Nirlon Complex, Off Western Express Highway, Goregaon (E)

Mumbai-400053,Maharashtra.

www.indiainfoline.com

Management Details

http://www.indiainfoline.com/http://www.indiainfoline.com/


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Chairperson- Nirmal Jain

MD- Nirmal Jain

Directors - A K Purwar, Falguni Sanghvi, Kapil Krishan, Kranti Sinha, Nilesh

Vikamsey, Nirmal Jain, R Venkataraman, Sat Pal Khattar, Sunil Lotke

Business Operation Finance - Stock Broking

Background

India Infoline (IIL) is engaged in business of equities broking, wealth advisory services

and portfolio management services. The company was incorporated in October 1995 as

Probity Research & Services and later in April 2000 the name was changed to India

Infoline.com. Then in March 2001 the company again changed its name to India

Infoline.

The company is part of India Infoline Group.

Financials Total Income - Rs. 5716.359805 Million (year ending Mar 2010)

Net Profit - Rs. 1058.253789 Million (year ending Mar 2010)

Company Secretary Sunil Lotke

Bankers Auditors Sharp & Tannan Associates

Company history

India Infoline (IIL) is engaged in business of equities broking, wealth advisory services

and portfolio management services. The company was incorporated in October 1995 as

Probity Research & Services and later in April 2000 the name was changed to India

Infoline.com. Then in March 2001 the company again changed its name to India

Infoline.

The company is part of India Infoline Group. It has pan- India presence through its

distribution network of 607 branches, 151 franchisees located in 346 cities. The

company also has presence in Dubai, New York and Singapore.



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IIFL operates portals such as www.indiainfoline.com and www.5paisa.com.

Products and Services

India Infoline provides a gamut of financial products and services. The company offersbroking services in the Cash and Derivatives segments of the NSE and BSE.

India Infoline Media and Research Services- This company offers content support to

India Infoline in area of broking, commodities, mutual fund and portfolio management

services.

India Infoline Commodities- This Company is engaged in broking services for

commodities segment.

India Infoline Marketing & Services- This is holding company of India Infoline

Insurance Services and India Infoline Insurance Brokers. The company is the largest

Corporate Agent for ICICI Prudential Life Insurance Company. It is also engaged in

insurance broking.

India Infoline Investment Services- This subsidiary is engaged in business such as loans

against securities, SME financing, distribution of retail loan products, consumer financebusiness and housing finance business.

IIFL (Asia) Pte- This subsidiary is engaged in carrying out financial sector activities in

other Asian markets.

Awards

India Infoline has been awarded the Best Broker in India by Finance Asia.

Companys Rs. 5 billion short-term debt programme has received an A1+ rating from

ICRA. This reflects highest -credit-quality of short-term debt instruments.

Outlook



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India Infoline has received approval from SEBI for sponsoring mutual fund. Through

this, the company wants to expand its product offerings.

B) FINANCE

Capital structure

PeriodInstrument

Authorized

Capital

Issued

Capital- P A I D U P -

From To (Rs. cr) (Rs. cr) Shares (nos) Face Value Capital

2008 2009 Equity Share100 56.68 283400000 2 56.68

2008 2010 Equity Share100 57.1 57102933 10 57.1

2005 2010 Equity Share80 50.17 50167198 10 50.17

2005 2005 Equity Share80 45.1 45100851 10 45.12004 2005 Equity Share45 31.62 31621862 10 31.62

2003 2004 Equity Share35 26.42 26421862 10 26.42

C).The competitors

The big competitor of India info line is share khan

1) India bulls2) India Infoline

3) HSBC Invest

4) Motilal Oswal F

5) Future Capital

6) Geojit BNP

7) Delta Corp

8) Nalwa Sons Inv

D).The customer

Products:

The India Infoline pvt ltd offers the following products

I. E-broking.



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II. Distribution

III. Insurance

IV. PMS

V. Mortgages

VI.

E). SWOT ANALYSIS

Strengths

Original research

Integrated technology platform

one stop shop

Pan-India distribution network

India infoloine.com and 5paisa.com have developed into brands

Weakness

Lack of banking arm all to complete the bank broker depository chain

Insignificant presence in institutional segment

Opportunities

Changing the demographics with higher disposable income and increasingly

complex financial instruments will drive demand for investment advisory

services

Rapid penetration of internet and computers means that technology enabled

financial services will gain market share

Threats



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Economic slowdown

Volatile movement in indices and events like may 17 2004.

Stock market falls will have a cascading effect on our mutual fund mobilization.

Increase/decrease in interest rates can effect our debt/ income fund mobilization. Future changes in personnel taxation rules can impact insurance sales

INDIA INFOLINE Ltd.

INDIA INFOLINE Ltd. is India's leading stock broking house with a market

share of around 8.5 % as on 31st March. INDIA INFOLINE Ltd. has been the

largest in IPO distribution.

The accolades that INDIA INFOLINE has been graced with include:

Prime Ranking Award (2003-04) - Largest Distributor of IPO's

Finance Asia Award (2004) - India's best Equity House

Finance Asia Award (2005)-Best Broker in India

Euro money Award (2005)-Best Equities House in India

Finance Asia Award (2005) - Best Broker in India

Euro money Award (2005) - Best Provider of Portfolio Management:

Equities

Whos who?

S.No Name Designation

1 Nirmal Jain Chairman

2 R Venkataraman Executive Director

3 Sat Pal Khattar Non Executive Director

4 Kapil Krishan Chief Financial Officer



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5 Nilesh Vikamsey Independent Director

6 Kranti Sinha Independent Director

7 A K Purwar Independent Director

8 Mukesh Sing- Director, India Infoline Securities Pvt Ltd.

9 Seshadri Bharathan- Director, India Infoline. Com Distribution

10 S Sriram- Vice President, Technology

11 Sandeepa Vig Aurora- Vice President, Portfolio Managements

12 Dharmesh Pandya- Vice President, Alternate Channel

13 Toral Munshi- Vice President, Research

14 Anil Mascarenhas- Chief Editor 15 Pinkesh Soni Financial controller

16 Harshad Apte Chief Marketing Officer

4.3 REVIEW OF LITERATURE

INTRODUCTION OF DERIVATIVES

Financial derivatives are so effective in reducing risk because they enable financial

Institutions to hedge that is, engage in a financial transaction that reduces or eliminates

risk. When a financial institution has bought an asset, it is said to have taken a long

position, and this exposes the institution to risk if the returns on the asset are uncertain.

Conversely, if it has sold an asset that it has agreed to deliver to another party at a

Future date, it is said to have taken a short position, and this can also expose the

Institution to risk. Financial derivatives can be used to reduce risk by invoking the

following basic principle of hedging :Hedging risk involves engaging in a financial

transaction that offsets a long position by taking an additional short position, or offsets



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a short position by taking an additional long position. In other words, if a financial

institution has bought a security and has therefore taken a long position, it conducts a

hedge by contracting to sell that security (take a short position) at some future date.

Alternatively, if it has taken a short position by selling a security that it needs to deliver

at a future date, then it conducts a hedge by contracting to buy that security (take a long

position)at a future date. We look at how this principle can be applied using forward

and futures

PARTICIPANTS OF DERIVATIVE

There are three broad categories of participants hedgers, speculators and arbitrageurs.

hedgers face risk associated with the price of an assets. They use futures or options

markets to reduce or eliminate this risk. Speculates wish to bet on future movement in

the price of an asset. features and options contracts cangue them an extra leverage;they

can increase both the potential gains and losses in a speculative venture. Arbitrageurs

are in business to take advantage of a discrepancy between prices in two different

markets.

Derivative products initially emerged, as hedging devices against fluctuation in

commodity prices and commodity-linked derivatives remained the sole form of such

products for almost three hundred days. In recent days, the market for financial

derivative has grown tremendously in terms of variety of instruments available. The

emergence of the market for derivative products, most notable 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.

Though the use of derivative products, it is possible to partially or fully transfer price

riks by locking in asset prices. as instrument of risk management , these generally do

not influence the fluctuations in the underlying asset prices.

DEFINITIONS



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According to JOHN C. HUL A derivatives can be defined as a financial instrument

whose Value depends on (or derives from) the values of other, more basic underlying

variables.

According to ROBERT L. MCDONALD 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.

With Securities Laws (Second Amendment) Act,1999, Derivatives has been included in

the definition of Securities. The term Derivative has been defined in Securities

Contracts

A Derivative includes: -

a. a security derived from a debt instrument, share, loan, whether secured or unsecured,

risk Instrument or contract for differences or any other form of security;

b. contract which derives its value from the prices, or index of prices, of underlying

securities.

Derivatives were developed primarily to manage, offset or hedge against risk but some

were

Developed primarily to provide the potential for high returns.

FACTERS AFFECTING GROWTH OF DERIVATIVE

Growth of derivative is affected by a number of factors; some of the important factors

are started below.

1. Increased volatility in asset prices in financial markets

2. Increased integration of national financial markets with the international markets.

3. Marked improvement in communication facilities and sharp decline in their costs.



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4. Development of more sophisticated risk management tools, providing economic

agents,

a wider choice of risk management strategies.

5. Innovation in the derivative markets, which optimally combine the risk and

returns,

Reduced risk as well as transaction costs as compared to individual financial assets.

TYPE OF DERIVATIVES

One of classifying derivatives is as,

COMMODITY DERIVATIVE

These deals with commodities like suger, gold, wheat, pepper etc..thus, futures or

options on gold, sugar, pepper, jute etc are commodity derivatives.

FINANCIAL DERIVATIVE

Futures or options or swaps on currencies, gift edged securities, stocks and shares,

stock market indices, cost of living indices etc are financial derivatives.

Another way of classifying derivatives.



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BASIC DERIVATIVES

They are forward /futures contracts and option contracts.

COMPLEX DERIVATIVE

Other derivative, such as swaps are complex



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A) OPTIONS:

The concept of options is not new one. In Fact, options have been in use for centuries.

The idea of an option existed in ancient Greece and Rome. The Romans wrote options

on the cargo that were transported by their ship. In the 17th century, there was an active

option markets in Holland. In fact, options were used in a large measure in the .tulip

bulb mania. Of that century. However, in the absence of mechanism to guarantee the

performance of the contract, the refusal of many put option writers to take delivery of

the tulip bulb and pay the high prices of the bulb they had originally agreed to, led to

bursting of the bulb bubble during the winter of 1637.A number of speculators were

wiped out in the process.

In India, options on stocks of companies were illegal until 25th January 1995 according

to sec. 20 of Securities Contracts (Regulation) Act, 1956. When Securities Laws

(Amendment) Act, 1956 deleted sec. 20, thus making the introduction of options as

legal act. An options contract is an agreement between a buyer and a seller. Such a

contract confers on the buyer a right but not an obligation to buy or sell a specified

quantity of the underlying asset at a fixed price on or up to a fixed day in the future on a

payment of a premium to the seller. The premium paid by the buyer to the seller is the

price of an option contract Options on a futures contract have added a new dimension to

future trading like futures options provide price protection against adverse price move.

Present day options trading on the floor of an exchange began in April 1973. When the

Chicago Board of trade created the Chicago Board Options Exchange (CBOE) for the

sole purpose of trading Options on a limited number of NEW YORK STOCK

EXCHAGE listed equities.

B) FORWARDS:

A forward is an agreement between two parties to exchange an agreed quantity of asset

at a specified future date at a predetermined price specified in the agreements. The

parties concerned agree the settlement date and price in advance. The promised asset

may be currency, commodity, instrument etc. It is the oldest type of all the derivatives.



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The party who promises to buy but he specified asset at an agreed price at a fixed future

date is said to be in the .Long position and the party who promises to sell at an agreed

price at a future date is said to be in short position..

C) FUTURES:

It is similar to the forward contract in all the respect. In fact, a future is a standardized

form of forward contract. A future is a contract or an agreement between two parties to

exchange assets / currency or commodity at a certain future date at an agreed price. The

trader who promises to buy is said to be in. long position. And the party who promises

to sell said be in .short position..

Futures contracts are contracts specifying a standard volume of a particular currency to

be exchanged on a specific settlement date. A future contract is an agreement between a

buyer and a seller. Such a contract confers on the buyer an obligation to buy from the

seller, and the seller an obligation to sell to the buyer a specified quantity of an

underlying asset at a fixed price on or before a fixed day in future. Such a contract can

be for delivery of an underlying asset.

To eliminate counter party risk and guarantee traders, futures markets use a clearing

house which employs initial margin, daily market to market margin, exposures limits

etc. to ensure contract compliance and guarantee settlement standardized futures

contracts generate liquidity. In addition, due to these instruments being traded on

recognized exchanges results in greater transparency, fairness and efficiency. Due to

these inherent advantages, futures markets have been enormously successful in

comparison with forward markets all over the world

The difference between forward contract and future is that future is a standardized

contract in terms of quantity, date and delivery. It is traded on organized exchanges. So

it has secondary markets. Future contract is always settled daily, irrespective of the

maturity date, which is called marking to the market.

D) SWAP:



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Swap is an agreement between two parties to exchange one set of financial obligations

with other. It is widely used throughout the world but is recent in India. Swap may be

interest swap or currency swaps. Swaps give companies extra flexibility to exploit their

comparative advantage in

their respective borrowing markets. Swaps allow companies to focus on their

comparative advantage in borrowing in a single currency in the short end of the

maturity spectrum vs. the long-end of the maturity spectrum. Swaps allow companies to

exploit advantages across a matrix of currencies and maturities.

DERIVATIVES MARKET IN INDIA

Prior to liberalization, in India financial markets, there were only a few financial

products and the stringent regulatory products and the stringent regulation environment

also eluded any possibility of development of a derivatives market in country. All

Indian corporate were mainly relying on term lending institution for meeting their

project financing or any other financing requirements and on commercial banks for

meeting working capital finance requirement. Commercial banks are on their assets and

liabilities. The only derivative product they were aware of is the foreign exchange

forward contract. But this scenario changed in the post liberalization period.

Conservative Indian business practitioners began to take a different view of various

aspects of their operations to remain competitive. Financial risks were given adequate

attention and .treasury function. has assumed a significance role in all major corporate

since then. Initially, banks were allowed to pass on gains arising out of cancellation of

forwards contracts to the customers and customers were permitted to cancel and re-

book the forward contracts. This remarkable change was followed by the introduction

of cross currency forward contacts. But the major milestone in developing forex

derivatives market in India was the introduction of cross currency options. The RBI.s

objective of introducing cross currency options was to provide a complicated hedging

strategy for the corporate in their risk management activities. The concept of



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derivatives is of course not new to the Indian market. Though derivatives in the

financial markets have nothing to talk about home, in the commodity markets they have

a long history of over hundred days. In 1875, the first commodity futures exchange was

set up in Mumbai under the guidance of Bombay Cotton Traders Association. A

clearinghouse for clearing and settlement of these traders was set up in 1918. Over a

period of twenty days during 1900-1920, other futures markets were set up in various

places. Futures market in raw jute in Kolkata (1912), wheat futures market in Hapur

(1913), and bullion futures market in Mumbai (1920). When it comes to financial

markets, derivatives in equities claim a long existence. The official history of Bombay

Stock Exchange (then known as Native Share and Stock Brokers Association) reveals

that the concept of options existed since 1898 as is reflected from a quote given by one

of the MPs-.India being the original home of options, a native broker would give a few

points to the brokers of the other nations in the manipulation of puts and calls..

However, such an early expertise gained by Indian traders in derivatives trading has

come to an end with the Government of Indias ban on forward contract during the

1960.s on the ground of their intrinsic undesirability. But ironically, the same were

reintroduced by the government in the 1980.s as essential instruments for eliminating

wide fluctuations in prices and more so because of the World Bank. UNCTAD report,

which strongly urged the Indian government to start futures trading in major cash crops,

especially in view of Indias entry to WTO. With the world embracing the derivative

trading on large scale, the Indian market obviously cannot remain aloof, especially after

liberalization has been set in motion. Now we are in the threshold of introducing

trading in derivatives, beginning with the stock index futures to be well set for the

introduction of derivative trading. With L.C. Gupta committee having recently

submitted its report on the subject, SEBI is engaged in the process of assessing the

feasibility and desirability of introducing such trading.

The NSE and BSE are two exchanges on which financial derivatives are traded. The

combined notional values of the daily volumes on both the bourses stand at around RS.

150000cr. In developed markets trading in the derivatives segment are thrice as large as

in the cash markets. In India, the figure is hardly 20% of cash markets. Quite clearly



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our derivative markets have a long way to go. According to the Executive Director of

Association of NSE Member of India

(Amni), Vinod Jain. Volumes in derivatives segment are stagnating due to lack of

growth in the number of markets participants. Besides these products are still to catch

up with the masses who are keeping away from this segment due to lack of

understanding of the products and high contract price.

a) COMMODITIES DERIVATIVES MARKETS

In order to give more thrust on agricultural sector, the National Agricultural Policy,

2000 has envisaged and domestic market reforms and dismantling of all controls and

regulations in agricultural commodity markets. It has also proposed to extend the

coverage of futures markets to minimize the wide fluctuations in commodity market

prices and for hedging the risk from price fluctuations. As a result of these

recommendations, there are presently, 15 exchanges carrying out futures trading in as

many as 30 commodity items. Out to these, two exchanges viz.

IPSTA, Cochin and the Bombay Commodity Exchange (BCE) Ltd.; have been

upgraded to international exchanged to deal international contracts in peeper and castor

oil respectively. Moreover, permission has been given to two more exchange viz. the

First Commodities Exchange of India Ltd., Kochi (for copra/coconut, its oil and

oilcake), and Keshave Commodity Exchange Ltd., Delhi (for potato), where futures

trading started very recently.

The government has also permitted four exchange viz., EICA, Mumbai. The Central

Gujarat Cotton Dealers Association, Vadodara; The South India cotton Association

Coimbatore; and the Ahmadabad Cotton Merchants Association, Ahmadabad, for

conducting forward (non-transferable specific delivery) contracts in cotton. Lately as

part of further liberalization of trade in agriculture and dismantling of ECA, 1955

futures trade in sugar has been permitted and three new exchanges viz., Commodities

Limited, Mumbai; NCS InfoTech Ltd., Hyderabad; and E-Sugar India.com, Mumbai

have been given approval for conducting sugar futures (Ministry of Food and



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Consumer Affairs, 1999). In the recent past, the GOI has set up a committee to explore

and appraise matters important to the establishment and financing of the proposed

national commodity exchange for the nationwide trading of commodity futures

contracts. The usage of warehouse receipts as a means for delivery of commodities

under the contracts is also being explored. The warehouse receipts system has been

operationalized in COFEI (coffee futures exchange of India) with effect from 1998. The

Government of India is on the move to establish a system of warehouse receipts in

other commodity stock exchanges at various places of the country.

Besides these domestic developments, during 1998, Reserve Bank of India permitted

the Indian Corporate Sector to access the exchanges subject to certain conditions with a

view to enable domestic metal manufacturers to compete with global players. The de-

regulation of oil-imports being on the cards, government should create the right

atmosphere for oil sector to participate in the international oil-derivatives Markets.

Despite these developments, there are still many impediments that hold back the

farming community from entering the futures market and reap full benefits. Brief

descriptions of commodity exchanges are those which trade in particular commodities,

neglecting the trade of securities, stock index futures and options etc. In the middle of

19th century in the United States, businessmen began organizing market forums to

make the buying and selling of commodities easier. These central marketplaces

provided a place for buyers and sellers to meet, set quality and quantity standards, and

establish rules of business.

Agricultural commodities were mostly traded but as long as there are buyers and

sellers, any commodity can be traded. In 1872, a group of Manhattan dairy merchants

got together to bring chaotic condition in New York market to a system in terms of

storage, pricing, and transfer of agricultural products.

In 1933, during the Great Depression, the Commodity Exchange, Inc. was established

in New York through the merger of four small exchanges . the National Metal



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Exchange, the Rubber Exchange of New York, the National Raw Silk Exchange, and

the New York Hide Exchange.

The major commodity markets are in the United Kingdom and in the USA. In India

there are 25 recognized future exchanges, of which there are three national level

multicommodity exchanges. After a gap of almost three decades, Government of India

has allowed forward transactions in commodities through Online Commodity

Exchanges, a modification of traditional business known as Adhat and Vayda Vyapar to

facilitate better risk coverage and delivery of commodities. The three exchanges are:

National Commodity & Derivatives Exchange Limited (NCDEX)

Multi Commodity Exchange of India Limited (MCX)

National Multi-Commodity Exchange of India Limited (NMCEIL)

All the exchanges have been set up under overall control of Forward Market

Commission (FMC) of Government of India.

National Commodity & Derivatives Exchange Limited (NCDEX)

National Commodity & Derivatives Exchange Limited (NCDEX) located in Mumbai is

a public limited company incorporated on April 23, 2003 under the Companies Act,

1956 and had commenced its operations on December 15, 2003.This is the only

commodity exchange in the country promoted by national level institutions. It is

promoted by ICICI Bank Limited, Life Insurance Corporation of India (LIC), National

Bank for Agriculture and Rural Development (NABARD) and National Stock

Exchange of India Limited (NSE). It is a professionally managed online multi

commodity exchange. NCDEX is regulated by Forward Market Commission and is

subjected to various laws of the land like the Companies Act, Stamp Act, Contracts

Act, Forward Commission (Regulation) Act and various other legislations.

Multi Commodity Exchange of India Limited (MCX)



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Headquartered in Mumbai Multi Commodity Exchange of India Limited (MCX), is an

independent and de-mutulised exchange with a permanent recognition from

Government of India. Key shareholders of MCX are Financial Technologies (India)

Ltd., State Bank of India, Union Bank of India, Corporation Bank, Bank of India and

Canara Bank. MCXfacilitates online trading, clearing and settlement operations for

commodity futures markets across the country.

MCX started offering trade in November 2003 and has built strategic alliances with

Bombay Bullion Association, Bombay Metal Exchange, and Solvent Extractors.

Association of India, Pulses Importers Association and Shetkari Sanghatana.

National Multi-Commodity Exchange of India Limited (NMCEIL)

National Multi Commodity Exchange of India Limited (NMCEIL) is the first

demutualized, Electronic Multi-Commodity Exchange in India. On 25th July, 2001, it

was granted approval by the Government to organize trading in the edible oil complex.

It has operationalised from November 26, 2002. Central Warehousing Corporation Ltd.,

Gujarat State Agricultural Marketing Board and Neptune Overseas Limited are

supporting it. It got its recognition in October 2002.

Commodity exchange in India plays an important role where the prices of any

commodity are not fixed, in an organized way. Earlier only the buyer of produce and its

seller in the market judged upon the prices. Others never had a say. Today, commodity

exchanges are purely speculative in nature. Before discovering the price, they reach to

the producers, end-users, and even the retail investors, at a grassroots level. It brings a

price transparency and risk management in the vital market.

A big difference between a typical auction, where a single auctioneer announces the

bids and the Exchange is that people are not only competing to buy but also to sell. By

Exchange rules and by law, no one can bid under a higher bid, and no one can offer to



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sell higher than someone else lower offer. That keeps the market as efficient as

possible, and keeps the traders on their toes to make sure no one gets the purchase or

sale before they do. Brief descriptions of commodity exchanges are those which trade

in particular commodities, neglecting the trade of securities, stock index futures and

options etc.

In the middle of 19th century in the United States, businessmen began organizing

market forums to make the buying and selling of commodities easier. These central

marketplaces provided a place for buyers and sellers to meet, set quality and quantity

standards, and establish rules of business.

Agricultural commodities were mostly traded but as long as there are buyers and

sellers, any commodity can be traded. In 1872, a group of Manhattan dairy merchants

got together to bring chaotic condition in New York market to a system in terms of

storage, pricing, and transfer of agricultural products.

b) CURRENCY DERIVATIVES

Foreign exchange derivatives market is one of the oldest derivatives markets in India.

Presently, India has got a well-established dollar-rupee forward market with contrast

traded for one month, two months and three months expiration. Currency derivatives

markets have begun to evolve with the allowing of banks to pass on the gains upon

cancellation of a forward to the customer and permitting customer to cancel and rebook

forward contracts.

Introduction of cross currency options can be considered as another major step towards

developing forex derivatives markets in India. Today, Indian corporate are permitted to

purchase cross currency options to hedge exposures arising out of trade. Authorized

dealers who offer these products have to necessarily cover their exposure in

international markets i.e., they shall not carry the risk in their own books. Cross

currency options are essentially meant for buying or selling any foreign currency in

terms of US dollar. They are therefore, useful only to those traders who invoice their



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exports and imports in currencies other than US dollar or for corporate who borrow in

currencies other than US dollar. As against this, majority of Indian trade is invoiced in

the US dollars. Thus, they have almost no relevance in the Indian context.

Indian banks are allowed to use the foreign currency interest rate swaps, forward rate

agreements/interest rate options/swaps, and forward rate agreements/interest rate

option/swaption/caps/floors to hedge interest rate and currency mismatch in their

balance sheets. Resident and the non-resident clients are also permitted to use the above

products as hedges for liabilities on their balance sheets.

Here it is worth remembering that globally, foreign exchange traders are becoming as

common as stock traders. But in India, forex dealers still play second fiddle to stock

traders and merely meet the needs of the exporters deposits. This may be due to their

risk averting behavior and perhaps lack of proper research. Such being the position of

the forex market, it is too premature to expect that once, foreign currency-Indian rupee

options are introduced, the market will pick up momentum.

This is all the more essential in a market where exchange rates though stated to be

market determined, are often found influenced by RBI.s intervention in the exchange

market. As a result, exchange rate movements hardly obey the principle of interest rate

differentials. The incongruence in the domestic money rates as derived from the

USD/INR forwards yield curve supports this assertion. For example, the one-year

domestic term money is around 6-6.25% whereas that of the one-year implied forward

rate is around 5.40%. In such a scenario, it is difficult for a currency trader to take a

firm view on the exchange rate movement.

c) STOCK MARKET DERIVATIVES

Today trading on the spot market for equity in India has always been a futures market

with weekly/fortnightly settlements. These markets features the risks and difficulties of

futures market, But without the gains in price discovery and hedging services that come

with separation the spot market from the futures market. Indias primary market is

acquainted with two types of derivatives.



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Convertible bonds

Warrants

As these warrants are listed and traded, it could be said that options market of a limited

sort already exist in our market. Besides, a wide range of interesting derivatives

markets exists in the informal sector. Contracts such as bhav-bhav, teji-mandi, etc. are

traded in these markets. These informal markets enjoy a very limited participation and

have their presence outside the conventional institutions of Indias financial system.

The first step towards introduction of derivatives trading in India in its current format

was the promulgation of the securities laws (Amendment) Ordinance, 1995 that

withdrew the prohibition on options in securities. The real push to derivatives market in

India was however given by the SEBI. The security market watchdog, in November

1996 by setting up a committee under the chairmanship of Dr L C Gupta to develop

.appropriate regulatory framework for derivatives trading in India..

In 2000, SEBI permitted NSE and BSE to commence trading in index futures contracts

based on S&P CNX Nifty and BSE 30(sensex) index. This was followed by approval

for trading in options based on these two indexes and options on individual securities.Futures contracts on Individual stocks were launched on November 9, 2001. Trading

and settlement is done in accordance with the rules of the respective exchanges. But the

trading volumes were initially quite modest.

This could be due to -----

Initially, few members have been permitted by SEBI to trade on derivatives;

FII.S, MFS have been allowed to have a very limited participation;

Mandatory requirements for brokerage firms to have .SEBI approved-

certification test-passed. Brokers for undertaking derivatives trading. And

Lack of clarity on taxation and accounting aspects under derivatives trading.



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The current trading behavior in the derivatives segments reveals that single stock

futures continues to account for sizeable proportion. A recent press report indicates that

futures in Indian exchanges have reached global volumes. One possible reason for such

skewed behavior of the traders could be that futures closely resemble the erstwhile

badla system. Such distortions are not however in the interest of the market. SEBI has

permitted trading in options and futures on individual stocks, but not on all the listed

stocks. It was very selective, stocks that are said to be highly volatile with a low market

capitalization are not allowed for option trading. This act of SEBI is strongly resented

by a section of the market. Their argument is that equity options are indispensable to

investors who need to protect their investment from volatility. The higher the volatility

of a stock the more necessary it is to list options on that stock. They are highly vocal in

arguing that SEBI should design an effective monitoring, surveillance and risk

management system at the level of the exchanges and clearing house to avert and

manage the default risks that are likely to arise owing to high volatility in low market

capital stocks instead of simply banning trading in options on them. SEBI needs to

examine these arguments. It may have to take a stand to nip in the bud all kinds of

manipulations by handling out severe punishments to all such erring companies.

Today, mutual funds are permitted to use equity derivatives products for hedging and

portfolio rebalancing.. However, such usage is not favored by fund managers as they

strongly apprehend that the dividing line between hedging and speculation being thin,

they may always get exposed to the questioning by the regulatory authorities.

d) CREDIT DERIVATIVES AND OTHERS

A credit derivative is a financial transaction whose pay-off depends on whether or not a

credit event occurs. A credit event can be:

Bankruptcy

Default

Upgrade

Downgrade

Interest rate movement



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Mortgage defaults

Unforeseen pay-offs

A credit derivative, like any other derivative, derives it.s value from an case is the

credit. In the event of the underlying asset failing to perform as expected, credit

derivatives, ensures that someone other than the principal lender absorbs the resulting

financial loss. Credit derivatives market in India though could be said as non-existent

holds huge potential. Some of the important factors/situation such as opening up of the

insurance sector to foreign private players, relief to investors, tax benefits to corporate,

proxy hedgers etc., could provide the momentum to the credit derivatives market in

India, boosting yields and bringing down risk for both the corporates and banks.

Secondly, Indian banking system is saddled with huge NPA.s, which it is of course,

eagerly trying to get rid off. The mounting pressure on profitability is making banks

more credit-averse. In such a situation, if markets can offer .credit-insurance. In the

form of derivatives, everyone would jump for it.

TYPES OF OPTIONS

CALL OPTION:

A contract that gives its owner the right but not the obligation to buy an underlying

asset-stock or any financial asset, at a specified price on or before a specified date is

known as a Call option. The owner makes a profit provided he sells at a higher current

price and buys at a lower future price.

PUT OPTION:

A contract that gives its owner the right but not the obligation to sell an underlying

asset-stock or any financial asset, at a specified price on or before a specified date is

known as a Put option. The owner makes a profit provided he buys at a lower current



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price and sells at a higher future price. Hence, no option will be exercised if the future

price does not increase.

Put and calls are almost always written on equities, although occasionally preference

shares, bonds and warrants become the subject of options.

The price at which option is exercised is called an exercise price or a strike price. The

asset on which the call or put option is created is referred to as the underlying asset.

Depending on when an option can be exercised, it is classified as follows:

European Option: When an option is allowed to exercise only on the maturity

date, it is called a European Option.

American Option: When an option can be exercised any time before its

maturity is called an American Option.

Capped Option: When an option is allowed to exercise only during a specified

period of time prior to its expiration unless the option reaches the cap value

prior to expiration in which the option is automatically exercised. The holder of

an option has to pay a price for obtaining a call or put option. The price will

have to be paid whether the holder exercises his option and it is called optionpremium.

Factors Determining the Option Value:

The precise location of the option value depends on five key factors:

Exercise price

Expiration date

Stock price

Stock price variability

Interest rate



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Exercise Price: Other things being constant, higher the exercise price, the lower the

value of call option. It should be remembered that the value of call option could never

be negative; regardless of how high the exercise price is set.

Expiration Date:

Other things being constant, the longer the time to expiration date, the more valuable

the call option. Consider two American calls with maturities of one year and two days.

The two-year call obviously is more valuable than one-year call because it gives its

holder one more year within which it can be exercised.

Stock Price: The value of a call option, other things being constant, increases with the

stock price.

Stock Price Variability: A call option has value when there is possibility that the stock

price exceeds the exercise price before the expiration date. Other things being equal, the

higher the variability of the stock price, the greater the likelihood that stock price will

exceed the exercise.

REASONS FOR USING OPTIONS

The reasons for using options on futures are reflected in the structure of an option

contract.

1) An option, when purchased gives the buyer the right, but not the obligation, to buy or

sell a specific amount of a specific commodity at a specific price within a specific

period of time.

2) The decision to exercise the option is entirely that of the buyer.

3) The purchaser of the options can lose no more than the initial amount of money

invested (premium).

4) An option buyer is never subject to margin calls. This enables the purchaser to

maintain a market position, despite any adverse moves without putting up additional

funds.

MOTIVES for BUYING and SELLING OPTIONS



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One may be buyer or seller of call or put option for a variety of reasons. A call option

buyer for e.g. is bullish that he is or she believes the price of the underlying futures

contract will rise. If price do rise, the call option buyer has three course of action

available.

First is to exercise the option and acquires the underlying futures contract at the strike

price

Second is to offset the long call position with a sale and realize a profit.

Third is to let the option expires worthless and forfeit the unrealized profit.

The seller of the call option expects futures prices to remain relatively stable or to

decline modestly. If prices remain stable, the receipt of the option premium enhances

the rate of return on a covered position. If prices decline, selling the call against a long

futures position enables the writer to use the premium as a cushion to provide

protection to the extent of the premium received. For instance, if T-bond futures were

purchased at 80.00 and call option with an 80.00 strike price were sold for 2.00, T-bond

futures could decline to the 78.00 levels before there would be a net loss in the position.

However, T-bond futures rise to 82.00 the call option seller forfeits the opportunity for

profit because the buyer would likely exercise the call against him and acquire a future

position at 80.00(strike price).

The perspective of the put buyer and put seller are completely different. The buyer of

the put option believes for the underlying futures will decline for e.g.: - if a TBond put

option with a strike price of 82.00 is purchased for 2.00 while T-Bond futures also are

at 82.00, the put option will be profitable for the purchaser to exercise if T-Bond futures

decline below 80.00

SWAPS

Swaps are transactions which obligates the two parties to the contract to exchange a

series of cash flows at specified intervals known as payment or settlement dates. They

can be regarded as portfolios of forward's contracts. A contract whereby two parties

agree to exchange (swap) payments, based on some notional principle amount is called



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as a SWAP. In case of swap, only the payment flows are exchanged and not the

principle amount. The two commonly used swaps are:

INTEREST RATE SWAPS:

Interest rate swaps is an arrangement by which one party agrees to exchange his series

of fixed rate interest payments to a party in exchange for his variable rate interest

payments. The fixed rate payer takes a short position in the forward contract whereas

the floating rate payer takes a long position in the forward contract.

CURRENCY SWAPS:

Currency swaps is an arrangement in which both the principle amount and the interest

on loan in one currency are swapped for the principle and the interest payments on loan

in another currency. The parties to the swap contract of currency generally hail from

two different countries. This arrangement allows the counter parties to borrow easily

and cheaply in their home currencies. Under a currency swap, cash flows to be

exchanged are determined at the spot rate at a time when swap is done. Such cash flows

are supposed to remain unaffected by subsequent changes in the exchange rates.

FINANCIAL SWAP:

Financial swaps constitute a funding technique which permit a borrower to access one

market and then exchange the liability for another type of liability. It also allows the

investors to exchange one type of asset for another type of asset with a preferred

income stream.

OTHER KINDS OF DERIVATIVES

The other kind of derivatives, which are not, much popular are as follows:

BASKETS -

Baskets options are option on portfolio of underlying asset. Equity Index Options are

most popular form of baskets

LEAPS -



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Normally option contracts are for a period of 1 to 12 months. However, exchange may

introduce option contracts with a maturity period of 2-3 days. These long-term option

contracts are popularly known as Leaps or Long term Equity Anticipation Securities.

WARRANTS

Options generally have lives of up to one year, the majority of options traded on

options exchanges having a maximum maturity of nine months. Longer-dated options

are called warrants and are generally traded over-the-counter.

SWAPTIONS -

Swaptions are options to buy or sell a swap that will become operative at the expiry of

the options. Thus a swaption is an option on a forward swap. Rather than have calls and

puts, the swaptions market has receiver swaptions and payer swaptions. A receiver

swaption is an option to receive fixed and pay floating. A payer swaption is an option to

pay fixed and receive floating.

Types of traders in a derivatives market

Hedgers, speculators and arbitrators are the types of traders in derivatives market.

Hedgers:

Hedgers are those who protect themselves from the risk associated with the price of an

asset by using derivatives. A person keeps a close watch upon the prices discovered in

trading and when the comfortable price is reflected according to his wants, he sells

futures contracts. In this way he gets an assured fixed price of his produce.

In general, hedgers use futures for protection against adverse future price movements in

the underlying cash commodity. Hedgers are often businesses, or individuals, who at

one point or another deal in the underlying cash commodity.

Take an example: A Hedger pays more to the farmer or dealer of a produce if its prices

go up. For protection against higher prices of the produce, he hedges the risk exposure

by buying enough future contracts of the produce to cover the amount of produce he

expects to buy. Since cash and futures prices do tend to move in tandem, the futures



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position will profit if the price of the produce rise enough to offset cash loss on the

produce.

Speculators:

Speculators are somewhat like a middleman. They are never interested in actual owing

the commodity. They will just buy from one end and sell it to the other in anticipation

of future price movements. They actually bet on the future movement in the price of an

asset. They are the second major group of futures players. These participants include

independent floor traders and investors. They handle trades for their personal clients or

brokerage firms. Buying a futures contract in anticipation of price increases is known as

.going long.. Selling a futures contract in anticipation of a price decrease is known as

.going short.. Speculative participation in futures trading has increased with the

availability of alternative methods of participation.

Speculators have certain advantages over other investments they are as follows:

If the traders judgment is good, he can make more money in the futures market faster

because prices tend, on average, to change more quickly than real estate or stock prices.

Futures are highly leveraged investments. The trader puts up a small fraction of the

value of the underlying contract as margin, yet he can ride on the full value of the

contract as it moves up and down. The money he puts up is not a down payment on the

underlying contract, but a performance bond. The actual value of the contract is only

exchanged on those rare occasions when delivery takes place.

Arbitrators:

According to dictionary definition, a person who has been officially chosen to make a

decision between two people or groups who do not agree is known as Arbitrator. In

commodity market Arbitrators are the person who takes the advantage of a discrepancy

between prices in two different markets. If he finds future prices of a commodity

edging out with the cash price, he will take offsetting positions in both the markets to



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lock in a profit. Moreover the commodity futures investor is not charged interest on the

difference between margin and the full contract value.

TRADING INTRODUCTION

The futures & Options trading system of NSE, called NEAT-F&O trading system,

provides a fully automated screen-based trading for Nifty futures & options and stock

futures & Options on a nationwide basis as well as an online monitoring and

surveillance mechanism. It supports an order driven market and provides complete

transparency of trading operations. It is similar to that of trading of equities in the cash

market segment.

The software for the F&O market has been developed to facilitate efficient and

transparent trading in futures and options instruments. Keeping in view the familiarity

of trading members with the current capital market trading system, modifications have

been performed in the existing capital market trading system so as to make it suitable

for trading futures and options.

On starting NEAT (National Exchange for Automatic Trading) Application, the log

on (Pass Word) Screen Appears with the Following Details.

1) User ID

2) Trading Member ID

3) Password NEAT CM (default Pass word)

4) New Pass Word

Note: - 1) User ID is a Unique

2) Trading Member ID is Unique & Function; it is Common for all user of the

Trading Member

3) New password Minimum 6 Characteristic, Maximum 8 characteristics only 3

attempts are accepted by the user to enter the password to open the Screen

4) If password is forgotten the User required to inform the Exchange in writing to

reset the Password.



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TRADING NETWORK



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Participants in Security Market


NSE MAIN FRAME

HUB ANTENNA

SATELLITE

BROKERS PREMISES


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1) Stock Exchange (registered in SEBI)-23 Stock Exchanges

2) Depositaries (NSDL,CDSL)-2 Depositaries

3) Listed Securities-9,413

4) Registered Brokers-9,519

5) FIIs-502

Highest Investor Population


State Total No. Investors % of Investors in India

Maharashtra 9.11 Lakhs 28.50

Gujarat 5.36 Lakhs 16.75

Delhi 3.25 Lakhs 10.10%

Tamilnadu 2.30 Lakhs 7.205

West Bengal 2.14 Lakhs 6.75%

Andhr a Pradesh 1.94 Lakhs 6.05%


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CHAPTER 4

ANALYSIS AND INTERPRETATION:

FUTURES:

Futures are legally binding agreement to buy or sel l an asset at a

certain time in the future at a certain price.

FORMULA:

Fo = So (1+r-d) T

So = closing price of a market on that day.

r = Rate of return

d = Dividend

T = Time period

OPTIONS:

Profit of the holder = (Spot Price Strike Price) Premium*

(Lot Size) in case of call option.



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Profit of the holder = Premium* (Lost Size) in case of Put

Option.

ANALYSIS OF ICICI:

The objective of this analysis is to evaluate the profit/loss position of futures and

options. This analysis is based on sample data taken of ICICI BANK scrip. This

analysis considered the Jun 2010 contract of ICICI BANK. The lot size of ICICI

BANK is 175,

the time period

in which this

analysis done is

from 27-05-

2010 to 1.07.10.


Date Market price Future price

28-May-10 1226.7 1227.05

31-May-10 1238.7 1239.7

1-June-10 1228.75 1233.75

2-June-10 1267.25 1277

3-June-10 1228.95 1238.75

4-June-10 1286.3 1287.557-June-10 1362.55 1358.9

8-June-10 1339.95 1338.5

9-June-10 1307.95 1310.8

10-June-10 1356.15 1358.05

11-June-10 1435 1438.15

14-June-10 1410 1420.75

15-June-10 1352.2 1360.1

16-June-10 1368.3 1375.75

17-June-10 1322.1 1332.1

18-June-10 1248.85 1256.45

21-June-10 1173.2 1167.8522-June-10 1124.95 1127.85

23-June-10 1151.45 1156.35

24-June-10 1131.85 1134.5

25-June-10 1261.3 1265.6

28-June-10 1273.95 1277.3

29-June-10 1220.45 1223.85

30-June-10 1187.4 1187.4

1-July-10 1147 1145.9


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Graph: 1

FINDINGS

If a person buys 1 lot i.e. 175 futures of ICICI BANK on 28th May, 2010 and sells on 1 st

July 2010 then he will get a loss of 1145.9-1227.05 = -81.15 per share. So he will get a loss

of 14201.25 i.e. -81.15 * 175

If he sells on 14th June, 2010 then he will get a profit of 1420.75-1227.05 = 193.7 i.e. a

profit of 193.7 per share. So his total profit is 33897.5 i.e. 193.7 * 175

The closing price of ICICI BANK at the end of the contract period is 1147 and this is

considered as settlement price.

The following table explains the market price and premiums of calls.



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The first column explains trading date

Second column explains the SPOT market price in cash segment on that date.

The third column explains call premiums amounting at these strike prices; 1200, 1230,

1260, 1290, 1320 and 1350.

Call options:


Strike prices

Date Market price 1200 1230 1260 1290 1320 1350

28-May-10 1226.7 67.85 53.05 39.65 32.25 24.2 18.5

31-May-10 1238.7 74.65 58.45 44.05 32.75 23.85 19.25

1-June-10 1228.75 62 56.85 39.2 30 22.9 18.8

2-June-10 1267.25 100.9 75.55 63.75 49.1 36.55 27.4

3-June-10 1228.95 75 60.1 45.85 34.5 26.4 22.5

4-June-10 1286.3 109.6 91.05 68.25 51.35 38.6 29.15

7-June-10 1362.55 170 143.3 120 100 79.4 62.35

8-June-10 1339.95 140 119.35 100 85 59.2 42.85

9-June-10 1307.95 140 101 74.35 62.05 46.65 33.1510-June-10 1356.15 160.6 131 110 95.45 70.85 53.1

11-June-10 1435 250.7 151.8 188.9 164.7 130.9 104.55

14-June-10 1410 240 213.5 148 134.9 96 88.2

15-June-10 1352.2 155 150.05 107.5 134.9 66 52.65

16-June-10 1368.3 128.4 140 90 63 78.2 60.95

17-June-10 1322.1 128.4 140 95 67.5 50.2 39.15

18-June-10 1248.85 128.4 60 54 37.95 29.15 19.3

21-June-10 1173.2 52 36.5 26.3 24.45 14.55 9.95

22-June-10 1124.95 44.15 31.05 22.55 12.45 10.35 6.7

23-June-10 1151.45 50.25 39.3 23.25 17 16.35 8.6

24-June-10 1131.85 40.4 22 17.05 12.1 9.45 5.1

25-June-10 1261.3 80.5 62 40.85 24.55 16.15 9.75

28-June-10 1273.95 91.85 61.65 44.8 31.4 20.25 11.35

29-June-10 1220.45 46 25.95 17.45 10.5 4.05 2.95

30-June-10 1187.4 18.65 9.05 4.5 1.4 0.75 0.2

1-July-10 1147 0.45 0.5 1 1.4 0.1 0.2


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CALL OPTION

BUYERS PAY OFF:

Those who have purchase call option at a strike price of 1260, the premium

payable is 39.65

On the expiry date the spot market price enclosed at 1147. As it is out of the

money for the buyer and in the money for the seller, hence the buyer is in loss.

So the buyer will lose only premium i.e. 39.65 per share.

So the total loss will be 6938.75 i.e. 39.65*175

SELLERS PAY OFF:

As Seller is entitled only for premium if he is in profit.

So his profit is only premium i.e. 39.65 * 175 = 6938.75

Put options:


Strike prices


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PUT OPTION

BUYERS PAY OFF:

As brought 1 lot of ICICI that is 175, those who buy for 1200 paid 39.05 premium per

share.

Settlement price is 1147

Strike price 1200.00

Spot price (-) 1147.00


Date Market price 1200 1230 1260 1290 1320 1350

28-May-10 1226.7 39.05 181.05 178.8 197.15 190.85 191.8

31-May-10 1238.7 34.4 181.05 178.8 197.15 190.85 191.8

1-June-10 1228.75 32.1 181.05 178.8 197.15 190.85 191.8

2-June-10 1267.25 22.6 25.50 178.8 41.55 190.85 191.8

3-June-10 1228.95 32 38.00 178.8 82 190.85 191.8

4-June-10 1286.3 17.65 25.00 37.05 82 190.85 191.8

7-June-10 1362.55 12.4 12.60 20.15 34.85 43.95 191.8

8-June-10 1339.95 10.15 12.00 20.05 30 42 191.8

9-June-10 1307.95 11.9 15.00 26.5 36 51 191.8

10-June-10 1356.15 9 11.00 15 25.2 33.7 47.811-June-10 1435 3.75 11.00 10 8.9 12.75 18.35

14-June-10 1410 3.75 11.00 8.5 12 12.4 22.45

15-June-10 1352.2 6.45 7.00 10 17.45 23.1 38.3

16-June-10 1368.3 8 8.00 11.25 13.3 22.55 35.35

17-June-10 1322.1 7.3 8.00 17.8 25.45 38.25 56.4

18-June-10 1248.85 18.15 36.60 35 67.85 76.05 112.2

21-June-10 1173.2 103.5 70.00 69.65 135.05 151.35 223.4

22-June-10 1124.95 110 138.90 138.6 170.05 210 280

23-June-10 1151.45 71 138.90 135 150 210 200

24-June-10 1131.85 99 138.90 135 150 210 200

25-June-10 1261.3 15.9 26.35 33 50.05 210 20028-June-10 1273.95 16.7 19.00 30 45 55 81.45

29-June-10 1220.45 18 38.00 50 45 100 145

30-June-10 1187.4 27.5 60.00 85.2 120 145.05 145

1-July-10 1147 50 60.00 85.2 120 145.05 145


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53.00

Premium (-) 39.05

13.95 x 175= 2441.25

Buyer Profit = Rs. 2441.25

Because it is positive it is in the money contract hence buyer will get more profit,

incase spot price decreases, buyers profit will increase.

SELLERS PAY OFF:

It is in the money for the buyer so it is in out of the money for the seller, hence

he is in loss.

The loss is equal to the profit of buyer i.e. 2441.25.

Graph: 2

INTERPRETATION:


GARPH SHOWING THE PRICE MOVEMNTS OF SPOT & FUTURE

10001050110011501200125013001350

140014501500

28-May

-10

1-Jun-10

3-Jun-10

7-Jun-10

9-Jun-10

11-Jun

-10

15-Jun

-10

17-Jun

-10

21-Jun

-10

23-Jun

-10

25-Jun

-10

29-Jun

-10

31-Jun

-10

CONTRACT DATES

PRIC

E

Market price

Future price


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The future price of ICICI is moving along with the market price.

If the buy price of the future is less than the settlement price, than the buyer of a

future gets profit.

If the selling price of the future is less than the settlement price, than the seller

incur losses.

ANALYSIS OF SBI:-

The objective of this analysis is to evaluate the profit/loss position of futures and

options. This analysis is based on sample data taken of SBI scrip. This analysis

considered the jun 2010 contract of SBI. The lot size of SBI is 132, the time period in

which this analysis done is from 28-05-2010 to 1-07-10.



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Table: 4


Date Market Price Future price

28-May-10 2377.55 2413.7

31-May-10 2371.15 2409.2

1-June-10 2383.5 2413.45

2-June-10 2423.35 2448.45

3-Ju

Derivatives Sridhar

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