Evolution of derivatives in India Commodities futures trading in India was initiated long back

in 1950. The 1960s marked a period of great decline in futures trading. Market after market was closed because different commodities

prices increases were attributed to speculation on these markets.

Central government imposed the ban on trading in derivatives in 1969 under a notification issue.

Late 1990s shows this signs of opposite trends, a large scale revival of futures markets in India.

Central government revoked the ban on futures trading in October 1995.

Civil supplies ministry agreed in principle for starting of futures trading in Basmati rice.

In 1996 the government granted permission to the Indian Pepper and Spice Trade Association to convert its Pepper Futures Exchange into an International Pepper Exchange.

On November 17, 1997, India’s first international futures exchange at kochi, known as the India pepper and spice trade association – International Commodity Exchange (IPSTA- ICE) was established.

The Cochin Oil Millers Association, in June 1996, demanded the introduction of futures trading in coconut oils.

Central minister for agriculture announced in June 1996, the introduction of futures trading both domestic and international.

A new coffee futures exchange (the Coffee Futures Exchange of India) is being started at Bangalore.

In August 1997, the central government proposed that Indian companies with commodity prices exposure should be allowed to use foreign futures and option markets

Reserve Bank of India set up the Sodhani Expert Group which recommended major liberalization of the forward exchange market and had urged the setting up of rupee-based derivatives in financial instruments.

The Securities and Exchange Board of India (SEBI) appointed a committee named Dr.L.C.Gupta committee by its resolution, dated November 18, 1996 in order to develop appropriate regulatory frame work for derivatives trading in India.

Committee’s focus was on equity derivatives but it had maintained a broad perspective of derivatives in general.

In December, 1999, the new frame work has been approved and ‘Derivatives’ have been accorded the status of ‘securities’.

In June, 2000, the National Stock Exchange and Bombay Stock Exchange started stock index based futures trading in India.

Benefits of Derivatives in India India’s financial market system will strongly benefits from

smoothly functioning index derivatives markets. Launch of derivatives has been associated with substantial

improvements in market quality on the underlying equity market. Liquidity and market efficiency on India's equity market will

improve once the derivatives commence trading. Risks in the financial markets can be eliminated by diversification. Index derivatives are special in, can be used by investor to protect

themselves from the one risk in the equity market that cannot be diversified away.

Once the investor use index derivatives, they will suffer less when fluctuations in the market index take place.

Foreign investors coming into India would be more comfortable if the hedging vehicles routinely used by them worldwide are available to them.

Launch of derivatives is a logical next step in the development of human capital in India.

Skills in the financial sector have grown tremendously.

Categories of Derivatives Traded in India Commodities futures for coffee, oil seeds, oil, gold, silver, pepper,

cotton, jute and jute goods are traded in the commodities futures. Forward markets commission regulates the trading of commodities

futures. Index futures based on Sensex and NIFTY index are also traded

under the supervision of securities and exchange board of India. RBI has permitted banks, financial institutions and primary dealers

to enter into forward rate agreement (FRA)/ interest rate swap in order to facilitate hedging of interest rate risk and ensuring orderly development of derivatives market.

National Stock Exchange (NSE) became the first exchange to launch trading in options on individual securities.

Trading in options on individual securities commenced from July, 2001.

Options contract are American style and cash settled and are available in about 40 securities.

NSE commenced trading in futures on individual securities on November 9, 2001. The futures contract are available in about 31 securities.

BSE started trading in stock options and futures around at the same time as the NSE.

NSE commenced trading in interest rate future on June 2003. Interest rate futures contract are available on 91-day T-bills,

10 years bonds and 10-years zero coupon bonds as specified by the SEBI.

Structure of Derivatives Markets in India Derivatives markets in India categorized into two markets

namely:- 1. Financial derivatives 2. Commodities futures markets. Financial derivatives markets deal the financial future instruments

like stock futures, index futures, stock options, index options, interest rate futures, currency, forwards and futures, financial swaps, etc.

Commodity futures markets deals with commodity instruments like agricultural products, food grains, cotton and oil; metals like gold, copper and steel and other assets like livestock, vegetables and so on.

Financial derivatives markets in India are regulated and controlled by the Securities and Exchange Board of India (SEBI).

SEBI is authorized under the SEBI Act to frame rules and regulations for financial futures trading on the stock exchanges with the objectives to protect the interest of the investors .

Carry forward trading (Badla trading) is also regulated by the SEBI which is traded on the stock exchanges.

Other financial derivatives like currency options and futures and interest rate futures are controlled by the Reserve Bank of India . These are dealt on Over-the -Counter (OTC)

RBI is the apex body to regulate currencies and interest rates in India. Financial derivatives relating to foreign currencies and interest rates

are come under the RBI regulation. Stock exchanges in India, under the regulation of the SEBI , trade in

two kinds of futures products, namely equity and carry forwards. Equity futures include stock futures, index futures, stock options and

index options. Currently these are traded on National Stock Exchange and Bombay Stock Exchange.

Commodity futures markets are regulated in India by Forward Market Commission (FMC) .

Important Eligibility/ Regulatory Conditions Specified by SEBI

Derivatives trading to take place through an on-line screen based trading system.

Derivatives exchange/ segment should have on-line surveillance capability to monitor positions, prices and volumes on a real time basis.

Derivatives exchange/ segment should have arrangements for dissemination of information about trades, quantities and quotes on a real time basis.

Derivatives exchange/ segment should have arbitration and investor grievances redressal mechanism operatives from all the regions of the country.

Derivatives exchange/ segment should have satisfactory system of monitoring investor complaints and preventing irregularities in trading.

Derivatives segment of the exchange would have a separate Investor Protection Fund.

The clearing house should have the capacity to monitor the overall position of members across both derivatives market .

Level of initial margin on index futures contracts will be related to the risk of loss on the position.

Clearing house will establish facilities for electronic funds transfer (EFT) for swift (fast) movement of margin payment.

A member defaulting in meeting its liabilities, the clearing house shall transfer client positions and assets to another solvent member or close-out all open position.

The clearing house should have capabilities to segregate initial margins deposited by clearing members for trades on their own account and on account of his client.

Regulatory Instruments Margin variation: Value which has to be paid in cash or securities by the seller or

the buyer in the futures market. Objective of such margin is to ensure the safety of the contract or

preventing from the defaults caused by one of the parties to the contract.

Higher margin will have more safety for the parties but at the higher cost.

Increase or decrease in margin will affect the volume of trading in that asset.

Imposition of special margins: Imposed by the regulatory authorities over and above the

ordinary margin as referred.

The volume of speculative trading in the market has crossed its normal limits, and the market has become explosive then to check this excessiveness, the special margin in addition to normal margin may be levied.

Special margins are imposed with ‘threshold’ prices, they are imposed only when prices are higher or lower to specified limits.

Daily or weekly limits on price changes: Basic objective of this tool is to keep the prices of the futures

instruments in a particular band (group) or limits, e.g. 10 per cent upper and lower band of the normal price.

Idea is to put limits temporarily on the price fluctuations or blind price movements.

Limits on open position: Relates to the limit on volume of trading for a particular

instrument for the traders in the market. Basic idea of making such restriction on open positions of the

market participants is just to avoid manipulation or excessive speculation by the large operators.

Temporary suspension of trading: The regulatory authority stops the trading in particular asset

temporarily for a particular period. Basic objective is to curb speculation, over dose (amount,

quantity) of speculative manipulation which rendered the markets completely out of tune (alter, adjust) with reality.

Authority can close out all the existing futures contract at a fixed rate which does not give the ‘offending’ (wrong) parties the speculative gain for which such deals were initiated.

Changes in number and /or timing of contracts: Related to change in number and timings of the futures contracts

being traded because it is not well suited to the seasonality of supply or demand of the particular asset or commodity.

Example, regulatory authority may change the trading months from February, March to April, May, etc.

Fixation of price limits: Regulatory authority fixes the price limits, i.e. maximum and /or

minimum, which the futures market is not allowed to move. Limits are reached then in that case all the transactions can be

undertaken at the price or within the acceptable price range. Basic idea of this technique is to protect the markets at the time of

shortage or glut.(excess, surplus)

Indefinite suspension or banning of trading: The futures market reached in such position where trading is to be

stopped indefinitely or till further order of the authority for restarting of the trading.

This is done in rare cases where the authority feels that no other alternative is available except indefinite suspension of trading in the market.

Contract terminology and specifications for index based futures

Index futures are futures contracts on an index, like the Nifty. The underlying asset in case of index futures is the index itself. For example, Nifty futures traded in NSE track spot Nifty returns.

If the Nifty index rises, so does the pay off of the long position in Nifty futures. Apart from Nifty other indices such as CNX IT, Bank Nifty etc. are also traded on the NSE.

They have one-month, two-month, and three-month expiry cycle: a one-month Nifty futures contract would expire in the current month, a two-month contract the next month, and a three-month

contract the month after. All contracts expire on the last Thursday of every month, or the

previous trading day if the last Thursday is a trading holiday.

Contract Specification for S&P Nifty Index Futures:Underlying Index S&P CNX Nifty

Exchange of trading National Stock Exchange of India Limited

Security Descriptor FUTIDX NIFTY

Contract Size Permitted lot size is 50 (minimum value Rs 2 lakhs)

Trading Cycle The future contracts have a maximum of three month trading cycle - the near month (one), the next month (two), and the far month (three). New contracts are introduced on the next trading day following the expiry of the near month contract.

• Expiry Day The last Thursday of the expiry month or the previous trading day if the last Thursday is a trading holiday• Settlement Basis Mark-to-market and final settlement are cash settled on T+1 basis• Settlement Price Daily Settlement price is the closing price of the future contracts for the trading day and the final settlement price is the value of the underlying index on the last trading day

Contract Specification for Stock Futures• Underlying Individual Securities

• Exchange of Trading NSE

• Security Descriptor FUTSTK

• Contract Size As specified by the exchange

(minimum value of Rs. 2 lakhs)• Trading Cycle The futures contracts have a

maximum of three month

trading cycle---the near month

(one), the next month (two),

and the far month (three).

New contracts are introduced

on the next trading day

following the expiry of the

near month contract

• Expiry Day The last Thursday of the expiry

month or the previous day if

Thursday is a trading holiday

• Settlement Basis Mark to market and final

settlement is cash settled on

T+1 basis

• Settlement Price Daily settlement price is the

closing price of the futures

contracts for the trading day

and the final settlement price

is the closing price of the

underlying security on the last

trading day.

Contract Specification for Stock Options• Underlying Individual Securities available

for trading in cash market

• Security Descriptor OPTSTK

• Style of Option European

• Contract size As specified by the exchange

(minimum value of Rs 2 lakhs)

• Trading Cycle The options contracts have a

maximum of three month

trading cycle—the near month

(one), the next month (two),

and the far month (three). New

contracts are introduced on the

next trading day following the

expiry of near month contract

• Expiry Day The last Thursday of the expiry

month or the previous trading

day if the last Thursday is a

trading holiday

• Settlement Basis Daily Settlement on T+1 basis

and final option exercice

settlement on T+1 basis

• Daily Settlement Premium value (net)

• Final Settlement price Closing price of underlying on

exercise day or on expiry day