WELINGKAR INSTITUTE OF MANAGEMENT DEVELOPMENT & RESEARCH

SUMMER PROJECT ON

Future

& Options in derivatives

By

MMS 2009 11 SEMESTER III SPECIALISATION: FINANCE

ROLL NO: 48

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ACKNOWLEDGEMENT
I wish to express my sincere gratitude to all those who helped in various capabilities in understanding this study and preparing this project. I am very much indebted to Mr. Suhas Wairaga !" DSK INVESTMENT SOLUTIONS" su# #r$%!r shi& 'i(h S)ICAP SECURITIES LTD for their valuable suggestions and continual support and as they guided, encouraged and inspired me to put my best efforts in the project. His constant support kept me motivated. Finally, I would like to express my gratitude towards the su&&$r( s(a** $* +S)ICAP S!,uri(i!s L( - for their immense help, co operation and encouragement throughout the project.

Vi.!% Sa/0a1ra$ )a2'ir !ate" 'lace" ##$ %Finance& ())* ()11

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+,-./-.

,01/+.I2/ ,F '3,1/+. 3/$/53+H #/.H,!,6,78 03/IF +,#'5-8 '3,FI6/ I-.3,!:+.I,- ., !/3I25.I2/$ I-.3,!:+.I,- ., F:.:3/$ < ,'.I,-$ !5.5 +,66/+.I,- 5-! 5-568$I$ +5$/ 5-568$I$ FI-!I-7 +,-+6:$I,$:77/$.I,-$ 0I06I,735'H8

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CHAPTER- 1 OBJECTVE OF PROJECT

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O#0!,(i.! $* &r$0!,(
.he entire project is based on the 5nalytical and ?uantitative method. .he project is concern with the !erivatives. .he topic selected for research is @.o understand and study .rading $trategies in !erivativesA. 5 crucial first step that you must take before you start investing is to define your objectives. 8ou do so by identifying your return goals and your risk preferences. 8ou already know that you cannot state your objectives only in terms of return because there is a relationship between risk and return. $o you cannot wish to make substantial returns if you do not have the willingness to tolerate high levels of risk. 3eturn objectives for different investors usually vary among the following" capital appreciation, current income, and total return. +apital appreciation is the goal for those investors who are willing to take risk for the sake of making large capital gains %increase of value of the stocks in the portfolio& over time. Bith current income, investors are interested in generating periodic income. .his is usually for the purpose of providing extra money to assist with the living expenses. .his usually involves little risk. Finally, total return is a blend between capital appreciation and current income. Here the investor desires to generate income as well as accumulate capital gains. Bith total return, moderate risk is undertaken. 5s the return objective dictates the level of risk that needs to be taken, it also helps guide the construction of an investorCs portfolio. For example, a portfolio aiming for capital appreciation will comprise mainly of common stocks since they have the potential for the highest gains %as well as carry the highest risk&. 5 portfolio of a risk averse person interested in preserving hisDher capital and looking for income will contain mainly corporate and government bonds. $o before you start investing it is essential that you assess your goals and objectives so that you can construct a portfolio that best meets your desires .o study and understand the concept of @derivatives market.A .he study analyEes the various strategies of derivatives market segment. .o study trading segment @derivatives market.A .o study how and why to invest .o analyEe the available data i.e. fact and figures affecting investment. .o analyEe and interpret the data i.e. strategies. .o identify the factors of Future and ,ptions. Find out #isconceptions about !erivatives and 2iew to overcome them.

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CHAPTER- 2 RESEARCH ETHO!O"O#$

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RESEARCH METHODOLOG3
3esearch in common parlance refers to a search for common knowledge. ,nce can also define research as a scientific and systematic search for pertinent information on a specific topic. 3esearch is an academic activity and as such the term should be used in term should be used in a technical sense. Da(a C$22!,(i$/4 .he task of data collection begins after a research problem has been defined and plan chalked out. .here are two types of data viE. 'rimary data, $econdary data. .he 'rimary data those which are collected afresh and for the first time, and thus happen to be original in character. .he $econdary data, on the other hand, are those which have already been collected by some one else and which have been passed through the statistical process. In research data is divided into two major parts i.e. 'rimary !ata < $econdary !ata. .here different sources and methods of data collection follows" Pri5ar1 a(a ,$22!,(i$/4 .he primary data is collected through 'ersonal interview of company manager, and open discussion with company employees, information provided by the company. S!,$/ ar1 Da(a C$22!,(i$/4 .he secondary data collected in project through #anuals Internet 0ooks and newspapers company websites, company literature -+F# modules.

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CHAPTER- % BR&EF CO PA'$ PROF&"E

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C$5&a/1 Pr$*i2!
S)ICAP S!,uri(i!s L( 6SSL7 is a 1))G subsidiary $* S)I Ca&i(a2 Mar%!(s 6td which is one of the oldest players in the Indian +apital #arket and has a dominant position in the Indian primary capital markets. $0I +apital #arkets 6td. commenced broking activities in #arch ())1 to fulfill the secondary market needs of Financial Institutions, FIIs, #utual Funds, 0anks, +orporate, High -et worth Individual, -on residential Investors and 3etail domestic investors. $0I+5' $ecurities 6td. %$$6& is a company, which has been formed to take over the broking operations of $0I +apital #arkets 6td. $$6 commenced operations in the first Huarter of financial year of ())> ())9 $0I+5'$/+ is the 1)) per cent subsidiary of $0I capital markets 6imited, which has a share holding of F>.1> per cent by $tate 0ank of India and 5sian !evelopment 0ank, which owns 1=.F; per cent.

Pr$ u,( a/ S!r.i,!s O**!r! 4

$r. -o. 1 ( = ; 4 'roduct and $ervices /Huity !erivative. #utual Fund. I',. !epositories

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$$6 is registered with the $ecurities /xchange 0oard of India for its various services, a
Registered it!"#s Registr#ti$% %$& INB231052938 INB011053031 INF231052938

SEBI -Stock Broker-NSE SEBI- Stock Broker BSE SEBI- Stock Broker-NSEF&O SEBI- Depository Participa t SEBI Port%o&io 'a a(er

IN-DP-!DS"-3#0-200$ INP000002098

summary of which is as under"

$$6 Institutional /Huities !ivision combines the efforts of 3esearch and $ales < .rading departments to best serve clientsC needs. .hey believe it is there unflinching commitment to providing superior client service that makes them stand out. $$6 have a dedicated research team, which is engaged in analyEing the Indian economy and corporate sectors to identify eHuity investment ideas. .hey staunchly practice the value investing philosophy and advise investors to take a long term view of eHuity investments. +onsistent delivery of high Huality advice on individual stocks, sector trends and investment strategy has established them as a reliable research unit amongst leading Indian as well as International Investors. $$6Is sales < trading Welingkar Institute of Management Development & Research 1) page

team, comprising top eHuity professionals, translates the research findings into actionable advice for clients, based on their specific needs. /ach sales personnel have significant experience in eHuity research. $ophisticated computeriEed tools are used to understand client investment profile and objectives, which ensures proactive and timely service. $$6Is .eam constituted by experienced professionals has entrenched knowledge and proven credentials in the business with cross product knowledge. .he key strengths of the team are" /xpertise in industry sectors. !eep understanding of the capital markets. $trong networking with buys side institutions. 5bility to structure transaction and products suitable to needs of the clients.

K!1 E8!,u(i.!s4
#r. $. 2ishvanathan J +hairman #rs. $wati !esai #anaging !irector $hri $ H 2isweswariah Bhole time !irector. !r #anoj 2aish Independent !irector $mt. 0harati 3ao non /xecutive !irector. $hri #.K. -ag non /xecutive !irector

S)I Orga/i9a(i$/4

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I/.!s(5!/( Ra(i$/a2!
/ach investment alternative has its own strengths and weaknesses. $ome options seek to achieve superior returns %like eHuity&, but with corresponding higher risk. ,ther provide safety %like ''F& but at the expense of liHuidity and growth. ,ther options such as F!s offer safety and liHuidity, but at the cost of return. #utual funds seek to combine the advantages of investing in arch of these alternatives while dispensing with the shortcomings. Indian stock market is semi efficient by nature and, is considered as one of the most respected stock markets, where information is Huickly and widely disseminated, thereby allowing each securityIs price to adjust rapidly in an unbiased manner to new information so that, it reflects the nearest investment value. 5nd mainly after the introduction of electronic trading system, the information flow has become much faster. 0ut sometimes, in developing countries like India, sentiments play major role in price movements, or say, fluctuations, where investors find it difficult to predict the future with certainty. $ome of the events affect economy as a whole, while some events are sector specific. /ven in one particular sector, some companies or major Welingkar Institute of Management Development & Research 1( page

market player are more sensitive to the event. $o, the new investors taking exposure in the market should be well aware about the maximum potential loss, i.e. 2alue at risk.

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CHAPTER- ( &'TRO!)CT&O' TO !EREVAT&VES

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:DERIVATIVES;
5 derivative is a product whose value is defined from the value of one or more basic variables, called bases %underlying asset, index, or reference rate&, in a contractual manner, the underlying asset can be eHuity, forex, commodity or any other asset. For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by the date. $uch a transaction is an example of a derivative. .he price of this derivative is driven by the spot price of wheat which is the @underlyingA. In the Indian context the securities +ontract %3egulation& 5ct, 1*4> %$+%3& 5& defines @derivativesA to include" 1& 5 security derived from a debt instruments, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security. (& 5 contract, which derives its value from the prices, or index of prices, of underlying securities. Th! /!! $* a !ri.a(i.!s 5ar%!( .he derivatives market performs a number of economic functions" 1. .hey help in transferring risks from risk adverse people to risk oriented people (. .hey help in the discovery of future as well as current prices =. .hey catalyEe entrepreneurial activity ;. .hey increase the volume traded in markets because of participation of risk adverse people in greater numbers 4. .hey increase savings and investment in the long run

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T3PES OF DERIVATIVES4

Fu(ur!s

T*pe o+

F$r'ar

!erivatives &nstru,ent-

O&(i$/s

S'a&s

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.he most commonly used derivative contracts are forwards, futures and options, which we shall discuss in detail later. Here we take a brief look at various derivatives contracts that have come to be used. Fu(ur!s4 5 future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the farmers are standardiEed exchange traded contracts. O&(i$/s4 ,ptions are of two types J call and put. +alls give the buyer the right but not the obligation to buy a given Huantity of the underlying assets, at a given price on or before a given future date. 'uts give the buyer the right, but not the obligation to sell a given Huantity of the underlying assets at a given price on or before a given date. Warra/(s4 ,ptions generally have lives of up to one yearL the majority of options traded on options exchanges having a maximum maturity of nine months. 6onger dated options are called warrants and are generally traded over the counter. L!a&s4 .he acronym 6/5'$ mean long term eHuity anticipation securities these are options having a maturity of up to three years. )as%!(s4 0asket options are options on portfolios of underlying assets. .he underlying asset is usually a moving average or a basket of assets. /Huity index options are a form of basket options. S'a&s4 $waps are private agreement between two parties to exchange cash flow in future according to prearranged formula. .hey can be as portfolio of future contracts. .wo commonly used swaps are" Interest rate swaps" .hese entail swapping only the interest related cash flow between the parties in the same currency. +urrency swaps" .hese entail swapping both principal and interest between the parties, with the cash flow in one direction being in a different currency then those in opposite direction. page

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Th! &ar(i,i&a/(s i/ a !ri.a(i.!s 5ar%!(4 H! g!rs4< Hedgers use futures or options markets to reduce or eliminate the risk associated with price of an asset. S&!,u2a($rs4< $peculators use futures and options contracts to get extra leverage in betting on future movements in the price of an asset. .hey can increase both the potential gains and potential losses by usage of derivatives in a speculative venture. Ar#i(rag!urs4< 5rbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. If, for example, they see the futures price of an asset getting out of line with the cash price, they will take offsetting positions in the two markets to lock in a profit

INDIA4 GROWTH OF DERIVATIVES

.he Indian financial market took a giant leap ahead with the introduction of derivatives trading on the stock exchanges. .he derivatives trading in India commenced with the introduction of index futures in 1un ())). .he advent of stock futures and options in ())1 resulted in dramatic increase in the volumes of derivatives. In less than three years, the volume in futures and options segment rose more than that of the cash market. $ince then, the volumes in the F<, segment have witnessed huge growth. +urrently, the volumes in F<, are consistently around four to five times more that the cash market volumes. .his is itself the huge popularity of these instruments among the 3etail and Institutional Investors. 7oing ahead, the derivatives markets see a further rise with the increase in knowledge levels among the investor about these products. .hey also act as very useful hedging tool for institutional investor who would like to protect their holdings against any negative surprise. Bith the government liberaliEing norms for #utual Funds participation in derivative segment, the participation is expected to rise further in the future. .he mutual fund industry is also launching derivative funds where the primary focus would be to generate returns through investments in derivatives.

Fa,($rs ri.i/g (h! gr$'(h $* !ri.a(i.!s4

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,ver the last three decades, the derivatives market has seen a phenomenal growth. 5 large variety of derivatives contracts have been launched at exchanges across the world. $ome of the factors driving the growth of financial derivatives are,

Increase volatility in asset prices in financial markets. Increased integration of national financial markets with the international market. #arked improvement in communication facilities and sharp decline in their costs !evelopment of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies. Innovations in the derivatives markets, which optimally combine the risk and returns over a large number of financial assets leading to higher return, reduced risk as well as transaction costs as compared to individual Financial assets

C$5&ara(i.! A/a21sis < W$r2 E8,ha/g!s 6Ju/ =>>?7

.he position of contracts traded on -$/ as against the total +ontracts .raded on the all /xchanges of the world /xchange, ,n =nd position in $tock Futures with >,(;1,(;9 contracts ,n @th position in Index Futures with F,;=9,=F( contracts ,n Ath position in Index ,ptions with 1,*11,=*F contracts ,n BCth position in $tock ,ptions with (>;,;F9 contracts

EDui(i!s vs. Fu(ur!s & O&(i$/s

-$/ started trading in the eHuities segment %+apital #arket segment& on -ovember =, 1**; and within a short span of 1 year became the largest exchange in India in terms of volumes transacted. .he -ational $tock /xchange of India 6imited %-$/& commenced trading in derivatives with the launch of index futures on 1une 1(, ())). .he futures contracts are based on the popular benchmark $<' +-M -ifty Index .he /xchange introduced trading in Index ,ptions %also based on -ifty& on 1une ;, ())1. -$/ also became the first exchange to launch trading in options on individual securities from 1uly (, ())1. Futures on individual securities were introduced on -ovember *, ())1. Futures and ,ptions on individual securities are available on 11F securities stipulated by $/0I. .he /xchange has also introduced trading in Futures and ,ptions contracts based on the +-M I. index from 5ugust (*, ())=.

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NSE E )usi/!ss Gr$'(h i/ D!ri.a(i.!s 6Tur/$.!r E Rs. i/ Cr7

'e#r 2009-10 2008-09 200#-08 200$-0# 2005-0$ 200)-05 2003-0) 2002-03 2001-02 2000-01 T(r%$)er *Rs& +r&, 17663665 11010482 13090478 7356242 4824174 2546982 2130610 439862 101926 2365

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V$2u5! Gr$'(h i/ Fu(ur!s & O&(i$/s s!g5!/(s

'e#r 2009-10 2008-09 200#-08 200$-0# 2005-0$ 200)-05 2003-0) 2002-03 2001-02 2000-01 F(t(res Rs i% Cr& 9129$35 #0)9#5) 113$9231 $3#05)1 )305)52 225$203 18$0385 330)85 #2998 23$5 O-ti$% Rs i% Cr& 853)029*) 39$0#28*# 1#212)#*) 985#01 518#22 290##9 2#0023 1093## 28928 0

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.he above graph depicts the picture of volume growth in Futures and ,ptions segments for India. .he volume growth of Futures is very high as compared to ,ptions.

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CHAPTER- . &'TRO!)CT&O' TO F)T)RES A'! OPT&O'S

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INTRODUCTION TO FUTURES AND OPTIONS

In recent years, derivatives have become increasingly important in the field of finance. Bhile futures and options are now actively traded on many exchanges, forward contracts are popular on the ,.+ market.

I/(r$ u,(i$/ ($ Fu(ur!s4

Futures markets were designed to solve the problems that exist in forward markets. 5 futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. 0ut unlike forward contracts, the futures contracts are standardiEed and exchange traded. .o facilitate liHuidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a standardiEed contract with standard underlying instrument, a standard Huantity and Huality of the underlying instrument that can be delivered, %or which can be used for reference purposes in settlement& and a standard timing of such settlement. 5 futures contract may be offset prior to maturity by entering into an eHual and opposite transaction. #ore than **G of futures transactions are offset this way. .his standardiEed item in a futures contract is" ?uantity of the underlying ?uality of the underlying .he date and the month of delivery .he units of price Huotation and minimum price change. 6ocation of settlement.

Wha( ar! *u(ur!s ,$/(ra,(F

Futures contract is a financial contract obligating the buyer to purchase an asset %or the seller to sell an asset&, such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the Huality and Huantity of the underlying assetL they are standardiEed to facilitate trading on a futures exchange. $ome futures contracts may call for physical delivery of the asset, while others are settled in cash. .he futures markets are characteriEed by the ability to use very high leverage relative to stock markets.

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H$' $!s (h! *u(ur!s 5ar%!( s$2.! (h! &r$#2!5s $* *$r'ar 5ar%!(sF
Futures markets feature a series of innovations in how trading is organiEed" 1& Futures contracts trade at an exchange with price time priority. 5ll buyers and sellers come to one exchange. .his reduces search costs and improves liHuidity. .his harnesses the gains that are commonly obtained in going from a non transparent club market %based on telephones& to an anonymous, electronic exchange which is open to participation. .he anonymity of the exchange environment largely eliminates cartel formation. (& Futures contracts are standardiEed all buyers or sellers are constrained to only choose from a small list of tradable contracts defined by the exchange. .his avoids the illiHuidity that goes along with the unlimited customiEation of forward contracts. =& 5 new credit enhancement institution, the clearing corporation, eliminates counterparty risk on futures markets. .he clearing corporation interposes itself into every transaction, buying from the seller and selling to the buyer. .his is called novation. .his insulates each from the credit risk of the other. In futures markets, unlike in forward markets, increasing the time to expiration does not increase the counterparty risk. -ovation at the clearing corporation makes it possible to have safe trading between strangers. .his is what enables large scale participation into the futures market in contrast with small clubs which trade by telephone and makes futures markets liHuid.

Fu(ur!s T!r5i/$2$g14
S&$( &ri,!4 .he price at which an asset trades in the spot market. Fu(ur!s &ri,!4 .he price at which the futures contract trades in the futures market. C$/(ra,( ,1,2!4 .he period over which a contract trades. .he index futures contracts on the -$/ have one month, two months and three month expiry cycles which expire on the last .hursday of the month. .hus a 1anuary expiration contract expires on the last .hursday of 1anuary and a February expiration contract ceases trading on the last .hursday of February. ,n the Friday following the last .hursday, a new contract having a three month expiry is introduced for trading. E8&ir1 a(!4 It is the date specified in the futures contract. .his is the last day on which the contract will be traded, at the end of which it will cease to exist. C$/(ra,( si9!4 .he amount of asset that has to be delivered less than one contract. For instance, the contract siEe on -$/Is futures market is ()) -ifties.

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 )asis4 In the context of financial futures, basis can be defined as the futures price minus the spot price. .here will be a different basis for each delivery month for each contract. In a normal market, basis will be positive. .his reflects that futures prices normally exceed spot prices. C$s( $* ,arr14 .he relationship between futures prices and spot prices can be summariEed in terms of what is known as the cost of carry. .his measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset. I/i(ia2 5argi/4 .he amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin. Ma%i/g<($<5ar%!(4 In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investorIs gain or loss depending upon the futures closing price. .his is called marking to market.

I/(r$ u,(i$/ ($ O&(i$/s4

In this section, we look at the next derivatives product to be traded on the -$/, namely options. ,ptions are fundamentally different from forward and futures contracts. 5n option gives the holder of the option the right to do something. .he holder does not have to exercise this right. In contrast, in a forward or futures contract, the two parties have committed themselves to doing something. Bhereas it costs nothing %expect margin reHuirements& to enter into a future contract, the purchase of an option reHuires an up front payment.

O&(i$/ T!r5i/$2$g14
I/ !8 $&(i$/4 .hese options have the index as the underlying. $ome options are /uropean while others are 5merican. 6ike index futures contracts, index options contracts are also cash settled. S($,% $&(i$/s4 $tock options are options on individual stocks. ,ptions currently trade on over 4)) stocks in the :nited $tates. 5 contract gives the holder the right to buy or sell shares at the specified price. )u1!r $* a/ $&(i$/4 .he buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the sellerDwriter . Wri(!r $* a/ $&(i$/4 .he writer of a callDput option is the one who receives the option premium and is thereby obliged to sellDbuy the asset if the buyer exercises on him. .here are two basic types of options, call options and put options. Welingkar Institute of Management Development & Research (> page

 Ca22 $&(i$/4 5 call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. Pu( $&(i$/4 5 put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price. O&(i$/ &ri,!G&r!5iu54 ,ption price is the price which the option buyer pays to the option seller. It is also referred to as the option premium. E8&ira(i$/ a(!4 .he date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity. S(ri%! &ri,!4 .he price specified in the options contract is known as the strike price or the exercise price.

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CHAPTER- / !ATA CO""ECT&O' A'! !ATA A'A"$S&S

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DATA COLLECTION AND DATA ANAL3SIS

DIFFERENT STRATEGIES IN FUTURES & OPTIONS
Wha( ar! S(ra(!gi!sF $trategies are specific game plans created by you based on your idea of how the market will move. $trategies are generally combinations of various products J futures, calls and puts and enable you to realiEe unlimited profits, limited profits, unlimited losses or limited losses depending on your profit appetite and risk appetite. H$' ar! S(ra(!gi!s *$r5u2a(! F .he simplest starting point of a $trategy could be having a clear view about the market or a script. .here could be strategies of an advanced nature that are independent of views, but it would be correct to say that most investors create strategies based on views. Wha( .i!'s ,$u2 #! ha/ 2! (hr$ugh S(ra(!gi!sF .here could be four simple views" bullish view, bearish view, volatile view and neutral view. 0ullish and bearish views are simple enough to comprehend. 2olatile view is where you believe that the market or scrip could move rapidly, but you are not clear of the direction %whether up or down&. 8ou are however sure that the movement will be significant in one direction or the other. -eutral view is the reverse of the 2olatile view where you believe that the market or scrip in Huestion will not move much in any direction

)u22ish S(ra(!gi!s
Vari$us #u22ish s(ra(!gi!s &$ssi#2! 0uy a Future 0uy a +all ,ption $ell a 'ut ,ption +reate a 0ull $pread using +alls +reate a 0ull $pread using 'uts 6et us discuss each of these using some examples. )u1 a Fu(ur!s C$/(ra,( If you buy a Futures +ontract, you will need to invest a small margin %generally 14 to =)G of the +ontract value&. If the underlying index or scrip moves up, the associated Futures will also Welingkar Institute of Management Development & Research (* page

move up. 8ou can then gain the entire upward movement at the investment of a small margin. For example, if you buy -ifty Futures at a price of 3s ;,1)) that moves up to ;,14) in say 1) days time you gain 4) points. -ow if you have invested only ()G, i.e. F(), your gain is over >.)*G in 1) days time. .he danger of the Futures value falling is very important. 8ou should have a clear stop loss strategy and if youIre -ifty Futures in the above example were to fall from ;,1)) to say ;,)F)L you should sell out and book your losses before they mount. Th! gra&h $* a )u1 Fu(ur!s S(ra(!g1 a&&!ars #!2$'4 '3,FI.
4)

) ;)4)
4)

;1))

;14)

-IFF.8

)u1 a Ca22 O&(i$/ If you buy a +all ,ption, your ,ption 'remium is your cost which you will pay on the day of entering into the transaction. .his is also the maximum loss that you can ever incur. If you buy a $atyam #ay (>) +all ,ption for 3s.(1, the maximum loss is 3s.(1. If $atyam closes above 3s.(>) on the expiry day, you will be paid the difference between the closing price and the strike price of 3s.(>). For example, if $atyam closes at 3s.=)), you will get 3s.;). 5fter setting off the cost of 3s.(1, your net profit is 3s.1*. .he +all buyer has a limited loss, unlimited profit profile. -o margins are applicable on the buyer. .he premium will be paid in cash upfront. If the $atyam scrip moves nowhere, the buyer is adversely impacted. 5s time passes, the value of the ,ption will fall. .hus if $atyam is currently at around 3s (>) and remains around that price till the end of #ay, the value of the ,ption which is currently 3s (1 would have fallen to nearly Eero by that time. .hus time affects the +all buyer adversely. Welingkar Institute of Management Development & Research =) page

Th! gra&h $* a )u1 Ca22 &$si(i$/ a&&!ars #!2$'

PA' OFF

BC> B>> C> > BJC ==> =CC =A> H=C <C> HI>

STRI.E PRICE

S!22 a Pu( O&(i$/ 5nother bullish strategy is to sell a 'ut ,ption. 5s a 'ut $eller, you will receive 'remium. For example, if you sell 3eliance #ay =)) 'ut ,ption for 3s 1FL you will earn an Income of 3s 1F on the day of the transaction. 8ou will however face a risk that you might have to pay the difference between =)) and the closing price of 3eliance scrip on the last .hursday of #ay. For example, if 3eliance were to close on that day at 3s (94, you will be asked to pay 3s (4. 5fter setting of the 'remium received of 3s 1F, the net loss will be 3s 9. If on the other hand, 3eliance closes above 3s =)) %as per your bullish view&, the entire income of 3s 1F would belong to you. 5s a 'ut $eller, you are reHuired to put up #argins. .hese margins are calculated by the exchange using a software program called $pan. .he margins are likely to be between () to Welingkar Institute of Management Development & Research =1 page

=4G of the +ontract 2alue. 5s a 'ut $eller, you have a limited profit, unlimited loss profile which is a high risk strategy. If time passes and 3eliance remains wherever it is %say 3s =))&, you will be very happy. 'assage of time helps the $ellers as value of the ,ption declines over time

Th! &r$*i2! $* (h! Pu( S!22!r '$u2 a&&!ar as u/ !r4

)u22 S&r!a s First of all, $preads are strategies, which combine two or more +alls %or alternatively two or more 'uts&. 5nother series of $trategies goes by the name +ombinations where +alls and 'uts are combined. 0ull $preads are those class of strategies that enable you benefit from a bullish phase on the index or scrip in Huestion. 0ull spreads allow you to create a limited profit, limited loss model of payoff, which you might be very comfortable with. )u22 S&r!a usi/g Ca22sG Pu(s

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0ull spreads can be created using +alls or using 'uts. 8ou need to buy one +all with a lower strike price and sell another +all with a higher strike price and a spread position is created. Interestingly, you can also buy a 'ut with a lower strike price and sell another with a higher strike price to achieve a similar payoff profile.

)!arish S(ra(!gi!s
Vari$us #!arish s(ra(!gi!s &$ssi#2! $ell $crip Futures $ell Index Futures 0uy 'ut ,ption $ell +all ,ption 0ear $preads +ombinations of ,ptions and Futures 6et us discuss each one of them now. S!22 S,ri& Fu(ur! $r I/ !8 Fu(ur!s4< In the current Indian system, when you sell $crip Futures, you are not reHuired to deliver the underlying scrip. 8ou will be reHuired to deposit a certain margin with the exchange on sale of $crip Futures. If the $crip actually falls %as per your belief&, you can buy back the Futures and make a profit. For example, $atyam Futures are Huoting at 3s (4) and you sell them today as you are bearish. 8ou could buy them back after 1) days at say 3s (=) %if they fall as per your expectations&, generating a profit of 3s (). ?uestion of delivering $atyam does not arise in the present set up. 8ou will be reHuired to place a margin with the exchange which could be around (4G %an illustrative percentage&. If you accordingly place a margin of 3s >(.4), a return of 3s () in 1) days time works out to a wonderful =)G plus return. ,bviously, if $atyam Futures move up %instead of down& you face an unlimited risk of losses. 8ou should therefore operate with a stop loss strategy and buy back Futures if they move in reverse gear. 8ou could adopt the same strategy with Index Futures if you are bearish on the market as a whole. $imilar returns and risks are attached to this strategy. )u1 Pu( O&(i$/ .he 'ut ,ption will rise in value as the scrip %or index& drops. If you buy a 'ut ,ption and the scrip falls %as you believe&, you can sell it at a later date. .he advantage of a 'ut ,ption %as against Futures& is that your losses are limited to the 'remium you pay on purchase of the 'ut ,ption.

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For example, a $atyam (>) 'ut may Huote at 3s (1 when $atyam is Huoting at 3s (>;. If $atyam falls to 3s (;; in F days, the 'ut will move up to say 3s =1. 8ou can make a profit of 3s 1) in the process. -o margins are applicable on you when you buy the 'ut. 8ou need to pay the 'remium in cash at the time of purchase. S!22 Ca22 O&(i$/ If you are moderately bearish %or neutral or bearish&, you can consider selling a +all. 8ou will receive a 'remium when you sell a +all. If the underlying $crip %or Index& falls as you expect, the +all value will also fall at which point you should buy it back. For example, if $atyam is Huoting at 3s (>; and the $atyam (>) +all is Huoting at 3s 1F, you might well find that in F days when $atyam falls to 3s (;;, the +all might be Huoting at 3s 9. Bhen you buy it back at 3s 9, you will make a profit of 3s 11. However, if $atyam moves up instead of down, the +all will move up in value. 8ou might be reHuired to buy it back at a loss. 8ou are exposed to an unlimited loss, but your profits are limited to the 'remium you collect on sale of the +all. 8ou will receive the 'remium on the date of sale of the ,ption. 8ou will however be reHuired to keep a margin with the exchange. .his margin can change on a day to day basis depending on various factors, predominantly the price of the scrip itself. )!ar S&r!a s In a bear spread, you buy a +all with a high strike price and sell a +all with a lower strike price. For example, you could buy a $atyam =)) +all at say 3s 4 and sell a $atyam (>) +all at 3s (>. 8ou will receive a 'remium of 3s (> and pay a 'remium of 3s 4, thus earning a -et 'remium of 3s (1. If $atyam falls to 3s (>) or lower, you will keep the entire 'remium of 3s (1. ,n the other hand if $atyam rises to 3s =)) %or above& you will have to pay 3s ;). 5fter set off of the Income of 3s (1, your maximum loss will be 3s 1*. $ 0

$atyam +losing 'rice 250 255 2$0 2#0 281 290 300

'rofit on (>) $trike +all %7ross& 0 0 0 -10 -21 -30 -)0

'rofit on =)) $trike +all %7ross& 0 0 0 0 0 0 0

'remium 3eceived on !ay ,ne 21 21 21 21 21 21 21

-et 'rofit 21 21 21 11 0 -9 -19

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-50

10

21

-19

Th! &a1 $** &r$*i2! a&&!ars as u/ !r4 In a bear spread, your profits and losses are both limited. .hus, you are safe from an unexpected rise in $atyam as compared to a clean ,ption sale. C$5#i/a(i$/ $* Fu(ur!s a/ O&(i$/s4< If you sell Futures in a bearish framework, you run the risk of unlimited losses in case the scrip %or index& rises. 8ou can protect this unlimited loss position by buying a +all. .his combination will result effectively in a payoff similar to that of buying a 'ut. 8ou can decide the strike price of the +all depending on your comfort level. For example, $atyam is Huoting at 3s (>; currently and you are bearish. 8ou sell $atyam Futures at say 3s (>4. If $atyam moves up, you will make losses. However, you do not want unlimited loss. 8ou could buy a $atyam =)) +all by paying a small 'remium of 3s 4. .his will arrest your maximum loss to 3s =4. If $atyam moves up beyond the 3s =)) level, you will receive compensation from the +all, which will offset your loss on Futures. For example, if $atyam moves to 3s =1(, you will make a loss of 3s ;9 on Futures %=1( J (>4& but make a profit of 3s 1( on the +all %=1( J =))&. For this comfort, you shell out a small 'remium of 3s 4 which is a cost.

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CHAPTER- 0 CASE A'A"$S&S

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:CASE ANAL3SIS;
Fu(ur!s C$/(ra,(4<
Cas!4<Bs( +lient name" #rs. $onali 'ritesh 0edmutha .he investor traded as followsL $he purchases the future of the )HEL of expire on (FD)>D()1)L !ate $ecurities ?ty. bought 1(4 1(4 ?ty. sold 7ross rate (;F=.( (;F(.4 /xpenses -et rate 144.() 144.14 (;F;.; (;F=.9; .otal =1)444.( =1)149.=

(FD)>D()1) 0H/6 (FD)>D()1) 0H/6

.he above trade is type of intraday i.e. the trade is completed in one trading session. .he investor is in loss of 3s. =*9.F>. $he invest 3s.>(111.; %()G of 3s. =1)444.(& as the margin money for a day and has a loss of 3s.=*9.F>, it means she had a loss N ).>;G. ,ther than the future contract if she invests in other field e.g. cash market she makes a loss N ).1=G, which is much less than the loss in the future contract. Cas!4<=/ +lient name" #r. 'ankaj 3amdas 'atel .he Investor traded as followsL !ate $ecurities ?ty. 0ought 1;D)>D()1) 1;D)>D()1) -IFF.8 -IFF.8 4) 4) ?ty. $old 7ross 3ate 41;4 41F) 1(F.>= 1(*.4 41;9.49 4199.;1 (49=9F.> (4FF9).4 /xpenses -et 3ate .otal

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.he above trade is type of intraday trade i.e. the transaction is completed in a trading session. .he investor earns the profit of 3s. 1;*1.FF. He invests the margin money 3s.41;94.9= %()G of 3s.(49=9F.>& for a day < earns 3s.1;*1.FF, it means he earn N(.*)G after the all charges. ,ther than the derivatives if he invests in cash market i.e. in eHuity then he earn 3s.1;*1.FF on investment of 3s.(1((*4.)) in one day, the rate of return is ).4FG, which is much less than he earn in future contract. Cas!4<Hr +lient name" #r. 1ayesh 6axshman Bani .he investor traded as followsL !ate $ecurities ?ty. 0ought ())) ())) ())) ())) ())) ())) ())) ())) ())) ())) ?ty. $old 7ross rate 1FF 1FF.;) 1FF.;) 1*(.4 1*(.4 1*>.4) 1*>.4) 1*9 1*9 1*9.4 /xp. -et rate .otal

(4D)>D1) 3+,# =)D)>D1) 3+,# =)D)>D1) 3+,# =)D)>D1) 3+,# =)D)>D1) 3+,# =)D)>D1) 3+,# =)D)>D1) 3+,# =)D)>D1) 3+,# =)D)>D1) 3+,# =)D)>D1) 3+,#

1FF 1FF.;) 1FF.;) 1*(.4 1*(.4 1*>.4) 1*>.4) 1*9 1*9 1*9.4

1FF.)*; 1FF.4) 1FF.4) 1*(.> 1*(.> 1*>.4*F 1*>.4*F 1*9.)** 1*9.)** 1*9.4**

=9>1FF =9>*FF.; =9>*FF.; =F41*(.4 =F41*(.4 =*(F)=.4 =*(F)=.4 =*=F)= =*=F)= =*;F)(.4

In above trade the investor sell five lot of 3+,# %3eliance +ommunication& by date =)D)>D()1) out of which four are bought on =)D)>D()1) and one is standing by date (4D1)D()1). From the above trade he earns the net profit of 3s.>*;=;.9, after deducting the expenses. It means he invest 3s.=F)1)*.*> i.e. ()G of 3s.1*))44), on which he earn the profit of 3s.>9;>4.9. If we calculate the rate of return in percentage it comes to 19.94G. If the investor invests any where other than the future the rate of return is much less than the return in future contract. If he invest in cash market and earn same amount of profit i.e. 3s.>9;>4.9, but the rate of return is much less, which comes to =.44G. Welingkar Institute of Management Development & Research =F page

Cas!4<@(h +lient name" #r. !inesh $hah. .he investor traded as followsL !ate $ecurities ?ty. bought 1))) ())) 1))) 1))) 1))) 1))) 1))) 1))) 1))) 1))) 1))) ?ty. sold 7ross rate (>>.4 (>9.( (>9.4 (>* (9).4 (>9.4 (>F (>F.4 (9) (91 (9( /xp. -et rate .otal

)(D)>D()1) )(D)>D()1) )(D)>D()1) )(D)>D()1) )(D)>D()1) )(D)>D()1) )(D)>D()1) )(D)>D()1) )(D)>D()1) )(D)>D()1) )(D)>D()1)

!6F !6F !6F !6F !6F !6F !6F !6F !6F !6F !6F

1==.(4 (>9.( 1==.94 1=;.4 1=4.(4 1==.94 1=; 1=;.(4 1=4 1=4.4 1=>

(>>.>= (>9.== (>9.>= (>*.1= (9).>; (>9.=9 (>9.F9 (>F.=9 (>*.F9 (9).F> (91.F>

(>>>==.= 534667.2 (>9>==.F (>*1=;.4 (9)>=4.= (>9=>>.= (>9F>> (>F=>4.F (>*F>4 (9)F>;.4 (91F>;

In the above trade, the investor buys six lot of !6F ltd., with expiry of (;D)>D()1) and sells all lot in trading session. .he investor earn net profit of 3s >;44.;, after deducting the all the charges. He invests the margin money of 3s. (>F(9;.1 i.e. ()G of 3s. 1=;1=9).)) and earns the profit of 3s. >;44.;. It means that he earn N(.;1G. If he invests in other field or in some other investment, rate of return is much less than rate of return which he earn in future contract. If he invests in cash market, then the rate of return is N).;FG.

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O&(i$/ C$/(ra,(4<
Cas!4<Bs( +lient name" #r. #anohar 3amdas 0handari !ate $ecurities ?ty. bought (9D)9D)F (FD)9D)F -IFF.8 -IFF.8 4) 4) ?ty. sold 7ross rate F.*) ;.>4 /xp. -et rate .otal

1)) 1))

1).* (.>4

4;4 1=(.4

In the above trade the investor buy +all of the -IFF.8 ;=)) of expiry =1D)9D())F. .he net rate at which he bought the call is ;=)*.11=> i.e. margin money plus strike price, he assume market goes up i.e. -IFF.8 goes towards ;=)), if that possible then he must earn maximum profit in option contract. 0ut hear the price of -IFF.8 goes down, so due to this price of the call goes down and investor suffer loss. 0ut in option there is minimum loss and maximum profit. In above trade investor invests only the margin money to buy the call of -IFF.8, the amount is 3s4;4 on which he losses 3s. ;1(.4. .he loss is minimum than the loss he will bear if he invest in cash market. Cas!4<=/ +lient name" #r. $nehal 0haiyyaji 'isudde. !ate $ecuritie s -IFF.8 -IFF.8 ?ty. bought 4) 4) ?ty. sold 7ross rate *( ** /xp -et rate *; *9 .otal

(;D)>D()1) (;D)>D()1)

1)) 1))

;9)) ;F4)

In the above trade caller buy a put option with strike of 4;)) i.e. '/ 4;)) at option price *(. !uring this market goes down and his option price increases to **. He sold a 'ut ,ption at **. !uring this trading, he made a profit of 3s.14), after deducting brokering charges.

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CHAPTER- 1 F&'!&'#S

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FINDINGS
1& !erivatives provided seven additional trading instruments to the investors. (& !erivatives, as their name implies, are contracts they are based on or derived from some underlying assets, reference rate, or index. #ost common financial derivatives, described later, can be classified as one, or a combination, of four types" swaps, forwards, futures, and options that are based on interest rates or currencies. =& Bithout clearly define risk management strategy, use of financial derivatives can be dangerous. It can be threaten the accomplishment of a firmIs long range objectives and result in unsafe and unsound practices that could lead to the organiEationIs insolvency. 0ut when used wisely, financial derivatives can increase shareholder value by providing a means to better control a firmIs risk exposures and cash flows. ;& Financial derivatives can be used in two ways" to hedge against the unwanted risk or to speculated by taking a position in anticipation of a market movement. 4& Financial derivatives have changed the face of finance by creating new ways to understand, measure, and manage risks. .he freedom to manage risk effectively must not be taken away. >& !ifferent trading strategies can be used by investors under different market trends i.e. bullish, bearish, range bound and volatile market. 0ut it is not easy to make profits in cash market in different market trends 9& !erivatives offer organiEations the opportunity to break financial risks into smaller components and then to buy and sell those components to best meet specific risk management objectives. #oreover, under a market oriented philosophy, derivatives allows for the free trading of individual risk components, thereby improving market efficiency. :sing financial derivatives should be considered a part of any businessIs risk management strategy to ensure that value enhancing investment opportunity could be pursued. F& From the simple forward agreement, financial future contracts were developed. Futures are similar to forwards, except that futures are standardiEed by /xchange clearinghouse, which facilitated anonymous trading in more competitive and liHuid market. In addition futures contracts are marked to market daily, which greatly decreases counter party risk. .he other party to the transaction will be unable to meet its obligation on the maturity dates.

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*& !erivatives also help to improve market efficiencies because risk can be isolated and sold to those who are willing to accept them at the least cost. :sing derivatives breaks risk into pieces that can be managed independently. +orporations can keep the risk they are most comfortable managing and transfer those they do not want to other companies that are more willing to accept them. From a market orientated prospective, derivatives offer the free trading of financial risks. 1)& #ost of the investors have not sufficient knowledge of derivative instruments, and hence they deal in cash market %eHuity market& only.

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CHAPTER- 2 CO'C")S&O'

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CONCLUSION4
.he project was done in order to understand and study various trading strategies used in derivatives. It included the study of various instruments like forward, future and options. ,n the basis of the analysis done, I conclude the following J !erivatives are the contracts derived form some underlying stock or index. #ost of common !erivative instruments are futures, options. 2arious trading strategies like bullish, bearish, neutral and volatile strategies can be used by the investors according to the market trends. !erivatives have become very important in the field finance. .hey are very important financial instruments for risk management as they allow risks to be separated and traded. !erivatives are used to shift risk and act as a form of insurance. .here are very few people knowing exactly what derivatives is all about. In my concluding part I would like to say that !erivatives could be a very effective tool to take advantage of a rising, falling and range bound underlying. 0ut for that awareness is to be created about the terminology of derivatives.

0ut as it is said @High ris% high r!(ur/A future and option are best way for hedging risk for high < high returns.

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CHAPTER-8 Suggestion

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SUGGESTION
17 Mar%!( s!/(i5!/( a( (h! (i5! $/ &ur,has!4 It is often that timing is everything but the longer your time horiEon, the less important is timing of your purchase. #arket sentiment can be gauged by the general direction of various market indices, the number of companiesI exceeding or not meeting earnings < what the investment community %analyst, brokers, traders, investors, commentators& are saying about eHuities in general or specific eHuities that pertain to the one you are considering. (& I/ us(r1 $* (h! ,$5&a/14 #any industries have are cyclical in nature. .hus a company may report excellent earning and posses strong fundamentals moving forwards, but due to itIs cyclical nature will decline over a given time period. 8ou should also evaluate the growth prospectus of the industry. For instance, wireless is as area that is expected to see a lot of growth in coming years. 0e careful though, as only a few companies often dominated sectors that are in their infancy in the long term future. =& .he concept of derivatives is not very simple. 5n investor should therefore have sound knowledge of technical terms in !erivatives before dealing in Future market. ;& 5n investor can use different strategies like bullish, bearish, neutral and volatile strategies in different market trends i.e. bullish, bearish, range bound and volatile market. 4& .he investor should also note that the price of future contracts depends on many factors which are uncontrollable. .herefore he should take care of such factors.

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B&B"&O#RAPH$
R!*!r!/,! )$$%4 NCFM M$ u2! E D!ri.a(i.!s Mar%!( 6D!a2!r a/ EDui(1 7 M$ u2! -$/ India Fi/a/,ia2 Ma/ag!5!/( 3avi. #. Kisore

W!#si(!s4 www.sbicap securities.com www.nseindia.com www.derivativesindia.com www.bseindia.com www.stock option trading.com www.moneycontrol.com

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