21 Derivative

DERIVATIVES (Instrument for risk reduction)
INTRODUCTION
The past decade witness the multiple growths in the volume of
international trade usiness due to the wave of gloali!ation and lierali!ation
all over the world" As a result# the demand for the international mone$ and
financial instruments increased significantl$ at the gloal level" In this respect#
changes in the interest rate# e%change rate# and stock market price at the
different financial market have increased the financial risk to the corporate
world" It is therefore to manage such risks& the new financial instrument has
een developed in this financial market# which is also known as financial
Derivatives"

The asic purpose of this instrument is to provide commitment to price
for future date for giving protection against adverse movement in future price
in order to reduce the e%tent of financial risks" 'ot onl$ this# the$ also provide
opportunit$ to earn profit for those who are read$ to go for high risks"
This instrument facilitates to transfer the risks from those who wish to
avoid it to those who are willing to accept the risks"
TYBBI 1
WHAT IS A DERIVATIVE?
Derivatives is a product( contract# which does not have an$ value on its
own i"e" it# derives its value from some underl$ing" Derivatives or derivatives
securities are contracts which are written etween two parties (counter
parties) and whose values is derived from underl$ing widel$ held and easil$
marketale assets such as agricultural and other ph$sical (tangile)
commodities or currencies or short term and long term financial instruments
tangile things like commodities price inde% (inflation rate)# e)uit$ price inde%
or ond price inde%" The counter parties to such contract are those other than
the original issuer (holder ) of the underl$ing assets " The e%change*traded
derivatives are )uit li)uid and have low transaction cost" It is possile to
comine them to match specific re)uirements"
The value of derivatives and those of their underl$ing assets are
closel$ related" +suall$ in trading derivatives# the taking or making of deliver$
of underl$ing assets is not involved & the transactions are mostl$ settled $
taking offsetting positions in the derivatives themselves" There is therefore# no
effective limit on the claims# which can e traded in respect of underl$ing
assets" Derivatives are ,off alance- instruments# a fact is said to e oscure
the leverage and financial might give to the part$" The$ are mostl$ secondar$
market instruments and have little usefulness in moili!ing fresh capital $ the
companies" Although the standardi!ed# general e%change traded derivatives
are eing increasingl$ evolved# still there are man$ privatel$ negotiated#
customi!ed# .T/* traded financial contracts which are in vogue and which
e%pose the uses to operational risk" There is also and uncertaint$ aout the
regulator$ status of such derivatives"
Derivatives are used to facilitate hedging of price risk of inventor$
holding or a financial ( commercial transaction over a certain period" In
practice# ever$ derivatives 0contract1 has a fi%ed e%piration date # mostl$ in the
range of 2 to 23 months from the date of commencement of the contract"
(4resentl$ 2#3#5# month-s contracts are availale in India)
Example: A ver$ simple e%ample of derivatives is curd# which is
derivative of milk" The price of curd depends upon the price of milk which in
turn depends upon the demand 6 suppl$ of milk"
TYBBI 2

CLASSIFICATION OF DERIVATIVES
Derivatives markets can asicall$ e classified into commodit$ and 7inancial
Derivatives market" /ommodit$ markets are further classified into tangile
commodities 6 intangile commodities" 7inancial derivatives roadl$ has four
ranches vi!" Real Estate# 7ore%# E)uit$ derivatives and Det Derivatives"
E)uit$ derivatives are further divided into inde% 4roducts and derivatives on
securities and Det derivatives are further divided into Interest rate 4roducts
and 8.I Securities # onds# T*ills"
TYBBI 3
HISTORY OF DERIVATIVES
The first centrali!ed commodities market in 9ritain was founded in
the 2:;<s in the Ro$al E%change (later to ecome the first home of the
=ondon International 7inancial 7utures E%change)" +nfortunatel$ the 8reat
7ire of =ondon destro$ed the Ro$al E%change in 2;;;# although trading
continued in the various coffee houses that were springing up in the /it$ of
=ondon at the time" Eventuall$ each coffee house started to speciali!e in
one particular product> the =ondon /ommodit$ E%change in the Virginian
and 9altic coffee house the =ondon ?etal E%change in @erusalem and the
=ondon Stock E%change in @onathans" At the same time there was an
options market in Aolland at the Amsterdam Trade /enter ased on tulips"
+nfortunatel$ the speculative use of these options rought aout the
collapse of the Dutch econom$
.rgani!ed futures markets# as we know them toda$ reall$ developed in
the last centur$# primaril$ in the +S# when the /hicago 9oard of Trade
(/9.T) was estalished in 2BCB" At that time /hicago was not onl$ at the
center of the railroads& it was also an important port on the 8reat =akes and
close to the ?idwest farmlands" Dith /hicago eing such an important center
for agricultural markets the /9.T was estalished to provide farmers with a
central market place to guarantee the prices for their livestock and grain"
THE NEED FOR A DERIVATIVES MARKET
The derivatives market performs a numer of economic functions>
2" The$ help in transferring risks from risk averse people to risk oriented
people
3" The$ help in the discover$ of future as well as current prices
5" The$ catal$!e entrepreneurial activit$
C" The$ increase the volume traded in markets ecause of participation of risk
averse people in greater numers
:" The$ increase savings and investment in the long run
TYBBI 4
FACTORS DRIVING THE GROWTH OF FINANCIAL
DERIVATIVES:
2" Increased volatilit$ in asset prices in financial markets#
3" Increased integration of national financial markets with the international
markets#
5" ?arked improvement in communication facilities and sharp decline in their
costs#
C" Development of more sophisticated risk management tools# providing
economic agents a wider choice of risk management strategies# and
:" Innovations in the derivatives markets# which optimall$ comine the risks
and returns over a large numer of financial assets leading to higher returns#
reduced risk as well as transactions costs as compared to individual financial
assets"
WHAT KINDS OF RISKS DO PARTICIPANTS IN THE
DERIVATIVES MARKETS FACE?
Some example o! "#$ a"e p"o%#&e& 'elo(>
Co)*+e"pa"+, -o" &e!a)l+. "#$ E ver$ low or almost !ero ecause
the e%change takes on the responsiilit$
Ope"a+#o*al "#$ E risk that operational s$stems might fail
Le/al "#$ E risk that legal oFections might e raised# regulator$
framework might disallow some activities
Ma"$e+ "#$ E risk that market prices ma$ move ups or down
L#0)#&#+, "#$ E risk that unwinding of transactions might e
difficult if the market is illi)uid"
TYBBI 5
TYPES OF DERIVATIVES
Fo"(a"&> A forward contract is a customi!ed contract etween two
entities# where settlement takes place on a
specific date in the future at toda$-s pre*agreed price"
F)+)"e> A futures contract is an agreement etween two parties to u$ or
4rofit contracts are special t$pes of forward contracts which are
standardi!ed e%change*traded contracts"
Op+#o*> .ptions are of two t$pes * calls and puts" /alls give the u$er
the right ut not the oligation to u$ a given )uantit$ of the underl$ing
asset# at a given price on or efore a given future date" 4uts give the
u$er the right# ut not the oligation to sell a given )uantit$ of the
underl$ing asset at a given price on or efore a given date"
Wa""a*+: .ptions generall$ have life of upto one $ear# the maForit$ of
options traded on options e%changes having a ma%imum maturit$ of nine
months" =onger*dated options are called warrants and are generall$
traded over*the*counter"
LEAPS: The acron$m =EA4S means =ong *Term E)uit$ Anticipation
Securities" These are options having a maturit$ of upto three $ears"
=EA4S are not currentl$ availale in India"
1a$e+: 9asket options are options on portfolios of underl$ing assets"
The underl$ing asset is usuall$ a moving average or a asket of assets"
E)uit$ inde% options are a form of asket options"
TYBBI 6
S(ap > Swaps are private agreements etween two parties to e%change
cash flows in the future according to a prearranged formula" The$ can e
regarded as portfolios of forward contracts"
T2e +(o 3ommo*l, )e& (ap a"e
45 I*+e"e+ "a+e (ap
65 C)""e*3, (ap
I*+e"e+ "a+e (ap: These entail swapping onl$ the interest related
cash flows etween the parties in the same currenc$"
C)""e*3, (ap> These entail swapping oth principal and interest
etween the parties with the cashflows in one direction eing in a different
currenc$ than those in the opposite direction"
S(ap+#o*: Swaption are options to u$ or sell a swap that will ecome
operative at the e%pir$ of the options" Thus a Swaption is an option on a
forward swap" Rather than have calls and puts# the Swaption market has
receiver Swaption and pa$er Swaption" A receiver Swaption is an option to
receive fi%ed and pa$ floating interest" A pa$er Swaption is an option to
pa$ fi%ed and receives floating interest"
TYBBI 7
DERIVATIVES MEM1ERSHIP
The Derivatives Segment memership is open to the e%isting memers
of the /ash Segment as well as non*memers provided the$ fulfill the
memership re)uired as laid down from time to time" The following are the
different t$pes of memership presentl$ availale for the Derivatives Segment>
2) P"o!e#o*al Clea"#*/ Mem'e" -PCM.: 4/? means a /learing
?emer# who is permitted to clear and settle trades on his own account# on
account of his clients and ( or on account of trading memers and their clients"
3) C)+o&#a* Clea"#*/ Mem'e" -CCM.: //? means /ustodian
registered as /learing ?emer# who ma$ clear and settle trades on his own
account# on account of his clients and ( or on account of trading memers and
their clients"
5) T"a&#*/ C)m Clea"#*/ Mem'e" -TCM.: A T/? means a Trading
?emer who is also a /learing ?emer and can clear and settle trades on his
own account# on account of his clients and on account of associated Trading
?emers and their clients"
C) Sel! Clea"#*/ Mem'e" -SCL)> A S/? means a Trading ?emer who is
also a /learing ?emer and can clear and settle trades on his own account and
on account of his clients"
:) T"a&#*/ Mem'e" -TM.: AT? is a memer of the E%change who has
onl$ trading rights and whose trades are cleared and settled $ the /learing
?emer with whom he is associated"
;) L#m#+e& T"a&#*/ Mem'e" -LTM.: A =T? is a memer# who is not the
memers of the /ash Segment of the E%change# and would like to e a Trading
?emer in the Derivatives Segment at 9SE" An =T? has onl$ the trading rights
and his trades are cleared and settled $ the clearing memer with whom he
is associated"
As on @anuar$ 2# 3<<5# there are 2 4rofessional /learing ?emer# 5
/ustodian /learing ?emers# G: Trading cum /learing ?emers# H5Trading
?emers and 2G =imited Trading ?emers in the Derivative Segment of the
E%change"
TYBBI 8
"
F#*a*3#al "e0)#"eme*+ !o" &e"#%a+#%e mem'e"2#p
The most asic means of controlling counter*part$ credit and li)uidit$
risks is to deal onl$ with creditworth$ counter*parties" The E%change seek to
ensure that their memers are creditworth$ $ la$ing down a set of financial
re)uirements for memership" The memers are re)uired to meet# oth
initiall$ and on an ongoing asis# minimum networth re)uirement" +nlike /ash
Segment memership where all the trading memers are also the clearing
memers#in the derivatives Segment the trading and clearing rights are
segregated" In other words# a memer ma$ opt to have oth clearing and
trading rights or he ma$ opt for trading rights onl$ in which case his trades are
cleared and settled $ his associated /learing ?emer" Accordingl$# the
networth re)uirement is ased on the t$pe of memership and is as under>
TYBBI 9
TYPES OF MEM1ERSHIPS
NET WORTH
RE7UIREMENTS
-RS5 LAKHS.
4rofessional /learing ?emer# /ustodian /learing
?emer and Trading cum /learing ?emer
5<<
Self /learing ?emer
2<<
Trading ?emer
3:
=imited Trading ?emer
3:
=imited Trading ?emer (for memers of other stock
e%change whose /learing ?emer is a susidiar$
compan$ of a Regional Stock E%change)
2<
CAPITAL ADE7UACY RE7UIREMENT
Ever$ /learing ?emer of the Derivatives Segment is re)uired to
maintain a minimum capital deposit of Rs" :< lakhs with the E%change# of
which# the 3:I is to e deposited in cash# 3:I $ wa$ of cash ( fi%ed deposit
receipts of ank(s) and the alance $ wa$ of ank guarantee(s) or eligile
securities" In addition to aove# a /learing ?emer is re)uired to deposit Rs"
G": lakhs with the E%change in the specified form for ever$ T? ( =T?
associated with him" Amount deposited $ a /learing ?emer in addition to
Rs" :< lakhs is treated as his additional capital deposit or initial margin
deposit" :<I of the additional capital deposit should e in the form of cash or
cash e)uivalents# vi!"# /ash# 7DRs# ank guarantees" At all points of time# a
TYBBI 10
/learing ?emer-s li)uid networth# i"e"# total capital deposited less capital
used towards margin should e greater than or e)ual to Rs" :< lakhs"
FORWARD CONTRACT
FUTURE CONTRACT
OPTION CONTRACT
SWAP CONTRACT
FORWARD CONTRACT
A forward contract is an agreement to u$ or sell an asset on a
specified date for a specified price agreed upon toda$ " It is a deal for the
purchase or sale of a commodit$# securit$ or other asset in the spot or forward
market" The essential idea of entering into a forward contract is to peg the
price and there$ avoid the price risk" +suall$ no part$ changes hands when
forward contracts are entered" Although a forward contract is a good means of
avoiding price risk ut it entails an element of risk that the part$ to the contract
ma$ not honor its part of the oligation"
.nce a position of u$er or seller is taken an investor cannot retreat
e%cept through mutual consent or u$ entering into an identical contract $
reversing his position" Dith forward contracts entered into on a one to one
asis and with no standardi!ation the forward contracts have a ver$ low
degree of li)uidit$" Therefore# the prolem associated with the forward
contracts led to the emergence of future contracts"
TYBBI 11
E8AMPLE
Imagine $ou are a farmer" Jou grow 2#<<< do!ens of mangoes ever$ $ear"
Jou want to sell these mangoes to a merchant ut are not sure what the price
will e when the season comes" Jou therefore agree with a merchant to sell
all $our mangoes for a fi%ed price for Rs 3 lakhs"
This is a forward contract wherein $ou are the seller of mangoes forward and
the merchant is the u$er"
The price is agreed toda$ in advance and the deliver$ will take place
sometime in the future"
WHERE ARE FORWARDS USED?
7orwards have een used in the commodities market since centuries"
7orwards are also widel$ used in the foreign e%change market"
ESSENTIAL FEATURES OF A FORWARD CONTRACT
K /ontract etween two parties (without an$ e%change etween them)
K 4rice decided toda$
K Luantit$ decided toda$ (can e ased on convenience of the parties)
K Lualit$ decided toda$ (can e ased on convenience of the parties)
K Settlement will take place sometime in future (can e ased on convenience
of the parties)
K 'o margins are generall$ pa$ale $ an$ of the parties to the other

LIMITATIONS OF FORWARDS
7orwards involve counter part$ risk" In the aove e%ample# if the merchant
does not u$ the mangoes for Rs 3 lakhs when the season comes# what can
$ou doM Jou can onl$ file a case in the court# ut that is a difficult process"
7urther# the price of Rs 3 lakhs was negotiated etween $ou and the
merchant"
If someod$ else wants to u$ these mangoes from $ou# there is no
mechanism of knowing what the right price is"
TYBBI 12
T2)9 +2e +(o ma:o" l#m#+a+#o* o! !o"(a"& a"e:
K /ounter part$ risk
K 4rice not eing transparent
/ounter part$ risk is also referred to as ,default- risk or ,credit- risk"
FUTURE CONTRACT
7utures trading was started in the mid E western part of +SA during
2HG<-s # ut toda$ it is traded through out the world" 7utures markets were
designed to solve the prolems that e%ist in forward markets" A futures
contract is an agreement etween two parties to u$ or sell an asset at a
certain time in the future at a certain price" 7utures are similar to forwards ut
unlike forward contracts# the futures contracts are standardi!ed and e%change
traded" " 4rices are availale to all those who want to u$ or sell ecause the
trading takes place on a transparent computer s$stem" To facilitate li)uidit$ in
the futures contracts# the e%change specifies certain standard features of the
contract" It is a standardi!ed contract with standard underl$ing instrument# a
standard )uantit$ and )ualit$ of the underl$ing instrument that can e
delivered# (or which can e used for reference purposes in settlement) and a
standard timing of such settlement" A futures contract ma$ e offset prior to
maturit$ $ entering into an e)ual and opposite transaction" ?ore than HHI of
futures transactions are offset this wa$"
T2e +a*&a"&#;e& #+em #* a !)+)"e 3o*+"a3+ a"e: <
Luantit$ of the underl$ing
Lualit$ of the underl$ing
The date and the month of deliver$
The units of price )uotation and minimum price change
=ocation of settlement
TYBBI 13
FEATURES OF FUTURES
K /ontract etween two parties through an e%change
K E%change is the legal counter part$ to oth parties
K 4rice decided toda$
K Luantit$ decided toda$ ()uantities have to e in standard denominations
specified $ the e%change)
K Lualit$ decided toda$ ()ualit$ should e as per the specifications decided $
the e%change)
K Tick si!e (i"e" the minimum amount $ which the price )uoted can change) is
decided $ the e%change
K Deliver$ will take place sometime in future (e%pir$ date is specified $ the
e%change)
K ?argins are pa$ale $ oth the parties to the e%change
K In some cases# the price limits (or circuit filters) can e decided $ the
e%change"
LIMITATION OF FUTURE:
7utures suffer from lack of fle%iilit$"
Suppose $ou want to u$ 2<5 shares of Sat$am for a future deliver$ date of
2Cth 7eruar$# $ou cannot" The e%change will have standardi!ed
specifications for each contract" Thus# $ou ma$ find that $ou can u$ Sat$am
futures in lots of 2#3<< onl$" Jou ma$ find that e%pir$ date will e the last
Thursda$ of ever$ month"
TYBBI 14
Thus# while forwards can e structured according to the convenience of the
trading parties involved# futures specifications are standardi!ed $ the
e%change"
FUTURE TERMINOLOGY
Spo+ p"#3e: The price at which an asset trades in the spot market"
F)+)"e p"#3e: The price at which the futures contract trades in the futures
market"
Co*+"a3+ 3,3le: The period over which a contract trades" The inde%
futures contracts on the 'SE have one*month# two*months and three*
months e%pir$ c$cles# which e%pire on the last Thursda$ of the month"
Thus a @anuar$ e%piration contract e%pires on the last Thursda$ of
@anuar$ and a 7eruar$ e%piration contract ceases trading on the last
Thursda$ of 7eruar$" .n the 7rida$ following the last Thursda$# a new
contract having a three*month e%pir$ is introduced for trading"
Exp#", &a+e: It is the date specified in the futures contract" This is the last
da$ on which the contract will e traded# at the end of which it will cease to
e%ist"
Co*+"a3+ #;e: The amount of asset that has to e delivered under one
contract" 7or in*stance# the contract si!e on 'SE-s futures market is 3<<
'ifties"
1a#: In the conte%t of financial futures# asis can e defined as the
futures price minus the spot price" There will e a different asis for each
deliver$ month for each contract" In a normal market# asis will e positive"
This reflects that futures prices normall$ e%ceed spot prices"
Co+ o! 3a"",: The relationship etween futures prices and spot prices
can e summari!ed in terms of what is known as the cost of carr$" This
TYBBI 15
measures the storage cost plus the interest that is paid to finance the
asset less the income earned on the asset"
I*#+#al ma"/#*: The amount that must e deposited in the margin account
at the time a futures contract is first entered into is known as initial margin"
Ma"$#*/<+o<ma"$e+: In the futures market# at the end of each trading da$#
the margin ac*count is adFusted to reflect the investor-s gain or loss
depending upon the futures closing price" This is called markingEtoE
market"
Ma#*+e*a*3e ma"/#*: This is somewhat lower than the initial margin" This is
set to ensure that the alance in the margin account never ecomes negative"
If the alance in the margin account falls elow the maintenance margin# the
investor receives a margin call and is e%pected to top up the margin account
to the initial margin level efore trading commences on the ne%t da$"
Ma+)"#+, o! !)+)"e 3o*+"a3+
Inde% futures of different maturities trade simultaneousl$ on the e%changes"
7or instance# 9SE trades three contracts on 9SE SE'SEN with one# two and
three month-s maturit$" These contracts of different maturities are called near
month (one month)# middle month (two months) and far month (three months)
contracts" At an$ point of time there will e three futures contracts availale
for trading"
TYBBI 16
Mea*#*/ o! exp#", o! F)+)"e
7utures contracts will e%pire on a certain pre*specified date" In India# futures
contracts e%pire on the last Thursda$ of ever$ month"
7or e%ample# a 7eruar$ 7utures contract will e%pire on the last Thursda$ of
7eruar$" In this case# 7eruar$ is referred to as the /ontract month"
If the last Thursda$ is a holida$# 7utures and .ptions will e%pire on the
previous working da$" .n e%pir$# all contracts will e compulsoril$ settled"
Settlement can e effected in cash or through deliver$"
Co*%e"/e*3e a+ Exp#"a+#o*
7utures pricing have e%pectations and a time value uilt into them" This
is the reason as time period e%pires the e%pectation value and the time value
deca$s and the futures price converges into the cash market price" This
process of convergence results in price discover$ of cash inde% at a given
point in time" /onvergence also forces the respective market participants to
s)uare off their respective e%posures or rollover their e%posures to the ne%t
contract month" /onvergence also reiterates the fact that derivatives
instruments have limited life"
TYBBI 17
WHAT TYPE OF MARGINS ARE PAYA1LE ON
FUTURES?
9oth u$ers and sellers of 7utures should pa$ an Initial ?argin to the
e%change at the point of entering into 7utures contracts" This Initial ?argin is
retained $ the e%change till these transactions are s)uared up"
7urther# ?ark to ?arket ?argins are pa$ale ased on closing prices at the
end of each trading da$" These ?argins will e paid $ the part$ who suffered
losses and will e received $ the part$ who made profits"
The e%change thus collects these margins from the losers and pa$s them to
the winners on a dail$ asis"
TYBBI 18
MARK = TO< MARKET
Ever$ da$ all the open positions in 7utures contracts are marked to the
closing price and the variation# if an$# is collected ( paid to the memers $
deiting ( crediting their settlement ank accounts with the respective clearing
anks on T O 2 morning" Also# where the positions are closed# profit ( loss on
such positions is also credited ( deited to the memer-s ank accounts"
Me+2o&olo/, !o" 3al3)la+#*/ 3lo#*/ p"#3e !o" &a#l, ma"$ +o
ma"$e+ :
The dail$ closing price of the futures contract for calculating mark*to*market
margin is arrived at using following algorithm>*
Deighted average price of all the trades in last half an hour of the continuous
trading session"
If there are no trades during last half an hour# then the theoretical price would
e taken as the official closing price" The theoretical price is arrived at $
using the following algorithm>*
T2eo"e+#3al p"#3e > Clo#*/ %al)e o! )*&e"l,#*/ ? - 3lo#*/
TYBBI 19
%al)e o! )*&e"l,#*/ @ No5 o! &a, +o exp#", @ "#$ !"ee #*+e"e+
"a+e - a+ p"ee*+ A5BC . D EFB .5
HOW CAN I S7UARE UP A FUTURES CONTRACT?
If $ou have ought a 7utures contract# $ou can sell it and thus s)uare up" If
$ou sold a 7utures contract# $ou can u$ it ack and s)uare up"
If $ou do not s)uare up till the da$ of e%pir$# it will e automaticall$ s)uared up
$ the e%change"
HOW TO 1ENEFIT FROM STOCK FUTURES
Jou are ullish on a stock sa$ Sat$am# which is currentl$ )uoting at Rs 3B<
per share" Jou elieve that in one month it will touch Rs 55<"
7)e+#o*: Dhat do $ou doM
A*(e"> Jou u$ Sat$am"
E!!e3+> It touches Rs 55< as $ou predicted E $ou made a profit of Rs :< on an
investment of Rs 3B< i"e" a Return of 2BI in one month E 7antastic PP
TYBBI 20
Wa#+> /an it get an$ etter M
Ye GG
7)e+#o*> Dhat should $ou do M
A*(e"> 9u$ Sat$am 7utures instead"
E!!e3+> .n u$ing Sat$am 7utures# $ou get the same position as Sat$am in
the cash market# ut $ou pa$ a margin and not the entire amount" 7or
e%ample# if the margin is 3<I# $ou would pa$ onl$ Rs :;" If Sat$am goes upto
Rs 55<# $ou will still earn Rs :< as profit" 'ow that translates into a faulous
return of BHI in one month"
U*'el#e%a'le GG1)+ T")e *e%e"+2ele GG
This is the advantage of ,leverage- which Stock 7utures provide" 9$ investing
a small margin (ranging from 2< to 3:I)# $ou can get into the same positions
as $ou would e ale to in the cash market" The returns therefore get
accordingl$ multiplied"
7)e+#o* > Dhat are the risksM
A*(e" > The risks are that losses will e get leveraged or multiplied in the
same manner as profits do" 7or e%ample# if Sat$am drops from Rs 3B< to Rs
3:<# $ou would make a loss of Rs 5<" The Rs 5< loss would translate to an
22I loss in the cash market and a :CI loss in the 7utures market"
7)e+#o* > what is the main advantage of 7uturesM
A*(e" > A great advantage of 7utures (at the moment) is that the$ are not
linked to ,deliver$-" Dhich means# $ou can sell 7utures (short sell) of Sat$am
TYBBI 21
even if $ou do not have an$ shares of Sat$am" Thus# $ou can enefit from a
downturn as well as from an upturn"
If $ou predict an upturn# $ou should u$ 7utures and if $ou predict a downturn#
$ou can alwa$s sell 7utures E thus $ou can make mone$ in a falling market as
well as in a rising one E an opportunit$ that till recentl$ was availale onl$ to
rokers(operators and not easil$ to retail investors"
Jou should look for opportunities where futures prices are higher than cash
prices" 7or e%ample# if Sat$am is )uoting at Rs 3:< in the cash market and
one month Sat$am futures are )uoting at Rs 3:5 in the futures market# $ou
can earn Rs 5 as difference" Jou will then u$ Sat$am in the cash market and
at the same time# sell Sat$am one month futures"
.n or around the e%pir$ da$ (last Thursda$ of each month)# $ou will s)uare up
oth the positions# i"e" $ou will sell Sat$am in the cash market and u$
futures" The two prices will e the same (or ver$ nearl$ the same) as cash
and futures prices will converge on e%pir$" It does not matter to $ou what the
price is" Jou will make $our profit of Rs 5 an$wa$"
Fo" example# if the price is Rs 3G<# $ou will make a profit of Rs 3< on selling
$our /ash market Sat$am and a loss of Rs 2G on u$ing ack Sat$am
futures" The net profit is Rs 5" .n the other hand# if the price is Rs 33:# $ou
make a loss of Rs 3: on selling /ash market Sat$am and a profit of Rs 3B on
Sat$am futures" The net profit remains Rs 5"
Jour investment in this transaction will e Rs 3:< on cash market Sat$am plus
a margin of sa$ 3<I on Sat$am futures (sa$ Rs :< appro%)" Thus an
investment of Rs 5<< has generated a return of Rs 5 i"e" 2I per month or
23I per annum"
'ow take a situation where onl$ 2: da$s are left for e%pir$ and $ou spot the
same opportunit$ as aove" Jou will still generate Rs 5 which will translate
into a return of 3I per month or 3CI per annum"
TYBBI 22
In this manner# $ou will generate returns whenever the futures prices are
aove cash market prices"
TRADERSD PARTICIPANTSD OPERATORS OF
FUTURE MARKETS
HEDGER
SPECULATOR
AR1ITRAGEURS
TYBBI 23
SPREADERS
7uture contracts are ought and sold u$ large numer of individuals#
usiness organi!ations# governments and others for variet$ of purposes"
The trader in the future market can e categori!ed on the asis of the
purposes for which the$ deal in the market"
U)all, !#*a*3#al &e"#%a+#%e a++"a3+ !ollo(#*/ +,pe o! +"a&e" a
)*&e":
HEDGER
A Aedging is a position taken in futures or other markets for the purpose of
reducing e%posure to one or more t$pes of risk" A person who undertakes
such position is called as 0Aedger1" In other words# a hedger uses future
markets to reduce risk caused $ the movement in prices of securities#
commodities# e%change rate# interest rate# indices# etc" as such# a hedger
will take an opposite position to a perceived risk is called (hedging strateg$
in future markets1" The essence of hedging strateg$ is the adoption of future
position that# on average# generates profits when the market value of the
commitment is higher than the e%pected value"
SPECULATOR
A Speculator ma$ e defined as investors who are willing to take a risk
$ taking future position with the e%pectation to earn profits" The
speculators forecast the future economic condition and decide which
position (long and short) to e taken that will $ield a profit if the forecast
is reali!ed" In other words# Speculators are those who do not have an$
TYBBI 24
position on which the$ enter in futures and options market" The$ onl$
have a particular view on the market# stock# commodit$# etc" In short#
speculators put their mone$ at risk in the hope of profiting from an
anticipated price change" The$ consider various factors such as demand#
suppl$# market positions# open interests# economic fundamentals and
other data to take their positions"
Ill)+"a+#o*:
Speculators usuall$ trade in the future markets to earn profits on
the asis of difference in spot and future prices of the underl$ing asset"
Ram is a trader ut has no time to track and anal$!e the stocks"
Aowever# he fancies his chances in predicting the market trend" So
instead of u$ing different stocks# he u$s SE'SEN futures"
.n ?a$ 2# 3<<2# he u$s 2<< SE'SEN futures Q 5;<< on the
e%pectations that the inde% will rise in future" .n @une 2# 3<<2# the
SE'SEN rises to C<<< and at that time he sells an e)ual numer of
contracts to close out his position"
Selling price > C<<< % 2<< R Rs" C#<<#<<<
=ess> 4urchase /ost > 5;<< % 2<< R Rs 5#;<#<<<
Ne+ Ga#* Rs C<#<<<
Ram has made a profit of Rs C<#<<< $ taking a call on the
future value of the SE'SEN" Aowever if the SE'SEN had fallen# he
would have made a loss" In Inde% futures# pla$ers can have a long*term
view of the market up to atleast 5 monthsS"
AR1ITRAGEURS
Aritrageurs are another important group of participants in the future
markets" An aritrageur is a trader who attempts to make profits $
locking in a risk less trading $ simultaneousl$ entering into two or mare
markets" In other words aritrageurs tr$ to earn risk less profit from
discrepancies etween future and spot prices and among future prices"
TYBBI 25
An aritrageur is asicall$ risk averse" Ae enters into those contracts
were he can earn risk less profits" Dhen markets are imperfect# u$ing in
one market and simultaneousl$ selling in other market gives risk less
profit" Aritrageurs are alwa$s in the look out for such imperfections"
In the futures market one can take advantages of aritrage opportunities
$ u$ing from lower priced market and selling at the higher priced
market" In Inde% futures aritrage is possile etween the spot market
and the futures market ('SE has provided a special software for u$ing
all :< 'ift$ stocks in the spot market)"
Take the case of the 'SE 'ift$"
Assume that 'ift$ is at 23<< and 5 month-s 'ift$ futures is at
25<<"
The futures price of 'ift$ futures can e worked out $ taking
the interest cost of 5 months into account"
If there is a difference then aritrage opportunit$ e%ists"
=et us take the e%ample of single stock to understand the concept etter"
If Dipro is )uoted at Rs 2<<< per share and the 5 months futures of
Dipro is Rs 2<G< then one can purchase IT/ at Rs2<<< in spot $
orrowing Q 23I annum for 5 months at Rs 2<G<"
Sale R 2<G<
/ost R 2<<<O5< R 2<5<
Aritrage profit R C<
These kind of imperfections continue to e%ist in the markets ut one has
to e altert to the opportunities as the$ tend to get e%hausted ver$ fast"
SPREADERS
Spreading is a specific activit$ trading activit$ in which offsetting futures
position is involved $ creating almost net position" So the spreads
elieves in lower e%pected return ut at the less risk" A successful trading
in spreading# the spreaders must forecast the relevant factors which
affect the changes in the spreads" Interest rate ehaviour is an important
TYBBI 26
factor which causes changes in the spreads" In a profitale spread
position# normall$# there is a large gain on one side of the spread in
comparison to the loss on the other side of the spread" In this wa$# a
spread reduces the risks even if the forecast is incorrect" .n the other
hand# the pure speculators would make mone$ $ taking onl$ the
profitale side of the market ut at ver$ high risk"
TYPES OF FUTURES
F)+)"e 3o*+"a3+ a"e '"oa&l, &#%#&e& #*+o +(o +,pe:
COMMODITY FUTURES
FINANCIAL FUTURES
TYBBI 27
COMMODITY FUTURES
A commodit$ futures is a contract in commodit$ like agricultural products#
metals 6 minerals etc" in organi!ed commodit$ futures markets#
contractscontracts are standardi!ed with standard )uantities" .f course this
standard varies from commodit$ to commodit$ "the$ also have fi%ed deliver$
dates in each month or a few months on a $ear"
I* I*&#a 3ommo&#+, !)+)"e #* a/"#3)l+)"al p"o&)3+ a"e pop)la"5
Some o! +2e (ell e+a'l#2e& 3ommo&#+, !)+)"e a"e a
!ollo(:
2" =ondon metal stock e%change (=?E) to deal in gold
3" /hicago oard of trade (/9T) to deal in so$aean oil
5" 'ew Jork cotton e%change (/T') to deal in cotton
C" /ommodit$ e%change# 'ED Jork (/.?EN) to deal in agricultural
products
:" International petroleum e%change of =ondon (I4E) to deal in crude oil
FINANCIAL FUTURES
The standardi!ed features or specification make 7utures tradale like a
contract" And since 7utures are derivatives# the 7utures contracts are ased
on an underl$ing" It is the movement of the underl$ing that decides how the
7utures price will move"
TYBBI 28
There are onl$ two possile trades with a futures contract E 9u$ or Sell" If
investor-s e%pectations for the underl$ing asset are ullish the$ should u$
futures" If the e%pectations prove to e correct# the futures contract will rise in
value allowing them to close out the position at a profit" If# on the other hand#
investors view the underl$ing asset as earish# then the$ should sell the
futures contract" If the view is correct# the$ will e ale to u$ ack the futures
at a lower price than the$ were sold for# the difference eing the profit the$
have made" Inde% 7utures contracts can e used to take a view on the
directions of the overall market with the added advantage of gearing"
7or e%ample# lets take the underl$ing asset on SE'SEN" If $ou elieve the
SE'SEN will rise $ou can u$ the futures contract ($ going long on the
SE'SEN futures) or if $ou elieve the SE'SEN will fall# $ou can sell the
SE'SEN futures ($ going short on the SE'SEN futures)"
7inancial Derivatives like futures do not generall$ terminate in deliver$" ?ost
positions are closed out efore e%pir$" So if investor# 0A1 had ought two
SE'SEN futures contracts giving them a long position# then he is re)uired to
sell two SE'SEN futures# which will result in the investor having a short
position" This will mean that as far as the /learing Aouse is concerned the
investor is oth long and short of two contracts"
Sell it ack into the market (If he is long)
9u$ it ack from the market (If he is short)
These two positions are then filed awa$ together netting one off with the
other" 'ot onl$ this will result in the investors having no outstanding position
in the futures# ut will also enale investors either to reali!e their profits or
reduce their losses"
TYBBI 29
TYPES OF FINANCIAL FUTURE
4. INTEREST RATE FUTURE CONTRACT:
It is one of the important financial future instruments in the world" 7uture
trading on interest earing securities started onl$ in 2HG:# ut growth in the
market has een tremendous" Important interest earing securities are like
treasur$ ills# notes# onds# deenture# euro dollar time deposits and
municipal onds" In this market almost entire ranges of maturities earing
securities are traded"
Fo" e/> Three month maturit$ instruments like treasur$ ills 6 # including
foreign det instruments at /?E# 9ritish govt" ond at =ondon International "
financial future e%change (=I77E)# @apanese govt" ond at /9.T etc" are
traded"
6. FOREIGN CURRENCY FUTURE CONTRACT:
This financial future # as the name indicates# trade in 7oreign currencies # thus
known as e%change rate futures " active future trading in certain currencies
started in the earl$ 2HG<s" Important 7oreign currencies in which this future
contract are made are +S T #4ound sterling# Jen 7rench 7rancs etc" these
contracs have directl$ corresponding to spot market# known as inter ank
foreign currenc$ market # and also have a parallel inter ank foreign market"
'ormall$ this contracts are used for hedging purpose $ the e%porters#
importers# ankers# financial institutions and large companies"
E. STOCK INDE8 FUTURE:
A futures contract is a standardi!ed contract to u$ or sell a specific
securit$ at a future date at an agreed price"
An inde% future is# as the name suggests# a future on the inde% i"e" the
underl$ing is the inde% itself" There is no underl$ing securit$ or a stock#
TYBBI 30
which is to e delivered to fulfill the oligations as inde% futures are cash
settled" As other derivatives# the contract derives its value from the
underl$ing inde%" The underl$ing indices in this case will e the various
eligile indices and as permitted $ the Regulator from time to"
CONTRACT SPECIFICATIONS OF SENSE8 FUTURES
Fea+)"e SENSE8 F)+)"e
+nderl$ing inde% 9SE sensitive inde% (SE'SEN)
/ontract ?ultiplier :<
Tick si!e or minimum price
difference
<"2 inde% point or Rs" :
=ast trading da$(e%piration da$ =ast Thursda$ of the e%piration month" If it
happens to e a holida$# the contract will e%pire on
the previous da$"
/ontract months 5 contracts of 5<# ;< and H< da$s maturit$" Thus#
at an$ point of time# there will e 5 contracts
availale for trading
Dail$ settlement price /losing price of the futures contract"
7inal settlement price /losing price of the cash inde% on the e%pir$ date
of the futures contract"
H. STOCK FUTURE CONTRACT
TYBBI 31
A stock futures contract is a standardi!ed contract to u$ or sell a specific
stock at a future date at an agreed price" A stock future is# as the name
suggests# a future on a stock i"e" the underl$ing is a stock" The contract
derives its value from the underl$ing stock" Single stock futures are cash
settled"
CONTRACT SPECIFICATIONS OF STOCK FUTURES
Fea+)"e S+o3$ F)+)"e
+nderl$ing Stock Respective Stock (Anne%ure)
/ontract ?ultiplier Varies from Stock to Stock (Anne%ure)
Tick si!e or minimum price difference *
=ast trading da$(e%piration da$
=ast Thursda$ of the e%piration month"
If it happens to e a holida$# the
contract will e%pire on the previous
da$"
/ontract months
5 contracts of 5<# ;< and H< da$s
maturit$" Thus# at an$ point of time#
there will e 5 contracts availale for
trading
Dail$ settlement price /losing price of the futures contract"
7inal settlement price
/losing price of the underl$ing scrip on
the e%pir$ date of the futures contract"
PAYOFF
TYBBI 32
A pa$off is the likel$ profit(loss that would accrue to a market participant with
change in the price of the underl$ing asset" This is generall$ depicted in the
form of pa$off diagrams which show the price of the underl$ing asset on the
NEa%is and the profits(losses on the JEa%is"
PAYOFF FOR FUTURES
7utures contracts have linear pa$offs" In simple words# it means that the
losses as well as profits for the u$er and the seller of a futures contract are
unlimited"
These linear pa$offs are fascinating as the$ can e comined with options
and the underl$ing to generate various comple% pa$offs"
PAYOFF FOR 1UYER OF FUTURES: LONG FUTURES
The pa$off for a person who u$s a futures contract is similar to the pa$off for
a person who holds an asset" Ae has a potentiall$ unlimited upside as well as
a potentiall$ unlimited downside"
Take the case of a speculator who u$s a two*month 'ift$ inde% futures
contract when the 'ift$ stands at 233<" The underl$ing asset in this case is
the 'ift$ portfolio" Dhen the inde% moves up# the long futures position starts
making profits# and when the inde% moves down it starts making losses"
7igure 2 shows the pa$off diagram for the u$er of a futures contract"
PAYOFF FOR A 1UYER OF NIFTY FUTURES
TYBBI 33
The figure shows the profits(losses for a long futures position" The investor
ought futures when the inde% was at 233<" If the inde% goes up# his futures
position starts making profit" If the inde% falls# his futures position starts
showing losses"
Profit
1220
0 Nifty
Loss
- FIGURE 4.
PAYOFF FOR SELLER OF FUTURES: SHORT
FUTURES
TYBBI 34
The pa$off for a person who sells a futures contract is similar to the pa$off for
a person who shorts an asset" Ae has a potentiall$ unlimited upside as well as
a potentiall$ unlimited downside" Take the case of a speculator who sells a
two*month 'ift$ inde% futures contract when the 'ift$ stands at 233<" The
underl$ing asset in this case is the 'ift$ portfolio" Dhen the inde% moves
down# the short futures position starts making profits# and when the inde%
moves up# it starts making losses" 7igure 3 shows the pa$off diagram for the
seller of a futures contract"
PAYOFF FOR A SELLER OF NIFTY FUTURES
The figure shows the profits(losses for a short futures position" The investor
sold futures when the inde% was at 233<" If the inde% goes down# his futures
position starts making profit" If the inde% rises# his futures position starts
showing losses"
4rofit
233<
< 'ift$
=oss
-FIGURE 6.
FORWARD VDS FUTURE
TYBBI 35
Fea+)"e Fo"(a"&
Co*+"a3+
F)+)"e Co*+"a3+
.perational
?echanism
'ot traded on
e%change
Traded directl$
etween 3 parties"
Traded on e%change
/ontract
Specifications
Differs from trade to
trade"
/ontracts are standardi!ed
contracts"
/ounter part$
Risk
E%ists E%ists# ut assumed $ /learing
/orporation( house"
=i)uidation
4rofile
4oor =i)uidit$ as
contracts are tailor
maid contracts"
Ver$ high =i)uidit$ as contracts are
standardi!ed contracts"
4rice Discover$ 4oor& as markets are
fragmented"
9etter& as fragmented markets are
rought to the common platform"
E%amples /urrenc$ market in
India
Inde%# Stock6 commodit$ futures
OPTIONS
TYBBI 36
.ption is a securit$ that represents the right# ut not the oligation# to u$
or sell a specified amount of an underl$ing securit$ (stock# ond# futures
contract# etc") at a specified price within a specified time" .ption Aolder is
the u$er of either a call or put option" .ption Driter is the seller of either
a call or put option"
.ptions are different from futures in man$ wa$s" 'ot onl$ oth the
instrument have separate pa$off profiles ut also .ptions have host of
parameters that affect their pricing compared to Fust e%pectations and time
in the case of 7utures pricing" The risk return profile of options is different
from futures"
.ptions unlike futures are also concerned with speed of the trend and not
Fust the underl$ing trend" This makes them a little more comple% than
7utures# ut then itUs this inuilt comple%it$ in them that also makes them
more versatile instruments" Dith .ptions traders can pla$ non * directional
strategies i"e" strategies which will make mone$ for $ou no matter whether
markets move up# down or remain sidewa$s" Even Directional strategies
can e implemented using .ptions" @ust like 7utures there can e an
underl$ing view even in .ptions# a view to u$ or a view to sell" 9ut the
u$er pa$s up an upfront premium to protect himself if his view is
incorrect" The seller on the other hand though is pla$ing on a view wants
to e the one to ook an upfront premium# as a trade off against a
possile loss" The seller gets paid onl$ ecause he is providing the hedge
to the long positions at his own risk"
.ptions can e categori!ed as call and put options" The option# which
gives the u$er a right to u$ the underl$ing asset# is called /all option
and the option# which gives the u$er a right to sell the underl$ing asset#
is called 4ut option" .ptions are instruments that give the u$er a right
and the seller an oligation" Aowever# a u$er can u$ a right to u$ or
right to sell an underl$ing securit$" The writer on the other hand charges a
premium to fulfil oth these oligations" De will discuss this at length later"
=ong option (a call or a put) position has no downside risk as his loss is
TYBBI 37
protected to the premium he pa$s whereas a seller (of a call or put) aka
writer can suffer an unlimited loss if the market moves against him"
There are four asic pa$offs that an option has a long call# a short call# a
long put and a short put" The four pa$offs or as we call them strategies are
discussed later" These are the asic four pa$offs are at the heart of the
.ption theor$"
HISTORY OF OPTIONS
Although options have e%isted for a long time# the$ were traded .T/# without
much knowledge of valuation" Toda$ e%change*traded options are activel$
traded on stocks# stock inde%es# foreign currencies and futures contracts" The
first trading in options egan in Europe and the +S as earl$ as the eighteenth
centur$" It was onl$ in the earl$ 2H<<s that a group of firms set up what was
known as the put and call 9rokers and Dealers Association with the aim of
providing a mechanism for ringing u$ers and sellers together" If someone
wanted to u$ an option# he or she would contact one of the memer firms"
The firm would then attempt to find a seller or writer of the option either from
its own clients or those of other memer firms" If no seller could e found# the
firm would undertake to write the option itself in return for a price" This market
however suffered from two deficiencies" 7irst# there was no secondar$ market
and second# there was no mechanism to guarantee that the writer of the
option would honor the contract" It was in 2HG5# that 9lack# ?erton and
Scholes invented the famed 9lack Scholes formula" In April 2HG5# /9.E was
set up specificall$ for the purpose of trading options" The market for options
developed so rapidl$ that $ earl$ -B<s# the numer of shares underl$ing the
option contract sold each da$ e%ceeded the dail$ volume of shares traded on
the 'JSE" Since then# there has een no looking ack"
OPTION TERMINOLOGY
TYBBI 38
I*&ex op+#o*: These options have the inde% as the underl$ing" Some
options are European while others are American" =ike inde% futures
contracts# inde% options contracts are also cash settled"
S+o3$ op+#o*: Stock options are options on individual stocks" .ptions
currentl$ trade on over :<< stocks in the +nited States" A contract gives
the holder the right to u$ or sell shares at the specified price"
1),e" o! a* op+#o*: The u$er of an option is the one who $ pa$ing the
option premium u$s the right ut not the oligation to e%ercise his option
on the seller(writer"
W"#+e" o! a* op+#o*: The writer of a call(put option is the one who receives
the option premium and is there$ oliged to sell(u$ the asset if the u$er
e%ercises on him" There are two asic t$pes of options# call options and
put options" Call option> A call option gives the holder the right ut not the
oligation to u$ an asset $ a certain date for a certain price" Put option>
A put option gives the holder the right ut not the oligation to sell an asset
$ a certain date for a certain price"
Op+#o* p"#3e: .ption price is the price which the option u$er pa$s to the
option seller"
Exp#"a+#o* &a+e: The date specified in the options contract is known as
the e%piration date# the e%ercise date# the strike date or the maturit$"
S+"#$e p"#3e: The price specified in the options contract is known as the
strike price or the e%ercise price"
Ame"#3a* op+#o*: American options are options that can e e%ercised at
an$ time upto the e%piration date" ?ost e%change*traded options are
American"
E)"opea* op+#o*: European options are options that can e e%ercised
onl$ on the e%piration date itself" European options are easier to anal$!e
than American options# and properties of an American option are
fre)uentl$ deduced from those of its European counterpart"
I*<+2e<mo*e, op+#o*: An in*the*mone$ (IT?) option is an option that
would lead to a positive cashflow to the holder if it were e%ercised
TYBBI 39
immediatel$" A call option on the inde% is said to e in*the*mone$ when the
current inde% stands at a level higher than the strike price (i"e" spot price V
strike price)" If the inde% is much higher than the strike price# the call is
said to e deep IT?" In the case of a put# the put is IT? if the inde% is
elow the strike price"
A+<+2e<mo*e, op+#o*: An at*the*mone$ (AT?) option is an option that
would lead to !ero cashflow if it were e%ercised immediatel$" An option on
the inde% is at*the*mone$ when the current inde% e)uals the strike price
(i"e" spot price R strike price)"W
O)+<o!<+2e<mo*e, op+#o*: An out*of*the*mone$ (.T?) option is an option
that would lead to a negative cashflow it it were e%ercised immediatel$" A
call option on the inde% is out*of* the*mone$ when the current inde% stands
at a level which is less than the strike price (i"e" spot price X strike price)" If
the inde% is much lower than the strike price# the call is said to e deep
.T?" In the case of a put# the put is .T? if the inde% is aove the strike
price"
I*+"#*#3 %al)e o! a* op+#o*: The option premium can e roken down
into two components * intrinsic value and time value" The intrinsic value of
a call is the amount the option is IT?# if it is IT?" If the call is .T?# its
intrinsic value is !ero" 4utting it another wa$# the intrinsic value of a call
is'Y4 which means the intrinsic value of a call is ?a% Z<# (S
t
E [)\ which
means the intrinsic value of a call is the (S
t
E [)" Similarl$# the intrinsic
value of a put is ?a% Z<# ([ *S
t
)\ #i"e" the greater of < or ([ * S
t
)" [ is the
strike price and S
t
is the spot price"
T#me %al)e o! a* op+#o*: The time value of an option is the difference
etween its premium and its intrinsic value" A call that is .T? or AT? has
onl$ time value" +suall$# the ma%imum time value e%ists when the option is
AT?" The longer the time to e%piration# the greater is a call-s time value# all
else e)ual" At e%piration# a call should have no time value"
2
TYPES OF OPTIONS
1
TYBBI 40
Call op+#o*
P)+ op+#o*
CALL OPTION
/all .ptions give the u$er the right to u$ a specified underl$ing at a set
price on or efore a particular date"
Fo" example# Sat$am 3;< 7e /all .ption gives the 9u$er the right to u$
Sat$am at a price of Rs ;< per share on or efore the last Thursda$ of
7eruar$" The price of 3;< in the aove e%ample is called the strike price or
the e%ercise price"
/all .ptions are also called teFi in the Indian markets"
PUT OPTION
4ut .ptions give the u$er the right to sell a specified underl$ing at a set price
on or efore a particular date"
Fo" example# Sat$am 3;< 7e 4ut .ption gives the 9u$er the right to sell
Sat$am at a price of Rs 3;< per share on or efore the last Thursda$ of
7eruar$"
4ut .ptions are also called mandi in the Indian markets"
OPTIONS CLASSIFICATIONS
TYBBI 41
Op+#o* a"e o!+e* 3la#!#e& a:
I* +2e mo*e, * These result in a positive cash flow towards the investor
A+ +2e mo*e, * These result in a !ero*cash flow to the investor
O)+ o! mo*e, * These result in a negative cash flow for the investor
IIN THE MONEYI9IAT THE MONEYIJ KOUT OF THE MONEYI
OPTIONS5
OPTION:
An op+#o* is said to e Ia+<+2e<mo*e,I9 when the optionUs strike price is
e)ual to the underl$ing asset price" This is true for oth puts and calls"
CALL OPTION :
A 3all op+#o* is said to e K#* +2e mo*e,L when the strike price of the option
is less than the underl$ing asset price"
Fo" example> A Sense% call option with strike of 5H<< is Uin*the*mone$U#
when the spot Sense% is at C2<< as the call option has value" The call
option holder has the right to u$ a Sense% at 5H<<# no matter $ what
amount the spot price e%ceeded the strike price" Dith the spot price at C2<<#
selling Sense% at this higher price can make a profit"
.n the other hand# a call option is o)+<o!<+2e<mo*e, when the strike price
is greater than the underl$ing asset price" +sing the earlier e%ample of
Sense% call option# if the Sense% falls to 5G<<# the call option no longer has
positive e%ercise value" The call holder will not e%ercise the option to u$
Sense% at 5H<< when the current price is at 5G<< and allow his ,option- right
to lapse"
PUT OPTION :
TYBBI 42
A put option is #*<+2e<mo*e, when the strike price of the option is greater
than the spot price of the underl$ing asset"
Fo" example# a Sense% put at strike of CC<< is in*the*mone$ when the
Sense% is at C2<<" Dhen this is the case# the put option has value ecause
the put option holder can sell the Sense% at CC<<# an amount greater than
the current Sense% of C2<<"
=ikewise# a put option is o)+<o!<+2e<mo*e, when the strike price is less than
the spot price of underl$ing asset" In the aove e%ample# the u$er of
Sense% put option wonUt e%ercise the option when the spot is at CB<<" The
put no longer has positive e%ercise value and therefore in this scenario# the
put option holder Dill allow his ,option- right to lapse"

CALL OPTION PUT OPTION
I*<+2e<
mo*e,
Strike price X Spot price
of underl$ing asset
Strike price V Spot price
of underl$ing asset
A+<+2e<
mo*e,
Strike price R Spot price
of underl$ing asset
Strike price R Spot price
.f underl$ing asset
O)+<o!<+2e<
mo*e,
Strike price V Spot price
of underl$ing asset
Strike price X Spot price
.f underl$ing asset
AMERICAN J EUROPEAN OPTION
TYBBI 43
T2e"e a"e +(o $#*& o! op+#o* 'ae& o* +2e &a+e5
The first is the E)"opea* Op+#o*# which can e e%ercised onl$ on the
maturit$ date" The second is the Ame"#3a* Op+#o*# which can e e%ercised
efore or on the maturit$ date"
Ame"#3a* a*& E)"opea* Exe"3#e S+,le o! Op+#o*

American and European are primaril$ natures of e%ercise or settlement of
.ptions" American .ptions can e E%ercised an$time prior to the the
e%piration date" European options in the other hand can onl$ e e%ercised
at the E%piration da$" Indian stock options have the American E%ercise
settlement while Inde% .ptions can onl$ e settles at E%piration"
In India# oth st$les are availale" Inde% .ptions are European st$le# while
individual stock options are American st$le"
E8CHANGE TRADE AND OTC = TRADE OPTIONS:<
TYBBI 44
The option can e traded like other financial assets either on an
organi!ed e%change or on the over*the counter (.T/) market" E%change
option contracts# like future contracts are traded on the recogni!ed
e%changes" .n the other hand# over the counter (.T/) option are customer
tailored agreement sold directl$ $ the dealer rather than through the
organi!ed e%change" The terms and conditions of these contracts are
negotiated $ the parties to the contracts" 9oth the option has have different
mechanism of functioning# which are discussed here as under:
E%change traded option like futures contracts# are standardi!ed and
are traded on organi!ed (or government designated) e%changes" .n
the other hand# the .T/ options are written on the counters of the
large commercial and investment ankers"
E%change traded option have certain specified norms relating to
)uantit$# maturit$ date# underl$ing assets# etc" which are determined $
the e%changes how ever in the case of .T/ option all such terms are
suFect to negotiation and mutuall$ determined $ u$er and seller of
the option contracts"
9eing standardi!e in nature an option contract traded through the
recogni!ed e%change has uniform underl$ing assets# limited no of
strike prices# limited e%piration dates and so on"
E%change traded option are performed and cleared through a clearing
house corporation which interposes it self as a thirt$ part$ to the all
options contracts"
Since# these options are guaranteed $ the e%changes# hence default
risks is almost eliminated"
TYBBI 45
O* '),#*/ a* op+#o* 3o*+"a3+ !"om a "e3o/*#;e& ex32a*/e9 +2e
o'l#/a+#o* 3a* 'e !)l!#lle& #* o*e o! +2e +2"ee (a, (2#32 a"e
me*+#o*e& a !ollo(:
2" The option u$er ma$ not e%ercise the current# allowing the option
to e%pire" The entire premium is retained $ the seller and seller-s
oligation is discharged"
3" In case of the parties to the option# the u$er can e%ercise his right
on or efore the e%piration date"
5" Either of the parties to the option contract can e%ecute an offsetting
transaction in the option market to eliminate the oligation"

TYBBI 46
THE UNDERLYING ASSET IN E8CHANGE TRADED
OPTION
Various assets # which are activel$ traded on recogni!ed e%changes are
stocks# stocks indices# foreign currencies and future contract "
T2ee a"e expla#*e& a !ollo(5
45 S+o3$ op+#o*
65 S+o3$ #*&#3e9
E5 Fo"e#/* 3)""e*3#e
H5 F)+)"e Op+#o*
B5 I*+e"e+ "a+e Op+#o*
45 STOCKS OPTIONS:
.ptions on Individual Stocks are options contracts where the underl$ings
are individual stocks" 9ased on eligiilit$ criteria and suFect to the approval
from the regulator# stocks are selected on which options are introduced"
These contracts are cash settled and are American st$le"
Trading on standardi!ed call option on e)uit$ shares started in 2HG5 on
/9.E where as on 4ut option egan in 2HGG" Stock options are most
popular asset # which are traded on various e%changes all over the world" In
India# 'SE and 9SE have started option trading in certain stock from the
$ear 3<<2"
TYBBI 47
CONTRACT SPECIFICATIONS OF STOCK OPTIONS
U*&e"l,#*/> Individual scrip
Co*+"a3+ M)l+#pl#e"> As specified
T#3$e" S,m'ol> As specified
S+"#$e P"#3e> minimum of : strikes (3 in the mone$# 2 near the mone$# 3
.ut of the mone$)"
P"em#)m 7)o+a+#o*> Rupees per share"
La+ T"a&#*/ Da,> =ast Thursda$ of the month" If it is a holida$ than the
preceding usiness da$"
Exp#"a+#o* Da,> =ast Thursda$ of contract month" If it is a holida$ than the
preceding usiness da$"
No+e> 9usiness da$ is a da$ during which the underl$ing stock market is
open for trading
Co*+"a3+ Mo*+2> 2# 3 and 5 months
Exe"3#e S+,le> American"
Se++leme*+ S+,le> /ash
TYBBI 48
T"a&#*/ Ho)"> H>5< A"?" to 5>5< 4"?"
T#3$ S#;e> <"<2
65 INDE8 OPTION5
?an$ different inde% options are currentl$ traded on the different e%changes in
different countries" 7or e% "ST4 2<< inde% at /9.E and maFor inde% at A?EN
are traded in the +S option markets" Similarl$# in India# such inde% option has
een started on national stock e%change and 9oma$ stock e%change" =ike
stock option# inde% options strike prices are the inde% value at which the u$er
of the option can u$ or sell the underl$ing stock inde%" The strike inde% is
converted into dollar (rupee) value $ multipl$ing the strike inde% $ the
multiple for the contract"
If the u$er of the stock inde% option indented to e%ercise the option then the
stock must e delivered" It would e complicated settle a stock inde% option
$ delivering all the stock that makes the particular inde%" If the option is
e%ercise# the stock e%change assigned option writer pa$s cash to the option
u$er# and there will no deliver$ of an$ share"
The mone$ value of the stock inde% underl$ing an inde% option is e)ual to the
current cash inde% value multiplied $ the contracts multiplied"
Rupees value of the underl$ing inde% R cash inde% value % contract multiplies
TYBBI 49
E5 FOREIGN CURRENCIES OPTION5
7oreign currencies is another important assets# which is traded on varies
stock e%changes" 7oreign e%change option has traded on the 4hiladelphia
stock e%change since 2HBC" ?aFor currencies traded in the option markets are
us dollar# Australian dollar# 9ritish pounds# /anadian dollar# 8erman mark#
7rench franc# @apanese $en# Swiss franc# etc"
/all option gives the owner the right to u$ stated amount of foreign e%change
at strike rate" The strike price is itself e%change rate" 7oreign currencies puts
give the owner the right to sell foreign e%change at strike prices" The
e%change traded currenc$ option market is )uit li)uid"
H5 FUTURE OPTION5
In the future option (or option on futures)# the underl$ing assets is a future
contract at a designated price at a time during life of the options" If the future
option is call option# the u$er has the right to ac)uire a long future position"
Similarl$# a put option on a future contract grants the u$er the right"
B5 INTEREST RATE OPTION5
Interest rate options are another important option contract# which are popular
in the international financial markets" Interest rate option can e written on
cash instrument or future" These are various det instruments which are used
as underl$ing instrument for interest rate option in different e%changes" These
contracts are referred as option on ph$sicals" Recentl$# these instrument rate
option have also gained popularit$ on the over the E counter markets like on
treasur$ ounds# agenc$ deentures# large anking firms# and mortgage *
acked E securities
TYBBI 50
OPTIONS PAY OFFS
The optionalit$ characteristic of options results in a non*linear pa$off for
options" In simple words# it means that the losses for the u$er of an option
are limited# however the profits are potentiall$ unlimited" 7or a writer# the
pa$off is e%actl$ the opposite" Ais profits are limited to the option premium#
however his losses are potentiall$ unlimited"
These non*linear pa$offs are fascinating as the$ lend themselves to e used
to generate various pa$offs $ using cominations of options and the
underl$ing"
PAYOFF PROFILE FOR 1UYER OF CALL OPTIONS:
LONG CALL
A call option gives the u$er the right to u$ the underl$ing asset at the strike
price specified in the option" The profit(loss that the u$er makes on the
option depends on the spot price of the underl$ing" If upon e%piration# the spot
price e%ceeds the strike price# he makes a profit" Aigher the spot price# more
is the profit he makes" If the spot price of the underl$ing is less than the strike
price# he lets his option e%pire un*e%ercised" Ais loss in this case is the
premium he paid for u$ing the option" 7igure 5 gives off for the u$er of a
three month call option (often referred to as long call) with a strike of 23:<
ought at a premium of B;";<"
TYBBI 51
PAY OFF FOR 1UYER OF CALL OPTION
The figure shows the profits(losses for the u$er of a three*month 'ift$ 23:<
call option" As can e seen# as the spot 'ift$ rises# the call option is in*the*
mone$" If upon e%piration# 'ift$ closes aove the strike of 23:<# the u$er
would e%ercise his option and profit to the e%tent of the difference etween the
'ift$*close and the strike price" The profits possile on this option are
potentiall$ unlimited" Aowever if 'ift$ falls elow the strike of 23:<# he lets the
option e%pire" Ais losses are limited to the e%tent of the premium he paid for
u$ing the option"
Profit
1250
0 Nifty
86.60
Loss
- FIGURE E .
PAYOFF PROFILE FOR WRITER OF CALL OPTIONS:
SHORT CALL
A call option gives the u$er the right to u$ the underl$ing asset at the strike
price specified in the option" 7or selling the option# the writer of the option
charges a premium" The profit(loss that the u$er makes on the option
depends on the spot price of the underl$ing" Dhatever is the u$er-s profit is
the seller-s loss" If upon e%piration# the spot price e%ceeds the strike price# the
u$er will e%ercise the option on the writer" Aence as the spot price increases
the writer of the option starts making losses" Aigher the spot price# more is the
loss he makes" If upon e%piration the spot price of the underl$ing is less than
the strike price# the u$er lets his option e%pire un*e%ercised and the writer
TYBBI 52
gets to keep the premium" 7igure C gives for the writer of a three month call
option (often referred to as short call) with a strike of 23:< sold at a premium
of B;";<"
PAYOFF FOR WRITER OF CALL OPTIONS
The figure shows the profits(losses for the seller of a three*month 'ift$ 23:<
call option" As the spot 'ift$ rises# the call option is in*the*mone$ and the
writer starts making losses" If upon e%piration# 'ift$ closes aove the strike of
23:<# the u$er would e%ercise his option on the writer who would suffer a
loss to the e%tent of the difference etween the 'ift$*close and the strike
price" The loss that can e incurred $ the writer of the option is potentiall$
unlimited# whereas the ma%imum profit is limited to the e%tent of the up*front
option premium of Rs"B;";< charged $ him"
Profit
Profit
86.60
1250
0 Nifty
Loss
-FIGURE H.
TYBBI 53
PAYOFF PROFILE FOR 1UYER OF PUT OPTIONS:
LONG PUT
A put option gives the u$er the right to sell the underl$ing asset at the strike
price specified in the option" The profit(loss that the u$er makes on the
option depends on the spot price of the underl$ing" If upon e%piration# the spot
price is elow the strike price# he makes a profit" =ower the spot price# more is
the profit he makes" If the spot price of the underl$ing is higher than the strike
price# he lets his option e%pire un*e%ercised" Ais loss in this case is the
premium he paid for u$ing the option" 7igure :gives the pa$off for the u$er
of a three*month put option (often referred to as long put) with a strike of 23:<
ought at a premium of ;2"G<"
PAYOFF FOR 1UYER OF PUT OPTIONS
The figure shows the profits(losses for the u$er of a three*month 'ift$ 23:<
put option" As can e seen# as the spot 'ift$ falls# the put option is in*the*
mone$" If upon e%piration# 'ift$ closes elow the strike of 23:<# the u$er
would e%ercise his option and profit to the e%tent of the difference etween the
strike price and 'ift$*close" The profits possile on this option can e as high
as the strike price" Aowever if 'ift$ rises aove the strike of 23:<# he lets the
option e%pire" Ais losses are limited to the e%tent of the premium he paid for
u$ing the option"
Profit
1250
0 Nifty
61.70
Loss
- FIGURE B .
TYBBI 54
PAYOFF PROFILE FOR WRITER OF PUT OPTIONS:
SHORT PUT
A put option gives the u$er the right to sell the underl$ing asset at the strike
price specified in the option" 7or selling the option# the writer of the option
charges a premium" The profit(loss that the u$er makes on the option
depends on the spot price of the underl$ing" Dhatever is the u$er-s profit is
the seller-s loss" If upon e%piration# the spot price happens to e elow the
strike price# the u$er will e%ercise the option on the writer" If upon e%piration
the spot price of the underl$ing is more than the strike price# the u$er lets his
option e%pire un*e%ercised and the writer gets to keep the premium" 7igure
;gives the pa$off for the writer of a three*month put option (often referred to
as short put) with a strike of 23:< sold at a premium of ;2"G<"
PAYOFF FOR WRITER OF PUT OPTIONS
The figure shows the profits(losses for the seller of a three*month 'ift$ 23:<
put option" As the spot 'ift$ falls# the put option is in*the*mone$ and the writer
starts making losses " If upon e%piration# 'ift$ closes elow the strike of 23:<#
the u$er would e%ercise his option on the writer who would suffer a loss to
the e%tent of the difference etween the strike price and 'ift$*close" The loss
that can e incurred $ the writer of the option is a ma%imum e%tent of the
strike price(Since the worst that can happen is that the asset price can fall to
!ero) whereas the ma%imum profit is limited to the e%tent of the up*front option
premium of Rs";2"G< charged $ him"
Profit
61.70
1250
0 Nifty
Loss
- FIGURE F .
TYBBI 55
FUTURE VDS OPTIONS

Lo*/
F)+)"e
S2o"+
F)+)"e
Lo*/
Call
S2o"+ Call Lo*/ P)+ S2o"+ P)+
T"a&e"L
"#/2+ a*&
o'l#/a+#o*
Right and
oligation
to u$
Right and
oligation
to sell
Right ut
not the
oligation
to u$
.ligation
to deliver
Right ut
not the
oligation
to sell
.ligation
to u$
P"em#)m
pa#& o"
"e3e#%e&
* * 4aid Received 4aid Received
Ma"/#*
"e0)#"eme
*+
Jes Jes 'one Jes 'one Jes
R#$ -lo.
+nlimited
in case of
a decline
in prices
+nlimited
in case
prices
rise"
=oss and
risk
limited to
the
premium
paid
upfront"
+nlimited
in case
prices rise
=oss and
risk limited
to the
premium
paid
upfront
+nlimited
in case of a
decline in
prices
Re+)"*
-P"o!#+.
+nlimited#
if prices
rise
+nlimited
in case of
a decline
in prices
+nlimited
in case
prices
rise
Return
limited the
premium
received
upfront
+nlimited#
in case
prices
decline
Return
limited to
the e%tent
of the
premium
received
upfront

TYBBI 56
WHAT ARE SWAPS?
A contract etween two parties# referred to as counterparties# to e%change two
streams of pa$ments for agreed period of time" The pa$ments# commonl$
called legs or sides# are calculated ased on the underl$ing notional using
applicale rates" Swaps contracts also include other provisional specified $
the counterparties" Swaps are not det instrument to raise capital# ut a tool
used for financial management" Swaps are arranged in man$ different
currencies and different periods of time" +ST swaps are most common
followed $ @apanese $en# sterling and Deutsche marks" The length of past
swaps transacted has ranged from 3 to 3: $ears"
WHY DID SWAPS EMERGE?
In the late 2HG<Us# the first currenc$ swap was engineered to circumvent the
currenc$ control imposed in the +[" A ta% was levied on overseas investments
to discourage capital outflows" Therefore# a 9ritish compan$ could not transfer
funds overseas in order to e%pand its foreign operations without pa$ing
si!eale penalt$" ?oreover# this 9ritish compan$ had to take an additional
currenc$ risks arising from servicing a sterling det with foreign currenc$ cash
flows" To overcome such a predicament# ack*to*ack loans were used to
e%change dets in different currencies" 7or e%ample# a 9ritish compan$
wanting to raise capital in the 7rance would raise the capital in the +[ and
e%change its oligations with a 7rench compan$# which was in a reciprocal
position" Though this t$pe of arrangement was providing relief from e%isting
protections# one could imagine# the task of locating companies with matching
needs was )uite difficult in as much as the cost of such transactions was high"
In addition# ack*to*ack loans re)uired drafting multiple loan agreements to
state respective loan oligations with clarit$" Aowever this t$pe of
arrangement lead to development of more sophisticated swap market of
toda$"
TYBBI 57
TYPES OF SWAP
4. C)""e*3, (ap
C)""e*3, (ap can e defined as a legal agreement etween two or more
parties to e%change interest oligation or interest receipts etween two
different currencies" I+ #*%ol%e +2"ee +ep>
Initial e%change of principal etween the counter parties at an agreed upon
rate of e%change which is usuall$ ased on spot e%change rate" This
e%change is optional and its sole oFective is to estalish the )uantum of
the respective principal amounts for the purpose for calculating the
ongoing pa$ments of interest and to estalish the principal amount to e
re*e%changed at the maturit$ of the swap"
.ngoing e%change of interest at the rates agreed upon at the outset of the
transaction"
Re*e%change of principal amount on maturit$ at the initial rate of
e%change"
This straight forward# three step process results in the effective transformation
of the det raised in one currenc$ into a full$ hedged liailit$ in other currenc$"
6. I*+e"e+ Ra+e S(ap
An I*+e"e+ Ra+e S(ap -IRS. is a financial contract etween two parties
e%changing or swapping a stream of interest pa$ments for a notional principal
amount of multiple occasions on specified periods" Accordingl$# on each
pa$ment date that occurs during the swap period*/ash pa$ments ased on
fi%ed(floating and floating rates are made $ the parties to one another"
E. De'+ = E0)#+, S(ap
TYBBI 58
In De'+ = E0)#+, S(ap # a firm u$ a counter det on the secondar$ loan
market at a discount 6 Swap it into local e)$uit$ " in other words # the det-s
are e%changed for e)uit$ $ one firm with another"
DEVELOPMENT OF DERIVATIVES MARKET IN INDIA
The first step towards introduction of derivatives trading in India was the
promulgation of options in securities" The market for derivatives# however# did
not take off# as there was no regulator$ framework to govern trading of
derivatives" SE9I set up a 3CEmemer committee under the /hairmanship of
Dr"="/"8upta on 'ovemer 2B# 2HH; to develop appropriate regulator$
framework for derivatives trading in India" The committee sumitted its report
on ?arch 2G# 2HHB prescriing necessar$ preEconditions for introduction of
derivatives trading in India" The committee recommended that derivatives
should e declared as ,securities- so that regulator$ framework applicale to
trading of ,securities - could also govern trading of securities" SE9I also set up
a group in @une 2HHB under the /hairmanship of 4rof"@"R"Varma# to
recommend measures for risk containment in derivatives mark et in India" The
report# which was sumitted in .ctoer 2HHB# worked out the operational
details of margining s$stem# methodolog$ for charging initial margins# roker
net worth# deposit re)uirement and realEtime monitoring re)uirements"
The Securities /ontract Regulation Act (SCRA) was amended in Decemer
2HHH to include derivatives within the amit of ,securities- and the regulator$
framework was developed for governing derivatives trading" The act also
made it clear that derivatives shall e legal and valid onl$ if such contracts are
traded on a recogni!ed stock e%change# thus precluding .T/ derivatives" The
government also rescinded in ?arch 3<<<# the threeE decade old notification#
which prohiited forward trading in securities"
Derivatives trading commenced in India in @une 3<<< after SE9I granted the
final approval to this effect in ?a$ 3<<2" SE9I permitted the derivative
segments of two stock e%changes# 'SE and 9SE# and their clearing
TYBBI 59
house(corporation to commence trading and settlement in approved
derivatives contracts" To egin with# SE9I approved trading in inde% futures
contracts ased on S64 /'N 'ift$ and 9SEE5<(Sense%) inde%" This was
followed $ approval for trading in options ased on these two inde%es and
options on individual securities"
The trading in 9SE Sense% options commenced on @une C# 3<<2 and the
trading in options on individual securities commenced in @ul$ 3<<2" 7utures
contracts on individual stocks were launched in 'ovemer 3<<2" The
derivatives trading on 'SE commenced with S64 /'N 'ift$ Inde% futures on
@une 23# 3<<<" The trading in inde% options commenced on @une C# 3<<2 and
trading in options on individual securities commenced on @ul$ 3# 3<<2"
Single stock futures were launched on 'ovemer H# 3<<2" The inde% futures
and options contract on 'SE are ased on S64 /'N"
Trading and settlement in derivative contracts is done in accordance with the
rules# $elaws# and regulations of the respective e%changes and their clearing
house(corporation dul$ approved $ SE9I and notified in the official ga!ette"
TYBBI 60
INDIAN DERIVATIVES MARKET
Starting from a controlled econom$# India has moved towards a world where
prices fluctuate ever$ da$" The introduction of risk management instruments in
India gained momentum in the last few $ears due to lieralisation process and
Reserve 9ank of India-s (R9I) efforts in creating currenc$ forward market"
Derivatives are an integral part of lieralisation process to manage risk" 'SE
gauging the market re)uirements initiated the process of setting up derivative
markets in India" In @ul$ 2HHH# derivatives trading commenced in India"
CHRONOLOGY OF INSTRUMENTS
4MM4

=ieralisation process initiated
4H De3em'e"
4MMB
'SE asked SE9I for permission to trade inde% futures"
4N No%em'e"
4MMF
SE9I setup ="/"8upta /ommittee to draft a polic$ framework
for inde% futures"
44 Ma, 4MMN ="/"8upta /ommittee sumitted report"
A O)l, 4MMM R9I gave permission for .T/ forward rate agreements
(7RAs) and interest rate swaps"
6H Ma, 6PPP SI?EN chose 'ift$ for trading futures and options on an
Indian inde%"
6B Ma, 6PPP SE9I gave permission to 'SE and 9SE to do inde% futures
trading"
M O)*e 6PPP Trading of 9SE Sense% futures commenced at 9SE"
46 O)*e 6PPP Trading of 'ift$ futures commenced at 'SE"
6B Sep+em'e"
6PPP
'ift$ futures trading commenced at S8N"
6 O)*e 6PP4 Individual Stock .ptions 6 Derivatives
TYBBI 61
CONCLUSION
This proFect conclude that derivatives are powerful and innovative product
which transfer the risk from those who do not want to take it at a price to those
who are capale of and e%pert in managing risk" Aedger# Speculator and
Aritrageurs are the people who are prepared to deal wIth the risk"
7inancial institution are ver$ sensitive to the risk e%poser measures so the$
look 7orward to derivatives market and use various innovative products like
7orward# 7uture# .ptions and Swaps"
Indian derivatives market is strongl$ routed through the stock e%changes and
commodities market derivatives" 7uture traders deal through the stock
e%changes in a standardi!e manner" 'SE India is the 4ioneer of derivatives
product in India"
Derivatives are important tools which help in growth of Indian /apital ?arkets"
SE9I on time to time issue various guidelines to all the dealers of derivatives
to ring transparenc$ in the working"
TYBBI 62

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DERIVATIVES (Instrument for risk reduction)

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