ACKNOWLEDGEMENT

“Our personalities are based on the foundation of

Education of the teachers who are next to the God.”

It is by the grace of Almighty we have been able to present this

humble piece of work which we are extremely indebted to him.

I am glad to present my project report on

“Trends and Futures of Derivatives: A Detailed Study”

I express my sincere thank and sense of gratitude to special

people for their valuable guidance and for their kind support
through out the project which I can’t forget.

Needless to say, errors and omissions are mine.

Last but not least, no one is forgotten but all may not be
mentioned.
To conclude, we thank our mind and heart for going hand in
hand.
 PREFACE

“One can learn more about a road by traveling it,

then by consulting all the maps in the world.”

As a part of degree of MBA every student has to under go for

training in a commercial organization. With the help of this
training research students come to know that how they
academic knowledge is applied in actual business situation.
They also come to know about the working conditions under
which they will have to work in near future.

In my summer trainings I studied about Stock Market,

Derivatives Market in particular. I must forewarn the readers
that this project is not a work of excellence by a scholar. It is a
student attempt to watch record, analysis and understand the
business activities and practical aspect of business by
applying his/her theoretical knowledge and concepts. Even
then I dare to say that I made the best possible attempt to
accomplish the work.
Introduction to the Project

Derivatives have vital role to play in enhancing

shareholder value by ensuring access to the cheapest source
of funds. Active use of derivatives instruments allows the
overall business risk profile to be modified, thereby providing
the potential to improve earning quality by offsetting
undesired risk.

Under my project report I have studied various

trends that comes in the way of Derivatives Market because
impression is usually given that losses arose from derivatives
are extremely complex and difficult to understand financial
strategies. So after interviewing with different brokers,
investors and dealers I have tried to give a solution to these
complexities.

I also find out that what would be the future of

derivative market in India on the basis of interviews and
observations of brokers, dealers and investors regarding
future. I have find out that derivatives can be indeed used
safely and successfully provided a sensible control and
management strategy is established and executed in spite of
that more awareness should be done and technical expertise
knowledge should be more expanded.
 Objectives of the Project
The main Objectives of my final project report are as follows:-

 To study the various trends that comes in the way of

derivatives market.
 To find out that what would be the future and market
potential of derivatives market in India.

 To know the awareness & familiarity of investors, dealers

and brokers hold regarding derivative markets.

 To know the experience of dealers, investors and brokers

with derivatives till date

 To get knowledge about shortcomings in Indian derivative

market.
 INTRODUCTION TO THE STOCK EXCHANGE
A Stock exchange is a corporation or mutual organization
which provides "trading" facilities for stock brokers and
traders, to trade stocks and other securities. Stock exchanges
also provide facilities for the issue and redemption of
securities as well as other financial instruments and capital
events including the payment of income and dividends. The
securities traded on a stock exchange include: shares issued
by companies, unit trusts and other pooled investment
products and bonds. To be able to trade a security on a certain
stock exchange, it has to be listed there. Usually there is a
central location at least for record keeping, but trade is less
and less linked to such a physical place, as modern markets
are electronic networks, which gives those advantages of speed
and cost of transactions. Trade on an exchange is by members
only. The initial offering of stocks and bonds to investors is by
definition done in the primary market and subsequent trading
is done in the secondary market. A stock exchange is often the
most important component of a stock market. Supply and
demand in stock markets is driven by various factors which,
as in all free markets, affect the price of stocks.

There is usually no compulsion to issue stock via the stock

exchange itself, nor must stock be subsequently traded on the
exchange. Such trading is said to be off exchange or over-the-
counter. This is the usual way that bonds are traded.
Increasingly, stock exchanges are part of a global market for
securities.

The Securities Contract (Regulation) Act 1956 defines

Stock Exchange as:
 “A body of individuals whether incorporated or not,
constituted for the purpose of assisting, regulating or controlling
the business of buying, selling & dealing in securities.”

A Stock Exchange is the essential pillar of the private sector

and corporate economy. It is the open auction market where
buyers and sellers meet and involve a competitive price for the
securities. It reflects hopes aspiration and fears of people
regarding the performance of the economy. It exerts a powerful
and significant influence as a depressant or stimulant of
business activity. So, stock exchange mobilizes savings,
canalizes them as securities into those enterprises which are
favored by the investors on the basis of such criteria as –

- Future growth prospects.

- Good Returns.

- Appreciation of capital.

The stock exchange serves the role of barometer, not

only of the state of wealth of individual companies, but also of
the nation’s economy as a whole (it measures of all the pull
and pressure of securities in the market). The trade in market
is through the authorized members who have duly registered
with concerned stock exchange and SEBI.

Stock markets refer to a market place where investors can buy

and sell stocks. The price at which each buying and selling
transaction takes is determined by the market forces (i.e.
demand and supply for a particular stock).

Let us take an example for a better understanding of how

market forces determine stock prices. ABC Co. Ltd. enjoys
high investor confidence and there is an anticipation of an
upward movement in its stock price. More and more people
would want to buy this stock (i.e. high demand) and very few
people will want to sell this stock at current market price (i.e.
less supply). Therefore, buyers will have to bid a higher price
for this stock to match the ask price from the seller which will
increase the stock price of ABC Co. Ltd. On the contrary, if
there are more sellers than buyers (i.e. high supply and low
demand) for the stock of ABC Co. Ltd. in the market, its price
will fall down.

In earlier times, buyers and sellers used to assemble at stock

exchanges to make a transaction but now with the dawn of IT,
most of the operations are done electronically and the stock
markets have become almost paperless. Now investors don’t
have to gather at the Exchanges, and can trade freely from
their home or office over the phone or through Internet.

FEATURES OF THE STOCK EXCHANGE:

 It provides the trading platform where buyers and sellers

meet to transact in securities.
 The stock exchange in India is under the supervision of
the regulatory authority, the Securities and Exchange
Board of India
 It is the place where sale and purchase of existing
securities is done.
 It enables an investor to adjust his holdings of securities
in response to changes in assessment about risk and
return.
 It enables to meet the liquidity needs by providing market
for sale of securities.
 Stock exchange is an association of individual members
called member brokers.
 Stock exchanges are formed for the purpose of regulating
and facilitating the buying and selling of securities.
 Stock exchange operate with due recognition from the
govt. under securities and contract regulation act 1956.
 Stock exchange facilitates trading in securities of the
public sector companies as well as govt. securities.
  It acts as a host of intermediaries which assist in trading
of securities and clearing and settlement of trade.

History of the Indian Stock Market

One of the oldest stock markets in Asia, the Indian Stock
Markets has a 200 years old history.

18th East India Company was the dominant institution

Century and by end of the century, business in its loan
securities gained full momentum
1830's Business on corporate stocks and shares in Bank
and Cotton presses started in Bombay. Trading
list by the end of 1839 got broader
1840's Recognition from banks and merchants to about
half a dozen brokers
1850's Rapid development of commercial enterprise saw
brokerage business attracting more people into
the business
1860's The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a
stoppage of cotton supply from United States of
America; marking the beginning of the "Share
Mania" in India
1862-63 The number of brokers increased to about 200 to
250
1865 A disastrous slump began at the end of the
American Civil War (as an example, Bank of
Bombay Share which had touched Rs. 2850 could
only be sold at Rs. 87)
Pre-Independence Scenario - Establishment of
Different Stock Exchanges

1874 With the rapidly developing share trading business,

brokers used to gather at a street (now well known
as "Dalal Street") for the purpose of transacting
business.
1875 "The Native Share and Stock Brokers' Association"
(also known as "The Bombay Stock Exchange") was
established in Bombay
1880's Development of cotton mills industry and set up of
many others
1897 Establishment of "The Ahmedabad Share and Stock
Brokers' Association"
1880 - Sharp increase in share prices of jute industries in
90's 1870's was followed by a boom in tea stocks and
coal
1908 "The Calcutta Stock Exchange Association" was
formed
1920 Madras witnessed boom and business at "The
Madras Stock Exchange" was transacted with 100
brokers.
1923 When recession followed, number of brokers came
down to 3 and the Exchange was closed down
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the
Punjab Stock Exchange
1937 Re-organisation and set up of the Madras Stock
Exchange Limited (Pvt.) Limited led by
improvement in stock market activities in South
 India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur
Stock Exchange Limited was established
1944 Establishment of "The Hyderabad Stock Exchange
Limited"
1947 "Delhi Stock and Share Brokers' Association
Limited" and "The Delhi Stocks and Shares
Exchange Limited" were established and later on
merged into "The Delhi Stock Exchange Association
Limited"

Post Independence Scenario

The depression witnessed after the Independence led to

closure of a lot of exchanges in the country. Lahore stock
Exchange was closed down after the partition of India, and
later on merged with the Delhi Stock Exchange. Bangalore
Stock Exchange Limited was registered in 1957 and got
recognition only by 1963. Most of the other Exchanges were in
a miserable state till 1957 when they applied for recognition
under Securities Contracts (Regulations) Act, 1956. The
Exchanges that were recognized under the Act were:

1. Bombay
2. Calcutta
3. Madras
4. Ahmedabad
5. Delhi
6. Hyderabad
7. Bangalore

8. Indore
Many more stock exchanges were established during 1980's,
namely:

 Cochin Stock Exchange (1980)

 Uttar Pradesh Stock Exchange Association Limited (at
Kanpur, 1982)
 Pune Stock Exchange Limited (1982)
 Ludhiana Stock Exchange Association Limited (1983)
 Gauhati Stock Exchange Limited (1984)
 Kanara Stock Exchange Limited (at Mangalore, 1985)
 Magadh Stock Exchange Association (at Patna, 1986)
 Jaipur Stock Exchange Limited (1989)
 Bhubaneswar Stock Exchange Association Limited (1989)
 Saurashtra Kutch Stock Exchange Limited (at Rajkot,
1989)
 Vadodara Stock Exchange Limited (at Baroda, 1990)
 National stock Exchange of India Limited (1994)
 Coimbatore Stock Exchange (1996)
 OTC Stock Exchange of India

 Interconnected Stock Exchange (ICSE)

At Present there are 23 recognized stock exchanges in India.

From these BSE & NSE are the two major stock exchanges
and rest 21 are the regional stock exchanges. Daily turnover of
all the stock exchange is appropriately 20,000 cr. BSE is 133
years old. NSE is 14 years old and it brought the screen based
trading system in India.
 The Function of Stock Exchanges
Stock exchanges have multiple roles in the economy, this may
include the following:

 Raising capital for businesses

The Stock Exchange provides companies with the facility

to raise capital for expansion through selling shares to
the investing public.

 Mobilizing savings for investment

When people draw their savings and invest in shares, it

leads to a more rational allocation of resources because
funds, which could have been consumed, or kept in idle
deposits with banks, are mobilized and redirected to
promote business activity with benefits for several
economic sectors such as agriculture, commerce and
industry, resulting in a stronger economic growth and
higher productivity levels and firms.

 Facilitating company growth

Companies view acquisitions as an opportunity to expand

product lines, increase distribution channels, hedge
against volatility, increase its market share, or acquire
other necessary business assets. A takeover bid or a
merger agreement through the stock market is one of the
simplest and most common ways for a company to grow
by acquisition or fusion.

 Redistribution of wealth

Stocks exchanges do not exist to redistribute wealth.

However, both casual and professional stock investors,
 through dividends and stock price increases that may
result in capital gains, will share in the wealth of
profitable businesses.

 Corporate governance

By having a wide and varied scope of owners, companies

generally tend to improve on their management
standards and efficiency in order to satisfy the demands
of these shareholders and the more stringent rules for
public corporations imposed by public stock exchanges
and the government. Consequently, it is alleged that
public companies (companies that are owned by
shareholders who are members of the general public and
trade shares on public exchanges) tend to have better
management records than privately-held companies
(those companies where shares are not publicly traded,
often owned by the company founders and/or their
families and heirs, or otherwise by a small group of
investors).

 Creating investment opportunities for small investors

As opposed to other businesses that require huge capital

outlay, investing in shares is open to both the large and
small stock investors because a person buys the number
of shares they can afford. Therefore the Stock Exchange
provides the opportunity for small investors to own
shares of the same companies as large investors.

 Government capital-raising for development projects

Governments at various levels may decide to borrow

money in order to finance infrastructure projects such as
sewage and water treatment works or housing estates by
selling another category of securities known as bonds.
These bonds can be raised through the Stock Exchange
whereby members of the public buy them, thus loaning
money to the government. The issuance of such bonds
can obviate the need to directly tax the citizens in order
 to finance development, although by securing such bonds
with the full faith and credit of the government instead of
with collateral, the result is that the government must
tax the citizens or otherwise raise additional funds to
make any regular coupon payments and refund the
principal when the bonds mature.

 Barometer of the economy

At the stock exchange, share prices rise and fall

depending, largely, on market forces. Share prices tend to
rise or remain stable when companies and the economy
in general show signs of stability and growth. An
economic recession, depression, or financial crisis could
eventually lead to a stock market crash. Therefore the
movement of share prices and in general of the stock
indexes can be an indicator of the general trend in the
economy.

Who Benefits from Stock Exchange

 Investors: It provides them liquidity, marketability,
safety etc. of investments.
 Companies: It provides them access to market funds,
higher rating and public interest.

 Brokers: They receive commission in lieu of services to

investors.

 Economy and Country: There is large flow of saving,

better growth, more industries and higher income.
Trading Pattern of the Indian Stock Market

Indian Stock Exchanges allow trading of securities of only

those public limited companies that are listed on the
Exchange(s). They are divided into two categories:
Types of Transactions
The flowchart below describes the types of transactions that
can be carried out on the Indian stock exchanges:

Indian stock exchange allows a member broker to perform

following activities:
  Act as an agent,
 Buy and sell securities for his clients and charge commission
for the same,
 Act as a trader or dealer as a principal,

 Buy and sell securities on his own account and risk.

About Bombay Stock Exchange

Bombay Stock Exchange is the oldest stock exchange in Asia
with a rich heritage, now spanning three centuries in its 133
years of existence. What is now popularly known as BSE was
established as "The Native Share & Stock Brokers' Association"
in 1875.

BSE is the first stock exchange in the country which obtained

permanent recognition (in 1956) from the Government of India
under the Securities Contracts (Regulation) Act 1956. BSE's
pivotal and pre-eminent role in the development of the Indian
capital market is widely recognized. It migrated from the open
outcry system to an online screen-based order driven trading
system in 1995. Earlier an Association Of Persons (AOP), BSE
is now a corporatised and demutualized entity incorporated
under the provisions of the Companies Act, 1956, pursuant to
the BSE (Corporatisation and Demutualization) Scheme, 2005
notified by the Securities and Exchange Board of India (SEBI).
With demutualization, BSE has two of world's best exchanges,
Deutsche Börse and Singapore Exchange, as its strategic
partners.

Over the past 133 years, BSE has facilitated the growth of the
Indian corporate sector by providing it with an efficient access
to resources. There is perhaps no major corporate in India
which has not sourced BSE's services in raising resources
from the capital market.

Today, BSE is the world's number 1 exchange in terms of the

number of listed companies and the world's 5th in transaction
numbers. The market capitalization as on December 31, 2007
stood at USD 1.79 trillion. An investor can choose from more
than 4,700 listed companies, which for easy reference, are
classified into A, B, S, T and Z groups.

The BSE Index, SENSEX, is India's first stock market index

that enjoys an iconic status, and is tracked worldwide. It is an
index of 30 stocks representing 12 major sectors. The SENSEX
is constructed on a 'free-float' methodology, and is sensitive to
market sentiments and market realities. Apart from the
SENSEX, BSE offers 21 indices, including 12 sectoral indices.
BSE has entered into an index cooperation agreement with
Deutsche Börse. This agreement has made SENSEX and other
BSE indices available to investors in Europe and America.
Moreover, Barclays Global Investors (BGI), the global leader in
ETFs through its iShares® brand, has created the 'iShares®
BSE SENSEX India Tracker' which tracks the SENSEX. The
ETF enables investors in Hong Kong to take an exposure to the
Indian equity market.

BSE provides an efficient and transparent market for trading

in equity, debt instruments and derivatives. It has a nation-
wide reach with a presence in more than 450 cities and towns
of India. BSE has always been at par with the international
standards. The systems and processes are designed to
safeguard market integrity and enhance transparency in
operations. BSE is the first exchange in India and the second
in the world to obtain an ISO 9001:2000 certification. It is also
the first exchange in the country and second in the world to
receive Information Security Management System Standard BS
7799-2-2002 certification for its BSE On-line Trading System
(BOLT).

BSE also has a wide range of services to empower investors

and facilitate smooth transactions:

Investor Services: The Department of Investor Services

redresses grievances of investors. BSE was the first
exchange in the country to provide an amount of Rs.1
million towards the investor protection fund; it is an
amount higher than that of any exchange in the country.
BSE launched a nationwide investor awareness programme
- 'Safe Investing in the Stock Market' under which 264
programmes were held in more than 200 cities.

The BSE On-line Trading (BOLT): BSE On-line Trading

(BOLT) facilitates on-line screen based trading in securities.
BOLT is currently operating in 25,000 Trader Workstations
located across over 450 cities in India.

BSEWEBX.com: In February 2001, BSE introduced the

world's first centralized exchange-based Internet trading
system, BSEWEBX.com. This initiative enables investors
anywhere in the world to trade on the BSE platform.

Surveillance: BSE's On-Line Surveillance System (BOSS)

monitors on a real-time basis the price movements, volume
positions and members' positions and real-time
measurement of default risk, market reconstruction and
generation of cross market alerts.

BSE Training Institute: BTI imparts capital market

training and certification, in collaboration with reputed
management institutes and universities. It offers over 40
courses on various aspects of the capital market and
financial sector. More than 20,000 people have attended
the BTI programmes
About National Stock Exchange
In order to lift the Indian stock market trading system on par
with the international standards, on the basis of the
recommendations of high powered Pherwani Committee, the
National Stock Exchange was incorporated in 1992 by
Industrial Development Bank of India, Industrial Credit and
Investment Corporation of India, Industrial Finance
Corporation of India, all Insurance Corporations, selected
commercial banks and others.

NSE provides exposure to investors in two types of markets,

namely:

1. Wholesale debt market

2. Capital market

Wholesale Debt Market - Similar to money market operations,

debt market operations involve institutional investors and
corporate bodies entering into transactions of high value in
financial instrumets like treasury bills, government securities,
commercial papers etc.

Trading at NSE

 Fully automated screen-based trading mechanism

 Strictly follows the principle of an order-driven
market
 Trading members are linked through a
communication network
 This network allows them to execute trade from their
 offices
 The prices at which the buyer and seller are willing
to transact will appear on the screen
 When the prices match the transaction will be
completed

 A confirmation slip will be printed at the office of the

trading member
Advantages of trading at NSE

 Integrated network for trading in stock market of

India
 Fully automated screen based system that provides
higher degree of transparency
 Investors can transact from any part of the country
at uniform prices

 Greater functional efficiency supported by totally

computerized network
About Ludhiana stock Exchange

Ludhiana Stock Exchange Association Limited (LSE) was

established in the year 1983 by Sh. S.P. Oswal and Sh. B.M.
Munjal, leading industrial luminaries, to fulfill a vital need of
having a Stock Exchange in this region. Since its inception,
the Stock Exchange has grown phenomenally. By 1999-2000,
the exchange had a total of 284 brokers, out of which 79 were
corporate brokers. Among 284 brokers, it was further
classified as 212 proprietor brokers, 2 partnership brokers
and 70 corporate brokers. Then, there were only 23 sub-
brokers registered.

Ludhiana Stock Exchange became the second bourse in India

to introduce modified carry forward system after BSE on April
6, 1998. On the same date, LSE also introduced a settlement
guarantee fund (SGF). The SGF guarantees settlement of
transactions and the carry forward facility provides liquidity to
the market.

LSE became the first in India to start LSE Securities Ltd., a

100% owned subsidiary of the exchange. The LSE Securities
got the ticket as sub-broker of the NSE. In 1998, the exchange
also got permission to start derivative trading.

OPERATIONS OF LUDHIANA STOCK EXCHANGE:

Turnover: LSE is one of the leading Stock Exchanges among

the Regional Stock Exchanges of the country, and has been
providing a trading platform for the investors situated in
Punjab, J&K, Himachal Pradesh and Chandigarh. At present it
has 344 listed companies and among them, 220 are listed as
regional companies. It had been generating significant amount
of business in the secondary market. It recorded a peak
turnover of Rs.9154crores during the year 2000-2001. The
structural changes that took place in the recent past in the
Capital Market of the country had a negative impact on the
trading volume of the Regional Stock Exchanges. There has
been a significant reduction of turnover during the financial
year 2001-2002, but the reduction in turnover of the
Exchange has been more than adequately compensated by
substantial rise in the turnover of LSE Securities Limited, a
subsidiary of Ludhiana Stock Exchange.

Listing: Listing is one of the major functions of a Stock

Exchange wherein the securities of the Companies are enlisted
for trading purpose. It is mandatory for the company coming
out with an IPO to get its shares listed on the Stock Exchange.
The Listing Dept. of the LSE deals with listing of securities,
further listing of issues like bonus and rights issues, post-
listing compliance of the companies, which are already listed
with LSE. The companies desirous of listing its securities on
the Exchange have to sign a Listing Agreement with the Stock
Exchange. After getting the listing approval, the company has
to ensure and report compliance of the post listing
requirements. The listing section of the LSE monitors the post-
listing compliance of all the listed companies and follows up
with the companies, which are found deficient in compliance.

Settlement Guarantee Fund (SGF): The Stock Exchange

established a Settlement Guarantee Fund (SGF) on April 6,
1998. It provides guarantee of all the genuine trades made
through the Screen Based Trading System of the Stock
Exchange.

Investors related services: The stock exchange offers the

various services investors related services such as it has
formed the Investor Grievance Cell which receives complaints
from investors and follows up the complaints with companies
and member-brokers to ensure their satisfactorily redressal. It
has also set up an Investors Protection Fund, Investors Service
Center; more over for the education of investors it has been
organizing investor’s awareness workshops in the parts of
Punjab, Himanchal Pradesh, Chandigarh and adjoining areas
of Rajasthan and Haryana since March, 2003.

DEPARTMENTS OF LSE:

The main aim of LUDHIANA STOCK EXCHANGE is to

ensure the safety and security to the investors and to provide
the proper services under the prescribed guidelines of SE 131.
So to maintain the proper system of working of exchange,
there are so many different interconnected departments,
which perform the specific functions. There is an organized
network of activities performed in various departments.

LIST OF THE VARIOUS DEPARTMENTS

A) Operational Departments:

 Margin Section
 Clearing House
 Market Surveillance
 Computer Section and Information System Department

B) Service Departments:
 Legal Department
 Secretarial Dept.
 I.G.C. (Investor Grievance Cell)
 Listing Section
 Accounting Section
 Membership Department/Personnel Department
OPERATIONAL DEPARTMENTS

MARGIN SECTION:

Margin Section is an important section. This section

apart from dealing and regulating the trading of brokers keeps
the check on excessive trading in speculation. Margin is the
amount, which is collected from tile brokers for the safety of
transactions. As the transactions are to be finalized on basis,
in the mean time the rates may fluctuate which may lead to
default. So to make the transaction safe, daily margins are
collected from brokers. When a member gets registered in the
exchange and with securities exchange board of India (SEBI),
then before starting trading he is supposed to deposit some
fixed by SEBI as security.
Now in SEBI rolling settlement prevails. Ultimately
margin is the difference between the limit and trade done by
the member. The security deposit by member is called Base
Minimum Capital. If any member wants to do trade up to
greater limit then he can deposit Additional Base Minimum
Capital.

Types of margins:

As we have discussed earlier margins collected from

members to avoid the losses and to provide security to the
investors. There are different types of margins, which are
imposed given as follows:
Mark to Market Margin: The exchange collects this margin on
daily bases, broker-wise 100% national loss of each member
for every scrip, calculated as the difference of his buying or
selling price and closing of that scrip at the end of the day.
This is also called loss margin. The margin is payable in cash
or in bank guarantee.
Value at risk or VAR Margin: For the scrips in the
compulsory rolling settlement 99% VAR based margin system
would be introduced w.e.f. July 02, 2001. The computation of
this margin is done by software developed by CHICAGO Stock
Exchange.
Additional Margin: Thus margin is 12% would be levied over
and above the VAR margin. This margin is collected from
brokers on T+2 basis.
Special Margin: The brokers will be required to deposit
margin as per the percentage prescribed by stock exchange in
this regard from time to time.

Payment of Margin: The broker's shall be required to deposit

margin demanded from them by 11:00AM on T+I day. That is
on next trading day. The margin brokers shall be collected by
way of cheques drawn on the prescribed banks, demand draft
or by way of direct debit to the bank account to broker.

CLEARING HOUSE:

Clearing house takes care of pay-in and pay-out

securities. At this time there is weekly trading system (Monday
to Friday) prevails. And securities are settled by rolling
settlement. Means pay-ill and pay-out of securities is settled
on T+3 Basis would commence from 1April, 2002. SEBI decide
the following activity schedule for exchanges for the T+3 rolling
settlement.

Settlement cycle schedule:

 Sr. Day Description of Activity Trade
No.
1 T Trade Date
2 T+1 Custodial Confirmation
3 T+3 Securities and Funds pay in and pay-
out
4 T+4 Auction of shortage in deliveries
5 T+6 Auction pay-in/pay-out as soon as
possible

T is Means TRADING PERIOD.

PAY IN/PAYOUT OF SECURITIES

On trading day brokers buy and sell the securities or

scrip and pay-I and pay out of securities will be completed on
T+3 basis e.g. if broker buy/sell shares on Monday then pay in
of securities will be on Wednesday, 11:00A.M. And pay out of
scrip will also on Wednesday up to 4:00 P.M. way pay-in/pay-
out of securities cycle will be completed.

AUCTION OF UNDELIVERED SCRIPS

In this in case if broker fails to deliver the scrips on

T+3 delivery day. Then it is responsibility of clearing house to
settle the undelivered scrips. Then T+4 cycle will start in above
example auction of pending securities will be conducted on
Thursday. In auction price of securities may fluctuate 20%
high or low on that trading day. In this way T+4 schedule is
settled.

CLOSE OUT

In case the shares of particular scrips is not available

on the date of auction. Then it is obligation of solicitor
(exchange) to give monetary benefit to initiator (buyer) against
the default of defaulter of securities in this manner settlement
schedule has completed.

COMPUTER SECTION

The growing technicalities and increase in workload

has enhanced the importance of computer section in Ludhiana
Stock Exchange. This department mainly referred to EDP i.e.
electronic data processing section. This section is that
backbone of entire stock exchange would come to halt if this
department becomes inactive.

It prepares several reports namely: -

 Scrips wise statement of each member for each
settlement period
 Sub broker wise delivery bill receive order (after payout)
 Downloading of delivery order.
 Downloading of receiving order.
 And broker on sub broker wise final settlement.
 HDFC bank entries.
 Scrip wise statement

Computer facilitates easily updating and automatically

adopting of new rates, once we feed new limits the whole
calculation to be done through computer will change. Rates
are updated either daily or month wise as per the
requirements.

Manual operations:
 It has reduced manual work. It has also eliminated
approximately the need to keep check the physical reports,
which is a time consuming as well as space consuming and
requires a lot of attention.

Volume and transparency:

This system is very much transparent, as each

individual involved knows every relevant thing. Also volume of
shares being traced is very high and increasing continuously.

Linking chain:

This section acts as a liking, which links each and every

department of the LSE with another and hence helps in
working as a whole.

Check and control over scrips and members:

This section also helps in maintaining check and

control over defaulting members and scrips. In case the
member crosses his limit of trading according to his deposited
amount, the computer section switches off his terminal and
same step is taken in case of defaulted scrips.

MARKET SURVEILLANCE SECTION:

The main task of this section is to see the market

sanctity and maintenance so that the investors are not
cheated. So market surveillance entails scientifically
identifying points in a stock price movement or trading
volumes, which don't match with the company's
fundamentals. So the price and volume trends in stock
exchange are checked for abnormalities scientifically.
INVESTORS GRIEVANCE SECTION:

LSE has a separate investor's grievance cell, which

receives complaints from investors111111 and follows up the
complaints with companies and member broker to ensure
their satisfactory redressal. For providing better services to the
investors the stock exchange has maintained investor
protection fund. In this fund Rs.500 is collected from each
member annually.
Apart from this 1% of the total listing fee is collected
and 10% interest covered on company deposits is also
transferred to the Investor Protection Fund. It has also set up
Investor Service Fund in favor of which 20% of the listing fee is
transferred and it is used for the maintenance of Investor
Service Center, holding of seminars for investor/brokers
benefit, and publication of LSE Bulletin.

The rationale behind establishing investor grievance

section is as follows:
 To safeguard the investor's interest through investors
grievance section.
 To participate as monitoring authority of the public and
right issue of the company.
 To ensure that the company listed at the LSE compiles
with all the listing requirements.
 To keep a record of the inquiry base of the listed
companies, their annual financial results and any
subsequent increase in the equity base.
LISTING SECTION:

This department plays an important role in the Stock

Exchange as it helps the company to raise money from the
capital market. Presently it is mandatory for Regional
Company to get itself listed at LSE. In order to get listed
company should have minimum capital of Rs.3 crores and at
least 25% of its equity should be offered to the public for the
listing company is also required to make a deposit

1% issue price with tile stock Exchange and it can not be

released before tile expiry of six months provided there is a
compliance of pre-listings and post, listing requirements b the
company. Company has also to comply with the conditions
enunciated in listing clause.

The schedule of annual Listing fee and up front listing fee

payable triennially is given below:

Paid up capital Annual Listing Fee (Rs.)

Up to 1 crores 7000
1 to 5 crores 10000
5 to 10 crores 18000
10 to 20 crores 36000
20 to 30 crores 54000
Above 50 crores 90000

Companies, which have paid up capital of more than

Rs.50 crores, will pay additional fee of Rs.2800 for every
increase of Rs.5 crores or part thereof. The annual listing fees
referred to above would be applicable only if the exchange is a
Regional Stock Exchange otherwise the fees will be 50% of the
fees indicated above.

ACCOUNTS SECTION:

Most of the work in the Account Section of LSE is

done manually, although the computers are used for the
purpose of making Trail Balance, Income and Expenditure
Account and Balance Sheet. The annual report of LSE is
generally published on August every year.

Some of the important polices of LSE are as follows:

 The company follows accrual system of accounting and
recognizes income and expenditure accordingly.
 Depreciation is provided on written down value method
in accordance with according to the manner specified in
schedule XIV of the Companies Act 1956.
 Fixed costs are stated at historical costs less
depreciation.
 Stock/Inventory (stationery) is valued at cost.
 Interest on funds borrowed which is attributable to
construction of fixed assets and other indirect
expenditure during construction is included under work
in progress.

The company has the procedure of receiving shares and scrips

of various companies as securities against the performance of
the contract. No accounting entries of such transaction are
made in respect of defaulting members by crediting security
account and debiting member's investment a/c. The shares in
such a case are valued at prices on the date of transfer deeds.
Functions of Accounts Section: The account section
performs the following function:
 To make and receive payments to the outside agencies,
these agencies include companies listed at LSE and
brokers working at LSE.
 To disburse personnel expenses.
 To get their accounts audited from the third party.

SECRETARIAL SECTION:

The secretarial department of LSE performs the duties

of the personnel department, as it does not have any separate
department for this purpose. The duties and responsibilities of
Secretarial Department of LSE are as follows:

 Recruitment of staff.
 Maintain employee record e.g. attendance leave, overtime
etc.
 Maintain employee service book up to date and other
detail as per the requirements to auditors at the time of
inspection (From date of joining registration)
 Employee welfare scheme like loans.
 Other activities like staff farewell party and Diwali puja
etc.

LEGAL SECTION:

When two broker or outside clients cannot settle claims

between themselves and approaches to the court, the legal
section comes into the picture to fight for the cause of
investors and against the defaulting members.
Legal section also assists the member investor to settle their
disputes through the arbitration committee Investors
Grievance Committee, Disciplinary committee, Defaulting
committee, so that they may be settled at the earlier without
incurring heavy dues on amount regarding court fee, advocate
fee etc.
The objective of the legal section is to make effective the
bylaws and regulation of the stock exchange and to see that
the guidelines, circular and any amendments in rules made by
the SEBI are enforced at appropriate time so that the future
complications may be reduced or avoided.
As the name legal section suggests it is clearly
mentioned and understood that each and every matter
regarding legal proceedings is to be solved by this department.
PERSONNEL DEPARTMENT:

Ludhiana Stock Exchange does not have a personnel

department in its Organization chart. This department carries
out all activities relating to the recruitment of the personnel,
whenever and wherever a vacancy arises, and maintenance of
attendance register. This department also deals with the
appointment or removal of floor clerks or authorized
representatives of brokers. These departments also maintain
records of leaves and overtime of employees.

MEMBERSHIP DEPARTMENT:

There are two types of members in stock exchanges.

1. Corporate members
2. Individual member
This department deals with membership of exchange.
The trade in market is through the authorized members who
have duly registered with concerned stock exchange and SEBI.

Following are the requirements to be an individual member of

exchange.

Age Limit: To be member of stock exchange there is age

limit Minimum age is 21 yrs Maximum age is
60 yrs.
Qualificatio To be member minimum qualification
n: Matriculation is plus person has three-year
 experience interview. Including written test
and membership department deal with all
above requirements of members.

Following are the requirements for corporate members:

1. Company must be registered under s 322 of the company
Act i.e. Directors with unlimited liability.
2. Two copies of memorandums & Articles of association.
3. Qualification & Proof of age of the at least two directors,
who will deal in securities.
ACHIEVEMENTS OF LUDHIANA STOCK
EXCHANGE:

Oct 1981 Incorporation of Stock Exchange

Aug 1983 Commencement of operations
Aug 1983 Shifting of operation to own
building
Nov 1996 Online Screen Trading
April 1998 Modified carry forward system
(MCTS) and settlement guarantee
fund.
Nov 1998 Trading and settlement in demat
scrips
Sep 1999 Trading at remote sites through
VSAT counters
Jan 2000 Introduction of rolling settlement
Aug 2000 Commencement of online real time
depository services
Dec 2000 Trading on N.S.E. in C.M. segment
(Through NSEL)
Sep 2000 Trading on B.S.E. in CM segment
(Through LSEL)
July 2001 Introduction of Compulsory rolling
settlement
January 2002 Complete shift of trading CM
segment from ISE To LSE securities
Ltd.
Feb 2002 Trading in F&O segment Of N.S.E.
April 2002 Rolling settlement cycle prevailing
at LSE on T+3 basis
April 2003 Rolling settlement cycle prevailing
at LSE on T+2 cycle
Incorporation of LSE commodities
trading services Ltd., a subsidiary
Oct 2003 of LSE. Securities Ltd.
March 2004 Introduction of MCX (Multi
Commodity Exchange of India) MCX
offers 14 different commodities
such as steel, kapas, rubber, black-
pepper, oil soil seeds, precious
metal etc.
March 2005 There was 27 sub broker of
company
Have been trading through VSAT on
NSE and 13 on BSE.

SUBSIDIARY OF LSE:

The management of the Stock Exchange apprehended

that the smaller regional stock exchanges would not be able to
meet the challenges imposed by expansion of bigger stock
exchanges like NSE and BSE and might end up losing their
counters to VSAT counters of the bigger stock exchanges. To
prepare for such a situation eventually, LSE set a broking arm
in the name of LSE Securities limited (a Subsidiary Company
of the Stock Exchange) in January 2000 and built
infrastructure and IT based sophisticated systems to enable
its members and investors to trade on NSE and BSE through
the subsidiary route.

LSE SECURITIES LIMITED:

It is the subsidiary of the LSE, which was formed in

January 2000 with an objective to enhance business and
investment opportunities for the investors and members of the
LSE at large, through innovative products by encompassing a
variety of activities related to the capital market.

Board of Directors:

The Company is managed by an independent Board of

Directors comprising of five elected Directors, three Public
Representatives Directors nominated by SEBI and two Officers
appointed by SEBI
Corporate member of NSE and BSE: LSE securities Ltd.
became Corporate Member of LSE and BSE. It commenced
trading in capital Market segment of BSE and NSE in
September, 2000 and December, 2000 respectively. Trading in
“FUTURE AND OPTIONS” segment of NSE was commenced in
February, 2002.
Network of Sub-brokers & VSAT counters: LSE Securities
Limited has 121 SEBI registered sub brokers on NSE and 61
on BSE. It is also providing facility to its sub-brokers for
trading on NSE and BSE through VSAT counters, which are
located throughout Northern India.

DP Services on NSDL & CDSL:

Depository Participant (DP) is a market intermediary where the

securities of share holders are held in electronic form at the
request of shareholders through the medium of participation.
The main function of DP is dematerialization of shares and
their maintenance on behalf of the Investors in electronic
form. LSE Securities Ltd. commenced its operations as DP of
NSDL and CDSL in August, 2000 and December, 2001
respectively. The DP of the company is providing on-line
services. As the result of the efficient services and the
competitive rates; the Company has been able to increase its
market share in the DP business at the cost of other DPs in
the region. As on date, DP on NSDL of the Company at
Ludhiana, Jalandhar, Amritsar and Chandigarh is servicing
over 20000 beneficiary accounts.

Branches:
 In order to expand its reach, LSE Securities Limited has
opened its branches at Amritsar, Chandigarh and Jalandhar.

Additional Trading Floor:

The Company is starting its trading activities from its

Chandigarh Office for providing trading opportunities to the
investors of the region.

LSE COMMODITIES TRADING SERVICES

LIMITED:
LSE Securities Limited formed its subsidiary company namely
LSE Commodities Trading Services Limited with a view to
provide Trading Services Limited with a view to provide
Trading Rights/Facilities in the area of Commodities to the
investors in the region. But the SEBI discharged this right
from the LSE because it was not able to achieve the desired
results then the new company LSE commodity Trading
Services Limited was set up as the separate company in the
year 2005. The company has got the corporate membership of
the Multi Commodity Exchange (MCX) under the category of
Institutional Trading cum Clearing Member. The investors in
this region would get an opportunity to, trade in the
commodities like gold, silver, steel, cotton, grains, pulses etc.
It has also got the membership of National Commodity and
Derivative Exchange (NCDEX).
 Introduction To Derivatives

Primary market is used for raising money and secondary

market is used for trading in the securities, which have been
used in primary market. But derivative market is quite
different from other markets as the market is used for
minimizing risk arising from underlying assets.

The word "derivative" originates from mathematics.

It refers to a variable, which has been derived from another
variable.

That is, X = f (Y)

WHERE, X (dependent variable) = DERIVATIVE PRODUCT
Y (independent variable) = UNDERLYING ASSET

A financial derivative is a product that derives value

from the market of another product. Hence derivative market
has no independent existence without an underlying asset.
The price of the derivative instrument is contingent on the
value of underlying assets.

Derivative means a Forward, Future, Option or any

other hybrid contract of Pre determined fixed duration, linked
for the purpose of contract fulfillment to the value of a
specified real or financial asset or to an index of securities.
 As a tool of risk management we can define it as, "a
financial contract whose value is derived from the value of an
underlying asset/derivative security ". All derivatives are based
on some cash product.

The underlying assets can be:

 Any type of agriculture product of grain (not prevailing in

India).
 Price of precious and metals gold.
 Foreign exchange rates.
 Short term as well as long-term bond of securities of
different type issued by Govt. and Companies etc.
 O.T.C. money instruments for example loan & deposits.

Example: Wheat farmers may wish to sell their harvest at a

future date to eliminate the risk of change in price by that
date. The price of these derivatives is driven from spot price of
wheat. Such a transaction could take place on a wheat
forward market. Here, the wheat forward is the “derivative”
and wheat on the spot market is “the underlying”. The terms
“derivative contract”, “derivative product”, or “derivative” are
used interchangeably.

In Indian context, the Securities Contract

(regulation) act, 1956 [SC(R) A] defines “Derivative” to
include:-
 A security derived from a debt instrument, share, loan
whether secured or unsecured, risk instrument or
contract for difference or any other from of security.
 A contract which drives it‘s value from prices, or index of
prices, or underlying security.
 HISTORICAL ASPECT OF DERIVATIVES:

The need for Derivatives as hedging tool was first felt in

the commodities market. Agriculture F&O helped farmers and
PROCESSORS hedge against commodity price risk. After the
fallout of BRITAIN WOOD AGREEMENT, the financial markets
in the world started undergoing radical changes, which gave
rise to the fear factor. This situation led to development of
derivatives as “Risk Management tools”.

Derivative trading in financial market started in 1972

when "Chicago Mercantile Exchange opened its International
Monetary Market Division (IIM). The IMM provided an outlet
for currency speculators and for those looking to reduce their
currency risks. Trading took place on currency. Futures,
which were contracts for specified quantities of given
currencies, the exchange rate was fixed at time of contract
later on commodity future contracts was introduced then
followed by interest rate futures.

Looking at the liquidity market, derivatives allow

corporate and institutional investors to effectively manage
their portfolios of assets and liabilities through instruments
like stock index futures and options. An equity fund e.g. can
reduce its exposure to the stock market and at a relatively low
cost without selling of part of its equity assets by using stock
index futures or index options. Therefore the stock index
futures first emerged in U.S.A. in 1982.

ORIGIN OF DERIVATIVE TRADING IN INDIA:

The first step towards introduction of derivatives

trading in India was the promulgation of the Securities Laws
(Amendment) Ordinance, 1995, which withdrew the
prohibition on options in securities. The market for
derivatives, however, did not take off, as there was no
regulatory framework to govern trading of derivatives. SEBI set
up a 24–member committee under the Chairmanship of Dr. L.
C. Gupta on November 18, 1996 to develop appropriate
regulatory framework for derivatives trading in India. The
committee submitted its report on March 17, 1998 prescribing
necessary pre–conditions for introduction of derivatives
trading in India. The committee recommended that derivatives
should be declared as ‘securities’ so that regulatory framework
applicable to trading of ‘securities’ could also govern trading of
securities. SEBI also set up a group in June 1998 under the
Chairmanship of Prof. J. R. Varma, to recommend measures
for risk containment in derivatives market in India. The report,
which was submitted in October 1998, worked out the
operational details of margining system, methodology for
charging initial margins, broker net worth, deposit
requirement and real–time monitoring requirements.
The Securities Contract Regulation Act (SCRA) was amended
in December 1999 to include derivatives within the ambit of
‘securities’ and the regulatory framework was developed for
governing derivatives trading. The act also made it clear that
derivatives shall be legal and valid only if such contracts are
traded on a recognized stock exchange, thus precluding OTC
derivatives. The government also rescinded in March 2000, the
three–decade old notification, which prohibited forward trading
in securities.

Trading and settlement in derivative contracts is done

in accordance with the rules, byelaws, and regulations of the
respective exchanges and their clearing house/corporation
duly approved by SEBI and notified in the official gazette.
Foreign Institutional Investors (FIIs) are permitted to trade in
all Exchange traded derivative products.

Some milestones:

 Nov.1996 - Formation of Dr. L C Gupta Committee

 Dec.1999 - Formation of Prof. J R Varma Committee
 May 2000 - Granting approval by SEBI
 June 2000 Commencement of Derivatives Trading (Index
Futures)
 June 2001 Commencement of trading in Index Options
 July 2001 Commencement of trading in Options on
Individual Securities
 November 2001 Commencement of trading in Futures on
Individual Securities
  August 2003 Launch of Futures & options in CNXIT
Index
 June 2005 Launch of Futures & options in BANK Nifty
Index
 December 2006 'Derivative Exchange of the Year', by Asia
Risk magazine

Products, Participants And Functions:

Derivatives contract have several variants. The most common
are FORWARDS, FUTURES, OPTIONS AND SWAPS.

The following three categories of Participants are - Hedgers,

speculators and Arbitrageurs.

(1) Hedger: Hedgers face risk associated with the price of

an asset. They use futures or options markets to
reduce the risk. Thus, they are operators who want to
eliminate the risk composing of their portfolio.

(2) Speculators: They wish to be on future movement in

the price of an asset. A speculator may buy securities
in anticipation of rise in price. If this expectation comes
true he sells the securities at a higher price and makes
a profit. Usually the speculator does not take direct
delivery of securities sold by him. He only receives and
pay the difference between the purchase and sale
prices.

(3) Arbitrageurs: They are in business to take advantage

of discrepancy between prices in two different markets.
For example, they see the future price of an asset
 getting out of line with the cash price, they will take off
setting positions in two markets to lock in profit.

Operators in Derivative
Market

Hedgers Speculator Arbitrageur

TYPES OF DERIVATIVE CONTRACTS:

The following types of derivative contracts are there. But, the
most commonly used derivative contracts are forwards,
futures and options.

 FORWARDS: a forward contract is a customized contract

between two entities, where settlement takes place on a
specific date in the futures at today's pre-agreed price.
 FUTURES: a future contract is an agreement between
two parties to buy or sell an asset at a certain time the
future at the certain price. Futures contracts are the
special types of forward contracts in the sense that are
standardized exchange traded contracts.
 OPTIONS: options are of two types: call option and put
options.
a. Call Option gives the buyer the right but not the
obligation to buy a given quantity of the underlying
asset, at a give price on or before a given future
date.
b. Put Option gives the buyer the right but not the
obligation to sell a give quantity of the underlying
asset at a given price on or before a given date.
 LEAPS: Normally option contracts are for a period of 1 to
12 months. However, exchange may introduce option
 contracts with a maturity period of 2-3 years. These long-
term option contracts are popularly known as Leaps or
Long term Equity Anticipation Securities.
 Warrants: Options generally have lives of up to one year,
the majority of options traded on options exchanges
having a maximum maturity of nine months. Longer-
dated options are called warrants and are generally
traded over-the-counter.
 BASKETS: Baskets options are option on portfolio of
underlying asset. Equity Index Options are most popular
form of baskets.
 SWAPS: these are private agreements between two
parties to exchange cash flows in the future according to
a prearrange formula. They can be regarded as portfolios
of forward's contracts. The two commonly used swaps
are:
a. Interest rate swaps: these entail swapping both
Principal and interest between the parties, with the
cash flow in one direction being in a different
currency than those in the opposite direction.
b. Currency swaps: these entail swapping both
Principal and interest between the parties, with the
cash flow in one direction being in a different
currency than those in the opposite direction.
 SWAPTIONS: Swaptions are options to buy or sell a swap
that will become operative at the expiry of the options.
Thus a swaption is an option on a forward swap. Rather
than have calls and puts, the swaptions market has
receiver swaptions and payer swaptions. A receiver
swaption is an option to receive fixed and pay floating. A
payer swaption is an option to pay fixed and receive
floating.

Examples:
Some common example of these derivatives are:
 CONTRACT TYPE
UNDERLYI Exchange
NG Exchange OTC OTC OTC
traded
traded options swap forward option
futures
DJIA Option on
Index DJIA Index
Equity future future Equity Back-
n/a
Index NASDAQ Option on swap to-back
Index NASDAQ
future Index future
Interest
Option on
Eurodollar Forward rate cap
Eurodollar Interest
Money future rate and floor
future rate
market Euribor agreeme Swaption
Option on swap
future nt Basis
Euribor future
swap
Repurc
Bond Option on hase Bond
Bonds n/a
future Bond future agreeme option
nt
Stock
Repurc
Single- option
Single Single-share Equity hase
stock Warrant
Stocks option swap agreeme
future Turbo
nt
warrant
Foreign Option on FX Currenc FX
FX future FX option
exchange future y swap forward
Credit Credit
Credit n/a n/a default n/a default
swap option

Cash Vs Derivative Market

The basis differences between these two may be noted as
follows:

 In cash market tangible asset are traded whereas in

derivatives market contract based on tangible assets or
intangible like index or rates are traded.
 The value of derivative contract is always based on and
linked to the underlying asset. Though, this linkage may
not be on point-to point basis.
 Cash market contracts are settled by delivery and
payment or through an offsetting contract. The derivative
contracts on tangible may be settled through payment
and delivery, offsetting contract or cash settlement,
whereas derivative contracts on intangibles are
necessarily settled in cash or through offsetting
contracts.
 The cash markets always have a net long position,
whereas the net position in derivative market is always
zero.
 Cash asset may be meant for consumption or
investment. Derivatives are used for hedging, arbitration
or speculation.
 Derivative markets are highly leveraged and therefore
could be much more risky.

THE DERIVATIVE MARKETS PERFORM A

NUMBER OF ECONOMIC FUNCTIONS:
 Prices in organized derivative markets reflect the
perception of market participants about the future and
lead the prices of underlying to perceived future level.
The prices of derivatives converge with the prices of the
underlying at the expiration of the derivative contract.
Thus derivatives help in discovery of future as well
current prices.
 The derivative market helps to transfer the risks from
those who have them but may like them to those who
have an appetite for them.
  Derivatives due to their inherent nature are linked to the
underlying cash markets. With the introduction of
derivative, the underlying market, witness higher trading
volumes because of participation by more players who
would not otherwise participate for lack of an
arrangement to transfer risk.
 Derivatives have a history of attracting many bright,
creative, well-educated people with an entrepreneurial
attitude. They often energize others to create new
business, new products and new employment
opportunities, the benefits of which are immense.
 Derivatives market helps increase savings and
investments in the long run Transfer of risk enables
market participants to expand their volume of activities.

Participants in Derivative Market:

 Exchange, trading members, clearing members.
 Hedgers, arbitrageurs, speculators.
 Clearing, clearing bank.
 Financial institutions.
 Stock lenders and borrowers.

Objectives of Derivative Trading:

(1) Hedging: You own a stock and you are confident about
the prospects of the company. However at the same time
you feel overall market may not perform as well and
therefore price of your stock may also fall in line with
overall market trend.

You expect that some adverse economic or political event

might affect the market sentiments, though fundaments
of the company will remain good, therefore, it is good to
retain the stock. In both these situations you would like
 to insure your portfolio against any such market fall.
Such insurance is known as Hedging.

Hedging is a tool to reduce the inherent risk in an

investment. Various strategies designed to reduce
investment risk using call options, put options, short
selling, and futures are used for hedging. The basic
purpose of a hedge is to reduce the risk of loss.

(2) Speculation: You may have very strong opinion about

the future market price of a particular asset based on
past trends, current information and future expectation.
Likewise you may also have an opinion about the overall
market trend. To take advantage of such opinion,
individual asset or the entire market (index) could be
sold or purchased.

Position taken either in cash market of derivative market

on the basis of personal opinion is known as
speculation.

(3) Arbitrage: The future price of an underlying asset is

function of spot price and cost of carry adjusted for any
return on investment. However, due to uncertainty
about interest rates, distortions in spot prices, or
uncertainty about future income stream, prices in
futures market may not truly reflect the expected spot
price in future. This imbalance in future and spot price
in the market are known as arbitrage transactions.
REASON FOR STARTING DERIVATIVES:
a. Counter party risk on the part of broker, in case it asks
money from us but before giving delivery of shares goes
bankrupt.
b. Liquidity risk in the form that the particular scrip might
not be traded on exchange.
c. Unsystematic risk in the form that the price of scrip may
go up or down due to "Company Specific Reasons".
d. Mutual funds may find it difficult to invest the funds
raised by them properly as the scrip in which they want
to invert might not be available at the right price.
e. Systematic risk in the form that the price of scrip may go
up or down due to reason affecting the sentiment of
whole market.

STRENGTH OF INDIAN CAPITAL MARKET

FOR INTRODUCTION OF DERIVATIVES:
  Large Market Capitalization: India is one of the largest
market capitalized country in Asia with a market
capitalization of more than 7,65,000 corers.
 High Liquidity: In the underlying securities the daily
average traded volume in Indian capital market today is
around 7,500 crores, which means on an average every
month 14% of the country market capitalization gets
traded, shows high liquidity.
 Trader Guarantee: The first "clearing corporation" (CCL)
guaranteeing trades has become fully functional from
July 1996 in the form of National Securities Clearing
Corporation (NSCCL) for which it does the clearing.
 Strong depository: A strong depository National
Securities Depositories Ltd. (NSDL), which started
functioning in the year 1997, has strengthen the
securities settlement in our country.
 A Good Legal Guardian: SEBI is acting as a good legal
guardian for Indian Capital market.

IMPORTANCE OF DERIVATIVE TRADING:

a. Reduction of borrowing cost.
b. Enhancing the yield on assets.
c. Modifying the payment structure of assets to correspond
to investor market view.
d. No physical delivery of share certificate so reduction in
cost by stamp duty.
e. Increase in hedger, speculator and arbitrageurs.
f. It does not totally eliminate speculation, which is basic
need of Indian investors.
INSTRUMENTS OF DERIVATIVE TRADING:
FORWARD

Derivative FUTURE

OPTIONS

SWAPS

FORWARD CONTRACT:
"It is an agreement to buy/sell an asset on a certain future
date at an agreed price".

The two parties are:

 Who takes a long position – agreeing to buy

 Who takes a short position—agreeing to sell
 The mutually agreed price is known as "delivery
price" or "forward price". The delivery price is chosen in such a
way that the value of contract for both parties is zero at the
time of entering the contract, but the contract takes a positive
or negative value for parties as the price of underlying asset
moves. It removes the future price risk. It a speculator has
information or analysis, which forecast an upturn in price,
and then he can go long on the forward market instead of cash
market.
The speculator would go long on the forward, wait
for the price to rise, and then take a reversing transaction to
book profits. Speculator may well be required to deposit a
margin upfront. However, this is generally a relatively small
proportion of the value of assets underlying the forward
contract.

Effect of change in price:

As mentioned above the value of such a contract in

zero for both the parties. But later as the price & the
underlying asset changes, it gives positive or negative value for
contract.

PRICE & HOLDER & LONG HOLDER & SHORT

UNDERLYING POSITION POSITION
ASSETS
INCREASE POSITIVE VALUE NEGATIVE VALUE
DECREASE NEGATIVE VALUE POSITIVE VALUE

E.g: Suppose that A wants to buy a house in one year's time.

At the same time, suppose that B currently owns a house
worth Rs.1 lac that he wishes to sell in one year's time. Both
parties could enter into a forward contract with each other.
Suppose that they both agree on the sale price in one year's
time of Rs.104,000 (more below on why the sale price should
be this amount).A and B have entered into a forward contract.
A, because he is buying the underlying, is said to have entered
a long forward contract. Conversely, B will have the short
forward contract.

At the end of one year, suppose that the current market

valuation of B’s house is Rs.110,000. Then, because B is
obliged to sell to A for only Rs.104,000. A will make a profit of
Rs.6,000. To see why this is so, one needs only to recognize
that A can buy from B for Rs.104,000 and immediately sell to
the market for Rs.110,000. A has made the difference in profit.
In contrast, B has made a potential loss of Rs.6,000, and an
actual profit of Rs.4000. Profit/Loss = ST-E

Where, ST= Spot price on maturity date

E = Delivery price

Limitations of forward contract:

 No standardization.
 One party can breach its obligation.
 Lack of centralization of trading.
 Lack of liquidity

A forward contract is specified with four variables:

 the underlier,
 the notional amount n,
 the delivery price k, and
 the settlement date on which the underlier and payment
will be exchanged.

Valuation of Forward Contract

 The Forward contract can be put under three categories for
the purpose & valuation:

Valuation of those Securities Providing No Income:

Shares which neither accepts to pay any dividend in future

nor having arbitrage opportunities.
e.g. Here Price (F) = Stert

Where, F = Future Price

St = the spot price of asset
r = Risk free rate of interest p.a. with continuous
compounding.
t = Time of maturity.

If (F) > Stert

In this case the investor will buy asset and take a short
position in the forward contract.
“Short position is not position of investor is of seller means
contract sold is greater then contract bought”.

Investor may buy the assets, borrowing an amount equal to * *

for “t” period at risk free rate. At the time of maturity, the
assets will be delivered for price F and repayment will be equal
to Stert and there is net profit equal to F - Stert

If F < Stert
He will long his position in Forward Contract. When contract
matures: the assets would be purchased for “F”. Here profit is
Stert – F.

E.g. Consider a forward contract where non–dividend shares

available at Rs. 70 matures in 3 months, Risk free rate 8% p.a.
compounded continuously.

0.25X0.08
Stert = 70 X [e]
= 70 X 0202
= Rs.71.41

If F = 73 then an arbitrageur will short a contract, borrow an

amount of Rs.70 & buy shares.
Repay the loan of Rs.70. At maturity sell it as Rs.73 (Forward
contract price) and 71.40, thus profit is (73 – 71.40) Rs.1.60.
Thus he shorts his forward contract position.

Securities Providing A Certain Cash Income

If there is certain cash income to be generated on securities in

future to the investor, we will determine present value of
income e.g. in case of preference shares.

Present value of dividend = Rate & Interest (Continuously

compounded)

~ If there is no arbitrage
Then F = (St – I) ert
~ If F > (St – I) ert
Arbitrageur can short a forward contract, borrow money and
buy the asset at present and at maturity asset is sold and
earns profit.
Profit = F - (St – I) ert

~ If F < (St – I) ert

Arbitrageur can long a forward contract, short the asset at
present and invest the proceeding.

Profit = (St – I) ert - F

E.g. Let us consider a 6 month forward contract on 100 shares

at Rs.38 each risk free of interest (compounding continuously)
earn is 10% p.a. dividend is expected to a yield of Rs.1.50 in 4
months.
Dividend receivable after 4 months = 100 X 1.5 = Rs.1.50
(4/12) (0.10)50
Present Value & Dividend = 150 X e
= 150 X 0.9672= Rs.145.88
(0.50) (0.10)
= (3800 – 145.8) e
= 3654.92 X 1.05127
F = 3842.31

Valuation & Forward Contract Providing A

Known Yield:
In case of shares included in portfolio companies the index,
as an underlying assets, are expected to give dividend in
 course of time, which may be percentage 0 their prices. It is
assumed to be paid continuously at a rate of “Y” p.a.
F = Stert

E.g. Stock underlying as under provide a dividend yield of

4.1% p.a., current value of index is 520 and risk free rate of
interest is 10% p.a.
r = 0.10, y = 0.04, * * = 520, T = 3/12 = 0.25
F = 520 X e(0.10 – 0.40) (0.25)
= 520 X 01512
= Rs.527.85

Futures

A futures contract is a legally binding agreement to buy or sell

a specific commodity, such as soybeans, or financial
instrument, such as silver or the Euro, on a particular date in
the future at an agreed upon price. Futures belong to a
category of financial instruments known as derivatives,
because their prices are derived from the value of other,
underlying instruments, items, or products. In the case of
futures, commodities of various kinds are the products
underlying the contracts.

From Forward to Future

Futures developed from forward contracts, originally used by

commodity producers — corn farmers for example — who
wanted to lock in the price they were to be paid for corn when
it was harvested some months later. The object was to reduce
risk. With the contract in hand, the farmer could be protected
if corn prices dropped.

Futures contracts formalized the forward contract process,

imposing standard contract terms for grade — or quality —
quantity, time, and location. With the imposition of standard
delivery specifications, it became possible to trade contracts
on an organized exchange, creating a futures marketplace.

Buying and selling a futures contract does not transfer

ownership, as buying or selling a stock does. Rather, it spells
out the terms under which the underlying commodity is to be
purchased or sold at a later date.

Categories of futures

Two distinct categories of commodities underlie futures

contracts — consumable and financial. Historically, futures
contracts were for consumable commodities — commodities
that are the raw materials literally consumed in production
processes that create food, fuel, clothes, cars, houses, and
thousands of other products that consumers buy. Futures
contracts were, and still are in many cases, a way to help
protect the producers and users of the consumable
commodities — the gold miner and the jeweler, the oat grower
and the cereal maker — from the risk of price fluctuations.

Though you may not think of currencies or Treasury bonds as

commodities, they are. Money is as much the raw material of
domestic and international trade, as wheat is the raw material
of bread. The value of a currency concerns people whose
businesses depend on the money supply, or on what imported
materials will cost. There are four basic categories of financial
commodities that are the subject of futures contracts:

Currencies
Stock indexes
Interest rates
Individual stocks

Futures contracts

A futures transaction always has two parties, a buyer and a

seller, and you can enter the market either way. If you buy a
contract, you take a long position and are called the long. If
you sell a contract, you take a short position and are called
the short. Further, in the futures market, every contract has
an equal number of long and short positions.
To liquidate and leave the futures market, you need to cancel
your existing futures position either by offsetting your contract
with a matching futures contract on the opposite side of the
market, or by delivering or taking delivery of the commodity or
its cash value. Long positions are offset by short positions,
and short positions by long ones. For example, if you have a
long position on 5,000 bushels of soybeans deliverable in
January, you need to short — or enter a contract to sell —
5,000 bushels of soybeans deliverable in January or expect to
have the 5,000 bushels delivered to your doorstep.
This obligation differs from the terms of an options contract
you buy, which you may allow to expire unexercised. But it
resembles what happens when you sell an options contract
and must offset or fulfill your part of the bargain.
To overcome the problems in forward contract, other type
of derivative instrument known as "Future Contract” came into
existence. It is an agreement between buyer and seller for the
purchase and sale of a particular assets at a specific future
date; specific size, date of delivery, place and alternative asset.
It takes obligation on both parties to fulfill the contract
It's nothing personal

Futures are interchangeable contracts that trade on formal

exchanges. This means that you don't have to find the person
who was on the other side of your original futures contract to
leave the market. When you give an order to offset an existing
futures position, the sale or purchase is handled by traders on
the exchange and then cleared through the futures
clearinghouse, which becomes the buyer for every futures
contract seller and the seller to every futures contract buyer.

History:

What we know as the futures market of today came from some

humble beginnings. Trading in futures originated in Japan
during the eighteenth century and was primarily used for the
trading of rice and silk. It wasn't until the 1850s that the U.S.
started using futures markets to buy and sell commodities
such as cotton, corn and wheat.

Futures Fundamentals:
A futures contract is a type of derivative instrument, or
financial contract, in which two parties agree to transact a set
of financial instruments or physical commodities for future
delivery at a particular price. If you buy a futures contract,
you are basically agreeing to buy something that a seller has
not yet produced for a set price. But participating in the
futures market does not necessarily mean that you will be
responsible for receiving or delivering large inventories of
physical commodities - remember, buyers and sellers in the
futures market primarily enter into futures contracts to hedge
risk or speculate rather than to exchange physical goods
(which is the primary activity of the cash/spot market). That is
why futures are used as financial instruments by not only
producers and consumers but also speculators. The
consensus in the investment world is that the futures market
is a major financial hub, providing an outlet for intense
competition among buyers and sellers and, more importantly,
providing a center to manage price risks. The futures market
is extremely liquid, risky and complex by nature, but it can be
understood if we break down how it functions.

Features of Future Contract:

 Standardized contracts e.g. contract size.
 Between two parties who do not necessarily know each
other.
 Guarantee for performance by a clearing corporation or
clearing house. Clearinghouse is associated with
matching, processing, registering, confirming setting,
reconciling and guaranteeing the trades on the future
exchanges. Clearinghouse tries to eliminate risk of
default by either party.
 Standardized Items in Futures:
 Quantity of the underlying
 Quality of the underlying
 The date and month of delivery
 The units of price quotation and minimum price change
 Location of settlement

Future terminology:

Spot price: the price at which an asset trades in the spot

market.

Futures price: the price at which the futures contract trades

in the futures market.

Contract cycle: the period over which the contract trades.

The index futures contracts on the NSE have one month, two
month, and three-month expiry cycles, which expire on the
last Thursday of the month. Thus a January expiration
contract expires on the last Thursday of the January. On the
Friday following the last Thursday, a new contract having
three-month expiry is introduced of trading.

Expiry date: it is date specified in the futures contract. This is

the last day on which the contract will be traded, at the end of
which it will cease to exist.

Contract size: the amount of asset that has to be delivered

less than one contract. For instance, the contract size on
NSE's futures market is Nifties.

Basis: in the contract of financial futures, basis can be defined

as the futures price minus the spot price. There will be a
different basis for each delivery month for each contract. in a
normal market, basis will be positive. This reflects that futures
prices normally exceed spot prices.

Initial margin: the amount that must be deposited in the

margin account at a time a future contract is first entered into
is known as initial margin.

Cost of carry: the relation between futures price and spot

price can be summarized in terms of what is known as cost of
carry. This measures the storage cost plus the interest that is
paid to finance the assets less the incomes earned on the
asset.

Marking-to-market: in the futures market, at the end of each

trading day, the margin account is adjusted to reflect the
investor's margin gain or loss depending upon the future's
closing price.

Maintenance margin: this is somewhat lower than initial

margin. This is set to ensure that the balance in the margin
account never becomes negative. If the balance amount falls
below the maintenance margin, the investor receives a margin
call and is expected to top up the margin account to the initial
margin level before trading commences on the next day.

Forwards Vs Futures:

Features Forward Future

Operational Traded between two Traded thro’
Mechanism parties exchange
Contract Customized contract Standardized
specification contract
Counter party risk Exists such risk No such risk
liquidity Low High
Price discovery Not efficient current Highly efficient
example market current market
settlement At end of period Daily

Futures Payoffs:
 Futures contracts have linear pay-offs – unlimited profits
or losses
 Payoff for buyer of futures: long futures
 An obligation to take delivery at a future date
 Similar to that of a person who holds an asset
 Example - A speculator buys a two-month nifty
index futures
contract when the nifty stands at 3250. When the
index starts
moving up, the long futures position makes profits
and when the
index moves down the future starts making losses.

 Payoff for seller of futures: short futures

 An obligation to give delivery at a future date
 Similar to that of a person who sells/shorts an asset
 Example - A speculator sells a two-month nifty index
futures contract when the nifty stands at 3250. when
the index starts moving down, the short futures
position makes profits and when the index moves up
the future starts making losses.
 Futures Payoffs:

Bought
Futures
Gain Gain
t t
ofi ofi
Loss Loss
Pr Pr

Sold
Futures
Current Price Current Price

Purchase Price of contract Purchase Price of Contract

Gain/Loss = Gain/Loss =
Sale Price – Purchase Price Purchase Price - Sale Price

Applications of Futures:

Hedging – a risk management tool

 long security, short futures
 Example – an investor holds a security but gets
uncomfortable with the movements in the short run. Sees
prices falling from 450 to 390. in the absence of stock
futures, he either live with it or sells the security.
 With security futures he can minimize the price risk. He
can enter into an off-setting short futures position.
  Assuming spot price is 390. Two-months’ future costs
him Rs. 402, for which he pays an initial margin. If prices
fall, so does the price of futures. As a result, his short
futures position starts making profits. The loss incurred
on the security will be made up by the profit on his short
futures position.
 N.B. Hedging does not always make money! It removes
unwanted exposure i.e. unnecessary risk.

Speculation – bullish security, buy futures

 Case 1 – a speculator believes a security at 1000 is
undervalued; in the absence of a deferred product, he
has to buy it and hold on to it till his hunch proves
correct. assume he buys 100 shares which cost him one
lakh rupees. Two-months later, say the security closes at
1010. he makes a profit of 1000 on an investment of
100,000 for a period of two-months. This works out to be
an annual return of 6% .
 Case 2 – the security trades at 1000 and the two-month
future at 1006. for the sake of comparison, assume the
minimum contract value is 100,000. he buys 100
security futures for which he pays a margin of Rs.
20,000. two months later, the security closes at 1010. on
the date of expiration, the future price converges to the
spot price and he makes a profit of Rs. 400 on an
investment of Rs. 20,000. this works out to an annual
return of 12 percent. There lies the power of leverage.

Arbitrage – Overpriced futures: buy spot, sell futures

 Cash-and-carry arbitrage opportunity
 The cost-of-carry ensures that futures price stay in tune
with the spot price.
 Whenever futures price deviates from its fair value,
arbitrage opportunities arise.
 Say X trades at 1000. one month future trades at 1025
and seems overpriced. As an arbitrageur, you can enter
into the following trade to make risk-less profit:
 – Borrow funds to buy the security in cash/spot
market for 1000.
– Simultaneously, sell the security future for 1025.

– Take delivery of the security and hold for a

month.
– On futures expiration date, spot and future prices
converge. Unwind the position.
– Say the security closes at 1015. sell the security.
– Futures position expires with a profit of Rs. 10
– The result is a risk-less profit of Rs.15 on the spot
position and Rs. 10 on the futures position.
– Return the borrowed funds.

Economic Importance of the Futures Market :

Because the futures market is both highly active and central

to the global marketplace, it's a good source for vital market
information and sentiment indicators.

Price Discovery - Due to its highly competitive nature, the

futures market has become an important economic tool to
determine prices based on today's and tomorrow's estimated
amount of supply and demand. Futures market prices depend
on a continuous flow of information from around the world
and thus require a high amount of transparency. Factors such
as weather, war, debt default, refugee displacement, land
reclamation and deforestation can all have a major effect on
supply and demand and, as a result, the present and future
price of a commodity. This kind of information and the way
people absorb it constantly changes the price of a commodity.
This process is known as price discovery.

Risk Reduction - Futures markets are also a place for people

to reduce risk when making purchases. Risks are reduced
because the price is pre-set, therefore letting participants
know how much they will need to buy or sell. This helps
reduce the ultimate cost to the retail buyer because with less
risk there is less of a chance that manufacturers will jack up
prices to make up for profit losses in the cash market.

TYPE OF FUTURE CONTRACTS:

In India, three types of future derivatives are available for

trading at NSE & two at BSE. Future derivatives that are
trading in BSE are:
 Equity index future on SENSEX.
 Stock futures on 41individual securities.
Future derivatives that are trading in NSE are:
 Equity index future on S & P CNX NIFTY.
 Stock futures on 41 individual securities.
 Interest rate future on 91/365 T-bills, ten
year notional bond (with coupon rate) &
ten year notional bond ( zero coupon rate)
But now there is more than 125 individual securities.

INDEX FUTURES:
Index futures are futures contracts where the
underlying asset is the index. The index futures provide a
hedge against price fluctuations of the securities and hedgers
are using it as an insurance tool.

A stock index future contract is an obligation to

deliver at settlement an amount of cash equal to the difference
between the stock index value at the clause of the last trading
day of the contract & the price at which the futures contracts
was originally struck. For instance ,if the SENSEX index is at
3000 & a lot size of contract is equal to 50,a contract struck at
this level could be worth Rs150000(3000* 50).If ,at the
expiration of the contracts ,the SENSEX stock index is at
3100,a cash settlement of Rs5000 is required [(3100-
3000)*50]. In stock index futures, no physical delivery of stock
is made.
 In India, the BSE was the first stock exchange to
introduce Index futures on June 9, 2000 on SENSEX. In NSE
the trading of index futures commenced on June 12, 2000 on
the S&P CNX NIFTY. The stock index futures are traded on the
F&O segment of the both exchanges.
Both buyers & sellers are required to deposit margin
at the time of contract. The margin amount is based volatility
if market indices. In India the initial margin is expected to be
around 8-10%.The margin is kept in a way that it covers price
movement more than 99% of the time. Usually key sigma
(standard deviation) is used or this measurement. This
technique is also called value at risk (VAR).

In futures market, at the end of each trading day the

margin account is adjusted to reflect the investor’s gains or
loss depending up on the futures closing price & variation may
be required or released. This is known as MTM (mark to
market).
In India, three types of future derivatives are
available for trading at NSE & two at BSE. Future derivatives
that are trading in BSE are:
 Equity index future on SENSEX.
 Stock futures on 41individual securities.
Future derivatives that are trading in NSE are:
 Equity index future on S&P CNX NIFTY.
 Stock futures on 41 individual securities.
 Interest rate future on 91/365 T-bills, ten year notional
bond (with coupon rate) & ten year notional bond (zero
coupon rate)

Contract Specification:
Underlying index S&P CNX NIFTY

Exchange of trading NSE

Security descriptor N FUTIDX NIFTY

Contract size Permitted lot size shall 200 &multiple

thereof (minimum value of Rs.2 lakh)

Price steps Rs.0.05

Price band Not applicable

Trading cycle The futures contracts will have a

maximum of three month trading cycle.
The near month (one), the next month
(two) & the far month (three). New
contracts will be introduced on the next
trading day following the expiry of the
near month contract.

Expiry day The last Thursday of the expiry month of

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

Settlement basis Mark to market &final settlement will be

cash settled on T +1 basis

Settlement price Daily settlement price will be closing

price the futures contracts for the
trading day & the final settlement price
shall be the closing value of the
underlying index on the last trading day.

STOCK FUTURE:
 Stock futures are the contracts where the underlying
asset is the individual securities or stock. In stock futures the
investors also require to deposit initial margin, the margin is
decided by the exchange (on the basis of four times changes in
security prices in a day) on the volatility of individual stock.
Beside this, exposure margin is also required by the stock
exchange, it can 5% (6% or 7% at specific securities) of all 41
individual securities. In India settlement of future on
individual stock is settled in cash only.
In India the stock future are available on the blue
chip securities & these securities are free from price
fluctuation bonds. The securities are approved by SEBI. At
present 41 individual securities are available for stock future.
NSE & BSE commenced trading in stock future on individual
securities on November 9, 2001 & November 2001
respectively.

Contract Specification:
Underlying Individual securities
Exchange of trading National Stock Exchange
Security descriptor NFUTSK
Contract size 100 or multiples there of( minimum
value of Rs.2 lakh)
Price steps Rs.0.05
Price band Not applicable
Trading cycle The contract will have a maximum of
three month trading cycle- the near
month (one), the next month (two),
&the far month (three). New
contracts will be introduced on the
next trading day following the expiry
of the near month contract.
Expiry day The last Thursday of the expiry
month of the previous trading day if
the last is Thursday is trading
holiday.
Settlement basis Mark to market & final settlement
will be cash settled on T+1 basis.
Settlement price Daily settlement will be the closing
price of the future contracts for the
trading day &the settlement price
shall be the closing vale of the
underlying index on the last trading
day.

INTEREST RATE FUTURE:

Interest rate futures are based on a list of underlying (T-bills,
bonds, notes & credit instrument).The list of underlying is
specified by the exchange & approved by SEBI time to time.
Interest rate futures provide a hedge against the interest rate
risk. In India, the interest rate has a downtrend since last four
years.
NSE was the exchange in India to introduce interest rate
future trading on June 24, 2003. To begin that interest rate
future contract, the following underlying shall be available for
trading in F&O segment of the exchange:

S.No Symbol Description

1 NSETB91D
2 NSE10Y06
3 NSE10YZC
Futures contracts on notional
91 days T-Bills
Future contract on notional 10
year coupon bearing bond
Future contract on notional 10
year zero coupon bond

The interest rate future contract shall be for a period of

maturity of one year with three-month continuous contract,
for the first three-month & fixed quartile contracts for the
entire year. New contract will be introduced on trading day
following the expiry the near month contract.
 Characteristics of the interest rate
futures/contract specification:

Contract Notional 10 Notional 10 Notional 91

underlying year bond (6% year zero day T-Bill
coupon) coupon bond
Contract N FUTINT NSE N FUTINT NSE N FUTINT
descriptor 10Y06 10YZ 26JUN NSETB91D
26JUN2003 2003 26JUN2003
Contract Rs.2,00,000
value
Lot size 2000
Tick size Re. 0.01
Expiry Last Thursday of month
date
Contract The contract shall be for a period of a maturity of
months one year with three months continuous contract
for the first three months & fixed quarterly
contract for the entire year
Price Not applicable
limits
Settlement As may be stipulated by NSCCL in this regard
price from time to time.

Buying futures

Futures contracts are highly leveraged instruments. Leverage

is the ability to control large dollar amounts of a commodity
with a comparatively small amount of capital. In most cases,
you can buy or sell futures with a good faith deposit, or initial
margin of 10% or less of the value of the contract on delivery.
The margin acts as a performance bond that is available to the
futures broker to meet your obligations for potential losses on
a futures position.

Changing contract value

Both over the term of your futures contract and throughout a

regular trading day, the price of liquidating your futures
position changes constantly. So during the term of a contract,
you must maintain the margin level of your account, adding
money if required to cover the loss if the value of the contract
you hold drops. Maintenance margin requirements may differ
from initial margin requirements, depending on the exchange.
Maintaining an appropriate margin level affirms to the
exchange that you will meet the terms of the contract, either
by delivering or taking delivery of the underlying commodity,
or, as happens in an estimated 98% of futures transactions,
by buying or selling an offsetting contract.

The changes in contract value are caused by fluctuations in

the price of an offsetting contract, which in turn is caused by
changes in the cash price of the underlying commodity, among
other factors. The difference between the price of your contract
and the price of an offsetting contract represents the profit or
loss of the position.

How futures trading works

Most producers and users of commodities buy and sell them

in the cash market, also called the spot market, because the
full cash price is paid on the spot. Cash prices are determined
by supply and demand, which in many cases move in
predictable seasonal cycles. Fresh fruits and vegetables are
cheapest in the summer when they're plentiful (and most
flavorful). So soup, juice, and jam manufacturers plan their
production season to take advantage of the highest-quality
produce at the lowest prices.

But supply and demand is also affected by unpredictable

events. Drought might wipe out a wheat crop, causing the
cash price of wheat to soar. Political turmoil in the Gulf region
might threaten the oil supply and cause the cash price of
energy commodities to rise. The futures market is designed to
help protect producers and users from just such price risks.
Farmers, loggers, manufacturers, and bakers can buy futures
contracts in the products they produce or use to smooth out
the unexpected price fluctuations.

Supply and demand, plus expectations

Futures prices tend to track cash prices closely, but not
identically. The difference between the futures contract price
and the cash price of the underlying commodity is the basis.
Futures prices are determined not only by supply and
demand, but also by traders' expectations of a host of other
factors, including weather changes, environmental conditions,
political situations, and what the market will bear.

Options

Options are fundamentally different from forward and futures.

An option gives the holder/buyers of the option the right to do
something. The holder does not have committed himself to
doing something. In contrast, in a forward or futures contract,
the two parties have committed them self to doing something.
Whereas it nothing (expect margin requirement) to enter in to
a futures he purchases of an option require an up front
payment.
An options is the right, but not the obligation to buy or
sell a specified amount (and quality) of a commodity,
currency, index or financial instruments to buy or sell a
specified number of underlying futures contracts, at a
specified price on a before a give date in the future.

OPTION

BUYER SELLER

RIGHT OBLIGATION

TO BUY TO SELL TO SELL TO BUY

(CALL) (PUT) (CALL) (PUT)

Thus, option like futures, also provide a mechanism by

which one can acquire a certain commodity on other assets, or
take position in order to make profits or cover risk for a price.

Participants in the Options Market:

There are four types of participants in options markets

depending on the position they take:
1. Buyers of calls
2. Sellers of calls
3. Buyers of puts
4. Sellers of puts

People who buy options are called holders and those

who sell options are called writers; furthermore, buyers are
said to have long positions, and sellers are said to have short
positions.

Here is the important distinction between buyers and sellers:

-Call holders and put holders (buyers) are not obligated to buy
or sell. They have the choice to exercise their rights if they
choose.
-Call writers and put writers (sellers), however, are obligated to
buy or sell. This means that a seller may be required to make
good on a promise to buy or sell

While the buyer takes "long position" the seller take "short
position"

History:

Options on stocks were first traded on an organized stock

exchange in 1973. Since then there has been extensive work
on these instruments and manifold growth in the field has
taken the world markets by storm. This financial innovation is
present in cases of stocks, stock indices, foreign currencies,
debt instruments, commodities, and futures contracts .

Terminology of Options

Options are of two basic types: The Call and the Put Option
A call option gives the holder the right to buy an underlying
asset by a certain date for a certain price. The seller is under
an obligation to fulfill the contract and is paid a price of this
which is called "the call option premium or call option price".

A put option, on the other hand gives the holder the right to
sell an underlying asset by a certain date for a certain price.
The buyer is under an obligation to fulfill the contract and is
paid a price for this, which is called "the put option premium
or put option price".

The price at which the underlying asset would be bought in

the future at a particular date is the "Strike Price" or the
"Exercise Price". The date on the options contract is called
the "Exercise date", "Expiration Date" or the "Date of
Maturity".

There are two kind of options based on the date. The first is
the European Option which can be exercised only on the
maturity date. The second is the American Option which can
be exercised before or on the maturity date.

In most exchanges the options trading starts with European

Options as they are easy to execute and keep track of. This is
the case in the BSE and the NSE

Cash settled options are those where, on exercise the buyer

is paid the difference between stock price and exercise price
(call) or between exercise price and stock price (put). Delivery
settled options are those where the buyer takes delivery of
undertaking (calls) or offers delivery of the undertaking (puts).

Call Options

The following example would clarify the basics on Call

Options.

Illustration1:
An investor buys one European Call option on one share of
Reliance Petroleum at a premium of Rs. 2 per share on 31
July. The strike price is Rs.60 and the contract matures on 30
September. The payoffs for the investor on the basis of
fluctuating spot prices at any time are shown by the payoff
table (Table 1). It may be clear form the graph that even in the
worst case scenario, the investor would only lose a maximum
of Rs.2 per share which he/she had paid for the premium. The
upside to it has an unlimited profits opportunity.

On the other hand the seller of the call option has a payoff
chart completely reverse of the call options buyer. The
maximum loss that he can have is unlimited though a profit of
Rs.2 per share would be made on the premium payment by
the buyer.

Payoff from Call Buying/Long (Rs.)

S Xt c Payoff Net Profit
57 60 2 0 -2
58 60 2 0 -2
59 60 2 0 -2
60 60 2 0 -2
61 60 2 1 -1
62 60 2 2 0
63 60 2 3 1
64 60 2 4 2
65 60 2 5 3
66 60 2 6 4

A European call option gives the following payoff to the

investor: max (S - Xt, 0).
The seller gets a payoff of: -max (S - Xt,0) or min (Xt - S, 0).
Notes:
S - Stock Price
Xt - Exercise Price at time 't'
C - European Call Option Premium
Payoff - Max (S - Xt, O )

Graph:

Net Profit - Payoff minus 'c'

Exercising the Call Option and what are its
implications for the Buyer and the Seller?
The Call option gives the buyer a right to buy the requisite
shares on a specific date at a specific price. This puts the
seller under the obligation to sell the shares on that specific
date and specific price. The Call Buyer exercises his option
only when he/ she feels it is profitable. This Process is called
"Exercising the Option". This leads us to the fact that if the
spot price is lower than the strike price then it might be
profitable for the investor to buy the share in the open market
and forgo the premium paid.

The implications for a buyer are that it is his/her decision

whether to exercise the option or not. In case the investor
expects prices to rise far above the strike price in the future
then he/she would surely be interested in buying call options.
On the other hand, if the seller feels that his shares are not
giving the desired returns and they are not going to perform
any better in the future, a premium can be charged and
returns from selling the call option can be used to make up for
the desired returns. At the end of the options contract there is
an exchange of the underlying asset. In the real world, most of
the deals are closed with another counter or reverse deal.
There is no requirement to exchange the underlying assets
then as the investor gets out of the contract just before its
expiry.

Put Options

The European Put Option is the reverse of the call option deal.
Here, there is a contract to sell a particular number of
underlying assets on a particular date at a specific price. An
example would help understand the situation a little better:

Illustration 2:
An investor buys one European Put Option on one share of
Reliance Petroleum at a premium of Rs. 2 per share on 31
July. The strike price is Rs.60 and the contract matures on 30
September. The payoff table shows the fluctuations of net
profit with a change in the spot price.

Payoff from Put Buying/Long

(Rs.)
S Xt p Payoff Net Profit
55 60 2 5 3
56 60 2 4 2
57 60 2 3 1
58 60 2 2 0
59 60 2 1 -1
60 60 2 0 -2
61 60 2 0 -2
62 60 2 0 -2
63 60 2 0 -2
64 60 2 0 -2

The payoff for the put buyer = Max (Xt - S, 0)

The payoff for a put writer = Max(Xt - S, 0) or Min(S - Xt, 0)

Graph

These are the two basic options that form the whole gamut of
transactions in the options trading. These in combination with
other derivatives create a whole world of instruments to
choose form depending on the kind of requirement and the
kind of market expectations.

Exotic Options are often mistaken to be another kind of

option. They are nothing but non-standard derivatives and are
not a third type of option.

AMERICAN Vs EUROPEAN OPTION:

Its owner can exercise an American option at any time on or

before the expiration date.
A European style option gives the owner the right to use the
option only on expiration date and not before.

OPTION PREMIUM:

A glance at the rights and obligation of buyer and seller

reveals that option contracts are skewed. One way naturally
wonders as to why the seller (writer) of an option would always
be obliged to sell/buy an asset whereas the other party gets
the right? The answer is that writer of an option receives, a
consideration for
Undertaking the obligation. This is known as the price or
premium to the seller for the option.
The buyer pays the premium for the option to the seller
whether he exercise the option is not exercised, it becomes
worthless and the premium becomes the profit of the seller.
Premium/Price of an option = Intrinsic Value + Time
Value

Do Nothing
Option to option holder Close out the position
matching by write a call option
or it in case of writer.

Exercise the option.

In-The-Money and Out-The-Money Options

Condition Call Put
So>E In the money Out of the money
So<E Out of the money In the money
So=E At the money At the money

So =spot price
E = exercise price

Options Basics: How to Read an Options Table

Column 1: Strike Price - This is the stated price per share for
which an underlying stock may be purchased (for a call) or
sold (for a put) upon the exercise of the option contract.
Option strike prices typically move by increments of $2.50 or
$5 (even though in the above example it moves in $2
increments).

Column 2: Expiry Date - This shows the termination date of

an option contract. Remember that U.S.-listed options expire
on the third Friday of the expiry month.

Column 3: Call or Put - This column refers to whether the

option is a call (C) or put (P).

Column 4: Volume - This indicates the total number of

options contracts traded for the day. The total volume of all
contracts is listed at the bottom of each table.

Column 5: Bid - This indicates the price someone is willing to

pay for the options contract.

Column 6: Ask - This indicates the price at which someone is

willing to sell an options contract.

Column 7: Open Interest - Open interest is the number of

options contracts that are open; these are contracts that have
neither expired nor been exercised.

INDEX OPTION:
Index options are the contracts between two parties that
give the right, but not the obligation, to buy or sell underlying
at a stated date & a stated price to the buyer of the contract.
In index option, the underlying is share price index & all
contracts are based up on it. In index option the buyer
requires to pay a sum for the buying the contract that is called
‘premium’. The premium is decided by the market forces & not
by the stock exchange. All index option is cash settled &
physical delivery is not applicable.
Beside the premium the seller of the contract is required
to pay 3% margin on contract value to the exchange to
eliminate the risk
That is called exposure margin.

In India the options on index started by the BSE & NSE

on their index SENSEX and S&P CNX NIFTY respectively.
Trading on S&P CNX NIFTY commenced at NSE on June 2,
2001.

Contract specification:

Underlying index S & P CNX NIFTY

Exchange of trading National Stock Exchange

Security descriptor N OPTIDX NIFTY

Contract size Permitted lot size shall be 200 &

multiples

thereof (minimum value Rs.2 lakh)

Price steps Rs.0.05
Price band Not applicable

Trading cycle The futures contracts will have a

maximum of three month trading cycle-
the near month (one), the next month
(two) & the far month (three).New
contracts will be introduced on the next
trading day following the expiry of the
near month contract.
Expiry date The last Thursday of the expiry month of
the previous trading day if the last
Thursday is a trading holiday.
Settlement basis Cash settled on T+1 basis.

Style of option EUROPEAN

Strike price RS.20

Daily settlement Premium value (net).

price
Final settlement Closing value of the index on the trading
price day.

In index option, the investor can hedge their risk &

make profits. In index options the loss is limited to premium
paid & profit is unlimited of the buyer, on the other hand the
profit to premium received of the writer is limited & loss is
unlimited.

Example:
Current Nifty is 1400. You buy one contract of nifty near
month calls for Rs.30 each. The strike price is 1430 i.e. 2.14%
out of money. The premium paid by you will be (Rs.30n *200)
Rs.6000.Given these, your break-even level nifty is 1460
(1430+30).If at expiration nifty advanced by 5%, i.e.1470, then

Nifty 1470
Less strike price 1430
Option value 40 (1470-1430)
Less purchase price 30
Profit per nifty 10
Profit on the contract Rs.2000 (Rs.10 * 200)

STOCK OPTION:
Stock options are the contract on the individual scrips
means where underlying are individual scrips. In stock options
the buyers of the options have right but not obligation to buy
or sell the underlying asset.

The buyer is requires to pay some money at the time of

the purchases of the contract to seller of the contract that is
called ‘premium’. And seller requires paying exposure margin
to exchange that is 5% (6%and 7% on specific securities) on
the contract value. At present in India 41 individual scrips are
approved by the SEBI for stock option.
The trading on the stock commenced at NSE on July 2,
2001.These contracts are available at BSE & NSE on highly
liquid & price band free 41scrips.

Contract Specification:

Underlying Individual securities

Exchange of trading National Stock Exchange

Security descriptor N-OPTSTK

Contract size 100 or multiples thereof (minimum

value of Rs.2 lakh)
Price steps Rs.0.05
Price band Not applicable

Trading cycle The futures contracts will have a

maximum of three month trading cycle-
the near month (one), the next month
(two) & the far month (three).new
contract will be introduced on the next
trading day following the expiry of the
near month contract.
Expiry day The last Thursday of the expiry month
of the previous trading day if the last
Thursday is trading holiday.
Settlement basis Daily settlement on T+1 basis & final
option exercise settlement on T+2
basis.
Style of option American

Strike price interval Between Rs.2.5 & Rs.100 depending on

the price of the under lying
Daily settlement Premium value (net).
price
Final settlement price Closing value of the index on the last
trading day.
Settlement day Last trading day

Buying options can be compared to buying insurance.

For Example to cover the risk of burglary, fire, etc., you by
insurance &pay premium in the event of any untoward
happening, the insurance cover expires after the specific
period of time.

Option-to-option holder in case of—he opt for expiry date. i.e.

How Option Work
 Market players

Hedgers: The objective of these kind of traders is to reduce the

risk. They are not in the derivatives market to make profits.
They are in it to safeguard their existing positions. Apart from
equity markets, hedging is common in the foreign exchange
markets where fluctuations in the exchange rate have to be
taken care of in the foreign currency transactions or could be
in the commodities market where spiraling oil prices have to
be tamed using the security in derivative instruments.

Speculators: They are traders with a view and objective of

making profits. They are willing to take risks and they bet
upon whether the markets would go up or come down.

Arbitrageurs: Riskless Profit Making is the prime goal of

Arbitrageurs. Buying in one market and selling in another,
buying two products in the same market are common. They
could be making money even without putting there own money
in and such opportunities often come up in the market but
last for very short timeframes. This is because as soon as the
situation arises arbitrageurs take advantage and demand-
supply forces drive the markets back to normal.

Options undertakings


Stocks

Foreign Currencies

Stock Indices

Commodities

Others - Futures Options, are options on the futures
contracts or underlying assets are futures contracts. The
futures contract generally matures shortly after the
options expiration.

Options Classifications

Options are often classified as :

In the money - These result in a positive cash flow towards
the investor.
At the money - These result in a zero-cash flow to the
investor.
Out of money - These result in a negative cash flow for the
investor.
Example:
Calls
Reliance 350 Stock Series

Naked Options: These are options which are not combined

with an offsetting contract to cover the existing positions.

Covered Options: These are option contracts in which the

shares are already owned by an investor (in case of covered
call options) and in case the option is exercised then the
offsetting of the deal can be done by selling these shares
held.
 OPTIONS PRICING

Prices of options are commonly depend upon six factors.

Unlike futures which derives there prices primarily from
prices of the undertaking. Option's prices are far more
complex. The table below helps understand the affect of
each of these factors and gives a broad picture of option
pricing keeping all other factors constant. The table
presents the case of European as well as American Options.

EFFECT OF INCREASE IN THE RELEVANT

PARAMETRE ON OPTION PRICES
EUROPEAN AMERICAN
OPTIONS OPTIONS
Buying Buying
PARAMETERS CALL PUT CALL PUT
Spot Price (S)
Strike Price (Xt)
Time to Expiration (T) ? ?
Volatility ()
Risk Free Interest
Rates (r)
Dividends (D)

Favourable
Unfavourable

SPOT PRICES: In case of a call option the payoff for the

buyer is max(S - Xt, 0) therefore, more the Spot Price more
is the payoff and it is favorable for the buyer. It is the other
way round for the seller, more the Spot Price higher are the
chances of his going into a loss.

In case of a put Option, the payoff for the buyer is max(Xt -

S, 0) therefore, more the Spot Price more are the chances of
going into a loss. It is the reverse for Put Writing.

STRIKE PRICE: In case of a call option the payoff for the

buyer is shown above. As per this relationship a higher
strike price would reduce the profits for the holder of the
call option.

TIME TO EXPIRATION: More the time to Expiration more

favorable is the option. This can only exist in case of
American option as in case of European Options the
Options Contract matures only on the Date of Maturity.

VOLATILITY: More the volatility, higher is the probability of

the option generating higher returns to the buyer. The
downside in both the cases of call and put is fixed but the
gains can be unlimited. If the price falls heavily in case of a
call buyer then the maximum that he loses is the premium
paid and nothing more than that. More so he/ she can buy
the same shares form the spot market at a lower price.
Similar is the case of the put option buyer. The table show
all effects on the buyer side of the contract.

RISK FREE RATE OF INTEREST: In reality the r and the

stock market is inversely related. But theoretically
speaking, when all other variables are fixed and interest
rate increases this leads to a double effect: Increase in
expected growth rate of stock prices Discounting factor
increases making the price fall

In case of the put option both these factors increase and

lead to a decline in the put value. A higher expected growth
leads to a higher price taking the buyer to the position of
loss in the payoff chart. The discounting factor increases
and the future value becomes lesser.

In case of a call option these effects work in the opposite

direction. The first effect is positive as at a higher value in
the future the call option would be exercised and would give
a profit. The second affect is negative as is that of
discounting. The first effect is far more dominant than the
second one, and the overall effect is favorable on the call
option.

DIVIDENDS: When dividends are announced then the stock

prices on ex-dividend are reduced. This is favorable for the
put option and unfavorable for the call option.

TRADING STRATEGIES
Single Option and Stock

These strategies involve using an option along with a position

in a stock.

Strategy 1:

A Covered Call: A long position in stock and short position in

a call option.

Illustration : An investor enters into writing a call option on

one share of Reliance Petrol. At a strike price of Rs.60 and a
premium of Rs.6 per share. The maturity date is two months
form now and along with this option he/she buys a share of
Rel.Petrol. in the spot market at Rs.58 per share.

By this the investor covers the position that he got in on the

call option contract and if the investor has to fulfill his/her
obligation on the call option then can fulfill it using the
Rel.Petrol. share on which he/she entered into a long contract.
The payoff table below shows the Net Profit the investor would
make on such a deal.

Writing a Covered Call Option

S Xt C Profit Net Profit Share Profit Total
from from Call bought from Profit
writing Writing stock
call
50 60 6 0 6 58 -8 -2
52 60 6 0 6 58 -6 0
54 60 6 0 6 58 -4 2
56 60 6 0 6 58 -2 4
58 60 6 0 6 58 0 6
60 60 6 0 6 58 2 8
62 60 6 -2 4 58 4 8
64 60 6 -4 2 58 6 8
66 60 6 -6 0 58 8 8
68 60 6 -8 -2 58 10 8
70 60 6 -10 -4 58 12 8

Strategy 2:

Reverse of Covered Call: This strategy is the reverse of writing

a covered call. It is applied by taking a long position or buying
a call option and selling the stocks.

Illustration :

An investor enters into buying a call option on one share of

Rel. Petrol. At a strike price of Rs.60 and a premium of Rs.6
per share. The maturity date is two months from now and
along with this option he/she sells a share of Rel.Petrol. in the
spot market at Rs. 58 per share.

The payoff chart describes the payoff of buying the call option
at the various spot rates and the profit from selling the share
at Rs.58 per share at various spot prices. The net profit is
shown by the thick line.

Buying a Covered Call Option

S Xt c Profit Net Profit Spot Profit Total
from from Call Price of from Profit
buying Buying Selling stock
call the stock
option
50 60 -6 0 -6 58 8 2
52 60 -6 0 -6 58 6 0
54 60 -6 0 -6 58 4 -2
56 60 -6 0 -6 58 2 -4
58 60 -6 0 -6 58 0 -6
60 60 -6 0 -6 58 -2 -8
62 60 -6 2 -4 58 -4 -8
64 60 -6 4 -2 58 -6 -8
66 60 -6 6 0 58 -8 -8
68 60 -6 8 2 58 -10 -8
70 60 -6 10 4 58 -12 -8
Strategy 3:

Protective Put Strategy:

This strategy involves a long position in a stock and long

position in a put. It is a protective strategy reducing the
downside heavily and much lower than the premium paid to
buy the put option. The upside is unlimited and arises after
the price rises high above the strike price.
Illustration 5:

An investor enters into buying a put option on one share of

Rel. Petrol. At a strike price of Rs.60 and a premium of Rs.6
per share. The maturity date is two months from now and
alongwith this option he/she buys a share of Rel.Petrol. in the
spot market at Rs. 58 per share.

Protective Put Strategy

S Xt p Profit from Net Profit Spot Profit Total
buying put from Price of from Profit
option Buying Buying stock
put the stock
option
50 60 -6 10 4 58 -8 -4
52 60 -6 8 2 58 -6 -4
54 60 -6 6 0 58 -4 -4
56 60 -6 4 -2 58 -2 -4
58 60 -6 2 -4 58 0 -4
60 60 -6 0 -6 58 2 -4
62 60 -6 0 -6 58 4 -2
64 60 -6 0 -6 58 6 0
66 60 -6 0 -6 58 8 2
68 60 -6 0 -6 58 10 4
70 60 -6 0 -6 58 12 6

Strategy 4:

Reverse of Protective Put

This strategy is just the reverse of the above and looks at the
case of taking short positions on the tock as well as on the put
option.

Illustration 6:
 An investor enters into selling a put option on one share of
Rel. Petrol. At a strike price of Rs.60 and a premium of Rs.6
per share. The maturity date is two months from now and
alongwith this option he/she sells a share of Rel.Petrol. in the
spot market at Rs. 58 per share.

Reverse of Protective Put Strategy

S Xt p Profit from Net Profit Spot Price Profit Total
writing a from Put of Selling from Profit
put option Writing the stock stock
50 60 6 -10 -4 58 8 4
52 60 6 -8 -2 58 6 4
54 60 6 -6 0 58 4 4
56 60 6 -4 2 58 2 4
58 60 6 -2 4 58 0 4
60 60 6 0 6 58 -2 4
62 60 6 0 6 58 -4 2
64 60 6 0 6 58 -6 0
66 60 6 0 6 58 -8 -2
68 60 6 0 6 58 -10 -4
70 60 6 0 6 58 -12 -6
All the four cases describe a single option with a position in a
stock. Some of these cases look similar to each other and
these can be explained by Put-Call Parity.

Put Call Parity

P + S = c + Xe-r(T-t) + D ---------------------- (1)

Or

S - c = Xe-r(T-t) + D - p ---------------------- (2)

The second equation shows that a long position in a stock and

a short position in a call is equivalent to the short put position
and cash equivalent to Xe-r(T-t) + D.

The first equation shows a long position in a stock combined

with long put position is equivalent to a long call position plus
cash equivalent to Xe-r(T-t) + D.
 Collar:
A collar is the use of a protective put and covered call to
delimit the value of a security position between 2 bounds. A
protective put is bought to protect the lower bound, while a
call is sold at a strike price for the upper bound, which helps
pay for the protective put. This position limits an investor’s
potential loss, but allows a reasonable profit. However, as with
the covered call, the upside potential is limited to the strike
price of the written call.

Example—Collar

On October 6, 2006, you own 1,000 shares of Microsoft

stock, which is currently trading at $27.87 per share. You
want to hang onto the stock until next year to delay paying
taxes on your profit, and to pay only the lower long-term
capital gains tax. To protect your position, you buy 10
protective puts with a strike price of $25 that expires in
January, 2007, and sell 10 calls with a strike price of $30 that
also expires in January, 2007. You get $350.00 for the 10 call
contracts, and you pay $250 for the 10 put contracts for a net
of $100. If Microsoft rises above $30 per share, then you get
$30,000 for your 1,000 shares of Microsoft. If Microsoft should
drop to $23 per share, then your Microsoft stock is worth
$23,000, and your puts are worth a total of $2,000. If
Microsoft drops further, then the puts become more valuable—
increasing in value in direct proportion to the drop in the
stock price below the strike. Thus, the most you’ll get is
$30,000 for your stock, but the least value of your position will
be $25,000. Thus, your position is collared at $25,000 below
and $30,000 above. Note, however, that your risk is that the
written calls might be exercised before the end of the year,
thus forcing you, anyway, to pay short-term capital gains
taxes in 2007 instead of long-term capital gains taxes in 2008.

Straddle:
A long straddle is established by buying both a put and
call on the same security at the same strike price and with the
same expiration. This investment strategy is profitable if the
stock moves substantially up or down, and is often done in
anticipation of a big movement in the stock price, but without
knowing which way it will go. For instance, if an important
court case is going to be decided soon that will have a
substantial impact on the stock price, but whether it will favor
or hurt the company is not known beforehand, then the
straddle would be a good investment strategy. The greatest
loss for the straddle is the premium paid for the put and call,
which will expire worthless if the stock price doesn’t move
enough.

One buys a straddle because he expects the stock price

to move substantially before the expiration of the options. The
buyer can only profit if the value of either the call or the put is
greater than the cost of the premium of both, the put and the
call.
A short straddle is created when one writes both a put and a
call with the same strike price and expiration date, which one
would do if she believes that the stock will not move much
before the expiration of the options. If the stock price remains
flat, then both options expire worthless, allowing the straddle
writer to keep both premiums.
A strap is a specific option contract consisting of 1 put and 2
calls for the same stock, strike price, and expiration date. A
strip is a contract for 2 puts and 1 call for the same stock.
Because strips and straps are 1 contract for 3 options, they
are also called triple options, and the premiums are less then
if each option were purchased individually.

Example—Long Straddle and Short Straddle

Merck is embroiled in potentially thousands of

lawsuits concerning VIOXX, which was withdrawn from the
market. On October, 31, 2006, Merck’s stock was trading at
$45.29, near its 52-week high. Merck has been winning and
losing the lawsuits. If the trend goes one way or the other in a
definite direction, it could have a major impact on the stock
price, and you think it might happen before 2008, so you buy
10 puts and 10 calls that expire in January, 2008. You pay
$2.30 per share for the calls, for a total of $2,300 for 10
contracts. You pay $1.75 per share for the puts, for a total of
$1,750 for the 10 put contracts. Your total cost is $4,050 plus
commissions. On the other hand, your sister, Sally, decides to
write the straddle, receiving the total premium of $4,050
minus commissions.

Let’s say, that, by expiration, Merck is clearly losing;

it’s stock price drops to $30 per share. Your calls expire
worthless, but your puts are now in the money by $10 per
share, for a net value of $10,000. Therefore, your total profit is
almost $6,000 after subtracting the premiums for the options
and the commissions to buy them, as well as the exercise
commission to exercise your puts. Your sister, Sally has lost
that much. She buys the 1,000 shares of Merck for $40 per
share as per the put contracts that she sold, but the stock is
only worth $30 per share, for a net $30,000. Her loss of
$10,000 is offset by the $4,050 premiums that she received for
writing the straddle. Your gain is her loss. (Actually, she lost a
little more than you gained, because commissions have to be
subtracted from your gains and added to her losses.) A similar
scenario would occur if Merck wins, and the stock rises to $60
per share. However, if, by expiration, the stock is less than
$50 and more than $40, then all of your options expire
worthless, and you lose the entire $4,050 plus the
commissions to buy those options. For you to make any
money, the stock would either have to fall a little below $36
per share or rise a little above $54 per share to compensate
you for the premiums for both the calls and the puts and the
commission to buy them and exercise them.
 Spread:
A spread is established by buying or selling various
combinations of calls and puts, at different strike prices
and/or different expiration dates on the same underlying
security. There are many possibilities of spreads, but they can
be classified based on a few parameters. A credit spread
results from buying a long position that costs less than the
premium received selling the short position of the spread; a
debit spread results when the long position costs more than
the premium received for the short position.

A money spread, or vertical spread, involves the

buying of options and the writing of other options with
different strike prices, but with the same expiration dates.

A time spread, or calendar spread, involves buying

and writing options with different expiration dates. A
horizontal spread is a time spread with the same strike
prices. A diagonal spread has different strike prices and
different expiration dates.

A bullish spread increases in value as the stock price

increases, whereas a bearish spread increases in value as the
stock price decreases. In general, the writing of options helps
to purchase long option positions.

Example — Bullish Money Spread

On October 6, 2006, you buy, for $850, 10 calls for

Microsoft, with a strike price of $30 that expires in April,
2007, and you write 10 calls for Microsoft with a strike price of
$32.50 that expires in April, 2007, for which you receive $200.
At expiration, if the stock price stays below $30 per share,
then both calls expire worthless, which results in a net loss,
excluding commissions, of $650 ($850 paid for long calls -
$200 received for written short calls).

If the stock rises to $32.50, then the 10 calls that you

purchased are worth $2,500, and your written calls expire
worthless. This results in a net $1,850 ($2,500 long call value
+ $200 premium for short call - $850 premium for the long
call). If the price of Microsoft rises above $32.50, then you
exercise your long call to cover your short call, netting you the
difference of $2,500 plus the premium of your short call minus
the premium of your long call minus commissions.

Butterfly Spread:

A long butterfly spread involves buying a call with a

low exercise price, buying a call with a high exercise price and
selling two calls with an exercise price in between the two.
Thus, there are three call contracts with different strike price.
A Short butterfly spread involves the opposite position; that
is, selling a call with a low exercise price, selling a call with a
high exercise price and buying two calls with an exercise price
in between the two.

Suppose a share is currently selling at Rs102 per

share. Further, assume that 3-month calls are selling as
follows: exercise price Rs100, premium Rs12; exercise Rs105,
premium Rs8 and exercise price Rs110, premium Rs6. An
investor buys one call with Rs100 exercise price, one call with
Rs110 exercise price and sells two calls with Rs105 exercise
price. The investor will call premium of Rs12+6=18Rs for
buying two calls and receive call premium of 2*8= Rs16. Thus
his cost is Rs.2. His net loss will be Rs2 when the share price
stays at RS 95 or below above Rs110.
 Swap
A swap is a derivative in which two counterparties agree to
exchange one stream of cash flows against another stream.
These streams are called the legs of the swap.

The cash flows are calculated over a notional principal

amount, which is usually not exchanged between
counterparties. Consequently, swaps can be used to create
unfunded exposures to an underlying asset, since
counterparties can earn the profit or loss from movements in
price without having to post the notional amount in cash or
collateral. Swaps can be used to hedge certain risks such as
interest rate risk, or to speculate on changes in the underlying
prices.

Structure
A swap is an agreement between two parties to exchange
future cash flows according to a prearranged formula. They
can be regarded as portfolios of forward contracts. The
streams of cash flows are called “legs” of the swap. Usually at
the time when contract is initiated at least one of these series
of cash flows is determined by a random or uncertain variable
such as interest rate, foreign exchange rate, equity price or
commodity price.

Most swaps are traded Over The Counter (OTC), "tailor-made"

for the counterparties. Some types of swaps are also
exchanged on futures markets, for instance Chicago
Mercantile Exchange Holdings Inc., the largest U.S. futures
market, the Chicago Board Options Exchange and Frankfurt-
based Eurex AG.

The five generic types of swaps, in order of their quantitative

importance, are: interest rate swaps, currency swaps, credit
swaps, commodity swaps and equity swaps.
 What is the structure of Derivative Markets
in India?
Derivative trading in India takes can place either on a separate
and independent Derivative Exchange or on a separate
segment of an existing Stock Exchange. Derivative
Exchange/Segment function as a Self-Regulatory Organisation
(SRO) and SEBI acts as the oversight regulator. The clearing &
settlement of all trades on the Derivative Exchange/Segment
would have to be through a Clearing Corporation/House,
which is independent in governance and membership from the
Derivative Exchange/Segment.

What is the regulatory framework of

Derivatives markets in India?
With the amendment in the definition of 'securities' under
SC(R)A (to include derivative contracts in the definition of
securities), derivatives trading takes place under the
provisions of the Securities Contracts (Regulation) Act, 1956
and the Securities and Exchange Board of India Act, 1992.

Dr. L.C Gupta Committee constituted by SEBI had laid

down the regulatory framework for derivative trading in
India. SEBI has also framed suggestive bye-law for
Derivative Exchanges/Segments and their Clearing
Corporation/House which lay's down the provisions for
trading and settlement of derivative contracts. The Rules,
Bye-laws & Regulations of the Derivative Segment of the
Exchanges and their Clearing Corporation/House have to
be framed in line with the suggestive Bye-laws. SEBI has
also laid the eligibility conditions for Derivative
Exchange/Segment and its Clearing Corporation/House.
The eligibility conditions have been framed to ensure that
Derivative Exchange/Segment & Clearing
 Corporation/House provide a transparent trading
environment, safety & integrity and provide facilities for
redressal of investor grievances. Some of the important
eligibility conditions are-

 Derivative trading to take place through an on-line screen

based Trading System.
 The Derivatives Exchange/Segment shall have on-line
surveillance capability to monitor positions, prices, and
volumes on a real time basis so as to deter market
manipulation.
 The Derivatives Exchange/ Segment should have
arrangements for dissemination of information about
trades, quantities and quotes on a real time basis through
atleast two information vending networks, which are easily
accessible to investors across the country.
 The Derivatives Exchange/Segment should have arbitration
and investor grievances redressal mechanism operative
from all the four areas / regions of the country.
 The Derivatives Exchange/Segment should have
satisfactory system of monitoring investor complaints and
preventing irregularities in trading.
 The Derivative Segment of the Exchange would have a
separate Investor Protection Fund.
 The Clearing Corporation/House shall perform full
novation, i.e., the Clearing Corporation/House shall
interpose itself between both legs of every trade, becoming
the legal counterparty to both or alternatively should
provide an unconditional guarantee for settlement of all
trades.
 The Clearing Corporation/House shall have the capacity to
monitor the overall position of Members across both
derivatives market and the underlying securities market for
those Members who are participating in both.
 The level of initial margin on Index Futures Contracts shall
be related to the risk of loss on the position. The concept of
value-at-risk shall be used in calculating required level of
initial margins. The initial margins should be large enough
 to cover the one-day loss that can be encountered on the
position on 99% of the days.
 The Clearing Corporation/House shall establish facilities for
electronic funds transfer (EFT) for swift movement of margin
payments.
 In the event of a Member defaulting in meeting its liabilities,
the Clearing Corporation/House shall transfer client
positions and assets to another solvent Member or close-out
all open positions.
 The Clearing Corporation/House should have capabilities to
segregate initial margins deposited by Clearing Members for
trades on their own account and on account of his client.
The Clearing Corporation/House shall hold the clients’
margin money in trust for the client purposes only and
should not allow its diversion for any other purpose.
 The Clearing Corporation/House shall have a separate
Trade Guarantee Fund for the trades executed on Derivative
Exchange / Segment.

Presently, SEBI has permitted Derivative Trading on the

Derivative Segment of BSE and the F&O Segment of NSE.

What are the various membership

categories in the derivatives market?
The various types of membership in the derivatives market are
as follows:

 Trading Member (TM) – A TM is a member of the derivatives

exchange and can trade on his own behalf and on behalf of
his clients.
 Clearing Member (CM) –These members are permitted to
settle their own trades as well as the trades of the other
non-clearing members known as Trading Members who
have agreed to settle the trades through them.
 Self-clearing Member (SCM) – A SCM are those clearing
members who can clear and settle their own trades only.
 What are the requirements to be a member
of the derivatives exchange/ clearing
corporation?
 Balance Sheet Networth Requirements: SEBI has prescribed
a networth requirement of Rs. 3 crores for clearing
members. The clearing members are required to furnish an
auditor's certificate for the networth every 6 months to the
exchange. The networth requirement is Rs. 1 crore for a
self-clearing member. SEBI has not specified any networth
requirement for a trading member.
 Liquid Networth Requirements: Every clearing member
(both clearing members and self-clearing members) has to
maintain atleast Rs. 50 lakhs as Liquid Networth with the
exchange / clearing corporation.
 Certification requirements: The Members are required to
pass the certification programme approved by SEBI.
Further, every trading member is required to appoint atleast
two approved users who have passed the certification
programme. Only the approved users are permitted to
operate the derivatives trading terminal.

What are requirements for a Member with

regard to the conduct of his business?
The derivatives member is required to adhere to the code of
conduct specified under the SEBI Broker Sub-Broker
regulations. The following conditions stipulations have been
laid by SEBI on the regulation of sales practices:

 Sales Personnel: The derivatives exchange recognizes the

persons recommended by the Trading Member and only
such persons are authorized to act as sales personnel of the
TM. These persons who represent the TM are known as
Authorised Persons.
 Know-your-client: The member is required to get the Know-
your-client form filled by every one of client.
 Risk disclosure document: The derivatives member must
educate his client on the risks of derivatives by providing a
copy of the Risk disclosure document to the client.
 Member-client agreement: The Member is also required to
enter into the Member-client agreement with all his clients.

What derivative contracts are permitted by

SEBI?
Derivative products have been introduced in a phased manner
starting with Index Futures Contracts in June 2000. Index
Options and Stock Options were introduced in June 2001 and
July 2001 followed by Stock Futures in November 2001.
Sectoral indices were permitted for derivatives trading in
December 2002. Interest Rate Futures on a notional bond and
T-bill priced off ZCYC have been introduced in June 2003 and
exchange traded interest rate futures on a notional bond
priced off a basket of Government Securities were permitted
for trading in January 2004.

What is the eligibility criteria for stocks on

which derivatives trading may be
permitted?
A stock on which stock option and single stock future
contracts are proposed to be introduced is required to fulfill
the following broad eligibility criteria:-

 The stock shall be chosen from amongst the top 500 stock
in terms of average daily market capitalisation and average
daily traded value in the previous six month on a rolling
basis.
 The stock’s median quarter-sigma order size over the last
six months shall be not less than Rs.1 Lakh. A stock’s
quarter-sigma order size is the mean order size (in value
 terms) required to cause a change in the stock price equal
to one-quarter of a standard deviation.
 The market wide position limit in the stock shall not be less
than Rs.50 crores.
 A stock can be included for derivatives trading as soon as it
becomes eligible. However, if the stock does not fulfill the
eligibility criteria for 3 consecutive months after being
admitted to derivatives trading, then derivative contracts on
such a stock would be discontinued.

What is minimum contract size?

The Standing Committee on Finance, a Parliamentary
Committee, at the time of recommending amendment to
Securities Contract (Regulation) Act, 1956 had recommended
that the minimum contract size of derivative contracts traded
in the Indian Markets should be pegged not below Rs. 2
Lakhs. Based on this recommendation SEBI has specified that
the value of a derivative contract should not be less than Rs. 2
Lakh at the time of introducing the contract in the market. In
February 2004, the Exchanges were advised to re-align the
contracts sizes of existing derivative contracts to Rs. 2 Lakhs.
Subsequently, the Exchanges were authorized to align the
contracts sizes as and when required in line with the
methodology prescribed by SEBI.

What is the lot size of a contract?

Lot size refers to number of underlying securities in one
contract. The lot size is determined keeping in mind the
minimum contract size requirement at the time of introduction
of derivative contracts on a particular underlying.

For example, if shares of XYZ Ltd are quoted at Rs.1000 each

and the minimum contract size is Rs.2 lacs, then the lot size
for that particular scrips stands to be 200000/1000 = 200
shares i.e. one contract in XYZ Ltd. covers 200 shares.

What is corporate adjustment?

 The basis for any adjustment for corporate action is such
that the value of the position of the market participant on
cum and ex-date for corporate action continues to remain
the same as far as possible. This will facilitate in retaining
the relative status of positions viz. in-the-money, at-the-
money and out-of-the-money. Any adjustment for corporate
actions is carried out on the last day on which a security is
traded on a cum basis in the underlying cash market.
Adjustments mean modifications to positions and/or
contract specifications as listed below:
 Strike price
 Position
 Market/Lot/ Multiplier
 The adjustments are carried out on any or all of the above
based on the nature of the corporate action. The
adjustments for corporate action are carried out on all
open, exercised as well as assigned positions.

 The corporate actions are broadly classified under stock

benefits and cash benefits. The various stock benefits
declared by the issuer of capital are:

 Bonus
 Rights
 Merger/ Demerger
 Amalgamation
 Splits
 Consolidations
 Hive-off
 Warrants, and
 Secured Premium Notes (SPNs) among others
 The cash benefit declared by the issuer of capital is cash
dividend.

What is the margining system in the

derivative markets?
Two type of margins have been specified -
Initial Margin - Based on 99% VaR and worst case loss over a
specified horizon, which depends on the time in which Mark to
Market margin is collected.

Mark to Market Margin (MTM) - collected in cash for all

Futures contracts and adjusted against the available Liquid
Networth for option positions. In the case of Futures Contracts
MTM may be considered as Mark to Market Settlement.

Dr. L.C Gupta Committee had recommended that the level of

initial margin required on a position should be related to the
risk of loss on the position. The concept of value-at-risk
should be used in calculating required level of initial margins.
The initial margins should be large enough to cover the one
day loss that can be encountered on the position on 99% of
the days. The recommendations of the Dr. L.C Gupta
Committee have been a guiding principle for SEBI in
prescribing the margin computation & collection methodology
to the Exchanges. With the introduction of various derivative
products in the Indian securities Markets, the margin
computation methodology, especially for initial margin, has
been modified to address the specific risk characteristics of the
product. The margining methodology specified is consistent
with the margining system used in developed financial &
commodity derivative markets worldwide. The exchanges were
given the freedom to either develop their own margin
computation system or adapt the systems available
internationally to the requirements of SEBI.

A portfolio based margining approach which takes an

integrated view of the risk involved in the portfolio of each
individual client comprising of his positions in all Derivative
Contracts i.e. Index Futures, Index Option, Stock Options and
Single Stock Futures, has been prescribed. The initial margin
requirements are required to be based on the worst case loss
of a portfolio of an individual client to cover 99% VaR over a
specified time horizon.
 What measures have been specified by SEBI
to protect the rights of investor in
Derivatives Market?
The measures specified by SEBI include:

 Investor's money has to be kept separate at all levels and is

permitted to be used only against the liability of the Investor
and is not available to the trading member or clearing
member or even any other investor.
 The Trading Member is required to provide every investor
with a risk disclosure document which will disclose the
risks associated with the derivatives trading so that
investors can take a conscious decision to trade in
derivatives.
 Investor would get the contract note duly time stamped for
receipt of the order and execution of the order. The order
will be executed with the identity of the client and without
client ID order will not be accepted by the system. The
investor could also demand the trade confirmation slip with
his ID in support of the contract note. This will protect him
from the risk of price favour, if any, extended by the
Member.
 In the derivative markets all money paid by the Investor
towards margins on all open positions is kept in trust with
the Clearing House/Clearing corporation and in the event of
default of the Trading or Clearing Member the amounts paid
by the client towards margins are segregated and not
utilised towards the default of the member. However, in the
event of a default of a member, losses suffered by the
Investor, if any, on settled / closed out position are
compensated from the Investor Protection Fund, as per the
rules, bye-laws and regulations of the derivative segment of
the exchanges.
 Research Methodology & Analysis

Research Methodology

Research is a procedure of logical and systematic application

of the fundamentals of science to the general and overall
questions of a study and scientific technique by which provide
precise tools, specific procedures and technical, rather than
philosophical means for getting and ordering the data prior to
their logical analysis and manipulation.

Different type of research designs is available depending upon

the nature of research project, availability of able manpower
and circumstances.

The study about “Trends and future of derivatives in India” is

descriptive in nature. So survey method is used for the study.

Sampling Procedure
The small representative selected out of large population is
selected at random is called sample. Well-selected sample may
reflect fairly, accurately the characteristic of population. The
chief aim of sampling is to make an inference about unknown
parameters from a measurable sample statistics. The
Statistical hypothesis relating t population. The sample size
was 60 which include brokers, dealers and investors.
Sources of Data:
The source of data includes Primary and Secondary data
sources.

Primary Data:
Primary data is collected by structured questionnaire
administered by sitting with guide and discussing problems.

Secondary Sources:
The secondary data is data, which is collected and compiled
for the different purpose, which are used in research for this
study.
The secondary data include material collected from:
 Newspaper
 Magazine
 Internet

Data collection Instruments:

The various method of data gathering involves the use of
appropriate recording forms. These are called ‘ tools’ or
‘instruments’ of data collection.
Collection Instruments:
1. Observation
2. Interview guide
3. Interview schedule
Each tool is used for specific method of data gathering. The
tool for data collection translates the research objectives in to
specific term/questions to the response, which will provide
research objective.

He instrument data collection in our study interview schedule

mainly. Every respondent was conducted personally with an
interview schedule containing questions. Interview method
was used because it can be explained more easily and clearly
and takes less time to answer.

Methodology
Assumptions:
The research was based on the following assumption:
1. The methodology used for this purpose is survey and
questionable method. It is assumed that this method is
more suitable for collection of data.
2. It is assumed that the respondent have sufficient
knowledge to ensure questionable.
3. It is assumed that the respondent have filled right and
correct option according to their view.
 Broker’s Perception about
Derivatives(Analysis)
Trading Period in Derivatives

From my sample of 60, 13 (22%) brokers and investors

investing in derivatives from last 1 year and less than
this, 21(35%) are investing from last 2 years, 7(11%)
are investing from last 3 years and only 6(10%) have
experience of more than 3 years of investment in
derivatives.
 Reasons Behind its Adoption

Reason behind adoption of derivatives are different by brokers,

investors and dealers e.g. liquidity, risk management, hedging,
investor demand (speculation) etc. Out of 60 brokers, investors
dealing in derivatives 14(23%) adopt it due to characteristics of
risk management, 15(25%) due to hedging, 24(40%) for
investor (client’s) demand (speculation) and remaining 7(12%)
due to liquidity.

Experience With Derivatives

Out of my sample size 60, only 23(38%) find derivatives as
quite profitable investment, 14 (23%) find that derivatives can’t
give big profits in future, 17(29%) feels that equities are better
option for investment than derivatives, remaining 6(10%) have
other opinion that only those investors, brokers, can derive
good return from derivatives those have surplus funds and
patience for long period because derivatives requires huge
investment and risk also.

Investment Amount In Derivatives

Out of my size 60, 27(45%) investors and brokers have

invested 2 lacs normally, 9(15%) invested between 2 lacs to 5
lacs and 15(25%) invested between 5 lacs to 10 lacs and
remaining have invested in other amounts. Reason behind this
those are investing from many years are taking the risk of
investing the huge amount.

Traded period in Derivatives

Out of 60 Samples 13(22%) investors and brokers are
investing weekly in derivatives, 23 (38%) investing monthly,
19(32%) investing after more than 1 month and only 5(8%)
investing too late after 2 months.

Impact on Customer Base

Out of 60 brokers and investors, 3(5%) brokers said that it
doesn’t increase their customer base because introducing
small savings as investment, but derivatives increases
customer base of 42(70%) which is more than half, it is
basically beneficial for those who are investing from last 2 or
more years. In investment sector need minimum of Rs.2 lac as
investment so it is basically for corporate and investment
sector only not for small investors, 15(25%) said their
customer base remain same because they have started just
now for investing in derivatives, in future it will increase their
customer base.

Results/Findings
1. Brokers not dealing in derivatives at present are also not
going to adopt it in near futures.
2. Hedging & Risk Management is the most important
feature of derivatives.
3. It is not for small Investors.
4. It has increased brokers turnovers as well as helpful in
aggregate investment.
5. Brokers don’t have adequate knowledge about options, so
most by them are dealing in futures only.
6. There is a risk factor in derivative also.
7. Most of investors are not investing in derivatives.
8. people are not aware of derivatives, even people who are
invested in it, haven’t adequate knowledge about it.
These are interested to take it in their future portfolio
also. They consider it as a tool of risk management.
9. They normally invest in future contracts.
10. They are investing in future contract, because
futures have up to home extent similar quality as Badla.

SUGGESTIONS:
 1. Lot size: Lot size should be reduced so that the major
segment of an India society i.e. small saving class can
come under F & O trading. There is strong need for
revision of lot sizes as the lot sizes of some of the
individual scrips that were worth of Rs. 200000 in
starting, now same lot size amount to a much larger
value.

2. Sub broker: Sub-broker concept should be added and

the actual brokers should give all rights of brokers in F &
O segment also.

3. Scrips: More scrips of reputed companies etc. should be

introduced in "F & O segment".

4. Trading period: Trading period should be increased.

5. Training classes or Seminars: There should be proper

classes on derivatives for investors, traders, brokers,
students and employees of stock exchanges. Because
lack of knowledge is the main reason of its less
development. The first step towards it should be
seminars provide to brokers & LSE employees and
secondly seminar to students.

Limitation of the Study

No study is complete in itself, however good it may and every

study has some limitations:
 Time is the main constraint of the study
 Availability of information was not sufficient because of
less awareness among investors/brokers
 Study is based only on NSE because information and
trading in BSE is not available here.
 Sample size is not enough to have a clear opinion.
CONCLUSION:
 The Indian accounting guidelines in this area need to be
carefully reviewed. The international trend is moving the
underlying securities as well as associated derivative
instrument to market. Such a practice would bring into the
account a Clear picture of the impact of derivative related
operations.

On the basis of overall study on derivatives it was

found that derivative products initially emerged as hedging
devices against fluctuation and commodity prices and
commodity linked derivatives remained the soul form of such
products. The financial derivatives came in spotlight in 1972
due to growing in stability in financial market.

I was really surprised to see during my study that a

layman or a simple investor does not even know how to hedge
and how to reduce risk on his portfolios. All these activities are
generally performed by big individual investors, institutional
investors, mutual funds etc.

No doubt that derivative growth towards the progress of

economy is positive. But the problems confronting the
derivative market segment are giving it a low customer base.
The main problems that it confronts are unawareness and bit
lot sizes etc. these problems could be overcome easily by
revising lot sizes and also there should be seminar and general
discussions on derivatives at varied places.

BIBLOGRAPHY
BOOKS :

NCFM on risk management modules by NSEIL

Indian Capital Market by H.S.Sidhu
Indian Securities Exchange
Capital Market Dealer Module-NSE
The Indian Commodity – Derivatives Market in Operations.

MAGAZINES & NEWSPAPER:

LSE Bulletin
NSE news
Economic Times
Business Standard

INTERNET SITES:

www.nseindia.com
www.bseindia.com
www.sebi.gov.in
www.derivativeindia.com
 SAMPLE QUESTIONNAIRE

Dear Respondent,

I am a student of MBA 2nd year. I am working on the project “Trends and

Future of Derivatives In India: A Detailed Study“. You are requested to fill
in the questionnaire to enable, to undertake the study on the said
project. Your cooperation will be highly appreciated.
Name:
Occupation:

Address:

Phone-no:

1) For how long you have been trading in derivatives?

1 Less than 1 year 2 1 Year

3 2 Year 4 3 Year or more

2) What is your purpose for trading in derivatives?

1 Hedging 2 Speculation
3 Risk Management 4 Liquidity

3) How often do you trade?

1 Weekly 2 Monthly
3 More than 1 month 4 Daily

4) How will you describe your experience with derivative till date?
Quite Profitable Average No profit Losses
Profitable No loss

5) In which market segment your majority of investors insist for dealing?

1 Capital market segment 2 F&O segment
3 Equal customers 4 Can’t say

6) What shortcomings do you feel in Indian derivative market?

1 Lack of awareness among the investors about derivatives.
2 Shortage of domestic technical expertise.
3 If any other___________________________

7) In which market segment derivative customer trade more?

1 Index futures 2 Stock futures
3 Index options 4 Stock options

8) What will be the affect of derivative trading on country’s economy?

1 Accelerates globalization of Indian markets
2 Makes Indian markets more safe
3 Inflate the gains of investors
4 Increased investment by FIIs

9) What is your customer base with introduction of derivatives?

1 Increase 22 Decrease 3 Remain Same

10) Do you think adoption of derivatives trading in India is a right step

towards survival & growth of capital market in India?
1 Yes No
2 No

Signature: