CHAPTER- I

INTRODUCTION

1
INTRODUCTION OF THE STUDY

HEDGING
Hedging means reducing or controlling risk. This is done by taking a position in the futures
market that is opposite to the one in the physical market with the objective of reducing or
limiting risks associated with price changes.

Hedging is a two-step process. A gain or loss in the cash position due to changes in price
levels will be countered by changes in the value of a futures position. For instance, a wheat
farmer can sell wheat futures to protect the value of his crop prior to harvest. If there is a fall
in price, the loss in the cash market position will be countered by a gain in futures position.

How hedging is done

In this type of transaction, the hedger tries to fix the price at a certain level with the objective
of ensuring certainty in the cost of production or revenue of sale.

The futures market also has substantial participation by speculators who take positions based
on the price movement and bet upon it. Also, there are arbitrageurs who use this market to
pocket profits whenever there are inefficiencies in the prices. However, they ensure that the
prices of spot and futures remain correlated.

Example - case of steel

An automobile manufacturer purchases huge quantities of steel as raw material for automobile
production. The automobile manufacturer enters into a contractual agreement to export
automobiles three months hence to dealers in the East European market.

This presupposes that the contractual obligation has been fixed at the time of signing the
contractual agreement for exports. The automobile manufacturer is now exposed to risk in the
form of increasing steel prices. In order to hedge against price risk, the automobile
manufacturer can buy steel futures contracts, which would mature three months hence. In case
of increasing or decreasing steel prices, the automobile manufacturer is protected. Let us
analyse the different scenarios:

2
Increasing steel prices
If steel prices increase, this would result in increase in the value of the futures contracts,
which the automobile manufacturer has bought. Hence, he makes profit in the futures
transaction. But the automobile manufacturer needs to buy steel in the physical market to meet
his export obligation. This means that he faces a corresponding loss in the physical market.

But this loss is offset by his gains in the futures market. Finally, at the time of purchasing steel
in the physical market, the automobile manufacturer can square off his position in the futures
market by selling the steel futures contract, for which he has an open position.

Decreasing steel prices

If steel prices decrease, this would result in a decrease in the value of the futures contracts,
which the automobile manufacturer has bought. Hence, he makes losses in the futures
transaction. But the automobile manufacturer needs to buy steel in the physical market to meet
his export obligation.

This means that he faces a corresponding gain in the physical market. The loss in the futures
market is offset by his gains in the physical market. Finally, at the time of purchasing steel in
the physical market, the automobile manufacturer can square off his position in the futures
market by selling the steel futures contract, for which he has an open position.

This results in a perfect hedge to lock the profits and protect from increase or decrease in raw
material prices. It also provides the added advantage of just-in time inventory management for
the automobile manufacturer.

Understanding the meaning of buying/long hedge

A buying hedge is also called a long hedge. Buying hedge means buying a futures contract to
hedge a cash position. Dealers, consumers, fabricators, etc, who have taken or intend to take
an exposure in the physical market and want to lock- in prices, use the buying hedge strategy.

Benefits of buying hedge strategy:

 To replace inventory at a lower prevailing cost.
 To protect uncovered forward sale of finished products.

3
The purpose of entering into a buying hedge is to protect the buyer against price increase of a
commodity in the spot market that has already been sold at a specific price but not purchased
as yet. It is very common among exporters and importers to sell commodities at an agreed-
upon price for forward delivery. If the commodity is not yet in possession, the forward
delivery is considered uncovered.

Long hedgers are traders and processors who have made formal commitments to deliver a
specified quantity of raw material or processed goods at a later date, at a price currently
agreed upon and who do not have the stocks of the raw material necessary to fulfill their
forward commitment.

Understanding the meaning of selling/short hedge

A selling hedge is also called a short hedge. Selling hedge means selling a futures contract to
hedge.

Uses of selling hedge strategy.

 To cover the price of finished products.
 To protect inventory not covered by forward sales.
 To cover the prices of estimated production of finished products.
Short hedgers are merchants and processors who acquire inventories of the commodity in the
spot market and who simultaneously sell an equivalent amount or less in the futures market.
The hedgers in this case are said to be long in their spot transactions and short in the futures
transactions.

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NEED AND IMPORTANCE OF STUDY

One of the single best things you can do to further your education in trading is to keep
thorough records of your trades. Maintaining good records requires discipline, just like good
trading. Unfortunately, many commodity traders don’t take the time to track their trading
history, which can offer a wealth of information to improve their odds of success most
professional traders, and those who consistently make money from trading Derivatives, keep
diligent records of their trading activity. The same cannot be said for the masses that
consistently lose at trading commodities.

Losing traders are either too lazy to keep records or they can’t stomach to look at their
miserable results. You have to be able to face your problems and start working on some
solutions if you want to be a successful trader. If you can’t look at your mistakes and put in
the work necessary to learn from them, you probably shouldn’t be trading Derivatives.

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SCOPE OF THE STUDY
The Study is limited to “Hedging techniqes of Derivatives” with special reference to Futures
and Option is the Indian context and the Indiabulls have been Taken as a representative
sample for the study. The study can’t be said as totally perfect. Any alteration may come. The
study has only made a humble Attempt at evaluation derivatives market only in India context.
The study is not based on the international perspective of derivatives markets, which exists in
NASDAQ, CBOT etc.

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OBJECTIVES OF THE STUDY
 To analyze the Hedging techniqes of derivative market in India
 To analyze the Hedging operations of futures and options
 To find the profit/loss position of futures buyer and also the option writer and option
holder.
 To study about risk management with the help of derivatives.

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RESEARCH METHODOLOGY
The data collection methods include both the Primary and Secondary Collection methods.
Primary Collection Methods:
This method includes the data collected from the personal discussions with the authorized
clerks and members of the Exchange.

Secondary Collection Methods:

The Secondary Collection Methods includes the lectures of the superintend of the Department
of Market Operations, EDP etc, and also the data collected from the News, Magazines of the
NSE, HSE and different books issues of this study.

DESCRIPTION OF THE METHOD:

The following are the steps involved in the study.
Selection of the script :
The scrip selection is done on a random and the scrip selected is M/S. HDFC LIMITED. The
lot size is 500. Profitability position of the futures buyer and seller and also the option holder
and option writer is studied.

Data Collection:
The data of the M/S. HDFC LIMITED has been collected from the “National Stock exchange”
and the internet. The data consist of the September 2018 contract and the period of data
collection is from 21st September 2018 to October 2018

Analysis:
The analysis consist of the tabulation of the data assessing the profitability positions of the
futures buyer and seller and also option holder and the option writer, representing the data
with graphs and making the interpretation using data.

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LIMITATIONS OF THE STUDY:
The following are the limitation of this study.
 The scrip chosen for analysis is M/S.HDFC LIMITED and the contract taken is
September 2018 ending one –month contract.
 The data collected is completely restricted to the M/S. HDFC LIMITED of September
2018; hence this analysis cannot be taken universal.

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 CHAPTER –II
REVIEW OF LITRETURE

10
ARTICLES

Article - 1

Title : Hedging performance of Nifty index futures

Authors : Anjali Prashad
Abstract : The primary objective of futures market is to provide a facility for hedging against
market risk. The L.C. Gupta committee on Indian derivative markets clearly supported the
introduction of exchange traded futures to aid risk management strategies. This paper attempts
to investigate whether the introduction of index futures trading in the National Stock
Exchange (NSE) of India has been an effective risk management instrument for the spot
market of Nifty portfolio. The daily return distributions are modelled through a rigorous
exploratory data analysis and risk management in futures market is quantified by employing
four alternative time series models with the objective to bring out the model that provides the
best fit to the returns series and the highest hedge performance. All the models prove to be
useful in providing significant reduction in the variance (more than 90%) of the hedged
portfolio. However, GARCH model outperforms others as it provides the highest hedge
effectiveness and the best fit to the data generating process of the two return series. Over all
the results indicate that hedging with Nifty futures is effective (97%) for managing risk in the
spot (Nifty) market.

Key words:- index futures; hedge ratio; hedge effectiveness; volatility clustering; excess
kurtosis.

Article -2

Title : Hedging Effectiveness of Constant and Time Varying Hedge Ratio in Indian Stock and
Commodity Futures Markets
Authors : Brajesh Kumar, Priyanka Singh, Ajay Pandey
Abstract : This paper examines hedging effectiveness of futures contract on a financial asset
and commodities in Indian markets. In an emerging market context like India, the growth of
capital and commodity futures market would depend on effectiveness of derivatives in
managing risk. For managing risk, understanding optimal hedge ratio is critical for devising

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effective hedging strategy. We estimate dynamic and constant hedge ratio for S&P CNX Nifty
index futures, Gold futures and Soybean futures. Various models (OLS, VAR, and VECM)
are used to estimate constant hedge ratio. To estimate dynamic hedge ratios, we use VAR-
MGARCH. We compare in-sample and out-of-sample performance of these models in
reducing portfolio risk. It is found that in most of the cases, VARMGARCH model estimates
of time varying hedge ratio provide highest variance reduction as compared to hedges based
on constant hedge ratio. Our results are
consistent with findings of Myers (1991), Baillie and Myers (1991), Park and Switzer
(1995a,b), Lypny and Powella (1998), Kavussanos and Nomikos (2000), Yang (2001),
and Floros and Vougas (2006).

Keywords: Hedging Effectiveness, Hedge ratio, Bivariate GARCH, S&P CNX Nifty index
and futures, Commodity futures.

Article - 3

Title : Estimating Optimal Hedge Ratio and Hedging Effectiveness in the NSE Index Futures
Authors : Gurmeet Singh
Abstract : This study attempts to study and suggest an optimal hedge ratio to Indian investors
and traders by examining the three main indices of National Stock Exchange of India (NSE),
namely, NIFTY, Bank NIFTY, and IT NIFTY, over the sample period from January 2011 to
December 2015. The present study estimated the hedge ratio through six econometric models,
namely, OLS, GARCH, EGARCH, TARCH, VAR, and VECM, in the minimum variance
hedge ratio framework as suggested by Ederington (1979). The findings of the present study
confirm the theoretical properties of Indian cash and futures market and suggest that the
optimal hedge ratio estimated through EGARCH model was lowest for the NIFTY and Bank
NIFTY, and that for IT NIFTY, the OLS model shows the lowest optimal hedge ratio as
compared to that estimated through other models.

Keywords : Conditional heteroscedasticity, volatility clustering, hedge ratio, hedging

effectiveness.

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Scott (1991) in his working paper demonstrates by arbitrage methods that futures and forward
prices should be functioned by current spot prices and interest ratios. Several examples of
actual prices of Stock index futures and Treasury bond futures are examined and in all cases
the prices are very close to the prices predicted by the arbitrage models.

The popular model for computing implied volatility is the Black –Scholes model and the
paper demonstrates that this model with expected volatility can be interpreted as the first order
approximation for a more complex model that allows the volatility to change randomly.

Srivastava (1998) in his study examines the cases in real life with the aim of providing a
detailed insight into the fact that if derivatives are not properly used they may lead to disaster.
In this study an attempt has been made to analyse the various issues relating to financial
derivatives in the global context. The study points out three main reasons why stock index
futures are mostly preferred: a) Institutional and other large equity holders think in terms of
portfolio hedging b)These are the most cost efficient hedging device, and c) Stock index
cannot be easily manipulated where as individual stock price is manipulated easily.

Subramanian (1998) observes the nature and content of various types of derivative products.
The study also highlights the macro economic benefits that can be derived from derivatives.
The road map of derivative landscape is also provided along with the present status and
prospectus for the development of derivative products in India. The study points out that
derivative arose due to the existence of incomplete markets.

Goyale (2000) focuses on the mode of operations of trading in equity derivatives on National
Stock Exchange. The study analyses the available data relating to derivatives trading in both
Sensex and Nifty futures for the period June to Oct 2000 with a view to identify the special
features of trading activity based on experience. The survey results of 112 respondents show
that index futures are the most preferred product. The study also suggests which new product
needs to be introduced into the market. The study also tells that index futures are the most
needed one for improving stock market efficiency.

Harminder (2000) examines the growth of derivatives segment in India and lists out the
major determinants in the segment. A brief idea about derivative and risk management is
given. The study also exhibits the relationship between futures and stock index from an

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international perspective. It also examines some of the derivative disasters in the world
market. It covers legal and regulatory framework of derivatives.

Chiang and Fong (2001) study the lead-lag relationship among the spot, futures, and options
markets on Hong Kong‟s Hang Seng index. The young options market experiences thin
trading and the option returns lag the cash index returns. The more matured futures market
experienced active trading. Yet its lead over the cash index appears to be less than the
counterparts in other countries. A possible reason is the dominance of a few major stocks in
the index, and these stocks have symmetric lead-lag relations with the futures.

Agarwal (2001) discusses derivatives, their historical perspective, the economic functions and
inherent risks in general. It also focuses on the development of derivatives in India, the
different derivative instruments being traded in this segment, future plans of this segment,
trends observed in the Indian capital markets so far and accounting and taxation aspects of
derivatives from an Indian perspective. Three main economic functions of derivatives listed
by him are risk management, price discovery and transactional efficiency which is the product
of liquidity is also being discussed. A well laid out chart of the proposed plan for introduction
of the instruments need to be formulated and placed before the market for the success of
derivatives market.

Jayabal (2001) points out the contribution made by capital market to the economic
development of the country and examines the extraordinary growth of derivatives market,
complex instruments in derivative market, users of derivative markets etc. As it is a 2001
study, it also talks about the importance of introducing derivatives into Indian market.

Dodd (2002) studies the trend towards the use of securities as a vehicle to transfer capital to
developing economies and how it is linked to the increasing use of derivatives transactions in
developing countries. It also provides a descriptive analysis of how each type of capital
vehicle is associated with various derivative instruments. It then looks at how various
derivative instruments decompose the risks associated with each capital vehicle, price them
separately and then allow those risks to be redistributed. The study says that this portfolio of
capital and derivatives can potentially add to the vulnerability of developing countries
financial systems to external shocks. It concludes with a set of policy recommendation in the

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form of prudential market regulations that are designed to reduce excessive or unproductive
risk taking.

Kumar (2002) tries to investigate the empirical price relationship between NSE 50 futures
and the NSE 50 index. The primary objective is to determine if there is any change in the
volatility of the underlying index due to the introduction of NSE 50 index futures and whether
movements in the futures price provide predictive information regarding subsequent
movements in the index. In the study it was found that Nifty volatility as measured by
standard deviation shows that the volatility in the post futures period is less than the volatility
before the introduction of futures. It was also found that the hypothesis ‟introduction of
futures trading has not affected the volatility of the underlying spot share market‟ is rejected.
The regression results clearly indicate the extent to which information is being impounded
into the markets. It is seen that the information coefficient in the post futures period is more
than that of pre-futures period. It was also found that lower auto correlation coefficient of
Nifty futures returns indicates that futures absorbs information faster as they arrive in the
market thereby giving no room for the past information to affect the current futures returns.

Amuthan (2005) is to study the investor protection system in both options and futures. It also
tries to find out the business growth of derivatives in NSE market. Here the researcher has
sampled 18 months index futures and index options of NSE and has been analysed by means
of percentile analysis. This is done to find out the growth in the derivative segment and to
compare the performance between index futures and index options with the help 0f mean,
standard deviation and coefficient of variation.

Banerjee and Bhattacharya (2005) analyse the relationship between stock index futures and
underlying spot index prices in Indian context. The study uses the most popular index futures,
Nifty in India. The purpose is to see whether futures contracts market in India behave
differently than similar markets in other parts. The study also tries to provide better price
discovery in spot market. The lead lag relationship is tested using the methodology of Granger
causality. The goodness of fit is examined using root need square error and need absolute
error. Nifty spot price lead to future prices but Nifty futures prices and the underlying spot
prices are known normal.

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Charles and Dutta (2005) give insights into a wide variety of areas of financial derivatives.
The most important character within this optimisation problem is the uncertainty of the futures
returns on assets. The objective of this study is to achieve maximum profit with minimum
investment in the stock market. This paper discusses the linear and non linear stochastic
fractional programming problems with mixed constraints which is the key aspect of the
model.

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THEORITICAL BACKGROUND
INTRODUCTION TO HEDGING
Hedging is any strategy designed to offset or reduce the risk of price fluctuations for an asset
or investment. Hedging should not be confused with hedge funds, which are private
investment funds that often, but not always, employ hedging strategies.

When an investor buys or sells a security, the investor bets that the price of the investment
will move in a certain direction. As with any bet, there's always the risk of losing money if the
price moves in the opposite direction. An investor hedges against this risk if he employs any
tool or strategy that minimizes this risk.

In general, creating a hedge requires the purchase of a second asset with a negative correlation
to the first. If the hedged security does not move as predicted, the hedge minimizes loss to the
investor.

A basic example of a hedge is buying a futures contract for a commodity, such as oil. For a
company that uses oil in its production process, an oil futures contract locks in a price until a
given date, protecting the company from the risk that the price will rise even higher by that
time. In this case, the company is said to be hedging against rising oil prices. The flip side of
this is that if prices don't rise, but fall, the company will still have to buy the oil at the agreed-
upon price.

Hedging is not about making a profit, but about removing uncertainty. Hedging merely aims
at reducing unfavorable and unexpected risks.

Various other, more complicated futures hedging strategies exist, as well.

Hedging using Options

A married put is a simple example of a hedge that uses options. In a married put, the investor
buys shares in a company and correspondingly buys a put option whose strike price is lower
than current market price. Should the share prices go up, the put option is worthless and

17
expires. However, should the share price go down, the put option is exercised and the investor
has recovered some of his loss.

A complicated hedging technique using optiions is delta-neutral hedging. In this strategy, a

portfolio of stocks is hedged in such a way that movements in the stock prices do not affect
overall portfolio value. However, increases in volatility leads to an increase in portfolio value.
One example of this is the CBOE Volatility Index, VIX.

Options are quickly becoming the hedging instrument of choice for investors all over the
world, particularly in hedging stock portfolios. This popularity is due to the versatility of
returns offered by option strategies, ranging from synthetic closings, complete downside
protection, complete delta-neutral hedging and multi-directional profiting.

Is Hedging Profitable?
Hedging is profitable when used sparingly and effectively.

Hedging is used to reduce risk. But with reduced risk comes reduced returns. Hedging is
usually expensive, and extensive hedging will not be cost-effective. Should an investor hedge
extensively, he may find himself spending all of his investment profits and possibly more
towards hedging.

Thus, most retail investors do not hedge, A few investors hedge if they know that their
investment values depend on a certain event, such as an earnings report. Should the earnings
report be negative, the hedge minimizes losses. Other than that, hedging and counter-risk
measures are primarily used by corporations and institutional investors.

5 Hedging Techniques to Reduce Investment Risk

Hedging is ideal for investors with large concentrated stock investments, as it helps them hold
positions for a longer time frame, and thus save a lot by avoiding short term capital gain tax.
Hedges are most popular among large corporations, institutional investors and portfolio
managers as strategically exercising financial instruments enable them to cut down investment
risks significantly. Investors must realize the purpose behind using hedging techniques and
these should not be wrongly attempted to profiteer. This article will list top five hedging

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techniques commonly used by stock market investors, but before moving on to them, let us
focus on nitty-gritty of an effective hedge.

Simply put, investing in different stocks, whose price movement is negatively correlated,
automatically creates a hedge. That’s why, hedging always cuts down possibility of returns
while minimizing investment risks. Common derivative instruments such as futures and
options can be used in creating hedge positions to protect invested capital from losses due to
absurd price fluctuations. Diversifying stock investments across global markets, such as
emerging world where liquidity keep floating from one market to another, is an effective
hedging strategy.

Top Stock Hedging Techniques

Hedging Using Non-Identical Stocks (Pairing)
At times when perfect hedges are not available, for instance- puts are not traded for the stocks
held in portfolio then the best way to create hedge is through short sale of a non-identical
security, whose price movement correlates with the security held. This technique can be
exercised by employees, who are not allowed to short their own company stocks. The main
task while applying this technique is to find the right match with similar risk metrics and a
high correlation in price movement. This method only works for a short time frame and there
is always the risk of hedge getting acquired.

Buy and Sell Options to Minimize Risks

Derivatives in form of options are most handy yet complex hedging instruments and should
not be used by layman investors. Tricky pricing aspects of options due to premium feature can
only be understood through in-depth knowledge, so that an effective hedge can be put in
place. Professional risk managers can do wonders using Options as hedges, but that requires
skill and knowledge. Common investors can benefit from simple strategies involving Options
for risk management.

 Call Options- Selling a call option against the concentrated holdings in a particular
stock is a hedging technique.

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  Put Options- Buying puts against existing stocks in portfolio is just like buying
insurance, but remember, there is hefty premium cost.
 Combining Options- Selling a call and buying a put for the same level and same expiry
makes a perfect hedge with premium cost at risk and unlimited profit possibility.

Automatic Hedging and Diversification through Exchange-Traded Funds

ETFs are ideal candidates for hedging sector specific stock holdings in different companies
through a single short position. However, dealing in ETF future’s can be a riskier bet.

Short Against the Box (SATB) still a great short term hedging technique
Once, selling SATB used to be a famous escape route for investors from capital gains tax, as
this is a low cost holding technique. But nowadays after congress lifted most of its tax
advantages; it is only a short term hedging option. This technique involves shorting the same
stock for which hedge is required.

Protect your invested money using Stock and Index Future’s

Using future’s as hedging instrument is the most cost effective way, but there are certain daily
cash flow caps and floors. Individual stock futures and index futures can be utilized to hedge
some of the risk till the expiry date of the contract.

Most investors never use hedges or exercise derivatives as these are difficult to understand
and implement. Ideally these instruments are for money managers and high worth individuals,
who often find it difficult to hedge perfectly in practice.

HISTORY OF DERIVATIVES MARKETS

Early forward contracts in the US addressed merchants concerns about ensuring that there
were buyers and sellers for commodities. However “credit risk” remained a serious problem.
To deal with this problem, a group of Chicago; businessmen formed the Chicago Board of
Trade (CBOT) in 1848. The primary intention of the CBOT was to provide a centralized
location known in advance for buyers and sellers to negotiate forward contracts. In 1865, the
CBOT went one step further and listed the first “exchange traded” derivatives contract in the
US; these contracts were called “futures contracts”. In 1919, Chicago Butter and Egg Board, a
spin-off CBOT was reorganized to allow futures trading. Its name was changed to Chicago

20
Mercantile Exchange (CME). The CBOT and the CME remain the two largest organized
futures exchanges, indeed the two largest “financial” exchanges of any kind in the world
today.

The first stock index futures contract was traded at Kansas City Board of Trade. Currently the
most popular stock index futures contract in the world is based on S&P 500 index, traded on
Chicago Mercantile Exchange. During the Mid eighties, financial futures became the most
active derivative instruments generating volumes many times more than the commodity
futures. Index futures, futures on T-bills and Euro-Dollar futures are the three most popular
futures contracts traded today. Other popular international exchanges that trade derivates are
LIFFE in England, DTB in Germany, SGX in Singapore, TIFFE in Japan MATIF in France,
Eurex etc.,

INTRODUCTION OF DERIVATIVES
The emergence of the market for derivatives products, most notably forwards, futures and
options, can be traced back to the willingness of risk-averse economic agents to guard
themselves against uncertainties arising out of fluctuations in asset prices. By their very
nature, the financial markets are marked by a very high degree of volatility. Through the use
of derivative products, it is possible to partially or fully transfer price risks by locking-in asset
prices. As instruments of risk management, these generally do not influence the fluctuations in
the underlying asset prices. However, by locking-in asset prices, derivative products minimize
the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-
averse investors.

Derivatives are risk management instruments, which derive their value from an underlying
asset. The underlying asset can be bullion, index, share, bonds, currency, interest, etc. Banks,
Securities firms, companies and investors to hedge risks, to gain access to cheaper money and
to make profit, use derivatives. Derivatives are likely to grow even at a faster rate in future.

21
DEFINITION:
Derivative is a product whose value is derived from the value of an underlying asset in a
contractual manner. The underlying asset can be equity, forex, commodity or any other asset.

 Securities Contracts (Regulation) Act, 1956 (SCR Act) defines “derivative” to

secured or unsecured, risk instrument or contract for differences or any other form of
security.
 A contract which derives its value from the prices, or index of prices, of underlying
securities.

FACTORS DRIVING THE GROWTH OF DERIVATIVES

Over the last three decades, the derivatives markets have seen a phenomenal growth. A large
variety of derivative contracts have been launched at exchanges across the world. Some of the
factors driving the growth of financial derivatives are:
 Increased volatility in asset prices in financial markets.
 Increased integration of national financial markets with the international markets.
 Marked improvement in communication facilities and sharp decline in their costs.
 Development of more sophisticated risk management tools, providing economic agents
a wider choice of risk management strategies, and
 Innovations in the derivates markets, which optimally combine the risks and returns
over a large number of financial assets leading to higher returns, reduced risk as well
as transaction costs as compared to individual financial assets.

Emergence of Financial derivative products

Derivative products initially emerged as hedging devices against fluctuations in commodity
prices, and commodity-linked derivatives remained the sole form of such products for almost
three hundred years. Financial derivatives came into spotlight in the Post-1970 period due to
growing instability in the financial markets. However since their emergence, these products
have become very popular and by 1990s, they accounted for about two-thirds of total
transactions in derivative products. In recent years, the market for financial derivatives has

22
grown tremendously in terms of variety of instrument available, their complexity and also
turnover.

In the class of equity derivatives the world over, futures and options on stock indices have
gained more popularity than on individual stocks, especially among institutional investors,
who are major users of index-linked derivatives. Even small investors find these useful due to
high correlation of the popular indexes with various portfolios and ease o use. The lower costs
associated with index derivatives vis-à-vis derivative products based on individual securities is
another reason for their growing use.

PARTICIPANTS IN THE DERIVATIVE MARKETS:

The following three broad categories of participants:
HEDGERS:
Hedgers face risk associated with the price of an asset. They use futures or options markets to
reduce or eliminate this risk.

SPECULATORS:
Speculators wish to bet on future movements in the price of an asset. Futures and options
contracts can give them an extra leverage; that is, they can increase both the potential gains
and potential losses in a speculative venture.

ARBITRAGERS:
Arbitrageurs are in business to take of a discrepancy between prices in two different markets,
if, for, example, they see the futures price of an asset getting out of line with the cash price,
they will take offsetting position in the two markets to lock in a profit.

ECONOMIC FUNCTION OF THE DERIVATIVE MARKETS:

In spite of the fear and criticism with which the derivative markets are commonly looked at,
these markets perform a number of economic functions.

 Prices in an organized derivatives market reflect the perception of market participants

about the future and lead the price of underlying to the perceived future level. The
prices of derivatives converge with the prices of the underlying at the expiration of the
derivate contract. Thus derivatives help in discovery of future as well as current prices.

23
  Derivatives market helps to transfer risks from those who have them but may not like
them to those who have an appetite for them.
 Derivative due to their inherent nature, are linked to the underlying cash markets. With
the introduction of derivatives, 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.
 Speculative trades shift to a more controlled environment of derivatives market. In the
absence of an organized derivatives market, speculators trade in the underlying cash
markets. Margining, Monitoring and surveillance of the activities of various
participants become extremely difficult in these kinds of mixed markets.
 Derivatives trading acts as a catalyst for new entrepreneurial activity.
 Derivatives markets help increase saving and investment in long run.

TYPES OF DERIVATIVES:
The following are the various types of derivatives. They are:

FORWARDS:
A forward contract is a customized contract between two entities, where settlement takes
place on a specific date in the future at today’s pre-agreed price.

FUTURES:
A futures contract is an agreement between two parties to buy or sell an asset at a certain time
in the at a certain price.

OPTIONS:
Options are of two types-calls and puts. Calls give the buyer the right but not the obligation to
buy a given quantity of the underlying asset, at a given price on or before a give future date.
Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying
asset at a given price on or before a given date.

24
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.

LEAPS:
The acronym LEAPS means long-term Equity Anticipation securities. These are options
having a maturity of up to three years.

BASKETS:
Basket options are options on portfolios of underlying assets. The underlying asset is usually a
moving average of a basket of assets. Equity index options are a form of basket options.

SWAPS:
Swaps are private agreements between two parties to exchange cash floes in the future
according to a prearranged formula. They can be regarded as portfolios of forward contracts.
The two commonly used Swaps are:

Interest rate Swaps:

These entail swapping only the related cash flows between the parties in the same currency.

Currency Swaps:
These entail swapping both principal and interest between the parties, with the cash flows in
on direction being in a different currency than those in the opposite direction.

SWAPTION:
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 received 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
received floating.

25
RATIONALE BEHIND THE DEVELOPMENT OF DERIVATIVES
Holding portfolios of securities is associated with the risk of the possibility that the investor
may realize his returns, which would be much lesser than what he expected to get. There are
various factors, which affect the returns:
 Price or dividend (interest)
 Some are internal to the firm like
 Industrial policy
 Management capabilities
 Consumer’s preference
 Labour strike, etc.
These forces are to a large extent controllable and are termed as non systematic risks. An
investor can easily manage such non-systematic by having a well-diversified portfolio spread
across the companies, industries and groups so that a loss in one may easily be compensated
with a gain in other.

There are yet other of influence which are external to the firm, cannot be controlled and affect
large number of securities. They are termed as systematic risk.
They are:
1. Economic
2. Political
3. Sociological changes are sources of systematic risk.
For instance, inflation, interest rate, etc. their effect is to cause prices of nearly all-individual
stocks to move together in the same manner. We therefore quite often find stock prices falling
from time to time in spite of company’s earning rising and vice versa.

Rational Behind the development of derivatives market is to manage this systematic risk,
liquidity in the sense of being able to buy and sell relatively large amounts quickly without
substantial price concession.

In debt market, a large position of the total risk of securities is systematic. Debt instruments
are also finite life securities with limited marketability due to their small size relative to many
common stocks. Those factors favor for the purpose of both portfolio hedging and speculation,

26
the introduction of a derivatives securities that is on some broader market rather than an
individual security.

NSE’s DERIVATIVES MARKET

The derivatives trading on the NSE commenced with S&P CNX Nifty index futures on June
12, 2000. The trading in index options commenced on June 4, 2001 single stock futures were
launched on November 9, 2001. Today, both in terms of volume and turnover, NSE is the
largest derivatives exchange in India. Currently, the derivatives contracts have a maximum of
3-month expiration cycles. Three contracts are available for trading, with 1 month, 2 month &
3 month expiry. A new contract is introduced on the next trading day following of the near
month contract.

GLOBAL DERIVATIVES MARKET

The global financial centers such as Chicago, New York, Tokyo and London dominate the
trading in derivatives. Some of the world’s leading exchanges for the exchange-traded
derivatives are:
 Chicago Mercantile Exchange (CME) & London International financial Futures
Exchange (LIFFE) (for currency & Interest rate futures)
 Philadelphia Stock Exchange (PSE), London stock Exchange (LSE) & Chicago Board
options exchange (CBOE) (for currency options)
 New York Stock Exchange (NYSE) and London Stock Exchange (LSE) (for equity
derivatives)
 Chicago Mercantile Exchange (CME) and London Metal Exchange (LME) (for
commodities)
These exchanges account for a large portion of the trading volume in the respective
derivatives segment.

27
ELIGIBILITY OF ANY STOCK TO ENTER IN DERIVATIVES
MARKET
 Non promoter holding (free float capitalization) not less than Rs.750crores from last 6
months.
 Daily Average Trading value not less than 5 crores in last 6 months.
 At least 90% of Trading days in last 6 months.
 Non Promoters Holding at least 30%.
 BETA not more than 4 (previous last 6 months)

REGULATORY FRAMEWORK:
The trading of derivatives is governed by the provisions contained in the S C (R) Act, the
SEBI Act, and the regulations framed there under the rules and byelaws of stock exchanges.

Regulation for Derivative Trading:

SEBI set up a 24-member committed under Chairmanship of Dr.L.C.Gupta develop the
appropriate regulatory framework for derivative trading in India. The committee submitted its
report in March 1998. On May11, 1998 SEBI accepted the recommendations of the committee
and approved the phased introduction of derivatives trading in India beginning with stock
index Futures. SEBI also approved he “suggestive bye-laws” recommended by the committee
for regulation and control of trading and settlement of Derivative contract.

The provision in the SC(R) Act governs the trading in the securities. The amendment of the
SCR Act to include “DERIVATIVES” within the ambit of securities in the SCR Act made
trading in Derivatives possible with in the framework of the Act.

 Any exchange fulfilling the eligibility criteria as prescribed in the L.C.Gupta committee
report may apply to SEBI for grant of recognition under section 4 of the SCR Act, 1956
to start Derivatives Trading. The derivative exchange- /segment should have a separate
governing council and representation of trading/clearing member shall be limited to
maximum 40% of the total members of the governing council. The exchange shall
regulate the sales practices of its members and will obtain approval of SEBI before start
of Trading in any derivative contract.

28
 The exchange shall have minimum 50 members.
 The members of an existing segment of the exchange will not automatically become the
members of the derivatives segment. The members of the derivatives segment need to
fulfill the eligibility conditions as lay down by the L. C. Gupta committee.
 The clearing and settlement of derivatives trades shall be through a SEBI approved
clearing corporation/clearing house. Clearing Corporation/Clearing House complying
with the eligibility conditions as lay down by the committee have to apply to SEBI for
grant of approval.
 Derivatives broker/dealers and Clearing members are required to seek registration from
SEBI. This is in addition to their registration as brokers of existing stock exchanges. The
minimum net worth for clearing members of the derivatives clearing corporation/house
shall be Rs.300 lakh. The net worth of the member shall be computed as follows:
 Capital + Free reserves
 Less non-allowable assets viz.,
1. Fixed Assets
2. Pledged securities
3. Member’s card
4. Non-allowable securities (unlisted securities)
5. Bad deliveries
6. Doubtful debts and advance
7. Prepaid expenses
8. Intangible Assets
9. 30% marketable securities
 The Minimum contract value shall not be less than Rs.2 Lakhs. Exchange should also
submit details of the futures contract they purpose to introduce.
 The trading members are required to have qualified approved user and sales persons
who have passed a certification programmed approved by SEBI.
 The L.C.Gupta committee report requires strict enforcement of “know your customer”
rule and requires that every client shall be registered with the derivates broker. The
members of the derivatives segment are also required to make their clients aware of the

29
 risks involved in derivatives trading by issuing to the client the Risk Disclosure and
obtain a copy of the same duly signed by the clients.

HISTORY OF FUTURES
Merton Miller, the 1990 Nobel Laureate had said that “financial futures represent the most
significant financial innovation of the last twenty years”. The first exchange that traded
financial derivatives was launched in Chicago in the year 1972. A division of the Chicago
Mercantile Exchange, it was called the international monetary market (IMM) and traded
currency futures. The brain behind this was a man called Leo Melamed, acknowledged as the
“father of financial futures” who was then the Chairman of the Chicago Mercantile Exchange.
Before IMM opened in 1972, the Chicago Mercantile Exchange sold Contracts whose value
was counted in millions. By 1990, the underlying value of all contracts traded at the Chicago
Mercantile Exchange totaled 50 trillion dollars.

These currency futures paved the way for the successful marketing of a dizzying array of
similar products at the Chicago Mercantile Exchange, the Chicago Board of Trade and the
Chicago Board Options Exchange. By the 1990s, these exchanges were trading futures and
options on everything from Asian & American Stock indexes to interest-rate swaps, and their
success transformed Chicago almost overnight into the risk-transfer capital of the world.

INTRODUCTION OF FUTURES
Futures markets were designed to solve the problems that exist in forward markets. A futures
contract is an agreement between two parties to buy or sell an asset as a certain time in the
future at a certain price. But unlike forward contract, the futures contracts are standardized
and exchange traded. To facilitate liquidity in the futures contract, the exchange specifies
certain standard underlying instrument, a standard quantity and quality of the underlying
instrument that can be delivered, (or which can be used for reference purpose in settlement)
and a standard timing of such settlement. A futures contract may be offset prior to maturity by
entering into an equal and opposite transaction. More than 90% of futures transactions are
offset this way.

30
The standardized items in a futures contract are:
 Quantity of the underlying
 Quality of the underlying
 The date and the month of delivery
 The units of price quotation and minimum price change
 Location of settlement

DEFINITION
A future contract is an agreement between two parties to buy or sell an asset at a certain time
in the future at a certain price. Futures contracts are special types of forward contracts in the
sense that the former are standardized exchange-traded contracts.

DISTINCTION BETWEEN FUTURES & FORWARDS CONTRACTS

Forward contracts are often confused with futures contracts. The confusion is primarily
because both serve essentially the same economic functions of allocating risk in the presence
of futures price uncertainty. However futures are a significant improvement over the forward
contracts as they eliminate counterparty risk and offer more liquidity. Comparison between
two as follows:

FORWARDS
FUTURES

1.Trade on an Organized 1.OTC in nature

Exchange 2. Customized
2. Standardized 3. Less Liquidity
3. More Liquidity 4. No Margin
4. Require Margin Payment
payment 5. settlement happens at end of
5. Follows daily period
settlement

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FEATURES OF FUTURES:
 Futures are highly standardized.
 The contracting parties need not pay any down payments.
 Hedging of price risks.
 They have secondary markets to.

TYPES OF FUTURES:
On the basis of the underlying asset they derive, the futures are divided into two types:

 Stock futures
 Index futures

Parties in the futures contract:

There are two parties in a future contract, the buyer and the seller. The buyer of the futures
contract is one who is LONG on the futures contract and the seller of the futures contract is
who is SHORT on the futures contract.

The pay off for the buyer and the seller of the futures of the contracts are as follows:
PAY-OFF FOR A BUYER OF FUTURES

CASE 1:- The buyer bought the futures contract at (F); if the future price goes to E1 then the
buyer gets the profit of (FP).
CASE 2:- The buyer gets loss when the future price goes less then (F), if the future price
goes to E2 then the buyer gets the loss of (FL).

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 PAY-OFF FOR A SELLER OF FUTURES:

F – FUTURES PRICE
E1, E2 – SETTLEMENT PRICE
CASE 1:- The seller sold the future contract at (f); if the future goes to E1 then the seller gets
the profit of (FP).

CASE 2:- The seller gets loss when the future price goes greater than (F), if the future price
goes to E2 then the seller gets the loss of (FL).

MARGINS
Margins are the deposits which reduce counter party risk, arise in a futures contract. These
margins are collect in order to eliminate the counter party risk. There are three types of
margins:

Initial Margins:
Whenever a futures contract is signed, both buyer and seller are required to post initial
margins. Both buyer and seller are required to make security deposits that are intended to
guarantee that they will infact be able to fulfill their obligation. These deposits are initial
margins and they are often referred as purchase price of futures contract.

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Marking to market margins:
The process of adjusting the equity in an investor’s account in order to reflect the change in
the settlement price of futures contract is known as MTM margin.

Maintenance margin:
The investor must keep the futures account equity equal to or grater than certain percentage of
the amount deposited as initial margin. If the equity goes less than that percentage of initial
margin, then the investor receives a call for an additional deposit of cash known as
maintenance margin to bring the equity up to the initial margin.

Role of Margins:
The role of margins in the futures contract is explained in the following example. Rakesh sold
a HDFC BANK December futures contract to Sravanthi at Rs.300; the following table shows
the effect of margins on the contract. The contract size of HDFC BANK is 200. The initial
margin amount is say Rs.28456/-, the maintenance margin is 56%of initial margin.
Pricing the Futures:
Pricing of futures contract is very simple. Using the cost-of-carry logic, we calculate the fair
value of the futures contract. Every time the observed price deviates from the fair value,
arbitragers would enter into trades to captures the arbitrage profit. This is turn would push the
futures price back to its fair value.

The cost-of-carry model used for pricing futures is given below.

F = Sert
Where:
F = Futures Price
S = Spot price of the underlying
R = cost of financing (using continuously compounded
Interest rate)
T = Time till expiration in years
e = 2.71828
(or)

F=S(1+r-q)t

34
Where:
F = Futures price
S = Spot price of the underlying
r = Cost of financing (or) interest rate
q = Expected Dividend yield
t = Holding Period.

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

Expiry date:
It is the date specifies 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 under one contract. For instance, the contract size
on NSE’s futures market is 50 Nifties.

35
Basis:
In the context of financial futures, basis can be defined as the futures price minus the spot
price. These 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.
Cost carry:
The relationship between futures prices and spot prices can be summarized in terms of what is
known as the cost of carry. This measures the storage cost plus the interest that is paid to
finance the asset less the income earned on the asset.
Initial margin:
The amount that must be deposited in the margin account at the time a futures contract is first
entered into is known as initial margin.
Marking-to-market:
In the futures market, at the end of each trading day, the margin account is adjusted to reflect
the investor’s gain or loss depending upon the futures closing price. This is called marking-to-
market.
Maintenance margin:
This is some what lower than the initial margin. This is set to ensure that the balance in the
margin account never becomes negative. If the balance in the margin account 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.

HISTORY OF OPTIONS
Although options have existed for a long time, they we traded OTC, without much knowledge
of valuation. The first trading in options began in Europe and the US as early as the
seventeenth century. It was only in the early 1900s that a group of firms set up what was
known as the put and call Brokers and Dealers Association with the aim of providing a
mechanism for bringing buyers and sellers together. If someone wanted to buy an option, he
or she would contact one of the member firms. The firms would then attempt to find a seller or
writer of the option either from its own client of those of other member firms. If no seller
could be found, the firm would undertake to write the option itself in return for a price.

36
This market however suffered form two deficiencies. First, there was no secondary market and
second, there was no mechanism to guarantee that the writer of the option would honor the
contract. In 1973, Black, Merton and scholes invented the famed Black-Scholes formula. In
April, 1973 CBOE was set up specifically for the purpose of trading options. The market for
option contract sold each day exceeded the daily volume of shares traded on the NYSE. Since
then, there has been no looking back.

Option made their first major mark in financial history during the tulipbulb mania in
seventeenth-century Holland. It was one of the most spectacular get rich quick binges in
history. The first tulip was brought into Holland by a botany professor from Vienna. Over a
decade, the tulip became the most popular and expensive item in Dutch gardens. The more
popular they became, the more Tulip bulb prices began rising. That was when options came
into the picture. They were initially used for hedging. By purchasing a call option and tulip
bulbs, a dealer who was committed to a sales contract could be assured of obtaining a fixed
number of bulbs for a set price. Similarly, tulip bulb growers could assure themselves of
selling their bulbs at a set price by purchasing put options. Later, however, options were
increasingly used by speculators who found that call options were an effective vehicle for
obtaining maximum possible gains on investment. As long as tulip prices continued to
skyrocket, a call buyer would realize returns far in excess of those that could be obtained by
purchasing tulip bulbs themselves. The writers of the put options also prospered as bulb prices
spiraled since writers were able to keep the premiums and the options were never exercised.
The tulip bulb market collapsed in 1636 and a lot of speculators lost huge sums of money.
Hardest hit were put writers who were unable to meet their commitments to purchase tulip
bulbs.

INTRODUCTION TO OPTIONS
In this section, we look at the next derivative product to be traded on the NSE, namely
options. Options are fundamentally different from forward and futures contracts. An option
gives the holder of the option the right to do something. The holder does not have to exercise
this right. In contrast, in a forward or futures contract, the two parties have committed
themselves to doing something. Whereas it costs nothing (except margin requirement) to enter
into a futures contracts, the purchase of an option requires as up-front payment.

37
DEFINITION :
Option is a type of contract between two persons where one grants the other the right to buy a
specific asset at a specific price within a specific time period. Alternatively the contract may
grant the other person the right to sell a specific asset at a specific price within a specific time
period. In order to have this right. The option buyer has to pay the seller of the option
premium. The assets on which option can be derived are stocks, commodities, indexes etc. If
the underlying asset is the financial asset, then the option are financial option like stock
options, currency options, index options etc, and if options like commodity option.

PROPERTIES OF OPTION :
Options have several unique properties that set them apart from other securities. The
following are the properties of option:
 Limited Loss
 High leverages potential
 Limited Life
PARTIES IN AN OPTION CONTRACT
Buyer/Holder/Owner of an option:
The buyer of an option is one who by paying option premium buys the right but not the
obligation to exercise his option on seller/writer.

Seller/writer of an option:
The writer of the call /put options is the one who receives the option premium and is their by
obligated to sell/buy the asset if the buyer exercises on him

TYPES OF OPTIONS
The options are classified into various types on the basis of various variables. The following
are the various types of options.

I. On the basis of the underlying asset:

On the basis of the underlying asset the option are divided into two types:
INDEX OPTIONS
These options have the index as the underlying. Some options are European while others are
American. Like index futures contract, index options contracts are also cash settled.

38
STOCK OPTIONS
Stock options are options on the individual stocks. Options currently trade on over 500 stocks
in the United States. A contract gives the holder the right to buy or sell shares at the specified
price
II. On the basis of the market movements:
On the basis of the market movements the option are divided into two types. They are:
CALL OPTION:
A call option is bought by an investor when he seems that the stock price moves upwards. A
call option gives the holder of the option the right but not the obligation to buy an asset by a
certain date for a certain price.
PUT OPTION:
A put option is bought by an investor when he seems that the stock price moves downwards.
A put option gives the holder of the option right but not the obligation to sell an asset by a
certain date for a certain price.

III. On the basis of exercise of option:

On the basis of the exercised of the option, the options are classified into two categories.
AMERICAN OPTION:
American options are options that can be exercised at any time up to the expiration date, most
exchange-traded option are American.
EUOROPEAN OPTION:
European options are options that can be exercised only on the expiration date itself. European
options are easier to analyze than American options, and properties of an American option are
frequently deduced from those of its European counterpart.

39
 PAY-OFF PROFILE FOR BUYER OF A CALL OPTION
The pay-off of a buyer options depends on a spot price of a underlying asset. The following
graph shows the pay-off of buyer of a call option.

S = Strike price OTM = Out of the money

SP = Premium/ Loss ATM = at the money
E1 = Spot price 1 ITM = in the money
E2 = Spot price 2
SR = Profit at spot price E1

CASE 1: (Spot price > Strike price)

As the spot price (E1) of the underlying asset is more than strike price (S). The buyer gets
profit of (SR), if price increases more than E1 then profit also increase more than (SR).
CASE 2: (Spot price < Strike price)
As a spot price (E2) of the underlying asset is less than strike price (s) The buyer gets loss of
(SP); if price goes down less than E2 then also his loss is limited to his premium (SP).

40
 PAY-OFF PROFILE FOR SELLER OF A CALL OPTION
The pay-off of seller of the call option depends on the spot price of the underlying asset. The
following graph shows the pay-off of seller of a call option:

S = Strike price ITM = in the money

SP = Premium /profit ATM = at the money
E1 = Spot price 1 OTM = Out of the money
E2 = Spot price 2
SR = Profit at spot price E1
CASE 1: (Spot price < Strike price)
As the spot price (E1) of the underlying is less than strike price (S). The seller gets the profit
of (SP), if the price decreases less than E1 then also profit of the seller does not exceed (SP).

CASE 2: (Spot price > Strike price)

As the spot price (E2) of the underlying asset is more than strike price (S) the seller gets loss
of (SR), if price goes more than E2 then the loss of the seller also increase more than (SR).

41
 PAY-OFF PROFILE FOR BUYER OF A PUT OPTION
The pay-off of the buyer of the option depends on the spot price of the underlying asset. The
following graph shows the pay-off of the buyer of a call option.

S = Strike price ITM = in the money

SP = Premium/loss OTM = Out of the money
E1 = Spot price 1 ATM = at the money
E2 = Spot price 2
SR = Profit at spot price E1
CASE 1: (Spot price < Strike price)
As the spot price (E1) of the underlying asset is less than strike price (S). The buyer gets the
profit (SR), if price decreases less than E1 then profit also increases more than (SR).
CASE 2: (Spot price > Strike price)
As the spot price (E2) of the underlying asset is more than strike price (s), the buyer gets loss
of (SP), if price goes more than E2 than the loss of the buyer is limited to his premium (SP).

42
 PAY-OFF PROFILE FOR SELLER OF A PUT OPTION

The pay-off of a seller of the option depends on the spot price of the underlying asset. The
following graph shows the pay-off of seller of a put option. They are:

S = Strike price ITM = in the money

SP = Premium/ profit ATM = at the money
E1 = Spot price 1 OTM = Out of the money
E2 = Spot price 2
SR = Profit at spot price E1

CASE 1: (Spot price < Strike price)

As the spot price (E1) of the underlying asset is less than strike price (S), the seller gets the
loss of (SR), if price decreases less than E1 than the loss also increases more than (SR).
CASE 2: (Spot price > Strike price)
As the spot price (E2) of the underlying asset is more than strike price (S), the seller gets
profit of (SP), if price goes more than E2 than the profit of seller is limited to his premium
(SP).

43
Factors affecting the price of an option
The following are the various factors that affect the price of an option they are:
Stock price:
The pay–off from a call option is a amount by which the stock price exceeds the strike price.
Call options therefore become more valuable as the stock price increases and vice versa. The
pay-off from a put option is the amount; by which the strike price exceeds the stock price. Put
options therefore become more valuable as the stock price increases and vice versa.
Strike price:
In case of a call, as a strike price increases, the stock price has to make a larger upward move
for the option to go in-the-money. Therefore, for a call, as the strike price increases option
becomes less valuable and as strike price decreases, option become more valuable.
Time to expiration:
Both put and call American options become more valuable as a time to expiration increases.
Volatility:
The volatility of a stock price is measured of uncertain about future stock price movements.
As volatility increases, the chance that the stock will do very well or very poor increases. The
value of both calls and puts therefore increase as volatility increase.
Risk-free interest rate:
The put options prices decline as the risk-free rate increases where as the prices of call always
increase as the risk-free interest rate increases.
Dividends:
Dividends have the effect of reducing the stock price on the x-dividend rate. This has a
negative effect on the value of call options and a positive effect on the value of put options.

PRICING OPTIONS
An option buyer has the right but not the obligation to exercise on the seller. The worst that
can happen to a buyer is the loss of the premium paid by him. His downside is limited to this
premium, but his upside is potentially unlimited. This optionality is precious and has a value,
which is expressed in terms of the option price. Just like in other free markets, it is the supply
and demand in the secondary market that drives the price of an option.

44
 There are various models which help us get close to the true price of an option. Most of these
are variants of the celebrated Black-Scholes model for pricing European options. Today most
calculators and spread-sheets come with a built-in Black-Scholes options pricing formula so to
price options we don’t really need to memorize the formula. All we need to know is the
variables that go into the model.
The Black-scholes formulas for the price of European calls and puts on a non-dividend paying
stock are:
CALL OPTION
C = SN (D1)-Xe-r t N (D2)
PUT OPTION
P = Xe-r t N (-D2)-SN (-D1)

Where d1 = Ln(S/X) + (r+ v2/2) t

v\/t
And d2 = d1- v\/t
Where
CA = VALUE OF CALL OPTION
PA = VALUE OF PUT OPTION
S = SPOT PRICE OF STOCK
N = NORMAL DISTRIBUTION
VARIANCE (v) = VOLATILITY
X = STRIKE PRICE
r = ANNUAL RISK FREE RETURN
t = CONTRACT CYCLE
e = 2.71828
r = in (1+r)
OPTIONS TERMINOLOGY
Option price/premium:
Option price is the price which the option buyer pays to the option seller; it is also referred to
as the option premium.

45
Expiration Date:
The date specified in the options contract is known as expiration date, the exercise date, the
strike date or the maturity.

Strike price:
The price specified in the options contract is known as strike price or Exercise price.

In-the-money option:
An In-the-money (ITM) option is an option that would lead to positive cash flow to the holder
if it were exercised immediately. A call option on the index is said to be in-the-money when
the current index stands at a level higher than the strike price (i.e. spot > strike price). If the
index is much higher than the strike price, the call is said to be deep ITM. In the case of a put,
the put is ITM if the index is below the strike price.

At-the-money option:
An at-the-money (ATM) option is an option that would lead to zero cash flow if it is exercised
immediately. An option on the index is at-the-money when the current index equals the strike
price (i.e. spot price = strike price).

Out-of-the-money option:
An out-of-the-money (OTM) option is an option that would lead to negative cash flow if it is
exercised immediately. A call option on the index is out-of-the-money when the current index
stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is
much lower than the strike price, the call is said to be deep OTM. In the case of a put, the put
is OTM if the index is above the strike price.

Intrinsic value of money:

The option premium can be broken down into two components-intrinsic value and time value.
The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the call is OTM,
its intrinsic value is zero.

46
Time value of an option:
The time value of an option is the difference between its premium and its intrinsic value. Both
calls and puts have time value. An option that is OTM or ATM has only time value. Usually,
the maximum time value exists when the option is ATM. The longer the time to expiration,
the greater is an option’s time value, all else equal. At expiration, an option should have no
time value.
DISTINCTION BETWEEN FUTURES AND OPTIONS

FUTURES OPTIONS

1.Exchange traded, with 1.Same in nature

Novation 2.Same in nature
2.Exchange defines the 3.Strike price is fixed, price moves
product 4.Price is always
3.Price is zero, strike positive
Price moves 5.Nonlinear payoff
4.Price is zero 6.only short at risk
5.Linear payoff
6.Both long & Short
at risk

TRADING INTRODUCTION
The futures & options trading system of NSE, called NEAT-F&O trading system, provides a
fully automated screen-based trading for Nifty futures & options and stock futures & options
on a nationwide basis as well as online monitoring and surveillance mechanism. It supports an
order driven market and provides complete transparency of trading operations. It is similar to
that of trading of equities in the cash market segment.

The software for the F&O market has been developed to facilitate efficient and transparent
trading in futures and options instruments. Keeping in view the familiarity of trading members

47
with the current capital market trading system, modifications have been performed in the
existing capital market trading system so as to make it suitable for trading futures and options.
On starting NEAT (National Exchange for Automatic Trading) application, the log on (pass
word) screen appears with the following details.

1. User ID
2. Trading Member ID
3. Password – NEAT CM (default pass word)
4. New Pass Word

Note:-
1. User ID is a Unique
2. Trading Member ID is Unique & Function; it is common for all user of the Trading
Member.
3. New password–Minimum 6 Characteristic, Maximum 8 characteristics only 3 attempts are
accepted by the user to enter the password to open the screen.
4. If password is forgotten the user required to inform the exchange in writing to reset the
password.
TRADING SYSTEM

Nation wide online fully Automated Screen Based Trading System (SBTS)
 Price priority
 Time priority
Note:-
1. NEAT system provides open electronic consolidated limit orders book (OECLOB)
2. limit order means: stated quantity and stated price

Before Opening the market:

User allowed to set up

 market watch screen

48
  inquiry screens only

Open phase (open Period):

User allowed to
 Enquiry
 Order Entry
 Order Modification
 Order Cancellation
 Order Matching

Market Closing Period:

User allowed only for inquires
Surcon period (Surveillance & Control period):
The system process the Date, for making the system, for the next trading day.
Log of the Screen (Before Surcon Period):
The screen shows :-
1. Permanent sign off
2. Temporary sign off
3. Exit
Permanent sign off: Market not updates.
Temporary sign off: Market up date (temporary sign off, after 5 minutes Automatically
Activate)
Exit: The user comes out sign off screen.
Local Database:
Local Database is used for all inquiries made by the user for own order/trades information. It
is used for corporate manager/ Branch Manager Makes inquiries for orders/trades of any
branch manager/dealer of the trading firm, and then the inquiry is serviced by the host. The
local database also includes message of security information.

49
Ticker Window:
The ticker window displays information of all trades in the system. The user has the option of
selecting the security, which should be appearing in the ticker window.

Securities in ticker can be selected for each market types:

The ticker window displays both derivative and capital market segment

Market Watch Window:

Title Bar: Title Bar Shows: NEAT, Date & Time.
Market watch window felicitate to set only 500 scrip’s, but the user set up a Maximum of 30
securities in one page.

Previous Trade Screen:

Previous trade screen shows & allows security wise information to user for his own trade in
chronological order.
1. Request for trade modification allowed with the following conditions
 During the day only
 Must be lower then the traded quantity
 Both parties acceptance (Buyer & Seller)
 Final Decision is taken by NSE (to accept or reject)
2. Request for trade cancellation allowed with same as above conditions (A)
Outstanding order Screen:
Out standing order screen show, Status out standing order enter by user for a particular
security (R.L. Order & SL Order) it allows:- order Modification & Orders Cancellation.
Activity Log Screen:
Activity logon screen show, all activities performed on any order by the user, in Reversal
Chronological Order
B = Buying
S = Selling orders
OC = Cancellation of order
OM = Modifying order

50
TC = Buy order & Sell order, involving in trade and cancelled
TM = By order & sell orders, involving trade is modified
It is very useful to a corporate manager to view all the activities that have been performed on
any order (or) all ordered under his branches & dealers

Order status screen:

Order status screen shows, current status of “dealers” own specified orders.

SNAP Quote Shows:

Instantaneous information about a particular security can be shown on Market watch window
(which is not set up in market watch window)

Market Movement Option:

Over all movement of the security, in current day, on time basis.

Market Inquiry
Market inquiry screen shows market statistics for particular market, for a particular security.
It shows information about:-

RL Market (Regular lot Market)

RD Market (Retail Debt Market)
OL Market (Odd lot Market)

It shows following statistics:- open price, High price, Low price, Last Traded Price, Traded
Quantity, 52 weeks high/low price.

MBP (Market by Price):

MBP (F6) screen shows total out standing orders of a particular security, in the market,
Aggregate at each price in order of Best 5 prices.
It shows:-

51
 RL Market (Regular lot Market)
SL Market (Stop Loss order)
ST order (Special Term orders)
Buy Back Order with ‘*’ symbol
P = indicate pre open position
S = indicate Security Suspend
Security/Portfolio list:
 It Facilitate the user to set up market watch screen
 And facilitate to set up his own portfolios

ON-LINE Batch Up:

It facilitates the user to take back up of all orders & trade related information, for current day
only.
ON-LINE/TABULAR SLIPS:
It selects the format for conformation slips
About Window:
This window displays software related version numbers details and copy right information.
Most Activity Securities Screen:
It shows most active securities, based on the total traded value during the day
Report Selection Window:
It facilitates to print each copy of report at any time. These reports are :
 Open order report : For details of out standing orders
 Order log report : For details of orders placed, modified & cancelled
 Trade Done-today report : For details of orders traded
 Market Statistics report : For details of all securities traded information in a
day

Internet Broking:
1. NSE introduced internet trading system from February 2000.
2. Client place the order through brokers on order routing system.
WAP (Wireless application protocol):

52
 1. NSE.IT Launches the from November 2000
2. 1st Step-getting the permission from exchange for WAP
3. 2nd step-approved by the SEBI (SEBI Approved only for SEBI registered members)

X.25 Address Check:

X.25 Address Check, is performed in the NEAT System, when the user log on into the NEAT,
system & during report down load request.

FTP (File Transfer Protocol):

1. NSE Provide for each member a separate directory (file) to know their trading
DATA, clear DATA, bill trade Report.
2. NSE Provide in addition a “common” directory also, to know circulars, NCFM &
Bhava Copy information
3. FTP is connected to each member through VSAT, leased line and internet.
4. VSAT (FROM 4.15PM to 9.30AM), Internet (24Hours).

Bhava Copy Database:

Bhava copy data provides summary information about each security, for each day (only last 7
days bhava copy file are stored in report directory.)
Note:- Details in bhava copy-open price, high and low prices, closing prices traded value,
traded volume and No. of transactions.
Snap Shot Database:
Snap shot database provides snap shot of the limit order book at many time points in a day.
Index Database:
Index Database provides information about stock market indexes.

Trade Database:
Trade database provides a database of every single traded order, take place in exchange.
BASKET TRADING SYSTEM:

53
 1. Taking advantage for easy arbitration between future market and cash market
difference, NSE introduce basket trading system by off setting position through off
line-order-entry facility.
2. Orders are created for a selected portfolio to the ratio of their market capitalization
from 1 lakh to 30 crores.
3. Offline-order-entry facility: Generate order file in as specified format outside the
system & up load the order file into the system by invoking this facility in Basket
Trading System.

Participants in Security Market

1) Stock Exchange (registered in SEBI)-23 stock Exchanges
2) Depositaries (NSDL, CDSL)-2 Depositaries
3) Listed Securities-9,413
4) Registered Brokers-9,519
5) FIIs-502

Investor Education & Protection Fund:

This fund used to educate & develop the awareness of the Investors. The following funds
credited to IE & PF.
1) Unpaid Dividends.
2) Due for refund (application money received for allotment).
3) Matured deposits & debentures with company.
4) Government donations.
Issue & Allotment of the Shares:
1) Issued & subscribing
 Either Physical or dematerialized.
 Issuing capital exceed 10 crores compulsory issued in dematerialized

2) Trading compulsory in dematerialized form.

3) Allotment made until the beginning of the 5th day after the day issue of prospectus.
4) Listing is possible issuing not less than 10% of the total equity and minimum of 20 Lakhs.

54
Holding of Shares(Voting Right)disclosing obligation:
 Any person or Director or Officer or the company
 More than 5% share or Voting Right
 With in 4th day inform to company is necessary
 Company inform with in 5th day to stock exchange is compulsory

First Started:
Future Trading: Chicago Board of Trading 1848
Financial Future Trading: CME (Chicago Mercantile Exchange 1919)
Stock Index Futures: Kansas City Board of trade
Option First Trade: Holland – Tulip Balabmania.

BROKER (Trading Member)

(Broker means a member in recognized stock exchange)
Eligibility:21 tears, graduation, 2 years experience in stock market relative affairs and
 30 Lakhs paid up capital
 100 Lakhs net worth
 125 Lakhs interest free security deposit
 25 Lakhs collatery security deposit
 1 Lakh annual business subscription.

Necessary Infrastructure:
Office Space, Manpower, Equipment
Disciplinary proceedings:
Not convicted involving fraud & Dishonesty
Fitness:
Not Bankrupt, not default in any stock exchange, not previously refused by NSE, fully
discharged from Debts by creditors (self declaration)

55
  First send application to stock exchange for broker ship-stock exchange send that
application to SEBI 30 days - SEBI satisfy above 1 & 2 points to grant Certificate of
Registration.
 Maximum commission of the broker 2.5% (including sub broker commission 1.5%) on
cash market and feature market buy and sell values but option market 2.5% is charged
on (Strike Price + Premium value).
 Contract note issued and signed by broker or authorized signatory within 24hrs.
 On contract note printed both offices registered office & dealing office address is
must.
 Each trading member (broker) in F&O segment of NSEIL (NSE India Limited) can
have as many users are he wishes.
 Compliance officer is appointed by the Broker.
 Broker ship Transfer fee 1 Lakh.

Dominant Promoters :
a) For Individual (not exceeding 4 members) his & his spouse not less than 51%-1
person Graduation is compulsory.
b) For firm:- Not less than 51% his & his spouse, children’s & brother’s -1 person
graduation is compulsory.
c) Corporate Company:- Not less than 40% of the director’s share holding (at least 50%
each director) – 2 Directors Graduation is compulsory.

BROKER & CLIENT RELATIONSHIP:

1. Fill the client Registration Application form (for all details of clients).
2. Agreement on non-judicial form (specified by SEBI that form)
3. PAN, Pass port, Driving License or Voter Identity Card (SEBI Registration Number in case
of FII’s)-pan cards are must to future and option trading.
4. And than Allot-Unique Client Code.
5. Take copy of instruction in writing before placing order, cancellation & modification.
6. If order values exceed 1 Lakh maintain the client record for 7 years.
7. on conformation any order, issue contract note within 24hrs.

56
8. Collect margin of 50,000 & multiple with 10,000.
NOTE:- PAN is compulsory if the transaction cost exceed Rs.1 Lakh.
9. Issuing the “Know your client” form is must.
For Continuing Membership-Trading Member
Fulfill the following documents
1. Audited two important financial statement (profit & loss account, balance sheet)
2. Net worth certificate (certificate by CA)
3. Details of Directors, Share holders (certificate by CA)
4. Renewal insurance covering proof.
NSCCL CHARGED PENAL CHARGES (PENALTY POINTS)
TO MEMBERS (CAUSING FOLLOWING FAILURES)
1. Failure to funds obligations
2. Failure to security delivery obligation
3. Gross exposure turnover violations
4. Margin shortages
5. Security deposit shortage
6. Client code modification & non confirmation of custodial trades.
NOTE:- Penalty points charged on calendar month basis.
Maintaining & Preserving Books of Accounts by Trading Member
1. Up to 5yrs, must be maintaining these books, by trading member.
Registrar of transaction (Soudha Book).
Client ledger.
General Ledger
Journal
Cash Book
Bank Pass Book
Document Register (particular of Securities received & delivered)
2. Up to 2yrs, must be maintaining these books, by trading member.
Member contract book.
Counter foils of contract notes
Return consent of clients (at the time order place).

57
SUB-BROKER
1. Eligibility:- 21 years, 10+2 qualification and paid up capital 5 Lakhs.
2. Not convicted involving fraud and dishonesty.
3. Not debarred by SEBI previously.
4. 51% of shares as dominant promoters his/her and his/her spouse.
5. First application to stock exchange-stock exchange send his application to SEBI-SEBI
satisfied issued certificate Registration.
6. A registered sub-broker, holding registration, granted by SEBI on the Recommendations of
a trading member, can transact through the member (broker) who had recommend his
application for registration.
7. Maximum Brokerage Commission 1.5%
8. Purchase note and sales note issued by the sub broker with 24 hours.

Investor Protection Fund

1. Investor protection fund setup under Bombay public trust Act 1950.
2. IPF maintained by NSE Exact mane of this fund is NSE Investors Protection Fund Trust.
3. Any Member defaulter the IPF paid maximum 10 Lakhs only to each investor.
4. Client against default member, customer have right to apply within 3 months from the date
of publishing notice by a widely circulated minimum one daily News paper.

Demat of the Shares

1. Agreement with depository by security holder (at the time opening the demat account)
2. Surrender the security certificates to “issuer” (company) for cancellation.
3. Issuer (company) informs the “depository” about the transfer of the shares.
4. Participant (company) informs the “depository” about the transfer of the shares.
5. “Depository” records the “transferee” name as “beneficial owner” in “book entry form” in
his records.
6. Each custodian/clearing member is requiring maintaining a clear pool account with
depositaries.
7. The investor has no restriction and has full right to open many (number of) depository
accounts.

58
8. Shares or securities are transferred from one account to another account only on the
instruction of the beneficial owner.
ISIN(International Securities Identification Number)

Any company going to foe dematerialized with shares that company get this ISIN for
demat shares.
ISIN is assigned by SEBI
ISIN is allotted by NSDL.
Main Objectives of Demat Trading
1. Freely transferability
2. Dematerialized in depository mode
3. Maintenance of ownership records in book entry form

Short term capital (according to the Income Tax Act 1961)

1. Not more than 36 months immediately proceeding the date of its transfer for any asset.
2. Not more than 12 months immediately proceeding the date of its transfer for any security
UTI units and mutual fund units.
3. No Tax per long term capital gains (after 1yr) (10%)

Risk in Settlement
1. Counter party Risk:
Replacement cost risk-short/long covering risk
Principle risk-counter party default
Liquidity risk-failure of the settlement of the transaction
Third party risk-failure of the clearing of the settlement by clearing bank.
2. System risk:
Operation risk-arise by error, fraud out ages
Legal risk-law does not support the settlement
Systematic risk-failure of the one party leads to failure of the other parties.

59
CORPORATE HIERARCHY

Corporate Manager

Branch Manager

Dealer (user)

Corporate Manager:
He has the right to see all branches and dealers out standing orders, previous traders, net
positions & end of day reports to set branch order limits.

Branch Manager:
He has the right to see all branches and dealers out standing orders, previous traders, net
positions & end of day reports to set branch order limits.
Dealers (user):
He has the right to perform orders & trading activities.

ELIGIBILITY CRITERIA OF CLEARING MEMBER

(Clearing member means a member in NSCCL)
Net worth : 300 Lakhs
Interest free security
Deposits : 34 Lakhs
Collateral Security
Deposits : 50 Lakhs
Annual Subscription (min) : 2.5 Lakhs
NOTE:
1. Net worth must include minimum liquid net worth 50 Lakhs
2. Liquid net worth means cash, deposits, B.G, T-BILL, Government Securities, and
dematerialized Shares.

60
CLEARING MEMBERS FUNCTIONS
 Enquiry of trade
 Confirmation of trade
 Clearing & settlement

NSCCL & CLEARING BANK

1) Clearing Members are three types
a) Trading Member cum Clearing Member:
A clearing member who is also a trading member such clearing members may clear & settle
their own proprietary trades, their client’s trades as well as trades other trading members.

b) Clearing Member (or) self Clearing Member:

A clearing member who is also a trading member, such clearing member may clear and settle
only their own proprietary trades and their clients trades but cannot clear and settle trades of
other trading members.

c) Professional Clearing Member:

1) Clearing member is not a trading member such clearing member clear and settles other
trading member’s transactions.
Ex: Individuals, Institutions
2) Clearing members must be members in NSCCL.
3) Settlement guarantees fund capital deposited by members in NSCCL.
4) Clearing and the settlement guarantees is settled by NSCCL.
5) Initial Margin charged by NSCCL.
6) Every clearing member must open a separate account in clearing bank with NSCCL.
7) Funds settle by clearing bank through cash.
8) Each clearing member (custodian) maintains a clear pool account with depositories (NSDL
& CDSL) by prescribed pay-in-time for security is required.

61
TYPES OF ORDERS :
1) Day order:
System cancels the order automatically at the end of day
2) GTC (Good till Cancel):
Order cancels from the system at the end of the day of the expiry date period
3) GTD (Good till Date):
This order stays in the system up to specify the number of days (Not Exceed).
4) IOC (Immediate or Cancel):
When an order enters in the system, it is searching for the matching. If matching is not traced
the order immediately cancelled.
5) Stop Loss Order:
An order which is activated when a price crosses a limit is called stop loss order.
Long Orders Short Order
Spot Rs.100/- Spot Rs.100/- Trigger Rs.95/-(Buy)
Trigger Rs.105/-(Sell)
Limit price Rs.93/-sell Limit price Rs.108 buy
(Stop Loss Order) (Stop Loss Order)

Settlement Basis
T = Trading day
Cash Market T+2
F&O Market T+1
Note: stock option final settlement only is T+3
Final settlement of future and option contract takes at the closing price of the underlying asset.
ODD LOT MARKET RETAIL DEBT MARKET
Market Type O Face Value Rs.100/-
Book Type OL Lot size 10
Only physical shares trade Ticker size Rs.0.01
Order quantity not exceed
500 shares Market Type D
Settlement Trade to Trade (T) Book Type RD

62
 Operating Range± 5%

MARKET WATCH WINDOW SHOW THE CORPORATE

ACTIONS WITH THE FOLLOWING INDICATORS
XB Ex-Dividend
XB Ex-Bonus
XI Ex-Interest
XR Ex-Rights
CD Cum-dividend
CB Cum-Bonus
CI Cum-Interest
CR Cum-Rights
“X” in case more than one of XD, XB, XI, XR
“c” in case more than one of CD, CB, CI, CR

63
 CHAPTER-III
INDUSTRY PROFILE
&
COMPANY PROFILE

64
 INDUSTRY PROFILE

Stocks that respond to interest rate moves, coupled with select debt schemes, are likely to be
the winners in 2015, with the Reserve Bank of India expected to start easing its monetary
policy.

Fund managers said economic prospects have improved, but the New Year may be tougher for
equity investors to make money as valuations of many stocks are rich after the broad-based
rally in 2014. Concern over interest rate hike in the US and weak global crude oil prices may
also keep investors on.

India is among the top-performing emerging markets in 2014. So far in 2014, the Sensex has
gained 34%. Smaller companies have fared even better, with the BSE Mid Cap index surging
56% and the BSE Small Cap Index jumping 75%.

Though the falling crude prices have improved the prospects of the Indian economy, India
may not be spared if there is an emerging market sell-off. "On the global front, oil exporting
nations could face problems, and there could be a global risk aversion.

Market participants consider probable interest rate cuts by the Reserve Bank of India (RBI) as
the biggest trigger for the economy and the markets. The extent of monetary policy easing
would determine the strength of rally in shares of the so-called interest rate-sensitive sectors
such as banks, auto, real estate and bonds.

Fund managers said debt funds could offer good returns in the coming year as a fall in interest
rates could lead to an appreciation in bond prices. With wholesale price inflation coming at nil
for November, expectations of interest rate cuts as early as in the March quarter are high.
"Shortterm rates can fall more than long-term rates. We expect consumer inflation to be in the
range of 5-5.5%, and expect RBI to cut interest rates by 50 basis points in 2015," said Dhawal
Dalal, executive V-P and head (fixed income), DSP BlackRock Mutual Fund. If interest rates
fall by 50 basis points, investors could see a 5% capital appreciation on their long-term gilt
fund portfolio.

65
Measured by BSE Sensex, stock market has generated a positive return of about 9 per cent for
investors in 2013, while gold prices fell by about three per cent and its poorer cousin silver
plummeted close to 24 per cent.

After outperforming stock market for more than a decade, gold has been on back foot for two
consecutive years now vis-a-vis equities, shows an analysis of their price movements.

"Gold's under-performance was mainly due to prices falling in dollar terms amid anticipated
tapering over last several months combined with FII investment in Indian stocks.
"This movement has been equally true for global markets as 2013 saw gold losing its shine
and markets coming back with a bang," said Jayant Manglik, President Retail Distribution,
Religare Securities.

"As always, gold and stock prices follow opposite trends and this year was no different except
that both changed direction," he said.

Improvement in the world economy has brought the risk appetite back amongst retail investors
and this has drenched the liquidity from safe havens such as gold leading to its under-
performance, an expert said.
In 2012, the Sensex had gained over 25 per cent, which was nearly double the gain of about
12.95 per cent in gold. The appreciation in silver was at about 12.84 per last year.
According to Hiren Dhakan, Associate Fund Manager, Bonanza Portfolio, "Markets have
particularly shown great strength post July-August 2013 when RBI took some strong
measures to control the steeply depreciating rupee."
"When the US Fed gave indications that it might taper its stimulus programme given the
economy shows improvement, a knee-jerk correction was seen in most risky assets, including
stocks in Indian markets. However, assurance by the Fed about planned and staggered
tapering in stimulus once again proved to be a catalyst for the markets."

"External factors affecting Indian stocks seem to be negative for the first half of 2014 due to
continued strength of the US dollar and benign in the second half. By that time, elections too
would have taken place. A combination of domestic and international factors point to a
bumper closing of Indian markets in 2014 with double-digit percentage growth," he said.

66
Stock market segment mid-cap and small-cap indices have fallen by about 10 per cent and 16
per cent, respectively, in 2013.
Foreign Institutional Investors have bought shares worth over Rs 1.1 lakh crore (nearly USD
20 billion) till December 19. In 2012, they had pumped in Rs 1.28 lakh crore (USD 24.37
billion).

Evolution

Indian Stock Markets are one of the oldest in Asia. Its history dates back to nearly 200 years
ago. The earliest records of security dealings in India are meager and obscure. The East India
Company was the dominant institution in those days and business in its loan securities used to
be transacted towards the close of the eighteenth century.

By 1830's business on corporate stocks and shares in Bank and Cotton presses took place in
Bombay. Though the trading list was broader in 1839, there were only half a dozen brokers
recognized by banks and merchants during 1840 and 1850.

The 1850's witnessed a rapid development of commercial enterprise and brokerage business
attracted many men into the field and by 1860 the number of brokers increased into 60.

In 1860-61 the American Civil War broke out and cotton supply from United States of Europe
was stopped; thus, the 'Share Mania' in India begun. The number of brokers increased to about
200 to 250. However, at the end of the American Civil War, in 1865, a disastrous slump began
(for example, Bank of Bombay Share which had touched Rs 2850 could only be sold at Rs.
87).

At the end of the American Civil War, the brokers who thrived out of Civil War in 1874,
found a place in a street (now appropriately called as Dalal Street) where they would
conveniently assemble and transact business. In 1887, they formally established in Bombay,
the "Native Share and Stock Brokers' Association" (which is alternatively known as " The
Stock Exchange "). In 1895, the Stock Exchange acquired a premise in the same street and it
was inaugurated in 1899. Thus, the Stock Exchange at Bombay was consolidated.

67
Other leading cities in stock market operations

Ahmadabad gained importance next to Bombay with respect to cotton textile industry. After
1880, many mills originated from Ahmadabad and rapidly forged ahead. As new mills were
floated, the need for a Stock Exchange at Ahmadabad was realized and in 1894 the brokers
formed "The Ahmadabad Share and Stock Brokers' Association".

What the cotton textile industry was to Bombay and Ahmadabad, the jute industry was to
Calcutta. Also tea and coal industries were the other major industrial groups in Calcutta. After
the Share Mania in 1861-65, in the 1870's there was a sharp boom in jute shares, which was
followed by a boom in tea shares in the 1880's and 1890's; and a coal boom between 1904 and
1908. On June 1908, some leading brokers formed "The Calcutta Stock Exchange
Association".

In the beginning of the twentieth century, the industrial revolution was on the way in India
with the Swadeshi Movement; and with the inauguration of the Tata Iron and Steel Company
Limited in 1907, an important stage in industrial advancement under Indian enterprise was
reached.

Indian cotton and jute textiles, steel, sugar, paper and flour mills and all companies generally
enjoyed phenomenal prosperity, due to the First World War.

In 1920, the then demure city of Madras had the maiden thrill of a stock exchange functioning
in its midst, under the name and style of "The Madras Stock Exchange" with 100 members.
However, when boom faded, the number of members stood reduced from 100 to 3, by 1923,
and so it went out of existence.

In 1935, the stock market activity improved, especially in South India where there was a rapid
increase in the number of textile mills and many plantation companies were floated. In 1937, a
stock exchange was once again organized in Madras - Madras Stock Exchange Association
(Pvt) Limited. (In 1957 the name was changed to Madras Stock Exchange Limited).

68
Lahore Stock Exchange was formed in 1934 and it had a brief life. It was merged with the
Punjab Stock Exchange Limited, which was incorporated in 1936.

Indian Stock Exchanges - An Umbrella Growth

The Second World War broke out in 1939. It gave a sharp boom which was followed by a
slump. But, in 1943, the situation changed radically, when India was fully mobilized as a
supply base.

On account of the restrictive controls on cotton, bullion, seeds and other commodities, those
dealing in them found in the stock market as the only outlet for their activities. They were
anxious to join the trade and their number was swelled by numerous others. Many new
associations were constituted for the purpose and Stock Exchanges in all parts of the country
were floated.

The Uttar Pradesh Stock Exchange Limited (1940), Nagpur Stock Exchange Limited (1940)
and Hyderabad Stock Exchange Limited (1944) were incorporated.

In Delhi two stock exchanges - Delhi Stock and Share Brokers' Association Limited and the
Delhi Stocks and Shares Exchange Limited - were floated and later in June 1947,
amalgamated into the Delhi Stock Exchnage Association Limited.

Post-independence Scenario

Most of the exchanges suffered almost a total eclipse during depression. Lahore Exchange
was closed during partition of the country and later migrated to Delhi and merged with Delhi
Stock Exchange.

Bangalore Stock Exchange Limited was registered in 1957 and recognized in 1963.

Most of the other exchanges languished till 1957 when they applied to the Central
Government for recognition under the Securities Contracts (Regulation) Act, 1956. Only
Bombay, Calcutta, Madras, Ahmadabad, Delhi, Hyderabad and Indore, the well established
exchanges, were recognized under the Act. Some of the members of the other Associations

69
were required to be admitted by the recognized stock exchanges on a concessional basis, but
acting on the principle of unitary control, all these pseudo stock exchanges were refused
recognition by the Government of India and they thereupon ceased to function.

Thus, during early sixties there were eight recognized stock exchanges in India (mentioned
above). The number virtually remained unchanged, for nearly two decades. During eighties,
however, many stock exchanges were established: Cochin Stock Exchange (1980), Uttar
Pradesh Stock Exchange Association Limited (at Kanpur, 1982), and 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) and recently
established exchanges - Coimbatore and Meerut. Thus, at present, there are totally twenty one
recognized stock exchanges in India excluding the Over The Counter Exchange of India
Limited (OTCEI) and the National Stock Exchange of India Limited (NSEIL).

The Table given below portrays the overall growth pattern of Indian stock markets since
independence. It is quite evident from the Table that Indian stock markets have not only
grown just in number of exchanges, but also in number of listed companies and in capital of
listed companies. The remarkable growth after 1985 can be clearly seen from the Table, and
this was due to the favouring government policies towards security market industry.

Trading Pattern of the Indian Stock Market

Trading in Indian stock exchanges are limited to listed securities of public limited companies.
They are broadly divided into two categories, namely, specified securities (forward list) and
non-specified securities (cash list). Equity shares of dividend paying, growth-oriented
companies with a paid-up capital of atleast Rs.50 million and a market capitalization of atleast
Rs.100 million and having more than 20,000 shareholders are, normally, put in the specified
group and the balance in non-specified group.

70
Two types of transactions can be carried out on the Indian stock exchanges: (a) spot delivery
transactions "for delivery and payment within the time or on the date stipulated when entering
into the contract which shall not be more than 14 days following the date of the contract" : and
(b) forward transactions "delivery and payment can be extended by further period of 14 days
each so that the overall period does not exceed 90 days from the date of the contract". The
latter is permitted only in the case of specified shares. The brokers who carry over the
outstandings pay carry over charges (cantango or backwardation) which are usually
determined by the rates of interest prevailing.

A member broker in an Indian stock exchange can act as an agent, buy and sell securities for
his clients on a commission basis and also can act as a trader or dealer as a principal, buy and
sell securities on his own account and risk, in contrast with the practice prevailing on New
York and London Stock Exchanges, where a member can act as a jobber or a broker only.

The nature of trading on Indian Stock Exchanges are that of age old conventional style of
face-to-face trading with bids and offers being made by open outcry. However, there is a great
amount of effort to modernize the Indian stock exchanges in the very recent times.

Over The Counter Exchange of India (OTCEI)

The traditional trading mechanism prevailed in the Indian stock markets gave way to many
functional inefficiencies, such as, absence of liquidity, lack of transparency, unduly long
settlement periods and benami transactions, which affected the small investors to a great
extent. To provide improved services to investors, the country's first ringless, scripless,
electronic stock exchange - OTCEI - was created in 1992 by country's premier financial
institutions - Unit Trust of India, Industrial Credit and Investment Corporation of India,
Industrial Development Bank of India, SBI Capital Markets, Industrial Finance Corporation of
India, General Insurance Corporation and its subsidiaries and CanBank Financial Services.

Trading at OTCEI is done over the centres spread across the country. Securities traded on the
OTCEI are classified into:

71
  Listed Securities - The shares and debentures of the companies listed on the OTC can
be bought or sold at any OTC counter all over the country and they should not be listed
anywhere else

 Permitted Securities - Certain shares and debentures listed on other exchanges and
units of mutual funds are allowed to be traded

 Initiated debentures - Any equity holding atleast one lakh debentures of a particular
scrip can offer them for trading on the OTC.

OTC has a unique feature of trading compared to other traditional exchanges. That is,
certificates of listed securities and initiated debentures are not traded at OTC. The original
certificate will be safely with the custodian. But, a counter receipt is generated out at the
counter which substitutes the share certificate and is used for all transactions.

In the case of permitted securities, the system is similar to a traditional stock exchange. The
difference is that the delivery and payment procedure will be completed within 14 days.

Compared to the traditional Exchanges, OTC Exchange network has the following
advantages:

 OTCEI has widely dispersed trading mechanism across the country which provides
greater liquidity and lesser risk of intermediary charges.

 Greater transparency and accuracy of prices is obtained due to the screen-based scrip
less trading.

 Since the exact price of the transaction is shown on the computer screen, the investor
gets to know the exact price at which s/he is trading.

 Faster settlement and transfer process compared to other exchanges.

72
  In the case of an OTC issue (new issue), the allotment procedure is completed in a
month and trading commences after a month of the issue closure, whereas it takes a
longer period for the same with respect to other exchanges.

Thus, with the superior trading mechanism coupled with information transparency investors
are gradually becoming aware of the manifold advantages of the OTCEI.

National Stock Exchange (NSE)

With the liberalization of the Indian economy, it was found inevitable 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.

Trading at NSE can be classified under two broad categories:

(a) Wholesale debt market and

(b) Capital market.

Wholesale debt market operations are similar to money market operations - institutions and
corporate bodies enter into high value transactions in financial instruments such as
government securities, treasury bills, public sector unit bonds, commercial paper, certificate of
deposit, etc.

There are two kinds of players in NSE:

(a) Trading members and

(b) Participants.

73
Recognized members of NSE are called trading members who trade on behalf of themselves
and their clients. Participants include trading members and large players like banks who take
direct settlement responsibility.

Trading at NSE takes place through a fully automated screen-based trading mechanism which
adopts the principle of an order-driven market. Trading members can stay at their offices and
execute the trading, since they are linked through a communication network. 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 and a confirmation slip will be printed at the office of
the trading member.

NSE has several advantages over the traditional trading exchanges. They are as follows:

 NSE brings an integrated stock market trading network across the nation.

 Investors can trade at the same price from anywhere in the country since inter-market
operations are streamlined coupled with the countrywide access to the securities.

 Delays in communication, late payments and the malpractice’s prevailing in the

traditional trading mechanism can be done away with greater operational efficiency
and informational transparency in the stock market operations, with the support of total
computerized network.

Unless stock markets provide professionalized service, small investors and foreign investors
will not be interested in capital market operations. And capital market being one of the major
source of long-term finance for industrial projects, India cannot afford to damage the capital
market path. In this regard NSE gains vital importance in the Indian capital market system.

Preamble

Often, in the economic literature we find the terms ‘development’ and ‘growth’ are used
interchangeably. However, there is a difference. Economic growth refers to the sustained
increase in per capita or total income, while the term economic development implies sustained
structural change, including all the complex effects of economic growth. In other words,

74
growth is associated with free enterprise, where as development requires some sort of control
and regulation of the forces affecting development. Thus, economic development is a process
and growth is a phenomenon.

Economic planning is very critical for a nation, especially a developing country like India to
take the country in the path of economic development to attain economic growth.

Why Economic Planning for India?

One of the major objective of planning in India is to increase the rate of economic
development, implying that increasing the rate of capital formation by raising the levels of
income, saving and investment. However, increasing the rate of capital formation in India is
beset with a number of difficulties. People are poverty ridden. Their capacity to save is
extremely low due to low levels of income and high propensity to consume. Therefor, the rate
of investment is low which leads to capital deficiency and low productivity. Low productivity
means low income and the vicious circle continues. Thus, to break this vicious economic
circle, planning is inevitable for India.

The market mechanism works imperfectly in developing nations due to the ignorance and
unfamiliarity with it. Therefore, to improve and strengthen market mechanism planning is
very vital. In India, a large portion of the economy is non-monetized; the product, factors of
production, money and capital markets is not organized properly. Thus the prevailing price
mechanism fails to bring about adjustments between aggregate demand and supply of goods
and services. Thus, to improve the economy, market imperfections has to be removed;
available resources has to be mobilized and utilized efficiently; and structural rigidities has to
be overcome. These can be attained only through planning.

In India, capital is scarce; and unemployment and disguised unemployment is prevalent. Thus,
where capital was being scarce and labour being abundant, providing useful employment
opportunities to an increasing labour force is a difficult exercise. Only a centralized planning
model can solve this macro problem of India.

75
Further, in a country like India where agricultural dependence is very high, one cannot ignore
this segment in the process of economic development. Therefore, an economic development
model has to consider a balanced approach to link both agriculture and industry and lead for a
paralleled growth. Not to mention, both agriculture and industry cannot develop without
adequate infrastructural facilities which only the state can provide and this is possible only
through a well carved out planning strategy. The government’s role in providing infrastructure
is unavoidable due to the fact that the role of private sector in infrastructural development of
India is very minimal since these infrastructure projects are considered as unprofitable by the
private sector.

Further, India is a clear case of income disparity. Thus, it is the duty of the state to reduce the
prevailing income inequalities. This is possible only through planning.

Planning History of India

The development of planning in India began prior to the first Five Year Plan of independent
India, long before independence even. The idea of central directions of resources to overcome
persistent poverty gradually, because one of the main policies advocated by nationalists early
in the century. The Congress Party worked out a program for economic advancement during
the 1920’s, and 1930’s and by the 1938 they formed a National Planning Committee under the
chairmanship of future Prime Minister Nehru. The Committee had little time to do anything
but prepare programs and reports before the Second World War which put an end to it. But it
was already more than an academic exercise remote from administration. Provisional
government had been elected in 1938, and the Congress Party leaders held positions of
responsibility. After the war, the Interim government of the pre-independence years appointed
an Advisory Planning Board. The Board produced a number of somewhat disconnected Plans
itself. But, more important in the long run, it recommended the appointment of a Planning
Commission.

The Planning Commission did not start work properly until 1950. During the first three years
of independent India, the state and economy scarcely had a stable structure at all, while
millions of refugees crossed the newly established borders of India and Pakistan, and while

76
ex-princely states (over 500 of them) were being merged into India or Pakistan. The Planning
Commission as it now exists was not set up until the new India had adopted its Constitution in
January 1950.

Objectives of Indian Planning

The Planning Commission was set up the following Directive principles:

 To make an assessment of the material, capital and human resources of the country,
including technical personnel, and investigate the possibilities of augmenting such of
these resources as are found to be deficient in relation to the nation’s requirement.

 To formulate a plan for the most effective and balanced use of the country’s resources.

 Having determined the priorities, to define the stages in which the plan should be
carried out, and propose the allocation of resources for the completion of each stage.

 To indicate the factors which are tending to retard economic development, and
determine the conditions which, in view of the current social and political situation,
should be established for the successful execution of the Plan.

 To determine the nature of the machinery this will be necessary for securing the
successful implementation of each stage of Plan in all its aspects.

 To appraise from time to time the progress achieved in the execution of each stage of
the Plan and recommend the adjustments of policy and measures that such appraisals
may show to be necessary.

 To make such interim or auxiliary recommendations as appear to it to be appropriate

either for facilitating the discharge of the duties assigned to it or on a consideration of
the prevailing economic conditions, current policies, measures and development
programs; or on an examination of such specific problems as may be referred to it for
advice by Central or State Governments.

77
The long-term general objectives of Indian Planning are as follows:

 Increasing National Income

 Reducing inequalities in the distribution of income and wealth

 Elimination of poverty

 Providing additional employment; and

 Alleviating bottlenecks in the areas of : agricultural production, manufacturing

capacity for producer’s goods and balance of payments.

Economic growth, as the primary objective has remained in focus in all Five Year Plans.
Approximately, economic growth has been targeted at a rate of five per cent per annum. High
priority to economic growth in Indian Plans looks very much justified in view of long period
of stagnation during the British rule

78
 COMPANY PROFILE
INTRODUCTION TO INDIABULLS

Indiabulls Group has a net worth of over ₹ 22,608 crore and the market capitalization stands at
over ₹ 75,838 crore (As on 31st March 2018). Indiabulls Housing Finance Ltd. (IBHFL), the
group’s flagship company is the 2nd largest housing finance company in India. It is Rated
‘AAA’ by all credit agencies and is a part of the NIFTY50 index.

Recently it has been ranked the 13th largest Consumer Financial Services company globally
by Forbes Global 2000. Indiabulls Group has a strong presence in important sectors like
financial services, real estate, pharmaceuticals & LED through independent companies. The
group continues its journey of building businesses with strong cash flows.

MILESTONES

1999

 Sameer Gehlaut started the 1st online platform by brokerage service

2000

 Indiabulls Financial Services was established as the flagship company Indiabulls

Securities started offering brokerage services both online and offline
2004

 Indiabulls Financial Services went public

 Raised 52 Crores through IPO
 IBFSL started its lending business
2005

 Indiabulls Properties Pvt. Ltd was established

 Won the auction on a defunct 11/14 acres mill in Lower Parel
2008

 IBFSL was rated AA+

 IBFSL Loan Assets crossed over 10000 Cr

79
2011

 IBFSL rating upgraded to AA

 IBFSL crossed 20000 Cr
 IBREL purchased Indiabulls BluLand
 Group PAT crosses 1000 Cr
2012

 IBFSL rated as AA+

 IBFSL crossed 30000 Cr
2013

 IBFSL demerged into IBHFL

 Group PAT crossed 1500 Cr
2015

 Net Worth was more than 19500 Cr

 Group PAT crossed 2300 Cr
 IBHFL upgraded to AAA
 IBHFL Gross disbursements crossed 1,00,000 Cr
 Gross dividend crossed 5600 Cr
2016

 Net Worth was more than 19800 Cr

 Group PAT crossed 2700 Cr
 IBHFL raised 4000 Cr through QIP
2017

 Group PAT crossed 3355 Cr

 IBHFL included in NIFTY50
 IBHFL Balance Sheet crosses over Rs. 1.07 Trillion

2018

80
  IBHFL – servicing 1 million happy customers
 IBHFL ranked as the 13th largest consumer financial services globally by Forbes 2000
global.

FOUNDER & CHAIRMAN

Sameer Gehlaut

CHAIRMAN, INDIABULLS GROUP

Sameer Gehlaut, the founder of Indiabulls Group, started the

Indiabulls journey after working briefly with Halliburton. Under
his leadership, the Indiabulls Group has grown in scale and size
to a flourishing business house with strong presence in various
sectors.

With an educational background in Mechanical Engineering from IIT Delhi, he is constantly

motivated to innovate through his businesses and contribute to the future of Modern India.

BOARD OF DIRECTORS

INDIABULLS HOUSING FINANCE LIMITED

Mr. Sameer Gehlaut - Founder & Executive Chairman

Mr. Gagan Banga - Vice Chairman & MD

Mr. Ashwini Omprakash Kumar - Deputy Managing Director

Mr. Ajit Kumar Mittal - Executive Director

Mr. Sachin Chaudhary - Chief Operating Officer & Whole-time Director

Mr. Majari Ashok Kacker - Director

Justice Gyan Sudha Misra - Independent Director

Justice Bisheshwar Prasad Singh - Independent Director

81
Dr. Kamlesh Chakrabarty - Independent Director

Mr. Shamsher Singh Ahlawat - Independent Director

Mr. Prem Prakash Mirdha - Independent Director

Brig. Labh Singh Sitara - Independent Director

INDIABULLS REAL ESTATE LIMITED

Mr. Sameer Gehlaut - Founder & Chairman

Mr. Narendra Gehlaut - Executive Vice Chairman

Mr. Gurbans Singh - Joint MD

Mr. Vishal Damani - Joint MD

Justice Gyan Sudha Misra - Independent Director

Justice Bisheshwar Prasad Singh- Independent Director

Mr. Shamsher Singh Ahlawat- Independent Director

Brig. Labh Singh Sitara - Independent Director

INDIABULLS VENTURES LIMITED

Mr. Sameer Gehlaut - Founder & Chairman

Mr. Gagan Banga - Non-Executive Director

Mr. Divyesh Shah - Executive Director & CEO

Mrs. Vijayalakshmi Rajaram Iyer Independent Director

Mr. Shyam Lal Bansal - Independent Director

Mr. Alok Kumar Misra - Independent Director

82
Brig. Labh Singh Sitara - Independent Director

Justice Bisheshwar Prasad Singh Independent Director

Dr. Kamlesh Chakrabarty - Independent Director

Mr. Shamsher Singh Ahlawat- Independent Director

Mr. Prem Prakash Mirdha - Independent Director

Brig. Labh Singh Sitara - Independent Director

OUR BUSINESSES

1. INDIABULLS HOME LOANS

2. INDIABULLS PERSONAL LOANS
3. INDIABULLS LOAN AGAINST PROPERTY
4. INDIABULLS BUSINESS LOANS
5. INDIABULLS ASSET MANAGEMENT
6. INDIABULLS VENTURES
7. INDIABULLS REAL ESTATE
8. INDIABULLS PHARMACEUTICALS
9. INDIABULLS LED

INDIABULLS HOME LOANS : Getting housing loans has never been this simple and
hassle-free. We guide you through the tedious process of property selection, checking of
approvals, documentation, and selection of the EMI tenure that suits you best, making it a
whole lot easier on you.

INDIABULLS PERSONAL LOANS : We strongly believe that dreams are meant to be

achieved and financial feasibility should not be an obstacle to it. Hence, we have created one
of the fastest ways for you to get a personal loan.

83
INDIABULLS LOAN AGAINST PROPERTY : We understand that your goals and
business need your complete attention which is why Loan Against Property is an ideal
financial support in reaching these goals.

INDIABULLS BUSINESS LOANS : With IVL Finance Limited’s business loans, funding
your small business has become so much easier. Get funds to invest in infrastructure, upgrade
to the latest plant and machinery, expand operations, increase working capital and maintain
inventory.

INDIABULLS VENTURES : Shubh by Indiabulls is the next generation trading app built to
help you take charge of your financial future on the go. This app is built with the idea of
helping every investor and trader with effective information to make wise decisions and earn
more profits.

INDIABULLS REAL ESTATE : Indiabulls Real Estate represents excellence and luxury in
residential and commercial properties. Incorporated in 2006, Indiabulls Real Estate focusses
on construction and development of residential, commercial and SEZ projects across major
Indian metros. With an ambition to create its global footprint, Indiabulls branched out to
London a couple of years ago with impressive projects in the heart of upscale central London.

INDIABULLS PHARMACEUTICALS : Indiabulls pharmaceuticals business’ aspiration is

to be a leading patient and physician centric, best in class, innovative healthcare company.
Our segments span both products and services and across prescription and consumer
healthcare markets.

INDIABULLS LED : Continuing Indiabulls' desire of constant reinvention, Indiabulls Group

introduces IB LED professional lighting for offices, malls, showrooms, factories, industries
and housing facilities.

INDIABULLS ASSET MANAGEMENT : Indiabulls Mutual Fund is a SEBI registered

Mutual Fund of India (Regn. No. MF/068/11/03). Indiabulls Mutual Fund has been
established as a Trust with Indiabulls Housing Finance Limited as its Sponsor and Indiabulls
Trustee Company Ltd as its Trustee.

84
Indiabulls Housing Finance Limited is one of India’s leading and fastest growing private
sector financial services companies providing Consumer Finance, Housing Finance,
Commercial Loans, Asset Management and Advisory services. The company is focused on
providing multiple financial services through an extensive network of consumer touch-points.
Indiabulls serves more than 9,20,000 customers across different financial products through its
branch network, call centre & the internet. It also ranks among the top private sector financial
services groups in terms of net worth.

MISSION

In keeping with our philosophy of creating value for our investors, we shall strive to achieve
the fine balance between safety, liquidity and return in the most ethical and transparent
manner. While maximizing our unit holders’ wealth by a judicious use of risk-reward
paradigm, we hope to enjoy the complete trust and confidence of our investors and emerge as
a “fund house of choice.”

PRODUCTS

Indiabulls Liquid Fund

 Investment Objective
 Indiabulls Ultra Short Term Fund
 Indiabulls Short Term Fund
 Indiabulls Income Fund
 Indiabulls Gilt Fund
 Indiabulls Savings Income Fund
 Indiabulls Blue Chip Fund
 Indiabulls Arbitrage Fund
 Indiabulls Value Discovery Fund
 Indiabulls Tax Savings Fund

85
 CHAPTER - IV

DATA ANALYSIS AND

INTERPRETATION

86
 DATA ANALYSIS

HDFC BANK FUTURES & OPTIONS

DATE PRICE CALL OPTION

SPOT FUTURE 900 930 960

SEP- 21- 2018 922.75 921.85 100.05 85.75 73.10

SEP-24-2018 898.85 898.90 79.20 66.25 47.00

SEP-25-2018 885.90 885.15 68.40 56.25 45.85

SEP-26-2018 880.40 882.10 35.55 49.90 40.00

SEP-27-2018 911.95 914.60 54.90 62.35 50.45

SEP-28-2018 901.58 902.32 51.25 55.69 49.36

OCT-01-2018 898.00 902.55 46.00 45.10 34.50

OCT-02-2018 923.75 926.80 52.00 52.85 40.30

OCT-03-2018 918.55 918.10 60.00 46.55 34.55

OCT-04-2018 919.95 921.55 54.00 43.70 31.70

OCT-05-2018 944.25 946.85 60.10 49.50 35.05

OCT-08-2018 984.95 985.40 95.15 74.35 45.00

OCT-09-2018 1002.20 997.60 109.35 84.75 63.15

OCT-10-2018 1058.65 1062.05 125.00 133.10 106.55

OCT-11-2018 1052.10 1056.15 153.95 125.35 98.35

87
 OCT-12-2018 1018.50 1022.05 119.05 89.70 62.00

OCT-15-2018 979.80 981.55 112.60 51.20 26.25

OCT-16-2018 912.32 902.54 89.32 75.64 55.21

OCT-17-2018 101.50 103.00 153.95 125.35 98.35

OCT-18-2018 104.80 104.50 119.05 89.70 62.00

ANALYSIS

The Objective of this analysis is to evaluate the profit/loss position futures and options. This
analysis is based on sample data taken of HDFC BANK LIMITED scrip. This analysis
considered the December contract of HDFC Bank. The lot size of HDFC is 200, the time
period in which this analysis done is from 21-09-2018 to 18-10-2018.

DATE PRICE

FUTURE

SEP-21-2018 921.85

SEP-24-2018 898.90

SEP-25-2018 885.15

SEP-26-2018 882.10

SEP-27-2018 914.60

SEP-28-2018 902.32

OCT-01-2018 902.55

OCT-02-2018 926.80

88
 OCT-03-2018 918.10

OCT-04-2018 921.55

OCT-05-2018 946.85

OCT-08-2018 985.40

OCT-09-2018 997.60

OCT-10-2018 1062.05

OCT-11-2018 1056.15

OCT-12-2018 1022.05

OCT-15-2018 981.55

OCT-16-2018 984.20

OCT-17-2018 103.00

OCT-18-2018 104.50

1200

1000

800

600

400

200

0
Oct-03

Oct-12
DATE

Sep-24

Oct-01
Oct-02

Oct-04
Oct-05
Oct-08
Oct-09
Oct-10
Oct-11

Oct-15
Oct-16
Oct-17
Oct-18
Sep-21

Sep-25
Sep-26
Sep-27
Sep-28

89
FUTURE MARKET

BUYER SELLER

25/11/2017 (Buying) 921.85 921.85

24/12/2018 (Cl., period) 984.20 984.20

Profit 62.35 Loss 62.35

Profit 200 x 62.35=12470, Loss 200 x 62.35=12470

INTERPRETATION

Because buyer future price will increase so, he can get Profit. Seller future price also increase
so, loss also increase, Incase seller future will decrease, and he can get profit.

The closing price of HDFC Bank at the end of the contract period is 984.20 and this is
considered as settlement price.

 The first column explains TRADING DATE.

 Second Column explains the SPOT MARKET PRICE in cash segment on that date.

 The third column explains the FUTURE MARKET PRICE in cash segment on that date.

 The Fourth column explains call premiums amounting 900, 930, 960.

CALL PRICES

90
 HDFC BANK FUTURES & OPTIONS

DATE PRICE CALL OPTION

SPOT FUTURE 900 930 960

SEP- 21- 2018 922.75 921.85 100.05 85.75 73.10

SEP-24-2018 898.85 898.90 79.20 66.25 47.00

SEP-25-2018 885.90 885.15 68.40 56.25 45.85

SEP-26-2018 880.40 882.10 35.55 49.90 40.00

SEP-27-2018 911.95 914.60 54.90 62.35 50.45

SEP-28-2018 901.58 902.32 51.25 55.69 49.36

OCT-01-2018 898.00 902.55 46.00 45.10 34.50

OCT-02-2018 923.75 926.80 52.00 52.85 40.30

OCT-03-2018 918.55 918.10 60.00 46.55 34.55

OCT-04-2018 919.95 921.55 54.00 43.70 31.70

OCT-05-2018 944.25 946.85 60.10 49.50 35.05

OCT-08-2018 984.95 985.40 95.15 74.35 45.00

OCT-09-2018 TRADING HOLIDAY

OCT-10-2018 TRADING HOLIDAY

OCT-11-2018 1002.20 997.60 109.35 84.75 63.15

OCT-12-2018 1058.65 1062.05 125.00 133.10 106.55

OCT-15-2018 1052.10 1056.15 153.95 125.35 98.35

91
 OCT-16-2018 1018.50 1022.05 119.05 89.70 62.00

OCT-17-2018 979.80 981.55 112.60 51.20 26.25

OCT-18-2018 912.32 902.54 89.32 75.64 55.21

SEP-21-2018 101.50 103.00 153.95 125.35 98.35

SEP-24-2018 104.80 104.50 119.05 89.70 62.00

OBSERVATIONS AND FINDINGS

CALL OPTION:

BUYERS PAY OFF:

 As brought 1 lot of HDFC Bank that is 200, those who buy for 900, paid 100.05 Premium per
share.

 Settlement price is 984.20

Spot price 984.20

Strike price 900.00

Amount 84.20

Premium paid (-) 100.05

Net Loss 15.85 x 200 = -3170

Buyer Loss = Rs.3170 (Loss)

Because it is negative it is in the money contract, hence buyer will get more loss, incase spot price
decrease buyer loss also increase.

SELLERS PAY OFF:

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 It is in the money for the buyer, so it is in out of the money for seller; hence his profit is also
increase.

Strike price 900.00

Spot price 984.20

Amount +84.20

Premium Received 100.05

Net profit 15.85 x 200 = +3170

Seller Profit = Rs.3170 (Net Amount)

Because it is positive it is out of the money, hence seller will get more profit, incase spot price
increase in below strike price, seller get loss in premium level.

PUT PRICES

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 HDFC BANK FUTURES & OPTIONS

DATE PRICE CALL OPTION

SPOT FUTURE 900 930 960

SEP- 21- 2018 922.75 921.85 100.05 85.75 73.10

SEP-24-2018 898.85 898.90 79.20 66.25 47.00

SEP-25-2018 885.90 885.15 68.40 56.25 45.85

SEP-26-2018 880.40 882.10 35.55 49.90 40.00

SEP-27-2018 911.95 914.60 54.90 62.35 50.45

SEP-28-2018 901.58 902.32 51.25 55.69 49.36

OCT-01-2018 898.00 902.55 46.00 45.10 34.50

OCT-02-2018 923.75 926.80 52.00 52.85 40.30

OCT-03-2018 918.55 918.10 60.00 46.55 34.55

OCT-04-2018 919.95 921.55 54.00 43.70 31.70

OCT-05-2018 944.25 946.85 60.10 49.50 35.05

OCT-08-2018 984.95 985.40 95.15 74.35 45.00

OCT-09-2018 1002.20 997.60 109.35 84.75 63.15

OCT-10-2018 1058.65 1062.05 125.00 133.10 106.55

OCT-11-2018 1052.10 1056.15 153.95 125.35 98.35

OCT-12-2018 1018.50 1022.05 119.05 89.70 62.00

OCT-15-2018 979.80 981.55 112.60 51.20 26.25

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 OCT-16-2018 912.32 902.54 89.32 75.64 55.21

OCT-17-2018 101.50 103.00 153.95 125.35 98.35

OCT-18-2018 104.80 104.50 119.05 89.70 62.00

OBSERVATIONS AND FINDINGS

PUT OPTION:

BUYERS PAY OFF:

 Those who have purchase put option at a strike price of 900, the premium payable is 71.10

 On the expiry date the spot market price enclosed at 984.20

Strike price 900.00

Spot price 984.20

Net pay off 84.20

Premium Paid 71.10

Net profit 13.10 x 200 = 2620

Already, premium paid 71.10, so it can get profit is 2620

Because it is Positive, out of the money contract, hence buyer will get more profit, incase spot price
increase buyer get loss in premium level.

SELLERS PAY OFF:

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 As seller is entitled only for premium so, if he is in profit and also seller has to borne total
profit.

Spot price 984.20

Strike price 900.00

Amount -84.20

Premium Received 71.10

Net profit 13.10 x 200 = -2620

Already premium received 71.10 so, it can get loss is 2620

Because it is negative, in the money contract, Hence seller gets more loss, incase spot price increase
in above strike price seller can get profit in premium level.

DATA OF HDFC BANK – THE FUTURES & OPTIONS OF THE DECEMBER MONTH

DATE SPOT FUTURE

PRICE PRICE

Sep-21-2018 922.75 921.85

Sep-24-2018 898.85 898.9
Sep-25-2018 885.9 885.15
Sep-26-2018 880.4 882.1
Sep-27-2018 911.95 914.6
Sep-28-2018 890.3 889.8
Oct-01-2018 898 902.55
Oct-02-2018 923.75 926.8
Oct-03-2018 918.55 918.1
Oct-04-2018 919.95 921.55
Oct-05-2018 944.25 946.85

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 Oct-08-2018 984.95 985.4
Oct-09-2018 1002.2 997.6
Oct-10-2018 1058.65 1062.05
Oct-11-2018 1052.1 1056.15
Oct-12-2018 1018.5 1022.05
Oct-15-2018 979.8 981.55
Oct-16-2018 984.2 984.2
Oct-17-2018 153.95 125.35
Oct-18-2018 119.05 89.7

1200

1000

800

600
SPOT PRICE
400 FUTURE PRICE

200

0
Jan/01

Jan/04

Jan/07

Jan/10

Jan/13

Jan/16

Jan/19

Jan/22

Jan/25

Jan/28

OBSERVATIONS AND FINDINGS

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 The future price of M/S. HDFC Bank is moving along with the market price.

 If the buy price of the future is less than the settlement price, than the buyer of a future gets
profit.

 If the selling price of the future is less than the settlement price, than the seller incur losses.

Using Index Options

There are potentially innumerable ways of trading on the index options market. However we
shall look at eight basic modes of trading on the index futures market:

Hedging

H5 Have portfolio, buy puts

Speculation

S3 Bullish index, buy Nifty calls or sell Nifty puts

S4 Bearish index, sell Nifty calls or buy Nifty puts

S5 Anticipate volatility, buy a call and a put at same strike

S6 Bull spreads, Buy a call and sell another

S7 Bear spreads, Sell a call and buy another

Arbitrage

A3 Put-call parity with spot-options arbitrage

A4 Arbitrage beyond option price bounds1

H5: Have portfolio, buy puts

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Have you ever experienced the feeling of owning an equity portfolio, and then, one day,
becoming uncomfortable about the overall stock market?

Sometimes you may have a view that stock prices will fall in the near future. Many investors
simply do not want the fluctuations of these three weeks. One way to protect your portfolio
from potential downside due to a market drop is to buy portfolio insurance.

Index options is a cheap and easily implementable way of seeking this insurance. The idea is
simple. To protect the value of your portfolio from falling below a particular level, buy the
right number of put options with the right strike price. When the index falls your portfolio will
lose value and the put options bought by you will gain, effectively ensuring that the value of
your portfolio does not fall below a particular level. This level depends on the strike price of
the options chosen by you.

Portfolio insurance using put options is of particular interest to Mutual funds who already own
well-diversified portfolios. By buying puts, the fund can limit its downside in case of a market
fall.

How do we actually do this?

We need to know the “beta” of the portfolio. We look at two cases, case one where the
portfolio has a beta of 1 and case two where the portfolio beta is not equal to 1.

Portfolio insurance when portfolio beta is 1.0

1. Assume we have a well-diversified portfolio with a beta of 1.0, which we would like to
insure against a fall in the market.

2. Now we need to choose the strike at which we should buy puts. This is largely a function of
how safe we want to play. Assume that the spot Nifty is 1250 and you decide to buy puts with
a strike of 1125. This will insure your portfolio against an index fall lower than 1125.

3. When the portfolio beta is one, the number of puts to buy is simply equal to the portfolio
value divided by the spot index.

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Now let us look at the outcome. We have just bought two–month Nifty puts at a strike of
1125. This is designed to ensure that the value of our portfolio does not decline below Rs.0.90
million. (For a portfolio with a beta of 1, a 10% fall in the index directly translates into a 10%
fall in the portfolio value). During the two–month period, suppose the Nifty drops to 1080.
This is a 13.6% fall in the index. The portfolio value too falls at the same rate and declines to
Rs.0.864 million. However the options provide a payoff of (1125-1080)*4*200 which is equal
to Rs.36,000. This is the amount needed to bring the value of the portfolio back to Rs.0.90
million.

S3: Bullish index, buy Nifty calls or sell Nifty puts

Do you sometimes think that the market index is going to rise? That you could make a profit
by adopting a position on the index? How does one implement a trading strategy to benefit
from an upward movement in the index? Today, using options you have two choices:

1. Buy call options on the index; or,

2. Sell put options on the index

We have already seen the payoff of a call option. The downside to the buyer of the call option
is limited to the option premium he pays for buying the option. His upside however is
potentially unlimited.

Strategies formulated

The simplest starting point of a Strategy could be having a clear view about the market or a
scrip. There could be strategies of an advanced nature that are independent of views, but it
would be correct to say that most investors create strategies based on views.

There could be four simple views : bullish view, bearish view, volatile view and neutral view.
Bullish and bearish views are simple enough to comprehend. Volatile view is where you
believe that the market or scrip could move rapidly, but you are not clear of the direction
(whether up or down). You are however sure that the movement will be significant in one
direction or the other. Neutral view is the reverse of the Volatile view where you believe that
the market or scrip in question will not move much in any direction.

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If I have a bullish view

The following strategies are possible:

 Buy a Future
 Buy a Call Option
 Sell a Put Option
 Create a Bull Spread using Calls
 Create a Bull Spread using Puts

Let us discuss each of these using some examples.

What if a Buy a Futures Contract?

If you buy a Futures Contract, you will need to invest a small margin (generally 15 to 30% of
the Contract value). If the underlying index or scrip moves up, the associated Futures will also
move up. You can then gain the entire upward movement at the investment of a small margin.
For example, if you buy Nifty Futures at a price of 1,100 which moves up to 1,150 in say 10
days time, you gain 50 points. Now if you have invested only 20%, i.e. 220, your gain is over
22% in 10 days time, which works out an annualized return of over 700%.

The danger of the Futures value falling is very important. You should have a clear stop loss
strategy and if your Nifty Futures in the above example were to fall from 1,100 to say 1,080,
you should sell out and book your losses before they mount.

What if a Buy a Call Option?

If you buy a Call Option, your Option Premium is your cost which you will pay on the day of
entering into the transaction. This is also the maximum loss that you can ever incur. If you buy
a Satyam May 260 Call Option for Rs 21, the maximum loss is Rs 21. If Satyam closes above
Rs 260 on the expiry day, you will be paid the difference between the closing price and the
strike price of Rs 260. For example, if Satyam closes at Rs 300, you will get Rs 40. After
setting off the cost of Rs 21, your net profit is Rs 19.

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The Call buyer has a limited loss, unlimited profit profile. No margins are applicable on the
buyer. The premium will be paid in cash upfront. If the Satyam scrip moves nowhere, the
buyer is adversely impacted. As time passes, the value of the Option will fall. Thus if Satyam
is currently at around Rs 260 and remains around that price till the end of May, the value of
the Option which is currently Rs 21 would have fallen to nearly zero by that time. Thus time
affects the Call buyer adversely.

What if I sell a Put Option?

Another bullish strategy is to sell a Put Option. As a Put Seller, you will receive Premium. For
example, if you sell Reliance May 300 Put Option for Rs 18, you will earn an Income of Rs 18
on the day of the transaction. You will however face a risk that you might have to pay the
difference between 300 and the closing price of Reliance scrip on the last Thursday of May.
For example, if Reliance were to close on that day at Rs 275, you will be asked to pay Rs 25.
After setting of the Premium received of Rs 18, the net loss will be Rs 7. If on the other hand,
Reliance closes above Rs 300 (as per your bullish view), the entire income of Rs 18 would
belong to you.

As a Put Seller, you are required to put up Margins. These margins are calculated by the
exchange using a software program called Span. The margins are likely to be between 20 to
35% of the Contract Value. As a Put Seller, you have a limited profit, unlimited loss profile
which is a high risk strategy. If time passes and Reliance remains wherever it is (say Rs 300),
you will be very happy. Passage of time helps the Sellers as value of the Option declines over
time.

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CHAPTER-V
 FINDINGS
 SUGGESTION
 CONCLUSION
 BIBILIOGRAPHY

103
 FINDINGS

 A positive derivative means that the function is increasing

 A M/S. HDFC BANK LTD derivative means that the function is decreasing
 A M/S. HDFC BANK LTD derivative means that the function has some special
behavior at the given point. It may have a local maximum, a local minimum, (or in
some cases, as we will see later, a "turning" point)

As a last remark we should remember that the derivative of a function is, itself, a function
since it varies from point to point. If we want to, we could plot it on its own set of axes. You
can compare the signs and slopes of the individual tangent lines of the original curve with the
graph of the derivative.

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 CONCLUSION

Derivatives market is an innovation to cash market. Approximately its daily turnover

reaches to the equal stage of cash market. The average daily turnover of the NSE derivative
segments. In cash market the profit/loss of the investor depend the market price of the
underlying asset. The investor may incur huge profits or he may incur huge profits or he
may incur huge loss. But in derivatives segment the investor the investor enjoys huge
profits with limited downside. In cash market the investor has to pay the total money, but in
derivatives the investor has to pay premiums or margins, which are some percentage of total
money. Derivatives are mostly used for hedging purpose. In derivative segment the
profit/loss of the option writer is purely depend on the fluctuations of the underlying asset.

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 SUGGESTIONS
 In bullish market the call option writer incurs more losses so the investor is suggested to
go for a call option to hold, whereas the put option holder suffers in a bullish market, so
he is suggested to write a put option.
 In bearish market the call option holder will incur more losses so the investor is suggested
to go for a call option to write, whereas the put option writer will get more losses, so he is
suggested to hold a put option.
 In the above analysis the market price of M/S. HDFC is having low volatility, so the call
option writers enjoy more profits to holders.
 The derivative market is newly started in India and it is not known by every investor, so
SEBI has to take steps to create awareness among the investors about the derivative
segment.
 In order to increase the derivatives market in India, SEBI should revise some of their
regulations like contract size, participation of FII in the derivatives market.
 Contract size should be minimized because small investors cannot afford this much of
huge premiums.
 SEBI has to take further steps in the risk management mechanism.
SEBI has to take measures to use effectively the derivatives segment as a tool of
hedging

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 BIBILOGRAPHY

BOOKS:
 Derivatives Dealers Module Work book–NCFM
 Financial Markets and Services–GORDAN and NATRAJAN
 Financial Management – PRASANNA CHANDRA

NEWS PAPERS:
 Economic times-2017-2018
 The Financial Express
 Business Standard
MAGAZINES:
 Business Today-2018
 Business World
 Business India
WEBSITES:
 WWW.derivativesindia.com
 www.hdfc.com
 www.nesindia.com
 www.bseindia.com
 www.sebi.gov.in

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