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Email: Delhi_jyoti2007@yahoo.co.in
TABLE OF CONTENTS
CHAPTER 1
INTRODUCTION TO STOCK MARKET
FINANCIAL MARKETS
MONEY MARKET
CAPITAL MARKETS
ABOUT CAPITAL MARKET
STOCK EXCHANGE
ROLE OF STOCK EXCHANGE
VARIOUS STOCK EXCHANGES
HISTORY OF STOCK EXCHANGE
CHAPTER 2
DERIVATIVES
CONCEPT
HISTORY OF DERIVATIVE MARKET IN THE WORLD
DEVELOPMENT OF DERIVATIVE MARKET IN INDIA
NEED BEHIND DERIVATIVES USAGE
PARTICIPITANTS
TYPES OF DERIVATIVES
FACTORS BEHIND GROWTH OF FINANCIAL DERIVATIVES
CHAPTER 3
CHAPTER 4
RESEARCH WORK
INTRODUCTION TO RESEARCH TOPIC
OBJECTIVES OF STUDY
RESEARCH METHODOLOGY
RESEARCH DESIGN
SAMPLING DESIGN
LIMITATIONS OF THE STUDY
DATA ANALYSIS
RESULTS AND FINDINGS
SUGGESTIONS AND RECOMMENDATIONS
CHAPTER 5
ANNEXURE AND BIBLIOGRAPHY
Every individual tries to plan and secure his future using various
avenues of investment. An individual invests money on account of
multiple reasons. A few of them are as follows:
3.Tax benefits
7.Possessing liquidity
FINANCIAL MARKETS
IT COMPROMISES OF
1.MONEY MARKET
2.CAPITAL MARKET
MONEY MARKET provides short-term capital to borrowers for
meeting their short term working requirement.
STOCK EXCHANGE
Redistribution of wealth
Corporate governance
The contract also has a fixed expiry period mostly in the range of
3 to 12 months from the date of commencement of the contract.
The value of the contract depends on the expiry period and also
on the price of the underlying asset.For example, a farmer fears
that the price of soybean (underlying), when his crop is ready for
delivery will be lower than his cost of production.
In this case, say the merchant agrees to buy the crop at Rs 9,000
per ton. Now, the value of this derivative contract will increase as
the price of soybean decreases and vice-a-versa.
If the selling price of soybean goes down to Rs 7,000 per ton, the
derivative contract will be more valuable for the farmer, and if the
price of soybean goes down to Rs 6,000, the contract becomes
even more valuable.
This is because the farmer can sell the soybean he has produced
at Rs .9000 per tonne even though the market price is much less.
If the underlying asset of the derivative contract is coffee, wheat,
pepper, cotton, gold, silver, precious stone or for that matter even
weather, then the derivative is known as a commodity derivative.
HISTORY OF
DERIVATIVES
MARKET IN
INDIA
The history of derivatives is surprisingly longer than what most
people think. Some texts even find the existence of the
characteristics of derivative contracts in incidents of
Mahabharata. Traces of derivative contracts can even be found in
incidents that date back to the ages before Jesus Christ.
However, the advent of modern day derivative contracts is
attributed to the need for farmers to protect themselves from any
decline in the price of their crops due to delayed monsoon, or
overproduction.
The first 'futures' contracts can be traced to the Yodoya rice
market in Osaka, Japan around 1650. These were evidently
standardised contracts, which made them much like today's
futures.
The Chicago Board of Trade (CBOT), the largest derivative
exchange in the world, was established in 1848 where forward
contracts on various commodities were standardised around
1865. From then on, futures contracts have remained more or
less in the same form, as we know them today.
Derivatives have had a long presence in India. The commodity
derivative market has been functioning in India since the
nineteenth century with organized trading in cotton through the
establishment of Cotton Trade Association in 1875. Since then,
contracts on various other commodities have been introduced as
well.
Exchange traded financial derivatives (FUTURES AND OPTIONS)
were introduced in India in June 2000 at the two major stock
exchanges, NSE and BSE. There are various contracts currently
traded on these exchanges.
National Commodity & Derivatives Exchange Limited (NCDEX)
started its operations in December 2003, to provide a platform for
commodities trading.
The derivatives market in India has grown exponentially,
especially at NSE. Stock Futures are the most highly traded
contracts on NSE accounting for around 55% of the total turnover
of derivatives at NSE, as on April 13, 2005
Financial Derivatives
market and its
development in India
The first step towards introduction of derivatives trading in India
was the promulgation of the Securities Laws (Amendment)
Ordinance, 1995, which withdrew the prohibition on options in
securities. The market for derivatives, however, did not take off,
as there was no regulatory framework to govern trading of
derivatives. SEBI set up a 24–member committee under the
Chairmanship of Dr.L.C.Gupta on November 18, 1996 to develop
appropriate regulatory framework for derivatives trading in India.
The committee submitted
its report on March 17, 1998 prescribing necessary pre–conditions
for introduction of derivatives trading in India. The committee
recommended that Derivatives should be declared as ‘securities’
so that regulatory framework applicable to trading of ‘securities’
could also govern trading of securities. SEBI also set up a group in
June 1998 under the Chairmanship of Prof. J.R.Varma, to
recommend measures for risk containment in derivative market in
India. The report, which was submitted in October 1998, worked
out the operational details of margining system, methodology for
charging initial margins, broker net worth, deposit requirement
and real–time monitoring requirements.
The Securities Contract Regulation Act (SCRA) was amended in
December 1999 to include Derivatives within the ambit of
‘securities’ and the regulatory framework was developed for
governing derivatives trading. The act also made it clear that
derivatives shall be legal and valid only if such contracts are
traded on a recognized stock exchange. Thus, precluding OTC
derivatives. The government also rescinded in March 2000, the
three–decade old notification, which prohibited forward trading in
securities.
• Daily option price variations suggest that traders use the F&O
segment as a less
risky alternative (read substitute) to generate profits from the
stock price movements. The fact that the option premiums tail
intra-day stock prices is an evidence to this. Calls on Satyam fall,
while puts rise when Satyam falls intra-day.
If calls and puts are not looked as just substitutes for spot trading,
the intra-day stock price variations should not have a one-to-one
impact on the option premiums.
NEED BEHIND USAGE OF DERIVATES
Types of Derivatives
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 given 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.
ACCOUNTING OF DERIVATIVES:
The Institute of Chartered Accountants of India (ICAI) has issued
guidance notes on accounting of index futures contracts from the
viewpoint of parties who enter into such
futures contracts as buyers or sellers. For other parties involved in
the trading process, like brokers, trading members, clearing
members and clearing corporations, a trade in equity
index futures is similar to a trade in, say shares, and does not
pose any peculiar accounting problems
Taxation
The Income Tax Act does not have any specific provision
regarding taxability from derivatives. The only provisions, which
have an indirect bearing on derivative transactions are sections
73(1) and 43(5). Section 73(1) provides that any loss, computed
in respect of a speculative business carried on by the assessee,
shall not be set off except against profits and gains, if any, of
speculative business. In the absence of a specific provision, it is
apprehended that the derivatives contracts, particularly the index
futures which are essentially cash-settled, may be construed as
speculative transactions and therefore, the losses, if any, will not
be eligible for set off against other income of the assessee and
will be carried forward and set off against speculative income only
up to a maximum of eight years. As a result, an investor’s losses
or profits out of derivatives even though they are of hedging
nature in real sense, are treated as speculative and can be set off
only against speculative income, that may exceed the cost
associated with leaving a part of the production uncovered.
WORKING OF OPTIONS
• Daily option price variations suggest that traders use the F&O
segment as a less Foreign Institutional Investors(FIIs) are
permitted to trade in all exchange traded derivative products.
• Daily option price variations suggest that traders use the F&O
segment as a less
Risky alternative (read substitute) to generate profits from the
stock price movements. The fact that the option premiums tail
intra-day stock prices is an evidence to this. Calls on Satyam fall,
while puts rise when Satyam falls intra-day.
If calls and puts are not looked as just substitutes for spot trading,
the intra-day stock price variations should not have a one-to-one
impact on the option premiums.
-
Trading strategies
Trading strategies - Participants in the market use
different strategies to maximize their profit or minimize
their loss..
• Buy a Future
• Buy a Call Option
• Sell a Put Option
• Create a Bull Spread using Calls
• Create a Bull Spread using Puts.
If one buy a Call Option, His Option Premium is his cost which he
will pay on the day of entering into the transaction. This is also
the maximum loss that he can ever incur. If he 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, he will be paid the
difference between the closing price and the strike price of Rs
260. For example, if Satyam closes at Rs 300, he will get Rs 40.
After setting off the cost of Rs 21, his net profit is Rs 19.
Bull Spreads
Bull Spreads are those class of strategies that enable you benefit
from a bullish phase on the index or scrip in question. Bull
spreads allow you to create a limited profit limited loss model of
payoff, which you might be very comfortable with.
Bull spreads can be created using Calls or using Puts. One need to
buy one Call with a lower strike price and sell another Call with a
higher strike price and a spread position is created. Interestingly,
one can also buy a Put with a lower strike price and sell another
with a higher strike price to achieve a similar payoff profile.
One could adopt the same strategy with Index Futures if you are
bearish on the market as a whole. Similar returns and risks are
attached to this strategy.
The Put Option will rise in value as the scrip (or index) drops. If
One buy a Put Option and the scrip falls (as one believe), he can
sell it at a later date. The advantage of a Put Option (as against
Futures) is that his losses are limited to the Premium he pay on
purchase of the Put Option.
No margins are applicable on you when one buy the Put. One
need to pay the Premium in cash at the time of purchase.
In a bear spread, One buy a Call with a high strike price and sell a
Call with a lower strike price. For example, one could buy a
Satyam 300 Call at say Rs 5 and sell a Satyam 260 Call at Rs 26.
He will receive a Premium of Rs 26 and pay a Premium of Rs 5,
thus earning a Net Premium of Rs 21.
If Satyam falls to Rs 260 or lower, he will keep the entire Premium
of Rs 21. On the other hand if Satyam rises to Rs 300 (or above)
he will have to pay Rs 40. After set off of the Income of Rs 21, his
maximum loss will be Rs 19.
In a Strangle, the loss range becomes wider as the Call and Put
are at different strike prices. For example, one could sell a
Satyam 220 Strike Put at Rs 5 and a Satyam 260 Strike Call at Rs
6. While he could earn lower premium of Rs 11 (as against Rs 24),
his break-even points are much wider at Rs 209 and Rs 271
respectively.
The pay off diagrams of the straddle and strangle for the buyer
and seller
STRADDLE BUYER
STRADDLE SELLER
Butterfly
Example:
One has sold a Straddle on Satyam with Strike Price 240 and
generated an Income of Rs 24 (as above). He could buy a 260
Strike Call for Rs 5 and buy a 220 Strike Put for Rs 6. This would
cost you Rs 11, thus reducing your Net Income to Rs 13. It will
however insure you from losses at both ends.
The final payoff table will emerge as under:
Conclusions:
risk.
Finding out how arbitrage opportunities exist between spot
RESEARCH METHODOLOGY
Research refers to search of knowledge.
RESEARCH DESIGN
The research design of my study “HEDGING AND ARBITRAGE
THROUGH INDEX FUTURES” is descriptive.
SAMPLING DESIGN
POPULATION : STOCKS OF NSE
SAMPLING TIME : 1st MAY 2006 TO 30th JUNE 2006
SAMPLING UNIT : NSE STOCKS
SAMPLING SIZE :10 STOCKS
DATA COLLECTION
BETA:
COFFICIENT OF CORELATION(r):
It measures the degree of relationship between two
variables. The value of “r” greater than 0.75 indicates high
degree of correlation between two variables.
ON
DATE RELIANCE INFOSYS SBIN WIPRO ITC CIPLA MARUTI ACC TATASTEEL
02-May-06 1031.15 1323.85 3164.25 937.65 539.3 207.5 263.05 942.2 991.2 671.05
03-May-06 1035.55 1332.25 3171.4 961.7 539.2 208.9 266.5 963.45 985.4 665.4
04-May-06 1080.2 1328.65 3211.3 958.95 540.85 209.4 268.2 957.65 975.05 656.25
05-May-06 1099.25 1364.95 3212.1 953.85 539.45 208.45 275.55 940.7 987.55 640.45
08-May-06 1155 1379.35 3228.25 956.9 538.5 207.8 272.4 939.55 1007.2 644.5
09-May-06 1154.1 1439.9 3237.15 976.05 538.7 206.35 274.7 965.8 1002.9 659.95
10-May-06 1169.8 1484.2 3256.25 1002.2 542.6 205.05 273.4 952.95 977.25 668.1
11-May-06 1110.25 1456.75 3256.05 976.45 544.85 203.75 271.05 937.2 964.95 639.05
12-May-06 1066.85 1420.5 3242.3 958.65 544.55 201.5 269.8 932.8 897.45 643.85
15-May-06 1021.65 1368.4 3151.1 923.9 534.6 191 259.8 885.75 862.85 586.65
16-May-06 1043.7 1361.25 3150.05 923.95 534.15 194.8 263.25 882.3 904.35 574.25
17-May-06 1086.2 1442.4 3208.2 989.7 543.95 204.3 257.95 912.55 908.7 611.9
18-May-06 1004.8 1349.2 3033.95 906.35 507.55 191.15 245.35 820.5 799.6 545.05
19-May-06 978.1 1288.05 2974.45 869.1 487.7 179.9 223.9 783.55 751.2 504.3
22-May-06 929.4 1207 2823.7 859.8 441.8 171.55 227.2 748.6 726.65 470.9
23-May-06 967.1 1235.55 2910.65 872.55 474.15 178 225.45 805.7 752.75 510.75
24-May-06 938.55 1163.2 2860.95 867.85 454.4 174.1 230.9 762.7 769.15 483.9
25-May-06 950 1204.95 2828.55 870.5 486.25 181.4 222.05 792.95 792.5 515.85
26-May-06 958.5 1179.75 2934.25 874.45 475 183.2 235.7 791.7 799.2 538.95
29-May-06 955.95 1194.65 2967.7 881.85 470.65 177.95 237.55 791.3 799.95 562.15
30-May-06 954.95 1179.15 3026.5 860.25 471.1 176.5 241.5 768.85 779.95 547
31-May-06 954.15 1116.25 2909.85 832.65 449.7 165.4 229.35 735 762.9 517.2
01-Jun-06 925.35 1064.75 2829.85 818.75 444.7 160.15 218.8 683.6 740.65 488.95
02-Jun-06 958.1 1126.9 2886 838.75 469.9 164.4 223 769.7 786.4 517.8
05-Jun-06 925.35 1085.65 2824.25 813.95 457.5 160.05 218.05 736.05 742.75 494.4
06-Jun-06 906.5 1039.8 2765.4 840.1 445.2 152.55 212.7 730.9 726.45 480.35
07-Jun-06 893 993.65 2763.25 806.65 445.35 151.8 211.65 715.5 709 460.9
08-Jun-06 825.7 959.45 2703.8 768.4 419.55 147.65 198.35 718.1 700.7 424.9
09-Jun-06 922.75 991.55 2794.65 771.6 434.9 160.5 203.85 770.05 754.85 456.05
12-Jun-06 901.05 977.15 2763.2 746.4 422.3 154.4 198.5 750.65 715.85 426.85
13-Jun-06 858.65 977.05 2639.1 750.55 395.3 146.25 191.2 702.3 704.9 388.1
14-Jun-06 858.45 989.7 2485.2 741.25 389.5 147.35 191.9 680.75 695.4 384.15
15-Jun-06 895.35 1030.65 2727.05 772.15 420 155.6 201.3 715.55 736.7 413.8
16-Jun-06 921.6 1012.65 2801.15 766.85 440.5 163.2 210.85 727.5 732.1 460.3
19-Jun-06 933.7 1018.9 2871.2 753.3 435.85 164.55 222.25 755.85 766.8 476.4
20-Jun-06 925 1012.6 2844 736.75 421.9 161.65 216.9 752.95 760.05 465.85
21-Jun-06 964.15 1026.55 2923.25 739.9 438.9 168.75 220.1 757.25 769.5 477.9
22-Jun-06 975.1 1063.05 2951.85 773.45 450.45 170.85 225.25 776.5 778.95 489.5
23-Jun-06 1011.9 1100.4 2991.55 762.65 469.6 170.8 226.3 773.1 786.2 512.6
25-Jun-06 1007.2 1113.55 2989.65 754.1 475.35 171.75 226.7 776.85 782.35 532.35
26-Jun-06 981.2 1066.35 2900.2 728.65 463.9 166.3 218.1 735.75 746.15 496.75
27-Jun-06 985.75 1062.7 2967.45 730.05 473.9 175.95 214.85 721.3 754.75 518.55
28-Jun-06 1000.95 1034.45 2974.5 714.6 484.15 177.05 212.85 723.25 746.25 514.3
29-Jun-06 1008.35 1055 2993.65 708.7 496.7 175.8 209.8 733.65 740.1 509.7
30-Jun-06 1059.85 1108.05 3078.95 727.75 513.35 182.4 216 796.7 783.95 533.65
Graph show ing com parision betw een portfolio stocks and index
4000
3500
RELIANCE
3000 ONGC
INFOSYSTCH
2500 SBIN
WIP RO
2000 ITC
CIP LA
1500 MARUTI
ACC
1000 TATASTEEL
NIFTY
500
Dates
6000000
5000000
VALUE
4000000
3000000 PORTFOLIO
2000000
1000000
0
30/05/2006
27/06/2006
02/05/2006
16/05/2006
13/06/2006
DATES
Graph show ing com parison betw een % change in PORTFOLIO and INDEX
8.000
6.000
4.000
2.000
0.000
PORTFOLIO
INDEX
-2.000
-4.000
-6.000
-8.000
-10.000
DATES
This graph shows how percentage change in the value of portfolio
is in tune with the market. As market has risen portfolio has
reacted to that in the same manner. Similarly when markets have
fallen, portfolio value has diminish in the same manner.
R =Σ xy/(N*σ x *σ y)
Σ xy=covariance of x and y
N=No of observations
If the investor squares off his position in between the hedge period i.e.
before expiry on 31st August,2006 :
Let us presume that the investor decides to square up his
portfolio which he had entered on 1st July, 2006 with an
investment of Rs.4431242 before the expiry date for August
contract i.e. 31st August, 2006 on 31st July,2006.
CAPITAL
Date FUTURE PRICE PRICE DIFFERENCE
28-Apr-06 1012 1008.9 3.1
29-Apr-06 1030.5 1022.95 7.55
2-May-06 1042 1031.15 10.85
3-May-06 1041.85 1035.55 6.3
4-May-06 1089 1080.2 8.8
5-May-06 1113.8 1099.25 14.55
8-May-06 1177 1155 22
9-May-06 1168 1154.1 13.9
10-May-06 1184.5 1169.8 14.7
11-May-06 1117 1110.25 6.75
12-May-06 1076.15 1066.85 9.3
15-May-06 1016.5 1021.65 -5.15
16-May-06 1057 1043.7 13.3
17-May-06 1092.2 1086.2 6
18-May-06 1005 1004.8 0.2
19-May-06 980 978.1 1.9
22-May-06 924.9 929.4 -4.5
23-May-06 964 967.1 -3.1
24-May-06 938 938.55 -0.55
25-May-06 949.65 950 -0.35
One can easily notice the price difference between the two
markets i.e. the Capital Market and the Futures Market. These
price differences do exist between the two markets because of
the Cost of Carry. Due to this Cost of Carry the Futures market
(stock) trades at a premium to the capital market(stock).
Conclusion
Thus one can say that index futures are useful to cover the risk
but it can’t eliminate the risk totally .It can minimise the risk to
some extent I would conclude my study by saying that
Derivatives are a tool available to minimize the risk to a particular
extent only.
The content of the analysis done by the summer trainees under the premises of
SMC cannot be copied, reproduced, republished, uploaded, posted, transmitted or
distributed for any non-personal use without obtaining prior permission from SMC
Global Securities Limited.
SMC Global Securities Limited is not responsible for the content of any of the
linked sites. By providing access to other web-sites, SMC Global Securities
Limited is neither recommending nor endorsing the content available in the linked
websites
The information gathered is to enable the students in their course of study and if
need arises, SMC reserves the right and may disclose such information to other
authorities in good faith.
Disclaimer
The content of the analysis done by the summer trainees under the premises of
SMC cannot be copied, reproduced, republished, uploaded, posted, transmitted or
distributed for any non-personal use without obtaining prior permission from SMC
Global Securities Limited.
SMC Global Securities Limited is not responsible for the content of any of the
linked sites. By providing access to other web-sites, SMC Global Securities
Limited is neither recommending nor endorsing the content available in the linked
websites
The information gathered is to enable the students in their course of study and if
need arises, SMC reserves the right and may disclose such information to other
authorities in good faith.