1.

INTROD UCTION
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DERIVATIVES-AN INTRODUCTION:
Risk is a characteristic feature of all commodity and capital markets. Prices of all commodities be they agricultural like wheat, cotton, rice, coffee or tea, or non- agricultural like silver, gold etc. are subject to fluctuation over time in keeping with prevailing demand and supply conditions. Producers or possessors of these commodities obviously cannot be sure of the prices that their produce or possession may fetch when they have to sell them, in the same way as the buyers and the processors ate not sure what they would have to pay for their buy. Similarly, prices of shares and debentures or bonds and other securities are also subject to continuous changes. Those who are charged with the responsibility of managing money, their own or of others are therefore constantly exposed to the threat of risk. In the same way, the foreign exchange rates are also subject to continuous change. Thus an importer of certain piece of machinery is not sure of the amount he would have to pay in rupee terms when the payment becomes due. While example where risk is seen to exist can be easily multiplied, it may be observed that parties involved in all such cases may see the benefits of, and are likely to desire, having some contractual form whereby forward prices may be fixed and the price risk facing them is eliminated. Derivatives came into being primarily for the reason of the need to eliminate price risk.

WHAT ARE DERIVATIVES?

A derivatives instrument broadly is a financial contract whose payoff structure is determined by the value of an underlying commodity, security, interest rate, share price index, exchange rate, oil price and the like. Thus a derivative instrument derives its value from some underlying variable. A derivative instrument by itself does not constitute ownership. It is, instead, a promise to convey ownership.

Derivatives have become very important in the field finance. They are very important financial instruments for risk management as they allow risks to be separated and traded. Derivatives are used to shift risk and act as a form of insurance. This shift of risk means that each party involved in the contract should be able to identify all the risks involved before the contract is agreed. It is also important to remember that derivatives are derived from an underlying asset. This means that risks in trading derivatives may change depending on what happens to the underlying asset. A derivative is a product whose value is derived from the value of an underlying asset, index or reference rate. The underlying asset can be equity, forex, commodity or any other asset. For example, if the settlement price of a derivative is based on the stock price of a stock for e.g. Infosys, which frequently changes on a daily basis, then the derivative risks are also changing on a daily basis. This means that derivative risks and positions must be monitored constantly. All derivatives are based on some cash products. The underlying basis of derivative instrument may be any product including Commodities including grain, coffee beans, orange juice etc. Precious metals like gold and silver Foreign exchange rate Bonds of different types, including medium to long- term negotiable Debt securities issued by government, companies, etc. Short-term debt securities such as T-bills; and Over-the-counter (OTC) money market products such as loans or deposits.

Derivatives are specialized contracts which are employed for a variety of purposes including reduction of funding costs by borrowers, enhancing the yield on assets, modifying the payment structure of assets to correspond to the investors market view, etc. however the most important use of derivatives is in transferring market risk, called hedging, which is a protection against losses resulting form unforeseen

price or volatility changes. Thus derivatives are very important tool of risk management. As awareness about the usefulness of derivatives as a risk management tool has increased, the markets for derivatives too have grown. Of late, derivatives have assumed a very significant place in the field of finance and they seem to be driving global financial markets. Derivatives have made the international and financial headlines in the past for mostly with their association with spectacular losses or institutional collapses. But market players have traded derivatives successfully for centuries and the daily international turnover in derivatives trading runs into billions of dollars. There are many kinds of derivatives including futures, options, interest rate swap, and mortgage derivatives. Are derivative instruments that can only be traded by experienced, specialist traders? Although it is true that complicated mathematical models are used for pricing some derivatives, the basic concepts and principles underplaying derivatives and their trading are quite easy to grasp and understand. Indeed, derivatives are used increasingly by market players ranging from governments, corporate treasurers, dealers and brokers and individual investors.

2. ABOUT

COMPA NY
2.1 CORPORATE VISION:

Mission & Vision

"To be a world-class financial services provider By arranging all conceivable financial services Under one-roof at affordable costs Through cost effective delivery systems, And achieve organic growth in business by adding newer lines of Business.

2.2 COMPANY INFORMATION:

Name:
Head Office :

Marwadi Shares & Finance Ltd.

Marwadi Financial Center Nr. Kathiawad Gymkhana Dr. Radhakrishnana Road Rajkot 360 001 smarwadi@hotmail.com www.marwadionline.com Mr. Ketan Marwadi

E-Mail: Web Site: Directors:

Mr. Deven Marwadi Mr. Sandeep Marwadi C.E.O.: General Manager: Company Secretary: DP Manager: H R Manager: Account Manager: Mr. Jeyakumar A. S. Mr. Hareshbhai Maniar Mr. Tushit Mangukiya Mr. Arvind Gamot Mr. Akshay Goswami Mr. Suresh Vichi Mr. Jayant Vithlani Mr. Bhargav Pathak

2.3 COMPANY PROFILE:

Marwadi Sales and Finance P. Ltd. started in the year 1994 when acquired membership of National Stock Exchange of India Ltd. That was the time when Govt. had just started liberalization. Capital market being at the base of every thing else was among the first few sectors taken up for liberalization and alignment with global benchmarks. NSE was therefore a result of Governments policy to modernize stock market and give our investors a cost - effective trading and settlement system. They enter into the stock market coincided with Government's initiative to give a modern Stock exchange. Marwadi had then very presciently felt that this development would change the very structure and content of the market. Then, when Depository system was introduced to automate the settlement system, we became the first Corporate DP in 1998 to bring this concept to investor's doorstep in Saurashtra. Marwadi had very early on seen that the future lay in the

ability to network and use technology to its fullest possible extent. Relying on your judgment, we used technology extensively which resulted in efficient client servicing. It also saw the synergy that lay in providing a bouquet of services under one roof. It is this realization that led us in the year 2003 to go for membership of National Level Commodity Exchanges, which were set up as part of Govt's policy to bring commodity market on par with the capital market in terms of integrity and practices. They bold initiatives starting with our journey from capital market up to commodities market has given us synergies in operations, enabling us to pass on the advantage to customers. As an organization, have achieved a leader's position by ensuring total satisfaction of customers through world class services. Utilize ultra modern technology for timely, seamless and accurate data processing. Proactively seek customers feedback in improving upon our service delivery modes. Promptly respond to customer issues in order to maximize clients satisfaction.

MARWADI GROUP MARWADI GROUP

ORGANISATION CHART
KETAN MARWADI KETAN MARWADI Managing Director Managing Director DEVEN MARWADI DEVEN MARWADI Director Director SANDEEP MARWADI SANDEEP MARWADI Director Director

SATISHKUMAR NEDUNGADI SATISHKUMAR NEDUNGADI General Manager General Manager

HARESHBHAI I. MANIYAR HARESHBHAI I. MANIYAR Senior Manager Senior Manager

Arvind A. Gamot Arvind A. Gamot HOD-Front Office HOD-Front Office

HOD-DP Back office HOD-DP Back office

Rajiv Bhatt Rajiv Bhatt

Piyushbhai Hasmukhbhai Piyushbhai / /Hasmukhbhai

HOD-Trading HOD-Trading

Tushit G. Mangukiya Tushit G. Mangukiya HOD-Audit/ Compliance HOD-Audit/ Compliance

Sureshbhai Jayantbhai Sureshbhai / /Jayantbhai

HOD-Accounts HOD-Accounts

Laxman Sonagra Laxman Sonagra HOD-Software HOD-Software

Bharat Arora Bharat Arora HOD-Technical HOD-Technical

Akshaybhai Goswami Akshaybhai Goswami HOD-HR/Admin. HOD-HR/Admin.

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2.4 HIRARCHY STRUCTURE:

Board of Director

General Manager

DP Front

Trading

Account

Technology

DP Back

Audit (Compliance)

Software

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2.5 COMPANYS MILESTONE:

1992: Marwadi Shares And Finance Pvt. Ltd. was incorporated 1996: Became a corporate member of national Stock Exchange of India. 1998: Became a member of Saurashtra Kutch Stock Exchange. 1999: Launched Depository services of Depository Participant under National Securities Depository Ltd. 2000: Commenced Derivative Trading after obtaining registration as a Clearing and Trading Member in NSE 2003: (MCBPL) became a corporate member of The Commodity and Derivatives Exchange of India Ltd. National

2004: Became a corporate member of The Stock Exchange, Mumbai. 2004: Launched Depository Services of Depository Participant under Central Depository Services (India) Ltd. 2006: MSFPL converted to Public Limited (Marwadi Shares And Finance Limited) 2007 - The Company raised further private equity from Caledonia Investments plc.

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2.6 MEMBERSHIP:
Capital market National Stock Exchange of India Ltd. (NSE) Bombay Stock Exchange Ltd. (BSE) Saurashtra-Kutch Stock Exchange Over- the- Counter exchange of India Ltd Commodities Derivatives: National Commodity & Derivatives Exchange Ltd. Multi Commodity Exchange of India Ltd.

Depository participation of: National Securities Depository Ltd. (NSDL) Central Depository Services India Ltd. (CDSL)

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2.7 SERVICES OF MARWADI:

Stock broking: Cash Market Derivatives Trading Margin Trading Internet Trading Commodities Broking: Commodities Futures Financing Against Commodities Depository Service: NSDL CDSL IPO Subscription Services Mutual Fund Products Portfolio management Insurance Services Qualitative Research in Stock & Commodities FUTURE SERVICES: Private Banking Sector Forex Market Commodities Demat Service Product Enhancement in commodity market

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3. ABOUT THE

15

DERIVA TIVES
3.1 HISTORY OF DERIVATIVES:
The history of derivatives is quite colorful and surprisingly a lot longer than most people think. To start we need to go back to the Bible. In Genesis Chapter 29, believed to be about the year 1700 B.C., Jacob purchased an option costing him seven years of labor that granted him the right to marry Laban's daughter Rachel. His prospective father-inlaw, however, reneged, perhaps making this not only the first derivative but the first default on a derivative. Laban required Jacob to marry his older daughter Leah. Jacob married Leah, but because he preferred Rachel, he purchased another option, requiring seven more years of labor, and finally married Rachel, bigamy being allowed in those days. Jacob ended up with two wives, twelve sons, who became the patriarchs of the twelve tribes of Israel, and a lot of domestic friction, which is not surprising. Some argue that Jacob really had forward contracts, which obligated him to the marriages but that does not matter. Jacob did derivatives, one way or the other. Around 580 B.C., Thales the Milesian purchased options on olive presses and made a fortune off of a bumper crop in olives. So derivatives were around before the time of Christ.

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The first exchange for trading derivatives appeared to be the Royal Exchange in London, which permitted forward contracting. The first "futures" contracts are generally traced to the Yodoya rice market in Osaka, Japan around 1650. These were evidently standardized contracts, which made them much like today's futures, although it is not known if the contracts were marked to market daily and/or had credit guarantees.

3.2 INTRODUCTION TO DERIVATIVES:

The term Derivative indicates that it has no independent value, i.e. its value is entirely derived from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pro determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real of financial asset of to an index of securities. Derivatives in mathematics, means a variable derived from another variable. Similarly in the financial sense, a derivative is a financial product, which has been derived from a market for another product. Without the underlying product, derivatives do not have any independent existence in the market. Derivatives have come into existence because of the existence of risks in business. Thus derivatives are means of managing risks. The parties managing risks in the market are known as HEDGERS. Some people/organizations are in the business of taking risks to earn profits. Such entities represent the SPECULATORS. The third player in the market, known as the ARBITRAGERS take advantage of the market mistakes. A derivative is a financial instrument, which derives its value from some other financial price. This other financial price is called the underlying. The underlying asset can be equity, forex, commodity or any other asset. A wheat farmer may wish to contract to sell his harvest at a future date to eliminate the risk of a change in prices by that date. The price for such a contract would obviously depend upon the current spot price of wheat. Such a transaction could take place on a wheat forward market. Here, the wheat forward is the derivative and wheat on the spot market is the underlying. The terms derivative contract,

17

derivative product, or derivative are used interchangeably. The most important derivatives are futures and options. Example: -

A very simple example of derivatives is curd, which is derivative of milk. The price of curd depends upon the price of milk, which in turn depends upon the demand, and supply of milk. Consider how the value of mutual fund units changes on a day-today basis. Dont mutual fund units draw their value from the value of the portfolio of securities under the schemes? Arent these examples of derivatives? Yes, these are. And you know what; these examples prove that derivatives are not so new to us. Nifty options and futures, Reliance futures and options, Satyam futures and options etc are all examples of derivatives. Futures and options are the most common and popular form of derivatives.

The need for a derivatives market:

The derivatives market performs a number of economic functions: They help in transferring risk from risk averse people to risk oriented people. They help in the discovery of future as well as current prices. They catalyze entrepreneurial activity. They increase the volume traded in markets because of participation of risk-averse people in greater numbers. They increase savings and investment in the long run.

Factors driving the growth of financial derivatives:

Increased volatility in asset process in financial markets, Increased integration of national financial markets with the international markets, Marked improvement in communication facilities and sharp decline in their costs,

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Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies, and Innovations in the derivatives markets, which optimally combine the risks and returns over a large number of financial assets leading to higher returns, reduced risk as well as transactions costs as compared to individual financial assets. A derivative is a financial instrument whose value depends on the value of other, more basic underlying variables.

3.3 DERIVATIVE TYPES:

A derivative as a term conjures up visions of complex numeric calculations, speculative dealings and comes across as an instrument which is the prerogative of a few smart finance professionals. In reality it is not so. In fact, a derivative transaction helps cover risk, which would arise on the trading of securities on which the derivative is based and a small investor can benefit immensely. A derivative security can be defined as a security whose value depends on the values of other underlying variables. Very often, the variables underlying the derivative securities are the prices of traded securities. An example of a simple derivative contract: Ram buys a futures contract. He will make a profit of Rs 1000 if the price of Infosys rises by Rs 1000. If the price is unchanged Ram will receive nothing. If the stock price of Infosys falls by Rs.800 he will lose Rs.800. As we can see, the above contract depends upon the price of the Infosys scrip, which is the underlying security. Similarly, a future trading has already started in Sensex futures and Nifty futures. The underlying security in this case is the BSE Sensex and NSE Nifty. Derivatives and futures are basically of 3 types: Forwards and Futures Options Swaps

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DERIVATIVES DERIVATIVES

Options Options

Futures Futures

Swaps Swaps

Forwards Forwards

Put Put

Call Call Commodit Commodit y y

Interest Interest Rate Rate Security Security

Currency Currency

3.4 DERIVATIVES INSTRUMENTS:

The main instruments under the derivative are:
Forward contract Future contract Options Swaps

1. Forward contract: A forward contract is a particularly simple derivative. It is an agreement to buy or sell an asset at a certain future time for a certain price. The contract is usually between two financial institutions of between a financial institution and one of its corporate clients. It is not normally traded on an exchange. 2. Future contract: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future for a certain price. Unlike forward contracts, futures contract are normally traded on an exchange

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3. Options: An option is a contract, which gives the buyer the right, but not the obligation, to buy or sell specified quantity of the underlying assets, at a specific (strike) price on or before a specified time (expiration date). The underlying may be commodities like wheat/rice/cotton/gold/oil/ or financial instruments like equity stocks/ stock index/bonds etc. There are basic two types of options. A call options gives the holder the right to buy the underlying asset by a certain date for a certain price. A put option gives the holder the right to sell the underlying asset by a certain date for a certain price. 4. Swaps:Swaps are private agreements between two companies to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts.

5. Warrants: Options generally have lives of up to one year, the majority of options traded on options exchange having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the counter. 6. Leaps: The scronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of up to three years. 7. Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average or a basket of assets. Equity index options are a form of basket options.

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4.

22

STOC K MARKET DERIVA TIVES

4.1 INTRODUCTION:
Futures & Options 23

In June 2000, National Stock Exchange and Bombay Stock Exchange started trading in futures on Sensex and Nifty. Options trading on Sensex and Nifty commenced in June 2001. Very soon thereafter trading began on options and futures in 31 prominent stocks in the month of July and November respectively. The market lots keeps on changing from time to time. The minimum quantity you can trade in is one market lot. The Exchange introduced trading in Index Options (also based on Nifty) on june4, 2001. NSC also became the first Exchange to launch trading in options on individual Securities form July 2, 2001. Futures on individual securities were introduced on November 9, 2001. Future and Options on individual securities are available on 31 securities stipulated by SEBI. Instruments available in India The National stock Exchange (NSE) has the following derivative products: Products Underlying Instrument Type Trading cycle Index Futures S&P CNX Nifty Index Options S&P CNX Nifty European Same as index futures Future on Individual securities 30 Securities stipulated by SEBI Same as index futures Options on Individual Securities 30 Securities stipulated by SEBI American Same as index futures

Maximum of 3month trading cycle. At any point in time, there will be 3 contracts available: 1)Near month, 2)Mid month & 3)Far month duration

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Expiry Day Contract Size

Last Thursday of the expiry month Permitted lot size is 200 & multiples there of

Same as index futures Same as index futures

Same as index futures As stipulated by NSE(not less than Rs.2 Lacs)

Same as index futures As stipulated by NSE(not less than Rs.2 Lacs)

Minimum contract size The standing committee on finance, a parliamentary committee, at the time of recommending amendment securities contract (Regulation) Act, 1956 had recommended that the minimum contract size of derivative contracts traded in the Indian markets should be pegged not below Rs. 2 Lakhs. Based on this recommendation SEBI has specified that the value of a derivative contract should not be less than Rs. 2 Lakh at the time of introducing he contract in the market. Lot size of a contract Lot size refers to number of underlying Securities in one contract. Additionally, for stock specific derivative contracts SEBI has specified that the lot size of the underlying individual security should be in multiples of 100 and fractions, if any, should be rounded of to the next requirement of minimum contract size forms the basis of arriving at the lot size of a contract. For example , if shares of XYZ Ltd are quoted at Rs.1000 each and the minimum contract size is Rs.2 Lacks, then the lot size for that particular scrips stands to be 200000/1000 = 200 Shares I.e. one contract in XYZ Ltd. Covers 200 Shares.

4.2 FORWARDS & FUTURES:

4.2.1 Forward Contracts:
A deal for the purchase or sale of a commodity, security or other asset can be in the spot or forward markets. A spot or cash market is

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the most commonly used for trading. A majority of our day to day transaction are in the cash market, where we pay cash and get the delivery of the goods. In addition to a cash purchase, another way to acquire or sell assets is by entering into a forward contract. In a forward contract, the buyer agrees to pay cash at a later date when the seller delivers the goods. As an analogy of a forward contract, suppose a patient calls a doctor for an appointment and sees him after two days at the appointed hour. After his examination, the patient pays the doctor. Similarly, if a car is booked with a dealer and the delivery matures the car is delivered after its price has been paid Usually no money changes hands when forward contracts are entered into, but sometimes one or both the parties to a contract may like to ask for some initial, good faith deposits to insure that the contract is honored by the other party.

4.2.2 Future Contracts:

As indicated, the futures contracts represent an improvement over the forward contracts in terms of standardization, performance guarantee and liquidity. A future contract is a standardized contract between two parties where one of the parties commits to sell, and the other to buy, a stipulated quantity of a commodity, currency, security, index or some other specified item at an agreed price on a given date in the future. The futures contracts are standardized ones, so that the quantity of the commodity or the other asset which would be transferred or would form the basis of gain/loss on maturity of a contract, the quantity of the commodity-if a certain commodity is involved-and the place where delivery of the commodity would be made, the date and month of delivery, the units of price quotation, the minimum amount by which the price would change and the price limits for a days operations, and other relevant details are all specified in a future contract. Thus, in a way, it becomes a standard asset, like any other asset, to be traded. Futures and Stock Indices: For understanding of stock index futures a thorough knowledge of the composition of indexes is essential. Choosing the right index is important in choosing the right contract for speculation or hedging. Since for speculation, the volatility of the index is important whereas for

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hedging the choice of index depends upon the relationship between the stocks being hedged and the characteristics of the index. Choosing and understanding the right index is important as the movement of stock index futures is quite similar to that of the underlying stock index. Volatility of the futures indexes is generally greater than spot stock indexes. Every time an investor takes a long or short position on a stock, he also has an hidden exposure to the Nifty or Sensex. As most often stock values fall in tune with the entire market sentiment and rise when the market as a whole is rising.Retail investors will find the index derivatives useful due to the high correlation of the index with their portfolio/stock and low cost associated with using index futures for hedging. Understanding Index Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Index futures are all future contracts where the underlying is the stock index (Nifty or Sensex) and helps a trader to take a view on the market as a whole. Index futures permits speculation and if a trader anticipates a major rally in the market he can simply buy a futures contract and hope for a price rise on the futures contract when the rally occurs. We shall learn in subsequent lessons how one can leverage ones position by taking position in the futures market. In India we have index futures contracts based on S&P CNX Nifty and the BSE Sensex and near 3 months duration contracts are available at all times. Each contract expires on the last Thursday of the expiry month and simultaneously a new contract is introduced for trading after expiry of a contract. Example: Futures contracts in Nifty in July 2008 Contract month Expiry/settlement July 2008 July 26

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August 2008 September 2008 On July 27 Contract month August 2008 September 2008 October 2008

August 30 September 27

Expiry/settlement August 30 September 27 October 25

The permitted lot size is 200 or multiples thereof for the Nifty. That is you buy one Nifty contract the total deal value will be 200*1100 (Nifty value) = Rs.2,20,000. In the case of BSE Sensex the market lot is 50. That is you buy one Sensex futures the total value will be 50*4000 (Sensex value) = Rs.2,00,000. The index futures symbols are represented as follows: BSE BSXJUN2008 (June contract) BSXJUL2008 (July contract) BSXAUG2008 (Aug contract) NSE FUTDXNIFTY28-JUN2008 FUTDXNIFTY28-JUL2008 FUTDXNIFTY28-AUG2008

Settlements: All trades in the futures market are cash settled on a T+1 basis and all positions (buy/sell) which are not closed out will be marked-tomarket. The closing price of the index futures will be the daily settlement price and the position will be carried to the next day at the settlement price. The most common way of liquidating an open position is to execute an offsetting futures transaction by which the initial transaction is squared up. The initial buyer liquidates his long position by selling identical futures contract. In index futures the other way of settlement is cash settled at the final settlement. At the end of the contract period the difference between the contract value and closing index value is paid.

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How to read the futures data sheet? Understanding and deciphering the prices of futures trade is the first challenge for anyone planning to venture in futures trading. The first step is start tracking the end of day prices. Closing prices, Trading Volumes and Open Interest are the three primary data we carry with Index option quotes. The most important parameters are the actual prices, the high, low, open, close, last traded prices and the intra-day prices and to track them one has to have access to real time prices. The following table shows how futures data will be generally displayed in the business papers daily. Series Volume Value No ofOpen (No of trades interest contracts) (Rs in (No of lakh) contracts) BSXJUN2007 4755 4820 4740 4783.1 146 348.70 104 51 BSXJUL2007 4900 4900 4800 4830.8 12 28.98 10 2 BSXAUG2007 4800 4870 4800 4835 2 4.84 2 1 Total 160 38252 116 54 The first column explains the series that is being traded. For e.g. BSXJUN2000 stands for the June Sensex futures contract. The column on volume indicates that (in case of June series) 146 contracts have been traded in 104 trades. One contract is equivalent to 50 times the price of the futures, which are traded. For e.g. In case of the June series above, the first trade at 4755 represents one contract valued at 4755 x 50 i.e. Rs. 2,37,750/-. First High Low Close Trade

Open interest indicates the total gross outstanding open positions in the market for that particular series. For e.g. Open interest in the June series is 51 contracts. The most useful measure of market activity is Open interest, which is also published by exchanges and used for technical analysis. Open interest indicates the liquidity of a market and is the total number of

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contracts, which are still outstanding in a futures market for a specified futures contract. A futures contract is formed when a buyer and a seller take opposite positions in a transaction. This means that the buyer goes long and the seller goes short. Open interest is calculated by looking at either the total number of outstanding long or short positions not both. Open interest is therefore a measure of contracts that have not been matched and closed out. The number of open long contracts must equal exactly the number of open short contracts. Action Resulting open interest New buyer (long) and new seller (short)Rise Trade to form a new contract. Existing buyer sells and existing seller buysFall The old contract is closed. New buyer buys from existing buyer. TheNo change there is no Existing buyer closes his position by sellingincrease in long contracts to new buyer. being held Existing seller buys from new seller. TheNo change there is no Existing seller closes his position by buyingincrease in short contracts from new seller. being held Open interest is also used in conjunction with other technical analysis chart patterns and indicators to gauge market signals. The following chart may help with these signals. Market Strong Warning signal Price Open interest

4.2.3 Difference between forward and futures contracts:

We may now differentiate between forward and future contracts. Broadly, a future contract is different from a forward contract on the following counts:

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1) Standardization: A forward contract is a tailor-made contract between the buyer and the seller where the terms are settled in mutual agreement between the parties. On the other hand, a future contract is standardized in regards to the quality, quantity, place of delivery of the asset etc. Only the price is negotiated. 2) Liquidity: There is no secondary market for forward contracts while futures contracts are traded on organized exchanges. Accordingly, futures contracts are usually much more liquid than the forward contracts. 3) Conclusion of contract: A forward contract is generally concluded with a delivery of the asset in question whereas the future contracts are settled sometimes with delivery of the asset and generally with the payment of the price differences. One who is long a contract can always eliminate his/her obligation by subsequently selling a contract for the same asset and same delivery date, before the conclusion of contract one holds. In the same manner, the seller of a futures contract can buy a similar contract and offset his/her position before maturity of the first contract. Each one of these actions is called offsetting a trade. 4) Margins: A forward contract has zero value for both the parties involved so that no collateral is required for entering into such a contract. There are only two parties involved. But in a futures contract, a third party called Clearing Corporation is also involved with which margin is required to be kept by both parties. 5) Profit/Loss Settlement: The settlement of a forward contract takes place on the date of maturity so that the profit/loss is booked on maturity only. On the other hand, the futures contracts are marked to market daily so that the profits or losses are settled daily. Following table summarizes the difference between the Forward and Futures: DIFFERCENCE BETWEEN FORWARD AND FUTURES CONTRACT DIFFERCENCE FORWARDS FUTURES Decided by buyer Size of contract and seller Standardized in each contract

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Price of contract Mark to market Margin Counterparty risk Liquidity Nature of Market Mode of delivery

Remains fixed till maturity Not done No margin required Present No liquidity Over the counter Specifically decided.

Changes every day Mark to market every day Margins are to be paid by both buyers and sellers Not present Highly liquid Exchange traded Standardized

4.3 OPTIONS:
4.3.1 What are Options?
Like forward and futures, options represent another derivative instrument and provide a mechanism by which one can acquire a certain commodity or other asset, or take positions in, in order to make profit or cover risk for a price. The options are similar to the futures contracts in the sense that they are also standardized but are different from them in many ways. Options, in fact, represent the rights. An option is the right, but not the obligation, to buy or sell a specified amount (and quality) of a commodity, currency, index, or financial instrument, or to buy or sell a specified number of underlying futures contracts, at a specific price on or before a given date in future. Like other contracts, there are two parties to an options contract: the buyer who takes a long position and the seller or writer, who takes a short position. The options contract gives the owner a right to buy/sell a particular commodity or other asset at a specific predestined price by a specified date. The price involved is called exercise or strike price and the date involved is known as expiration. It is important to understand that such a contract fives its holder the right, and not the obligation to buy/sell. The option writer, on the other hand, undertakes upon himself the obligation to sell/buy the underlying asset if that suits the option holder. The notion of options can be exemplified as follows. Options are of two types: call option and put option. A call option gives an owner the right to buy while a put option gives its owner the right to sell. There is a wide variety of underlying assets including

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agricultural commodities, metals, shares, indices and so on, on which options are written. Further, like futures contracts, options are also tradeable on exchanges. The exchange-traded options are standardized contracts and their trading is regulated by the exchanges that ensure the honoring of such contracts. Thus, in case of options as well, a clearing corporation takes the other side in every contract so that the party with the long position has a claim against the clearing corporation and the one with short position is obliged to it. However, while buying or selling of futures contracts does not require any price to be paid, called premium. The writer of an option receives the premium as a compensation of the risk that he takes upon himself. The premium belongs to the writer and is not adjusted in the price if the holder of the option decides to exercise it. This price is determined on the exchange, like the price of a share, by the forces of demand and supply. Further, like the share prices, the option prices also keep on changing with passage of time as trading in the, takes place. A Call Option is an option to buy a stock at a specific price on or before a certain date. In this way, Call options are like security deposits. If, for example, you wanted to rent a certain property, and left a security deposit for it, the money would be used to insure that you could, in fact, rent that property at the price agreed upon when you returned. If you never returned, you would give up your security deposit, but you would have no other liability. Call options usually increase in value as the value of the underlying instrument rises. When you buy a Call option, the price you pay for it, called the option premium, secures your right to buy that certain stock at a specified price called the strike price. If you decide not to use the option to buy the stock, and you are not obligated to, your only cost is the Option Premium. A Put Option is an option to sell a stock at a specific price on or before a certain date. In this way, Put options are like insurance policies If you buy a new car, and then buy auto insurance on the car, you pay a premium and are, hence, protected if the asset is damaged in an accident. If this happens, you can use your policy to regain the insured value of the car. In this way, the put option gains in value as the value of the underlying instrument decreases. If all goes well and the insurance is not needed, the insurance company keeps your premium in return for taking on the risk.

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With a Put Option, you can "insure" a stock by fixing a selling price. If something happens which causes the stock price to fall, and thus, "damages" your asset, you can exercise your option and sell it at its "insured" price level. If the price of your stock goes up, and there is no "damage," then you do not need to use the insurance, and, once again, your only cost is the premium.

4.3.2 Types of Options:

Call Options Put Options

Call options:
Call options give the taker the right, but not the obligation, to buy the underlying shares at a predetermined price, on or before a predetermined date. Illustration 1: Raj purchased 1 Satyam Computer (SATCOM) AUG 150 CallPremium8 This contract allows Raj to buy 100 shares of SATCOM at Rs.150 per share at any time between the current date and the end of next August. For this privilege, Raj pays a fee of Rs.800 (Rs.8 a share for 100 shares). The buyer of a call has purchased the right to buy and for that he pays a premium. Now let us see how one can profit from buying an option. Sam purchases a December call option at Rs.40 for a premium of Rs.15. That is he has purchased the right to buy that share for Rs.40 in December. If the stock rises above Rs.55 (40+15) he will break even and he will start making a profit. Suppose the stock does not rise and instead falls he will choose not to exercise the option and forego the premium of Rs.15 and thus limiting his loss to Rs.15.

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Let us take another example of a call option on the Nifty to understand the concept better. Nifty is at 1310. The following are Nifty options traded at following quotes. Option contract Strike price Dec Nifty 1325 1345 Jan Nifty 1325 1345 Call premium Rs 6,000 Rs 2,000 Rs 4,500 Rs 5000

A trader is of the view that the index will go up to 1400 in Jan 2002 but does not want to take the risk of prices going down. Therefore, he buys 10 options of Jan contracts at 1345. He pays a premium for buying calls (the right to buy the contract) for 500*10= Rs.5,000/-. In Jan 2002 the Nifty index goes up to 1365. He sells the options or exercises the option and takes the difference in spot index price which is (1365-1345) * 200 (market lot) = 4000 per contract. Total profit = 40,000/- (4,000*10). He had paid Rs.5, 000/- premium for buying the call option. So he earns by buying call option is Rs.35, 000/- (40,000-5000). If the index falls below 1345 the trader will not exercise his right and will opt to forego his premium of Rs.5,000. So, in the event the index falls further his loss is limited to the premium he paid upfront, but the profit potential is unlimited.

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Call Options-Long & Short Positions: When you expect prices to rise, then you take a long position by buying calls. You are bullish. When you expect prices to fall, then you take a short position by selling calls. You are bearish.

Put Options:
A Put Option gives the holder of the right to sell a specific number of shares of an agreed security at a fixed price for a period of time. Illustration 1: Sam purchases 1 INFTEC (Infosys Technologies) AUG 3500 Put --Premium 200 This contract allows Sam to sell 100 shares INFTEC at Rs.3500 per share at any time between the current date and the end of August. To have this privilege, Sam pays a premium of Rs.20,000 (Rs.200 a share for 100 shares). The buyer of a put has purchased a right to sell. The owner of a put option has the right to sell. Illustration 2: Raj is of the view that the a stock is overpriced and will fall in future, but he does not want to take the risk in the event of price rising so purchases a put option at Rs.70 on X. By purchasing the put option Raj has the right to sell the stock at Rs.70 but he has to pay a fee of Rs.15 (premium). So he will breakeven only after the stock falls below Rs.55 (70-15) and will start making profit if the stock falls below Rs.55.

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Illustration 3: An investor on Dec 15 is of the view that Wipro is overpriced and will fall in future but does not want to take the risk in the event the prices rise. So he purchases a Put option on Wipro. Quotes are as under: Spot Rs.1040 Jan Put at 1050 Rs.10 Jan Put at 1070 Rs.30 He purchases 1000 Wipro Put at strike price 1070 at Put price of Rs.30/-. He pays Rs.30,000/- as Put premium. His position in following price position is discussed below. Jan Spot price of Wipro = 1020 Jan Spot price of Wipro = 1080 In the first situation the investor is having the right to sell 1000 Wipro shares at Rs.1,070/- the price of which is Rs.1020/-. By exercising the option he earns Rs. (1070-1020) = Rs.50 per Put, which totals Rs.50,000/-. His net income is Rs. (50000-30000) = Rs.20,000. In the second price situation, the price is more in the spot market, so the investor will not sell at a lower price by exercising the Put. He will have to allow the Put option to expire unexercised. He looses the premium paid Rs.30,000. Put Options-Long & Short Positions: When you expect prices to fall, then you take a long position by buying Puts. You are bearish. When you expect prices to rise, then you take a short position by selling Puts. You are bullish. CALL OPTIONS PUT OPTIONS Short Long Long Short

If you expect a fall in price(Bearish) If you expect a rise in price (Bullish)

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SUMMARY: CALL OPTION BUYER Pays premium Right to exercise and buy the shares Profits from rising prices Limited losses, Potentially unlimited gain CALL OPTION WRITER (Seller) Receives premium Obligation to sell shares if exercised Profits from falling prices or remaining neutral Potentially unlimited losses, limited gain PUT OPTION BUYER PUT OPTION WRITER (Seller) Pays premium Receives premium Right to exercise and sell shares Obligation to buy shares if exercised Profits from falling prices Profits from rising prices or remaining Limited losses, Potentially unlimited neutral gain Potentially unlimited losses, limited gain

4.3.3 Option Styles:

Settlement of options is based on the expiry date. However, there are three basic styles of options you will encounter which affect settlement. The styles have geographical names, which have nothing to do with the location where a contract is agreed! The styles are:

European:
These options give the holder the right, but not the obligation, to buy or sell the underlying instrument only on the expiry date. This means that the option cannot be exercised early. Settlement is

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based on a particular strike price at expiration. Currently, in India only index options are European in nature. E.g.: Sam purchases 1 NIFTY AUG 1110 Call --Premium 20. The exchange will settle the contract on the last Thursday of August. Since there are no shares for the underlying, the contract is cash settled.

American:
These options give the holder the right, but not the obligation, to buy or sell the underlying instrument on or before the expiry date. This means that the option can be exercised early. Settlement is based on a particular strike price at expiration. Options in stocks that have been recently launched in the Indian market are "American Options". E.g.: Sam purchases 1 ACC SEP 145 Call --Premium 12 Here Sam can close the contract any time from the current date till the expiration date, which is the last Thursday of September. American style options tend to be more expensive than European style because they offer greater flexibility to the buyer. Option Class & Series: Generally, for each underlying, there are a number of options available: For this reason, we have the terms "class" and "series". An option "class" refers to all options of the same type (call or put) and style (American or European) that also have the same underlying. E.g.: All Nifty call options are referred to as one class. An option series refers to all options that are identical: they are the same type, have the same underlying, the same expiration date and the same exercise price.

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JUL

Calls AUG Wipro

SEP

JUL

Puts AUG Wipro

SEP

1300 1400 1500

45 35 20

60 45 42

75 65 48

15 25 30

20 28 40

28 35 55

E.g.: Wipro JUL 1300 refers to one series and trades take place at different premiums All calls are of the same option type. Similarly, all puts are of the same option type. Options of the same type that are also in the same class are said to be of the same class. Options of the same class and with the same exercise price and the same expiration date are said to be of the same series.

4.3.4 Concepts OF PRICE:

Strike price:
The Strike Price denotes the price at which the buyer of the option has a right to purchase or sell the underlying. Five different strike prices will be available at any point of time. The strike price interval will be of 20. If the index is currently at 1,410, the strike prices available will be 1,370, 1,390, 1,410, 1,430, 1,450. The strike price is also called Exercise Price. This price is fixed by the exchange for the entire duration of the option depending on the movement of the underlying stock or index in the cash market.

In-the-money:
A Call Option is said to be "In-the-Money" if the strike price is less than the market price of the underlying stock. A Put Option is In-TheMoney when the strike price is greater than the market price. E.g.: Raj purchases 1 SATCOM AUG 190 Call --Premium 10 In the above example, the option is "in-the-money", till the market price of SATCOM is ruling above the strike price of Rs 190,

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which is the price at which Raj would like to buy 100 shares anytime before the end of August. Similarly, if Raj had purchased a Put at the same strike price, the option would have been "in-the- money", if the market price of SATCOM was lower than Rs 190 per share.

Out-of-the-Money:
A Call Option is said to be "Out-of-the-Money" if the strike price is greater than the market price of the stock. A Put option is Out-OfMoney if the strike price is less than the market price. E.g.: Sam purchases 1 INFTEC AUG 3500 Call --Premium 150 In the above example, the option is "out-of- the- money", if the market price of INFTEC is ruling below the strike price of Rs 3500, which is the price at which SAM would like to buy 100 shares anytime before the end of August. Similarly, if Sam had purchased a Put at the same strike price, the option would have been "out-of-the-money", if the market price of INFTEC was above Rs 3500 per share.

At-the-Money:
The option with strike price equal to that of the market price of the stock is considered as being "At-the-Money" or Near-the-Money. E.g.: Raj purchases 1 ACC AUG 150 Call or Put--Premium 10 In the above case, if the market price of ACC is ruling at Rs 150, which is equal to the strike price, then the option is said to be "at-themoney". If the index is currently at 1,410, the strike prices available will be 1,370, 1,390, 1,410, 1,430, 1,450. The strike prices for a call option that is greater than the underlying (Nifty or Sensex) are said to be outof-the-money in this case 1430 and 1450 considering that the underlying is at 1410. Similarly in-the-money strike prices will be 1,370 and 1,390, which are lower than the underlying of 1,410.

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At these prices one can take either a positive or negative view on the markets i.e. both call and put options will be available. Therefore, for a single series 10 options (5 calls and 5 puts) will be available and considering that there are three series a total number of 30 options will be available to take positions in.

Covered Call Option:

Covered option helps the writer to minimize his loss. In a covered call option, the writer of the call option takes a corresponding long position in the stock in the cash market; this will cover his loss in his option position if there is a sharp increase in price of the stock. Further, he is able to bring down his average cost of acquisition in the cash market (which will be the cost of acquisition less the option premium collected). E.g.: Raj believes that HLL has hit rock bottom at the level of Rs.182 and it will move in a narrow range. He can take a long position in HLL shares and at the same time write a call option with a strike price of 185 and collect a premium of Rs.5 per share. This will bring down the effective cost of HLL shares to 177 (182-5). If the price stays below 185 till expiry, the call option will not be exercised and the writer will keep the Rs.5 he collected as premium. If the price goes above 185 and the Option is exercised, the writer can deliver the shares acquired in the cash market.

Covered Put Option:

Similarly, a writer of a Put Option can create a covered position by selling the underlying security (if it is already owned). The effective selling price will increase by the premium amount (if the option is not exercised at maturity). Here again, the investor is not in a position to take advantage of any sharp increase in the price of the asset as the underlying asset has already been sold. If there is a sharp decline in the price of the underlying asset, the option will be exercised and the investor will be left only with the premium amount. The loss in the option exercised will be equal to the gain in the short position of the asset.

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4.3.5 Pricing of options:

Options are used as risk management tools and the valuation or pricing of the instruments is a careful balance of market factors. There are four major factors affecting the Option premium: Price of Underlying Time to Expiry Exercise Price Time to Maturity Volatility of the Underlying

And two less important factors: Short-Term Interest Rates Dividends

Review of Options Pricing Factors:

The Intrinsic Value of an Option: The intrinsic value of an option is defined as the amount by which an option is in-the-money or the immediate exercise value of the option when the underlying position is marked-to-market. For a call option: Intrinsic Value = Spot Price - Strike Price For a put option: Intrinsic Value = Strike Price - Spot Price The intrinsic value of an option must be positive or zero. It cannot be negative. For a call option, the strike price must be less than the price of the underlying asset for the call to have an intrinsic value greater than 0. For a put option, the strike price must be greater than the underlying asset price for it to have intrinsic value.

Price of underlying:

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The premium is affected by the price movements in the underlying instrument. For Call options the right to buy the underlying at a fixed strike price as the underlying price rises so does its premium. As the underlying price falls so does the cost of the option premium. For Put options the right to sell the underlying at a fixed strike price as the underlying price rises, the premium falls; as the underlying price falls the premium cost rises. The following chart summaries the above for Calls and Puts. Opt Option Underlying price Premium cost Call Put Time Value of an Option: Generally, the longer the time remaining until an options expiration, the higher its premium will be. This is because the longer an options lifetime, greater is the possibility that the underlying share price might move so as to make the option in-the-money. All other factors affecting an options price remaining the same, the time value portion of an options premium will decrease (or decay) with the passage of time. Note: This time decay increases rapidly in the last several weeks of an options life. When an option expires in-the-money, it is generally worth only its intrinsic value. Option Call Put Time to expiry Premium cost

Volatility:
Volatility is the tendency of the underlying securitys market price to fluctuate either up or down. It reflects a price changes magnitude; it does not imply a bias toward price movement in one direction or the other. Thus, it is a major factor in determining an options premium. The higher the volatility of the underlying stock, the higher the premium because there is a greater possibility that the option will move

44

in-the-money. Generally, as the volatility of an under-lying stock increases, the premiums of both calls and puts overlying that stock increase, and vice versa. Higher volatility=Higher premium Option Call Put Volatility Lower volatility = Lower premium Premium cost

Interest rates:
In general interest rates have the least influence on options and equate approximately to the cost of carry of a futures contract. If the size of the options contract is very large, then this factor may take on some importance. All other factors being equal as interest rates rise, premium costs fall and vice versa. The relationship can be thought of as an opportunity cost. In order to buy an option, the buyer must either borrow funds or use funds on deposit. Either way the buyer incurs an interest rate cost. If interest rates are rising, then the opportunity cost of buying options increases and to compensate the buyer premium costs fall. Why should the buyer be compensated? Because the option writer receiving the premium can place the funds on deposit and receive more interest than was previously anticipated. The situation is reversed when interest rates fall premiums rise. Option Call Put Interest rates Premium cost

4.3.6 Reading Stock Options Table:

In India, option tables published in business newspapers and are fairly similar to the regular stock tables. The following is the format of the options table published in Indian business news papers:

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NIFTY OPTIONS Contracts RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE Exp. Date 7/26/08 7/26/08 7/26/08 7/26/08 7/26/08 7/26/08 7/26/08 7/26/08 8/30/08 8/30/08 8/30/08 7/26/08 7/26/08 7/26/08 Str. Price 360 360 380 380 340 340 320 320 360 340 320 300 300 280 Opt. Type CA PA CA PA CA PA CA PA PA CA PA CA PA CA Open High Low 3 29 1 35 8 10 22 4 31 15 10 38 2 59 3 39 1 40 9 14 24 7 35 15 10 38 2 60 2 29 1 35 6 10 16 2 31 15 10 38 2 53 Trade No.of. Trade qty. Cont. Value 4200 1200 1200 1200 7 2 2 2 1512000 432000 456000 456000 3876000 4692000 3648000 9408000 432000 204000 192000 180000 360000 504000

11400 19 13800 23 11400 19 29400 49 1200 600 600 600 1200 1800 2 1 1 1 2 3

The first column shows the contract that is being traded i.e. Reliance. The second column displays the date on which the contract will expire i.e. the expiry date is the last Thursday of the month. Call options-American are depicted as 'CA' and Put optionsAmerican as 'PA'. The Open, High, Low, Close columns display the traded premium rates.

4.3.7 Advantages of option trading:

Risk management: Put options allow investors holding shares to hedge against a possible fall in their value. This can be considered similar to taking out insurance against a fall in the share price.

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Time to decide: By taking a call option the purchase price for the shares is locked in. Speculation: The ease of trading in and out of an option position makes it possible to trade options with no intention of ever exercising them. Leverage: Leverage provides the potential to make a higher return from a smaller initial outlay than investing directly. Income generation: Shareholders can earn extra income over and above dividends by writing call options against their shares. Strategies: By combining different options, investors can create a wide range of potential profit scenarios. To find out more about options strategies read the module on trading strategies.

4.4 TRADERS IN DERIVATIVE MARKET:

4.4.1 Hedgers:
Hedgers are the traders who wish to eliminate the risk (of price change) to which they are already exposed We have seen how one can take a view on the market with the help of index futures. The other benefit of trading in index futures is to hedge your portfolio against the risk of trading. In order to understand how one can protect his portfolio from value erosion let us take an example. Illustration: Ram enters into a contract with Shyam that six months from now he will sell to Shyam 10 dresses for Rs 4000. The cost of manufacturing for Ram is only Rs 1000 and he will make a profit of Rs 3000 if the sale is completed.

Cost (Rs)

Selling price

Profit

47

1000

4000

3000

However, Ram fears that Shyam may not honour his contract six months from now. So he inserts a new clause in the contract that if Shyam fails to honour the contract he will have to pay a penalty of Rs 1000. And if Shyam honour the contract Ram will offer a discount of Rs 1000 as incentive. Shyam defaults 1000 (Initial Investment) 1000 (penalty from Shyam) - (No gain/loss) Shyam honours 3000 (Initial profit) (-1000) discount given to Shyam 2000 (Net gain)

As we see above if Shyam defaults Ram will get a penalty of Rs 1000 but he will recover his initial investment. If Shyam honours the contract, Ram will still make a profit of Rs 2000. Thus, Ram has hedged his risk against default and protected his initial investment.

4.4.2 Speculators:
If hedgers are the people who wish to avoid the price risk, speculators are those who are willing to take such risk. Speculators are those who do not have any position on which they enter in futures and options market. They only have a particular view on the market, stock, commodity etc. In short, speculators put their money at risk in the hope of profiting from an anticipated price change Illustration: Ram is a trader but has no time to track and analyze stocks. However, he fancies his chances in predicting the market trend. So instead of buying different stocks he buys Sensex Futures. On May 1, 2001, he buys 100 Sensex futures @ 3600 on expectations that the index will rise in future. On June 1, 2001, the Sensex rises to 4000 and at that time he sells an equal number of contracts to close out his position. Selling Price: 4000*100 = Rs.4,00,000

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Less: Purchase Cost: Net gain

3600*100

= Rs.3,60,000 = Rs. 40,000

Ram has made a profit of Rs.40,000 by taking a call on the future value of the Sensex. However, if the Sensex had fallen he would have made a loss. Similarly, if would have been bearish he could have sold Sensex futures and made a profit from a falling profit. In index futures players can have a long-term view of the market up to at least 3 months.

4.4.3 Arbitrageurs:
Arbitrageurs thrive on market imperfections. An arbitrageur profits by trading a given commodity, or other item, that sells for different prices in different markets. Take the case of the NSE Nifty. Assume that Nifty is at 1200 and 3 months Nifty futures is at 1300. The futures price of Nifty futures can be worked out by taking the interest cost of 3 months into account. If there is a difference then arbitrage opportunity exists.

Let us take the example of single stock to understand the concept better. If Wipro is quoted at Rs 1000 per share and the 3 months futures of Wipro is Rs 1070 then one can purchase ITC at Rs 1000 in spot by borrowing @ 12% annum for 3 months and sell Wipro futures for 3 months at Rs 1070. Sale = 1070 Cost= 1000+30 = 1030 Arbitrage profit = 40 These kinds of imperfections continue to exist in the markets but one has to be alert to the opportunities as they tend to get exhausted very fast.

4.5 TYPES OF ORDERS:

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In the stock market, when prices of the well traded securities are quoted, full prices are seldom indicated. The various kinds of order given by various traders are as explained as below.

Market Order:

Market Order is the most common type of order and simply involves an instruction to buy or sell at the prevailing price in the market.

Limit Order:

A limit order is an order to buy or sell at a specified price, or a price better than that

Stop-Loss Order:

A stop-loss order is aimed at closing out positions when a particular price level is traded

Stop-Limit Order:

A stop-limit order is said to be placed when, for example, a client can place a stop order at a particular level with a limit beyond which the market would cease to be chased

Market if Touched (MIT):

It is a limit order which automatically becomes a market order once a predetermined price is reached.

Good Till Cancelled (GTC):

This is a clients order to buy or sell, usually at a specified price, which remains valid until its execution or cancellation. .

4.6 VARIOUS KINDS OF MARGINS:

Variation or mark-to-market margin:

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All daily losses must be met by depositing of further collateral known as variation margin, which is required by he close of business, the following day. Any profits on the contract are credited to the clients variation margin account.

Maintenance Margin:

It is typically three-forth of initial margin. Some exchanges work on the system of maintenance margin, which is set at a level slightly less than initial margin. The margin is required to be replenished to the level of initial margin, only if the margin level drops below the maintenance margin limit

Margin Call:

In the process of marking to the market, if the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is required to deposit additional funds to bring the balance to the level of initial margin in a very short period of time. The extra funds deposited are called variation margin.

Additional Margin:

In case of sudden higher than expected volatility, additional margin may be called for by the exchange. This is generally imposed when the exchange fears that the markets have become too volatile and may result in some crisis, like payments crisis, etc. this is preemptive move by exchange to prevent breakdown.

Cross Margining:

This is a method of calculating margin after taking into account combined positions in Future, options, cash market etc. Hence the total margin requirement reduces due to cross-hedges. This is unlikely to be introduced in India immediately.

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5. COMMO DITY MARKET

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DERIVA TIVES
5.1 INTRODUCTION:
Commodity derivatives have a crucial role to play in the price risk management process especially in any agriculture dominated economy. Derivatives like forwards, futures, options, swaps etc are extensively used in many developed and developing countries in the world. The Chicago Mercantile Exchange; Chicago Board of Trade; New York Mercantile Exchange; International Petroleum Exchange, London; London Metal Exchange; London Futures and Options Exchange; Marche a Terme International de France; Sidney Futures Exchange; Singapore International Monetary Exchange; The Singapore Commodity Exchange; Kuala Lumpur Commodity Exchange ; Bolsa de Mercadorias & Futuros (in Brazil), the Buenos Aires Grain Exchange; Shanghai Metals Exchange; China Commodity Futures Exchange; Beijing Commodity Exchange, etc are some of the leading commodity exchanges in the world engaged in trading of derivatives in commodities. However, they have been utilized in a very limited scale in India Although India has a long history of trade in commodity derivatives, this segment remained underdeveloped due to government intervention in many commodity markets to control prices. The government controls

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the production, supply and distribution of many agricultural commodities and only forwards and futures trading are permitted in certain commodity items. Free trade in many commodity items is restricted under the Essential Commodities Act, 1955, and forward and futures contracts are limited to certain commodity items under the Forward Contracts (Regulation) Act, 1952. Futures in gold and silver began in Mumbai in 1920 and continued until the government prohibited it by mid-1950s. Later, futures trade was altogether banned by the government in 1966 in order to have control on the movement of prices of many agricultural and essential commodities. Options are though permitted now in stock market, they are not allowed in commodities. The commodity options were traded during the pre-independence period. Options on cotton were traded until the along with futures were banned in 1939. However, the government withdrew the ban on futures with passage of Forward Contract (Regulation) Act in 1952.

5.2 COMMODITY MARKET IN INDIA:

Organized futures market evolved in India by the setting up of "Bombay Cotton Trade Association Ltd." in 1875. In 1893, following widespread discontent amongst leading cotton mill owners and merchants over the functioning of the Bombay Cotton Trade Association, a separate association by the name "Bombay Cotton Exchange Ltd." was constituted. Futures trading in oilseeds were organized in India for the first time with the setting up of Gujarati Vyapari Mandali in 1900, which carried on futures trading in groundnut, castor seed and cotton. Before the Second World War broke out in 1939 several futures markets in oilseeds were functioning in Gujarat and Punjab. There were booming activities in this market and at one time as many as 110 exchanges were conducting forward trade in various commodities in the country. The securities market was a poor cousin of this market as there were not many papers to be traded at that time. The era of widespread shortages in many essential commodities resulting in inflationary pressures and the tilt towards socialist policy, in which the role of market forces for resource allocation got diminished, saw the decline of this market since the mid-1960s. This coupled with the regulatory constraints in 1960s, resulted in virtual dismantling of

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the commodities future markets. It is only in the last decade that commodity future exchanges have been actively encouraged. However, the markets have been thin with poor liquidity and have not grown to any significant level.

5.3 MECHANICS OF FUTURES TRADING:

Futures are a segment of derivative markets. The value of a futures contract is derived from the spot (ready) price of the commodity underlying the contract. Therefore, they are called derivatives of spot market. The buying and selling of futures contracts take place in organized exchanges. The members of exchanges are authorized to carryout trading in futures. The trading members buy and sell futures contract for their own account and for the account of non-trading members and other clients. All other persons interested to trade in futures contracts, as clients must get themselves registered with the exchange as registered non-members.

5.3.1 Commodity Future Exchange:

Exchange is an association of members, which provides all organizational support for carrying out futures trading in a formal environment. These exchanges are managed by the Board of Directors, which is composed primarily of the members of the association. There are also representatives of the government and public nominated by the Forward Markets Commission. The majority of members of the Board have been chosen from among the members of the Association who have trading and business interest in the exchange. The chief executive officer and his team in day-to-day administration assist the Board. There are different classes of members who capitalize the exchange by way of participation in the form of equity, admission fee, security deposits, registration fee etc. a. Ordinary Members: They are the promoters who have the right to have own account transactions without having the right to execute transactions in the trading ring. They have to place orders with trading members or others who have the right to trade in the exchange.

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b. Trading Members: These members execute buy and sell orders in the trading ring of the exchange on their account, on account of ordinary members and other clients. c. Trading-cum-Clearing Members: They have the right to trade and also to participate in clearing and settlement in respect of transactions carried out on their account and on account of their clients. d. Institutional Clearing Members: They have the right to participate in clearing and settlement on behalf of other members but do not have the trading rights. e. Designated Clearing Bank: It provides banking facilities in respect of pay-in, payout and other monetary settlements. The composition of the members in an exchange however varies. In so me exchanges there are exclusive clearing members, broker members and registered non -members in addition to the above category of members.

5.3.2 Commodity Future Contract:

Futures contracts are an improved variant of forward contracts. They are agreements to purchase or sell a given quantity of a commodity at a predetermined price, with settlement expected to take place at a future date. While forward contracts are mainly over-thecounter and tailor-made which physical delivery futures settlement standardized contracts whose transactions are made in formal exchanges through clearing houses and generally closed out before delivery. The closing out involves buying a different times of two identical contracts for the purchase and sale o the commodity in question, with each canceling the other out. The futures contracts are standardized in terms of quality and quantity, and place and date of delivery of the commodity. The commodity futures contracts in India as defined by the FMC has the following features: (a) Trading in futures is necessarily organized under the auspices of a recognized association so that such trading is confined to or conducted through members of the association in accordance with the procedure laid down in the Rules and Bye-laws of the association.

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(b) It is invariably entered into for a standard variety known as the basis variety with permission to deliver other identified varieties known as tender able varieties. (c) The units of price quotation and trading are fixed in these contracts, parties to the contracts not being capable of altering these units. (d) The delivery periods are specified. (e) The seller in a futures market has the choice to decide whether to deliver goods against outstanding sale contracts. In case he decides to deliver goods, he can do so not only at the location of the Association through which trading is organized but also at a number of other prespecified delivery centers. (f) In futures market actual delivery of goods takes place only in a very few cases. Transactions are mostly squared up before the due date of the contract and contracts are settled by payment of differences without any physical delivery of goods taking place. The terms and specifications of futures contracts vary depending on the commodity and the exchange in which it is traded.

5.3.3 Participants In Future Market:

Broadly, speculators who take positions in the market in an attempt to benefit from a correct anticipation of future price movements, and hedgers who transact in futures market with an objective of offsetting a price risk on the physical market for a particular commodity make the futures market in that commodity. Although it is difficult to draw a line of distinction between hedgers and speculators, the former category consists of manufacturing companies, merchandisers, and farmers. Manufacturing companies who use the commodity as a raw material buy futures to ensure its uninterrupted supply of guaranteed quality at a predetermined price, which facilitates immunity against price fluctuations. While exporters in addition to using the price discovery mechanism for getting better prices for their commodities seek to hedge against their overseas exposure by way of locking-in the price by way of buying futures contracts, the importers utilize the liquid futures market for the purpose of hedging their outstanding position by way of selling futures contracts. Futures market helps farmers taking informed decisions about their crop pattern on the basis of the futures prices and reduces the risk associated with variations in their sales revenue due to unpredictable future supply

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demand conditions. Above all, there are a large number of brokers who intermediate between hedgers and speculators create the market for futures contracts.

5.3.4 Commodity Orders:

The buy and sell orders for commodity futures are executed on the trading floor where floor brokers congregate during the trading hours stipulated by the exchange. The floor brokers/trading members on receipt of orders from clients or from their office transmits the same to others on the trading floor by hand signal and by calling out the orders (in an open outcry system they would like to place and price. After trade is made with another floor broker who takes the opposite side of the transaction for another customer or for his own account, the details of transactions are passed on to the clearing house through a transaction slip on the basis of which the clearinghouse verifies the match and adds to its records.

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5.3.5 Role of Clearing House:

Clearinghouse is the organizational set up adjunct to the futures exchange which handles all back-office operations including matching up of each buy and sell transactions, execution, clearing and reporting of all transactions, settlement of all transactions on maturity by paying the price difference or by arranging physical delivery, etc., and assumes all counterparty risk on behalf of buyer and seller. It is important to understand that the futures market is designed to provide a proxy for the ready (spot) market and thereby acts as a pricing mechanism and not as part of, or as a substitute for, the ready market. The buyer or seller of futures contracts has two options before the maturity of the contract. First, the buyer (seller) may take (give) physical delivery of the commodity at the delivery point approved by the exchange after the contract matures. The second option, which distinguishes futures from forward contracts is that, the buyer (seller) can offset the contract by

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selling (buying) the same amount of commodity and squaring off his position. For squaring of a position, the buyer (seller) is not obligated to sell (buy) the original contract. Instead, the clearinghouse may substitute any contract of the same specifications in the process of daily matching. As delivery time approaches, virtually all contracts are settled by offset as those who have bought (long) sell to those who have sold (short). This offsetting reduces the open position in the account of all traders as they approach the maturity date of the contract. The contracts, if any, which remain unsettled by offset until maturity date are settled by physical delivery.

5.3.6 Margins:
Margins (also called clearing margins) are good -faith deposits kept with a clearinghouse usually in the form of cash. There are two types of margins to be maintained by the trader with the clearinghouse: initial margin and maintenance or variation margins. Initial margin is a fixed amount per contract and does not vary with the current value of the commodity traded. Margins are deposited with the clearing house in advance against the expected exposure of the trading member on his account and on account of the clients. The member who executes trade for them in turn collects this amount from the clients. Generally, the margin is payable on the net exposure of the member.

5.3.7 Future Contract Facilitates Hedging Against Price Risk:

The futures contracts are designed to deal directly with the credit risk involved in locking-in prices and obtaining forward cover. These contracts can be used for hedging price risk and discovering future prices. For commodities that compete in world or national markets, such as coffee, there are many relatively small producers scattered over a wide geographic area. These widely dispersed producers find it difficult to know what prices are available, and the opportunity for producer, processor, and merchandiser to ascertain their likely cost for coffee and develop long range plans is limited. Futures trading, used in the Midwest for grains and similar farm commodities since 1859, and adapted for coffee in 1955, provides the industry with a guide to what coffee is worth now as well as todays best estimate for the future. Moreover, since all transactions are guaranteed through a central body, clearing house, which is the counter party to each buyer and seller

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ensuring zero default risk, market participants need not worry about their counterparts creditworthiness. Hedge is a purchase or sale on a futures market intended to offset a price risk on the physical (ready) market. It involves establishing a position in the futures market again ones position or firm commitments in the physical market. The producers who seek to protect themselves from an expected decline in prices of their commodity in future go for short hedge (also called sell hedge). He undertakes the following operations in the market to lock-in the price in advance which he is going to receive after the product. I ready for physical sale. We assume that the producer anticipates a harvest of 5 metric tones (equivalent to 2 units of contracts in Cochin pepper exchange) of pepper in March, the futures price for March delivery of the specific variety of pepper is Rs.8400 per quintal (Rs.2.10lakh per unit, and the prevailing (say, October) ready market price is Rs.8100 per quintal.

5.4 TRADED EXCHANGE:

ITEMS

IN

COMMODITY

Bullion: Gold, Gold M, Gold HNI, Silver, Silver M, Silver HNI Oil & Oil Seeds: Castor Seeds, Soy Seeds, Castor Oil, Refined Soy Oil, Soy meal, RBD Palmolein, Crude Palm Oil, Groundnut Oil, Mustard Seed, Mustard Seed Oil, Cottonseed Oilcake, Cottonseed Spices: Pepper, Red Chilly, Jeera, Turmeric Metal: Steel Long, Steel Flat, Copper, Nickel, Tin

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Fiber: Kapas, Long Staple Cotton, Medium Staple Cotton Pulses: Chana, Urad, Yellow Peas, Tur Cereals: Rice, Basmati Rice, Wheat, Maize, Sarbati Rice Energy: Crude Oil Others: Rubber, Guar Seed, Gur, Guargum Bandhani, Guargum, Cashew Kernel, Guarseed Bandhani

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6. RESE ARCH STUDY

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6.1 RESEARCH OBJECTIVE:

The main objective of the study is to check literacy ratio of Derivatives & Commodities and their potential market among the people of Rajkot City.

Some other secondary objectives are as under:

To know the awareness about Derivatives & Commodities. To know the scope of the Derivatives & Commodities. To know the investment habit of the people of Rajkot City. To know the purpose of investing in Derivative & Commodities. To know the influencing force behind the decision making while trading in derivatives and Commodities. To find out the best pattern to educate about Derivatives & Commodities. To find out the medium which is the best suitable for trading on Derivatives & Commodities.

HYPOTHESIS: H0: The degree of literacy about derivatives commodities among the people of Rajkot City is less. H1: The degree of literacy about derivatives & commodities among the People of Rajkot City are high. &

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6.2 SOURCES OF DATA:

There are mainly two sources of data i.e.

Primary Secondary Primary Data:

The data, which is collected directly from the respondents to the base of knowledge and belief of the research, are called primary data. The normal procedure is to interview some people individually to get a sense of how people feel about the derivatives & commodities segment. So far as our research is concerned, primary data is the main source of information. We have collected data through Questionnaire and information from respondent.

Secondary Data:
When data are collected and compelled from the published nature or any others primary data is called secondary data. So far as our research is concerned, we have not collected any information from any sources. So, we have not used secondary data for our research

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6.3 SAMPLING PROCESS:

It is very true that its very difficult to do the research with the whole universe. As we know that it is not feasible to go for population survey because of the numerous customers and their scattered location. So for this purpose sample size has to be determined well in advance and selection of sample also must be scientific so that it represents the whole universe. So far as our research is concerned, we have taken sample size of 300 respondents. We have selected Income Earners with savings to invest in Rajkot city. All the respondents are stratified on the basis of their profession and savings. We have selected the samples as per our convenience.

Sample universe Sampling Technique Sample size

Rajkot city Stratified and Random 300 respondents Professional = Random Business Man = Random Government Employees = Random Employees working in private firms = Random

Sampling Unit:

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6.4 SCOPE OF STUDY:

The research that is being conducted by us will be useful in the following respect. This will help the company, how to make people aware about derivatives & commodities by imparting best education. This will help the company to know the taste of masses and turn it towards derivatives & commodities. This will help the company to frame effective Marketing Strategy. This will also help to select the right media for advertising to create brand awareness as well as to give knowledge of the products. This will also help to select right medium for trading in derivatives & commodities segment. This will help the company to reduce the obstacles which come in the way for the development of derivatives & commodities segment.

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6.5 LIMITATION OF THE STUDY:

The limitations of this study are as follows:

Personal Bias:
People may have personal bias towards particular investment option so they may not give correct information and due to which conclusion may be derived.

Time Limit:
The time duration of the research is short thats why the information is not covered fully.

Area:
The area was limited to Rajkot city only, so we can not know the degree of the literacy outside the city.

Sample Size:
The last limitation is Sample size, taken by us is of 300 only; due to which we may not get the proper results.

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6.6 ANALYSIS OF STUDY:

1. Gender Ratio:
Male 186 Female 114

2. Age:

Age

21 35 183

36 50 24

51 65 93

Above 66 0

3. Educational Qualification:
Post Graduate 114 Under Graduate 0

Qualification

Graduate 186

4. Occupation:
Business Man 45 Employees working in Pvt. Firm 69 Govt. Employees 72

Professionals 114

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5. Investment Pattern of the people:

Securities Bank FD Mutual Fund Shares/ Equity Postal Scheme Insurance Real Estate Govt. Securities Bonds/Debentures Jewellery Nos. 231 138 186 207 231 162 114 138 231 Percentage (%) 77 46 62 69 77 54 38 46 77

250 200 150 100 50 0 Bank FD Postal Scheme G-secs Mutual Fund Insurance Bonds/Debentures Shares/ Equity Real Estate Jew ellery

It can be seen from the graph that the respondents have given first preference for investment to Bank FD. Insurance and Jewellary are at 77% while postal schemes, shares/equities have almost equal share with second and third position. We can say

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that the respondents are not in favor of taking risk. But by seeing the shares on second preferences we can say that people are now turning towards capital market.

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6. Instruments in which people are trading:

Instruments Equity Derivative Commodities Nos. 207 114 45 Percentage (%) 69 38 15

250

200

150

100

50

0 Equity Derivative Commodities

Nos. 207 114 45

When asked to the respondents that out of the given three options in which they are trading. Equity got the first preference by 69%. While derivatives i.e. F&O has got second rank and commodities has been least preferred now a days.

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7. Instruments in which people want to be trade in:

Instruments Equity Derivative Commodities Nos. 93 93 114 Percentage (%) 31 31 38

120 100 80 60 40 20 0 Equity Derivative Commodities

Nos. 93 93 114

On asked about their preferences for trading in future, the respondents have shown equal interest in equity and commodity with 38% followed by derivatives. From this we can say that commodity segment has got a brighter future.

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8. The Constraints those are decreasing the use of Derivatives & Commodities segment:

Obstacles Risk Taking Ability Fund Facilities Lack of Knowledge Non Availability of Option with the Broker Regulatory Constraints Still in wait & see Lack of Guidance

Nos. 69 69 45 24 24

Percentage (%) 23 23 15 08 08

While questioned about the constraints which hold them back from trading in derivatives and commodities, respondents have given the maximum votes to their Risk awareness and lack of funds with 23% each. While the lack of knowledge about derivatives and commodities is also one of the big constraints followed by lack of guidance.

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9. Factors that are to be considered by people while jumping in to Derivative & Commodity segment:
Factors Risk Reduction To Increase Leverage Investment Arbitrage Speculation Nos. 28.4 21.9 24.6 11.4 13.7 Rank 1 3 2 5 4

30 25 20 15 10 5 0 Risk Reduction To Increase Leverage Investment Arbitrage Speculation Nos. 28.4 21.9 24.6 11.4 13.7

While investigating the factors which have been given the maximum importance by investors while trading in derivatives and commodities we have come up with Risk Reduction as the first priority with 28.4%, while 24.6% people have considered it as an investment option near to that almost 22% people are using derivatives and commodity as a tool to increase the leverage. So, in future derivatives and commodities can be highlighted as an investment option which given higher leverage.

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10. Factors which people takes into consideration while taking the decision to trade in Derivatives & Commodities:
Factor Independently Broker/Agents advice News Channel News Papers Internet Advice of Friends/Colleagues Advice of CA/Tax consultants Well-known Stock Broking Houses Business Magazines Percentage (%) 14.3 11.6 9.3 8 11.3 12 9.7 12 11.8 Rank 1 5 8 9 6 2 7 2 4

Business Magazines 12% Well-known stock Broking Houses 12% Advice of CA/Tax consultant s 10% Advice of Friends/Coll eagues 12%

Independe ntly 14%

Broker/Age nt's advice 12%

News channel 9% News Papers 8%

Internet 11%

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On asked to the respondents that while deciding to trade in derivative commodities, which do they consider the reliable source of information. We come up with the conclusion that most of investors take their decision independently. While they consider Business Magazines, Advice of friends/colleagues and services of well known stock broking houses equally important. Also brokers have a good knowledge on investment. So, stock broking houses like Marwadi can plan out their strategy to increase the trading on derivatives and commodities.

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11. Tools preferred by the people while learning Derivatives & Commodities:
Tools Classroom Teaching Literature Self-Experience Internet Documentaries Seminars Nos. 114 114 207 93 69 Percentage (%) 38 38 69 31 23

70 60 50 40 30 20 10 0 Classroom Teaching Literature Self-experience Internet Documentaries Seminars Percentage (%) 38 38 69 31 23

When the respondents were asked about the learning technique on derivatives and commodities, the most of them preferred preference self experience that is they wanted to learn through trial n error: after all Experience is The Best Teacher.

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12. Time which people can devote to learn Derivatives & Commodities:

Time 1 day 2 days 3 days 2 hrs per day over 1 month Cant say

Nos. 45 93 24 45 93

Percentage (%) 15 31 8 15 31

1 day 15% can't say 31%

2 days 31% 2 hrs a day over 1 month 15%

3 days 8%

When asked about the time which the respondents would like to devote for learning about derivatives and commodities, 31% were not sure about the time limit. It means it depends and varies on person to person.

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13. Most preferred medium for trading in Derivatives & Commodities:

Medium Stock Broking Cos. (Branded) Online Brokers Franchisees Percentage (%) 33.1 25.8 25.8 15.3 Rank 1 2 2 3

Online 26%

Stock Broking Cos. (Brande d) 33%

Brokers 26%

Franchis ees 15%

While finding out the medium which people consider the most reliable while trading derivatives and commodities, the respondents gave maximum vote to Branded Stock Broking Houses like Sharekhan, ICICIdirect.com, and Kotakstreet.com. While the second choice was given to local brokers. So from the above we can say that if proper attention is given on online trading and brokers the chances of development of derivatives and commodities would be increasing.

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14. Most preferred Broking companies of the city:

Broking Company Angel broking Marwadi Share khan India bulls Icici direct Kotak securities HDFC Securities Motilal Oswal Karvy Percentage (%) 10.20 29.30 14.10 08.90 25.00 05.10 03.80 01.20 02.40 Rank 4 1 3 5 2 6 7 9 8

karvy 2% HDFC Securities 4% Motilal Oswal 1%

angel broking 10%

icici direct 25%

marwadi 30%

kotak securities 5% inda bulls 9% share khan 14%

This question was one of the most crucial for investigating the mind share of stock broking houses. In this question we came up with the company which is one of the leading in stock broking industry i.e. marwadi the next close challenger was icici direct followed by sharekhan.

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15. Individual perception and knowledge:

True 54.8 False 32.7 Cans Say 12.5

Cans Say 13%

False 33%

True 54%

In this question we asked eight sub questions on derivatives and commodities segment. Almost 55% questions were correctly answered by the respondents; while 32.7% were false. So, we can say that the people have more or less knowledge about derivatives and commodities.

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6.7 FINDINGS:
Most of the people in Rajkot City are investing in fixed return instruments but there are investors who use Equity as an investment tool. Those people who want to invest in Derivatives & Commodities are investing mainly for reducing risk and they consider them as investment tool. People generally want to take trading decision independently or under the guidance of Friends or Well known Stock Broking Houses. Literature and self Experience can be taken as the best method to impart education about derivatives & commodities. More than 40% of the respondents are interested to invest into the stock market.

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6.8 CONCLUSION:
Marwadi needs to make its marketing team strong and also it should increase marketing activities such as promotional campaigns. Marwadi should educate the investors about Derivatives & Commodities by organizing classes, corporate presentations, taking part in consumer fairs, organizing events. Marwadi should show the benefits of trading on Derivatives & Commodities. Marwadi should turn existing customer (who are trading in equity only) towards Derivatives & Commodities. Marwadi can also use Newspapers and Local New Channels as a medium of advertising. Marwadi should start helpline number specifically for clients who are dealing in Derivatives & Commodities. Marwadi may appoint special team for giving education & attracting people towards trading on Derivatives & Commodities.

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6.9 TESTING OF HYPOTHESIS:

Testing of hypothesis using Z test (two tailed):
The null hypothesis (H0): There is no significant difference in level of knowing the different investment avenues in the current capital market among the people of Rajkot City. Therefore, H0: = 50% H1: 50%

Level of significance: The level of significance should be set at = 0.05 The statistical test: Z = X - / x Where, Z = No.of standard deviations for the desired level of confidence. X = Means of the sample = Means of the population or hypothetical mean x = Estimation for the standard error or the mean The decision rule: 1.000 (1-0.025) = 0.975 1.9=0.6 = 1.963 & -1.96 (the result will be between two) . x = 5 / 300 1 Z = 55 50 / 0.8676 = 15 / 17.29 = 5.763 = 0.8676 Draw a statistical conclusion: The absolute value of the computerized Z statistic (5.763) is larger than 1.6, therefore null hypothesis is rejected. So Alternate Hypothesis is accepted. H1: There is significant difference in level of knowing the different investment avenues in the current capital market among the people of Rajkot City,

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6.10 QUESTIONNAIRE:
THE DEGREE OF LITERACY ABOUT DERIVATIVES & COMMODITIES IN THE PEOPLE OF RAJKOT CITY.
Gender: Age: Education: Occupation: Male: Below 30: 46-60: O O O Female: O

31-45: O Above 60: O O O Graduate: O O O Businessmen: O Govt. Employee: O

Undergraduate: PG:

Professional: Employees working: In Pvt. Firms:

Of this investment options, where do you invest your savings? Bank FD: Mutual Funds: Real Estate:O O O Postal Scheme: Insurance: O O Jewellary: Shares/Equity: O O

If you invest in stock market which would be you preference from below: Equity: O Derivatives:O Commodity: O

Which factor plays crucial role when you make a decision to invest in stock market: Risk Reduction: Leverage Benefit: Arbitrage Benefit: O O O Speculative Motive: Investment: O O

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How do you take decision if you want to invest in stock market (Give rank) Independently: Broker/Agents advice: News Channels: Newspapers: Internet: O O O O O Advice of friends/colleagues: Advice from CA/Tax Consultant: Well-known stock broking house: Business Magazines: O O O O

Which stock exchange would you prefer to carry out you transaction? BSE: O NCDEX: O NSE: O MCX: O

Do you consider investment in stock market, are safer than other investment avenues? YES: O NO: O

If no than which constraints that are holding you back? Lack of knowledge: O Lack of fund availability: O Lack of guidance from broker:O Lack of Risk Taking ability: O

How much time will you be able to devote for learning stock market? 1 Day: 2 hrs per day over 1 week: O O 2 Days: O Cant Say: O 3 Days: O

According to you, which medium is the most reliable for trading in stock market? (Give Rank) Stock Broking cos. (Branded):O Franchisees: Brokers: O O Online: O

Name any 5 Stock-broking companies that you like to recommend (Give Rank). Marwadi O Kotak Street(online) Indiabulls O Motilal Oswal ICICI direct.com O

O O

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Bibliography
For preparation of this project report I have collected information from various sources like visiting various websites, referring to journals, publications. For gathering information we have also referred to various books on Futures & Options written and published by different authors and publications. Following are some of the major sources we have referred to for getting information:

Web Sites Referred:

www.marwadionline.com www.nseindia.com www.bseindia.com www.derivativesindia.com www.sharekhan.com www.sebi.com www.cboe.com

Books Referred:
Future And Options
By: N.D. Vohra and B.R. Bagri

Options And Futures In Indian Perspective By: D.C. Patwari

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Glossary
American style options: An option contract that may be exercised at any time between the date of purchase and the expiration date. Arbitrage: The purchase or sale of a security in one market and the simultaneous purchase or sale in another to take advantage of price differentials. At-the-money: An option is said to be at the money if it would lead to zero cash flow if exercised immediately. When the price of the underlying security is equal to the strike price, an option is at-the-money. Basis: The difference between the Index and the respective contract is the basis i.e. cash netted for the Futures price. A negative basis means Futures are at a premium to cash and vice versa. It is the strengthening and weakening of basis that is tracked by market players i.e. whether the basis is widening or narrowing. A widening of basis is indicative of increasing longs and narrowing means increasing short positions. Basis Point: It is equal to one hundredth of a percentage point Bear market: A market where prices are falling. Brokerage fee: A fee charged by a broker for execution of a transaction. The fee may be a flat amount or a percentage. Bull market: A market where prices are continuously rising.

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Call option: A call option gives the buyer the right but not the obligation, to buy the underlying security at a specific price for a specified time. The seller of a call option has the obligation to sell the underlying security should the buyer exercise his option to buy. Class of options: Options contracts of the same type (call or put) and style (American or European) that covers the same underlying asset. Close out: A purchase or sale transaction leaving a trader with a zero net position. Closing buys transaction: Means a buy transaction which will have the effect of partly or fully offsetting a short position. Closing sells transaction: Means a sell transaction which will have the effect of partly or fully offsetting a long position. Cost of carry: Costs incurred in warehousing a physical commodity including interest for purchase storage & insurance Day order: A day order, as the name suggests is an order which is valid for the day on which it is entered. If the order is not executed during the day, the system cancels the order automatically at the end of the day. Day trader: Speculators who take positions in futures or options contracts and liquidate them prior to the close of the same trading day, thereby avoiding overnight margin calls. Delivery month: Is the month in which delivery of futures contracts need to be made.

Delivery price:

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The price fixed by the clearinghouse at which deliveries on futures contracts are invoiced. Also known as the expiry price or the settlement price. Derivative: A financial instrument designed to replicate an underlying security for the purpose of transferring risk. Derivative instruments: A derivative instrument is an instrument whose value is derived from the value of one or more underlying which can be commodities, precious metals, currency, bonds, stock, stock indices etc.. European style options: An option contract that may be exercised only during a specified period of time just prior to its expiration Exercise settlement amount: The difference between the exercise price of the option and the exercise settlement value of Index on the day an exercise notice is tendered, multiplied by the index multiplier. Expiration date: The last day on which an option may be exercised. Exercise / Assignment: When you buy an option you have the right either to purchase or sell the underlying at a predetermined price. When if you choose to purchase or sell the underlying at the predetermined price you are said to be exercising your right. Fair value: Theoretical value of a futures contract derived from a mathematical model of valuation.

Forward contracts: A forward contract is contract between two parties where settlement takes place on a specific date in future at a price agreed today. Futures:

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Futures are exchange traded contracts to sell or buy financial instruments or physical commodities for Future delivery at an agreed price. Give up trades: The purpose of this functionality is to provide the clearing member users to confirm or reject the trades, on orders entered by other trading members, on behalf of Participants, clearing through the clearing member. GTC: A Good Till Cancelled (GTC) order remains in the system until it is cancelled by the user. GTD: A Good Till Days (GTD) order allows the user to specify the number of days / date till which the order should stay in the system if not executed. Hedge: A conservative strategy used to limit investment loss by effecting a transaction which offsets an existing position. Holder: Purchaser of option. In-the-money: An option is said to be in the money if it would lead to a positive cash flow to the holder if it were exercised immediately. A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in the money if the strike price is greater than the market price of the underlying security. Initial margin: The amount of money required to be paid by market participant in the F&O segment at the time they place orders to buy or sell contracts. Intrinsic value: The amount by which an option is in the money Kill / Fill Order:

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An Immediate or Cancel (IOC) order allows the user to buy or sell a contract as soon as the order is released into the system, failing which the order is cancelled from the system. Long Position: Long Position in a derivatives contract means outstanding purchase obligations in respect of a permitted derivatives contract at any point of time. Mark to market: Process of revaluing positions daily using daily settlement prices to obtain profit or loss. Market order: An order to buy or sell a contract at whatever price is available at the time of entering the order on the system. Net position: The difference between the buy and sell contracts held by a trader. Offer: Willingness to sell a contract at a given price. Open Interest: Open Interest means the total number of Derivatives Contracts of an underlying security that have not yet been offset and closed by an opposite Derivatives transaction nor fulfilled by delivery of the cash or underlying security or option exercise. For calculation of Open Interest only one side of the Derivatives Contract is counted. Opening buys transaction: Means a buy transaction which will have the effect of creating or increasing a long position.

Opening sells transaction: Means a sell transaction which will have the effect of creating or increasing a short position

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Out-of-money: An option is said to be out of money if it would lead to a negative cash flow to the holder if it were exercised immediately. A call option is out of money if the strike price is greater than the market price of the underlying security. A put option is out of money if the strike price is less than the market price of the underlying security. Options: When you sell an option you now have an obligation to sell or purchase the underlying. You have or may not have to fulfill that obligation. When you are required to fulfill the obligation to either purchase or sell the underlying you are said to be assigned. Typically this occurs when the option is in the money. Option holder: The person who buys the option contract is known as the holder of an option. In purchasing the option, the buyer makes payments and receives rights to buy or sell the underlying on specific terms. Option premium: The premium is the price at which the contract trades. The premium is the price of the option and is paid by the buyer to the writer or seller of the option. In return, the writer, of a call option is obligated to deliver the underlying security to an option buyer if the call is exercised or buy the underlying security if the put is exercised. The writer keeps the premium whether or not the option is exercised. Price priority: Price priority means that if two orders are entered into the system, the order having the best price gets the priority. Put Call Ratio: It is the ratio of put to call in terms of either open interest or in volume terms

Put option: A put option gives the buyer the right, but not the obligation, to sell an underlying security at a specific price for a specified time. The seller of a put option has the obligation to buy the underlying security should the buyer choose to exercise his option to sell.

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Regular lot/Market Lot: Means the number of units that can be bought or sold in a specified derivatives contract as specified by the F&O Segment of the Exchange from time to time. Series: All option contracts of the same classes that have the same expiration date and strike price. Settlement Date: Means the date on which the settlement of outstanding obligations in a permitted Derivatives contract are required to be settled as provided in these Regulations. Short Position: Short position in a derivatives contract means outstanding sell obligations in respect of a permitted derivatives contract at any point of time. Strike price: The stated price per unit for which the underlying index may be purchased (incase of a call) or sold (in the case of a put) by the option holder upon exercise of the option contract. Time priority: Time priority means if two orders having the same price are entered, the order which entered the trading system first gets the highest priority. Type: The classification of an option contract as either a call or put. Writer: The seller of an option contract.

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