1.

1 INTRODUCTION OF DERIVATIVES The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by very high degrees of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset Prices. As instruments of risk management, these generally do not influence the Fluctuations in the underlying asset prices. However, by locking in asset prices, Derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation or risk-averse investors. Derivatives are risk management instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, share, bonds, Currency, Interest, etc., Banks, Securities firms, Companies and investors to hedge risks, to gain access to cheaper money and to make profit, use derivatives. Derivatives are likely to grow even at a faster rate in future. DEFINITION OF DERIVATIVES Derivative is a product whose value is derived from the value of an underlying asset in a contractual manner. The underlying asset can be Equity, Forex, Commodity or any other asset.

A contract which derives its value from the prices, or index of prices, of underlying securities.

Securities Contract (Regulation) Act, 1956 (SC A) defines debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security
1

1.2 NEED FOR THE STUD The study is limited to Derivatives with special reference to futures and Option in the Indian context and the Inter-Connected Stock Exchange have been taken as a representative sample for the study.

The study cant be said as totally perfect. Any alteration may come.

The study has only made a humble Attempt at evaluation derivatives market only in India context.

The study is not based on the international perspective of derivatives markets, which exists in NASDAQ, CBOT etc.

1.3 OBJECTIVES OF THE STUDY To understand the concept of the Derivatives and Derivative Trading. To know different types of Financial Derivatives. To know the role of derivatives trading in India. To analyze the performance of Derivatives Trading since 2001 with special reference to Futures & Options. To know the investors perception towards investment in derivative market.

1.4 METHODOLOGY OF THE STUDY

The data collection of the study consists of two kinds of data.

Primary data Personal observation Discussions with the management Personal interaction with employees

Secondary data

The companys annual records The company trade journals Company manuals and magazines Web sites. Financial management text books. Printed materials. Journals & magazines. News papers. Text books. World wide webs. Company maintained reports.

1.5 LIMITATIONS OF THE STUDY

In spite of honest and sincere efforts, there are certain discrepancies and inconsistencies. The limitations are. The study is restricted to limited period The firm refused to disclose some confidential information The company has restricted to give the information for more than four years The study was conducted with the data available and the analysis was made accordingly. It is restricted to Hyderabad only. This study is completely based on information given by th

Company Profile India Infoline:We were originally incorporated on October 18, 1995 as Probilty Research and Services private Limited at Mumbai under the Companies Act, 1956 with Registration No. 11 93797. We commenced our operations as an independent provider of information, analysis and research covering Indian business, financial markets and economy, to institutional Customers. We became a public limited company on April 28, 2000 and the name of the Company was changed to Probity Research and Services Limited. The name of the company was changed to India infoline.com Limited on May 23, 2000 and later to India Infoline Limited on March23, 2001. In 1999, we identified the potential of the Internet to cater to a mass retail segment and transformed our business model from providing information services to institutional customers to retail customers. Hence we launched our Internet portal, www.indianfoline.com in May 1999 and started providing news and market information, independent research, interviews with business leaders and other specialized features. In May 2000, the name of our Company was changed to India Infoline.com Limited to reflect the transformation of our business. Over a period of time, we have emerged as one of the leading business and financial information services provider in India. In the year 2000, we leveraged our position as a provider of Financial information and analysis by diversifying into transactional services, primarily for online trading in shares and securities and online as well as offline distribution of personal financial products, like Mutual funds and RBI Bonds. These activities were carried on by our wholly owned subsidiaries. Our broking services was launched under the brand name of 5paisa.com through our subsidiary, India Infoline Securities Private Limited and www.5paisa.com, the e-broking portal, was launched for online trading in July 2000. It combined competitive brokerage rates and research,

supported by Internet technology Besides investment advice from an experienced team of research analysts, we also offer real time stock quotes, market news and price chars with multiple tools for technical analysis. Acquisition of Agri Marketing Services limited(Agri) In March 2000, we acquired 100% of the equity shares of Agri Marketing services Limited, from their owners in exchange for the issuance of 508,482 of our equity shares. Agri was a direct selling agent of personal financial products including mutual funds, fixed deposits, corporate bonds and post-office instruments. At the time of our acquisition, Agri operated 32 branches in South and West India. Serving more than 30,000 customers with a staff of, approximately 180 employees. After the acquisition, we changed the company name to India Infoline.com Distribution Company Limited. Facilities Out main offices are located in approximately 4,000 square feet of office space located in Mumbai, India. Our India Infoline Branches collectively occupy an additional 10,000 square feet of office space located throughout India, as on March 31,2005 we have 73 brnaches across 36 locations in India.

Previous Address 208-C, Agarwal Market, Vile Pane (East) Mumbai 400 057 1. Snehdeep, Gokhale Road Vile Parle (East) Mumbai 400 057 Goregaon (E), Mumbai 400 057 Reason for Change Requirement of more floor space

New Address 1. Snehdeep, Gokhale Road Vile Parle (East) Mumbai 400 057 Building No.24, 1st floor, Nirlon Complex, Off Western Express Highway,

Date of Change August 6, 1999

Jan, 15, 2001

The instances when the name of the Company was changed are cited below: Previous name Probity Research and Services Private-Limited Probity Research and Services Limited India Infoline.com Limited Date of Change April 28, 2000 Public Limited Company May 23, 2000 through an online set-up To focus on the retail financial intermediary business India Infoline Limited Reason for change Conversion from Private Limited to New Name Probity Research and Services Limited India Infoline.com Limited

Milestones 1995 -Incorporated as an equity research and consulting firm with a client base that included leading FIIs, banks, consulting firms and Corporate. 1999 -Restructured the business model to embrace the internet; launched archives.indianfoline.com mobilized capital from reputed private equity investors. 2000 -Commenced the distribution of personal financial products; launched online equity trading; entered life insurance distribution as a corporate agent. Acknowledged by Forbes as Best of the Web and must read for investors. 2004 -Acquired commodities broking license; launched Portfolio Management service. 2005 -Listed on the Indian stock markets -India Infoline fixes a price band between Rs 70 and Rs 80 for its forthcoming public issue. The company is coming out with public issue of 1.18 crore shares with a face value of Rs 10 through the book building route. The issue is slated to open on April 21 and close on April 27. Enam Financial Consultants Private Ltd would be the sole book running lead manager to the issue while Intimate Spectrum Registry Ltd is the registrar to the issue. -India Infoline public issue gets 6.6 times oversubscription. -IIL appoints R Mohan as VP

-India Infoline Ltd has informed that the Company has entered into a advertising agreement with Times Group where in the Company and other group companies would spend about Rupees Thirty Crores over the next 5 years in print as well as non print media of The Times Group. -India Infoline to buy 75-pc stake in Money tree 2006 -India Infoline launches exclusive SMS Value Added Service -India infoline enters into strategic agreement with Saraswat Bank -India Infoline to launch stock trading on cell phones -India Infoline to roll out MCX, NCDEX, DGCX software -Acquired membership of DGCX; launched investment banking services 2007 -Launched a proprietary trading platform; inducted and institutional equites team; formed a Singapore subsidiary; raised over USD 300 mn in the group; launched consumer finance business under the Money line brand. 2008 -Launched wealth management services under the IIFL Wealth brand; set up Indian Infoline Private Equity fund; received the Insurance broking license from IRDA; received the venture capital license; received in principle approval to sponsor a mutual fund; received Best brokerIndia award from Finance Asia; Most Improved Brokerage-India award from Asia money. -India Infoline Ltd has informed that the Board of Directors of the Company have vide circular resolution passed on March 10, 2008 approved the appointment of Mr. A.K. Purwar, exChairman of the State Bank of India, as an independent director on the Board of the Company.

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-India Infoline Ltd has informed that pursuant to the resignation of Mr. Nimish Mehata, Company Secretary and Compliance Officer of the Company. Ms. Falguni Sanghvi has been appointed as the Company Secretary with effect from October 07, 2008 -The Company has splits its face value from Rs 10/- to Rs 2/2009 -Received registration for a housing finance company from the National Housing Bank; received Fastest growing Equity Broking house.

INDUSTRY PROFILE The Indian broking industry is one of the oldest trading industries that have beenaround even before the establishment of the BSE in 1875. Despite passing throughnumber of changes in the post liberalization period, the industry has found its wayonwards sustainable growth. With the purpose of gaining a deeper understandingabout the role of the Indian stock broking industry in the countrys economy, we present in this section some of the industry insights gleaned from analysis of datareceived through primary research.F o r t h e b r o k i n g i n d u s t r y , w e s t a r t e d w i t h a n i n i t i a l d a t a b a s e o f o v e r 1 , 8 0 0 broking firms that were contacted, from which 464 responses were received. The listw a s f u r t h e r s h o r t l i s t e d b a s e d o n t h e n u m b e r o f t e r m i n a l s a n d the top 210. weres e l e c t e d f o r p r o f i l i n g . 3 9 4 r e s p o n s e s , t h a t p r o v i d e d m o r e t h a n 8 5 % o f t h e information sought have been included for this analysis presented here as insights.All the data for the study was collected through responses received directly from the b r o k i n g firms. The insights have been arrived at through an analysis on various parameters, pertinent to the equity broking industry, such as region, t e r m i n a l , market, branches, sub brokers, products and growth areas.Some key characteristics of the sample 394 firms are: On the basis of geographical concentration, the West region has the maximumrepresentation of 52%. Around 24% firms are located in the North, 13% in theSouth and 10% in the East13DC School of Management and Technology % firms started broking operations before 1950, 65% between 1950-1995 and32% post 1995. On the basis of terminals, 40% are located at Mumbai, 12% in Delhi, 8% inAhmedabad, 7% in Kolkata, 4% in Chennai and 29% are from other cities

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From this study, we find that almost 36% firms trade in cash and derivativesand 27% are into cash markets alone. Around 20% trade in cash, derivativesand commodities I n t h e c a s h m a r k e t , a r o u n d 3 4 % f i r m s t r a d e a t N S E , 1 4 % a t B S E a n d 5 2 % trade at both exchanges. In the derivative segment, 48% trade at NSE, 7% atBSE and 45% at both, whereas in the debt market, 31% trade at NSE, 26% atBSE and 43% at both exchanges Majority of branches are located in the North, i.e. around 40%. West has 31%,24% are located in South and 5% in East In terms of sub-brokers, around 55% are located in the South, 29% in West,11% in North and 4% in East Trading, IPOs and Mutual Funds are the top three products offered with 90%f i r m s o f f e r i n g t r a d i n g , 6 7 % I P O s a n d 5 3 % f i r m s o f f e r i n g m u t u a l f u n d transactions I n t e r m s o f v a r i o u s a r e a s o f g r o w t h , 8 4 % f i r m s h a v e e x p r e s s e d i n t e r e s t i n expanding their institutional clients, 66% firms intend to increase FII clientsand 43% are interested in setting up JV in India and abroad In terms of IT penetration, 62% firms have provided their website and around94% firms have email facility

Act, 1956w i t h R e g i s t r a t i o n N o . 1 1 9 3 7 9 7 . I n d i a I n f o l i n e c o m m e n c e d o p e r a t i ons as anindependent provider of information, analysis and research c o v e r i n g I n d i a n businesses, financial markets and economy, to institutional customers. India Infoline became a public limited company on April 28, 2000 and the name of the Companywas changed to Probity Research and Services Limited. The name of the Companyw a s c h a n g e d t o I n d i a I n f o l i n e . c o m L i m i t e d o n M a y 2 3 , 2 0 0 0 a n d l a t e r t o I n d i a Infoline Limited on March 23, 2001.In 1999, India Infoline.com identified the potential of the Internet to cater toa m a s s r e t a i l s e g m e n t a n d t r a n s f o r m e d o u r b u s i n e s s m o d e l f r o m p r o v i d i n g information services to institutional customers to retail c u s t o m e r s . H e n c e I n d i a Infoline launched Internet portal, www.indiainfoline.com in May 1999 and started p r o v i d i n g n e w s a n d m a r k e t i n f o r m a t i o n , i n d e p e n d e n t r e s e a r c h , i n t e r v i e w s w i t h business leaders and other specialized features.In May 2000, the name of India Infoline was changed to India Infoline.comLimited to reflect the transformation of our business. Over a period of time, IndiaInfoline.com has emerged as one of the leading business and financial informationservices provider in India.

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A BRIEF HISTORY India Infoline was originally incorporated on October 18, 1995 as ProbityResearch and Services Private Limited at Mumbai under the Companies Act, 1956w i t h R e g i s t r a t i o n N o . 1 1 9 3 7 9 7 . I n d i a I n f o l i n e c o m m e n c e d o p e r a t i ons as anindependent provider of information, analysis and research c o v e r i n g I n d i a n businesses, financial markets and economy, to institutional customers. India Infoline became a public limited company on April 28, 2000 and the name of the Companywas changed to Probity Research and Services Limited. The name of the Companyw a s c h a n g e d t o I n d i a I n f o l i n e . c o m L i m i t e d o n M a y 2 3 , 2 0 0 0 a n d l a t e r t o I n d i a Infoline Limited on March 23, 2001.In 1999, India Infoline.com identified the potential of the Internet to cater toa m a s s r e t a i l s e g m e n t a n d t r a n s f o r m e d o u r b u s i n e s s m o d e l f r o m p r o v i d i n g information services to institutional customers to retail c u s t o m e r s . H e n c e I n d i a Infoline launched Internet portal, www.indiainfoline.com in May 1999 and started p r o v i d i n g n e w s a n d m a r k e t i n f o r m a t i o n , i n d e p e n d e n t r e s e a r c h , i n t e r v i e w s w i t h business leaders and other specialized features.In May 2000, the name of India Infoline was changed to India Infoline.comLimited to reflect the transformation of our business. Over a period of time, IndiaInfoline.com has emerged as one of the leading business and financial informationservices provider in India.

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

13

Derivatives are risk management instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, share, bonds, Currency, Interest, etc., Banks, Securities firms, Companies and investors to hedge risks, to gain access to cheaper money and to make profit, use derivatives. Derivatives are likely to grow even at a faster rate in future. DEFINITION OF DERIVATIVES Derivative is a product whose value is derived from the value of an underlying asset in a contractual manner. The underlying asset can be Equity, Forex, Commodity or any other asset. Securities Contract (Regulation) Act, 1956 (SC A) defines debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security A contract which derives its value from the prices, or index of prices, of underlying securities. HISTORY OF DERIVATIVES MARKETS Early forward contracts in the US addressed merchants concerns about ensuring that there were buyers and sellers for commodities. However Credit Risk remained a serous problem. To deal with this problem, a group of Chicago, Businessmen formed the Chicago Board of Trade (CBOT) in 1848. The primary intention of the CBOT was to provide a centralized location known in advance for buyers and sellers to negotiate forward contracts. In 1865 the CBOT went one step further and listed the first Exchange Traded derivatives Contract in the US; these contracts were called Futures Contracts. In 1919 Chicago Butter and Egg Board, a spi9n-off CBOT was reorganized to allow futures trading. Its name was changed to Chicago Mercantile
14

Exchange (CME). The CBOT and the CME remain the two largest organized futures exchanges, indeed the two largest Financial exchanges of any kind in the world today.

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

THE GROWTH OF DERIVATIVES MARKET

Over the last three decades, the derivatives markets have seen a phenomenal growth. A large variety of derivative contracts have been launched at exchanges across the world. Some of the factors driving the growth of financial derivatives are: Increased volatility in asset prices in financial markets. Increased integration of national financial markets with the international markets. Marked improvement in communication facilities and sharp decline in their costs.

15

Development of more sophisticated risk management tolls, 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.

DERIVATIVE PRODUCTS (TYPES) The following are the various types of derivatives. They are: Forwards: A forward contract is a customized contract between two entities, where settlement takes places on a specific date in the future at todays pre-agreed price. Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain pri9ce. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. Options: Options are of two types-calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Warrants:

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Options generally have lives of up to one year; the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over the counter. Leaps: The acronym LEAPS means Long-team Equity anticipation Securities. These are options having a maturity of up to three years. Baskets: Baskets options are options on portfolio of underlying assets. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options. Swaps: Swaps are private agreement between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts.

PARTICIPANTS THE DERIVATIVES MARKETS The following three bro9ad categories of participants HEDGERS: Hedgers face risk associated with the price of an asset. They use futures or options markets to reduce or eliminate this risk. SPECULATIORS:
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Speculators with so bet on future movements in the price of an asset. Futures and options contracts can give them an extra leverage; that is, they can increase both the potential gains and potential losses in a speculative venture. ARBITRAGEURS Arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. If, for example they see the futures prices of an asset getting out of line with the cash price, they will take offsetting positions in the two markets to lock in a profit.

FUNCTIONS OF THE DERIVATIVES MARKET In spite of the fear and criticism with which the derivative markets are commonly looked at, these markets perform a number of economic functions. Price in an organized derivative markets reflect the perception of market participants about the future and lead the prices of underlying to the perceived future levl. The prices of derivatives converge with the prices of the underlying at the expiration of the derivative contract. Thus derivatives help in discovery of future as well as current prices.
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The derivative markets helps to transfer risks from those who have them but may not like them to those who have an appetite for them.

Derivative due to their inherent nature, are linked to the underlying cash markets. With the introduction of derivatives, the underlying market witness higher trading volumes because of participation by more players who would not otherwise participate for lack of an arrangement to transfer risk.

Speculative trades shift to a more controlled environment of derivatives market. In the absence of an organized derivatives market, speculators trade in the underlying cash markets. Margining, Monitoring and Surveillance of the activities of various participants become extremely difficult in these kinds of mixed markets.

An important incidental benefit that flows from derivatives trading is that is acts as a catalyst for new entrepreneurial activity. The derivatives have a history of attracting many bright, creative, Well-educated people with an entrepreneurial attitude.

NATURE OF THE PROBLEM The turnover of the stock exchange has been tremendously increasing from last 10 Years. The number of trades and the number of investors, who are participating, have increased. The investors are willing to reduce their risk, so they are seeking for the risk management tools. Prior to SEBI abolishing the BADLA system, the investors had this system as a source of reducing the risk, as it has many problems like no strong margining system, unclear expiration

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date and generating counter party risk. In view of this problem SEBI abolished the BADLA system. After the abolition of the BADLA system, the investors are seeking for a Hedging system, which could reduce their portfolio risk, SEBI thought the Introduction of the derivatives trading, as a first step it has set up a 24 Member committee under the chairmanship of Dr. L.C. Gupta to develop the appropriate Framework for derivatives trading in India, SEBI accepted the recommendation of the committee on May 11, 1998 and approved the phase introduction of the Derivatives trading beginning with stock index futures. There are many investors who are willing to trade in the derivatives segment, because of its advantages like limited loss unlimited profit by paying the small premiums.

THE DEVLOPMENT OF DERIVATIVES MARKET Holding portfolios of Securities is associate with the risk of the possibility that the investor may realize his returns, which would be much lesser than what he expected to get. There are various factors, which affect the returns: 1. Price or dividend (interest) 2. Some are internal to the firm like

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Industrial Policy Management Capabilities Consumers preference Labor strike, etc.

These forces are to a large extent controllable and are termed as non systematic risks. An investor can easily manage such non-systematic by having a Well-diversified portfolio spread across the companies, industries and groups so that a loss in one may easily be compensated with a gain in other. There are yet other of influence which are external to the firm, cannot be controlled and affect large number of securities. They are termed as systematic risk. They are: 1. Economic 2. Political 3. Sociological changes are sources of systematic risk.

For instance, inflation, interest rate, etc. their effect is to cause prices if nearly All individual stocks to move together in the same manner. We therefore quite often find stock prices falling from time to time in spite of companys earnings rising and vice versa. Rational Behind the development of derivatives market is to manage this systematic risk, liquidity in the sense of being able to buy and sell relatively large amounts quickly without substantial price concession. In debt market, a large position of the total risk of securities is systematic. Debt instruments are also finite life securities with limited marketability due to their small size relative
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to many common sticks. Those factors favor for the purpose of both portfolio hedging and speculation, the introduction of a derivatives securities that is on some broader market rather than an individual security. GLOBAL DERIVATIVES MARKET The global financial centers such as Chicago, New York, Tokyo and London dominate the trading in derivatives. Some of the worlds leading exchanges for the exchange traded derivatives are: Chicago Mercantile exchange (CME) and London International Financial Futures Exchange (LIFE) (for currency & Interest Futures). Philadelphia Stock Exchange (PSE), London Stock Exchange (LSE) & Chicago Board Options Exchange (CBOE) (for currency & Interest Futures). New York Stock Exchange (NYSE) and London Stock Exchange (LSE) (for equity derivatives). Chicago Mercantile Exchange (CME) and London Metal Exchange (LME) (for Commodities) These exchanges account for a large portion of the trading volume in the respective derivatives segment.

NSES DERIVATIVES MARKET The derivatives trading on the NSE commenced with S & P CNX Nifty index Futures on June 12, 2000. The trading in index options commenced on June 4, 2001 and trading in options on individual securities commence on July 2, 2001 Single stock futures were launched on
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November 9, 2001. Today, both in terms of volume and turnover, NSE is the largest derivatives exchange in India. Currently, the derivatives contracts have a maximum of 3-Months expiration cycles. Three contracts are available for trading, with 1 month, 2 month and 3 month expiry. A new contact is introduced on the next trading day following of the near month contract. REGULATORY FRAMEWORK The trading of derivatives is governed by the provisions contained in the SC (R) A, the SEBI Act., the rules and regulations framed there under and the rules and bye-laws of stock exchanges. In this chapter we look at the broad regulatory framework for derivatives trading and the requirement to become a member and an authorized dealer of the F & O segment and the position limits as they apply to various participants.

Regulation for derivatives trading: SEBI set up a 24-members committee under the Chairmanship of Dr. L.C GUPTA to develop the appropriate regulatory framework for derivatives trading in India. On May 11, 1998 SEBI accepted the recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with stock index futures. The provision in the SC(R) A and the regulatory framework developed there under govern trading in securities. The amendment of the SC (R) A to include derivatives within the ambit of securities in the SC (R) a made trading in derivatives possible within the framework of that Act.

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Any Exchange fulfilling the eligibility criteria as prescribed in the L.C.Gupta Committee report can apply to SEBI for grant of recognition under Section 4 of the SC (R) A, 1956 to start trading derivatives. The derivatives exchange / segment should have a separate governing council and representation of trading / clearing members shall be limited to maximum of 40% of the total members of the governing council. The exchange would have to regulate the sales practices of its members and would have to obtain prior approval of SEBI before start of trading in any derivative contract.

The exchange should have minimum 50 Members. The members of an existing segment of the exchange would not automatically become the members of derivative segment. The members of the derivative segment would need to fulfill the eligibility conditions as laid down by the L.C. Gupta committee.

The clearing and settlement of derivatives trades would be through a SEBI approved clearing corporation / house. Clearing corporations/ houses complying with the eligibility as laid down by the committee have to apply to SEBI for grant of approval.

Derivatives brokers / dealers and clearing members are required to seek registration from SEBI. This is in addition to their registration as brokers of existing stock exchanges. The minimum net worth for clearing members of the derivatives clearing corporation / house shall be Rs.300 Lakhs. The net worth of the member shall be computed as follows. Capital + Free Reserves Less non-allowable assets viz., Fixed assets Pledged securities Members card
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Non allowable securities (Unlisted securities) Bad deliveries Doubtful debts and advances Prepaid expenses Intangible assets 30 % marketable securities

The minimum contact value shall not be less than Rs.2 Lakhs. Exchanges have to submit details of the futures contract they propose to introduce.

The initial margin requirement, exposure limits linked to capital adequacy and margin demands related to the risk of loss on the position will be prescribed by SEBI / Exchanged from time to time.

The L.C. Gupta committee report requires strict enforcement of Know your customer rule and requires that every client shall be registered with the derivatives broker. The members of the derivatives segment are also required to make their clients aware of the risks involved in derivatives trading by issuing to the clients the Risk Disclosure and obtain a copy of the same duly signed by the clients.

The trading members are required to have qualified approved user and sales person who have passed a certification programmed approved by SEBI.

ELIGIBILITY OF ANY STOCK TO ENTER IN DERIVATIVES MARKET Non Promoter holding (Free float capitalization) not less than Rs. 750 Crores from last 6 Months. Daily Average Trading value not less than 5 Crores in last 6 Months
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At least 90% of Trading days in last 6 Months Non Promoter Holding at least 30% BETA not more than 4 (previous last 6 Months)

FUTURES IMPORTANCE OF DERIVATIVES Derivatives are becoming increasingly important in world markets as a tool for risk management. Derivatives instruments can be used to minimize risk. Derivatives are used to separate risks and transfer them to parties willing to bear these risks. The kind of hedging that can be obtained by using derivatives is cheaper and more convenient than what could be obtained by using cash i9nstruments. It is so because, when we use derivatives for hedging, actual delivery of the underlying asset is not at all essential for settlement purposes.

Moreover, derivatives would not create any risk. They simply manipulate the risks and transfer to those who are willing to bear these risks. Suppose he buys insurance [a derivative instrument on the bike] he reduces his risk. Thus, having an insurance policy reduces the risk of owing a bike. Similarly, hedging through derivatives reduces the risk of owing a specified asset, which may be a share, currency, etc

INTRODUCTION OF FUTURES

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Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contract, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contract, the exchange specifies certain standard features of the contract. It is standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, (Or which can be used for reference purpose in settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 90% of futures transactions are offset this way. The standardized items in a futures contract are: Quantity of the underlying Quality of the underlying The date and the month of delivery The units of price quotation and minimum price change Location of settlement.

DEFINITON 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. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts.

HISTORY OF FUTURES

27

Merton Miller, the 1990 Nobel Laureate had said that Financial futures represent the most significant financial innovation of the last twenty years. The first exchange that traded financial derivatives was launched in Chicago in the year 1972. A division of the Chicago Mercantile Exchange, it was called the International Monetary Market (IMM) and traded currency futures. The brain behind this was a man called Leo Melamed, acknowledged as the Father of Financial Futures who was then the Chairman of the Chicago Mercantile Exchange. Before IMM opened in 1972, the Chicago Mercantile Exchange sold contracts whose value was counted in millions. By 1990, the underlying value of all contracts traded at the Chicago Mercantile Exchange totaled 50 trillion dollars. These currency futures paved the way for the successful marketing of a dizzying array of similar products at the Chicago Mercantile Exchange, the Chicago Board of Trade and the Chicago Board Options Exchange. By the 1990s, these exchanges were trading futures and options on everything from Asian and American stock indexes to interest-rate swaps, and their success transformed Chicago almost overnight into the risk-transfer capital of the world. DISTINCTION BETWEEN FUTURES AND FORWARDS CONTRACTS Forward contracts are often confused with futures contracts. The confusion is primarily because both serve essentially the same economic functions of allocating risk in the presence of futures price uncertainty. However futures are a significant improvement over the forward contacts as they eliminate counterparty risk and offer more liquidity. Comparison between two as follows.

28

FUTURES 1. Trade on an

FORWARDS Organized 1.OTC in nature

Exchange 2. Standardized contract terms 3. Hence more liquid 4. Requires margin payment 5. Follows daily Settlement 2.Customized Contract terms 3.Hence less liquid 4.No Margin Payment 5.Settlement happens at end of period

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

TYPES OF FUTURES On the basis of the underlying asset they derive, the futures are divided into two types: Stock Futures
29

Index Futures

PARTIES IN THE FUTURES CONTRACT There are two parties in a futures contract, the buyers and the seller. The buyer of the futures contract is one who is LONG on the futures contract and the seller of the futures contract is who is SHORT on the futures contract. The pay-off for the buyers and the seller of the futures of the contracts are as follows:

PAY-OFF

FOR

BUYER

OF

FUTURES

30

Figure 3.2

CASE 1: -

The buyers bought the futures contract at (F); if The futures price Goes to E, Then the buyer gets the profit of (FP)

CASE 2: -

The buyers gets loss when the futures price less then (F); if The futures price goes to E2 then the buyer the loss of (FL)

PAY-OFF FOR A SELLER OF FUTURES

31

F = FUTURES PRICE E1, E2 = SATTLEMENT PRICE

CASE 1: -

The seller sold the future contract at (F); if the future goes to E1 Then the seller gets the profit of (FP)

CASE 2: -

The seller gets loss when the future price goes greater than (F); If the future price goes to E2 then the seller get the loss of (FL).

MARGINS Margins are the deposits which reduce counter party risk, arise in a futures contract. These margins are collect in order to eliminate the counter party risk. There are three types of margins: Initial Margins Whenever a future contract is signed, both buyer and seller are required to post initial margins. Both buyers and seller are required to make security deposits that are intended to guarantee that they will infect be able to fulfill their obligation. These deposits are initial margins and they are often referred as purchase price of futures contract.
32

Mark to market margins The process of adjusting the equity in an investors account in order to reflect the change in the settlement price of futures contract is known as MTM Margin. Maintenance margin The investor must keep the futures account equity equal to or grater than certain percentage of the amount deposited as initial margin. If the equity goes less than that percentage of initial margin, then the investor receives a call for an additional deposit of cash known as maintenance margin to bring the equity up to the initial margin. ROLE OF MARGINS The role of margins in the futures contract is explained in the following example: Siva Rama Krishna sold an ONGC July futures contract to Nagesh at Rs. 600; the following table shows the effect of margins on the Contract. The contract size of ONGC is 1800. The initial margin amount is say Rs. 30,000 the maintenance margin is 65% of initial margin.

PRICING FUTURES Pricing of futures contract is very simple. Using the cost-of-carry logic, we calculate the fair value of a future contract. Every time the observed price deviates from the fair value, arbitrages would enter into trades to captures the arbitrage profit. This in turn would push the futures price back to its fair value. The cost of carry model used for pricing futures is given below.

F=SerT
Where
33

F S r T e

= = = = =

Futures price Spot Price of the Underlying Cost of financing (using continuously compounded Interest rate) Time till expiration in years 2.71828 (OR) F=S (1+r-q) t

Where: F S r q t = = = = = Futures price Spot Price of the Underlying Cost of financing (or) Interest rate Expected dividend yield Holding Period

FUTURES TERMINOLOGY Spot price: The price at which an asset trades in the spot market Futures Price: The price at which the futures contract trades in the futures market. Contract cycle: The period over which a contract trades. The index futures contracts on the NSE have one-month and three-month expiry cycles which expire on the last Thursday of the month. Thus a January

34

expiration contract ceases trading on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three-month expiry is introduced for trading. Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist. Contract size: The amount of asset that has to be delivered under one contract. For instance, the contract size on NSEs futures markets is 200 Nifties. Basis: In the context of financial futures, basis can be defined as the futures price minus the spot price. These will be a different basis for each delivery month for each contract. In a normal market, basis will be positive. This reflects that futures prices normally exceed spot prices.

Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset. Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin.

35

Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investors gain or loss depending upon the futures closing price. This is called marking-tomarket. Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin called and is expected to top up the margin account to the initial margin level before trading commences on the next day.

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

36

DEFINITION Options are of two types calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyers the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. HISTORY OF OPTIONS Although options have existed for a long time, they wee traded OTC, without musch knowledge of valuation. The first trading in options began in Europe and the US as early as the seventeenth century. It was only in the early 1900s that a group of firms set up what was known as the put and call Brokers and Dealers Association with the aim of providing a mechanism for bringing buyers and sellers together. If someone wanted to buy an option, he or she would contact one of the member firms. If no seller could be found, the firm would undertake to write the option itself in return for a price. This market however suffered from two deficiencies. First, there was no secondary market and second, there was no mechanism to guarantee that the writer of the option would honor the contract. In 1973, Black, Merton and Scholes invented the famed Black-Scholes formula. In April 1973, CBOE was set up specifically for the purpose of trading options. The market for option developed so rapidly that by early 80s, the number of shares underlying the option contract sold each day exceeded the daily volume of shares traded on the NYSE. Since then, there has been no looking back. Option made their first major mark in financial history during the tulip-bulb mania in seventeenth-century Holland. It was one of the most spectacular get rich quick binges in history. The first tulip was brought Into Holland by a botany professor from Vienna. Over a

37

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

PROPERTIES OF OPTION Options have several unique properties that set them apart from other securities. The following are the properties of option: Limited Loss High leverages potential Limited Life

PARTIES IN AN OPTION CONTRACT There are two participants in Option Contract.

38

Buyer/Holder/Owner of an Option: The Buyer of an Option is the one who by paying the option premium buys the right but not the obligation o exercise his option on the seller/writer. Seller/writer of an Option: The writer of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.

TYPES OF OPTIONS The Options are classified into various types on the basis of various variables. The following are the various types of options. 1. On the basis of the underlying asset: On the basis of the underlying asset the option are divided into two types: Index options: These options have the index as the underlying. Some options are European while others are American. Like index futures contracts, index options contracts are also cash settled. Stock options: Stock Options are options on individual stocks. Options currently trade on over 500 stocks in the United States. A contract gives the holder the right to buy or sell shares at the specified price. 2. On the basis of the market movements: On the basis of the market movements the option are divided into two types. They are: Call Option: A call Option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. It is brought by an investor when he seems that the stock price moves upwards.

39

Put Option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price. It is brought by an investor when he seems that the stock price moves downwards. 3. On the basis of exercise of option: On the basis of the exercise of the Option, the options are classified into two Categories. American Option: American options are options that can be exercised at any time up to the expiration date. Most exchange-traded options are American European Option: European options are options that can be exercised only on the expiration date itself. European options are easier to analyze than American options, and properties of an American option are frequently deduced from those of its European counterpart.

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

40

Figure 3.4 S SP E1 E2 SR = = = = = Strike Price Premium/Loss Spot price 1 Spot Price 2 Profit at spot price E1 ITM = In the Money At the Money Out of the Money

ATM = OTM =

CASE1: (Spot Price > Strike price) As the Spot price (E1) of the underlying asset is more than strike price (S) The buyer gets profit of (SR), if price increases more than E1 then profit also increase more than (SR) CASE 2: (Spot Price < Strike Price) As a spot price (E2) of the underlying asset is less than strike price (S) The buyer gets loss of (SP); if price goes down less than E2 then also his loss is limited to his premium (SP) PAY-OFF PROFILE FOR SELLER OF A CALL OPTION The pay-of of seller of the call option depends on the spot price of the underlying asset. The following graph shows the payoff seller of a call option.

41

Figure 3.5 S SP E1 E2 SR = = = = = Strike Price Premium/profit Spot price 1 Spot Price 2 Loss at spot price E2 ITM = In the Money At the Money Out of the Money

ATM = OTM =

CASE 1: (Sport price < Strike price) As the spot price (E1) of the underlying is less than strike price (S). The seller gets the profit of (SP), if the price decreases less than E1 then also profit of the seller does not exceed (SP). CASE 2: (Spot price > Strike price) As the spot price (E2) of the underlying asset is more than strike price (S) the Seller gets loss of (SR), if price goes more than E2 then the loss of the seller also increase more than (SR).

42

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

Figure 3.6 S SP E1 E2 SR = = = = = Strike Price Premium/Loss Spot price 1 Spot Price 2 Profit at spot price E1 ITM = In the Money At the Money Out of the Money

ATM = OTM =

CASE 1: (Spot price < Strike price) As the spot price (E1) of the underlying asset is less than strike price (S). The buyer gets the profit (SR), if price decreases less than E1 then profit also increases more than (SR). CASE 2: (Spot price > Strike price) As the spot price (E2) of the underlying asset is more than strike price (S).

43

The buyer gets loss of (SP), if price goes more than E2 than the loss of the buyer is limited to his premium (SP). PAY-OFF PROFILE FOR SELLER OF A PUT OPTION The pay-off of the Seller of the option depends on the spot price of the underlying asset. The following graph shows the pay-off of the buyer of a call option.

Figure 3.7 S SP E1 E2 SR = = = = = Strike Price Premium/profit Spot price 1 Spot Price 2 Loss at spot price E1 ITM = In the Money At the Money Out of the Money

ATM = OTM =

44

CASE 1: (Spot price < Strike price) As the spot price (E1) of the underlying asset is less than strike price (S). The seller gets the loss of (SR), if price decreases less than E1 then the loss also increases more than (SR). CASE 2: (Spot price > Strike price) As the spot price (E2) of the underlying asset is more than strike price (S), the seller gets profit of (SP), if price goes more than E2 than the profit of seller is limited to his premium (SP).

FACTORS AFFECTING THE PRICE OF AN OPTION The following are the various factors that affect the price of an option they are: Stock Price: The pay-off from a call option is an amount by which the stock price exceeds the strike price. Call options therefore become more valuable as the stock price increases and vice versa. The pay-off from a put option is the amount; by which the strike price exceeds the stock price. Put options therefore become more valuable as the stock price increases and vice versa.

Strike price: In case of a call, as a strike price increase, the stock price has to make a larger upward move for the option to go in-the-money. Therefore, for a call, as the strike price increases option becomes less valuable and as strike price decreases, option become more valuable. Time to expiration: Both put and call American options become more valuable as a time to expiration increase.

45

Volatility: The volatility of a stock price is measured of uncertain about future stock price movements. As volatility increases, the chance that the stock will do very well or very poor increases. The value of both calls and puts therefore increases as volatility increase. Risk-free interest rate: The put option prices decline as the risk-free rate increases where as the price of call always increases as the risk free interest rate increases. Dividends: Dividends have the effect of reducing the stock price on the X-dividend rate. This has a negative effect on the value of call options and a positive effect on the value of put options. PRICING OPTIONS An option buyer has the right but not the obligation to exercise on the seller. The worst that can happen to a buyer is the loss of the premium paid by him. His downside is limited to this premium, but his upside is potentially unlimited. This optionality is precious and has a value, which is expressed in terms of the option price. Just like in other free markets, it is the supply and demand in the secondary market that drives the price of an option. There are various models which help us get close to the true price of an option. Most of these are variants of the celebrated Black-Scholes model for pricing European options. Today most calculators and spread-sheets come with a built-in Black Scholes options pricing formula so to price options we dont really need to memorize the formula. All we need to know is the variables that go into the model. The Black-Scholes formulas for the price of European calls and puts on a non-dividend paying stock are:

46

Call Option CA= SN (d1) Xe-rT N(d2) Put Option PA = Xe-rT N(-d2) - SN (-d1) Where d1 = In (S/X) + (r+v2/2) T
v T And d2 = d1 - v T Where = VALUE OF CALL OPTION = VALUE OF PUT OPTION = SPOT PRICE OF STOCK = NORMAL DISTRIBUTION = VOLATILITY = STRIKE PRICE = ANNUAL RISK FREE RETURN = CONTROCT CYCLE = 2.71828 = ln (1+r)

CA PA S N VARENCE(V) X r T E r

OPTIONS TERMINOLOGY Option price/premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium. Expiration date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity.

47

Strike price: The price specified in the option contract is known as the strike price or the exercise price.

DISTINCTION BETWEEN FUTURES AND OPTIONS

FUTURES 1. Exchange traded, with Innovation 2. Exchange defines the product 3. Price is zero, strike price moves 4. Price is Zero 5. Linear payoff 6. Both long and short at risk

OPTIONS 1. Same as futures 2. Same as futures 3. Strike price is fixed, price moves 4. Price is always positive 5. Nonlinear payoff 6. Only short at risk

CALL OPTION PREMIUM STRIKE PRICE INTRINSIC VALUE 560 540 520 500 0 0 0 0 TIME VALUE 2 5 10 15 TOTAL VALUE 2 5 10 15 CONTRACT

OUT OF THE MONEY AT MONEY THE

48

480 460 440

20 40 60

10 5 2

30 45 62

IN MONEY

THE

PUT OPTION STRIKE PRICE 560 540 520 500 480 460 440 PREMIUM INTRINSIC VALUE 60 40 20 0 0 0 0 TIME VALUE 2 5 10 15 10 5 2 TOTAL VALUE 62 45 30 15 10 5 2 IN MONEY AT MONEY OUT OF THE MONEY THE THE CONTRACT

PREMIUM = INTRINSIC VALUE + TIME VALUE The difference between strike values is called interval

49

TRADING NETWORK

Participants in Security Market

50

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

Highest Investor Population

State Maharashtra Gujarat Delhi Chennai West Bengal Andhra Pradesh

Total No. Investors 9.11 Lakhs 5.36 Lakhs 3.25 Lakhs 2.30 Lakhs 2.14 Lakhs 1.94 Lakhs

% of Investors in India 28.50 16.75 10.10 7.205 6.75 6.05

LOT SIZES OF SELECTED COMPANIES FOR ANALYSIS

51

CODE ACC

LOT SIZE 750

COMPANY NAME Associates Cement Companies Ltd

ARVIND MILLS BHEL

2150 300

Arvind Mills Ltd. Bharat Heavy Electrical Ltd.

The following tables explain about the table that took place in futures and options between 25/02/2010 to 29/02/2010. The table has various columns, which explains various factors involved in derivative trading. Date Closing premium Open interest Traded Quantity N.O.C Closing price - The day on which the trading took place - Premium for that day. - No.of options that did not get exercised - No.of futures and options traded on that day. - No.of contracts traded on that day. - The price of the futures at the end of the trading day

CALCULATION OF RATE OF RETURN

52

ANALYSIS AND INTERPRETATION: FUTURES: Futures are legally binding agreement to buy or sell an asset at a certain time in the future at a certain price. FORMULA: Fo = So (1 + r-d) T So = closing price of a market on that day. r = Rate of return d = Dividend T = Time period

FUTURES OF ACC CEMENTS

53

Table I Date High Rs. Low Rs. 768.00 712.60 589.80 598.50 790.50 Close Rs 810.65 755.95 591.40 616.85 806.20 Open Int Trd Qty ('000) 7146 7322 1800 8168 1785 ('000) 986 1012 1943 891 1465 N.O.C. FO 2781 3482 2591 2270 1953 88582.21 89881.32 89858.54 90154.82 90132.04

23.05.11 818.34 24.05.11 812.45 25.05.11 698.30 26.05.11 691.00 27.05.11 827.00

The above table has been given in the following graph. Source

FUTURES PRICE OF ACC

90500 90000 89500 89000 88500 88000 87500 23.05.11 24.05.11 25.05.11 26.05.11

FO
The data has been collected BUSINESS STANDARED (Paper) and Online Trading of INDIA INFOLIONE LTD INTERPRETATION: It is observed from the above mentioned table that the future price (FO) has increased tremendously due to increase in closing price, decrease in open interest and reduction in value and volume of futures. FUTURES OF ARVIND MILLS
54

Table 2 Open Date High Rs. Low Rs. Close Rs Int ('000) 23.05.11 24.05.11 25.05.11 26.05.11 27.05.11 100.40 95.10 96.65 96.70 96.70 97.40 92.25 94.85 95.10 94.50 98.00 94.90 96.25 95.95 95.45 13360 10636 9129 5609 3038 Trd Qty ('000) 5334 3053 4444 3990 5771

N.O.C.

FO

2481 1420 2067 1856 2684

1515.3 1467.4 1488.3 1483.6 1475.9

The above table has been given in the following graph. Picture 2

FUTURES PRICE OF ARVIND MILLS

1520
1500 1480 1460 1440 FO Source: The data has been collected BUSINESS STANDARDS (paper) and Online Trading of INDIA INFOLINE LTD. INTERPRETATION: The above graph shows that the future price (FO) has been decrease due to decrease in closing price and decrease in open interest and it is observed that increase in volume and value. 23.05.11 24.05.11 25.05.11 26.05.11 27.05.11

FUTURES OF BHEL:
55

Table 3 Open Date High Rs. Low Rs. Close Rs Int ('000) 23.05.11 24.05.11 25.05.11 26.05.11 27.05.11 2010.00 2057.00 2260.00 2335.00 2405.00 1978.00 1995.00 2038.00 2210.00 2300.00 2006.40 2024.75 2221.60 2223.10 2350.00 2192 1586 1257 871 462 Trd Qty ('000) 988 1405 1508 934 1400

N.O.C.

FO

3293 4682 5025 6147 4667

218768 212665 218096 222906 219881

The above table has been given in the following graph. Picture 3

FUTURES PRICE OF BHEL

225000
220000 215000 210000 205000 FO Source: The data has been collected BUSINESS STANDARDS (paper) and Online Trading of INDIA INFOLINE LTD. INTERPRETATION: From the above mentioned table it is observed that the future price (FO) has shown fluctuation due to fluctuation in closing price and volume, value is increase and it is observed that open interest is decrease. OPTIONS:
56

23.05.11 24.05.11 25.05.11 26.05.11

27.05.11

Options are two types. They are CALL OPTION and PUT OPTION

CALL OPTION: A Call option is bought by an investor when he seems that the stock price moves upwards. A call option gives the holder of the option the right but not the obligation to buy an asset by an certain date for a certain price. PUT OPTION: A put option is bought by an investor when he seems that the stock price moves downwards. A put option gives the holder of the option the right but not the obligation to sell asset by an certain date for a certain price.

Formula: Profit of the holder = (Spot price Strike Price) (Lot Size) in case of call option. Profit of the holder Source: The data has been collected BUSINESS STANDARDS (paper) and Online Trading of INDIA INFOLINE LTD. = Premium* (Lost Size) in case of Put Option. - Premium

The following table of Net pay-of explain the profit/loss of option holder/writer of ACC for the week 23/05/2011 to 27/05/2011

57

PROFIT / LOSS POSITION OF CALL OPTION BUYES OF ACC Table - 1 SPOT PRICE 818.34 STRIKE PRICE 800 PREMIUM WHETHER EXERCISED YES BUYERS GAIN/LOSS 150.00 WEITER GAIN/LOSS -150.00

27.00

818.34

820

10.45

YES

2737.50

-2737.50

818.34

840

5.30

NO

-3975.00

13875.00

818.34

860

1.90

NO

-1425.00

26325.00

Profit and Loss graph of the buyers with stike price of call option
4000 2000 0 1 -2000 -4000 -6000 2 3 4

STRIKE PRICE

BUYERS GAIN/LOSS

58

Profit and Loss graph of the writer with stock price of call option
30000 20000 10000 0 -10000
1 2 3 4

STRIKE PRICE

WEITER GAIN/LOSS

PROFIT / LOSS POSITION OF PUT OPTION BUYER / WRITER OF ACC Table - 2 SPOT PRICE 818.34 STRIKE PRICE 800 PREMIUM WHETHER BUYERS WEITER

EXERCISED GAIN/LOSS GAIN/LOSS NO -150.00 150.00

0.20

818.34

820

2.40

NO

-1800.00

1800.00

818.34

840

8.90

NO

-6675.00

6675.00

818.34

860

12.00

YES

900.00

-900.00

59

Profit and Loss graph of the buyers with stike price of put option
2000 0 -2000 -4000 -6000 -8000 1 2 3 4

STRIKE PRICE

BUYERS GAIN/LOSS

Profit and Loss graph of the writer with stock price of Put option
8000 6000 4000 2000 0 1 2 STRIKE PRICE 3 WEITER GAIN/LOSS 4

-2000

INTERPERATATION From the above graph it observed that the buyer get profit when the Strike Price is less than the spot price and it is also observed that the writer get loss when the strike price is more than the spot price. The following table of Net pay-off explains the profit / loss of option holder / writer of ARAVIND MILL.

60

PROFIT / LOSS POSITION OF CALL OPTION BUYER / WRITER OF ARAVIND MILL Table 3

SPOT PRICE 100.40

STRIKE PRICE 85

PREMIUM

WHETHER

BUYERS

WEITER

EXERCISED GAIN/LOSS GAIN/LOSS YES 537.50 -537.50

12.50

100.40

90

8.30

YES

1182.50

-1182.50

100.40

95

4.30

YES

3332.50

-3332.50

100.40

100

2.00

NO

-4300.00

9137.50

Profit and Loss graph of the buyers with stike price of Call option
2000 0 -2000 -4000 -6000 -8000 STRIKE PRICE BUYERS GAIN/LOSS 1 2 3 4

61

Profit and Loss graph of the writer with strick price of Call option
10000

5000

0 1 -5000 STRIKE PRICE WEITER GAIN/LOSS 2 3 4

PROFIT / LOSS POSITION OF PUT OPTION BUYER / WRITER OF ARVIND MILL Table - 4 SPOT PRICE 100.40 STRIKE PRICE 80 PREMIUM WHETHER BUYERS WEITER

EXERCISED GAIN/LOSS GAIN/LOSS NO -537.5 537.5

0.25

100.40

85

0.05

NO

-967.5

967.5

100.40

90

0.45

NO

-2795

2795.00

100.40

95

1.300

NO

-10535

10535.00

100.40

100

4.900

YES

5697.5

-5697.5

62

Profit and Loss graph of the buyers with stike price of Put option
2000 0 -2000 -4000 -6000 -8000 STRIKE PRICE BUYERS GAIN/LOSS 1 2 3 4 5

Profit and Loss graph of the writer with strick price of Put option
15000 10000 5000 0 -5000 -10000 1 2 3 4 5

STRIKE PRICE

WEITER GAIN/LOSS

INTERPERATATION It is observed from the above mentioned tables that the strike price is less than the spot price the buyer will get profit and strike price is more than the spot price the buyer will get loss then obviously in case of writer it is vice-versa. The following table of Net pay off explains the profit / loss of holder / writer of BHEL.

63

PROFIT/LOSS POSTION OF CALL OPTION BUYER / WRITER OF BHEL Table 5 SPOT PRICE 2010.00 STRIKE PRICE 1830 PREMIUM WHETHER BUYERS WEITER

EXERCISED GAIN/LOSS GAIN/LOSS YES 5700.0 -5700.0

25.00

2010.00

1860

40.00

YES

7800.0

-7800.0

2010.00

1890

19.00

NO

-5700

5700.00

2010.00

1920

10.00

NO

-3000

300.00

2010.00

1980

20.00

NO

-6000.0

600.0

Profit and Loss graph of the buyers with stike price of Call option
10000 5000 0 1 -5000 -10000 STRIKE PRICE BUYERS GAIN/LOSS 2 3 4 5

64

Profit and Loss graph of the writer with strick price of Call option
10000 5000 0 1 -5000 -10000 STRIKE PRICE WEITER GAIN/LOSS 2 3 4 5

PROFIT / LOSS POSITION OF PUT OPTION BUYER / WRITER OF BHEL Table 6 SPOT PRICE STRIKE PREMIUM PRICE EXERCISED GAIN/LOSS GAIN/LOSS WHETHER BUYERS WEITER

1874.00

1800

20.00

NO

-6000

6000.0

1874.00 1874.00

1830 1860

28.55 1.00

NO NO

-8565 -9300

8565.0 9300.00

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Profit and Loss graph of the writer with strick price of Put option
10000 8000 6000 4000 2000 0 1 STRIKE PRICE 2 WEITER GAIN/LOSS 3

INTERPERATATION From the above call option and put option tables it is observed that the writer get profit when the strike price is more than the spot price and the writer get loss when the strike price is less than the spot price and it is observed that the buyer it is vice-versa.

CALCULATION OF FUTURE PRICE On May 23rd :

If an investor holds the following contract of ACC Future closing price = R.s. 818.34 Equity share capital = R.s. 179.58 Net profit = 4446.20 Preference dividend = 0 Dividends = 0.07

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r = Net Profit preference dividend Equity share capital

* 100

r = (4446.20 0) * 100 / 179.58 = 2475.88 = 818.34 (1+ 2475.88 0.07)3 = 818.34 (15194.208)3 = 288582.23

On May 23rd :

If an investor holds the following contract of Arvind mills Future closing price = R.s. 100.40 Equity share capital = R.s. 195.38 Net profit = 484.81 Preference dividend = 0 Dividends = 0.01 r = Net Profit preference dividend Equity share capital * 100

r = (484.18 0) * 100 / 195.38 = 248.14 = 100.40 (1+ 248.14 0.01)3 = 100.40 (249.13)3 = 11515.31

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On May 23rd :

If an investor holds the following contract of the BHEL Future closing price = R.s. 2010.40 Equity share capital = R.s. 32500.00 Net profit = 158163.56 Preference dividend = 0 Dividends = 0.08

r = Net Profit preference dividend Equity share capital

* 100

r = (158163.56 0) * 100 / 32500.00 = 486.66 = 2010.40 (1+ 486.66 0.08)3 = 2010.40 (487.58)3 = 518768

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5.1SUMMARY
Project deals with five chapters Chapter I- deals with introduction, need, objectives, methodology and limitations of the project.

The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices.
Chapter II- deals with the company profile and industry profile. We were originally incorporated on October 18, 1995 as Probilty Research and Services private Limited at Mumbai under the Companies Act, 1956 with Registration No. 11 93797. We commenced our operations as an independent provider of information, analysis and research covering Indian business, financial markets and economy, to institutional Customers. We became a public limited company on April 28, 2000 and the name of the Company was changed to Probity Research and Services Limited. The name of the company was changed to India infoline.com Limited on May 23, 2000 and later to India Infoline Limited on March23, 2001. The Indian broking industry is one of the oldest trading industries that have beenaround even before the establishment of the BSE in 1875. Despite passing throughnumber of changes in the post liberalization period, the industry has found its wayonwards sustainable growth. Chapter III deals with the review of literature for derivative(future&options)

Derivative is a product whose value is derived from the value of an underlying asset in a contractual manner. The underlying asset can be Equity, Forex, Commodity or any other asset.

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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 pri9ce. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. Options: Options are of two types-calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given dateChapter VI- deals with the data analysis
and interpretation. Chapter V- deals with the summary, findings, suggestions and conclusion.

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5.2FINDINGS The above analysis of futures and options of ACC, ARVINDMILLS AND BHEL had shown a positive market in the week. The major factors that influence the futures and options market are the cash market, foreign institutional investor involvement, News related to the underlying asset, national and international markets, Researchers view etc. In cash market the profit / loss is limited but where in future and option an investor can enjoy unlimited profit / loss. It is recommended that SEBI should take measures in improving awareness about the future and option market as it is launched vary recently. At present scenario the derivatives market is increased to a great position. Its daily turnover reaches to the equal stage of cash market. The average daily turnover of the NSE in derivative is four lacks volume. The derivatives are mainly used for hedging purpose. In cash market the investor has to pay the total money, but in derivatives has to pay the premiums or margins, which are some percentage of the total money. Application of future, forward and option. Different tools of Hedging, Speculation and Arbitrage.

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5.3 SUGGESTIONS In a bearish market it is suggested to an investor to opt for put option in order to minimize profits. In a bullish market it is suggested to an investor to apt for call option in order to maximize profits. It is suggested to an investor to keep in mind the time or expiry duration of futures and options contract before trading. The lengthy time, the risk is low and profit making. The fewer time may be high risk and chances of loss making. At present futures and options are traded on NSE. It is recommended to SEBI to take actions in trading of futures and options in other regional exchanges. SEBI has to take further steps in the risk management mechanism. Contract sixe should be minimized because small investors cannot afford this much of huge premiums. SEBI should conduct seminars regarding the use of derivatives to educate individual investors.

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5.4 CONCLUSION

Derivatives are mostly used for hedging purpose. In derivative segment the profit/loss of the option writer is purely depend on the fluctuations of the underlying asset.

During the study of the option and future trading in India we found that the trading of the option and future (stock and index ) rapidly growing till 2008 and then decline for the one year and then increase . The decline year was basically the 2008-09 because of the slow down in this year and then increase by the speed . This trend is basically very popular in India during these year so many persons trading by option and future in Indian market .

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BIBLIOGRAPHY

WEBSITES WWW.derivativesindia.com WWW.kotiksecurities.com WWW.nseindian.com WWW.bseindia.com

Books: FINANCIAL MANAGEMENT Prasanna Chandra DERIVATES CORE MODULE NCFM MATERIAL SAPM - Prasanna Chandra

JOURNALS: FINANCIAL EXPRESS

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