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BY
G.VENKATACHALAM
History of Derivatives
Chicago Board of Trade (CBOT) for derivatives trading, became functional in 1848 and by 1865 futures contract in commodities started trading. In 1972 currency futures were introduced, followed by equity options in 1973. Year 1975 saw introduction to Interest Rate futures. Currency Swaps were introduced in 1981 and in 1982 Index futures, Interest Rate swaps and Currency Options were started. In 1983, Index Options and Options on futures were started.
India (Cont)
The National Securities Clearing Corporation (NSCCL) was set up to clear and settle trades. Dematerialized trading was introduced with the setting up of the NSDL. The attention then shifted to derivatives, for it was felt that that investors in India needed access to risk management tools.
India (Cont)
There was however a legal barrier. The Securities Contracts Regulation Act, SCRA, prohibited trading in derivatives. Under this Act forward trading in securities was banned in 1969. Forward trading on certain agricultural commodities however was permitted, although these markets have been very thin.
India (Cont)
The first step was to repeal this Act. The Securities Laws (Amendments) Ordinance was promulgated in 1995. This ordinance withdrew the prohibition on options on securities. The next task was to develop a regulatory framework to facilitate derivatives trading.
India (Cont)
SEBI set up the L.C. Gupta committee in 1996 to develop such a framework. The committee submitted its report in 1998. It recommended that derivatives be declared as securities so that the regulatory framework applicable for the trading of securities could also be extended to include derivatives trading.
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India (Cont)
Trading in derivatives has its inherent risks from the standpoint of non-performance of a party with an obligation to perform. For this purpose SEBI appointed the J.R. Varma Committee to recommend a suitable risk management framework. This committee submitted its report in 1998.
India (Cont)
The SCRA was amended in December 1999 to include derivatives within the ambit of securities. The Act made it clear that trading in derivatives would be legal and valid only if such contracts were to be traded on a recognized stock exchange. Thus OTC derivatives were ruled out.
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India (Cont)
In March 2000, the notification prohibiting forward trading was rescinded. In May 2000 SEBI permitted the NSE and the BSE to commence trading in derivatives. To begin with trading in index futures was allowed.
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India (Cont)
Thus futures on the S&P CNX Nifty and the BSE-30 (Sensex) were introduced in June 2000. Approval for index options and options on stocks was subsequently granted. Index options were launched in June 2001 and stock options in July 2001. Finally futures on stocks were launched in November 2001.
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DERIVATIVES IN INDIA: A CHRONOLOGICAL DEVELOPMENT December 14, 1995 November 18, 1996 May 11, 1998 July 7, 1999 The NSE sought SEBI's permission to trade index futures. The LC Gupta Committee set up to draft a policy framework for index futures. The LC Gupta Committee submitted a report on the policy framework for index futures.
May 2000 May 2000 June 12, Trading of Nifty futures commenced on the NSE. 2000 Trading on interest rate futures commenced at NSE June 2003
July 2003 Trading on FC-rupee option started
Reserve Bank of India gave permission for OTC forward rate agreements and interest rate swaps. 24, SIMEX chose Nifty for trading futures and options on an Indian index. 25, SEBI allowed the NSE and the BSE to trade in index futures.
Items
Date of introduction Name of security
underlying asset Contract size Tick size/price step Minimum price fluctuations Price bands Expiration months Trading cycle
BSE
June 9,2000 BSE
BSE sensitive index(SENSEX) Sensex value*50 o.1 point of sensex (equivalent to Rs 5) Rs 5 NA 3 near months A maximum of 3 months: the near month (1), the next month(2) and the a month(3) Last Thursday of the month or the preceding day In cash on T+1 bas Index closing price on the last trading day(a) Closing of future contract(a)a() 9.30 am to 3.30 pm Upfront margin on daily basis
NSE
June 12, 2000 N FUTIDX NIFTY
S&P CNX NIFTY 200 or multiples of 200 Rs 0.05 Not applicable NS 3 near months As in previous column
10
11
As in previous column
As in previous column Index closing price on the 1st trading day(s) Closing of future contract As in previous column
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13 14 15
option contract necessary infrastructure to trade. Clearing House - Clearing house ensures solvency of the members by putting various limits Custodian / Ware House- Futures and options contracts do not generally result into delivery but there has to be smooth and standard delivery mechanism to ensure proper functioning of market. Bank for fund movements - Futures and options contracts are daily settled for which large fund movement from members to clearing house and back is necessary. This can be smoothly handled if a bank works in association with a clearing house.
REGULATORY FRAMEWORK
SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992 SEBI Act, 1992 provides for establishment of Securities and Exchange Board of India(SEBI) with statutory powers for (a) protecting the interests of investors in securities (b) promoting the development of the securities market and (c) regulating the securities market. POWERS OF SEBI
Regulating the business in stock exchanges and any other securities markets. Registering and regulating the working of stock brokers, subbrokers etc. Promoting and regulating self-regulatory organizations. Prohibiting fraudulent and unfair trade practices. Calling for information from, undertaking inspection, conducting inquiries and audits of the stock exchanges, mutual funds and other persons associated with the securities market and intermediaries Performing such functions and exercising according to Securities Contracts (Regulation) Act, 1956, as may be delegated to it by the Central Government.
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 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.
Introduction Date
June 12,2000 June 4,2001 July 2, 2001 November 9,2001 June 23,2003 August 29,2003 June 13,2005 June 1,2007 June 1,2007 October 5,2007 January 1, 2008 March 3,2008 August 29,2008 December 10, 2008
COMMODITY FUTURES
Buying and selling of commodities through contract basis. These are a large number of commodities on which the futures contracts are available. They range from agricultural products, such as wheat, rice, sugar, etc., to metals such as gold, silver, to plantations such as rubber, coffee, to energy products such as oil. Furnace oil, etc.
Clearing Bank
Commodities Ecosystem
MCX
A processor/ manufacturing firm can buy in futures to hedge against volatile raw material costs
An exporter can commit to a price to his foreign clients
Easy availability of finance Based on hedged positions commodity market players (farmers, processors, manufacturers, exporters) may get easy financing from the banks Seasonal volatility: Faster dissemination of information:
S&P CNX Nifty Exchange of trading National Stock Exchange of India Limited Contract size Permitted lot size shall be 50 (minimum value Rs.2 lakh) Price steps Re. 0.05 Price bands Not applicable Trading cycle The futures contracts will have a maximum of three month trading cycle - the near month (one), the next Month (two) and the far month (three). New contract will be introduced on the next trading day following the Expiry of near month contract
Expiry day Settlement basis Settlement price
The last Thursday of the expiry month or the previous trading day if the last Thursday is a trading holiday Mark to market and final settlement will be cash Settled on T+1 basis. Daily settlement price will be the closing price of the futures contracts for the trading day and the final settlement price shall be the closing value of the Underlying index on the last trading day.
Contract specification: S&P CNX Nifty Options Underlying index S&P CNX Nifty Exchange of trading National Stock Exchange of India Limited Security descriptor NOPTIDX NIFTY Contract size Permitted lot size shall be 50 (minimum value Rs.2 lakh) Price steps Re. 0.05 Price bands Not applicable Trading cycle The options contracts will have a maximum of three month trading cycle - the near month (one), the next month (two) and the far month (three). New contract will be introduced on the next trading day following the expiry of near month contract. Expiry day The last Thursday of the expiry month or the previous trading day if the last Thursday is a trading holiday. Settlement basis Cash settlement on T+1 basis. Daily settlement price N.A Final settlement price Closing value of the index on the last trading day of the options contract
Expiry day
Settlement basis Settlement price
The last Thursday of the expiry month or the previous trading day if the last Thursday is a trading holiday. In Cash on T+1 Basis Daily settlement price will be the closing price of the futures contracts on the trading day and the the final settlement price will be the closing price of the the underlying on the last trading day of the options contract.
Expiry day
Settlement basis Daily settlement price
The last Thursday of the expiry month or the previous trading day if the last Thursday is a trading holiday.
T+1 Basis Closing price of underlying on the day of exercise
Closing price of underlying on the last trading day of the options contract
Last trading day