Indian Derivatives Market

INTRODUCTION- RISK
MANAGMENT
 Risk management is a discipline that helps bringing risks to manageable
extent .
 One risk does not get transformed into undesirable risk.

PLAYERS:
Hedgers, Speculators and Arbitrageurs - Market Role
 Hedgers and investors provide the economic substance to any financial
market. Without them the markets would lose their purpose and become
mere tools of gambling.
(E.g. Banks)
 Speculators provide liquidity and depth to the market.
 Arbitrageurs
DERIVATIVES
 Derivatives are financial contracts whose value/price is dependent on the behavior of
the price of one or more basic underlying assets (often simply known as the
underlying). These contracts are legally binding agreements, made on the trading
screen of stock exchanges, to buy or sell an asset in future.

 The asset can be a share, index, interest rate, bond, rupee dollar exchange rate,
sugar, crude oil, soybean, cotton, coffee and what have you.
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.
HISTORY OF DERIVATIVES AND
THE MARKET IN INDIA
According to Mr. Asani Sarkar’s research work, Derivatives market
has been in existence in India since 1875
He also mentions that in early 1900s India had the largest Futures
Industry
In 1952, Indian Government banned the options and futures
trading
But, by 2000 various reforms assisted in lifting all such bans and
the derivatives market is booming since then
The exchange traded derivative market is the largest in terms of
number of contracts made
In 2004, the daily trading value was 30 billion USD
The commodities eligible for futures trading was 8 and in 2004 it
was increased to 80
Current Scenario
 India’s experience with the launch of equity derivatives
market has been extremely positive. The derivatives
turnover on the NSE has surpassed the equity market
turnover. The turnover of derivatives on the NSE
increased from Rs. 23,654 million (US $ 207 million) in
2000-01 to Rs. 110,104,821 million (US $ 2,161 bn) in
2008-09. The average daily turnover in this segment of
the markets on the NSE was Rs. 453,106 mn in 2008-09.
FORWARDS
 A forward contract is a customized contract between
the buyer and the seller where settlement takes place
on a specific date in future at a price agreed today.
The rupee-dollar exchange rate is a big forward
contract market in India with banks, financial
institutions, corporate and exporters being the market
participants.
Features of forward contract

 It is a negotiated contract between two parties

and hence exposed to counter party risk.

eg: Trade takes place between A&B@ 100 to buy &

sell x commodity.After 1 month it is trading at
Rs.120. If A was he buyer he would gain Rs. 20
& B Loose Rs.20. In case B defaults you are
exposed to counter party Risk i.e. you will now
entitled to your gains. In case of Future, the
exchange gives a counter guarantee even if the
counter party defaults you will receive Rs.20/- as
a gain.
Features of forward contract…
 Each contract is custom designed and hence unique in
terms of contract size, expiration date, asset type, asset
quality etc.

 A contract has to be settled in delivery or cash on

expiration date.

 In case one of the two parties wishes to reverse a contract,

he has to compulsorily go to the other party. The counter
party being in a monopoly situation can command the
price he wants.
FUTURES
 Futures are exchange-traded contracts to buy or sell an
asset in future at a price agreed upon today. The asset can
be share, index, interest rate, bond, rupee-dollar exchange
rate, sugar, crude oil, soybean, cotton, coffee etc.
The standard Feature in any
futures contract

 Obligation to buy or sell

 Stated quantity
 At a specific price
 Stated date (Expiration Date)
 Marked to Market on a daily basis
 For example: when you are dealing in March 2002
Satyam futures contract, you know that the market
lot, ie the minimum quantity you can buy or sell, is
1,200 shares of Satyam, the contract would expiry
on March 28, 2002, the price is quoted per share, the
tick size is 5 paise per share or (1200*0.05) = Rs60
per contract/ market lot, the contract would be
settled in cash and the closing price in the cash
market on expiry day would be the settlement price.
Motives behind using Futures

 Hedging: It provides an insurance against an increase

in the price.

 The futures market has two main types of foreseeable

risk:
- price risk
- quantity risk
Interest Rate Futures
 An interest rate futures contract is an agreement to buy or
sell a standard quantity of specific interest bearing
instruments, at a predetermined future date and a price
agreed upon between parties
DIFFERENCE BETWEEN FORWARD
AND FUTURE CONTRACT.

 Customised vs Standardised contract:

 Counter Party Risk

 Liquidity

 Squaring off:
FUTURES TERMINOLOGY
 COST OF CARRY
 INITIAL MARGIN
 MARKING TO MARKET
 MAINTENANCE MARGIN
OPTIONS
 Options contracts grant their purchasers the
right but not the obligation to buy or sell a
specific amount of the underlying at a
particular price within a specified period.
OPTIONS Terminology …
 Commodity options
 Stock Options
 Buyer of an option
 Writer of an option
 Call option
 Put option
 Option price
OPTIONS Terminology …
 Expiration date
 Strike Price
 American option
 European option
Pay-off for Options…
 Buyer of call options : long call
 Writer of call options : short call
 Buyer of put options : long put
 Writer of call options : short put
Buyer of call options : long call
Writer of call options : short call
Buyer of put options : long put
Writer of call options : short put
Long Straddle
Short Straddle
Long Strangle
Short Strangle
Distinguishing Options & Futures