derivatives kotak 2010

Derivatives (Futures & Options)

CHAPTER-I

INTRODUCTION

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INTRODUCTION OF DERIVATIVES

The emergence of the market for derivatives 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 a very high degree 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 of 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”.

Securities Contracts (Regulation) Act, 1956 (SCR Act) 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.

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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

serious 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 spin-off CBOT was

reorganized to allow futures trading. Its name was changed to Chicago Mercantile

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 indexes, traded on Chicago Mercantile Exchange. During the Mid eighties,

financial futures became the most active derivative instruments generating volumes

many times more than the commodity futures. Index futures, futures on T-bills and

Euro-Dollar futures are the three most popular futures contracts traded today. Other

popular international exchanges that trade derivates are LIFFE in England, DTB in

Germany, SGX in Singapore, TIFFE in Japan MATIF in France, Eurex etc.

THE GROWTH OF DERIVATIVES

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:

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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.

Development of more sophisticated risk management tools, providing economic

agents a wider choice of risk management strategies, and

Innovations in the derivates markets, which optimally combine the risks and

returns over a large number of financial assets leading to higher returns, reduced

risk as well as transaction costs as compared to individual financial assets.

TYPES OF DERIVATIVES

The following are the various types of derivatives.

FORWARDS:

A forward contract is a customized contract between two entities, where settlement

takes place on a specific date in the future at today’s 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 price. 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 give 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-term Equity Anticipation securities. These are

options having a maturity of up to three years.

BASKETS:

Basket options are options on portfolios 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 agreements between two parties to exchange cash flows in the

future according to a prearranged formula. They can be regarded as portfolios of

forward contracts. The two commonly used Swaps are:

Interest rate Swaps:

These entail swapping only the related cash flows between the parties in the same

currency.

Currency Swaps:

These entail swapping both principal and interest between the parties, with the cash

flows in on direction being in a different currency than those in the opposite direction.

SWAPTION:

Swaptions are options to buy or sell a swap that will become operative at the expiry of

the options. Thus a swaption is an option on a forward swap. Rather than have calls

and puts, the swaptions market has received swaptions and payer swaptions. A

receiver swaption is an option to receive fixed and pay floating. A payer swaption is

an option to pay fixed and received floating.

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PARTICIPANTS IN THE DERIVATIVE MARKETS

The following three broad 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.

SPECULATORS:

Speculators wish to 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.

ARBITRAGERS:

Arbitrageurs are in business to take of a discrepancy between prices in two different

markets, if, for, example, they see the futures price of an asset getting out of line with

the cash price, they will take offsetting position in the two markets to lock in a profit.

FUNCTION OF THE DERIVATIVE MARKETS

In spite of the fear and criticism with which the derivative markets are commonly

looked at, these markets perform a number of economic functions.

Prices in an organized derivatives market reflect the perception of market

participants about the future and lead the price of underlying to the perceived

future level. The prices of derivatives converge with the prices of the underlying

at the expiration of the derivate contract. Thus derivatives help in discovery of

future as well as current prices.

Derivatives market helps to transfer risks from those who have them but may

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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 it 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. They often energize others to create new businesses, new products and

new employment opportunities, the benefit of which are immense.

Derivatives trading acts as a catalyst for new entrepreneurial activity.

Derivatives markets help increase saving and investment in long run.

SCOPE OF THE STUDY

The Study is limited to “Derivatives” with special reference to Futures and Option is

the Indian context and the Inter-Connected Stock Exchange have been Taken as a

representative sample for the study. The study can’t 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.

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OBJECTIVES OF THE STUDY

To analyze the derivatives market in India

To analyze the operations of futures and options

To find the profit/loss position of futures buyer and also the option writer and

option holder.

To study about risk management with the help of derivatives.

LIMITATIONS OF THE STUDY

The following are the limitation of this study.

The scrip chose for analysis is M/s. RELIANCE POWER and the contract

taken is January 2009. Ending one-month contract.

The data collected is completely restricted to the M/s. RELIANCE

POWER of January 2009; hence this analysis cannot be taken universal.

]

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CHAPTER-II

INDUSTRY PROFILE

&

COMPANY PROFILE

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Banking in India

Banking in India originated in the last decades of the 18th century. The oldest bank in existence in

India is the State Bank of India, a government-owned bank that traces its origins back to June 1806

and that is the largest commercial bank in the country. Central banking is the responsibility of the

Reserve Bank of India, which in 1935 formally took over these responsibilities from the then

Imperial Bank of India, relegating it to commercial banking functions. After India's independence in

1947, the Reserve Bank was nationalized and given broader powers. In 1969 the government

nationalized the 14 largest commercial banks; the government nationalized the six next largest in

1980.

Currently, India has 96 scheduled commercial banks (SCBs) - 27 public sector banks (that is with the

Government of India holding a stake), 31 private banks (these do not have government stake; they

may be publicly listed and traded on stock exchanges) and 38 foreign banks. They have a combined

network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a

rating agency, the public sector banks hold over 75 percent of total assets of the banking industry,

with the private and foreign banks holding 18.2% and 6.5% respectively

Early history

Banking in India originated in the last decades of the 18th century. The first banks were The General

Bank of India which started in 1786, and the Bank of Hindustan, both of which are now defunct. The

oldest bank in existence in India is the State Bank of India, which originated in the Bank of Calcutta

in June 1806, which almost immediately became the Bank of Bengal. This was one of the three

presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all three of

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http://en.wikipedia.org/wiki/State_Bank_of_India

http://en.wikipedia.org/wiki/Bank_of_Madras

http://en.wikipedia.org/wiki/Bank_of_Bombay

http://en.wikipedia.org/wiki/Bank_of_Bengal

http://en.wikipedia.org/wiki/Automated_teller_machine

http://en.wikipedia.org/wiki/Government_of_India

http://en.wikipedia.org/wiki/Reserve_Bank_of_India


which were established under charters from the British East India Company. For many years the

Presidency banks acted as quasi-central banks, as did their successors. The three banks merged in

1921 to form the Imperial Bank of India, which, upon India's independence, became the State Bank

of India.

Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a

consequence of the economic crisis of 1848-49. The Allahabad Bank, established in 1865 and still

functioning today, is the oldest Joint Stock bank in India. It was not the first though. That honor

belongs to the Bank of Upper India, which was established in 1863, and which survived until 1913,

when it failed, with some of its assets and liabilities being transferred to the Alliance Bank of Simla.

When the American Civil War stopped the supply of cotton to Lancashire from the Confederate

States, promoters opened banks to finance trading in Indian cotton. With large exposure to

speculative ventures, most of the banks opened in India during that period failed. The depositors lost

money and lost interest in keeping deposits with banks. Subsequently, banking in India remained the

exclusive domain of Europeans for next several decades until the beginning of the 20th century.

Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The Comptoire d'Escompte

de Paris opened a branch in Calcutta in 1860, and another in Bombay in 1862; branches in Madras

and Pondichery, then a French colony, followed. HSBC established itself in Bengal in 1869. Calcutta

was the most active trading port in India, mainly due to the trade of the British Empire, and so

became a banking center.

The Bank of Bengal, which later became the State Bank of India.

The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in 1881 in

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http://en.wikipedia.org/wiki/State_Bank_of_India

http://en.wikipedia.org/wiki/Bank_of_Bengal

http://en.wikipedia.org/wiki/British_Raj

http://en.wikipedia.org/wiki/Bengal

http://en.wikipedia.org/wiki/HSBC

http://en.wikipedia.org/wiki/Pondichery

http://en.wikipedia.org/wiki/Chennai

http://en.wikipedia.org/wiki/Mumbai

http://en.wikipedia.org/w/index.php?title=Comptoire_d'Escompte_de_Paris&action=edit&redlink=1

http://en.wikipedia.org/w/index.php?title=Comptoire_d'Escompte_de_Paris&action=edit&redlink=1

http://en.wikipedia.org/wiki/Kolkata

http://en.wikipedia.org/wiki/Confederate_States

http://en.wikipedia.org/wiki/Confederate_States

http://en.wikipedia.org/wiki/Lancashire

http://en.wikipedia.org/wiki/American_Civil_War

http://en.wikipedia.org/wiki/Alliance_Bank_of_Simla

http://en.wikipedia.org/wiki/Allahabad_Bank

http://en.wikipedia.org/wiki/Imperial_Bank_of_India

http://en.wikipedia.org/wiki/File:Bank_of_Bengal.jpg


Faizabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in 1895,

which has survived to the present and is now one of the largest banks in India.

Around the turn of the 20th Century, the Indian economy was passing through a relative period of

stability. Around five decades had elapsed since the Indian Mutiny, and the social, industrial and

other infrastructure had improved. Indians had established small banks, most of which served

particular ethnic and religious communities.

The presidency banks dominated banking in India but there were also some exchange banks and a

number of Indian joint stock banks. All these banks operated in different segments of the economy.

The exchange banks, mostly owned by Europeans, concentrated on financing foreign trade. Indian

joint stock banks were generally under capitalized and lacked the experience and maturity to compete

with the presidency and exchange banks. This segmentation let Lord Curzon to observe, "In respect

of banking it seems we are behind the times. We are like some old fashioned sailing ship, divided by

solid wooden bulkheads into separate and cumbersome compartments."

The period between 1906 and 1911, saw the establishment of banks inspired by the Swadeshi

movement. The Swadeshi movement inspired local businessmen and political figures to found banks

of and for the Indian community. A number of banks established then have survived to the present

such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central

Bank of India.

The fervour of Swadeshi movement lead to establishing of many private banks in Dakshina Kannada

and Udupi district which were unified earlier and known by the name South Canara ( South

Kanara ) district. Four nationalised banks started in this district and also a leading private sector

bank. Hence undivided Dakshina Kannada district is known as "Cradle of Indian Banking".

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http://en.wikipedia.org/wiki/Udupi_district

http://en.wikipedia.org/wiki/Dakshina_Kannada

http://en.wikipedia.org/wiki/Central_Bank_of_India

http://en.wikipedia.org/wiki/Central_Bank_of_India

http://en.wikipedia.org/wiki/Canara_Bank

http://en.wikipedia.org/wiki/Bank_of_Baroda

http://en.wikipedia.org/wiki/Indian_Bank

http://en.wikipedia.org/wiki/Corporation_Bank

http://en.wikipedia.org/wiki/Bank_of_India

http://en.wikipedia.org/wiki/Swadeshi

http://en.wikipedia.org/wiki/Joint_stock_company

http://en.wikipedia.org/wiki/Indian_rebellion_of_1857

http://en.wikipedia.org/wiki/Lahore

http://en.wikipedia.org/wiki/Punjab_National_Bank

http://en.wikipedia.org/wiki/Faizabad


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http://en.wikipedia.org/wiki/File:Scheduled_banking_structure_in_India.png


COMPANY PROFILE

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Company Overview

The Kotak Mahindra Group was born in 1985 as Kotak Capital Management Finance Limited. Uday

Kotak, Sidney A.A.Pinto and Kotak & Company promoted this company. Industrialists Harish

Mahindra and Anand Mahindra took a stake in 1986, and that’s when the company changes its name

to Kotak Mahindra Finance Limited.

Since then it’s been a steady and confident journey to growth and success.

1986: - Kotak Mahindra Finance Limited starts the activity of Bill Discounting.

1987: - Kotak Mahindra Finance Limited enters the lease and hire purchase market.

1990: - The Auto Finance Division is started.

1991: - The Investment Banking Division is started.

1992: - Enters the Funds Syndication sector.

1995: - Brokerage and Distribution Businesses incorporated in to a separate

company - Kotak Securities Investment Banking Division incorporated into a

separate company – Kotak Mahindra Capital Company.

1996: - The Auto Finance Business is hired off into a separate company – Kotak

Securities investment Banking Division Incorporated into a separate company -

Kotak Mahindra Capital Company.

1998: - Enters the Mutual Fund Marker with the launch of Kotak Mahindra asset

Management Company.

2000: - Kotak Mahindra tie up with old Mutual PIC for the life insurance business.

Kotak Securities launches its on-line broking site ( www.kotak securities .com )

2001: - Matrix sold to Friday Corporation launches insurance Services

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http://www.kotak/


2003: - Kotak Mahindra Finance Limited converts to a Commercial Bank – The first Indian Company to do so.

2004: - Launches India growth fund, a private equity fund.

2005: - Kotak group realigns Joint Ventures in ford credit; Buys Kotak Mahindra

prime and sells ford credit Kotak Mahindra.

Launches a Real-estate Fund.

Group Management : -

Mr.Uday Kotak – Executive Vice Chairman & Managing Director.

Mr.Sivaji Dam

Mr.C.Jayaram

Mr.Dipak Gupta.

Kotak Mahindra Group

Kotak Mahindra is one of India’s leading financial institutions offering complete financial

solutions that encompass every sphere of life. From commercial banking, to stock broking, to

mutual funds, to life insurance to investment banking, the group caters to the financial needs of

individuals and corporate.

The group has a net worth of around Rs.2000 crore and the AUM across the group is around

120 billion and employs over 6000 employees in its various businesses. With a presence in 216

cities in India and offices in New York, London, Dubai and Mauritius, it services a customer base of

over 10.00,000.

The group specializes in offering top class financial services catering to every segment of the

industry. The various group companies include.

Kotak Mahindra Capital Limited

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Kotak Mahindra Securities Limited

Kotak Mahindra Inc

Kotak Mahindra (International) Limited

Global Investments Opportunities Fund Limited

Kotak Mahindra(UK) Limited Kotak Securities Limited

Kotak Mahindra Old Mutual Life Insurance Company Limited

Kotak Mahindra Asset Management Company Limited

Kotak Mahindra Trustee Company Limited

Kotak Mahindra Investments Limited

Kotak Forex Brokerage Limited

Kotak Mahindra Private-Equity Trustee Limited

Group Structure

Kotak Securities Limited.

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Kotak Mahindra Bank

Kotak Mahindra Capital Company

Kotak Securities

Kotak Mahindra Investments

Kotak Mahindra Prime

Kotak Mahindra Asset Management Company

Kotak Mahindra Trust Company

Kotak Mahindra Securities

Kotak Mahindra ( International)

Kotak Mahindra Inc.

Kotak Mahindra (UK)

Global Investment Opportunities Fund


Kotak Securities Ltd. Is India’s leading stock broking house with a marker share of around 8% Kotak

Securities Ltd. Has been the largest in IPO distribution.

The accolades that Kotak Securities has been graced with include :

Prime Ranking Award (2003-04) Largest Distributor of IPO’s

Finance Asia Award (2004) – India’s best Equity House.

Finance Asia Award (2005) – Best Broker in India.

Euromoney Award (2005) – Best Equities House in Inida

The company has a full-fledged research division involved in Macro Economic studies Sectoral

research and Company specific Equity Research combined with a strong and well networked sales

force which helps deliver current and up to date market information and news.

Kotak Securities Ltd is also a depository participant with National Securities Depository Limited

(NSDL) and Central Depository services Limited (CSDL), Providing dual benefit services wherein in

investors can use the brokerage services of the company for executing the transactions and the

depository services for settling them.

Kotak Securities has 122 branches servicing more than 1,70,000 customer and a coverage of 187

cities, kotaksecurities.com, the online division of Kotak Securities Limited offers internet Broking

services and also online IPO and Mutual Fund Investments.

Kotak Securities Limited Manages assets over 2500 crores of Assets under Management (AUM).

The Portfoilo Management Services provide top class service, catering to the high end of the market.

Portfolio Management from Kotak Securities comes as an answer to those who would like to grow

exponentially on the crest of the stock market, with the backing of an expert.

At Kotak securities.com, acknowledge and accept that the personal details that you inpart to us, is to

be kept in strict confidentiality and to use the information only in the manner which would be

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beneficial to our customers. We consider our relationship with you as invaluable and strive to

respect and safeguard your right to privacy.

We shall protect the personal details received from you with the same degree of care, but no less than

a reasonable degree of care, to prevent the unauthorized use, dissemination, or publication of these

information as we protect our own confidential information of a like nature.

We shall use the personal information to improve our service to you and to keep you updated about

our new product or information that may be of interest to you. The information collected from you

would be used in the right spirit and context in which it is intended to be used. Your information

would be used by us to process your trading request and to carry out the settlements of your

obligations.

We would ensure that we collect personal information only to the extent it is necessary to administer

out services in the best possible manner and what is required under the various regulations of India

Laws.

HDFC

Vision

To be a dominant player in the Indian mutual fund space recognized for its high levels of ethical and

professional conduct and a commitment towards enhancing investor interests.

Sponsors

Housing Development Finance Corporation Limited (HDFC)

HDFC was incorporated in 1977 as the first specialized Mortgage Company in India. HDFC provides

financial assistance to individuals, corporate and developers for the purchase or construction of

residential housing. It also provides property related services (e.g. property identification, sales

services and valuation), training and consultancy. Of these activities, housing finance remains the

dominant activity. HDFC has a client base of around 9.5 lac borrowers, around 1 million depositors,

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over 91,000 shareholders and 50,000 deposit agents, as at June 30, 2007. HDFC has raised funds

from international agencies such as the World Bank, IFC (Washington), USAID, DEG, ADB and

KfW, international syndicated loans, domestic term loans from banks and insurance companies,

bonds and deposits. HDFC has received the highest rating for its bonds and deposits program for the

twelfth year in succession. HDFC Standard Life Insurance Company Limited, promoted by HDFC

was the first life insurance company in the private sector to be granted a Certificate of Registration

(on October 23, 2000) by the Insurance Regulatory and Development Authority to transact life

insurance business in India.

For further details: www.hdfc.com

Standard Life Investments Limited

The Standard Life Assurance Company was established in 1825 and has considerable experience in

global financial markets. The company was present in the Indian life insurance market from 1847 to

1938 when agencies were set up in Kolkata and Mumbai. The company re-entered the Indian market

in 1995, when an agreement was signed with HDFC to launch an insurance joint venture. On April

2006, the Board of The Standard Life Assurance Company recommended that it should demutualise

and Standard Life plc float on the London Stock Exchange. At a Special General Meeting held in

May voting members overwhelmingly voted in favor of this. The Court of Session in Scotland

approved this in June and Standard Life plc floated on the London Stock Exchange on 10th July

2006. Standard Life Investments was launched as an investment management company in 1998. It is

a wholly owned subsidiary of Standard Life Investments (Holdings) Limited, which in turn is a

wholly owned subsidiary of Standard Life plc. Standard Life Investments is a leading asset

management company, with approximately US$ 282 billion as at June 30, 2007, of assets under

management. The company operates in the UK, Canada, Hong Kong, China, Korea, Ireland and the

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USA to ensure it is able to form a truly global investment view. In order to meet the different needs

and risk profiles of its clients, Standard Life Investments Limited manages a diverse portfolio

covering all of the major markets world-wide, which includes a range of private and public equities,

government and company bonds, property investments and various derivative instruments. The

company's current holdings in UK equities account for approximately 1.8% of the market

capitalization of the London Stock Exchange.

Management:

ABN AMRAO

With assets over US $504 billion and an AA credit rating, ABN AMRO Bank ranks among the top

10 banks in the world in size and strength. Our international network comprises 3,568 branches and

offices in over 320 cities and 76 countries and territories, with over 100,000 highly qualified staff. As

a global bank, we can handle the most complicated cross-border transactions, yet we also understand

the subtleties of local markets.

ABN AMRO IN INDIA

Traditionally known as a strong diamond financing bank, ABN AMRO today offers unparalleled

suite of client services in India.

By leveraging our global reach and drawing on the expertise of our team of research, sales and

trading, equity capital market and M&A advisory professionals, we have led many of the biggest and

most innovative landmark transactions in India for our Corporate and Institutional Clients.

In addition, we also offer a broad range of transaction banking products, fixed income and foreign

exchange products and services including sales and trading, fixed income origination, derivatives,

structured lending and commodity financing.

For our Business Banking clients, we offer top quality services in trade finance, business loans,

21


supply chain management, credit facilities, payment and cash management- solutions that help small

to medium size businesses enhance cash flow, boost overall business efficiency and capitalize on

new opportunities.

Through a diverse range of product offerings including personal loans, credit cards, savings accounts,

financial planning, investment and insurance services, ABN AMRO meets the everyday financial

needs of over a million Personal Banking clients in India.

In addition ABN AMRO has Van Gogh Preferred Banking which represents a new standard of

relationship banking which has been exclusively created to offer an enhanced level of service to

demanding individuals. Van Gogh Preferred Banking services offers a wide range of wealth

maximization opportunities offering new standards of freedom, access, advice and service.

At ABN AMRO Broking we offer world class research, timely advice, extreme ease of use and swift

real time transaction systems for our clients.

Private Banking Services in India offers our select and premium clients a comprehensive range of

quality Portfolio Advisory Services along with a sophisticated execution platform. We aid in

enhancing their wealth with premium services including investment advisory, non-discretionary

portfolio management, investment funds, international estate planning and trust.

Asset Management in India is among the fastest growing asset managers with just two years of

operations in the country. Backed by the favourable market conditions and a strong focus on the

business we have an ever-increasing and widening distribution and aim to emerge as a leading player

in the Indian asset management industry. Leveraging our Group's comprehensive research and

diverse range of investment products, we offer our clients investment options in fixed income,

equities, money markets and structured products. The Microfinance program of ABN AMRO, the

largest amongst its peer foreign banks in India, is aimed at delivering credit to our target community

22


of rural poor woman through intermediaries called microfinance institutions. We today service 26

MFIs across 16 states in India with over 390,000 customers receiving micro financing small loans of

USD 200 or less. Our aim is to reach a million customers by 2009. During the annual Sustainable

Banking Awards ceremony held by Financial Times of London, ABN AMRO India was named the

Sustainable Bank of the Year in the Emerging Markets category - both in the Asia region as well as

globally.

Mission

"ABN AMRO's mission is to create maximum economic value for our shareholders through a

constant relationship focus on the financial services needs of our chosen client segments and a strict

adherence to our financial targets. We are operating in three principal customer segments, whereby

the objective is to maximize the value of each of these businesses as well as the synergies between

them. Excellence of service to our clients and leadership in our chosen markets are of paramount

importance to our long-term success. The Bank's corporate values play an integral role in the

fulfilment of our mission."

History

On 29 March 1824 King Willem-I issued a royal decree creating the Nederlandsche Handel-

Maatschappij with the aim of reviving trade between the Netherlands and the Dutch East Indies. In

1964, NHM merged with De Twentsche Bank to form Algemene Bank Nederland (ABN), while

Amsterdamsche Bank and Rotterdamsche Bank joined to become Amsterdam-Rotterdam (Amro)

Bank. In 1991, these two banks merged as ABN AMRO Bank. Today, ABN AMRO Bank has a

powerful presence in world markets, building on a tradition of stimulating international trade.

BIRLA SUN LIFE

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Birla Sun Life Asset Management Company Ltd. (BSLAMC), the investment managers of Birla Sun

Life Mutual Fund, is a joint venture between the Aditya Birla Group and the Sun Life Financial

Services Inc. of Canada. The joint venture brings together the Aditya Birla Group's experience in the

Indian market and Sun Life's global experience.

Since its inception in 1994, Birla Sun Life Mutual fund has emerged as one of India's leading Mutual

Funds managing assets of a large investor base. The fund offers a range of investment options, which

include diversified and sector specific equity schemes, fund of fund schemes, hybrid and monthly

income funds, a wide range of debt and treasury products and offshore funds.

BSLAMC follows a long-term, fundamental research based approach to investment. The approach is

to identify companies, which have excellent growth prospects and strong fundamentals. The

fundamentals include the quality of the company’s management, sustainability of its business model

and its competitive position, amongst other factors. Birla Sun Life Asset Management Company has

one of the largest team of research analysts in the industry, dedicated to tracking down the best

companies to invest in.

Birla Sun Life AMC strives to provide transparent, ethical and research-based investments and

wealth management services

. VISION To be the most trusted name in investment and wealth management, to be the preferred

employer in the industry and to be a catalyst for growth and excellence of the asset management

business in India.

MISSION

To consistently pursue investor's wealth optimization by: Achieving superior and consistent

investment results. Creating a conducive environment to hone and retain talent. Providing customer

24


delight. Institutionalizing system-approach in all aspects of functioning. Upholding highest

standards of ethical values at all times.

ADITYA BIRLA GROUP

The Aditya Birla Group is India's first truly multinational corporation. Global in vision, rooted in

Indian values, the Group is driven by a performance ethic pegged on value creation for its multiple

stakeholders.The Aditya Birla Group’s products and services offer distinctive customer solutions

worldwide. The Group has operations in 20 countries - India, Thailand, Laos, Indonesia, Philippines,

Egypt, China, Canada, Australia, USA, UK, Germany, Hungary, Brazil, Italy, France, Luxembourg,

Switzerland, Malaysia and Korea.A US $24 billion corporation with a market cap. of US $31.5

billion and in the League of Fortune 500, the Aditya Birla Group is anchored by an extraordinary

force of 100,000 employees, belonging to 25 different nationalities. Over 50 per cent of its revenues

flow from its operations across the world.It's 66 state-of-the-art manufacturing units and sectoral

services span India, Thailand, Indonesia, Malaysia, Philippines, Egypt, Canada, Australia and

China.The Aditya Birla Group is a dominant player in all of the sectors in which it operates. These

sectors include viscose staple fibre, non-ferrous metals, cement, viscose filament yarn, branded

apparel, carbon black, chemicals, fertilisers, sponge iron, insulators and financial services. In India,

the Group has been adjudged “The Best Employer in India and among the top 20 in Asia” by the

Hewitt-Economic Times and Wall Street Journal Study 2007.

25


CHAPTER-III

REVIEW OF LITERATURE

26


REVIEW OF LITERATURE

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 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.

27


THE DEVELOPMENT OF DERIVATIVES

Holding portfolios of securities is associated 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

Industrial policy

Management capabilities

Consumer’s preference

Labour 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 of 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 company’s earnings rising and vice

28


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 to many common stocks. 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 MARKETThe global financial centers such as Chicago, New York, Tokyo and London dominate

the trading in derivatives. Some of the world’s leading exchanges for the exchange-

traded derivatives are:

Chicago Mercantile Exchange (CME) & London International financial Futures

Exchange (LIFFE) (for currency & Interest rate futures)

Philadelphia Stock Exchange (PSE), London stock Exchange (LSE) & Chicago

Board options exchange (CBOE) (for currency options)

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.

NSE’s 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

29


trading in options on individual securities commenced on June 2, 2001, Single stock

futures were launched on 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-month expiration cycles. Three contracts are

available for trading, with 1 month, 2 month & 3 month expiry. A new contract 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 S C (R) Act,

the SEBI Act, and the regulations framed there under the rules and byelaws of stock

exchanges.

In this chapter we look at the broad regulatory frame work for derivatives

trading and the requirement to become a member and authorized dealers of the F&O

segment and the position limits as they apply to various participants.

Regulation for Derivative Trading:

SEBI set up a 24-member committed under Chairmanship of Dr.L.C.Gupta develop

the appropriate regulatory framework for derivative trading in India. On May11, 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) Act governs the trading in the securities. The amendment

of the SCR Act to include “DERIVATIVES” within the ambit of securities in the SCR

Act made trading in Derivatives possible within the framework of the Act.

Any exchange fulfilling the eligibility criteria as prescribed in the L.C.Gupta

committee report may apply to SEBI for grant of recognition under section 4 of

30


the SCR Act, 1956 to start Derivatives Trading. The derivative exchange-

/segment should have a separate governing council and representation of

trading/clearing member shall be limited to maximum 40% of the total

members of the governing council. The exchange shall regulate the sales

practices of its members and will obtain approval of SEBI before start of

Trading in any derivative contract.

The exchange shall have minimum 50 members.

The members of an existing segment of the exchange will not automatically

become the members of the derivatives segment. The members of the

derivatives segment need to fulfill the eligibility conditions as lay down by the

L. C. Gupta committee.

The clearing and settlement of derivatives trades shall be through a SEBI

approved clearing corporation/clearing house. Clearing Corporation/Clearing

House complying with the eligibility conditions as lay down by the committee

have to apply to SEBI for grant of approval.

Derivatives broker/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 lakh. The net worth of

the member shall be computed as follows:

o Capital + Free reserves

o Less non-allowable assets viz.,

Fixed Assets

Pledged securities

Member’s card

Non-allowable securities (unlisted securities)

31


Bad deliveries

Doubtful debts and advance

Prepaid expenses

Intangible Assets

30% marketable securities

The Minimum contract value shall not be less than Rs.2 Lakhs. Exchange

should also submit details of the futures contract they purpose to introduce.

The trading members are required to have qualified approved user and sales

persons who have passed a certification programmed approved by SEBI.

The L.C.Gupta committee report requires strict enforcement of “know your

customer” rule and requires that every client shall be registered with the

derivates 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 client the Risk Disclosure and obtain a copy of the same duly signed by

the clients.

ELIGIBILITY OF ANY STOCK TO ENTER IN DERIVATIVES MARKET

Non promoter holding (free float capitalization) not less than Rs.750crores

from

last 6 months.

Daily Average Trading value not less than 5 crores in last 6 months.

At least 90% of Trading days in last 6 months.

Non Promoters Holding at least 30%.

BETA not more than 4 (previous last 6 months)

DESCRIPTION OF THE METHOD

The following are the steps involved in the study.

Selection of the Scrip:

32


The scrip selection is done on a random and the scrip selected is M/s. Reliance Power

The Lot is 500. Profitability position of the futures buyers and seller and also the

option holder and option writers is studied.

Data Collection:

The data of the M/s. Reliance Power has been collected from the “The Economic

Times” and internet. The data consist of the January Contract and period of Data

Collection is from 29th December 2008 to 29th January 2009.

Analysis:

The analysis consist of the tabulation of the data assessing the profitability position of

the futures buyers and sellers and also option holder and the option Writer,

representing the data with graphs and making the interpretation using Data.

INTRODUCTION OF FUTURES

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 as 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 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

33


The units of price quotation and minimum price change

Location of settlement

DEFINITION

A future 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

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 & 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 & FORWARDS CONTRACTS

Forward contracts are often confused with futures contracts. The confusion is primarily because both

34


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 contracts as they

eliminate counterparty risk and offer more liquidity. Comparison between two as follows:

FUTURES FORWARDS

1. Trade on an Organized Exchange2. Standardized3. More Liquidity4. Require Margin payment5. Follows daily settlement

1. OTC in nature2. Customized3. Less Liquidity4. No Margin Payment5. Settlement happens at end of period

Table 2.1

FEATURES OF FUTURES: Futures are highly standardized.

The contracting parties need not pay any down payments.

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

Index futures

PARTIES IN THE FUTURES CONTRACT:

There are two parties in a future contract, the buyer 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 buyer and the seller of the futures of the contracts are as

follows:

35


PAY-OFF FOR A BUYER OF FUTURES

Figure 2.1

36


CASE 1:- The buyer bought the futures contract at (F); if the future price goes to E1

then the buyer gets the profit of (FP).

CASE 2:- The buyer gets loss when the future price goes less then (F), if the future

price goes to E2 then the buyer gets the loss of (FL).

PAY-OFF FOR A SELLER OF FUTURES:

Figure 2.2

37


F – FUTURES PRICE

E1, E2 – SETTLEMENT 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 gets 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 futures contract is signed, both buyer and seller are required to post initial

margins. Both buyer and seller are required to make security deposits that are

intended to guarantee that they will infact be able to fulfill their obligation. These

deposits are initial margins and they are often referred as purchase price of futures

contract.

Marking to market margins:

The process of adjusting the equity in an investor’s account in order to reflect the

change in the settlement price of futures contract is known as MTM margin.

38


Maintenance margin:

The investor must keep the futures account equity equal to or greater 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. ’A’

sold a M/s. Reliance Power January futures contract to ‘B’ at Rs.104.80; the

following table shows the effect of margins on the contract. The contract size of

Reliance Power is 500. The initial margin amount is say Rs.14000/-, 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 the futures contract. Every time the observed price deviates from the

fair value, arbitragers would enter into trades to captures the arbitrage profit. This is

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: F = Futures Price S = Spot price of the underlying R = cost of financing (using continuously compounded Interest rate) T = Time till expiration in years e = 2.71828

(OR) F=S (1+r-q) t

39


Where: F = Futures price q = Expected Dividend yield S = Spot price of the underlying t = Holding Period r = Cost of financing (or) interest rate .

FUTURES TERMINOLOGYSpot 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 contract trades. The index futures contracts on the NSE have

one-month, two–month and three-month expiry cycle which expire on the last

Thursday of the month. Thus a January expiration contract expires 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 specifies 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 NSE’s futures market is 50 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.

40


Cost 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.

Marking-to-market:

In the futures market, at the end of each trading day, the margin account is adjusted to

reflect the investor’s gain or loss depending upon the futures closing price. This is

called marking-to-market.

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 call and is expected to top up the margin account to the initial margin level before trading commences on the next day.

INTRODUCTION

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.

DEFINITION

Option is a type of contract between two persons where one grants the other the right

41


to buy a specific asset at a specific price within a specific time period. Alternatively

the contract may grant the other person the right to sell a specific asset at a specific

price within a specific time period. In order to have this right. The option buyer has to

pay the seller of the option premium. The assets on which option can be derived are

stocks, commodities, indexes etc. If the underlying asset is the financial asset, then the

option are financial option like stock options, currency options, index options etc, and

if options like commodity option.

HISTORY OF OPTIONS

Although options have existed for a long time, they we traded OTC, without much

knowledge of valuation. The first trading in options began in Europe and the US as

early as the 17th century. It was only in the early 1900’s 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. The firms would then

attempt to find a seller or writer of the option either from its own client of those of

other 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 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

42


Vienna. Over a 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 and 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 their 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

Buyer/Holder/Owner of an option:

The buyer of an option is one who by paying option premium buys the right but not the

43


obligation to exercise his option on seller/writer.

Seller/writer of an option:

The writer of the call /put options is the one who receives the option premium and is

their by obligated 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.

I. 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 contract, index options contracts are also cash

settled.

STOCK OPTIONS

Stock options are options on the 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.

II. 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 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 a 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 right but not the obligation to

44


sell an asset by a certain date for a certain price.

III. On the basis of exercise of option:

On the basis of the exercised 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 option are American.

EUOROPEAN 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 a underlying asset. The

following graph shows the pay-off of buyer of a call option.

45


Figure 2.3

S = Strike price ITM = In the moneySP = Premium/ profit ATM = At the moneyE1 = Spot price 1 OTM = Out of the moneyE2 = Spot price 2SR = Profit at spot price E1

CASE 1: (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-off of seller of the call option depends on the spot price of the underlying

asset. The following graph shows the pay-off of seller of a call option:

46


Figure 2.4


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).

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.

47


Figure 2.5


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).


As the spot price (E2) of the underlying asset is more than strike price (s),

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 a seller of the option depends on the spot price of the underlying asset.

48


The following graph shows the pay-off of seller of a put option. They are:

Figure 2.6


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 than the loss also

increases more than (SR).


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:

49


Stock price:

The pay–off from a call option is a 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 increases, 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

increases.

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 increase as volatility

increase.

Risk-free interest rate:

The put options prices decline as the risk-free rate increases where as the prices of call

always increase 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.

50


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 spreadsheets come with a built-in Black-Scholes

options pricing formula so to price options we don’t 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:

CALL OPTIONC = SN (D1)-Xe-r t N (D2)

PUT OPTIONP = Xe-r t N (-D2)-SN (-D1)

Where d1 = Ln(S/X) + (r+ v 2 /2) t

v\/tAnd d2 = d1- v\/t

Where:CA = VALUE OF CALL OPTIONPA = VALUE OF PUT OPTION

S = SPOT PRICE OF STOCKN = NORMAL DISTRIBUTIONVARIANCE (v) = VOLATILITY

X = STRIKE PRICEr = ANNUAL RISK FREE RETURN

t = CONTRACT CYCLEe = 2.71828r = in (1+r)

OPTIONS TERMINOLOGY

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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 expiration date, the exercise

date, the strike date or the maturity.

Strike price:

The price specified in the options contract is known as strike price or Exercise price.

In-the-money option:

An In-the-money (ITM) option is an option that would lead to positive cash flow to

the holder if it were exercised immediately. A call option on the index is said to be in-

the-money when the current index stands at a level higher than the strike price (i.e.

spot > strike price). If the index is much higher than the strike price, the call is said to

be deep ITM. In the case of a put, the put is ITM if the index is below the strike price.

At-the-money option:

An at-the-money (ATM) option is an option that would lead to zero cash flow if it is

exercised immediately. An option on the index is at-the-money when the current index

equals the strike price (i.e. spot price = strike price).

Out-of-the-money option:

An out-of-the-money (OTM) option is an option that would lead to negative cash flow

if it is exercised immediately. A call option on the index is out-of-the-money when the

current index stands at a level which is less than the strike price (i.e. spot price < strike

price). If the index is much lower than the strike price, the call is said to be deep OTM.

In the case of a put, the put is OTM if the index is above the strike price.

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Intrinsic value of money:

The option premium can be broken down into two components-intrinsic value and

time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If

the call is OTM, its intrinsic value is zero.

Time value of an option:

The time value of an option is the difference between its premium and its intrinsic

value. Both CALL and PUT have time value. An option that is OTM or ATM has only

time value. Usually, the maximum time value exists when the option is ATM. The

longer the time to expiration, the greater is an option’s time value, all else equal. At

expiration, an option should have no time value.

DISTINCTION BETWEEN FUTURES AND OPTIONS

FUTURES OPTIONS

1.Exchange traded, with Novation2.Exchange defines the product3.Price is zero, strike Price moves4.Price is zero5.Linear payoff6.Both long & Short at risk

1.Same in nature2.Same in nature3.Strike price is fixed, price moves4.Price is always positive5.Nonlinear payoff6.only short at risk

Table 2.2

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INTRODUCTION

The futures & options trading system of NSE, called NEAT-F&O trading system,

provides a fully automated screen-based trading for Nifty futures & options and stock

futures & options on a nationwide basis as well as online monitoring and surveillance

mechanism. It supports an order driven market and provides complete transparency of

trading operations. It is similar to that of trading of equities in the cash market

segment.

The software for the F&O market has been developed to facilitate efficient and

transparent trading in futures and options instruments. Keeping in view the familiarity

of trading members with the current capital market trading system, modifications have

been performed in the existing capital market trading system so as to make it suitable

for trading futures and options.

On starting NEAT (National Exchange for Automatic Trading) application, the log on

(pass word) screen appears with the following details.

1. User ID

2. Trading Member ID

3. Password – NEAT CM (default pass word)

4. New Pass Word

Note: -1. User ID is a Unique2. Trading Member ID is Unique & Function; it is common for all user of the Trading Member.3. New password–Minimum 6 Characteristic, Maximum 8 characteristics only 3

attempts are accepted by the user to enter the password to open the screen.

4. If password is forgotten the user required to inform the exchange in writing to

reset the password.

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TRADING SYSTEM

Nationwide online fully Automated Screen Based Trading System (SBTS)

Price priority

Time priority

Note: -

1. NEAT system provides open electronic consolidated limit orders book

(OECLOB)

2. Limit order means: stated quantity and stated price

Before Opening the market

User allowed to set up:

1. market watch screen

2. inquiry screens only

Open phase (open Period):

User allowed to

1. Enquiry

2. Order Entry

3. Order Modification

4. Order Cancellation

5. Order Matching

Market Closing Period

User allowed only for inquires

Surcon period

(Surveillance & Control period)

The system process the Date, for making the system, for the next trading day.

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Log of the Screen (Before Surcon Period)

The screen shows: -

1. Permanent sign off

2. Temporary sign off

3. Exit

Permanent sign off: Market not updates.

Temporary sign off: Market up date (temporary sign off, after 5 minutes

Automatically Activate)

Exit: The user comes out sign off screen.

Local Database

Local Database is used for all inquiries made by the user for own order/trades

information. It is used for corporate manager/ Branch Manager Makes inquiries for

orders/trades of any branch manager/dealer of the trading firm, and then the inquiry is

serviced by the host. The local database also includes message of security information.

Ticker Window

The ticker window displays information of all trades in the system. The user has the

option of selecting the security, which should be appearing in the ticker window.

Securities in ticker can be selected for each market types

The ticker window displays both derivative and capital market segment

Market Watch Window

Title Bar: Title Bar Shows: NEAT, Date & Time.

Market watch window felicitate to set only 500 scrip’s, but the user set up a Maximum

of 30 securities in one page.

Previous Trade Screen

Previous trade screen shows & allows security wise information to user for his own

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trade in chronological order.

1. Request for trade modification allowed with the following conditions

During the day only

Must be lower than the traded quantity

Both parties acceptance (Buyer & Seller)

Final Decision is taken by NSE (to accept or reject)

2. Request for trade cancellation allowed with same as above conditions (A).

Outstanding order Screen

Outstanding order screen show, Status outstanding order enters by user for a particular

security (R.L. Order & SL Order) it allows: - order Modification & Orders

Cancellation.

Activity Log Screen

Activity logon screen show, all activities performed on any order by the user, in

Reversal Chronological Order

B = Buying

S = Selling orders

OC = Cancellation of order

OM = Modifying order

TC = Buy order & Sell order, involving in trade and cancelled

TM = Buy order & sell orders, involving trade is modified

It is very useful to a corporate manager to view all the activities that have been

performed on any order (or) all ordered under his branches & dealers

Order status screen

Order status screen shows, current status of “dealers” own specified orders.

SNAP Quote Shows

Instantaneous information about a particular security can be shown on Market watch

57


window (which is not set up in market watch window)

Market Movement Option

Over all movement of the security, in current day, on time basis.

Market Inquiry

Market inquiry screen shows market statistics for particular market, for a particular

security.

It shows information about:-

RL Market (Regular lot Market)

RD Market (Retail Debt Market)

OL Market (Odd lot Market)

It shows following statistics:- open price, High price, Low price, Last Traded Price,

Traded Quantity, 52 weeks high/low price.

MBP (Market by Price)

MBP (F6) screen shows total outstanding orders of a particular security, in the market,

Aggregate at each price in order of Best 5 prices.

It shows: -

RL Market (Regular lot Market)SL Market (Stop Loss order)ST order (Special Term orders)Buy Back Order with ‘*’ symbolP = indicate pre open positionS = indicate Security Suspend

Security/Portfolio list

It Facilitate the user to set up market watch screen

And facilitate to set up his own portfolios

ON-LINE Batch Up

It facilitates the user to take back up of all orders & trade related information, for

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current day only.

ON-LINE/TABULAR SLIPSIt selects the format for conformation slipsAbout WindowThis window displays software related version numbers details and copy right information.Most Activity Securities ScreenIt shows most active securities, based on the total traded value during the day

Report Selection WindowIt facilitates to print each copy of report at any time. These reports are

1. Open order report: For details of outstanding orders

2. Order log report: For details of orders placed, modified & cancelled

3. Trade Done-today report: For details of orders traded

4. Market Statistics report: For details of all securities traded information in a

day

Internet BrokingNSE introduced Internet trading system from February 2000.Client place the order through brokers on order routing system.

WAP (Wireless application protocol)NSE.IT Launches the from November 20001st Step-getting the permission from exchange for WAP

2nd step-approved by the SEBI (SEBI Approved only for SEBI registered members)X.25 Address Check

X.25 Address Check is performed in the NEAT System, when the user log on into the NEAT, system & during report down load request.

FTP (File Transfer Protocol)1. NSE Provide for each member a separate directory (file) to know their trading

DATA, clear DATA, bill trade Report.

2. NSE Provide in addition a “common” directory also, to know circulars, NCFM

& Bhava Copy information

3. FTP is connected to each member through VSAT, leased line and Internet.

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4. VSAT (FROM 4.15PM to 9.30AM), Internet (24Hours).

Bhava Copy Database

Bhava copy data provides summary information about each security, for each day

(only last 7 days bhava copy file are stored in report directory.)

Note: - Details in bhava copy-open price, high and low prices, closing prices traded

value, traded volume and No. of transactions.

Snap Shot Database

Snap shot database provides snap shot of the limit order book at many time points in a

day.

Index Database

Index Database provides information about stock market indexes.

Trade Database

Trade database provides a database of every single traded order, take place in

exchange.

BASKET TRADING SYSTEM

1. Taking advantage for easy arbitration between future market and cash market

difference, NSE introduce basket-trading system by offsetting position through

off line-order-entry facility.

2. Orders are created for a selected portfolio to the ratio of their market

capitalization from 1 lakh to 30 crores.

3. Offline-order-entry facility: Generate order file in as specified format outside

the system & up load the order file into the system by invoking this facility in

Basket Trading System.

Participants in Security Market

1) Stock Exchange (registered in SEBI)-23 stock Exchanges

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2) Depositaries (NSDL, CDSL)-2 Depositaries

3) Listed Securities-9, 413

4) Registered Brokers-9, 519

5) FIIs-502

Investor Education & Protection Fund

This fund used to educate & develop the awareness of the Investors. The following

funds credited to IE & PF.

1) Unpaid Dividends.

2) Due for refund (application money received for allotment).

3) Matured deposits & debentures with company.

4) Government donations.

Issue & Allotment of the Shares

1) Issued & subscribing

A. Either Physical or dematerialized.

B. Issuing capital exceed 10 crores compulsory issued in dematerialized

2) Trading compulsory in dematerialized form.

3) Allotment made until the beginning of the 5th day after the day issue of prospectus.

4) Listing is possible issuing not less than 10% of the total equity and minimum of 20

Lakhs.

Holding of Shares (Voting Right) disclosing obligation

1. Any person or Director or Officer or the company

2. More than 5% share or Voting Right

3. Within 4th day inform to company is necessary

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4. Company inform with in 5th day to stock exchange is compulsory

First Started

Future Trading: Chicago Board of Trading 1848

Financial Future Trading: CME (Chicago Mercantile Exchange 1919)

Stock Index Futures: Kansas City Board of trade

Option First Trade: Holland – Tulip Balabmania.

BROKER (Trading Member)(Broker means a member in recognized stock exchange)

Eligibility: 21 Years, graduation, 2 years experience in stock market relative affairs

and

o 30 Lakhs paid up capital

o 100 Lakhs net worth

o 125 Lakhs interest free security deposit

o 25 Lakhs collatery security deposit

o 1 Lakh annual business subscription.

Necessary Infrastructure: Office Space, Manpower, Equipment

Disciplinary proceedings: Not convicted involving fraud & Dishonesty

Fitness: Not Bankrupt, not default in any stock exchange, not previously refused by

NSE, fully discharged from Debts by creditors (self declaration)

First send application to stock exchange for broker ship-stock exchange send

that application to SEBI 30 days - SEBI satisfy above 1 & 2 points to grant

Certificate of Registration.

Maximum commission of the broker 2.5% (including sub broker commission

1.5%) on cash market and feature market buy and sell values but option market

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2.5% is charged on (Strike Price + Premium value).

Contract note issued and signed by broker or authorized signatory within 24hrs.

On contract note printed both offices registered office & dealing office address

is must.

Each trading member (broker) in F&O segment of NSEIL (NSE India Limited)

can have as many users are he wishes.

Compliance officer is appointed by the Broker.

Broker ship Transfer fee 1 Lakh.

Dominant Promoters

a) For Individual (not exceeding 4 members) his & his spouse not less than 51%-1

person Graduation is compulsory.

b) For firm: - Not less than 51% his & his spouse, children’s & brother’s -1 person

graduation is compulsory.

c) Corporate Company: - Not less than 40% of the director’s share holding (at least

50% each director) – 2 Directors Graduation is compulsory.

BROKER & CLIENT RELATIONSHIP

1. Fill the client Registration Application form (for all details of clients).

2. Agreement on non-judicial form (specified by SEBI that form)

3. PAN, Passport, Driving License or Voter Identity Card (SEBI Registration Number

in case of FII’s)-pan cards are must to future and option trading.

4. And then Allot-Unique Client Code.

5. Take copy of instruction in writing before placing order, cancellation &

modification.

6. If order values exceed 1 Lakh maintain the client record for 7 years.

7. On conformation any order issue contract note within 24hrs.

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8. Collect margin of 50,000 & multiple with 10,000.

NOTE: - PAN is compulsory if the transaction cost exceed Rs.1 Lakh.

9. Issuing the “Know your client” form is must.

For Continuing Membership-Trading MemberFulfill the following documents

1. Audited two important financial statement (profit & loss account, balance sheet)

2. Net worth certificate (certificate by CA)

3. Details of Directors, Share holders (certificate by CA)

4. Renewal insurance covering proof.

NSCCL CHARGED PENAL CHARGES (PENALTY POINTS)TO MEMBERS (CAUSING FOLLOWING FAILURES)

1. Failure to funds obligations

2. Failure to security delivery obligation

3. Gross exposure turnover violations

4. Margin shortages

5. Security deposit shortage

6. Client code modification & non-confirmation of custodial trades.

NOTE: - Penalty points charged on calendar month basis.

Maintaining & Preserving Books of Accounts by Trading Member

1. Up to 5yrs must be maintaining these books, by trading member.

a. Registrar of transaction (Saudha Book).

b. Client ledger.

c. General Ledger

d. Journal

e. Cash Book

f. Bank Pass Book

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g. Document Register (particular of Securities received & delivered)

2. Up to 2yrs must be maintaining these books, by trading member.

a. Member contract book.

b. Counter foils of contract notes

c. Return consent of clients (at the time order place).

SUB-BROKER

1. Eligibility: - 21 years, 10+2 qualification and paid up capital 5 Lakhs.

2. Not convicted involving fraud and dishonesty.

3. Not debarred by SEBI previously.

4. 51% of shares as dominant promoters his/her and his/her spouse.

5. First application to stock exchange-stock exchange send his application to SEBI-

SEBI satisfied issued certificate Registration.

6. A registered sub-broker, holding registration, granted by SEBI on the

Recommendations of a trading member, can transact through the member (broker)

who had recommend his application for registration.

7. Maximum Brokerage Commission 1.5%

8. Purchase note and sales note issued by the sub broker with 24 hours.

Investor Protection Fund

1. Investor protection fund setup under Bombay public trust Act 1950.

2. IPF maintained by NSE Exact mane of this fund is NSE Investors Protection Fund

Trust.

3. Any Member defaulter the IPF paid maximum 10 Lakhs only to each investor.

4. Client against default member, customers have right to apply within 3 months from

the date of publishing notice by a widely circulated minimum one daily Newspaper.

Demat of the Shares

1. Agreement with depository by security holder (at the time opening the demat

65


Account)

2. Surrender the security certificates to “issuer” (company) for cancellation.

3. Issuer (company) informs the “depository” about the transfer of the shares.

4. Participant (company) informs the “depository” about the transfer of the shares.

5. “Depository” records the “transferee” name as “beneficial owner” in “book entry

form” in his records.

6. Each custodian/clearing member is requiring maintaining a clear pool account with

depositaries.

7. The investor has no restriction and has full right to open many (number of)

depository accounts.

8. Shares or securities are transferred from one account to another account only on the

instruction of the beneficial owner.

ISIN (International Securities Identification Number)

Any company going to for dematerialized with shares that company get this

ISIN for Demat shares.

ISIN is assigned by SEBI

ISIN is allotted by NSDL.

Main Objectives of Demat Trading

1. Freely transferability

2. Dematerialized in depository mode

3. Maintenance of ownership records in book entry form

Short term capital (according to the Income Tax Act 1961)

1. Not more than 36 months immediately preceding the date of its transfer for any

asset.

2. Not more than 12 months immediately preceding the date of its transfer for any

security UTI units and mutual fund units.

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3. No Tax per long term capital gains (after 1yr) (10%).

Risk in Settlement

1. Counter party Risk:

Replacement cost risk-short/long covering risk

Principle risk-counter party default

Liquidity risk-failure of the settlement of the transaction

Third party risk-failure of the clearing of the settlement by clearing bank.

2. System risk:

Operation risk-arise by error, fraud out ages

Legal risk-law does not support the settlement

Systematic risk-failure of the one party leads to failure of the other parties.

CORPORATE HIERARCHY

Corporate Manager

Branch Manager

Dealer (user)Figure 2.7

Corporate Manager:

He has the right to see all branches and dealers out standing orders, previous traders,

net positions & end of day reports to set branch order limits.

Branch Manager:

He has the right to see all branches and dealers out standing orders, previous traders,

net positions & end of day reports to set branch order limits.

Dealers (user)

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He has the right to perform orders & trading activities.

ELIGIBILITY CRITERIA OF CLEARING MEMBER(Clearing member means a member in NSCCL)

Net worth : 300 LakhsInterest free security Deposits : 34 LakhsCollateral Security Deposits : 50 LakhsAnnual Subscription (min) : 2.5 Lakhs

NOTE:

1. Net worth must include minimum liquid net worth 50 Lakhs

2. Liquid net worth means cash, deposits, B.G, T-BILL, Government Securities, and

dematerialized Shares.

CLEARING MEMBERS FUNCTIONS

Enquiry of trade

Confirmation of trade

Clearing & settlement

NSCCL & CLEARING BANK

1) Clearing Members are three types

a) Trading Member cum Clearing Member:

A clearing member who is also a trading member such clearing members may clear &

settle there own proprietary trades; their client’s trades as well as trades other trading

members.

b) Clearing Member (or) self Clearing Member:

A clearing member who is also a trading member, such clearing member may clear

and settle only their own proprietary trades and their clients trades but cannot clear and

settle trades of other trading members.

c) Professional Clearing Member:

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A Clearing member is not a trading member such clearing member clear and settles

other trading member’s transactions.

Ex: Individuals, Institutions

2) Clearing members must be members in NSCCL.

3) Settlement guarantees fund capital deposited by members in NSCCL.

4) Clearing and the settlement guarantees is settled by NSCCL.

5) Initial Margin charged by NSCCL.

6) Every clearing member must open a separate account in clearing bank with

NSCCL.

7) Funds settle by clearing bank through cash.

8) Each clearing member (custodian) maintains a clear pool account with depositories

(NSDL & CDSL) by prescribed pay-in-time for security is required.

TYPES OF ORDERS

1) Day order:

System cancels the order automatically at the end of day

2) GTC (Good till Cancel):

Order cancels from the system at the end of the day of the expiry date period

3) GTD (Good till Date):

This order stays in the system up to specify the number of days (Not Exceed).

4) IOC (Immediate or Cancel):

When an order enters in the system, it is searching for the matching. If matching is not

traced the order immediately cancelled.

5) Stop Loss Order:

An order which is activated when a price crosses a limit is called stop loss order.

Long Orders Short Order

Spot Rs.100/- Spot Rs.100/-

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Trigger Rs.95/-(Buy) Trigger Rs.105/-(Sell)

Limit price Rs.93/-sell Limit price Rs.108 buy

(Stop Loss Order) (Stop Loss Order)

Settlement Basis

T = Trading day

Cash Market T+2

F&O Market T+1

Note: stock option final settlement only is T+3

Final settlement of future and option contract takes at the closing price of the

underlying asset.

ODD LOT MARKET RETAIL DEBT MARKET

Market Type O Face Value Rs.100/-

Book Type OL Lot size 10

Only physical shares trade Ticker size Rs.0.01

Order quantity not exceed 500 shares Market Type D

Settlement Trade to Trade (T) Book Type RD

Operating Range± 5%

MARKET WATCH WINDOW SHOW THE CORPORATEACTIONS WITH THE FOLLOWING INDICATORS

XB Ex-Dividend

XB Ex-Bonus

XI Ex-Interest

XR Ex-Rights

CD Cum-dividend

70


CB Cum-Bonus

CI Cum-Interest

CR Cum-Rights

“X” in case more than one of XD, XB, XI, XR

“C” in case more than one of CD, CB, CI, CR

FULL MESSAGE DISPLAY OPTION

Full message display option is possible to filter (chose) the messages according

to the message code, symbol, series, PRO/CLI/WHS, client date and time.

Message area shows order conformation/ modification/cancellation and

rejection, according to the User ID.

In message filter screen, message code shows, by default “ALL”

The user desires to view all messages, “ALL” has to be specified in the place of

message code, and the “client account field” should be blank.

In case the desired to view trading member’s own order/trade related messages,

“PRO” has to be specified with the trading message code, defaulting in the

“Client Account” field.

In case the user desired to view client order/trade related messages, “Cli” has to

be specified with the client account code, in the “Client Account” Field.

MESSAGE CODE DESCRIPTION OF MESSAGE SELECTED

PRO Trading Number Code

CLI Client Code

ALL All Messages Ex-interest

AUC Auction order/Trade Message

AUI Auction initiation Message

LIS All Listing related Message

ORD Order related message3

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OTHER Miscellaneous

SPD Security Suspension & De Suspension

SYS System Message

TRD Trader

Table 2.3

AUCTION MARKET

BOOK TYPE AO

Parties in Auction Market

Initiator (buyer): who initiates the auction process is called Initiator.

Competitor (Competitive Buyer): who enter the same side of the Initiator is called

competitor.

Solicitor: who enter the opposite side of the Initiator is called Solicitor. Auction trade take place at the Auction Price (solicitor Order Price) The User is not allowed to modify any auction order (initiator order, competitor

order and solicitor order). The user can cancel only solicitor order (No power to cancel initiator order &

competitor orders) The system calculates trading price for the auction and all possible trades for the

auction are generated at the calculated trading price.Auction Enquiry for user

S Auction is in solicitor period

M System is Matching the order

F Auction is over

X Auction is deleted

P Auction is pending & yet to begin

Table 2.4

Order Value Limits

Market price protection functionality by default set to 5% of the LTP.

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Branch order value limit: is set up by corporate manager of the broking

company based on end of day report.

User order value limit: Cumulative value of orders of all securities is by

default “Zero” – user order value limit is setup by branch manager or corporate

manager based on end of day reports.

END OF DAY REPORTS USEFUL TO

For Corporate Manager: Set branch order value limits

For Branch Manager: Set user order value limits

For User: perform orders & trade activities

PRICE BANDS FOR STOCKS

2%

5%

10%

20%

No price bands applicable to derivative scrip’s

Auction market price band 20%

TRANSACTION CHARGES & INVESTOR PROTECTION FUND CHARGES

Transaction charges paid by trading member: Rs.2/- per lakh (each side) or one

lakh, whichever is higher on index future and stock feature values. But in option

market charged on (strike Price + premium) value

Investor protection fund charges paid by trading member: Rs.10/- per 1 crore

(each side)

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EXPOSURE LIMITS IN CASH MARKETS

1) Gross Exposure Limit:

Gross Exposure limit calculate on Cumulative net outstanding position (Buy values –

sell Values) of the member

Up to one crore (Total Base Capital NSCCL) : 8.5 Times

Above one crore (Base capital in NSCCL) : 10 Times

2) Gross intraday Turnover Limits:

Gross intraday turnover is calculated on cumulative net outstanding position on each

security (Buy + Sell) of the member, at any point of time. Base Capital (in NSCCL) x

331/3 Times

a) Online Exposure Monitoring:

a system of alert has been built in so that both the member and NSCCL are alerted as

per present level (reaching 70%, 85%, 95% and 100%) when the members approach

their allowable limits.

b) Exposure Limits Violation:

Members exceeding the gross exposure limit are not permitted to trade with immediate

effect (trading Terminals are disabled automatically) until the Member’s cumulative

gross exposure is reduced to below the allowed gross exposure limits.

3) VAR Margin for Institutional trades:

VAR margin is charged at differential rate on the net outstanding sales position of the

client on under laying assets spot price.

ARBITRATION

If any trading member neglects or fails to carryout any award to arbitration made in

connection with the exchange rules, bye-laws and regulation is necessary.

NSE DATES WISE DATA

NSE incorporated November 1992Base Value of nifty (at 1000) started Nov,3rd 1995

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Index Futures June 2000Index Option June 2001Security (stock) Futures November 2001Security (Stock) Options July 2001

S & P CNX Nifty have 50 Scrip’sSensex have 30 Scrip’s

Table 2.5

INDEX (S&P CNX NIFTY 50 STOCKS)INDEX USED FOR THE FOLLOWING ADVANTA

Barometer of the market behavior

Bench mark port folio performance

Base (underlying) for Derivative index

Passive Fund Management by index funds

(The fund would buy all index 50 stocks in the proportion, in which they exist in the

Nifty)

Good Index Attributes (Characteristics)

Large variety of different portfolios

Taking highly liquid stocks

Professionally maintained stocks

IISL (India index & service & Products ltd)

IISL provides profession index management service to nifty

IISL Established by NSE & CRISIL

IISL get the Technical Assistance from standard & poor.

Impact Cost

Impact cost is measure the liquidity of the market

Any stock qualify to include in Nifty, it has market impact cost below 0.75%

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Any stock to enter in Nifty lower impact cost is the main Qualification

INDEX FUND (PASSIVE FUND

This fund would be 50 stocks in the proportion, in which they exist in the Nifty.

ETF (Exchange traded fund)

ETF are innovative product, first introduced in USA in 1993-60% of trading value in

American trading volumes in American Stock Exchange is from ETF.

TYPES OF DERIVATIVES

1) Equity Derivatives (security Derivatives):

Index Future & Option Stock Future & Option

2) Financial Derivatives:

Equity Derivatives Forex currency future Interest rate future

3) Underlying Asset or Derivatives:

Financial Derivatives Commodities Any other asset

DIFFERENCE BETWEEN FUTURE MARKET & OPTION MARKET

A future contract buyer give the right but obligation to buy

A future contract seller give the right but obligation to sell

Call gives the buyer the right, but not obligation to sell

Put gives to buyer the right, but not obligation to sell

Call gives the seller option premium, but obligation to sell

Put gives to seller option premium, but obligation to buy

Value of option increase, when volatility increase

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Value of option decrease, when volatility decreases.

INITIAL MARGINS

At the inception (beginning) of a contract every client is required to pay initial

margin is must to trading number.

Initial margins are charged on trade by trade basis

Initial margins charged by NSCCL-Clearing member positions upto client level.

Initial margins are charged for the purpose of recover & safe guard against the

worst scenario loss of port folio of an individual client to cover 99% VAR

Worst scenario loss means, maximum loss under any scenario

For calculating worst scenario loss of option value “black-scholes” model is

used.

Future value is calculated on cost of carry model.

FUTURE VALUE=SPOT+COST OF CARRY

Initial margin charged on portfolio of future & option contract

Assign margin are charged on clearing member level

Premium margin are charged client level

Initial margin is debited to initial margin-EQ index future account.

ASSIGNMENT MARGIN

Assignment margin is charged in addition to initial margin on premium margin. It paid

on clearing member assigned position of option contract on individual securities,

according to the interim and final exercise settlement.

OPEN INTEREST CALCULATION

Open interest means out standing orders of (long position + short position) contracts in

a particular point of time

INITIAL MARGIN CHARGED ON F&O MARKET

Index Future 5%

Index Option 3%

77


Stock F&O 7.5%

Spread Calendar Margins 1% min & 3% max

Table 2.6

Initial margin paid by Option seller only.

EXPOSURE LIMITS IN DERIVATIVE MARKET

For Index Futures & Options:

Liquid Net worth x 33 1/3 times = National value of gross open position

For Stock Future & Options:

Liquid net worth x 20 Times = National Value of gross open position

For Calendar Spread:

For month MTM value (profit) x 1/3 = Open position

OPEN POSITION SELF DISCLOSING OBLIGATION

TRADING MEMBER LEVEL

Index Future & Option 15% of open position or Rs.500

crores whichever is higher

Stock Future & Option 20% of open position or 500 crores

whichever is higher

CLIENT LEVEL

Index Future & Option 15% of the open position (not

78


exceeding)

Stock Future & Option 1% of Free float market capitalization

or 5% of the open position whichever

is lower

Table 2.7

MARK TO MARKET (MTM) MARGINS

MTM margins is charged on continuous basis at the end of each day on daily

basis of cumulative net outstanding open position (loss)

CM (Clearing Member) are responsible to collect & settle the daily MTM

margins (profit/loss) from their Trading Member according to their open

position

TM (Trading Member) are responsible to collect & settle the daily MTM

margins for pay in/pay out of their client according to the client open position

For calculating MTM margin Future last ½hour average price is takes, if it is not

traded on that day or last half hour MTM is calculated on theoretical price

model

MTM margin balance at the yearend shown in current asset account

FUTURE & OPTION CONTRACT SPECIFICATIONS

Nifty & security F&O contract value 2,00,000/- min

Nifty Lot 100

Security lot 100

S&P CNX Nifty options interval 10 Points

CNX IT 10 points

79


Bank Nifty 10 points

Security option Intervals 2.5 to 50

Table 2.8

NSE-SPAN (Standard Portfolio Analysis of risk)

The object of NSE-SPAN is to identify overall risk in a portfolio of all future and

option contracts for each member.

CLEARING MEMBER-KEEPING THE BOOKS

(According to the SEBI Committee recommendation on derivative market)

Fund received and paid in clearing member account book

Fund received and paid of each client information account book

Fund obligations to the clearing member and client a separate & distinct account

book

CLEARING SOFTWARE GENERATE THE FOLLOWING REPORTS

Daily obligation statement

Daily obligation statement of custodial trades

Final settlement obligation statement

Note:- Initial margin report not generate by the clearing software.

80


CHAPTER-IV

DATA ANALYSIS AND INTERPRETATION

DATA ANALYSIS AND INTERPRETATION

The Objective of this analysis is to evaluate the profit/loss position futures and

options. This analysis is based on sample data taken of M/s. DLF INDIA LTD scrip.

This analysis considered the January contract of Power. The lot size of DLF

INDIA LTDis 500, the time period in which this analysis done is from 28-11-2011 to

81


29-12-2011.

DLF INDIA LTD (FUTURES & OPTIONS)

DATES

(1)

PRICE

(2)CALL OPTION

(3)PUT OPTION

(4)

SPOT FUTURE 110 120 130 100 110 120

NOV/MON/28

111.25 114.60 11.00 6.25 2.90 3.00 6.15 12.50

NOV/TUE/29 115.60 110.95 14.00 7.65 4.05 2.25 4.50 7.90

NOV/WED/30 120.70 117.75 13.40 6.65 3.65 2.00 4.85 9.50

DEC/ THU /01 122.85 121.90 15.00 8.60 4.55 0 3.15 645

DEC/FRI/02 118.00 127.10 13.15 8.85 4.85 1.60 3.50 6.80

DEC/SAT/03TRADING HOLIDAY

DEC/SUN/04TRADING HOLIDAY

DEC/MON/05 122.00 119.90 8.05 4.05 1.70 3.85 7.65 13.00

DEC/TUE/06MOHARAM HOLIDAY

DEC/WED/07 120.70 117.75 13.40 6.65 3.65 2.00 4.85 9.50

DEC/THU/08 118.00 127.10 13.15 8.85 4.85 1.60 3.50 6.80

DEC/FRI/09 122.35 121.70 14.95 8.50 4.55 1.20 3.25 6.65



DEC/MON/12 104.00 100.65 4.10 2.20 1.60 7.50 13.10 0

DEC/TUE/13 100.50 94.70 2.55 1.14 0.65 10.25 16.65 26.00

82


DEC/THU/15 101.10 95.55 2.70 1.35 0 6.55 0 0

DEC/FRI/16 97.55 99.25 3.00 1.40 0 6.55 0 0



DEC/MON/19 99.80 99.85 2.44 1.15 0 5.55 0 0

DEC/TUE/20 97.00 100.55 2.55 1.05 0 5.05 0 0

DEC/WED/21 98.30 98.90 1.45 0.55 0 6.60 0 0

DEC/THU/22 99.60 97.85 1.00 0.35 0.20 6.00 0 0

DEC/FRI/23 97.60 97.65 0.55 0 0 4.80 0 0



DEC/TUE/27 99.60 100.35 0.45 0.25 0.70 2.50 0 0

DEC/WED/28 101.50 103.00 0.50 0.30 0 0.55 0 0

DEC/THU/29 104.80 104.50 0.05 0.20 0 0.05 0 0

TABLE DETAILS The first column explains TRADING DATE.

Second Column (a) explains the SPOT MARKET PRICE in cash segment on

that date of Opening Balance of Future Market Amount.

Second column (b) explains the FUTURE MARKET PRICE in cash segment on

that date of Closing Balance on Future Market Amount.

The Third column explains call Option premiums amounting 110, 120, 130.

The Fourth column explains Put Option premiums amounting 100, 110, 120.

83


OBSERVATIONS AND FINDINGS

CALL OPTION

BUYERS PAY OFF:

As brought 1 lot of DLF INDIA LTDthat is 500, those who buy for 110, paid 11.00

premiums per share.

Settlement price is 104.80

Spot price 104.80

Strike price 110.00

Amount -5.20

Premium paid (-) 11.00

Net Profit 5.80 x 500 = 2900

Buyer Profit = Rs.2900 (Profit)

Because it is Pasitive it is out of the money contract, hence buyer will get more Profit,

incase spot price increase buyer profit also increase.

SELLERS PAY OFF:

It is in the money for the buyer, so it is in out of the money for seller; hence his profit

is also increase.

Strike price 110.00

Spot price 104.80

Amount 5.20

Premium Received 11.00

Net Loss -5.80 x 500 = -2900

Seller Loss = Rs.-2900 (Net Amount)

Because it is negitive it is in the money, hence seller will get more loss, incase spot

price decrease in below strike price, seller get profit in premium level

84


OBSERVATIONS AND FINDINGSPUT OPTION

BUYERS PAY OFF:

Those who have purchase put option at a strike price of 110, the premium payable is

3.00

On the expiry date the spot market price enclosed at 104.80

Strike price 100.00

Spot price 104.80

Net pay off -4.80 x 500 = -2400

Already, premium paid 11.00, so it can get loss is -2400

Because it is negative, in the money contract, hence buyer will get more loss, incase

spot price decrease buyer get profit in premium level.

SELLERS PAY OFF:

As seller is entitled only for premium so, if he is in profit and also seller has to borne

total profit.

Spot price 104.80

Strike price 100.00

Amount 4.80 x500 =2400

Already premium received 11.00 so, it can get profit is 2400

Because it is pasitive, out of the money contract, Hence seller gets more profit, incase

spot price decrease in above strike price seller can get loss in premium level.

85


ANALYSIS OF FUTURE PRICES

The Objective of this analysis is to evaluate the profit/loss position futures and

options. This analysis is based on sample data taken of M/s. DLF INDIA LTD

LIMITED scrip. This analysis considered the December contract of Reliance Power.

The lot size of DLF INDIA LTDis 500, the time period in which this analysis done is

from 28-11-2011 to 29-12-2011.

Table 4.2

86

DATE FUTURE PRICE

NOV/MON/28 114.60NOV/TUE/29 110.95NOV/WED/30 117.75DEC/ THU /01 127.10DEC/FRI/02 121.90DEC/MON/05 122.80DEC/WED/07 121.70DEC/THU/08 119.90DEC/FRI/09 105.20DEC/MON/12 100.65DEC/TUE/13 94.70DEC/THU/15 95.55DEC/FRI/16 99.25DEC/MON/19 99.85DEC/TUE/20 100.55DEC/WED/21 98.90DEC/THU/22 97.85DEC/FRI/23 97.65DEC/TUE/27 100.35DEC/WED/28 103.00DEC/THU/29 104.50


Figure 4.1

FUTURE MARKETBUYER SELLER

29/12/2008(Buying) 114.60 114.60

29/01/2009(Cl., period) 104.80 104.80

Profit 9.80 Loss 57.00

Loss 500 x9.80=4900, Profit 500 x9.800=4900

Because buyer future price will increase so, he can get profit. Seller future price also

increase so, profit decrease, Incase seller future will decrease, and he can get profit.

The closing price of DLF INDIA LTDat the end of the contract period is 104.80 and

87

GRAPH ON THE MOVEMENTS OF DFE FUTURE PRICE

020406080

100120140

CONTRACT DATES

PR

ICE

S

Future Prices


this is considered as settlement price.

DATA OF DLF INDIA LTD– THE FUTURES & OPTIONS OF THE MONTH DECEMBER

DATE SPOT PRICE FUTURE PRICE

NOV/MON/28 111.25 114.60NOV/TUE/29 115.60 110.95NOV/WED/30 120.70 117.75DEC/ THU /01 118.00 127.10DEC/FRI/02 122.85 121.90DEC/MON/05 123.90 122.60DEC/WED/07 123.35 121.70DEC/THU/08 122.00 119.90DEC/FRI/09 108.85 105.20DEC/MON/12 104.00 100.65DEC/TUE/13 100.50 94.70DEC/THU/15 101.10 95.55DEC/FRI/16 97.55 99.25DEC/MON/19 99.80 99.85DEC/TUE/20 97.00 100.55DEC/WED/21 98.30 98.90DEC/THU/22 99.60 97.85DEC/FRI/23 97.60 97.65DEC/TUE/27 99.60 100.35DEC/WED/28 101.50 103.00DEC/THU/29 104.80 104.50

Table 4.3

88


Figure 4.2

OBSERVATIONS AND FINDINGS

The future price of M/S. DLF INDIA LTD moving along with the market

price.

If the buy price of the future is less than the settlement price, than the buyer of

a future gets profit.

If the selling price of the future is less than the settlement price, than the seller

incur losses.

89

GRAPH SHOWING THE MOVEMENTS OF SPOT & FUTURE PRICES

050

100150

CONTRACT DATES

PR

ICE

S

SPOT PRICE

FUTUREPRICE


CHAPTER-V

FINDINGSCONCLUSIONS

SUGGESTION

BIBILOGRAPHY

90


FINDINGS

The future price of M/S. Reliance Power Limited moving along with the

market price.

If the buy price of the future is less than the settlement price, than the buyer of

a future gets profit.

If the selling price of the future is less than the settlement price, than the seller

incur losses.

91


CONCLUSIONS

Derivates market is an innovation to cash market. Approximately its daily

turnover reaches to the equal stage of cash market. The average daily turnover

of the NSE derivative segments

In cash market the profit/loss of the investor depend the market price of the

underlying asset. The investor may incur huge profits or he may incur huge

profits or he may incur huge loss. But in derivatives segment the investor the

investor enjoys huge profits with limited downside.

In cash market the investor has to pay the total money, but in derivatives the

investor has to pay premiums or margins, which are some percentage of total

money.

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.

92


SUGGESTION

In bullish market the call option writer incurs more losses so the investor is

suggested to go for a call option to hold, where as the put option holder suffers

in a bullish market, so he is suggested to write a put option.

In bearish market the call option holder will incur more losses so the investor is

suggested to go for a call option to write, where as the put option writer will get

more losses, so he is suggested to hold a put option.

In the above analysis the market price of M/S. Reliance Power Limited is

having low volatility, so the call option writers enjoy more profits to holders.

The derivative market is newly started in India and it is not known by every

investor, so SEBI has to take steps to create awareness among the investors

about the derivative segment.

In order to increase the derivatives market in India, SEBI should revise some of

their regulations like contract size, participation of FII in the derivatives market.

Contract size should be minimized because small investors cannot afford this

much of huge premiums.

SEBI has to take further steps in the risk management mechanism.

SEBI has to take measures to use effectively the derivatives segment as a tool of

hedging.

93


BIBILOGRAPHYBOOKS :

Derivatives Dealers Module Work book–NCFM

Financial Markets and Services–GORDAN and NATRAJAN

Financial Management – PRASANNA CHANDRA

NEWS PAPERS:

Economic times

The Financial Express

Business Standard

MAGAZINES:

Business Today

Business World

Business India

WEBSITES:

WWW.derivativesindia.com

www.kotak.com

www.nesindia.com

www.bseindia.com

www.sebi.gov.in

www.google.com

94

http://www.google.com/

http://www.sebi.gov.in/

http://www.bseindia.com/

http://www.nesindia.com/

http://www.kotak.com/

http://WWW.derivativesindia.com/


MARKET WATCH WINDOWS

BLUE COLOUR INDICATE SHARE VALUE INCREASERED COLOUR INDICATE SHARE VALUE DECREASE

NSE Scrip’s

Figure 7.1

95


NSE & BSE Scrip’s

Figure 7.2

96


(BUY Order Form)

Figure 7.3

97


(Sell Order Form)

Figure 7.4

98


(Market Depth)

Figure 7.5

99


(Order Book)

Figure 7.6

100


Client Margin

Figure 7.7

101


Trade Book

Figure 7.8

102


Client Activity Report

Figure 7.9

103


Exercise Report

Figure 7.10

104