karthika project

8/17/2019 Karthika Project

1/50

“ FORMULATING DERIVATIVE STRATEGIES ”

INTRODUCTION

Stock markets extremely risky and volatile and hence the risk consideration is an

important concern for investors. To reduce this risk, the concept of derivatives comes into

the picture. Derivatives trading commenced in India in June 2000, S!I permitted the

derivative segments of t"o stock exchanges, #S and !S, and their clearing

house$corporation to commence trading and settlement in derivatives contracts, The

trading in !S Sensex options commenced on June %, 200& and the trading in options on

individual securities commenced in July 200&. 'utures contracts on individual stocks

"ere launched in #ovem(er 200&.

Single stock futures "ere launched on #ovem(er ), 200&. The index futures and options

contract on #S are (ased on S*+ #-, at present utual 'unds are permitted to

participate in the derivatives market for the purpose of hedging /minimiing risk1 and re

(alancing their portfolio.

The derivatives market per!rms a "#m$er ! #"%ti!"s&

&. They help in transferring risks from risk averse people to risk oriented people

2. They help in the discovery of future as "ell as current prices

3. They give rise to entrepreneurial activity

%. They increase the volume traded in markets (ecause of participation of risk averse

people in greater num(ers

4. They increase savings and investment in the long run period

The expected outcomes from the thesis is to understand and apply ho" to use the

concept of e5uity strategies and under "hat market conditions one should use these

5uity market strategies and try to (eat the market (y hedging our holdings and implies

the use of all the popular e5uity derivatives strategies "ith practical examples .


2/50

LITERATURE REVIE'

Mea"i"( ! Derivatives&

6 Derivative are types of investments "hose performance are amplified from the

performance of assets /such as commodities, shares or (onds1, interest rates, exchange

rates, or indices /such as a stock market index like #ifty and Sensex1. This performance

can determine (oth the amount of the payoffs. The diverse range of underlying assets and

payoff alternatives leads to a huge range of derivatives contracts availa(le to (e traded in

the financial market. The main types of 5uity derivatives are futures and options

6 very simple example of derivatives is curd, "hich is derivative of milk. The price of curd depends upon the price of milk "hich in turn depends upon the demand and supply

of milk. See it this "ay. 6nd the price of ipla "arrants depends upon the price of ipla

shares. 6merican depository receipts$glo(al depository receipts of III, Satyam and

Infosys traded on stock exchanges in the 7S6 and ngland don8t have their o"n values9

They dra" their price from the underlying shares traded in India. ven the value of

mutual fund units changes on a day to day (asis. Don8t mutual fund units dra" their value

from the value of the portfolio of securities under the schemes9 these examples prove that

derivatives are not so ne" to us.

E)#it* F#t#res &

ontracts "hich a investor or trader can (uy to take advantage of the market and protect

against un"anted price movements ie (uy hedging his portfolio against un"anted risks

arising from volatility of prices. very time futures contract is (ought a fixed margin

"hich is calculated per stock (asis and trade on that margin (asis is needed to (e paid to

(uy Infosys in lot sies ie 200 or 300 lot sie per stock, if (ought in cash market full

amount need to (e paid ,!ut if (ought in futures it can (e played on :ust the margin

amount and take advantage of market movements if the Infosys stock falls then the long

futures position loses !ut if the Infosys stock rises then the Infosys position gains


3/50

E)#it* Opti!"s &

ontracts "hich give used (y traders or investors "herein a call or put options is (ought

ie the e5uivalent of long futures and short futures (ut unlike the futures position "hich

makes profit ,if the long futures make profits "hen underlying share prices rise,

;ptions the payoff is only "hen exiting our positions so its less riskier than futures

"hich means the loss is restricted the loss is only to the premium amount paid and the

profit position is unlimited "hen into a ;ptions contract the premium is paid and if in one

"eek the premium rises due to underlying market movements then the position can (e

exited and make profits in that position

+ist!r* ! “Derivatives”

Derivatives trading in &


4/50

India has (een trading derivatives contracts in silver, gold, spices, coffee, cotton and oil

etc for decades in the gray market. Trading derivatives contracts in organied market "as

legal (efore orar:i Desai8s government (anned for"ard contracts. Derivatives on stocks

"ere traded in the form of Te:i and andi in unorganied markets. @ecently futures

contract in various commodities "ere allo"ed to trade on exchanges. 'or example, no"

cotton and oil futures trade in um(ai, soy(ean futures trade in !hopal, pepper futures in

ochi, coffee futures in !angalore etc. In June 2000, #ational Stock xchange and

!om(ay Stock xchange started trading in futures on Sensex and #ifty. ;ptions trading

on Sensex and #ifty commenced in June 200&.

Disti"%t (r!#ps ! derivative %!"tra%ts&

There are t,! (r!#ps ! derivative %!"tra%ts- ,hi%h are disti"(#ished $* the ,a*

that the* are traded i" market&

Over.the.%!#"ter /OTC0 derivatives are contracts that are traded directly

(et"een t"o parties, "ithout going through an exchange like #S and !S

S"aps, for"ard rate agreements, and exotic options are almost al"ays traded

in this "ay.

E1%ha"(e.traded derivatives are those derivatives that are traded via stock exchanges. 6 stock exchange like #S and !S acts as an intermediary to all

transactions, and takes Initial margin from (oth sides of the trade to act as a

guarantee. There are host of Derivatives products availa(le in #S and !S

in India.

E1%ha"(e.traded vs2 OTC /Over the C!#"ter0 derivatives markets&

The ;T derivatives markets have seen sharp gro"th over the last years, "hich has

accompanied the development of commercial and investment (anking and glo(alisation

of financial activities. The recent developments in IT have contri(uted to a great extent to

these developments. Bhile (oth exchangetraded and ;T derivative contracts offer

many (enefits, the former have rigid regulations compared to the latter. It has (een


5/50

"idely discussed that the highly leveraged institutions and their ;T derivative positions

"ere the main cause of tur(ulence in stock markets in the year &))


6/50

C!mm!" %!"tra%t t*pes

There are three ma4!r %3asses ! Derivatives %!"tra%ts &

F!r,ards & Bhich are contracts to (uy or sell an asset at a future date, (et"een t"o private parties xA Tea gro"er may enter into a contract "ith a "holesale (uyer to sell

Tea at a particular price on a future date. The Tea (uyer could have a mutually agreed

contract "ith the seller /'or"ard ontract1.

F#t#res& 'utures contract is a standardied contract, contracted on a futures exchange, to

(uy or sell a certain underlying instrument at a certain date in the future, at a preset

price. The future date is called the delivery date or final settlement date. The preset price

is called the futures price. The price of the underlying asset on the delivery date is called

the settlement price. The futures price, naturally, converges to"ards the settlement price

on the delivery date.

E1A offee gro"er may enter into a contract "ith a "holesale (uyer to sell offee at a

particular price on a future date. Ee $ she could (uy a contract through a regulated market

like the offee 'utures xchange India Fimited /;'I1. The #ational Stock xchange

and the !om(ay Stock xchange offer such facilities for trading 'utures contracts on an

underlying financial instrument like stocks$shares. xampleA "hen you are dealing in

6ugust Satyam futures contract the market lot, i.e. the minimum 5uantity that you can

(uy or sell, is &,200 shares of Satyam9 the contract "ould expire on ay 29 the

price is 5uoted per share9 the tick sie is 4 paise per share or /&,200 G 0.041 H @s=0 per

contract$market lot9 the contract "ould (e settled in cash9 and the closing price in the

cash market on the expiry day "ould (e settlement price


7/50

Diere"%e $et,ee" F!r,ards a"d F#t#res %!"tra%t&

'utures contracts are traded on an exchange. 'or"ard contracts are mutually agreed

(et"een t"o parties. The only (enefit of entering into a 'or"ards contract comes from

the flexi(ility of having tailormade contracts. 'or"ards are important as prices in

'or"ard markets serve as indicator of 'utures prices. ontracts on 'utures markets are

fixed in terms of contract sie, product type, product 5uality, expiry, and mode of

settlement. 'utures markets, ho"ever, provide li5uidity as contracts are traded on a

(roader client (ase. ounter party risk is also eliminated in the 'utures market as thedesignated learinghouse (ecomes counter party to each trade that is, it acts as (uyer to

seller and as a seller to the (uyer and guarantees the trades.

Feat#res ! #t#res %!"tra%ts&

• Feveraged positionsonly margin re5uired for taking up positions

• Trading in either directionshort$long positions

• Index trading are possi(le

• Eedging$6r(itrage opportunity exists

• The settlement price is availa(le

Adva"ta(es ! F#t#res !ver %ash tradi"(&

• In futures the investor can short sell$(uy "ithout having the stock and carry the

position for a long time, "hich is not possi(le in the cash market

• 6n investor can (uy and sell index instead of individual securities "hen he has a

general idea of the direction in "hich the market may move in the next fe"

months.


8/50

• The investor is re5uired to pay a small fraction of the value of the total contract as

margin. This means trading in stock index futures is a leveraged activity since the

investor is a(le to control the total value of the contract "ith a relatively small

amount of margin.

E1amp3eA Suppose the investor expects a @s&00 stock to go up (y @s&0. ;ne option

is to (uy the stock in the cash segment (y paying @s&00. Ee "ill then make @s&0 on

an investment of @s&00, giving a(out &0 returns. 6lternatively he can take futures

position in the stock (y paying @s30 to"ards initial and marktomarket margin. Eere

he makes @s&0 on an investment of @s30, i.e a(out 33 returns.

• In the case of individual stocks, the positions, "hich remain outstanding on the

expiration date, "ill have to (e settled (y physical delivery, "hich is not the case

in futures.

• @egulatory complexity is likely to (e less in the case of stock index futures

compared to the other kinds of e5uity derivatives, such as stock index options,

individual stock options etc.

The "e1t %3ass ! Derivative pr!d#%t is&

Opti!"s A Bhich are contracts that give the (uyer the right /(ut not the o(ligation1 to

(uy or sell an asset at a specified future date. 'or entering into an option transaction

E1amp3eA Suppose you have (ought a call option of 2,000 shares of Eindustan

7nilever Ftd /E7F1 at a strike price of @s240 per share. This option gives you the

right to (uy 2,000 shares of E7F at @s240 per share on or (efore ay 2. The

seller of this call option "ho has given you the right to (uy from him is under the

o(ligation to sell 2,000 shares of E7F at @s240 per share on or (efore ay 2

"henever asked.


9/50

Feat#res ! Opti!"s&

• Fimited risk, unlimited profitcall options

• Eigher returns, higher riskput options

• +ositions in all market conditions$vie"s

There are t,! t*pes ! Opti!"s& “CALL” a"d “5UT”2

CALL Opti!"& !uyerK of a all ;ption on a particular stock “(ets the ri(ht t! 6#*”

the underlying Stock, "hereas Seller $ BriterK of the all ;ption is o(liged to SellK the

underlying stock "hen the (uyer of all decides to xercise his $ her ;ption. Bhen the

spot $ cash price is higher than the Strike price /plus cost1, the (uyer of all could

exercise his right to (uyK at the Strike price.

E1amp3eA Suppose you have (ought a call option of 2,000 shares of Eindustan 7nilever

Ftd /E7F1 at a strike price of @s 240 per share. This option gives you the right to (uy

2,000 shares of E7F at @s240 per share on or (efore ay 30, 200>. The seller of this call

option "ho has given you the right to (uy from him is under the o(ligation to sell 2,000

shares of E7F at @s240 per share on or (efore ay 30, 200> "henever asked.

5UT Opti!"& !uyerK of a +ut ;ption on a particular Stock “(ets the ri(ht t! Se33” the

underlying Stock, "hereas Seller$BriterK of the +ut ;ption is o(liged to !uyK the

underlying Stock if the (uyer of +ut decides to xercise his $ her ;ption. Bhen the spot $

cash price /less cost1 is lo"er than the Strike price, the (uyer of +ut could exercise his

right to sellK at the Strike price.

E1amp3eA suppose you (ought a put option of 2,000 shares of E7F at a strike price of

@s240 per share. This option gives its (uyer the right to sell 2,000 shares of E7F at

@s240 per share on or (efore arch 30, 200). The seller of this put option "ho has given


10/50

you the right to sell to him is under o(ligation to (uy 2,000 shares of E7F at @s240 per

share on or (efore arch 30, 200) "henever asked.

Diere"%e $et,ee" Opti!"s a"d F#t#res&

7nderstanding ;ptions re5uires understanding of concepts of rightK and o(ligationK.

;n entering an ;ption contract the (uyer gets the rightK and the seller /also called the

"riter1 has the o(ligationK$ gives the rightK. !ut in futures, (oth the (uyer and the seller

are under o(ligation to fulfill the contract and the (uyer and seller are su(:ect to

unlimited risk of losing. !ut in ;ptions, The seller is su(:ect to unlimited risk of losing

"hereas the (uyer has a limited potential to lose, in futures the (uyer and seller have

unlimited potential to gain, !ut in ;ptions the seller of the option has limited potential togain "hile the (uyer of the has unlimited potential to gain.

S,aps & "here the t"o parties agree to exchange cash flo"s. The t"o commonly used

s"aps are A

I"terest rate s,aps& These entail s"apping only the interest related

cash flo"s (et"een the parties in the same currency

C#rre"%* s,aps & These entail s"apping (oth principal and interest (et"een the parties, "ith the cashflo"s in one direction (eing in a

different currency than those in the opposite direction


11/50

5LA7ERS IN T+E DERIVATIVE MAR8ET &

The !33!,i"( three $r!ad %ate(!ries ! parti%ipa"ts are

+ed(ers& Eedgers face risk associated "ith the price of an asset. They use futures or

options markets to reduce or eliminate this risk. 6 hedge is an investment that is taken out

specifically to reduce or cancel out the risk in another investment. The term comes from a

gam(ling saying Lhedging your (ets.L Eedging is a strategy designed to minimie

exposure to an un"anted (usiness risk, "hile still allo"ing the (usiness to profit from an

investment activity. Typically, a hedger might invest in a security that he (elieves is

underpriced relative to its Lfair valueL.

E1A Take the case of investor "ho holds the shares of a company and gets uncomforta(le

"ith market movements in the short run , Ee sees the value of his security falling from

@s. %40 to @s. 3)0 . In the a(sence of stock futures he "ould either suffer the discomfort

of a price fall or sell the security in anticipation of a market upheaval . "ith security

futures he can minimie his price risk 6ll he need to do is enter into an offsetting stock

futures position , in this case take on a short futures position . 6ssume that the spot price

of the security he holds is @s .3)0. T"omonth futures cost him @s. %02. 'or this he pays

an initial margin. #o" if the price of the security he holds falls further he "ill suffer

losses on the security he holds. Eo"ever the losses he suffers "ill (e offset (y the profit

he makes on his short futures position. Eedging, in its (roadest sense, is the act of

protecting oneself against loss.

Eedging is not confined to the private sector, Movernments also use it. Movernments use

this to sta(ilie a country8s export earnings or to protect farmers producing export crops.

Some countries are already making extensive use of futures and options for this purpose.

Similarly, futures and options can (e /and are1 used (y governments to hedge against

shortterm rises in import prices /e.g. the price of crude oil1.


12/50

!ased on the a(ove explanation hedging can thereof (e descri(ed as a “meth!d !

pr!te%ti!" a(ai"st #"%ertai"t*”. Since, in common and less rigorous parlance,

uncertainty is often referred to as Nrisk8, hedging can also (e descri(ed as a form of

Ninsurance8 against noninsura(le risks. Eo"ever it provides a lo"er degree of protection

than insurance since hedges are often only partially effective.

Spe%#3at!rs& If a futures market is restricted to hedgers alone, it is 5uite conceiva(le that

one or other group of hedgers "ould (e una(le to hedge "ithout distorting the price

(ecause of the a(sence of counter parties to the transactions. It is here that the role of the

speculator (ecomes apparent. It is the speculators "ho take up the slack in the marketand provide li5uidity. The speculators have no specific interest in the commodity rather

they are risk seekers "hose interest stems from the profit "hich they expect to make from

assuming the price risk.

Fet us see the main use of speculation, "e can say yes as there can (e no effective

hedging since the volume of demand for long and short hedging "ill not (e e5ual except

(y occasional coincidence. It must (e noted that the practice of speculation, (y

facilitating hedging, reduces the costs of marketing. Secondly, speculative activity

increases the li5uidity of markets there(y ena(ling hedgers to transact large volumes of

(usiness on the market 5uickly, easily and "ithout unduly affecting the market price.

Ar$itra(e#rs& 6r(itrage can (e descri(ed as a transaction involves (uying and selling a

good or asset in t"o different markets in order to achieve a risk less profit through the

difference in price (et"een them. In a (roadest sense "e can say an ar(itrageur is one

"ho trades only to realie profits from discrepancies in the market. ;f course, in practicethe ar(itrageur is not a separate person9 either a hedger or a speculator can indulge in

ar(itrage "hen the opportunity arises. 6r(itrage plays a (ig role in ensuring that prices in

futures markets do not diverge from the level dictated (y supply and demand and in

ensuring speedy correction of any pricing anomalies.


13/50

E1amp3eA

;n a particular day, the shares of T#+F are selling at @s.


14/50

@s.%000.00 in cash market. In the 'utures market a minimum of &00 /one lot1

I#';S?STE has to (e traded. Eence the total value of trade has increased from

@s.=0,000.00 in cash market to @s.%,00,000.00 in the 'utures arket. 6 fall of @s.20.00

in cash market amounts to a loss of @s.300.00 as against a loss of @s.2000.00 in the

'utures market.

Adva"%ed %!"%epts i" derivatives&

St!%ks that %a" $e traded i" derivatives se(me"t&

urrently on the #S &20 stocks are trading in the derivatives markets. ontract sies are

determined (y the exchange. 'or example the contract sie for Satyam omputer is =00

stocks. That is, each trade has to (e a minimum 5uantity of =00 Satyam omputer stocks.

They could also (e traded in larger 5uantities like &200, &


15/50

Mea"i"( ! I".the.m!"e* Opti!"&

;ptions that provide the holder positive cash flo"s if exercised immediately are called

Intheoney options.

Mea"i"( ! At.the.m!"e* Opti!"&

;ptions that provide the holder ero cash flo"s if exercised immediately are called 6tthe

oney options.

Mea"i"( ! O#t.!.m!"e* Opti!"&

;nes that provide negative cash flo"s if exercised immediately are called ;utofmoney

;ptions.

The !#t 3!,s ,hi3e tradi"( i" Opti!"s are&

The (uyer of an option pays a small amount as +remium to the seller for privilege of

getting the right to exercise his $ her option. It is also the maximum amount that the (uyer

stands to lose "hen the market moves against his $ her expectations. This amount is due

on TO&. Similarly, the seller of options receives the premium amount on TO&. Eere, T is

the day of trading.

There are t,! 3eve3s ! mar(i"s t! $e paid at the %3ie"t 3eve32 I"itia3 Mar(i" a"d

Marked.t!.market mar(i"2

• I"itia3 Mar(i" amount is charged upfront. This value determines the gross

exposure to (e taken (y the investor. The extent of exposure given on a particular

margin amount depends on several factors including the Polatility of the scrip, the

;pen interest on the scrip, and the extent of Eedging used. #S uses soft"are

called S+6# to calculate margins. 7p to 30 of total Initial margin can (e paid in

stocks.

• Mark t! Market mar(i" /MTM0& 6 minimum percentage of Initial margin value

is re5uired to (e maintained as markedtomarket margin. This margin acts as a

security against intraday losses. This percentage could (e up to 20 of I.


16/50

Varia"%e mar(i"& ;n a particular day, the difference (et"een the ontract price andlosing price of the underlying scrip determines the net gain or loss on the

• ontract. 6ny de(its$losses a(ove the T margin is re5uired to (e paid on the

next day of the trade /TO&1. /See annexure1

5ri%i"( F#t#res&

+ricing of 'utures contract is very simple. 7sing the cost of carry logic, It is (y

calculating the fair value of a futures contract. very time the o(served price deviates

from the fair value, ar(itragers "ould enter into trades to capture the ar(itrage profit. This

in turn "ould push the futures price (ack to its fair value. The cost of carry model usedfor pricing futures is given (elo"A

'H SerT

Bhere,

r H ost of financing /using continuously compounded interest rate1

T H time till expiration in years

e H 2.>&


17/50

There are various models, "hich help us get close to the true price of the option.. The

!lackScholes formulas for the prices of uropean calls and puts on a nondividend

paying stock areA

H S# /d&1 Q -erT # /d21

+H -e rT # /d21S# /d&1

Bhere d&H In s$x O /rO2 $21 T R

Bhere d2H d& R

5a*! !r derivatives %!"tra%ts&

6 payoff is the likely profit$loss that "ould accrue to a market participant "ith change in

the price of the underlying asset. In this section "e shall look at the payoffs for (uyers

and sellers of futures and option.

5a*! !r #t#res&

'utures contract has linear payoffs. In simple "ords it means that losses as "ell as profits

for the (uyer and the seller of futures contract are unlimited. These linear payoffs are

fascinating as they can (e com(ined "ith options and the underlying to generate various

complex payoffs.

5a*! !r $#*er !r #t#res& 3!"( #t#res

The payoff for a person "ho (uys a futures contract is similar to the payoff for person"ho holds an asset. Ee has a potentially unlimited upside as "ell as potentially unlimited

do"nside take case of speculator "ho (uys a t"omonth nifty index futures contract

"hen the nifty stands %220. The underlying asset in this case is the nifty portfolio. Bhen

the index moves up, it starts making profits and "hen the index moves do"n it starts

making losses.


18/50

+rofit

%220 0 #ifty

Foss

5a*! !r se33er ! #t#res& sh!rt #t#res&

The payoff for a person "ho sells a futures contract is similar to the payoff for person

"ho shorts an asset. Ee has a potentially unlimited upside as "ell as potentially unlimited

do"nside take case of speculator "ho sells a t"o month nifty index futures contract "hen

the nifty stands %220. The underlying asset in this case is the nifty portfolio. Bhen the

index moves do"n, it starts making profits and "hen the index moves up it starts making

losses.

+rofit

%220

0

#ifty


19/50

Foss

Opti!"s pa*!s

The optionality characteristics of options results in a nonlinear payoff for options. In

simple "ords, it means that the losses for the (uyer of an option are limited9 ho"ever the

profits are potentially unlimited. 'or a "riter, the payoff is exactly the opposite. Eis

profits are limited to the option premium9 ho"ever his losses are potentially unlimited.

5a*! pr!i3e ! $#*er ! asset& 3!"( asset

In this (asic position, an investor (uy the underlying asset, nifty for instance, for %220

and sells it at a future date at unkno"n price, s. ;nce it is purchased, the investor is said

to (e longK the asset.

+rofit

O=0

0 %&=0 %220 %2


20/50

In this (asic position, an investor shorts the underlying asset, #ifty for instance, for %220,

and (uys it (ack at the future date at an unkno"n price, s. ;nce it is sold, the investor is

said to (e shortK the asset.

+rofit

O=0

0 %&=0 %220 %2


21/50

5a*! pr!i3es !r ,riter ! %a33 !pti!"s& Sh!rt %a33

6 call option gives the (uyer the right to (uy the underlying asset at the strike price

specified in the option. 'or selling the option, the "riter of the option charges a premium.

The profit$loss that the (uyer makes on the option depends on the spot price of the

underlying. Bhatever is the (uyer8s profit is the seller8s loss. If upon expiration, the spot

price exceeds the strike price, the (uyer "ill exercise the option on the "riter. Eence as

the spot price increases the "riter of the option starts making losses. Eigher the spot

price, more is the loss he makes. If upon expiration the spot price of the underlying is less

than the strike price, the (uyer lets his option expire unexercised and the "riter gets to

keep the premium.

+rofit


22/50

underlying is higher than the strike price, he lets his option expire unexercised. Eis loss

in this case is the premium he paid for (uying the option.

+rofit

%240

0 #ifty

=&.>0

Foss

5a*! pr!i3e !r ,riter ! p#t !pti!"& Sh!rt p#t

6 put option gives the (uyer the right to sell the underlying asset at the strike price

specified in the option. 'or selling the option, the "riter of the option charges a premium.

The profit$loss that the (uyer makes on the option depends on the spot price of the

underlying. Bhatever is the (uyer8s profit is the seller8s loss. If upon expiration, the spot

price happens to (e (elo" the strike price, the (uyer "ill exercise the option on the

"riter. If upon expiration, the spot price of the underlying is more than the strike price,

the (uyer lets his option expire unexercised and the "riter gets to keep the premium.

+rofit

=&.>0

%240

0 #ifty

Foss


23/50

N!, ,e ,i33 3!!k at the $asi% E)#it* Derivative strate(ies ,ide3* #sed

6ASIC STRATEGIES IN E9UIT7 5a*.!

!7? 6FF

Bhen very (ullish on the stock

!7? +7T

Bhen very (earish on stock

SFF +7T

Bhen sure that the price "ill not fall

!7FF S+@6D

all option is (ought "ith a lo"er strike price of andanother call option sold "ith a higher strike,

;@+ut option is (ought "ith a strike of lo"er strike andanother put sold "ith a higher strike.

Bhen the stock "ill go up some"hat or at least is a (it morelikely to rise than to fall

!6@ S+@6D

+ut option is (ought "ith a higher strike price and another put option sold "ith a lo"er strike,

;@all option is (ought "ith a higher strike price and another call sold "ith a lo"er strike.

Bhen the stock "ill go do"n some"hat or at least is a (itmore likely to fall than to rise.

SFF ;P@D 6FF

all option against the stock holding is sold.Bhen sure that the price of the stock you hold "ill not fall.

!7? ST@6DDF

all option and put option are (ought "ith the same strike usually atthemoney.


24/50

Bhen the stock is expected to move far enough in either direction in the shortterm.

!7? ST@6#MF

+ut option is (ought "ith a strike 6 and a call option is (ought "ith a strike !. / 6 !1

Bhen the stock is expected to move far enough from the predefined range.

!7? !7TT@'F?

all option "ith lo" strike (ought and t"o call options "ithmedium strike sold and call option "ith high strike (ought.The same position can (e created "ith puts.

Bhen the stock price is expected to fluctuate in a narro"range.

SFF !7TT@'F?

all option "ith lo" strike sold and t"o call options "ithmedium strike (ought and call option "ith high strike sold.The same position can (e created "ith puts.

Bhen the stock price are expected to move su(stantially

Usi"( i"de1 #t#res

There are ei(ht $asi% m!des ! tradi"( !" the i"de1 #t#res market&

• +ed(i"(

&. Fong security, short #ifty futures

2. Short security, long #ifty futures

3. Eave portfolio, short #ifty futures

%. Eave funds, long #ifty futures

• Spe%#3ati!"

&. !ullish index, long #ifty futures

2. !earish index, short #ifty futures

• Ar$itra(e

&. Eave funds, lend them to the market

2. Eave securities, lend them to the market @efA /#' Derivatives1


25/50

+ed(i"(& L!"( se%#rit*- sh!rt Nit* #t#res

6 stock picker carefully purchases securities (ased on a sense that they are "orth more

than the market price. Bhen doing so, he faces t"o kinds of risksA

&. Eis understanding can (e "rong, and the company is really not "orth more than the

market price9 or,

2. The entire market moves against him and generates losses even though the underlying

idea "as correct.

The second outcome happens all the time. 6 person may (uy @eliance at @s.&)&&

thinking that it "ould announce good results and the security price "ould rise. 6 fe"

days later, #ifty drops, so he makes losses, even if his understanding of @eliance "as

correct.

There is a peculiar pro(lem here. very (uy position on a security is simultaneously a

(uy position on #ifty. This is (ecause a F;#M @FI6# position generally gains if

#ifty rises and generally loses if #ifty drops. In this sense, a F;#M @FI6# position

is not a focused play on the valuation of @eliance. It carries a F;#M #I'T? position

along "ith it, as incidental (aggage. The stock picker may (e thinking he "ants to (e

F;#M @FI6#, (ut a long position on @eliance effectively forces him to (e F;#M

@FI6# O F;#M #I'T?.

There is a simple "ay out. very time you adopt a long position on a security, you should

sell some amount of #ifty futures. This offsets the hidden #ifty exposure that is inside

every longQsecurity position. ;nce this is done, you "ill have a position "hich is purely

a(out the performance of the security. The position F;#M @FI6# O SE;@T

#I'T? is a pure play on the value of @FI6#, "ithout any extra risk from

fluctuations of the market index. Bhen this is done, the stock picker has hedged a"ayK

his index exposure. The (asic point of this hedging strategy is that the stock picker

proceeds "ith his core skill, i.e. picking securities, at the cost of lo"er risk.

+ed(i"(& Sh!rt se%#rit*- 3!"( Nit* #t#res


26/50


27/50

2 Do nothing, i.e. suffer the pain of the volatility. This leads to political pressures for

government to do something "hen security prices fall. In addition, "ith the index

futures market, a third and remarka(le alternative (ecomes availa(leA

3 @emove your exposure to index fluctuations temporarily using index futures. This

allo"s rapid response to market conditions, "ithout panic sellingK of shares. It allo"s an

investor to (e in control of his risk, instead of doing nothing and suffering the risk.

very portfolio contains a hidden index exposure. This statement is true for all portfolios,

"hether a portfolio is composed of index securities or not.

+ed(i"(& +ave #"ds- $#* Nit* #t#res

Eave you ever (een in a situation "here you had funds, "hich needed to get invested in

e5uityV ;r of expecting to o(tain funds in the future "hich "ill get invested in e5uity.

Some common occurrences of this includeA

• 6 closedend fund that :ust finished its initial pu(lic offering has cash, "hich is

not yet invested.

• Suppose a person plans to sell land and (uy shares. The land deal is slo" and

takes "eeks to complete. It takes several "eeks from the date that it (ecomes sure

that the funds "ill come to the date that the funds actually are in hand

• 6n openended fund has :ust sold fresh units and has received funds.

Spe%#3ati!"& 6#33ish i"de1- 3!"( Nit* #t#res

6fter a good (udget, or good corporate results, or the onset of a sta(le government, many

people feel that the index "ould go up. 6n investor has t"o choices, he can (uy selected

li5uid securities, "hich move "ith the index, and sell them at a later dateA or, (uy the

entire index portfolio and then sell it at a later date.

Spe%#3ati!"& 6earish i"de1- sh!rt Nit* #t#res

6fter a (ad (udget, or (ad corporate results, or the onset of a coalition government, many

people feel that the index "ould go do"n. There is t"o choices sell selected li5uid


28/50

securities, "hich move "ith the index, and (uy them at a later dateA or, sell the entire

index portfolio and then (uy it at a later date.

Ar$itra(e& +ave #"ds- 3e"d them t! the market

ost people "ould like to lend funds into the security market, "ithout suffering the risk.

Traditional methods of loaning money into the security market suffer from /a1 price risk

of shares and /(1 credit risk of default of the counterparty. The main advantage of the

index futures market is that it supplies a technology to lend money into the market

"ithout suffering any exposure to #ifty, and "ithout (earing any credit risk.

Ar$itra(e& +ave se%#rities- 3e"d them t! the market

;"ners of a portfolio of shares often think in terms of :uicing up their returns (y earning

revenues from stock lending. Eo"ever, stock lending schemes that are "idely accessi(le

do not exist in India. The index futures market offers a riskless mechanism for

/effectively1 loaning out shares and earning a positive return for them.

The (asic idea is 5uite simple. Investor "ill sell off all 40 securities in #ifty and (uy

them (ack at a future date using the index futures. Ee "ill soon receive money for the

shares he has sold. Ee can deploy this money, as he like until the futures expiration. ;n

this date, he "ould (uy (ack his shares, and pay for them.

Usi"( #t#res !" i"divid#a3 se%#rities&

+ed(i"(& L!"( se%#rit*- se33 #t#res

Stock futures can (e used as an effective riskQmanagement tool. Take the case of an

investor "ho holds the shares of a company and gets uncomforta(le "ith market

movements in the short run. Ee sees the value of his security falling from @s.%40 to

@s.3)0. In the a(sence of stock futures, he "ould either suffer the discomfort of a price

fall or sell the security in anticipation of a market upheaval. Bith security futures he can

minimie his price risk. 6ll he need do is enter into an offsetting stock futures position, in


29/50

this case, take on a short futures position. 6ssume that the spot price of the security he

holds is @s.3)0. T"oQmonth futures cost him @s.%02. 'or this he pays an initial margin.

#o" if the price of the security falls any further, he "ill suffer losses on the security he

holds. Eo"ever, the losses he suffers on the security, "ill (e offset (y the profits he

makes on his short futures position. Take for instance that the price of his security falls to

@s.340. The fall in the price of the security "ill result in a fall in the price of futures.

'utures "ill no" trade at a price lo"er than the price at "hich he entered into a short

futures position. Eence his short futures position "ill start making profits. The loss of

@s.%0 incurred on the security he holds, "ill (e made up (y the profits made on his short

futures position.

Spe%#3ati!"& 6#33ish se%#rit*- $#* #t#res

Take the case of a speculator "ho has a vie" on the direction of the market. Ee "ould

like to trade (ased on this vie". Ee (elieves that a particular security that trades at

@s.&000 is undervalued and expect its price to go up in the next t"oQthree months. Eo"

can he trade (ased on this (eliefV In the a(sence of a deferral product, he "ould have to

(uy the security and hold on to it. 6ssume he (uys a &00 shares "hich cost him one lakh

rupees. Eis hunch proves correct and t"o months later the security closes at @s.&0&0. Ee

makes a profit of @s.&000 on an investment of @s.&,00,000 for a period of t"o months.

This "orks out to an annual return of = percent. Today a speculator can take exactly the

same position on the security (y using futures contracts. Fet us see ho" this "orks. The

security trades at @s.&000 and the t"omonth futures trades at &00=. Just for the sake of


30/50

comparison, assume that the minimum contract value is &,00,000. Ee (uys &00 security

futures for "hich he pays a margin of @s.20,000. T"o months later the security closes at

&0&0. ;n the day of expiration, the futures price converges to the spot price and he makes

a profit of @s.%00 on an investment of @s.20,000. This "orks out to an annual return of

&2 percent. !ecause of the leverage they provide, security futures form an attractive

option for speculators.

Spe%#3ati!"& 6earish se%#rit*- se33 #t#res

Stock futures can (e used (y a speculator "ho (elieves that a particular security is overQ

valued and is likely to see a fall in price. Eo" can he trade (ased on his opinionV In the

a(sence of a deferral product, there "asn8t much he could do to profit from his opinion.

Today all he needs to do is sell stock futures. Fet us understand ho" this "orks. Simple

ar(itrage ensures that futures on an individual securities move correspondingly "ith the

underlying security, as long as there is sufficient li5uidity in the market for the security. If

the security price rises, so "ill the futures price. If the security price falls, so "ill the

futures price.

Ar$itra(e& Overpri%ed #t#res& $#* sp!t- se33 #t#res

The costofcarry ensures that the futures price stay in tune "ith the spot price. Bhenever

the futures price deviates su(stantially from its fair value, ar(itrage opportunities arise. If

you notice that futures on a security that you have (een o(serving seem overpriced, ho"

can you cash in on this opportunity to earn riskless profits. Say for instance, 6! trades

at @s.&000. ;neQmonth 6! futures trade at @s.&024 and seem overpriced. 6s an

ar(itrageur, you can make riskless profit (y entering into the follo"ing set of

transactions.

&. ;n day one, (orro" funds, (uy the security on the cash$spot market at &000.

2. Simultaneously, sell the futures on the security at &024.

3. Take delivery of the security purchased and hold the security for a month.

%. ;n the futures expiration date, the spot and the futures price converge. #o" un"ind

the position.


31/50

4. Say the security closes at @s.&0&4. Sell the security.

=. 'utures position expires "ith profit of @s.&0.

>. The result is a risk less profit of @s.&4 on the spot position and @s.&0 on the futures

position.

. The result is a riskless profit of @s.24 on the spot position and @s.&0 on the futures

position.

If the returns you get (y investing in riskless instruments is less than the return from the


32/50

ar(itrage trades, it makes sense for you to ar(itrage. This is termed as reverseQcashQandQ

carry ar(itrage. It is this ar(itrage activity that ensures that the spot and futures prices stay

in line "ith the costQofQcarry. 6s "e can see, exploiting ar(itrage involves trading on the

spot market. 6s more and more players in the market develop the kno"ledge and skills to

do cashQandQcarry and reverse cashQandQcarry, "e "ill see increased volumes and lo"er

spreads in (oth the cash as "ell as the derivatives market.

Usi"( Opti!"s

'he" ,e are $#33ish a$!#t the market&

6#* %a33 !pti!"- se33 p#t !pti!"

Bhen "e are (ullish a(out the market "e can (uy a call option and pay premium on it,

Simultaneously "e can sell a put option, and get premium on it, this is (ecause incase the

market comes do"n "e can (e hedged against the losses, Take in this situation the spot

price rises a(ove the strike price "e "ill exercise the option (ecause "e "ill have the

right to (uy. So "e "ill earn a profit. 6nd the person "hom "e sell the put option "ill (e

under loss so he "ill forego the contract hence "e "ill also keep the premium he gave us

as profit.

'he" ,e are $earish a$!#t the market&

6#* p#t !pti!"- se33 %a33 !pti!"

Bhen "e are (earish a(out the market "e can (uy a put option and pay premium on it,

Simultaneously "e can sell a call option, and get premium on it, this is (ecause incase the

market goes up "e can (e hedged against the losses, Take in this situation the spot price

falls (elo" the strike price "e "ill exercise the option (ecause "e "ill have the right to

sell. So "e "ill earn a profit. 6nd the person "hom "e sell the call option "ill (e under

loss so he "ill forego the contract hence "e "ill also keep the premium he gave us as

profit.


33/50

D!,"side ! Derivatives ,ith e, 3ive e1amp3es

A %ase st#d* !" re%e"t deve3!pme"ts i" R5L2 As t! ,h* F:O tradi"( i" a NIFT7 ;<

st!%k %ame #"der a $a" i" F:O Se(me"t

@eliance Industries Ftd. /@IF1, holding company of @eliance +etroleum Ftd. /@+F1, hassold a(out %.0& stake of @+F, (eing &4to >0.)).

The share price of @+F has "itnessed a lot of volatility, especially in '*; segment, inthe current month series of #ovem(er, "hen share price fell from @s.2)4 to no" [email protected]&4. The scrip @+F, "as also under (an, till 'riday, in '*;, due to arket BideFimit having crossed )4. !ut no", from today, the scrip has resumed trading again in'*;. This "as also first instance "hen a scrip of #I'T? 40, came under (an in '*;

segment.

The market report indicates that a(out &2 crore shares are in open interest in futuresegment, apart from additional open interests for +ut and all, in options segments atvarious rates for three months. Bhile taking a feel of retail investorsW position, ma:ority of them are long on the scrip, and since the scrip "as under (an, they kept continuing "ithopen position, even after paying mark to market losses and incremental margins, imposeddue to higher volatility. onversely, informed circle is reported to (e short in the counter,for matching open interest.

Initially, short positions seems to have (een created (y the informed circles, at the higherlevels of @s.2>4 plus, o(viously, finding these price levels as unrealistic, andsu(se5uently, actual sell has (een triggered (y @IF in cash market, thus realiing anaverage of @s.223 per share. This has resulted in reverse ar(itrage, till last "eek, "hencash segment ruled higher than '*;. This also indicates paucity of floating stock.

Shareholding pattern of @+F is as under A

&1 @IF 33>.40 cr shares (eing >4 @s.3,3>4 crores

21 hevron 22.40 cr. shares (eing 4 @s.224 crores

31 +u(lic )0.00 cr. shares (eing 20 @s.)00 crores

Total %40.00 cr. shares (eing &00 @s.%,400 crores


34/50

@IF has ac5uired its >4 stake as under A

&1 2>0 cr. shares at par @s.2,>00 crores

21 =>.4 cr. shares at @s.=0 per share @s.%,040 crores

33>.40 cr. Total @s.=,>40 crores

@IF has almost realied its cost of @s.%,040 crores for su(scri(ing =>.40 shares, in 6pril200=, at @s.=0 per share. Since, investments sold are (ased on 'I'; /first in first out1 (asis, shares having su(scri(ed at par "ere presumed to have (een sold, on "hich longterm capital gain of @s.3,&stake is 5uite reasona(le, in the mega refinery, "hich "ould vastly improve theconsolidated results of @IF.

21 @IF "ould have an other income of @s.3,, "hich "ould give an extra +S of @s.2=.40, on enhanced e5uity of @s.&,%43 crores, post I+F merger.

31 @IF has (een a(le to mop up close to @s.%,000 crores /tax free1 "hen it needsfunds, for its capex programme at M !asin.

%1 @IF may further decide to offload .)) stake, (eing %.%= crore share, and realieclose to @s.&,000 crores, and keeping its stake in @+F at >0.

41 hevron, presently has 4 stake in @+F, "ith an option to raise it to 2) (y June0), post commencement of refinery. The preferential allotment can only (e made, (asedon S!I formula, "hich "ould (e at @s.200 plus, /presuming market price to remaina(ove @s.2001. 6t this rate, hevron may not (e interested in raising its stake to 2) as it"ould need close to @s.30,000 crores. Eence, hevron, "ould opt to offload its 4 stakein favour of @IF, at @s.=0 per share, as per the terms of the share su(scription 6greement.


35/50

=1 ;n happening this event, @IF "ould (e a(le to raise its stake, (ack to >4, at acost of :ust @s.&,340 crores.

>1 The informed circles, having initiated shorts in '*; at an average of @s.2>4 pershare, are reported to have made a gain of @s.&,000 crore plus.

#o", letWs take a call, ho" share price of @+F is likely to (ehave, in coming times.

&1 6s ma:ority of retail investors are long, they "ould opt to roll over their positionsin Decem(er series, as (ullish outlook on the stock, continues, for various reasons /noneed to ela(orate them1.

21 Informed circle, holding short position of close to &0 crore shares, may not (einterested in rolling over, as market perception has changed positive, on the stock. !ut, inthis case, they may (e interested to see a lo"er rate, on closing day, /Thursday 2) th #ovem(er1 to ena(le them to have a (etter close out.

31 Since, no more, delivery (ased selling is expected on the counter, "eakness maynot (e seen from (eginning of Decem(er '*; series

%1 If informed circle, tries to (ring do"n the price on closing day, lot of interested

(uying may (e seen, (elo" @s.200 per share, from investment and ar(itrage vie" point.

In nutshell, this "as a calculated move, (y @IF, "here(y, huge cost has (een recovered,

coupled "ith retaining ma:ority and respecta(le stake. 6lso, the market /cash and '*;1

is in full control of the management, "hich "ould take direction, on the next move of the

management, as that "ill have far reaching conse5uences.

T+E 6ARINGS 6AN8 DE6ACLE

The derivative trading is not as easy as perceived. Eere is a famous case that depicts the

ho" risky the (usiness is. The events that led to the fall of !arings, !ritainWs oldest

merchant (ank, is a example of ho" not to manage a derivatives operation. The control

and risk management lessons to (e learnt from this fall are the same as much to cash

positions as they do to derivative ones. The leverage and li5uidity offered (y futures

contracts makes an institution fall "ith lightning speed.


36/50

The activities of #ick Feeson on the Japanese and Singapore futures exchanges led to the

do"nfall of !arings. The (uildup of the #ikkei positions (y Feeson "ent in the opposite

direction to the #ikkei as the Japanese stock market fell. !efore the earth5uake, #ikkei

traded in a range of &),000 to &),400. Feeson had long futures positions of approximately

3,000 contracts on the ;saka Stock xchange. 6 fe" days after the earth5uake, Feeson

started an aggressive (uying programmed "hich culminated in a high of &),0)% contracts

reached a(out a month later.

!arings collapsed as it could not meet the enormous trading o(ligations, "hich Feeson

esta(lished in the name of the (ank. Bhen it "ent into receivership on 'e(ruary 2>,

&))4, !arings had outstanding notional futures positions on Japanese e5uities and interest

rates of 7SX2> (illionA 7SX> (n on the #ikkei 224 e5uity contract and 7SX20 (n onJapanese government (ond /JM!1 and uro yen contracts. Feeson sold >0,


37/50

IM5ORTANCE OF 5UT.CALL 5ARIT7 RATIO /5CR0 IN DERIVATIVES

In :ust the past couple "eeks, an extremely intriguing anomity has arisen in the Indian

stock markets. The famous +ut$all @atio 2&day moving average has soared a(ove &.00

for the first time in at least a decadeU This odd development is vexing (ulls and (ears

alike.

The +ut$all @atio, or +@, is a po"erful technical trading indicator that monitors the

stock and stockindex (ets that speculators are making at any given time. Speculators

"ho expect individual stocks or the indices to fall in the months ahead (uy put options,

derivatives (ets "hich increase in value "hen prices decline. Speculators "ho expect

rising prices (uy call options, "hich promise hefty payouts on higher prices.

The +@ 5uantifies the ratio of the daily trading volume in these t"o opposing (ets,

granting speculators valua(le insights into "hat the ma:ority happens to (e expecting.

Bhen the +@ is a(ove &.00, as today, it literally means that the daily trading volume on

puts is higher than calls. Translated into pure sentiment terms, it indicates that the

ma:ority pro(a(ly expects lo"er prices in the months ahead. 6nd since "e humans are

naturally (ullish, a +@ a(ove &.00 is an extraordinarily rare event.

Today8s high +@ anomaly is difficult to interpret, as I "ill outline in this essay. !oth

(ullish and (earish cases can (e (uilt around this surreal development, and the contrarian

slant on this is complex as "ell. Bhile I certainly "ish there "as an easy (ulletproof

interpretation of this odd event, its sudden appearance today "ithin the context of current

market conditions is a puling mystery. /This +ointer taken from """.ealllc.com1


38/50

Resear%h Meth!d!3!(*&

The "hole study "as totally (ased on the primary data there "as no as such formal

procedure most of the research "as done in the dealing room

6s it is one type of mechanism so a lot of time "as spent to understand the concept. ost

important factor in this research "as the dealing room operation. The dealings of the firm

"ith its client investors "as properly o(served and studied in detail.

The total sample sie "as 40 i.e. the num(er of cases considered during the pro:ect for

various dealings.

The main function "as to look at the screen and "atch ho" the market is (asically

moving "ith the change in time. The data "as primary and secondary data and collected

from the ;rion soft"are and 'alcon soft"are. 6ll over the "orld there are lots of stock

exchanges dealing "ith 5uity derivatives (ut for the purpose of the study #I'T? has

(een considered and various examples are 5uoted using #ifty and certain stock

derivatives are taken for examples "hen strategies are 5uoted using examples and

studying the futures and options market during different market times and trying to adopt

different strategies for different types of market conditions like !ull run ,(ear run and

heavy volatile and during consolidation trends of the market.

The market methodology follo"ed is primary data collected from a channel of net"ork

that involves independent

'inancial institutions, !anks, E#I8s, 68s, !rokers "ho use thesederivative strategies or use them on (ehalf of their clients.

6lso dealing room operations.The dealings of the firm "ith its clientinvestors "ill properly o(served and studied in detail.

Yuestionnaire survey "ith the various derivatives dealers and "ith feed(ack

and tips "ere taken from Derivatives strategist team.


39/50

6nd secondary data from a host of (ook materials, and Derivatives materials

The expected outcomes from the thesis is to understand and apply ho" to use the concept

of e5uity strategies and under "hat market conditions "e should use these 5uity market

strategies and try to (eat the market (y hedging our holdings and implies the use of all

the popular e5uity derivatives strategies "ith practical examples it has (een illustrated

"ell for even a layman can understand and try to grasp ho" these strategies are useful in

the stock markets

DATA ANAL7SIS AND INTER5RETATION

The conditions under "hich the use of e5uity derivative strategies can (e analyed (y the

help of using 5uestionnaire to collect data areA

&1 Strategies you normally use "hen market vie" is highly (ullish

6#* Ca33 Opti!"

CALL Opti!"& !uyerK of a all ;ption on a particular stock “(ets the ri(ht t!

6#*” the underlying Stock, "hereas Seller $ BriterK of the all ;ption is

o(liged to SellK the underlying stock "hen the (uyer of all decides to xercisehis $ her ;ption. Bhen the spot $ cash price is higher than the Strike price /plus

cost1, the (uyer of all could exercise his right to (uyK at the Strike price.

E1amp3eA Suppose you have (ought a call option of 2,000 shares of Eindustan

Fever Ftd /EFF1 at a strike price of @s 240 per share. This option gives you the

right to (uy 2,000 shares of EFF at @s240 per share on or (efore arch 30, 200>.

The seller of this call option "ho has given you the right to (uy from him is under

the o(ligation to sell 2,000 shares of EFF at @s240 per share on or (efore arch

30, 200> "henever asked.

StockA I#';S?STE

Pie"A !ullish

StrategyA F;#M /!7?1 6FF


40/50

@ationaleA Technically the stock has given an up"ard

(reakout * should find a target of around 2300 in the next fe" trading sessions.

Fong allA Initiated on 2%th ar

Spot +riceA @s .2230$

StrategyA !ought I#';S?STE 2240 June 6 Z @s.%4

/Fot sie H &001

Res#3t& In a(out a "eeks8 time, the call option appreciated to @s.>0 as the stock

price rose and "e sold off the position resulting in a profit. 6 graphical

representation of this option position is given (elo"

!@6 P# +;I#TA @s.22)4 i.e., strike price O premium paid 6-I7 +@;'ITA 7nlimited 6-I7 F;SSA @s.%,400 per lot


41/50

21 Strategies you use "hen the stock is expected to move far enough in eitherdirection in the shortterm

IndexA #I'T?

;utlookA Eighly PolatileStrategyA LONG STRADDLE /!uy an e5ual num(er of calls and puts ofthe same strike price and same expiry1@ationaleA Due to glo(al markets the #I'T? Index is expected to volatile

Fong StraddleA Initiated on &st aySpot PalueA %0)0 levels

StrategyA !uy #I'T? %&00 ay 6 Z @s.)0 /Fot sie H 401!uy #I'T? %&00 ay +6 Z @s.&&0 /Fot sie H 401

@esultA #I'T? (roke the crucial support level of %040 andtrended do"n"ard to 3


42/50

31 Strategy to (e used "hen market is highly volatile A

StockA TIS;

;utlookA Eighly Polatile StrategyA LONG /6#*0 STRANGLE /!uy an e5ual num(erof calls and puts at different strike prices and same expiry1@ationaleA The stock could respond either "ay "ith high volatility due tothe orus takeover.

Fong StrangleA Initiated on 23rd Jan

Spot +riceA %>0 levels StrategyA !uy TIS; 'e( 400 6 Z @s.&0 /Fot sie H =>41

!uy TIS; 'e( %40 +6 Z @s.&0 /Fot sie H =>41

@esultA TIS; stock responded positively to this strategyand rallied to 4&0420 levels "here "e cleared our call and sold it [email protected]


43/50

%1 Strategy to (e used "hen the market is moderately (ullish

StockA S!I#

;utlookA oderately !ullishStrategyA 6ULL S5READ

/!uy a call and sell a call at a higher strike1

@ationaleA The overall (anking sector is looking attractivefor (uying.Technical indicators are

suggesting strong up"ard move in S!I# "ith strongresistance at &230&240 levels.

!ull SpreadA Initiated on 3&st ar

Spot +riceA @s .&&%0$ StrategyA !uy S!I &&%0 6pril 6 Z @s.%2 /Fot sie H 2401

Sell S!I &230 6pril 6 Z @s.&0 /Fot sie H 2401 @esultA 6fter executing this strategy, S!I rallied higher and

"e realied a net profit in this strategy. Be sold the&&%0 call for @s.


44/50

41 Strategies you use "hen market vie" is (ullish to stagnant A

StockA S6IF

;utlookA !ullish to stagnant

StrategyA S+ORT /Se330 5UT

@ationaleA The stock is trading in a oversold one along "ith massive increase

in the open interest in call options of strike prices in &&4 * &&001

@esultA This is one example "here our strategy resulted in a loss. ;ur outlook

"as "rong and S6IF stock fell along "ith the general market.Be had to (uy

(ack our put at a higher price /at @s.3.)01 as the stock "ent do"n and this

resulted in a loss of @s.&.%0 per lot.

6 graphical representation of this strategy is given (elo".

!@6 P# +;I#TA @s. &0>.40, Strike price +remium received6-I7 +@;'ITA +remium received6-I7 F;SSA 7nlimited.


45/50

= 1 Strategy to (e used "hen market is mildly (ullish

StockA @FI6#;utlookA ildly !ullish

StrategyA 6ULL CALL RATIO S5READ/!uy a call and sell$three t"o higher strike calls1@ationaleA The overall market is positive and @FI6# is trading at its 40retracement levels and may sho" an up"ard move "ith resistance at &%%0 and &%>0.

!ull all @atio SpreadA Initiated on 3&st fe(Pie"A oderately !ullish on @elianceSpot +riceA @s.&3=0 levelsStrategyA !uy @IF ar &30 6 Z @s.&0 /Fot sie H &401

@esultA @eliance rallied to levels most profita(le for this strategy.Bhen reliance "as at &%20 levels profits on the &30 call "as (ought (ack at @s.2 resulting in a net profit of @s.34 per lot.

!@6 P# +;I#TA &3)0 * &4206-I7 +@;'ITA @s. >400 per spread6-I7 F;SSA @s. &400 on the do"nside * 7nlimited a(ove &420


46/50

>1 Strategy to (e used "hen market is moderately (ullish

StockA EI#D6F;

;utlookA oderately !ullishStrategyA 5ROTECTIVE 5UT/;"n stock$futures, and (uy a put1

@ationaleA The momentum in stock is good along "ith positive movement inthe @SI. Technically the stock is (ullish "ith a target price of &)0&)4.

-6+FA EI#D6F; +rotective +utSpot +riceA &.%0 per lot


47/50

@;#D6TI;#S

Ma4!r i"di"(s&

&1 Due to more transparency and ne" policies implemented (y S!I players in this

market is increasing at a very high rate and the ne" comers are "elle5uipped to

compete "ith others. So most of the share (roking firms are trying to gra( ne"

customers in derivatives as "ell as to retain the old ones, so this re5uires fine ad

favoura(le (rokerage charges as "ell as excellent service to their customers and

they have a separate desk for formulating or using e5uity derivatives

21 !roking firms should shift from 5uity research to Derivatives research to (e a(le

to compete "ith the foreign (roking house "hen 'DI in retail (roking opens for

these foreign players

31 'e" dealers are not professionally 5ualified to understand strategies to play on

(ehalf of their clients. This leads to reduction in the cliental (ase (e it institutional

or (roking.

%1 During the recent market trend /"here sensex has "itnessed correction of &400

points and nifty (y


48/50

Re%!mme"dati!"s&

&1 The (roking houses needs to recruit fe" more Derivatives analysts in their

research department to cope "ith the gro"th in Derivatives segment.

21 +roper training has to (e conducted for the dealers on time to time (asis to

make them more kno"ledgea(le and efficient to properly deal "ith the clients.

6nd to give proper advice in market crashes

31 !roking houses should have specialty soft"are package to deal "ith

Derivatives strategies at all levels of the firm even to the dealers so they can

employ these strategies

%1 aking the importance of derivatives understanda(le to retail clients (y

organiing investor camps

41 !ringing in more small sie contracts for retail pu(lic to hedge their positions

like mini nifty /20 lot sie1 , chota sensex / 4 lot sie1 etc.

=1 @educing margins for easier access to f*o rather than heavy margins at present

>1 S!I should consider longer expiration contracts like = months expiry to 3

years expiry contracts


49/50

CONCLUSION

Derivatives as a risk management tool should (e employed after understanding the risk

profile of yourelf or your clients or it "ill lead to increased risk if not used at the righttime or "ithout understanding the market trend. ;ne should avoid using derivatives in a

very volatile market that "ould magnify the losses to a greater extent as "e (uy or sell in

lot sies and should use proper strategies re5uired in a volatile market and derivatives

trading "ill soon surpass the daily turnover in the cash segment in (oth !S and #S

currently derivatives trading is dominated (y #S in terms of turnover.

Bhen retail (roking space is opened to 'DI "e "ill (e a(le to see more use of complex

derivatives product availa(le in the market in India "hich is currently not availa(le

Then "e "ill (e a(le to see retail pu(lic trading more in the derivatives segment than the

institutional trading "hich holds a ma:ority of the chunk in the Derivatives trading

segment in India.

The advent of Derivatives trading in the country "ill change the face of the Indian capital

market very soon in terms of the volume of transactions, the nature and settlement of

trade, and the profile of market participants. I personally don8t think many of our

colleagues in the (usiness have really understood the impact that Derivatives can have on

the (roking (usiness. The gro"th of Derivatives as a mass trading techni5ue in the

country is unstoppa(le, going (y the indicators availa(le and the signals for the future.

Bhen it ultimately gathers momentum, the (iggest (eneficiary "ill (e the traders and

speculators, "ho "ill (e a(le to trade and speculate (etter than in the cash market

Bith Derivatives one needs to apply common sense and take small positions in the

market rather than taking exu(erant positions and losing the entire capital deployed in the

'*; segment D@IP6TIPS 6@ T; ! PIBD 6S B6+;#S ;' 6SS

DST@7TI;#K as said (y the great investor of all times r. Barren !uffet.


50/50

karthika project

Documents