trend analysis of fo & op of rel ind ltd 138
TRANSCRIPT
TREND ANALYSIS OF FUTURES AND OPTIONS WITH RESPECT OF RELIANCE INDUSTRIES
ATINTER-CONNECTED STOCK EXCHANGE OF INDIA LTD
HYDERABAD.BY
B. SHIVA KRISHNA102-07-138
Project submitted in partial fulfillment for the award of the degree of
MASTER OF BUSINESS ADMINISTRATIONBy
Aurora’s P.G College(Affiliated to Osmania University, Hyd-500007)
2007-2009
DECLARATION
I hereby declare that this Project Report titled TREND ANALYSIS OF
FUTURES OF FUTURES AND OPTIONS WITH RESPECT
RELIANCE INDUSTRIES submitted by me to the Department of Business
Management, O.U., Hyderabad, is a bonafide work undertaken by me and it is
not submitted to any other University or Institution for the award of any
degree diploma / certificate or published any time before.
Name and Address of the Student Signature of the StudentB.SHIVA KRISHNA (B. SHIVA KRISHNA)
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POST-GRADUATE COLLEGE Ramanthapur, Hyderabad -500 013.
CERTIFICATION
This is to certify that the Project Report title TREND ANALYISIS OF
FUTURES AND OPTIONS WITH RESPECT OF RELIANCE
INDUSTRIES submitted in partial fulfillment for the award of MBA
Program of Department of Business Management, O.U. Hyderabad was carried
out by B. SHIVA KRISHNA under our guidance. This has not been submitted
to any other University or Institution for the award of any
degree/diploma/certificate.
Ms. Neetu Sachdeva Mr.C.S.Pattnaik Dr.Mohd.Zafar Sheikh Internal guide HOD Principal
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ACKNOWLEDGEMENT
My sincere thanks to Mr. K.V. Nagabhushan for granting me permission to
do my project in INTER – CONNECTED STOCK EXCHANGE
My gratitude to Mr. M. Ramasubba Rao for extending her co- operation in
course of my project.
I am very grateful to Ms. Neetu Sachdeva for her continuous support and
guidance during the course of my project.
I take great pleasure to express my deep sense of gratitude to one and all
in the company who has been directly or indirectly helpful to me in completing the
project.
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ABSTRACT
The title of the study is “TREND ANALYSIS OF FUTURES AND
OPTIONS OF RELIANCE INDUSTRIES Ltd”.The study is confined to one
month trading of future and options of selected company. The scrip chosen for
analysis is RELIANCE INDUSTRIES LTD and the contract taken is
September 2008 ending one-month contract. The reference period of the
project covers one month (01-09-2008 to 25-09-2008) over the price
fluctuations for the above-mentioned scrip’s were analyzed.
The objective of the study is to know the various trends in derivative
market and also to analyze in detail the role of operations of futures and
options. This project is helpful to the potential investor. The main objective of
this study is to find the profit/loss position of futures buyer and also the option
writer and option holder.
In this study I found the moment of price, the pay off of the
buyers/sellers and the process of trading. The norms of the Security Exchange
Board of India (SEBI) and about other exchanges.
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CHAPTERIZATION
CONTENTS PAGE NO
LIST OF TABLES 7
LIST OF FIGURES 8
CHAPTER- 1: INTRODUCTION 9 1.1 Nature of the Problem 10 1.2 Scope of the Study 11 1.3 Objectives of study 11 1.4 Description of the Study 12
CHAPTER- 2: REVIEW OF LITERATURE 132.1 DERIVATIVES 142.2 Types of Derivatives 272.3 Futures 282.4 Options 36
CHAPTER- 3: COMPANY’S PROFILE 50 3.1 Inter Connected Stock Exchange 513.2 Industry Profile 55
3.2.1. NSE 583.2.2. BSE 60
CHAPTER- 4: ANALYSIS 624.1 Analysis on Future Market 634.2 Analysis on Option Market 66
4.2.1. Call Prices 664.2.2. Put Prices 68
CHAPTER-5: CONCLUSIONS AND SUGGETIONS 70 5.1. Limitations of Study 715.2 Conclusion 725.3. Recommendations and Suggestions 73
BIBLIOGRAPHY 74
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LIST OF TABLES Page No.
1. RELIANCE INDUSTRIES Future and Spot prices 63
2. RELIANCE INDUSTRIES Call Option prices 66
3. NET PAY OFF OF CALL OPTION HOLDER & WRITER 67
4. RELIANCE INDUSTRIES Put Option prices 68
5. NET PAY OFF OF PUT OPTION HOLDER & WRITER 69
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LIST OF FIGURES Page No.
1. Market Participants of DERIVATIVES 23
2. Types of DERIVATIVES 27
3. Pay-off profile for the Buyer of Future 33
4. Pay-off profile for the Seller of Future 34
5. Pay-off profile for the Buyer of Call Option 43
6. Pay-off profile for the Seller of Call Option 44
7. Pay-off profile for the Buyer of Put Option 47
8. Pay-off profile for the Seller of Put Option 48
9. Figure showing Spot and Future prices of 64
RELIANCE INDUSTRIES
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CHAPTER - 1
INTRODUCTION
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1.1 NATURE OF THE PROBLEM
The turnover of the stock exchange has been tremendously increasing from Last 10
years. The number of trades and the number of investors, who are participating, have
increased. The investors are willing to reduce their risk, so they are seeking for the risk
management tools.
Prior to SEBI abolishing the BADLA system, the investors had this system as a
source of reducing the risk, as it has many problems like no strong margining System,
unclear expiration 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.
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1.2 SCOPE OF THE STUDY
The Study is limited to “Derivatives” with special reference to futures and Option in the
Indian context and the Inter-Connected Stock Exchange have been Taken as a
representative sample for the study. The study 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 Indian context. The study is not based on the international perspective of
derivatives markets, which exists in NASDAQ, CBOT etc.
1.3 OBJECTIVES OF THE STUDY
1. To analyze in detail role of operations of futures and options.
2. To find the profit/loss position of futures buyer and also the option writer and
option holder.
3. This project is helpful for potential investor
4. To study one month (September) market movements of RELIANCE INDUSTRIES
Futures and Options.
5. To study the pay off profile of a buyer/seller of futures or options.
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1.4 DESCRIPTION OF THE METHOD
The following are the steps involved in the study.
Selection of the scrip The scrip selection is done on a random and the scrip selected is Reliance Industries Ltd. The lot size is 75. Profitability position of the futures buyers and seller and also the option holder and option writers is studied.
Data CollectionThe data of the Reliance Industries Ltd has been collected from the “THE ECONOMIC TIMES” and the Internet. The data consist of the September Contract and period of Data collection is from 1st SEP 2008 – 29th SEP 2008.
AnalysisThe analysis consist of the tabulation of the data assessing the profitability Positions 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.
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CHAPTER – 2
LITERATURE REVIEW
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2.1 DERIVATIVES
Derivatives are products whose value is derived from one or more variables called
bases. These bases can be underling asset such as foreign currency, stock or commodity,
bases or reference rates such as LIBOR or US treasury rate etc. Example, an Indian
exporter in anticipation of the ric9ipt of dollar denominated export proceeds may wish to
sell dollars at a future date to eliminate the risk of exchange rate volatility by the data. Such
transactions are called derivatives, with the spot price of dollar being the underling asset.
Derivatives thus have no value of their own but derive it from the asset that is being
dealt with under the derivative contract. A financial manager can hedge himself from the
risk of a loss in the price of a commodity or stock by buying a derivative contract. Thus
derivative contracts acquire their value from the spot price of the asset that is covered by
the contract.
The primary purposes of a derivative contract is to transfer “risk” from one party to
another i.e. risk in a financial sense is transfer from a party that is willing to take it on.
Here, the risk that is being dealt with is that of price risk. The transfer of such a risk can
therefore be speculative in nature or act as a hedge against price movement in a current or
anticipated physical position.
Derivatives or derivative securities are contracts which are written between two
parties (counterparties) and whose value is derived from the value of underlying widely-
held and easily marketable assets such as agricultural and other physical (tangible)
commodities or currencies or short term and long-term and long term financial instruments
or intangible things like commodities price index (inflation rate), equity price index or bond
piece index. The counterparties to such contracts are those other than the original issuer
(holder) of the underlying asset.
Derivatives are also known as “deferred delivery or deferred payment instruments”. In a
sense, they are similar to securitized assets, but unlike the latter, they are not the obligations
which are backed by the original issuer of the underlying asset or security. It is easier to
take a short position in derivatives than in other possible to combine them to match specific
requirements, i.e., they are more easily amenable to financial engineering.
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The values of derivatives and those of their underlying assets are closely related.
Usually, in trading derivatives, the taking or making of delivery of underlying assets is not
involved; the transactions are mostly settled by taking offsetting positions in the derivatives
themselves. There is, therefore, no effective limit on the quantity of claims which can be
traded in respect of underlying assets. Derivatives are “off balance sheet” instruments, a
fact that is said to obscure the leverage and financial might they give to the party. They are
mostly secondary market instruments and have little usefulness in mobilizing fresh capital
by the companies (warrants, convertibles being the exceptions). Although the standardized,
general, exchange-traded derivatives are being contracts which are in vogue and which
expose the users to operational risk, counterparty risk, liquidity risk, and legal risk. There is
also an uncertainty about the regulatory status of such derivatives.
DefinitionContracts, whose values are to be derived from the asset covered by them (such as
paddy), are commonly named as “derivatives”. These are basically, financial instruments
whose value depends on the value of the other, more basic underling variable-such as
commodity, stock, currency, etc…
“A contract or an agreement for exchange of payments, whose values derives from
the value of an underling asset or underling reference rates or indices”.
A derivative is a security whose price ultimately depends on that of another asset
called underling.
“Derivatives means forward, futures or options contracts of predetermined fixed
duration, linked for the purpose of contract fulfillment to the value of specified real or
financial asset or to an index security”.
HistoryDerivatives have probably existed ever since people have been trading with another.
Forward contracting dates back at list to the twelth century and may well have been around
before then. However the development and growth of the derivatives products has been one
of the most extraordinary things to happen in the financial markets place. In 1972, the
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Bretton Woods agreement, the post-war pact that instituted a fixed exchange rate regime to
the worlds major nations, effectively collapsed, when the US suspended the dollar
convertibility into the gold. This resulted in exchange rate volatility derivative products
have come quite handy. They have established themselves as irreplaceable tools to hedge
against risks in currency, stock and commodity markets.
The history of the derivatives can be traced to the Middle Ages when formers and
traders in gains and other agriculture products used certain specific types of futures and
forwards to hedge, their risks. Essentially the former wants to ensure that he receives a
reasonable price for the grain that he would harvest (say) three to four months later. An
oversupply will hurt him badly. For the grain merchant, the opposite is true. A fall in the
agricultural production will push up the prices. It made sense therefore for the both of them
to fix a price for the future. This was now the future market first developed in agricultural
commodities such as cotton, coffee, petroleum, Soya bean, sugar and then to financial
products such at interest rates, foreign exchange and shares. In 1995 the Chicago Board of
Trade commenced trading in derivatives.
The need for a derivatives market The derivatives market performs a number of economic functions:
1. They help in transferring risks from risk adverse people to risk oriented people.
2. They help in the discovery of future as well as current prices.
3. They catalyze entrepreneurial activity.
4. They increase the volume traded in markets because of participation of risk adverse
people in greater numbers.
5. They increase savings and investment in the long run.
Stock options and stock futures were introduced in both the exchange in the year 2001.
Thus started trading in derivatives in India stock exchanges (both BSE & NSE) covering
index options, index futures, stock options and futures at in the wake of the new
millennium. In a short span of three years the volume traded in the derivative market has
outstripped the turnover of the cash market.
Functions of derivatives
Risk transfer Derivative products allow splitting of economic risks into smaller units
and transfer risk, derivatives thus facilitate the allocation of risk. Derivatives redistribute
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the risk between market players and are useful in risk management. Derivative instrument
do not involve any risk on themselves.
Essentially derivative market delivers three basic functions Hedging,
Speculation and Arbitrage. Hedgers transfer risk to another market participant Speculators
takes un-hedged risk positions so as to exploit information inefficiencies or take advantage
of risk capacity. Arbitrageurs take position mispriced instruments in order to earn risk less
return.
The economic functions of these activities are quite different.
1. Hedging and speculation generates information about the pricing of risks.
2. While arbitrages creates a consistent price systems.
Uses of derivatives
There can be a variety of uses of derivatives.
Example: A manufacture has received order for supply of his products after six months.
Price of the product has been fixed. Production of goods will have to start after four
months. He fears that, in case the price of raw material goes up in the meanwhile, he will
suffer a loss on the order. To protect himself against the possible risk, he buys the raw
material in the futures market for delivery and payment after four months at an agreed
price, say,Rs.100 per unit.
In the above example, at the end of the one year, ruling price may be more than
Rs.100 or less than Rs.100. If the price is higher (sayRs.125), the buyers is gainer for the
pays Rs.100 and gets shares worth Rs.125, and the seller is the loser for he gets Rs.100 for
shares worth Rs.125 at the time of delivery. On the other hand, in case the price is lower
(say Rs.75), the purchaser is loser, and the seller is the gainer. There is the method to cut a
part of such loss by buying a “futures” contract with an “option”, on payments of fee.
From the above example it is clear that one’s gain is another’s loss. That is why
derivatives are a ‘zero sum game’. The mechanism helps in distribution of risks among the
market players.
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Dr. L. C. Gupta Committee recommendations
The securities and exchange board of India (SEBI) appointed with Dr.L.C.Gupta as its
chairman on 18th November, 1996 to develop regulatory frame work for derivatives trading
in India and to suggest buy-laws for regulation and control of trading and settlement of
derivatives contracts. The committee was also to focus on the financial derivatives and
equity derivatives. The committee submitted its report in March 1998.
The committee recommended introduction of derivatives market in a phased
manner with the introduction of index futures and SEBI appointed a group with Prof.J.R.
Varma as its chairman to recommended measures for risk containment in the derivative
market in India.
The board of SEBI in its meeting held on may 11, 1998 accepted the
recommendation and approved the introduction of derivatives trading in India beginning
with stock index futures. The board also approved the “suggestive bye-laws” recommended
by the L.C.Gupta committee for regulation and control of trading and settlement of
derivatives contracts. SEBI circulated the contents of the report in June 1998.
The L.C.Gupta committee had conducted a wide market survey with contract of several
entities relevant to derivatives trading like brokers, mutual funds, banks/FIIs, FIIs and
merchant banks. The committee observation was that there is widespread recognition of the
needs for derivatives products including equity, interest rate and currency derivatives
products. However stock index future is the most preferred product followed by stock index
options. Options on individual stocks are the third I the order of preference. The
participants took interviews, mostly stated that their objective in derivative trading would
be hedging. But there were also a few interested in derivatives dealing for speculation or
dealing.
The recommendations of L.C.Gupta committee at a glance1. Stock index futures to be the starting point of equity derivatives.
2. SEBI to approve rules, buy-laws and regulations of the derivatives exchange level
regulations.
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3. SEBI need not be involved in framing exchange level regulations.
4. SEBI should create a special derivatives cell as it involves special knowledge and a
derivatives advisory council may be created a tap outside exports for independent
advice.
5. Legal restrictions on institutions, including mutual funds, on use of derivatives should
be removed.
6. Existing stock exchanges with cash trading to be allowed to trade derivatives if they
meet prescribed eligibility conditions-importantly a separate governing council and at
least 50 members.
7. Two categories of members – clearing members and non clearing members, with the
later depending on the former for settlement of trades. This is to bring in more traders.
8. Broker members, dealers and salespersons in the derivatives market must have passed a
certificate program to be registered with SEBI.
9. Co-ordination between SEBI and the RBI of financial derivatives market must have
passed a certificate program registered with the SEBI.
10. Clearing corporation to be the centre piece of the derivative market, both for
implementing the margin systems and providing trade guarantee.
11. Minimum net worth requirement of Rs.3 crore for participants, maximum exposure
limits for each broker/dealer on gross basis and capital adequacy requirement to be
prescribed.
12. Mark to market margins to be collected before next day’s trading starts.
13. As a conservative measure, margins for derivatives purposes not to take into account
positions in cash and futures, market and across all stock exchanges.
14. Margin to be systematically collected and not left to discretion of brokers/dealers.
15. Much stricter regulation for derivatives as compared to cash trading.
16. Strengthen cash market with uniform settlement cycles among all SEs and regulatory
over weight.
17. Proper supervision of sales practices withy regulation of every client with the
dealer/broker and risk disclosure as the corner stone.
SEBI-RBI co-ordination mechanism
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As all the three types of financial derivatives are set to emerge in India in the near
future, it is desirable that such development be coordinated. The committee recommends
that a formal mechanism be established for such coordination between SEBI and RBI in
respect of all financial derivatives markets. This will help to avoid the problem of
overlapping jurisdictions.
Derivatives exchangeThe committee strongly favored the introduction financial derivatives to facilitate
hedging in most cost-efficient way against market risk. There is a need for equity
derivatives, interest rate derivative and currency derivatives; there should be phased
introduction of derivatives products. To start with, index future to be introduced, which
should be followed by options on index and later options on stocks.
The derivative trading should take place on separate segment of the existing stock
exchanges with an independent governing council where the number of trading members
should be limited to 40 percent of the total number. Trading to be based on online screen
trading with disaster recovery site. Per half hour capacity should 4-5 times the anticipated
peck load. Percentage of broker-member in the council to be prescribed by the SEBI.
The settlement of derivatives to be through an independent clearing
corporate/clearing house, which should become counter party for all trades or alternatively
guarantee the settlement of all the trades. The clearing corporation to have adequate risk
containment measures and to collect margins through EFT. The derivative exchange to
have both online trading and surveillance system. It should disseminate trade and price
information on real time basis through two information vending networks. The committee
recommended separate membership for derivatives segment.
Regulatory frameworkRegulatory control should envisage systems for full proof regulation. Regulatory
framework for derivatives trading envisaged two-level regulation i.e. exchange-level and
SEBI-level, with considerable emphasis on self-regulatory competence of derivative
exchanges under the overall supervision and guidance of SEBI.
Regulatory role of SEBI
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SEBI will approve rules, buy-laws and regulations. New derivative contracts to be
approved by SEBI. Derivative exchanges to provide full details of proposed contract, like
economic purposes of the contract; likely contribution to the market’s development;
safeguards incorporated for investor protection and fair trading.
Market to Market settlementThere should the system of daily settlement of futures contracts. Similarly the
closing price of futures to be settled on daily basis. The final settlement price to be as per
the closing price of underlying security.
Sales practices1. Risk disclosure document with each client mandatory.
2. Sales person to pass certification exam.
3. Specific authorization from client’s board of directors/trustees.
Trading parameters1. Each order- buy/sell and open/close
2. Unique order identification number
3. Regular market lot size, tick size
4. Gross exposure limits to be specified
5. Price bands for, each derivative contract
6. Maximum permissible open position
7. Off line order entry permitted
Brokerage 1. Prices on the system shall be exclusive of brokerage
2. Maximum brokerage rates shall be prescribed by the exchange
3. Brokerage to be separately indicated in the contracts note
Margins from Clients1. Margins to be collected from all clients/trading members
2. Daily margins to be further collected
3. Losses if any to be charged clients/TMs and adjusted against margins
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Other recommendations1. Removal of regulatory prohibition on the use of derivative by mutual funds while
making the trustees responsible to restrict the use of derivatives by mutual funds
only to hedging and portfolio balancing and not for speculation.
2. Creation of derivative cell, a derivative advisory committee, and economic research
wing by SEBI.
Derivatives MarketThere are two types of derivative market:
1. Exchanged based market.
2. Over the counter (OTC) markets.
Exchanged based market and clearing housesThese markets are developed, highly organized and regulated by their own owners
who are usually traders. It is the exchange with decides on the
1. Standard units – currency, size maturity to be traded and the times when trading begin
and cease each day.
2. Rules of the clearing house through which all deals are routed.
3. Margin requirements that all members have to deposit with the clearing house to ensure
that the default is unlikely.
Mechanics of the markets
Example: In S&P 500 stock index futures contracts are tied to the standard and
Poor’s composite stock index. The futures have standard maturity and the exchange
prescribes rules for settlement of any outstanding contracts in cash on the expiration dates.
In contrast, OTC derivatives are customized to meet the specific needs of the counterparty.
A financial swap is a good example of OTC derivative.
An important difference between exchange traded and OTC derivative is the credit
risk. In the OTC markets, one party is exposed to the risk that his counterparty may default
on the contract. In case of default there will be need to replace the counterparty that is also
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knows as replacement risk. The risk becomes insignificant in case of exchange-traded
derivatives.
Market participants in DERIVATIVES
Derivatives markets are essential frequented by three kinds of hedgers, speculators
and arbitrageurs. Traders who are exposed to market risk by virtue of their long/short
position under foreign currency; stocks, commodities, etc. visit derivatives market
primarily as hedgers. They are basically interested in reducing a risk that they already face.
The other category of visitors to derivatives markets in speculators. They bet that
the price of the stock or a currency will go up or will go down. Speculators can use all the
three products namely forward contracts, futures and options to take a position in the
market. A speculator who thinks that the price of Reliance share will rise can speculate by
taking a long position on Reliance option say @Rs.300, expiry three months. If on the date
of expiry, the price of Reliance is proved to be Rs.350, the speculator with a long position
can take delivery of reliance at Rs.300 and sell it at the market price of Rs.350. thus he will
realize a gain of Rs.50 per share. If reverse happens, his are marginal for all that he would
be losing is only the option premium paid upfront.
The third category of market participants is arbitrageurs. They usually lock into a
risk-less profit by entering simultaneously into transactions in two or more markets.
Consider Infosys is treated in both New York and Mumbai exchanges and suppose the
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stock price is Rs.2000 in Mumbai stock exchange and US $42 in New York stock exchange
and the dollar exchange rate is Rs.50. an arbitrageur would then jump to buy 100 shares in
Mumbai stock exchange and sell them in New York stock exchange @42 dollars per share
to make a risk free profit of Rs.10000 provided such transactions are permitted.
A wide range of participants uses derivatives instruments, such as individual
investors, institutional investors, treasury departments, banks and other financial
intermediaries, securities traders etc.
Indian derivatives market Indian derivatives market, through has a history of more than a century, is still in its
nascent stage vis-à-vis global derivatives market.
The first step towards development of derivatives markets in India is the
appointment of L.C.Gupta committee by SEBI to go into the question of derivatives trading
and to suggest various policy and regulatory measures that need to be undertaken before
such trading is formally allowed. We have today active derivative markets in the segment
of stock and foreign currency while trading in commodities is in the process of
stabilization. Stock market derivative have indeed picked up momentum and the volumes
under futures on individual stock have reached global proportions. We have also well
established OTC currency derivatives market. In a net shall we may say that derivatives
market in India an evolving phase.
Derivatives products
Derivatives are in fact as old as trading but their dramatic rise in popularly took
place in the last thirty years. The break down of Bretton woods system of fixed exchange
rates and the resulting volatility in forex markets put the derivative on a pedestal. The key
reason for their popularly has been that derivatives such as futures and options have indeed
filed a gape in the financial system. Prier to their emergence, there was no mechanism for
that could protect to trades, banks, etc, from price risk. Secondly, they are highly flexible
and thus have a universal applicability. For instance, stock market index futures provide
insurance against stock price risk due to market fluctuations, while currency futures
provide insurance against price risk due to exchange rate fluctuations.
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All derivatives can be classified based on the following features
1. Nature of contracts
2. Underlying assets
3. Market mechanism
Nature of contract based on the nature of contract, derivatives can be classified into
three categories:
1. Forward rate contract and futures
2. Options
3. Swaps
Underlying assets Most derivatives are based on one of the following four types of
assets:
1. Foreign exchange
2. Interest being financial assets
3. Commodities (grain, coffee, cotton, wool, etc.)
4. Equities
5. Precious metals (gold, silver, copper, etc.)
6. Bonds of all types
Market mechanism1. OTC products
2. Exchange traded products
Role of clearing houseA clearing house is a key institution in the derivatives market. It performs two
critical functions. Offering customer’s deals and assuring the financial integrity of the
transactions that take place in the exchange. The clearing house could be a part of the
exchange of a separate body coordinating with the exchange.
Trading in derivativesIndian securities markets have indeed waited for too long for derivatives trading to
emerge. Mutual funds, FIIs, and other investors who are deprived of hedging opportunities
will now have a derivatives market to bank on. First to change are the globally popular
variety – index futures.
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While derivatives markets flourished in the developed world Indian markets remain
deprived of financial derivatives to the beginning of this millennium. While the rest of the
world progressed by the leaps and the bonds on the derivatives front, Indian market lagged
behind. Having emerged in the market of the developed nations in the 1970s, derivatives
market grew from strength to strength. The trading volumes nearly doubled in every three
years making it a trillion-dollar business. They become so ubiquitous that, now one cannot
think of the existence of financial markets without derivatives.
Two board approaches of SEBI is to integrate the securities market at the national
level, and also to diversify the trading banks, financial institutions, insurance companies,
mutual funds, primary dealers etc, choose to transact through the exchanges. In this context
the introduction of derivatives trading through Indian stock exchanges permitted by SEBI
in 2000 AD is real landmark.
SEBI first appointed the L.C.Gupta committee in 1998, to recommend the
regulatory frame work for derivatives recommended suggestive buy-laws for regulation and
control of trading and settlements of derivatives contracts. The board of SEBI in its
meeting held on May 11, 1998 accepted the recommendations of the Dr.L.C.Gupta,
committee and approved the phased introduction of derivatives trading in India beginning
with stock index futures. The board also approved the “suggestive Bye-laws”
recommended by the committee for regulation and control of trading and settlement of
derivatives contracts.
SEBI subsequently the J.R.Varma committee to recommended risk containment
measures in the Indian stock index futures market. The report was submitted in the same
year (1998) in the month of November by the said committee.
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2.2 Types of derivatives
There are four most commonly traded derivative instruments: Forwards, Futures,
Options, and Swaps. Futures and options are actively traded on many exchanges. Forward
contracts and swaps and certain kind of options are mostly traded as over the counter
(OTC) products.
FORWARDS
A forwards contract is a customized contract between two parties, where settlement takes
place on a specific date in the future 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 at a certain price.
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.
DERIVATIVES
OPTIONS FUTURES SWAPS FORWADS
INREST RATE CURRENCYCOMMODITY SECURITYPUT OPTION CALL OPTION
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SWAPS
Swaps are private between two parties to exchange cash flows in the future according to
prearranged formula. They can be regarded as portfolios of forward contracts. The two
commonly used Swaps are:
2.3 FUTURES A financial future is an agreement between two parties to buy or sell a standard quantity of
a specific asset at a future date at a price agreed between the parties through an open outcry
on the floor of an organized futures exchange. The underlying asset could as well be a
commodity such as gold, crude oil, stock market index, individual stocks, interest rates, etc.
the futures contracts are standardized in terms of quantity of underlying, quality of
underlying, the date and month of delivery, the units of the price quotation and minimum
change in price and location of settlement.
Definition of 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.
Futures are considered to be a better when compared to forward because of the
following reasons:
1. Standard volume
2. Liquidity
3. Counterparty guarantee by exchange
4. Intermediate cash flows
Organized exchanges
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Futures are traded on organized exchanges with a designated physical location
where trading takes place. This provides a ready liquid market.
Standardization
Amount of the commodity to be delivered and the maturity date are
standardized by the exchange on which the contract is traded.
Clearing House On the trading floor of the future exchange, a future contract is agreed upon
between two parties A and B is replaced by the two contract one between A and the
clearing house and the other between the B and the clearing house.
The exchange interposes itself in every deal as a buyer to every seller and as a
seller to every buyer. This guarantees all the transactions routed through the exchange. The
clearing house protects itself from the counterparty default from imposing margin
requirements on traders.
The clearing house may subsidiary of the exchange itself or an independent
corporation.
Margins Only members of exchange can trade in futures on the exchange. A sub-set of
exchange members are “clearing members” i.e. members of the clearing house when the
clearing house is a subsidiary of the exchange. Every transaction is thus between an
exchange member and the exchange clearing house.
Since the clearing house assumes the credit risk in futures transactions, it demands
a performance bond in the form of margin to be deposited with the clearing house by each
member, who enters into the futures commitment. The amount of margin is fixed by the
exchange and it has to be complied with. The compliance could be in the form of cash or
securities such as treasury bills etc.
Market to market At the end of the trading session, all outstanding contracts are reprised by the
clearing corporation the settlement price of that session. Margin accounts of those, who
made losses, are debited and those who gained are credited.
Example
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A trader shyam bought on 2nd December, 2002 single stock futures contract of NSE
on ACC at Rs.162, expiry date being 26th December, 2002. Suppose next day, the price on
the futures contract on ACC increases and at the end of the trading session on 3rd December
the settlement price is Rs.163. It means, shyam the trader who bought futures on ACC
made a profit of Rs.1 (as 163-162=1 and obviously, some one with the corresponding short
position lost a matching amount). This gain is credited to the margin amount of shyam
and contract is reprised at Rs.163. shyam can immediately withdraw this gain. Suppose the
reverse happens, the loss is debited to margin account and a demand is made on shyam to
make good the loss is debited to the margin account by a fresh credit.
Trading process Futures contracts are traded by a system of open-outcry on the trading floor of a
centralized and regulated exchange. The exchange member can alone take part in the
trading. Members, who trade for their own account, are called as “Floor traders” and who
trade on behalf of others, are called as “Floor brokers” while those, who trade for both are
known as “Dual traders”.
A buyer of traders in terms of negotiated price and the member of contracts
acquire a long position while the seller requires short positions.
Owing to losses, if the margin account falls below a certain level viz.,
“maintenance” margin, the trader is served with a ‘margin sell” and the trader has to
deposit the required money to bring the margin back to maintenance level within the
specific time.
If the trader fails to do so, his position to be liquidated immediately, so as to
limit the losses, the exchange or the broker may have to incur, to almost a day’s price
change.
In future market, actual derivatives are very uncommon as most of the contract is
extinguished by entering into a matching contract in the opposite direction.
However those, who have not liquidated their contracts by the end of the
‘declared last trading day’, are obliged to make or accept delivery.
TYPES OF FUTURES
1. Commodity futures
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A future contract where the underlying asset is a commodity is referred to as a
commodity futures contract.
Evolution of commodity futuresTraders in response to the burden that volatile prices create developed price risk
instrument. Contracts, which enabled the improved management of price risk, have become
a fixture of commodity markets since sixteenth century when forward delivery contracts for
gains were first developed.
In the seventeenth century the first option appeared, fixing a price for future
delivery without the obligation of the buyer to actually take possession of the goods.
Tradable forward contracts become important after the late seventeenth century. Most of
these transactions are what is now called ‘over the counter’ i.e. directly between to parties.
While these instruments reduced the price risk, they created a new source of risk.
In the mid-nineteenth century, futures market developed an effective means of
managing price and overcoming counterparty risk. Trades in these “tradable” forward
contracts become centralized in organized commodity futures exchanges, where contract
performances were guaranteed by a clearing house collecting margins.
The first future was established in 1848, was the Chicago Board of Trade. At the end of the
nineteenth century, futures contracts in commodities such as Grains, Arabica, Coffee,
Cotton, Silver and Tin were already being traded. By the early 1980s active commodity
futures exchanges existed in Australia, Canada, France, Japan, Malaysia, New Zealand, the
United Kingdom, United States of America and India.
2. Interest Rate FuturesIn the century futures the underlying asset for the futures contract will be different
currencies and in case of interest rate futures the underlying asset will be different interest
bearing instruments like T-bills, T-bonds, deposits, etc.
Interest rate futures can be defined as follows
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“An interest rate futures contract is an agreement to buy or sell a standard quantity
of specific interest bearing instruments, at a predetermined future date and at a price agreed
upon between the parties”.
It is known fact that money lenders stand to loss if the interest rates go down in the
future and the borrowers stand to loss if the interest go up in the future. The dislike of those
two sections of society to uncertainty in interest rate fluctuations has led to the innovations
of techniques to hedge such risks. Interest rate futures are one such method of doing the
same.
The main factors behind the growth rate of interest future are as follows
1. Enormous growth of the market for fixed income securities
2. Increased fluctuations in interest rate worldwide
Interest rate futures can be based upon both short-term (less than one year) and long term
debt obligation (more than one year).
3. Index futuresThe trading in index-based futures has commenced in June 2000
An index is representative of a set and is generally the indicator of the status of the
set. In a stock market context, index is an indicator of the broad market. For, instance by
tracking the changes of the BSE-sensex, one can effectively gauge stock market moods in
India.
An index futures contract is basically an obligation to the deliver at settlement, an
amount equal to ‘X’ times the difference between the stock index value on the expiration
date of the contract and the price at which the contract was originally struck. The value of
‘X’, which is referred to as the multiple is predetermined for the each market index.
Example futures contract on S&P 200 stock index use a multiple of 250 while the futures
contract on BSE-sensex use a multiple of 50. stock index futures are based on complex
cash instruments.
The first index futures contract was first introduced in 1982 at the Kansas City
Board of Trade and today, index futures are one of the most popular types of futures as far
as trading is concerned.
The most actively traded stock index contract is the S&P 500 of the Chicago
Mercantile Exchange. The silent features of the index futures contracts are as follows:
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1. These contracts are cash settled; there is usually no delivery of the underlying stock or
stock certificates, as matching the physical stocks as per the index may be quite
difficult and costlier than setting the contract by cash.
2. An investor can either buy or sell an index futures contract. When an investor goes long
in the index futures contract, he will receive a cash settlement on the expiration date, if
the closing price exceeds the contract price. On the other hand, if the closing price is
less than the contract price, the investor will be required to pay the difference.
Example If the investor has bought the S&P 500 index futures at 350 and on the expiration
day the value of the contract is 360, the investor will receive $5000 [(360-350)*500]. On
the other hand if the index closes at 340, on the expiration date the buyer will be required to
the difference of $5000.
3. Since the index futures contract are listed and traded on futures exchanges,
investors can off set his position on any day prior to the expiration day.
Example An investor who has gone long on an index futures contract can offset his
position by going short on the contract and vice versa.
4. The performance of the all index futures contracts is guaranteed by the exchanges
clearing.
The index future curry the margin requirements which are applicable to the both the buyer and the seller. The purpose of maintaining margin money is to minimizethe risk of default by either party.
PAY-OFF FOR A BUYER OF FUTURES
33
CASE 1 The buyers bought the futures contract at (F); if the futures Price Goes to E1 then the buyer gets the profit of (FP).
CASE 2 The buyers gets loss when the futures price less then (F); if
The Futures price goes to E2 then the buyer the loss of (FL).
PAY-OFF FOR A SELLER OF FUTURES
LOSS
PROFIT
F
L
P
E1
E2
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F = FUTURES PRICE
E1, E2 = SATTLEMENT PRICE
CASE 1 The seller sold the future contract at (F); if the future goes to
E1 Then the seller gets the profit of (FP).
CASE 2The seller gets loss when the future price goes greater than (F);
If the future price goes to E2 then the seller get the loss of (FL).
PRICING OF FUTURES
Pricing of futures contract is very simple. Using the cost-of-carry logic, we calculate the
fair value of a future contract. Every time the observed price deviates from the fair value,
arbitragers would enter into trades to captures the arbitrage profit. This in turn would push
the futures price back to its fair value. The cost of carry model used for pricing futures is
given below.
F
LOSS
PROFIT
E1
P
E2
L
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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
Where: F = Futures price
S = Spot price of the underlying
r = Cost of financing (or) interest Rate
q = Expected dividend yield
t = Holding Period
2.4 OPTIONS
An option gives its owner the right to buy or sell an underlying asset at a future
date. This can be done at the price specified in the option contract. But one can use it only
if the option contract price is favorable to him. If the price trend is unfavorable, he need not
exercise the option. Instead he can go and buy or sell the asset in the market at a price
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better than the option contract price. This means an option holder has a right but not the
obligation to exercise the contract.
Options are first traded in 1973 on an organized exchange and are now traded on
exchanges, by banks and financial institutions. The underlying asset in options includes
stocks, stock indices, foreign currencies, debt instruments, commodities and future
contracts.
Options are available on many traditional products such as equities, stock indices
commodities and foreign exchange interest rates, etc. foreign exchange markets are
particularly suited to the use of options as they have traditionally been very volatile. The
holder of an option has the right, but not obligation, to buy or sell the underlying asset at
the fixed rate (strike price) on a date in the future. The quantity of underlying asset, rate
and date are all predetermined.
Unlike under a forward contract or futures contract where the holder is obliged to buy
or sell the underlying asset, the option gives the buyer of the contract or buyer has a right to
do something and he does not have to necessarily exercise that right. As against this the
writer or seller of the option is obligated upon to honor the commitments as per the terms
of the contract should the buyer exercise it. Obviously, a buyer has to pay a cost, usually
referred to as “premium” to acquire such a right.
SEBI has permitted option trading in Indian capital market securities in the year 2001;
both buy way of trading in stock options and also index options. Options are currently
traded on the Mumbai stock exchange (BSE) and National Stock Exchange (NSE). Like
trading in stocks, options trading are regulated by SEBI. These exchanges seek to provide
competitive, liquid and orderly markets for the purpose and sale of standardized options.
Options are an important element of investing in markets, serving a function of
managing risk and generating income. Unlike the most other types of investments today,
options provide a unique set of benefits. Not only does option trading provide a chip a
defective means of hedging one’s portfolio against adverse and unexpected price
fluctuations, but it also offers a tremendous speculative dimension to trading.
GENERAL FEATURES OF OPTIONSOptions are traded both on exchanges and in the over-the-counter market. There
are two basic types of options. A call option gives the holder the right to buy the
underlying asset by a certain date for a certain price. A put option gives the holder the
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right to sell the underlying asset by a certain date in the contract is known as the expiration
date or maturity. American options can be exercised at any time up to the expiration
date. European options can be exercised only on the expiration dare itself. Most of the
options that are traded on exchanges are American. In the exchange-traded equity options
market, one contract is usually an agreement to buy or sell 100 shares. European options
are generally easier to analyze than American option are frequently deduced from those of
its European counterpart.
It should be emphasized that an option gives the holder the right to do something.
The holder does not have to exercise this right. This is what distinguishes options from
forwards and futures, where the holder is obligated to buy or sell the underlying asset. Note
that whereas it costs nothing to enter into a forward or futures contract, there is a cost to
acquiring an option.
In options markets, the exercise (strike or striking) price means the price
at which the option holder can buy and/or sell the underlying asset. If the current price of
the underlying asset exceeds the exercise price of a call option, the call is said to be in the
money. Similarly, if the current piece of the underlying asset is less than the exercise price
of a call option, it is said to be out of the money. The near the money call options are
those whose exercise price is slightly greater than current market price of the asset.
Premium is the price paid by the buyer to the seller of the option, whether put or call. A
call option when it is written against the asset owned by the option writer is called a
covered option, and the one written without owning the asset is called naked option.
Option contract illustrated:
On March 1, 2003, ‘A’ sells a call option (right to buy) on “INFOSYS”. To ‘B’ for
a price of say Rs. 300. Now ‘B’ has the right to approach ‘A’ on march 31, 2003 and he
buy 1 share of “INFOSYS” at Rs. 5000. Here:
‘B’ may find it worthwhile to exercise his right to buy only if “INFOSYS Ltd”.
Trades above Rs. 5000. If ‘B’ exercises his option, A has to necessary sell ‘B’ one share of
“INFOSYS”. At Rs. 5000 on March 31, 2003. So if the price “INFOSYS” goes above Rs.
5000 ‘B’ may exercise this option, or else the option, or else the option may lapse. Then
‘B’ loses the original option price of Rs. 300 and ‘A’ as gained it.
Basic Terms used in Option Trading Explained:
Option premium or option price:
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The buyer pays to the seller (sometimes called the writer) of the option, a fee for acquiring
the right to say or sell the underlying, known as premium. It represents the maximum that
can be lost by the buyer and the maximum profit available to the seller of the option.
In the above transaction Rs. 300 is called is the option price or option premium. In the
trading of the options, the holder (buyer) of the options is enjoying the right to buy/sell
while the writer (seller) is obliged to sell/buy depending of the action of the holder.
Exercise Price or Strike Price:
Exercise
If the option buyer decides to take delivery of the underlying asset say Example, foreign
exchange, the most notify the seller of his decision by exercising his right to delivery. This
exercise is effectively the collection of option and the resultant creation of foreign
exchange transaction, value spot. Options that are not exercised expire worthless.
Strike
It is also known as the strike or striking price. This is determined rate of exchange at which
the underlying asset is to be exchanged the option is exercisable.
Strike is usually chosen at a level close the current spot or forward rate (if available as in
the case of forex-market) of the underlying asset or at any reasonable level as perceived by
the parties. Rs. 5000 is the exercise price or strike price in the above example.
The strike price is the price at which an option can be exercised. For instance,
assume that you hold a European option on INFOSYS Company for one share. The strike
price is fixed at Rs. 5000 and the expiration date is 31st march 2003. If the prevailing
market price is say Rs. 5500, then you can exercise your option on the 31st march and buy
one share of INFOSYS for Rs. 5000.
Expiration Date:
In illustration referred above March 31st, 2003 is the expiration date i.e. the date on
which the option expires. Option quoted in exchange includes the date and the month on
which the option can exercise. This is called the expiration date.
Contract cycle:
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The period over which the contract trades. The futures and option contract at NSE
have one month, two months and three months expiry cycles. The contracts expire on the
last Tuesday of the corresponding month.
Basis:
Basis is defined as the future price minus the spot price. In most of the times basis
shall be positive, which reflect that futures price normally exceeds spot price.
Covered & Naked Calls:
A call option position that is covered by an opposite position in the underlying
instrument (Example shares, commodities etc.) is called a covered call. Writing covered
calls involves writing call options when the shares that might have to be delivered (if
position holder exercises his right to buy), are already owned. E.g. writer writes a call on
Reliance and at the same time holds share of Reliance so that if the call is exercised by the
buyer, he can deliver the stock. Covered calls are far less risky than naked calls (where is
no opposite position in the underlying), since the most can happen is that the investor is
required to sell shares already owned at below their market value. When a physical delivery
uncovered/naked call is assigned a exercise, the writer will have to purchase the underlying
asset to meet his call obligation and his loss will be the excess of the purchase price over
the exercise price of the call reduced by the premium received for writing the call.
Intrinsic Value of Option:
The intrinsic value of an option is defined as the amount by which an option is in
the money or the immediate exercise value of the option when the underlying position is
marked-to-market.
For a call option: Intrinsic value = Spot price-Strike price
For a put option: Intrinsic value = Strike price-Spot price
The intrinsic value of an option must be a positive number or 0. if can’t be negative.
Option Holder:
Is the one who buys an option, which can be a call or a put option. He enjoys the
right to buy or sell the underlying asset at a specified price on or before specified time.
Cash-Settled Options:
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This gives the owner the right to receive a cash payment based on the difference
between a determined value of the underlying at the time of exercise and the fixed exercise
price of the option, Nifty options shall be cash settled.
Example: a bought Nifty November call at a strike price of 1400. On expiration of
November options, the expiration level was 1430. The cash settlement will be 30 per Nifty
and for one contract, Rs.6000 (that is, 30x200, is the minimum contract size).
Cash settled options are those where, on exercise the buyers is paid the difference
between stock price and exercise price (call) or between exercise price and stock price
(put). Delivery settles options are those where the buyer takes delivery of undertaking
(calls) or offers delivery of the undertaking (puts).
Call Option & Put Option
1. Call Option:A call option gives the right but not the obligation to buy the underlying
asset at a specific price. Since the initial cash flow to buy the option is comparatively small,
investor bullish on the asset (can be a stock or any other asset for that matter) can use call
option to maximize the returns by buying into the product. Further, even in the case of the
asset moving the other way, the maximum loss for the investor is only the premium he has
paid.
Example: an investor buys one European call option on Infosys at the strike price
of Rs. 5000 at a premium of Rs. 300. if the market price of Infosys on the day of expiry is
more than Rs. 5000, the option will be exercised. The investors will earn profits once the
share price crosses Rs. 5300, (strike price + premium i.e. 5000+300). Suppose stock price
is Rs. 5800, the option will be exercised and the investor will buy 1 share of Infosys from
the seller of the option at Rs. 5000 and sell it in the market at Rs. 5800 making a profit of
Rs. 500 [(spot price – strike price )-premium].
In another scenario, if at the time of expiry stock price falls below Rs. 5000 say
suppose it touches Rs. 4800, the buyer of the call option will choose not to exercise to his
option. In this case the investor losses the premium (Rs. 300), paid which should be the
profit earned by the seller of the call option.
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Example: Shyam, purchase a call option on ACC at a strike of R. 150 exercisable
on December 26th 2004 by paying the specified premium to the seller. On 26th December
2004 Shyam observes that the price of ACC in the cash market is Rs. 155. The option is
than obviously, worth exercising therefore, Shyam exercise the option and demands for
delivery of ACC shares. Excluding the premium, paid upfront by Shyam, the pay off from
the option is:
Spot price of ACC = Rs. 155.00
Exercise price of ACC = Rs. 150.00
Pay off = Rs. 5.00
The net gain under this call option is:
Pay off = Rs. 5.00
Less: Premium = Rs. 1.00
Net gain = Rs.4.00
On the other hand if the price of ACC on the maturity dates of the option is Rs.143,
the option has finished out of the money and thus it becomes worthless. The payoff is zero.
Therefore, Shyam will not exercise the option and he goes to the cash market and purchase
ACC shares @ Rs. 145.
Illustration 1:
An investor buys one European call option on one share of Reliance petroleum at a
premium of Rs. 2 per share on 31st July. Then strike price is Rs. 60 and the contract matures
on 30th September. The pay off for the investor by the basis of fluctuating spot prices at any
time is shown by the pay off table (table 1). It may be clear on the graph that even in the
worst case scenario; the investor would only lose a maximum of Rs. 2 per share, which
he/she had paid for the premium. The upside to it has an unlimited profits opportunity.
On the other hand the seller of the call option has a payoff chart completely reverse
of the call option buyer. The maximum loss that he can have is unlimited though the buyer
would make a profit of Rs. 2 per share on the premium payment.
Payoff from Call Buying/long (Rs)
42
S Xt C Payoff Net Profit
57 60 2 0 -2
58 60 2 0 -2
59 60 2 0 -2
60 60 2 0 -2
61 60 2 1 -1
62 60 2 2 0
63 60 2 3 1
64 60 2 4 2
65 60 2 5 3
66 60 2 6 4
A European call option gives the following payoff to the investor.
Max (S-Xt, 0). The seller gets a payoff of: max (S-Xt, 0) or min (Xt-S, 0).
Notes:
S - Stock price
Xt - Exercise price at time‘t’
C - European Call option premium
Payoff – Max (S-Xt, 0)
Payoff from Call Buying/long
Net profit - Payoff minus ‘C’
Exercising the Call Option and its implications for the buyer and the seller:
The Call Option gives the buyer a right to buy the requisite shares on a specific
price. This puts the seller under the obligation to sell the shares on that specific price. The
Call buyer exercises his option only when he/she felt it is profitable. This process is called
“exercising the option”.
The implications for a buyer are that it is his/her decision whether to exercise the
option or not. In case the investor expects prices to rise for above the strike price in the
future then he/she would surely be interested in buying call options. On the other hand, if
the seller feels that his shares are not giving to perform any better in the future, a premium
can be charged and returns from the selling the call option can be used to make up for the
desired returns.
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PAY-OFF PROFILE FOR BUYER OF A CALL OPTION
]The Pay-off of a buyer options depends on a spot price of an underlying asset. The following graph shows the pay-off of buyers of a call option.
S = Strike price ITM = In the Money Sp = premium/loss ATM = At the Money E1 = Spot price 1 OTM = Out of the Money E2 = Spot price 2 SR = 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
OTM
LOSS
S
P E2
R PROFIT
ITM
ATM E1
44
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:
S = Strike price ITM = In The Money SP = Premium / profit ATM = At The money E1 = Spot Price 1 OTM = Out of the Money E2 = Spot Price 2 SR = loss at spot price E2
CASE 1: (Spot price < Strike price)As the spot price (E1) of the underlying is less than strike price (S). The seller gets the profit of (SP), if the price decreases less than E1 then also profit of the seller does not exceed (SP).
CASE 2: (Spot price > Strike price)As the spot price (E2) of the underlying asset is more than strike price (S) the Seller gets loss of (SR), if price goes more than E2 then the loss of the seller also increase more than (SR).
2. Put OptionA Put Option is the reverse of the Call Option. It gives the holder the right to sell an
asset at the predetermined price. When a put option is exercised, the holder/buyer of the
option sells the underlined asset and the writer/seller of the option has to accept it at the
pre-specified strike price.
ITM
PROFIT
E1
P
S
ATM E2
OTM
R
LOSS
45
Example: an investor buying one European put option on Reliance at the strike
price of Rs. 300, at a premium of Rs. 25. If the market price of Reliance, on the day of
expiry is less than RS.300, the option can be exercised as it is ‘in the money’. The
investor’s Break-even point is Rs. 275 (strike price – premium paid) i.e., investor’s make
earn profit if the market falls below Rs. 275. suppose stock price is Rs. 260, the buyer of
the put option immediately buys Reliance share in the market @ Rs. 260 and exercises his
option selling the Reliance share at Rs. 300 to the option writer thus making a net profit of
Rs. 15 [(strike price – spot price) – premium paid].
In other scenario, if at the time of expiry, market price of the Reliance is Rs. 320,
the buyer of the put option will choose not to exercise his option to sell a share can sell in
the market at a higher rate. In this case the investor losses the premium paid (i.e. Rs. 25),
which shall be the profit earned by the seller of the put option.
Example: Shyam, a stock market investor buys a put option from NSE for selling
BPCL shares at the strike price of Rs. 230, expiry date being 26 th December, 2002. -If
BPCL trades at Rs. 225 on 26th December, Shyam would exercise the option. He will
deliver the BPCL shares and demand for the payment @ Rs. 230 the pay off under the put
option is:
Strike price = Rs. 230.00
Current price = Rs. 225.00
In the money = Rs. 5.0
In otherwise means that excluding upfront premium, by exercising the put option, Shyam
realizes the gain of Rs. 5 per share.
On the other hand if the price of the BPCL shares at the maturity is Rs. 240, Shyam
will not exercise the option since, he can sell the same in the cash market at a price higher
than the strike price of the option. Thus the put option becomes worthless.
Illustration 2:
An investor buys one European put option on one share of Reliance petroleum at a
premium of Rs.2 per share on 31st July. The strike price is Rs.60 and the contract matures
on 30th September. The pay off table shows the fluctuations of net profit with a change in
spot price.
Payoff from put buying/long (Rs.)
S Xt P Payoff Net profit
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55 60 2 5 3
56 60 2 4 2
57 60 2 3 1
58 60 2 2 0
59 60 2 1 -1
60 60 2 0 -2
61 60 2 0 -2
62 60 2 0 -2
63 60 2 0 -2
64 60 2 0 -2
The payoff for the put buyer is: max (Xt-S, 0)
The payoff for the put writer is: max (Xt-S, 0)
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
S = Strike price ITM = In The Money SP = Premium / loss ATM = At the Money E1 = Spot price 1 OTM = Out of the Money E2 = Spot price 2 SR = Profit at spot price E1
CASE 1: (Spot price < Strike price)As the spot price (E1) of the underlying asset is less than strike price (S). The buyer gets the profit (SR), if price decreases less than E1 then profit also increases more than (SR).
CASE 2: (Spot price > Strike price)As the spot price (E2) of the underlying asset is more than strike price (S),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. The following graph shows the pay-off of seller of a put option.
PROFIT
ITM
R
E1 ATM
P LOSS
OTM
E2S
48
S= Strike price ITM = In The Money SP = Premium/profit ATM = At The Money E1 = Spot price 1 OTM = Out of the Money E2 = Spot price 2 SR = Loss at spot price E1
CASE 1: (Spot price < Strike price)As the spot price (E1) of the underlying asset is less than strike price (S), the seller gets the loss of (SR), if price decreases less than E1 than the loss also increases more than (SR).CASE 2: (Spot price > Strike price)As the spot price (E2) of the underlying asset is more than strike price (S), the seller gets profit of (SP), of price goes more than E2 than the profit of seller is limited to his premium (SP).
PRICING OF OPTIONS
LOSS
OTM
R
S
E1
P PROFIT
ITM ATM
E2
49
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 that 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 optionCA = SN (d1) – Xe- rT N (d2)
Put Option
PA = Xe- rT N (- d2) – SN (- d1)
Where d1 = ln (S/X) + (r + v 2 /2) T v√T
And d2 = d1 - v√T
Where
CA = VALUE OF CALL OPTION e = 2.71828
PA = VALUE OF PUT OPTION r = ln (1 + r)
S = SPOT PRICE OF STOCK
N = NORMAL DISTRIBUTION r = ANNUAL RISK FREE RETURN
T = CONTRACT CYCLE VARIANCE (V) = VOLATILITY
50
CHAPTER - 3
COMPANY PROFILE
51
3.1 COMPANY PROFILE
INTER-CONNECTED STOCK EXCHANGE
INTRODUCTION
Inter-connected Stock Exchange of India Limited (ISE) is a national-level stock exchange, providing trading, clearing, settlement, risk management and surveillance support to its Trading Members. It has 841 Trading Members, who are located in 131 cities spread across 25 states. These intermediaries are administratively supported through the regional offices at Delhi, Kolkata, Patna, Ahmedabad, Coimbatore and Nagpur, besides Mumbai.
ISE aims to address the needs of small companies and retail investors by harnessing the potential of regional markets, so as to transform them into a liquid and vibrant market using state-of-the art technology and networking.
ISE has floated ISE Securities & Services Limited (ISS) as a wholly-owned subsidiary under the policy formulated by the Securities and Exchange Board of India (SEBI) for “Revival of Small Stock Exchanges”. The policy enunciated by SEBI permits a stock exchange to float a subsidiary, which can take up membership of larger stock exchanges, such as the National Stock Exchange of India Limited (NSE), and Bombay Stock Exchange Limited (BSE). ISS has been registered by SEBI as a Trading-cum-Clearing Member in the Capital Market segment and Futures & Options segment of NSE and Capital Market segment of BSE. Trading Members of ISE can access NSE and BSE by registering themselves as Sub-brokers of ISS. Thus, the trading intermediaries of ISS can access other markets in addition to the ISE market. ISS, thus provides the investors in smaller cities, a one-stop solution for cost-effective and efficient trading and settlement services in securities.
Complementing the stock trading function, ISE’s depository participant (DP) services reach out to intermediaries and investors at industry-leading prices. The full suite of DP services are offered using online software, accessible through multiple connectivity modes - leased lines, VSATs and internet. Operation of the demat account by a client requires just a few mouse clicks.
The Research Cell has been established with the objective of carrying out quality research on various facets of the Indian financial system in general and the capital market in particular.
It brings out a monthly newsletter titled “NISE” and a fortnightly publication titled “V share”. The Research Cell plans to expand its activities by publishing a host of value based
52
research publications, covering a number of areas, such as equities, derivatives, bonds, mutual funds, risk management, pension funds, money markets and commodities. The ISE Training Centre conducts class-room training programmes on different subjects related to the capital market, such as equities trading and settlement, derivatives trading, day trading, arbitrage operations, technical analysis, financial planning, compliance requirement, etc. Through these courses, the training centre provides knowledge to stock brokers, sub-brokers, professionals and investors to also appear for the certificate courses conducted by the stock exchanges.
It also aims to make and build the professional careers of MBAs, post graduates and graduates, with a view to enabling them to work effectively in securities trading, risk management, financial management, corporate finance disciplines or function as intermediaries (viz. stock brokers, sub-brokers, merchant bankers, clearing bankers, etc.)
MILESTONES July 6, 1996 A report on Inter-connected Market System (ICMS) submitted to the
Federation of Indian Stock Exchange (FISE).
October 26, 1996 Steering Committee was constituted by FISE at Hyderabad.
January 4, 1997 Pricewater House Coopers,the management consultancy firm, submitted a feasibility report and recommended the establishment of ICMS.
January 22, 1998 ISE incorporated as a company limited by guarantee.
November 18, 1998 SEBI grants recognition to ISE.
February 26, 1999 Commencement of trading on ISE.
December 31, 1999 Induction of 450 Dealers commences.
January 18, 2000 Incorporation of ISS as a company limited by share capital.
February 24, 2000 SEBI registers ISS for the Capital Market segment of NSE.
May 3, 2000 Commencement of trading by ISS in the Capital Market segment of NSE.
January 10 , 2001 Turnover in the Capital Market segment of NSE crosses Rs. 1000 million per day.
February 28, 2001 Turnover of Rs. 1508.80 million recorded by ISS in the Capital Market segment of NSE.
May 4, 2001 Internet trading for clients started by ISS for the NSE segment through DotEx Plaza.
May 19, 2001 ISE’s website, www.iseindia.com, launched.
February 13, 2002 SEBI registers ISS for the Futures & Options segment of NSE.
53
May 6, 2002 ISS commences trading in the Futures & Options segment of NSE.
March 12, 2003 ISS admitted as a member of the Equities segment of BSE.
April 1, 2003 DP services through CDSL launched by ISE.
June 21, 2003 First Investor Education Program under the Securities Market Awareness Campaign (SMAC) of SEBI conducted at Vashi.
January 9, 2004 Peak turnover of Rs. 3034.90 million recorded by ISS in the Capital Market segment of NSE.
May 17, 2004 First DP branch office opened at Coimbatore by ISE.
July 17, 2004 First Investor Point opened at the Vashi Railway Station Complex by ISE.
July 24, 2004 Second DP branch opened at New Delhi by ISE.
September 3, 2004 Third DP branch opened at Kolkata by ISE.
December 27, 2004 Trading in the BSE equities segment started by ISS.
September 15, 2005 Approval of ISE’s Corporatisation and Demutualisation Scheme by SEBI.
October 20, 2005 Switchover to Direct Client Dealing commences in ISS.
November 24, 2005 ISE re-registered as a “for profit” company, limited by shares.
November 24, 2005 Board of ISE reconstituted in tune with the Corporatisation and Demutualisation provisions.
MISSION ISE shall endeavor to provide flexible and cost-effective access to multiple markets to its intermediaries across the country using the latest technology.
OBJECTIVE Create a single integrated national-level solution with access to multiple markets by
providing high cost-effective service to investors across the country. Create a liquid and vibrant national-level market for all listed companies in general
and small capital companies in particular. Optimally utilising the existing infrastructure and other resources of Participating
Stock Exchanges,which are under-utilised now. Provide a level playing field to small Trading Members by offering opportunity to
participate in a national market for investment-oriented business. Provide clearing and settlement facilities to the Trading Members across the
country at their doorstep in a decentralised mode. Spread demat trading across the country.
54
BOARD OF DIRECTORS
1. Shri S. Ravi - Public Interest Director2. Shri K. Rajendran Nair - Public Interest Director3. Shri P. J. Mathew - Managing Director4. Shri M. K. Ananda Kumar - Shareholder Director, Bangalore Stock Exchange5. Shri K. D. Gupta - Shareholder Director, Uttar Pradesh Stock Exchange6. Shri T. N. T. Nayar - Shareholder Director, Cochin Stock Exchange7. Shri P. Sivakumar - Shareholder Director, Madras Stock Exchange8. Shri Sanjeev Puri - Shareholder Director, 9. Shri Maninder Singh Grewal - Shareholder Director10. Shri Jambu Kumar Jain - Trading Member Director, Gauhati Stock Exchange11. Shri Rajiv Vohra - Trading Member Director
3.2 INDUSTRY PROFILE
HISTORY OF THE STOCK EXCHANGE The only stock exchanges operating in the 19th century were those of Bombay set up
in 1875 and Ahmedabad set up in 1894.these were organized as voluntary non profit
making organization of brokers to regulate and protect their interests. Before the controls
on securities trading become a central subject under the constitution in 1950,it was a state
55
subject and the Bombay securities contract (control) Act of 1952 used to regulate trading in
securities. Under this Act, the Bombay stock exchange in 1972 and the Ahmedabad in
1973.
During the war boom, a number of stock exchanges were organized in Bombay,
Ahmedabad and other centers, but they were not organized. Soon after it become a central
subject, central legislation proposed on a committee headed by A.D.Gorwala went into the
bill securities regulation. On the basis of committee’s recommendations and the public
discussion the securities contract (regulation) Act become law in 1956.
Definition of the stock exchange
“Stock exchange means any body or individuals whether incorporated or not,
constituted for the purpose of assisting, regulating or controlling the business of buying,
selling or dealing in securities.
It is an association of member brokers for the purpose of self regulation and
protecting the interest of its members. It can operate only if the government recognizes it.
Under the securities contract (regulation) act 1956, the recognition is granted under section
3 of the act by central finance ministry.
By-lawsBeside the above act, the securities contract (regulations) rules were also made in
1975 to regulate certain matters of trading of stock exchanges, which are concerned with
following subjects.
Opening/closing of stock exchanges, timing of trading, regulation of bank transfer,
regulation of carryover business, control of settlement, and other actives of stock
exchanges, fixation of margins, fixation of market prices or making prices, regulation of
taravani business (jobbing), regulation of broker trading, brokerage charges, trading rules
on exchanges, arbitration and settlement of disputes, settlement and clearing of the trading.
56
Regulations of stock exchangesThe securities contract (regulation) is the basis for operations of the stock exchange
o India. One exchange can leally without the government permission or recognition. Stock
exchanges are given monopoly in certain areas under section 19 of the above act is to
ensure that the control and regulation are facilitated. Recognition can be granted to a stock
exchange provided certain conditions are satisfied and the necessary information is
supplied to the government. Recognition can be withdrawn, if necessary. Where there is no
stock exchange, the government can license some to the brokers to perform the function of
a stock exchange in its absence.
Securities Exchange Board of India (SEBI)SEBI was set up an autonomous regulatory authority by the government of India in
1988 “to perform the interest of investors in securities and to promote the development of
and to regulate the securities the securities markets and for matters connected therewith or
incidental thereto”. It is empowered by to acts namely the SEBI Act, 1982 and the
securities contract (regulation) Act, 1956 to perform the function of protecting investor’s
rights and regulating the capital market.
There are about 24 Stock Exchanges all over India. They are as follows
Name of The Stock Exchange Year
Bombay Stock Exchange.
Ahmedabad share and stock brokers association.
Calcutta stock exchange association Ltd.
Delhi stock exchange association Ltd.
Madras stock exchange association Ltd.
Indore stock brokers association.
1875
1957
1957
1957
1957
1958
57
Bangalore stock exchange.
Hyderabad stock exchange.
Cochin stock exchange.
Pune stock exchange.
U.P. stock exchange.
Ludhiana stock exchange.
Jaipur stock exchange.
Gawhati stock exchange.
Mangalore stock exchange.
Maghad stock exchange Ltd., Patna.
Bhuvaneshwar stock exchange association Ltd.
Over the counter exchange of India, Bombay.
Saurastra Kuth stock exchange Ltd.
Vsdodard stock exchange Ltd.
Coimbatore stock exchange Ltd.
The Meerut stock exchange.
National stock exchange.
Integrated stock exchange.
1963
1943
1978
1982
1982
1983
1983-84
1984
1985
1986
1989
1989
1990
1991
1991
1991
1991
1999
3.2.1 National Stock Exchange (NSE)
The NSE was incorporated in NOVEMBER 1994 with an equity capital of
Rs.25 Crores. The International Securities Consultancy (ISC) of Hong Kong has helped in
setting up NSE. ISC has prepared the detailed business plans and installation of hardware
58
and software systems. The promotions for NSE were financial institutions, insurance
companies, banks and SEBI capital market ltd, Infrastructure leasing and financial services
ltd. and stock holding corporation ltd.
It has been set up to strengthen the move towards professionalism of the capital
market as well as provide nation wide securities trading facilities to investors.NSE is not an
exchange in the traditional sense where the brokers own and manage the exchange. A two
tier administrative setup involving a company board and a governing board of the exchange
is envisaged.
NSE is a national market for shares, PSU bonds, debentures and government
securities since infrastructure and trading facilities are provided.
The genesis of the NSE lies in the recommendations of the Pherwani
Committee (1991).It has been setup to strengthen the move towards professionalisation of
the capital market as well as provide nation wide securities trading facilities to investors.
NSE-NiftyThe NSE on April22, 1996 launched a new equity index. The NSE-50 the new
index which replaces the existing NSE-100, is expected to serve as an appropriate index for
the new segment of futures and options.
“Nifty” means National Index for Fifty Stocks.
The NSE-50 comprises 50 companies that represent 20 broad industry groups with
an aggregate market capitalization of around Rs. 1, 70,000 crores. All the companies
included in the Index have a market capitalization in excess of Rs. 500 crores. Each and
should have traded for 85% of trading days at an impact cost of less than 1.5%.
The base period for the index is the close of price on NOV 3, 1995 which
makes one year of completion of operation of NSE’s, capital market segment. The base
value of the index has been set at 1000.
NSE-Madcap IndexThe NSE madcap index or the Junior Nifty comprises 50 stocks that represents
21 board Industry groups and will provide proper representation of the madcap. All stocks
59
in the index should have market capitalization of greater than Rs.200 crores and should
have traded 85% of the trading days an impact cost of less 2.5%.
The base period for the index is Nov 4, 1996 which signifies 2 years for
completion of operations of the capital market segment of the operations. The base value of
the index has been set at 1000.
Average daily turnover of the present scenario 258212(laces) and number of
average daily trades 2160(lakhs).
3.2.2 Bombay Stock Exchange (BSE)
This stock exchange, Mumbai, popularly known as “BSE” was established
In 1875 as “The native share and stock brokers association”, as a voluntary non-profit
making association .It has evolved over the year s into its present status as the premier
stock exchange in the country. It may be noted that the stock exchange is the oldest one
in Asia, even older than the Tokyo Stock Exchange, this was founded in 1878.
A governing board comprising of 9 elected directors, 2 SEBI nominees, 7
public representatives and an executive director is the apex body, which decides the
policies and regulates the affairs of the exchange.
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The executive director as the Chief Executive Officer (CEO) is responsible for
the day-to-day administration of the exchange. The average daily turnover of the exchange
during the year 2000-01(April-March) was Rs. 3984.19 Crores and average no. of daily
trades was 5.69 lacks.
However the average daily turnover of the exchange during the year 2000-01
has declined to Rs1244.10 Crores and average daily trades during the period to 5.17 lacks.
The average daily turnover of the exchange during the year 2002-03 has
declined and the no of average daily trades during the period is also decreased.
The ban on all the deferral products like BLESS AND ALBM in the Indian
capital markets by SEBI with effect from July 2, 2001, abolition of account period
settlements, introduction of compulsory rolling settlements in all scripts traded on the
exchanges with effect from Dec 31, 2001, etc., have adversely impacted the liquidity and
consequently there is a considerable decline in the daily turnover at the exchange. The
average daily turnover of the exchange in the present scenario is 110363(laces) and the no
of average daily trades is 1057(laces)
BSE Indices:
In order to enable the market participants, analysts etc., to track the various ups and
downs in Indian stock market, the exchange had introduced in 1986 an equity stock index
called BSE-SENSEX that subsequently became the barometer of the moments of the share
prices in the Indian stock market. It is a “market capitalization –weighted” index of 30
component stocks representing a sample of large, well established and leading companies.
The base year of sensex is 1978-79.
The Sensex is widely reported in both domestic and international markets
through print as well as electronic media.
Sensex is calculated using a market capitalization weighted method. As per this
methodology, the level of index reflects the total market value of all 30-component stocks
from different industries related to particular base period. The total value of a company is
determined by multiplying the price of its stock by the number of shares outstanding.
Statisticians call an index of a set of combined variables (such as price number
of shares) Composite index. An Indexed number is used to represent the results of this
calculation in order to make the value easier to work with and track over a time. IT is much
61
easier to graph a chart base on indexed values then one based on actual values world over
majority of the well known indices are constructed using “Market capitalization weighted
method”. The divisor is only link to original base period value of the sensex.
New base year average=old base year average*(new market value/old market
value)
62
CHAPTER - 4
ANALYSIS
4.1 ANALYSIS ON THE FUTURE MARKET ON SELECTED SCRIP
63
RELIANCE INDUSTRIES FUTURE & SPOT PRICES
(01-09-2008 to 25-09-2008)
DATE SPOT PRICE FUTURE PRICE01-09-08 2141.65 2155.6502-09-08 2212.75 2228.9504-09-08 2152.25 2168.2005-09-08 2080.90 2098.1008-09-08 2133.20 2146.3509-09-08 2142.55 2152.4510-09-08 2082.65 2098.8511-09-08 1997.40 2011.5512-09-08 1932.65 1948.1515-09-08 1886.95 1892.2016-09-08 1928.05 1941.5517-09-08 1876.65 1881.4018-09-08 1938.25 1943.7019-09-08 2055.10 2060.4022-09-08 2039.10 2047.4023-09-08 2006.45 2015.2524-09-08 2046.10 2050.9025-09-08 2025.70 2026.90
64
1700
1800
1900
2000
2100
2200
2300
1/9/20
08
4/9/20
08
8/9/20
08
10/9/
2008
12/9/
2008
16-09
-08
18-09
-08
22-09
-08
24-09
-08
SPOT PRICE
FUTURE PRICE
FINDINGS
1. As of the early day of the trading with open penetrating price with Rs.2155.65 and the next day the price shoot up to Rs. 2228.95. But on the third day and fourth day the price has fallen to Rs. 2098.10. Again on fifth day the price shoot up to Rs. 2146.35 and it was stable on sixth day i.e. on 09-09-08. But from 10-09-08 the buyers were Bearish as the price was continuously fallen down and on 25-09-08 i.e. at the end of the SEPTEMBER month the price slowly recovered and settled down at 2026.90.
2. The future of RELIANCE INDUSTRIES showed a Bullish way till the 9 th of September. But from 10th September the buyers were Bearish till the end of the month.
65
ANALYSIS ON THE FUTURE MARKET
CALCULATION OF PROFIT/ LOSS TO BUYER AND SELLER.
Reliance Ind
BUYER SELLER
1/9/2008(buying) 2155.65 2155.65
25/9/2008 (Closing period) 2026.90 2026.90
Loss 128.75 Profit 128.75
Loss 128.75 x 75= 9656.25, Profit 128.75 x 75 = 9656.25
1. Because buyer future price will decrease so, loss also increase, seller future price also
decrease so, he can get profit. Incase buyer future will increase, he can get profit.
2. The closing price of RIL at the end of the contract period is 2026.90 and this is
considered as settlement price.
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4.2 ANALYSIS ON THE OPTION MARKET ON SELECTED SCRIP
DATEPRICE PREMIUM
SPOT FUTURE 1950 1980 2010 204001-09-08 2141.65 2155.65 290.55 274.80 190.65 130.1002-09-08 2212.75 2228.95 290.55 274.80 190.65 150.0004-09-08 2152.25 2168.20 290.55 274.80 190.65 150.0005-09-08 2080.90 2098.10 290.55 274.80 190.65 150.0008-09-08 2133.20 2146.35 290.55 274.80 190.65 150.0009-09-08 2142.55 2152.45 290.55 274.80 190.65 150.0010-09-08 2082.65 2098.85 290.55 274.80 150.00 150.0011-09-08 1997.40 2011.55 111.35 91.55 74.45 60.1512-09-08 1932.65 1948.15 69.40 56.45 43.80 34.3515-09-08 1886.95 1892.20 43.00 33.95 25.15 18.8016-09-08 1928.05 1941.55 52.00 39.95 30.30 22.1517-09-08 1876.65 1881.40 29.60 20.60 13.25 10.5518-09-08 1938.25 1943.70 47.00 33.65 25.45 16.9019-09-08 2055.10 2060.40 119.65 95.60 70.55 55.4522-09-08 2039.10 2047.40 105.90 78.40 56.55 43.0523-09-08 2006.45 2015.25 75.25 51.80 33.65 19.7024-09-08 2046.10 2050.90 97.00 71.30 46.10 26.1525-09-08 2025.70 2026.90 64.00 38.50 13.70 2.00
1. The following table explains the market price and premiums of calls.
2. The first column explains TRADING DATE.
3. Second column explains the SPOT MARKET PRICE in cash segment on that date.
67
4.2.1 CALL PRICES
4. The third column explains the FUTURE MARKET PRICE in cash segment on that date.
5. The fourth column explains call premiums amounting 1950,1980,2010,2040
WORKING NOTES FOR CALLOPTIONS NET PAY OFF OF CALL OPTION HOLDER & WRITER
SPOT PRICE STRIKE PRICE
PREMIUM BUYERSGAIN/LOSS
SELLERSGAIN/LOSS
2025.70 1950 290.55 -16113.75 16113.75
2025.70 1980 274.80 -17182.5 17182.5
2025.70 2010 190.65 -13121.25 13121.25
2025.70 2040 130.10 8685.00 -8685.00
PUT PRICES
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DATE PRICE PREMIUM SPOT FUTURE 1950 1980 2010 2040
01-09-08 2141.65 2155.65 20.00 29.00 30.25 38.05 02-09-08 2212.75 2228.95 9.90 11.00 15.15 15.05 04-09-08 2152.25 2168.20 14.55 9.00 20.90 29.50 05-09-08 2080.90 2098.10 25.00 37.00 43.15 54.20 08-09-08 2133.20 2146.35 12.80 21.00 23.75 38.00 09-09-08 2142.55 2152.45 8.20 15.00 22.50 25.50 10-09-08 2082.65 2098.85 18.65 27.45 32.00 42.00 11-09-08 1997.40 2011.55 41.45 54.65 68.75 85.35 12-09-08 1932.65 1948.15 70.85 89.40 102.80 129.15 15-09-08 1886.95 1892.20 101.70 118.05 147.80 155.00 16-09-08 1928.05 1941.55 58.20 130.00 99.30 120.00 17-09-08 1876.65 1881.40 96.50 101.00 146.00 180.00 18-09-08 1938.25 1943.70 55.70 185.00 85.00 110.00 19-09-08 2055.10 2060.40 10.50 15.40 21.55 33.95 22-09-08 2039.10 2047.40 9.85 16.30 23.50 35.65 23-09-08 2006.45 2015.25 8.60 18.30 29.05 43.15 24-09-08 2046.10 2050.90 1.80 4.20 8.25 19.50 25-09-08 2025.70 2026.90 0.10 0.10 0.85 11.95
NET PAY OFF OF PUT OPTION HOLDER & WRITER
SPOT PRICE STRIKE PRICE
PREMIUMBUYERSGAIN/LOSS
SELLERSGAIN/LOSS
2025.70 1950 20.00 -4177.5 4177.5
69
2025.70 1980 29.00 -1252.5 1252.5
2025.70 2010 30.25 1091.25 -1095.25
2025.70 2040 38.05 1072.5 -1072.5
OBSERVATIONS & FINDINGS
1. The call option 1950, 1980, 2010 & 1770 were out-of-the-money only
2040 were in the-money for the buyer of call option.
2. The Put option 1950, 1980 were out-of-the-money and 2010, 2040 were
in-the-money for the buyer of put option.
3. If it is a profit for buyer then obviously it is a loss for the writer &
Vice-versa.
4. The Profit of Holder = (Strike Price - Spot Price) - Premium *75
(Lot size) incase of Put Option.
5. The Profit of Holder = (Spot Price - Strike Price) - Premium * 75(Lot
size) incase of Call Option.
70
CHAPTER - 5
CONCLUSION
AND
SUGGESTIONS
5.1 LIMITATIONS OF THE STUDY
71
The following are the limitation of this study.
1. The study is conducted for a limited period of time.
2. The study is restricted to scrip’s of only one company randomly
selected from the scrip’s traded in futures and options.
3. The scrip chosen for analysis is RELIANCE INDUSTRIES LTD and
the contract taken is September 2008 ending one-month contract.
4. The reference period of the project covers one month (01-09-2008 to
25-09-2008) over the price fluctuations for the above-mentioned scrip’s
were analyzed.
5. The data collected is completely restricted to the RELIANCE
INDUSTRIES LTD of September 2008; hence this analysis cannot be
taken universal.
5.2 CONCLUSION
72
1. 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.
2. 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.
3. In the above analysis the market price of RELIANCE INDUSTRIES
LTD is having high volatility, so the call option writer enjoys more
losses to holders.
5.3 RECOMMENDATIONS & SUGGESITIONS
1. The prices of RELIANCE INDUSTRIES on the first ten days of
September month were Bullish; the call option writer incurs more losses
during this period. So the investor is suggested to go for a call option to
73
hold, where as the put option holder suffers in a bullish market, so he is
suggested to write a put option.
2. And the remaining days of the month were Bearish 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.
3. The derivative market is newly started in India. Has it is not known by
every investor, SEBI has to take steps to create awareness among the
investors about the derivative segment.
4. 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.
5. Contract size should be minimized because small investors cannot
afford this much of huge premiums.
6. SEBI has to take further steps in the risk management mechanism.
7. SEBI has to take measures to use effectively the derivatives segment as
a tool of hedging.
BIBILOGRAPHY
BOOKS: -
74
Derivatives Dealers Module Work Book - NCFM Option, Future And Other Derivatives – JOHN C. HULL
JOURNALS: -
Economic times Times of India
WEBSITES: -
www.derivativesindia.com www.nseindia.com www.bseindia.com
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