5.Derivative Project
Transcript of 5.Derivative Project
INTRODUCTION
A derivative is a security whose value depends on the value of to
gather more basic underlying variable. These are also known as contingent
claims. Derivative securities have been very successful innovation in capital
market.
The emergence of the market for derivative products, most notably
forwards, futures and options, can be traced back to the willingness of risk
averse economic agents to guard themselves against uncertainties arising out
of fluctuations in asset prices. By their very nature, financial markets are
marked by a very high degree of volatility. Through the use of derivative
products, is possible to partially or fully transfer price risks by a locking-in
asset prices. As instruments of risk management, these generally do not
influence the fluctuation in the underlying asset prices.
However, by locking-in asset prices, derivative products minimize the
impact of fluctuations in asset prices on the profitability and cash flow
situation of risk-averse investor.
Derivatives are risk management instruments, which drive their value
form underlying asset. Underlying asset can be bullion, index; share, currency,
bonds, interest etc.
1
NEED OF THE STUDY:
Different investment avenues are available investors. Stock market also offers
good investment opportunities to the investor alike all investments, they also
carry certain risks. The investor should compare the risk and expected yields
after adjustment off tax on various instruments while talking investment
decision the investor may seek advice from expertly and consultancy include
stock brokers and analysts while making investment decisions. The objective
here is to make the investor aware of the functioning of the derivatives.
Derivatives act as a risk hedging tool for the investors. The objective if to help
the investor in selecting the appropriate derivates instrument to the attain
maximum risk and to construct the portfolio in such a manner to meet the
investor should decide how best to reach the goals from the securities
available.
To identity investor objective constraints and performance, which help
formulate the investment policy?
The develop and improvement strategies in the with investment policy
formulated. They will help the selection of asset classes and securities in each
class depending up on their risk return attributes.
2
OBJECTIVES
To study the various trends in derivatives in derivative market.
To study the role of derivatives in Indian financial market.
To study in detail the role of futures and options.
To find out profit/loss of the option holder and option writer.
To study about risk management with the help of derivatives.
SCOPE OF THE STUDY:
The study is limited to “Derivatives” with special reference to futures
and options in the Indian context; the study is not based on the international
perspective of derivative markets.
The study is limited to the analysis made for types of instruments of
derivates each strategy is analyzed according to its risk and return
characteristics and derivatives performance against the profit and policies of
the company.
3
METHODOLOGY
To achieve the objective of studying the stock market data has been
collected.
Research methodology carried for this study can be two types
1. Primary data
2. Secondary data
PRIMARY DATA
The data, which is being collected for the first time and it is the original
detain this project the primary data has been taken from NSE staff and guide
of the project.
SECONDARY DATA
The secondary information is mostly taken from websites, books, &
journals etc.
4
LIMITATION OF THE STUDY
The subject of derivative if vast it requires extension study and research to
understand the debt of the various instrument operating in the market only
a recent plenomore.
But various international examples have also been added to make the study
more comfortable.
There are various other factors also which define the risk and return
preference of an investor however the study was only contained towards
the risk minimization and profit maximization objective of the investor.
The derivative market is a dynamic one premiums, contract rates strike
price fluctuate on demand and supply basis.
Data related to last few trading months was only consider and interpreted.
5
INTRODUCTION TO DERIVATIVES
The emergence of the market for derivative products, most notably
forwards, futures and options, can be traced back to the willingness of risk-
averse economic agents to guard themselves against uncertainties arising out
of fluctuations in asset price. By their very nature, the financial markets are
marked by a very high degree of volatility.
Through the use of derivative products, it is possible to partially or fully
transfer price risks by locking-in asset prices. As instruments of risk
management, these generally do not influence the fluctuations in the
underlying asset prices. However, by locking-in asset prices, derivative
products minimize the impact of fluctuations in asset prices on the profitability
and cash flow situation of risk-averse investors.
Derivatives defined:
Derivative is a product whose value is derived from the value of one or
more basic variables, called bases (underlying asset, index, or reference rate),
in a contractual manner. The underlying asset can be equity, forex, commodity
or any other asset.
For example: wheat farmers may wish to sell there heaviest at a future date to
eliminate the risk of a change in prices by that date. Such a transaction is an
example of a derivative. The price of this derivative is driven by the spot price
of wheat which is the “underlying”. In the Indian context the Securities
Contracts (Regulation) Act, 1956(SC®A) defines “derivatives” to include…
6
1. A security derived from a debt instrument, share and loan whether secured
or unsecured, risk instrument or contract for differences or any other form
of security.
2. A contract, which derives its value from the prices, or index of prices, of
underlying securities.
Derivatives are securities under the SC® A and hence the regulatory
framework under the SC® A governs the trading of derivatives.
Definitions
“A Derivative can be defined as a financial instrument whose value
depends on (or derives from) the value of other, more basic underlying
variables.”
- John C. Hull
“A Derivative is simply a financial instrument (or even more simply an
agreement between two people) which has a value determined by the price
of something else.”
- Robert L. McDonald
Derivatives are financial instruments whose value is derived from its
underlying it may be stock, commodity, gold, Index, etc.
Derivatives give an opportunity to buy or sell the underlying at a future date
but at a pre-specified price decided at the date of entry of the contract.
Functions
The following are the various functions that are performed by the derivatives
markets. They are…
7
1. Prices in an organized derivatives market reflect the perception of market
participants about the future and lead the prices of the underlying asset to
the perceived future level.
2. Derivatives markets help to transfer risks from those who have them but
may not like them to those who want them.
3. Derivatives market helps increase savings and investments in the long run.
4. Derivatives trading act as catalyst for new entrepreneurial activity.
Advantages
1. Transactional efficiency-greater liquidity and lower cost.
2. Price discovery-dissemination of price information
3. Risk management-transfer of risks.
Characteristics of derivatives
1. Their value is derived from an underlying instrument such as stock index,
currency, etc.
2. They are vehicles for transferring risk.
3. They are leveraged instruments
Participants
There are three broad categories of participants participating in the
derivative segment
They are
Hedgers: Hedgers are investors who would like to reduce risk. Hedges
seek to protect themselves against price changes in a commodity in which
they have an interest.
8
Speculators: Speculators bet on the future price movements of an asset.
Derivatives give them an extra leverage that they can increase both the
potential gains and losses. Speculators are major players in the markets,
without whom the market probably would ever exist.
Arbitrageurs: These are specialized in making purchase and sales in
different markets at the same time and there by make profits by the
differences in the prices between two countries i.e. they take the advantage
of the discrepancy between prices in two different markets.
Functions
The following are the various functions that are performed by the
derivatives markets. They are:
Prices in an organized market reflect the perception of market participants
about the future and lead the prices of the underlying asset to the perceived
future level.
Derivatives market help to transfer risks from those who have them but
may not like them to those who want them.
Derivatives markets help increase savings and investments in the long run.
Derivatives trading act as a catalyst for new entrepreneurial activity.
ADVANTAGES
Risk management:
Risk management is not about the elimination of risk rather it is about
the management of risk. Financial derivatives provide a powerful tool for
limiting risk that individual an organizations face in ordinary conduct of
their business. Successful risk management with derivatives requires are
thorough understandings of principles that govern the pricing of financial
9
derivatives. Used correctly, derivatives can save costs and increased
returns.
Trading Efficiency:
Derivatives allow for the free trading of individual risk components,
there by improving market efficiency. Traders can use a position in one or
more financial derivatives as a substitute for a position in the underlying
instruments. In many instances traders find financial to more attractive
instrument than the underlying security is reason being the greater amounts
of liquidity in the market afford by the financial derivatives and lowered
transaction costs associated with a trading a financial derivative as
compared to the cost of trading the underlying instrument.
Speculation:
Serving as a speculative tool is not the only use, and probably not the
most important use, of financial derivatives. Financial derivatives are
considered to be risky. However, these instrument acts as a powerful
instrument for knowledgeable traders to expose themselves to properly
calculated and well understood risks in pursuit of a reward i.e. profit.
Types of Derivatives
Following are the various types of derivatives:
Forwards
A forward contract is a customized contract between two entities, where
settlement takes place on a specific date on the future at today’s pre-agreed
price.
10
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 contract are
special types of forward contracts in the sense that the former or
standardized exchange-traded contracts.
Options
Options are of two types- Calls and Puts. Calls give the buyer the right but
not the obligation to buy a given quantity of the underlying asset, at a
given price on or before a given future date.
Puts give the buyer the right, but not the obligation to sell a given quantity
of the underlying asset at a given price on or before a given date.
Warrants
Options generally have lives up to one year, the majority of the options
traded on options exchanges having a maximum maturity of 9 months.
Longer- dated options are called warrants and are generally trade over-the-
counter.
Leaps
The acronym Leaps means long-term equity anticipation securities. These
are options having a maturity of up to three years.
Baskets
Basket options are options on portfolio of underlying assets. The
underlying asset is usually a moving average of a basket of asset. Equity
index options are a form of basket options.
11
Swaps
Swaps are private agreements between two parties to exchange cash flows
in the future according to her pre-arranged formula. They can be regarded
as portfolios of forward contracts. The two commonly used swaps are:
Interest rate swaps; these entail swapping only the interest related
cash flows between the parties in the same currency.
Currency swaps
These entail swapping both principal and interest between the parties,
with the cash flows in one direction being in a different currency than
those in the opposite direction.
Swap options
Swap options are options to buy or sell a swap that will become
operative at the expiry of the options. Thus a swap option is an option on
a forward swap. Rather than have calls and puts, the swap options market
has receiver swap options and payer swap options. A receiver swap option
is an option to receive fixed and pay floating. A prayer swap option is an
option to pay fixed and receive floating.
Forwards
The salient features of forward contracts are:
They are bilateral contracts and hence exposed to counter-party risk.
Each contract is custom designed, and hence is unique in terms of contract
size, expiration date and the asset type and quality.
The contract price is generally not available in public domain. On the
expiration date, the contract has to be settled by delivery of the asset. If the
12
party wishes to reverse the contract, it has to compulsorily go to the same
counter party, which often results in high prices being charged.
Forward contracts are very useful in hedging and speculation.
Limitations of forward markets
Forward markets world-wide are afflicted by several problems:
Lack of centralization of trading
Liquidity, and
Counter party risk is a very serious issue.
The basic problem is that of too much flexibility and generality.
Futures
Defined futures: A future contract is on by which one party agrees to
Buy from/Sell to the other party at a specified future time, on a asset at a
price agreed at the time of the contract and payable on maturity date. The
agreed price is known as the strike price. The underlying asset can be a
commodity, currency debt or equity securities etc.
The standardized items on a futures contract are:
Quantity of the underlying
Quality of the underlying
The date and the month of delivery
The units of price quotation and minimum price change
Distinctive future
Trade on an organized exchange
Standardized contract terms
13
More liquid
Requires margin payments
Follows daily settlement
Spot price: The price at which an asset trades in the spot market.
Futures price: The price at which the futures contract trades in the futures
market.
Multiplier: It is pre-determined value, used to arrive as the contract size.
It is price per index point.
Contract cycle: The period over which a contract trades. The index
futures contracts on the NSE have one-month, two-months and three-
months expiry cycles, which expire on the last Thursday of the month.
Thursday, a new contract having a three-month expiry is introduced for
trading.
Expiry date: it is the date specified in the futures contract. This is the last
day on which the contract will be traded, at the end of which it will cease
to exist.
Contract size: The amount of asset that has to be delivered under one
contract. For instance, the contract size on NSE’s futures market is 200
Nifties.
Basis: In the context of financial futures, basis is the differences of futures
price minus the spot price. There will be a different basis for each delivery
month for each contract. In a normal market, basis will be positive. This
reflects that futures prices normally exceed spot prices
Cost of carry: The relationship between futures prices and spot prices can
be summarized in terms what is known as the cost of carry. This measures
14
the storage cost plus the interest that is paid to finance the asset less the
income earned on the asset.
Open Interest: Total outstanding long or short positions in the market at
any specific time. As total long positions for market would be equal to
short positions, for which calculation of open Interest, only one side of the
contract is counted.
Initial margin: the amount that must be deposited in the margin account
at the time a futures contract is first entered into is known as initial margin.
Making-to-market: In the futures market, at the end of each trading day,
the margin account is adjusted to reflect the investor’s gain or loss
depending upon the futures closing price. This is called marking-to-
market.
Maintenance margin: This is somewhat lower than the initial margin.
This is set to ensure that the balance in the margin account never becomes
negative. If the balance in the account falls below the maintenance margin,
the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next
day.
Cash settled: Open position at the expiry of the contract is cash settled.
Physical delivery: Open position at the expiry of the contract is settled
through delivery of the underlying asset. In the futures market, the
physical delivery of the underlying is very rare.
15
Parties in futures contracts
There are two parties in the future contract, the buyer and the seller. The
buyer of the contract is one who is LONG on the futures contract and the
seller of the contract is one who is SHORT on the futures contract.
The payoff for the buyer and seller of the futures contracts:
Pay-off for a buyer of futures:
P
E2 F E1
Options
Introduction: Option is a type of a contract between two persons where one
grants the other the right to buy a specific asset at a price within a specified
period of time. Alternatively the contract may grant the other person the right
to sell a specific asset at a price with in a specific period of time. In order to
have this right, the option buyer has to pay the seller of option premium.
The assets on which options can be derived are stocks, commodities, indexes,
etc., and if the underlying asset is the non-financial asset the options are Non-
financial options like Commodity options.
16
Properties of options
Options have several unique properties that set them apart from other
securities. The following are the properties of options.
Limited loss
High leverage
Limited life
Distinctive features
Exchange traded with notation.
Exchange defines the product same as futures.
Strike price is fixed, price moves
Price is always positive
Nonlinear payoff
Only short at risk
The purchase of an option requires an up-front payment.
Elementary option strategies
Pay-off profile for buyer of a call option:
The pay-off of buyer of the option depends on the spot price of the
underlying asset. The following graph shows the pay-off of buyer of a call
option.
R S ITM
E2 E1
O T M ATM
P
17
S = strike price ITM = In-the-MoneySP = Premium/profit ATM = At-the-MoneyE1 = Spot price 1 OTM = Out-of the MoneyE2 = Spot price 2 SR = Profit at Spot price E2
Case1: (Strike price > Strike price)
As the spot price [E1] of the underlying asset is more than strike price [S].
The buyer gets the profit increases more than [E1] then the profit also
increase more than SR.
Case 2: (Strike price < Strike price)
As the spot price [E2] of the price underlying asset is less than strike price
[S]. The buyer gets loss of [SP], if price goes down less than [E2] then also
his loss is limited to his premium [SP].
Pay-off profile for seller of a call option:
The pay-off of seller of the call option depends on the spot price of the
underlying asset.
The following graph shows the pay-off of seller of a call option.
P ATM
ITM E1 E2
S O T M
R
S = Strike price ITM = In-the-MoneySP = Premium/profit ATM = At-the-MoneyE1 = Spot price 1 OTM = Out-of the MoneyE2 = Spot price 2 SR = Profit at Spot price E2
18
Case1: (Strike price < Strike price)
As the spot price [E1] of the underlying asset is more than strike price [S].
The seller gets the profit of [SP], if price decreases less than [E1] then also
profit of the seller does not exceed [SP].
Case 2: (Strike price > Strike price)
As the spot price [E2] of the price underlying asset is more than strike
price [S]. The seller gets loss of [SR], if price goes more less than [E2]
then also the loss of the seller increases more than [SR].
Pay-off profile for buyer of a put option:
The pay-off of seller of the call option depends on the spot price of the
underlying asset.
The following graph shows the pay-off of seller of a put option.
R ITM
E1 E2
S O T M
ATM P
S = Strike price ITM = In-the-MoneySP = Premium/profit ATM = At-the-MoneyE1 = Spot price 1 OTM = Out-of the MoneyE2 = Spot price 2 SR = Profit at Spot price E2
Case1: (Strike price < Strike price)
As the spot price [E1] of the underlying asset is less than strike price [S].
The buyer gets the profit of [SR], if price decreases less than [E1] then
also profit increases more than [SR].
19
Case 2: (Strike 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] then the loss of
the buyer is limited to his premium [SP].
Pay-off profile for seller of a put option:
The pay-off of seller of the call option depends on the spot price of the
underlying asset.
The following graph shows the pay-off of seller of a call option.
P ATM ITM
E1 E2
S
S = Strike price ITM = In-the-MoneySP = Premium/profit ATM = At-the-MoneyE1 = Spot price 1 OTM = Out-of the MoneyE2 = Spot price 2 SR = Profit at Spot price E2
Case1: (Strike 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] then also
loss exceeds more than [SR].
Case 2: (Strike price > Strike price)
20
As the spot [E2] of the price underlying asset is more than strike price [S].
The seller gets profit of [SP], if price goes more than [E2] then the profit
of the seller is limited to his premium [SP].
Factors affecting the price of an option:
The following are the various factors, which affect the price of an option
they are…
Stock price:
The pay-off from a call option is the amount by which the stock price
exceeds the strike price. Call options therefore become more valuable as
the stock price increases and vice versa. The pay-off from a put option is
the amount by which the strike price exceeds the stock price.
Put option therefore become more valuable as the stock price increases and
vice versa.
Strike price:
In the case of a call, as the strike price increases, the stock price has to
make a larger upward move for the option to go In-the-money. Therefore,
for a call as the strike price increases options become less valuable and
strike price decreases, options become more valuable.
Time to expiration:
Both put and call American options become more valuable as the time to
expiration increases.
Volatility:
The volatility of a stock price is a measure of uncertain about futures stock
price movements. As volatility increases, the change of that the stock will
21
do very well or very poor increases. The value of both calls and puts
therefore increases as volatility increase.
Risk free interest rate:
The put option prices decline as the risk-free rate increase where as the
prices of calls always increase as the risk-free interest increases.
Dividends:
Dividends have the effect of reducing the stock price on the ex-dividend
date. This has a negative effect on the value of call options and a positive
affect on the value of put options.
Option terminology
Strike price: The price specified in the options contract is known as the
strike price or the exercise price.
Option price: Option price is the price, which the option buyer pays to the
option seller. It is also referred to as the option premium.
Expiration date: The date specified in the options contract is known as
the expiration date, the exercise date, the strike date or the maturity.
In-the-money option: An in-the-money (ITM) option is an option that
would lead to a positive cash flow, to the holder if it were exercised
immediately. A call option on the index is said to be in the money when
the current index stands at a level higher than the strike price (i.e. spot
price - strike price). If the index is much higher than the strike price, the
call is said to be deep ITM. In the case of a put, the put is ITM if the index
is below the strike price.
At-the-money option: An at-the-money (ATM) option is an option that
would lead to zero cash flow, if it were exercised immediately. An option
22
on the index is at-the-money when the current index equals the strike price
(i.e. spot price = strike price).
Out-of-the-money option: An out-of-the-money (OTM) option is an
option that would lead to a negative cash flow, if it were exercised
immediately. A call option on the index is out-of-the-money when the
current index stands at a level, which is less than the strike price (i.e. spot
price _strike price). If the index is much lower than the strike price, the
call is said to be deep OTM. In the case of a put, the put is OTM if the
index is above the strike price.
Intrinsic value of an option: The option premium can be broken down
into two components – intrinsic value and time value. The intrinsic value
of a call is the amount the option is ITM, if it is ITM. If the call is OTM,
its intrinsic value is zero.
Time value of an option: The time value of an option is the difference
between its premium and its intrinsic value. Both calls and puts have time
value. An option that is OTM or ATM has only time value. Usually, the to
expiration, the greater is an option’s time value, all else equal. At
expiration, an option should have no time value.
Futures and Options
Futures…
Futures price: Agreed-upon price at maturity.
Long position: Agree to purchase.
Short position: Agree to sell.
Profit or loss is unlimited to both buyer and seller of the Futures.
23
Stock Futures: The underlying to these contracts are the individual stocks
like Satyam, Infosys, HCL, HPCL, Wipro, etc..
Index Futures: The underlying to these contracts are indices like S&P
(Standard and Poor’s), CNX, Nifty, Sensex…
Implied cost of carry:
(Future Price – spot price) / spot price
It indicates the notional cost the investor would have incurred in carrying
the stock.
Options…
Option class: All listed options of a particular type (call or put) on a
particular underlying instrument. E.g.: Infosys calls or Infosys puts.
Option series: All options of a given class with the same expiration date
and strike price.
Open interest: The total number of options contract outstanding in the
market at any given point of time.
Covered option: If an investor takes a position in options and also on its
underlying then his position is covered.
E.g.: If investor buys a put on Reliance and also possesses Reliance shares
then his position is covered. This is protective in nature.
Naked option: If the investor takes a position only in option with out
possessing its underlying then its naked option.
E.g.: If investor buys either a put or call option on Reliance with out
possessing the underlying then it is a naked option. This is speculative in
nature.
24
Buy call Option Buy Put Option Sell Call Option
Sell Put Option
A right to buy A right to sell A duty to buy
A duty to
At set strike At set strike At set strike At set strikeFor an expiry For an expiry For an
expiryFor an
Paying a price Paying a price Receive a price
Receive a
Sans a duty Sans a duty Sans a right Sans a rightSettle in cash Settle in cash Settle in
cashSettle in
Particulars Futures OptionsContract Size Standardized StandardizedProfits Unlimited Unlimited to buyer
Losses Unlimited Limited to BuyerType of Trade Exchange traded Exchange tradedCounter party Risk Does not exist Does not existPrice Margin is paid, No cost Premium is paid,
This is the price of the Right.
Derivatives are the contracts for a limited time period say one month, two
months, and three months. The last Thursday of the month is expiry day for
those contracts. The proceeding day to last Thursday of the month only
trading will starts and new contracts will exist.
One month trading contract is called “Near month contract”,
Two month trading contract is called “Middle month contract”, and
Three months trading contract is called “Far month contract”.
At any point of time there would be three contracts of varying maturities. The
maximum maturity of the month contract will be one (1) month and the
maximum of a far month contract will be three (3) months.
An example on PUT option:
25
X buys one April month put option on NIFTY at the strike price of
Rs.1470/- of Infosys at a premium of Rs.35/-.
1). If on the date of expiry the market price is less than 1470, the put
option will be economically viable and hence exercised.
2). The investor will earn profits once the share price falls below Rs.
1435/- (strike price – premium [i.e. 1470-35).
3). Suppose price of NIFTY is at 1430 on expiry date, the investor who
will get a profit of Rs.5/-, will exercise the put option.
[(Strike price – spot price) - premium][(1470 = 1430) - 35].Long on PUT (buyer’s perspective)
Pay-off on NIFTY long put for different spot pricesStrike Price – 1470/- Premium – 35/-Spot Price
Premium Strike Price
Profit/Loss Exercised
1380 35 1470 55 Yes1390 35 1470 45 Yes1400 35 1470 35 Yes1410 35 1470 25 Yes1420 35 1470 15 Yes1430 35 1470 5 Yes1440 35 1470 -15 Yes
1450 35 1470 -25 Yes
1460 35 1470 -35 Yes1470 35 1470 -35 Indifferent1480 35 1470 -35 No1490 35 1470 -35 No
An example on CALL option:
Y buys one April month call option on NIFTY at the strike price of
Rs.1500/- of Infosys at a premium of Rs.35/-.
26
1). If on the date of expiry the market price is more than 1500, the call
option will be economically viable and hence exercised.
2). The investor will earn profits once the share price exceeds more than
the Rs. 1535/- (strike price + premium [i.e. 1500+35]).
3). Suppose price of NIFTY is at 1540 on expiry date, the investor who
will get a profit of Rs.5/-, will exercise the call option.
[Spot price – Strike price) - premium]
[(1540 - 1500) - 35].
Long on Call (buyer’s perspective)
Pay-off on Nifty long can for different spot PricesStrike Price – 1500/- Premium – 35/-Spot Price
Premium Strike Price
Profit/Loss Exercised
1450 35 1500 -35 No
1460 35 1500 -35 No
1470 35 1500 -35 No
1480 35 1500 -35 No
1490 35 1500 -35 No1500 35 1500 -35 Indifferent1510 35 1500 -25 Yes1520 35 1500 -15 Yes1530 35 1500 -5 Yes
1540 35 1500 5 Yes1550 35 1500 15 Yes1560 35 1500 25 Yes
Protective PUT
27
Long on STOCK + Long on PUT
Instead of buying the stock, I can also buy a future, in which case my out
flow will be limited to the margin.
If price of the stock goes up by more than the premium paid then profits
are unlimited.
If price of the stock goes down then maximum loss is confined to the (spot
price – strike price + premium paid)
Down side is limited and upwards unlimited.
Example:
If the HCL technologies price is Rs, 140/-.
Buy at Rs.130/- of April put @ 5/-
At Time TPrice Long Stock Long Put Profit / Loss100 -40 25 -15
110 -30 15 -15
120 -20 5 -15
130 -10 -5 -15140 0 -5 -5
150 10 -5 5160 20 -5 15170 30 -5 25180 40 -5 35
Covered call:
Long on stock + short on call
Instead of buying the stock, buyer can also buy a future, in which case my
outflow will be limited to the margin.
28
If price of the stock goes down, the loss on stock is partially offset by
premium receipt on call, if the price of the stock goes up, loss on call is
offset by the gain in the stock.
Example:
TISCO Company’s share price is Rs.860/-Sell at Rs.900/- of April call of Rs.@20/-
At Time T
Price Long stock Short call Profit / Loss820 -40 20 -20840 -20 20 0860 0 20 20
880 20 20 40
900 40 20 60920 60 20 60
940 80 20 60
Example
Illustration
Two parties, Jack and Jill enter into a contract to buy and sell 100
shares of Infosys at Rs 3500 each, two months down the line from the date
of contract. Assuming that Jack is the buyer and Jill is the seller. In the
given example, both the parties concerned have determined product,
quantity of the product, price of the product and time of the delivery in
advance. Delivery and payments will take place as per the terms of this
contract on the designated date and place. This is a simple example of
forward contract.
Forward contracts are being used in India on large scale in the foreign
exchange market to cover the currency risk.
29
Forward contracts being negotiated by the parties on one to one basis,
offer the tremendous flexibility to them to articulate the contract in terms
of price, quantity, quality, delivery time and place. However, forward
contracts suffer from poor liquidity and default risk.
Limitations
Limitations of forward markets
Forward markets world-wide are afflicted by several problems:
Lack of centralization of trading,
Illiquidity, and
Counterparty risk
In the first two of these, the basic problem is that of too much flexibility
and generality.
The forward market is like a real estate market in that any two consenting
adults can form contracts against each other. This often makes them design
terms of the deal which are very convenient in that specific situation, but
makes the contracts non-tradable.
Counterparty risk arises from the possibility of default by any one party to
the transaction. When one of the two sides to the transaction declares
bankruptcy, the other suffers. Even when forward markets trade
standardized contacts, and hence avoid the problem of illiquidity, still the
counterparty risk remains a very serious issue.
30
Distinctive Future
Distinction between futures and forwards contracts
Forward contracts are often confused with futures contracts. The confusion
is primarily because both serve essentially the same economic functions of
allocating risk in the presence of future price uncertainty. However futures
are a significant improvement over the forward contracts as they eliminate
counterparty risk and offer more liquidity.
Distinction between futures and forwards
Futures ForwardsTrade on an organized exchange OTC in nature
Standardized contract terms Customized contract terms
Hence more liquid hence less liquid
Requires margin payments No margin payment
Follows daily settlements Settlement happens at end of period
The date and the month of delivery
The units of price quotation and minimum price change
Location of settlement
Future Terminology
Spot price: The price at which an asset trades in the spot market.
Futures price: The price at which the futures contract trades in the futures
market.
31
Contract cycle: The period over which a contract trades. The index
futures contracts on the NSE have one-month, two-months and three-
months expiry cycles which expire on the last Thursday of the month.
Thus a January expiration contract expires on the last Thursday of January
and a February expiration contract ceases trading on the last Thursday of
February. On the Friday following the last Thursday, a new contract
having a three-month expiry is introduced for trading.
Expiry date: It is the date specified in the futures contract. This is the last
day on which the contract will be traded, at the end of which it will cease
to exist.
Contract size: The amount of asset that has to be delivered under one
contract. For instance, the contract size on NSE’s futures market is 200
Nifties.
Basis: In the context of financial futures, basis can be defined as the
futures price minus the spot price. There will be a different basis for each
delivery month for each contract. In a normal market, basis will be
positive. This reflects that futures prices normally exceed spot prices.
Cost of carry: The relationship between futures prices and spot prices can
be summarized in terms of what is known as the cost of carry. This
measures the storage cost plus the interest that is paid to finance the asset
less the income earned on the asset.
Initial margin: The amount that must be deposited in the margin account
at the time a futures contract is first entered into is known as initial margin.
Marking-to-market: In the futures market, at the end of each trading day,
the margin account is adjusted to reflect the investor’s gain or loss
32
depending upon the futures closing price. This is called marking-to-
market.
Maintenance margin: This is somewhat lower than the initial margin.
This is set to ensure that the balance in the margin account never becomes
negative. If the balance in the margin account falls below the maintenance
margin, the investor receives a margin call and is expected to top up the
margin account to the initial margin level before trading commences on
the next day.
Types of futures
Stock index futures
Stock index futures are most popular financial futures, which have
been used to hedge or manage the systematic risk by the Investors of the
stock market. They are called Hedgers, who own portfolio of securities
and are exposed to systematic risk.
Stock index is the apt hedging asset since, the rise or fall due to
systematic risk is accurately shown in the stock index. Stock index futures
contract is an agreement to buy or sell a specified amount of an underlying
stock index traded on a regulated futures exchange for a specified price at
a specified time in future.
Stock index futures will require lower capital adequacy and margin
requirement as compared to margins on carry forward of individual
scrip’s. The brokerage cost on index futures will be much lower. Savings
in cost is possible through reduced bid-ask spreads where stocks are traded
in packaged forms. The impact cost will be much lower incase of stock
33
index futures as opposed to dealing in individual scrips. The market is
conditioned to think in terms of the index and therefore, would refer trade
in stock index futures. Further, the chances of manipulation are much
lesser.
The stock index futures are expected to be extremely liquid, given the
speculative nature of our markets and overwhelming retail participation
expected to be fairly high. In the near future stock index futures will
definitely see incredible volumes in India. It will be a blockbuster product
and is pitched to become the most liquid contract in the world in terms of
contracts traded. The advantage to the equity or cash market is in the fact
that they would become less volatile as most of the speculative activity
would shift to stock index futures. The stock index futures market should
ideally have more depth, volumes and act as a stabilizing factor for the
cash market. However, it is too early to base any conclusions on the
volume are to form any firm trend. The difference between stock index
futures and most other financial futures contracts is that settlement is made
at the value of the index at maturity of the contract.
Example: If BSE Sensex is at 6800 and each point in the index equals to
Rs.30, a contract struck at this level could work Rs. 204000(6800x30). If
at the expiration of the contract, the BSE Sensex is at 6850, a cash
settlement of Rs.1500 is required ((6850-6800) x30).
Stock Futures
With the purchase of futures on a security, the holder essentially makes a
legally binding promise or obligation to buy the underlying security at
some point in the future (the expiration date of the contract). Security
34
futures do not represent ownership in a corporation and the holder is
therefore not regarded as a shareholder.
A futures contract represents a promise to transact at some point in the
future. In this light, a promise to sell security is just as easy to make as a
promise to buy security. Selling security futures without previously
owning them simply obligates the trader to sell certain amount of the
underlying security at some point in the future. It can be done just as easily
as buying futures, which obligates the trader to buy a certain amount of the
underlying security at some point in future.
Example: If the current price of the ACC share is Rs.170 per share. We
believe that in one month it will touch Rs.200 and we buy ACC shares. If
the price really increases to Rs.200, we made profit of Rs.30 i.e. a return of
18%. If we buy ACC futures instead, we get the same position as ACC in
the cash market, but we have to pay the margin not the entire amount. In
the above example if the margin is 20%, we would pay only Rs.34 initially
to enter into the futures contract. If ACC share goes up to Rs.200 as
expected, we still earn Rs.30 as profit.
Pricing futures
Stock index futures began trading on NSE on the 12 th June 2000. Stock
futures were launched on 9th November 2001. The volumes and open,
interest on this market has been steadily growing. Looking at the futures
prices on NSE’s market, have you ever felt the need to know whether the
quoted prices are a true reflection of the price of the underlying
index/stock? Have you wondered whether you could make risk-less profits
by arbitraging between the underlying and futures markets? If so, you need
35
to know the cost-of-carry to understand the dynamics of pricing that
constitute the estimation of fair value of futures.
The cost of carry model
We use fair value calculation of futures to decide the no-arbitrage limits on
the price of a futures contract. This is the basis for the cost-of-carry where
the price of the contract is defined as:
F=S+C
Where:
F=Futures price
S=Spot price
C=Holding costs or carry costs
This can also be expressed as:
F=S (1 + r)T
Where:
r=Cost of financing
T=time till expiration
If F < S(1 + r)T or F > S(1 + r)T , arbitrage opportunities would exist i.e.,
whenever the futures price moves away from the fair value, there would be
chances for arbitrage.
We know what the spot and futures prices are, but what are the
components of holding cost? The components of holding cost vary with
contracts on different assets. At times the holding cost may even be
36
negative. In the case of commodity futures, the holding cost is the cost of
financing plus cost of storage and insurance purchased etc. In the case of
equity futures, the holding cost is the cost of financing minus the dividends
returns.
Pricing futures contracts on commodities
Let us take an example of future contracts on a commodity and work
out the price of the contract. The spot price of silver is Rs.7000/kg. If the
cost of financing is 15% annually, what should be the futures price of 100
gms of silver one month down the line? Let us assume that we’re on 1 st
January 2002. How would we compute the price of a silver futures price is
nothing but the spot price plus the cost-of-carry. Let us first try to work out
the components of the cost-of-carry model.
1. What is the spot price of silver? The spot price of silver,
S=Rs.7000/kg.
2. What is the cost of financing for a month? (1 + 0.15) 30/365.
3. What are the holding costs? Let us assume that the storage cost=0.
In this case the fair value of the futures price, works out to be = Rs.708.
F = S (1 + r )T + C = 700(1.15)30/365 = Rs.708
If the contract was for a three-month period i.e. expiring on 30 th march,
the cost of financing would increase the futures price. Therefore, the
futures price would be
F = 700(1.15)30/365 = Rs.724.5 On the other hand, if the one-month contract
was for 10,000 kg. Of silver instead of 100 gms, then it would involve a
non-zero storage cost, and the price of the futures contract would be
Rs.708 plus the cost of storage.
37
Pricing equity index futures
A futures contract on the stock market index gives its owner the right and
obligation to buy or sell the portfolio of stocks characterized by the index.
Stock index futures are cash settled; there is no delivery of the underlying
stocks.
The main differences between commodity and equity index futures are that:
There are no costs of storage involved in holding equity.
Equity comes with a dividend stream, which is a negative cost if you are
long the stock and positive costs if you are short the stock.
Therefore, Cost of carry = Financing cost – Dividends. Thus, a crucial aspect
of dealing with equity futures as opposed to commodity futures is an accurate
forecasting of dividends. The better the forecast of dividend offered by a
security, the better is the estimate of the futures price.
Pricing index futures given expected dividend amount
The pricing of index futures is also based on the cost-of-carry model, where
the carrying cost is the cost of financing the purchase of the portfolio
underlying the index, minus the present value of dividends obtained from the
stocks in the index portfolio.
Illustration
Nifty futures trade on NSE as one, two and three-month contracts. Money
can be borrowed at a rate of 15% per annum. What will be the price of a new
two-month futures contract on Nifty?
1. Let us assume that M&M will be declaring a divident of Rs.10 per
share after 15 days of purchasing the contract.
38
2. Current value of Nifty is 1200 and Nifty trades with a multiplier of
200.
3. Since Nifty is traded in multiples of 200, value of the contract is 200 *
1200 = Rs. 240,000.
4. If M&M has a weight of 7% in Nifty, its value in Nifty is Rs.16,800
i.e.(240,000 * 0.07).
5. If the market price of M&M is Rs.140, then a traded unit of Nifty
involves 120 shares of M&M i.e.(16,800/140).
6. To calculate the futures price, we need to reduce the cost-of-carry to
the extent of dividend received.
The amount of dividend received is Rs. 1200 i.e(120 * 10). The dividend
is received 15 days later and hence compounded only for the remainder of 45
days. To calculate the futures price we need to compute the amount of
dividend received per unit of Nifty.
Hence we divide the compounded dividend figure by 200.
Thus, futures price
F= 1200(1.15)60/365 – (120x10(1.15)45/365)/200 = Rs.1221.80
Pricing index futures given expected dividend yield
If the dividend flow throughout the year is generally uniform, i.e. if there are
few historical cases of clustering of dividends in any particular month, it is
useful to calculate the annual dividend yield
F=S (1 + r – q )T
Where:
F=futures price
S=spot index value
R=cost of financing
Q=expected dividend yield
39
T=holding period
Example: A two-month futures contract trades on the NSE. The cost of
financing is 15% and the dividend yield on Nifty is 2% annualized. The spot
value of Nifty is 1200. What is the fair value of the futures contract?
Fair value = 1200(1 + 0.15 – 0.02)60/365 = Rs. 1224.35
Definition
Option is a contract between two persons where one grants the other
the right to buy a specific asset at a specific price within a stipulated time
period. Alternatively the contract may grant the other person the right to sell a
specific asset at a specific price within a specific time period. In order to have
this right, the option buyer has to pay the seller of the option premium.
The assets on which the option can be derived are stocks, commodities,
indexes, etc. If the underlying asset is the financial asset, then the options are
financial options like stock options, currency options, index options etc, and if
the underlying is the non-financial asset the options are non-financial options
like commodity options.
Properties of options:
Options have several unique properties that set them apart from other
securities. The following are the properties of options:
Limited Loss
High Leverage Potential
Limited Life
40
Characteristics of Options
The following are the main characteristics of options:
1. Options holders do not receive any dividend or interest.
2. Options yield only capital gains.
3. Options holder can enjoy a tax advantage.
4. Options are traded on O.T.C and in all recognized stock exchanges.
5. Options holders can control their rights on the underlying asset.
6. Options create the possibility of gaining a windfall profit.
7. Options holders can enjoy a much wider risk-return combinations.
8. Options can reduce the total portfolio transaction costs.
Illustration
On 1 July 2000, S sells a call option to L for a price of Rs.3.25. Now L has
the right to come to S on 31 Dec 2000 and buy 1 share of Reliance at Rs.500.
Here, Rs.3.25 is the “option price”, Rs.500 is the exercise price” and 31 Dec
2000 is the “expiration date” L does not have to buy 1 share of Reliance on 31
Dec 2000 at Rs.5000 from S (unlike a forward/futures contract which is
binding on both sides). It is only if Reliance is above exercising the option, S
is obliged to live up to his end of the deal: i.e. S stands ready to sell a share of
Reliance to L at Rs.500 on 31 Dec 2000. Hence, at option expiration, there are
two outcomes that are possible: an option could be profitably exercised, or it
could be allowed to die unused. If the option lapses unused, then L has lost the
original option price (Rs.3.25) and S has gained it. When L and S enter into a
futures contract, there is not payment (other than initial margin). In contrast,
41
the option has positive price, which is paid in full on the date that the option is
purchased. Options come in two varieties – European and American. In a
European option, the holder of the option can only exercise his right (if he
should so desire) on the expiration date. In an American option, he can
exercise this right anytime between purchase date and the expiration date. The
price of an option is determined on the secondary market. An option always
has a non-negative value: i.e., the value of an option is never negative.
History of options
Options made their first major mark in financial history during the tulip-
bulb mania in seventeenth century Holland. It was one of the most spectacular
get rich quick binges in history. The first tulip was brought into Holland by a
botany professor from Vienna. Over a decade, the tulip became the most
popular and expensive item in Dutch gardens. The more popular they became,
the more Tulip bulb prices began rising. That was when options came into the
picture. They were initially used for hedging. By purchasing a call option on
tulip bulbs, a dealer who was committed to a sales contract could be assured of
obtaining a fixed number of bulbs for a set price. Similarly, tulip-bulb growers
could assure themselves of selling their bulbs at a set price by purchasing put
options. Later, however, speculators who found that call options were an
effective vehicle for obtaining maximum possible gains on investment
increasingly used options. As long as tulip prices continued to skyrocket, a call
buyer would realize returns far in excess of those that could be obtained by
purchasing tulip bulbs themselves. The writers of the put options also
prospered as bulb prices spiraled since writers were able to keep the premiums
and the options were never exercised. The tulip-bulb market collapsed in 1636
42
and a lot speculators lost huge sums of money. Hardest hit were put writers
who were unable to meet their commitments to purchase Tulip bulbs.
Parties in an options contract
The following are the parties in an option contract.
Buyer of the option: The buyer of an option is one who by paying the option
premium buys the right but not the obligation to exercise his option on seller
or writer.
Writer/seller of the option: The writer or seller of a call option/put option is
the one who receives the option premium and is there by obligated to sell/buy
the asset if the buyer exercises the option on him.
Types of options
The options are classified in to various types on the basis of various variables.
The following are the various types of options:
I. On the basis of the underlying asset:
On the basis of the underlying asset the options are divided into two types:
INDEX OPTIONS
Underlying assert as the index.
STOCK OPTIONS:
A stock option gives the buyer of the options the right to buy/sell stock at
a specified price. Stock options are options on the individual stocks, there
are currently more than 50 stocks, that are trading in this segment.
II. On the basis of the market movement:
On the basis of the market movement the options can be divided into two
types. They are:
43
CALL OPTION
An investor buys a call option when he seems that the stock price
moves upwards. A call option gives the holder of the option the right but not
the obligation to buy an asset by a certain date for a certain price.
Illustration
An investor buys 100 European call options on Infosys at the strike price
of Rs3500 when the current price of the stock is Rs3400 at a premium of
Rs100.
If the stock price, on the day of expiry is more than Rs3600 (Strike Price +
Cost incurred in form of premium paid), lets us say Rs3800, the buyer of the
call option will decide to exercise his option to buy the 100 Infosys shares. If
the buyer sells the shares in the market immediately, he will earn Rs200 per
share as profit (or Rs20, 000 in the whole of transaction). The seller of the call
will have the obligation to deliver the stock. In another scenario, if at the time
of expiry stock price falls below Rs3500 say suppose it touches Rs3000, the
buyer of the call option will choose to not to exercise his option. In this case
the investor loses the premium paid which shall be the profit earned by the
seller of the call option.
PUT OPTION
A put option is bought by an investor when he thinks that the stock price
moves downwards. A put option gives the holder of the option the right but
not the obligation to sell an asset by a certain date for a certain price
44
Illustration
An investor buys 100 European put options on Reliance at the strike price of
Rs300 when the current price of the stock is Rs280 at a premium of Rs15. If
the stock price, on the day of expiry is less than Rs300 (Strike Price + cost
incurred in form of premium paid), say Rs270, the buyer of the Put option will
decide to exercise his option to sell the 100 Reliance shares. He will buy 100
shares of Reliance from the market @ Rs270/share and sell the same at
Rs300 / share, he will earn Rs15 per share (taking premium paid into
consideration), as profit or Rs1,500 in the whole of transaction. The seller of
the put will have the obligation to buy the stock. In another scenario, if at the
time of expiry stock price rises above Rs300 (strike price), say suppose it
touches Rs320, the buyer of the put option will choose to not to exercise his
option to sell as he can sell in the market at a higher rate. In this case the
investor loses the premium paid which shall be the profit earned by the seller
of the put option.
III. On the basis of exercise of option:
On the basis of the exercising of the option, the options are classified into two
categories:
AMERICAN OPTION
American options are options that are exercised at any time up to the
expiration date most exchanged-traded options are American
EUROPEAN OPTION
45
European options are options that can be exercised only on the
expiration date itself. European options are easier to analyze than American
options.
PLAYERS IN OPTION MAKET
In the option markets, the players fall into four categories:
The Exchanges
Financial Institution
Market Makers
Individual(Retail) Investors
What follows is a brief overview of each group along with insights into their
trading objectives and strategies.
The Exchanges
The exchange is a place where market makers and traders gather to buy
and sell stocks, options, bonds, futures, and other financial instruments. Since
1973 when the Chicago Board Options Exchange first began trading options, a
number of other players have emerged. At first, the exchanges each
maintained separate listings and therefore didn’t trade the same contracts. In
recent years this has changed.
Now that BSE and NSE both these exchanges list and trade the same
contracts, they compete with each other. Nevertheless, even though a stock
may be listed on multiple exchanges, one exchange generally handles the bulk
of the volume. This would be considered the dominant exchange for that
particular option.
The competition between exchanges has been particularly valuable to
professional traders who have created complex computer programs to monitor
46
price discrepancies between exchanges. These discrepancies, though small,
can be extraordinarily profitable for traders with the ability and speed to take
advantage. More often than not, professional traders simply use multiple
exchanges to get the best prices on their trades.
Deciding between the two would be simply a matter of choosing the
exchange that does the most trading in this contract. The more volume the
exchange does, the more liquid the contract. Greater liquidity increases the
likelihood the trade will get filled at the best price.
Financial Institutions
Financial institutions are professional investment management
companies that typically fall into several main categories: mutual funds, hedge
funds, insurance companies, stock funds. In each case, these money managers
control large portfolios of stocks, options, and other financial instruments.
Although individual strategies differ, institutions share the same goal – to
outperform the market. In a very real sense, their livelihood depends on
performance because the investors who make up any fund tend to a fickle
group. When fund don’t perform, investors are often quick to move money in
search of higher returns.
Where individual investors might be more likely to trade equity
options related to specific stocks, fund managers often use index options to
better approximate their overall portfolios. For example, a fund that invests
heavily in a broad range of tech stocks will use NSE Nifty Index options rather
than separate options for each stock in their portfolio. Theoretically, the
performance of this index would be relatively close to the performance of a
47
subset of comparable high tech stocks the fund manager might have in his or
her portfolio.
Market Makers
Market makers are the traders on the floor of the exchanges who create
liquidity by providing two-sided markets. In each counter, the competition
between market makers keeps the spread between the bid and the offer
relatively narrow. Nevertheless, it’s the spread that partially compensates
market makers for the risk of willingly taking either side of a trade.
For market makers, the ideal situation would be to “scalp” every trade. More
often than not, however, market makers don’t benefit from an endless flow of
perfectly offsetting for trading techniques that characterize how different
market makers trade options. The same market makers depending on trading
conditions may employ any or all of these techniques.
Day Traders
Premium Sellers
Spread Traders
Theoretical Traders
Day traders
Day traders, on or off the trading screen, tend to use small positions to
capitalize on intra day market movement. Since their objective is not to hold a
position for extended periods, day traders generally don’t hedge options with
the underlying stock. At the same time, they tend to be less concerned about
delta, gamma, and other highly analytical aspects of option pricing.
Premium Sellers
48
Just like the name implies, premium sellers tend to focus their efforts
selling high priced options and taking advantage of the time decay factor by
buying them later at a lower price. This strategy works well in the absence of
large, unexpected price swings but can be extremely risky when volatility
skyrockets.
Spread Traders
Like other market makers, spread traders often end up with large
positions but they get there by focusing on spreads. In this way, even the
largest of positions will be somewhat naturally hedged. Spread traders employ
a variety of strategies buying certain options and selling others to offset the
risk. Floor traders primarily use some of these strategies like reversals,
conversions, and boxes because they take advantage of minor price
discrepancies that often only exist for seconds. However, spread traders will
use strategies like butterflies, condors, call spreads, and put spreads that can be
used quite effectively by individual investors.
Theoretical Traders
By readily making two-sided markets, market makers often find
themselves with substantial option positions across a variety of months and
strike prices. The same thing happens to theoretical traders who use complex
mathematical models to sell options that are overpriced and buy options that
are relatively under priced. Of the four groups, theoretical traders are often the
most analytical in that they are constantly evaluating their position to
determine the effects of changes in price, volatility, and time.
Individual (Retail)
49
As option volume increases, the role of individual investors becomes
more important because they account for over 90% of the volume. That’s
especially impressive when you consider that option volume in February 2000
was 56.2 million contracts – an astounding 85% increase over February 1999
The psychology of the Individual Investor
From a psychological standpoint, individual investors are in interesting
group because there are probably as many strategies and objectives as there
are individuals. For some, options are a means to generate additional income
through relatively conservative strategies such as covered calls. For others,
options in the form of protective puts provide an excellent form of insurance
to lock in profits or prevent losses from new positions. More risk tolerant
individuals use options for the leverage they provide. These people are willing
to trade options for large percentage gains even knowing their entire
investment may be on the line.
In a sense, taking a position in the market automatically means that
you are competing with countless investors from the categories described
above. While that may be true, avoid making direct comparisons when it
comes to your trading results. The only person you should compete with is
yourself. As long as you are learning, improving, and having fun, it doesn’t
matter how the rest of the world is doing.
Pricing options
Option pricing
There are two main approaches that are used to replicate an option
position and, thus, price an option. The most commonly used is an analytical
50
formula known as the Black Scholes model. The second widely –used
approach is a methodology known as the binomial model from Ross, Cox and
Rubinstein. The binomial option-pricing model is more like process than a
formula, in that it is a series of steps that can be used to price an option.
Although the two pricing models appear to be very different, mathematicians
have proven their equivalency through calculations.
The Black-Scholes option pricing formulae
The black-scholes option pricing model has been one of the most influential
formulas in finance since its initial publication in 1973. In 1997, Myron
Scholes and Robert Merton won the Nobel prize in Economics for their work
in developing the formula. Unfortunately, Fischer Black, the other major
contributor, passed away before the announcement of the Nobel awards.
Although it has its limitations, the formula is widely used.
Black and Scholes start by specifying a simple and well-known
equation that models the way in which stock prices fluctuate. This equation
called Geometric Brownian Motion, implies that stock returns will have
lognormal distribution, meaning that the logarithm of the stock’s return will
follow the normal (bell shaped) distribution. Black and Scholes then propose
that the option’s price is determined by only two variables that are allowed to
change: time and the underlying stock price. The other factors – the volatility,
the exercise price, and the risk-free rate do affect the option’s price but they
are not allowed to change. By forming a portfolio consisting of a long position
in stock and a short position in calls, the risk of the stock is eliminated. This
hedged portfolio is obtained by setting the number of shares of stock equal to
the approximated change in the call price for a change in the stock price. This
51
mix of stock and calls must be revised continuously, a process known as delta
hedging.
.
Black and Scholes then turn to a little-known result in a specialized field of
probability known as stochastic calculus. This result defines how the option
price changes in terms of combination of options and stock should grow in
value at the risk-free rate. The result boundary condition on the model that
requires the option price to converge to the exercise valued at expiration. The
end result is the Black and Scholes model.
The original Black-Scholes model is based on the following assumptions:
1. The option is European style.
2. The evolution of share prices follows a continuous random process.
3. The model is based on a lognormal distribution of stock prices.
4. No commissions or taxes are charged.
5. Short-selling is permitted and the proceeds of such a sale are immediately
available for use.
6. Stock prices move in smooth increments (there are no stock market
crashes or bubbles).
7. We can borrow or lend at the risk-free interest rate and this rate is
constant.
8. Markets are efficient and there are no arbitrage possibilities.
9. The stock pays no dividends during the life of the options.
52
10. Robert Merton later modified the last assumption and introduction a
variable to the original model accounting for continuous stock dividend
payments.
11. Development of the mathematics behind the formula is beyond the
scope of this reference manual. The equations below show the formula for
pricing a European call and put option, respectively. These equations apply
for a stock that pays a continuous dividend.
Where:
C= is the call option price
P=is the put option price
S=is the stock price
X=is the strike price
R=is the risk-free interest rate (continuously compounded)
Q=is the dividend yield (continuously compounded)
T= is the time to maturity (in years)
E=is the operator for the exponential function (equal to approximately 2.718)
N(*) is the operator for the cumulative normal distribution function
53
THE COMPANY PROFILE
The birth of Karvy was on a modest scale in 1981. It began with the
vision and enterprise of a small group of practicing Chartered Accountants
who founded the flagship company …Karvy Consultants Limited. We started
with consulting and financial accounting automation, and carved inroads into
the field of registry and share accounting by 1985. Since then, we have
utilized our experience and superlative expertise to go from strength to
strength…to better our services, to provide new ones, to innovate, diversify
and in the process, evolved Karvy as one of India’s premier integrated
financial service enterprise.
Thus over the last 20 years Karvy has traveled the success route,
towards building a reputation as an integrated financial services provider,
offering a wide spectrum of services. And we have made this journey by
taking the route of quality service, path breaking innovations in service,
versatility in service and finally totality in service.
KARVY is a premier integrated financial services provider and ranked among
the top five in the country in all its business segments, services over 16 million
individual investors in various capacities, and provides investor services to
54
over 300 corporate, comprising the who is who of Corporate India. KARVY
covers the entire spectrum of financial services such as Stock broking,
Depository Participants, Distribution of financial products like mutual funds,
bonds, fixed deposit, Merchant Banking & Corporate Finance, Insurance
Broking, Commodities Broking, Personal Finance Advisory Services,
placement of equity, IPOs, among others. Karvy has a professional
management team and ranks among the best in technology, operations, and
more importantly, in research of various industrial segments.
Quality Policy
To achieve and retain leadership, Karvy shall aim for complete
customer satisfaction, by combining its human and technological resources, to
provide superior quality financial services. In the process, Karvy will strive to
exceed Customer's expectations.
Quality Objectives
As per the Quality Policy, Karvy will:
Build in-house processes that will ensure transparent and harmonious
relationships with its clients and investors to provide high quality of
services.
Establish a partner relationship with its investor service agents and
vendors that will help in keeping up its commitments to the customers.
Provide high quality of work life for all its employees and equip them
with adequate knowledge & skills so as to respond to customer's needs.
55
Continue to uphold the values of honesty & integrity and strive to
establish unparalleled standards in business ethics.
SECTOR OF KARVY
1. KARVY CONSULTANTANTS LIMITED: Deals in
Registrar and Transfer Agent.
We have traversed wide spaces to tie up with the world’s largest transfer
agent, the leading Australian company, Computer share Limited. The
company that services more than 75 million shareholders across 7000
corporate clients and makes its presence felt in over 12 countries across 5
continents has entered into a 50-50 joint venture with us.
With our management team completely transferred to this new entity,
we will aim to enrich the financial services industry than before. The future
holds new arenas of client servicing and contemporary and relevant
technologies as we are geared to deliver better value and foster bigger
investments in the business. The worldwide network of Computer share will
hold us in good stead as we expect to adopt international standards in addition
to leveraging the best of technologies from
around the world.
KARVY SECURITIES LIMITED
Deals in distribution of various investment products, viz., equities,
mutual funds, bonds and debentures, fixed deposits, insurance policies for the
investor.
56
3. KARVY INVESTOR SERVICE LIMITED
Deals in issue management, investment banking and merchant
banking.
4. KARVY STOCK BROKING LIMITED
Deals in buying and selling equity shares and debentures on the
National Stock Exchange(NSE), the Hyderabad Stock Exchange(HSE) and the
over The Counter Exchange of India(OTCEI).
PRODUCTS & SERVICES
With greater choices comes greater value. KARVY offers you more
choices by providing a wide array of products and personalized services, so
you can take charge of your financial future with confidence.
So whether you are a new investor or a seasoned one, we have the resources
and advice you would need to make smart, well-researched investments. You
have the option to choose the level support you would like from us:
Invest Independently – If you are an independent investor and prefer calling
your own shots, you can access our extensive Market Research section for
relevant, in-depth resources and support.
SERVICES
Take our advice – If you are new to the world of investing, or are unable
to do your own research due to time constraints, our highly experienced
team of advisors will help you. get started and meet your financial goals.
Day Trading – If you thrive on the thrill of riding the market wave on a
daily basis, we offer our Day Traders the resources you would need to
strategize, buy and sell conveniently.
57
KARVY’s products and services are geared towards meeting your
individual financial requirements. To find out more about a product / service,
click on it from the menu on the left.
DEPOSITORY SERVICES
We offer Depository facilities to facilitate a seamless transaction
platform as a part of our value-added services for our clients. KARVY is a
depository participant with the Central Depository Services (India) Ltd.
(CDSL) and National Securities Depository Ltd. (NSDL) for trading and
settlement of dematerialized shares
WEALTH MANAGEMENT SERVICES
It is our aim to empower clients by helping them to diversify their
investments. To this end, KARVY has added a range of products such as
Mutual Funds, Insurance and online facilities to its offerings.
We meet our clients on an individual basis and analyze important
factors such as your risk appetite, investment horizon and your existing
investments before making our recommendations as to what clients should
invest in. The fund and scheme selection is then done after conducting in-
depth research on parameters like risk adjusted returns, rolling returns,
volatility and portfolio churn. We are also in close contact with fund houses as
well as insurance agencies and are therefore always cognizant with new
offerings and occurrences in the market and like to keep our clients updated on
the same. Our clients can pick from Mutual Funds, IPOs, and Insurance
products.Our Wealth Management Services include Portfolio Management
Services (PMS)
58
PRODUCTS
EQUITIES
Our experienced trading consultants and advanced trading tools will
provide the support you need to achieve your long-term goals via the stock
markets. We trade on the BSE, NSE and CN and our website has facilities
such as live stock tickers, news updates, and more, to help our clients stay in
the know. We also provide NRI specific services to meet the needs of our
clients who live abroad
COMMODITIES
Indian markets have recently thrown open a new avenue for investors
and traders to participate: COMMODITY DERIVATIVES. For those who
want to diversify their portfolios beyond shares, bonds and real estate,
commodities are the best option.
Commodities actually offer immense potential to become a separate asset class
for market-savvy investors, arbitrageurs and speculators. They are also easy to
understand as far as fundamentals of demand and supply are concerned.
Historically, pricing in commodities futures has been less volatile compared
with equity and bonds, thus providing an efficient portfolio diversification
option.
KARVY now offers to investors a platform to trade in COMMODITY
FUTURES. As a member of the Multi Commodity Exchange of India Ltd. and
of the National Commodity and Derivative Exchange, we offer futures trading
in 10 commodities (gold, silver, castor, soya, canola/mustard oil, crude palm
59
oil, RBD palmolein and cotton) – NCDEX and in gold, silver and castor seed,
rubber through MCX.
MARKET RESEARCH
Information is power. At KARVY, it is also at your fingertips!
KARVY is powered by a top-notch research team that penetrates and
investigates the market to provide you with reliable, relevant information that
helps you make intelligent investment decisions. Our commitment to keeping
you updated on the latest market conditions stems from our desire to give you
the option to invest in ways that are the most suitable to you.
To explore our research reports in the category of your interest, please
select it from the list on your right.
Market Musing
Company Reports
Theme Based Reports
Weekly Notes
IPOs / FPO
Sector Reports
Stock Stance
Pre-quarter/Updates
Commodity
Research Recommendation Card
Pivot Points
INVESTOR HANDBOOK
60
Registrars and Transfer Agent
(Share transfers and communications regarding share certificates,
dividends and change of address)
Purva Sharegistry (India) Pvt. Ltd.
9,ShivShaktiIndustrialEstate, GroundFloor, SitaramMiill Compound,
JR Boricha Marg, Lower Parel, Mumbai-400 011.
Tel No.: 23016761,
Fax No.: 22626407
E-Mail: [email protected]
Listing of Equity Shares on Stock Exchange at
Bombay Stock Exchange Limited,
Mumbai (BSE) Phiroze Jeejeebhoy Towers,
Dalal Street, Mumbai – 400 001
PORTFOLIO MANAGEMENT SERVICES
KARVY PMS will help you achieve your objective of preserving and
growing capital by conducting a thorough analysis of your investment needs,
returns expected and risk taking ability. Our focus is to craft a basket of
Stocks, Bonds, and Mutual Funds through strong research and corporate
interface, keeping in mind your risk-profile in specific relation with the ever.
Investment Philosophy
61
We focus on a Bottom – Up approach to stock picking. The stock selection
process starts with fundamental analysis of companies and includes
management meeting and plant visits to get a first hand feel of the company,
rather than depending solely on quantitative analysis. The investment process
is fairly rigorous and includes qualitative as well as quantitative criteria and
builds upon the decade long experience of KARVY in Indian equity markets.
Who is it for?
Our offering is ideal for high net-worth customers -
Who are investing in Indian equities
Who desire to create wealth over longer period
Who appreciate a high level of personalized service
Benefits of being with KARVY PMS
Portfolio Management with a difference Every investor, whether individual or
corporate, has unique needs based on their objectives and risk profiles. We
recognize the difference and design tailored investment advice to achieve
specific investment objectives.
Professional Management- We offer professional management of your
equity portfolio with an aim to deliver consistent returns while
controlling risk.
Continuous Monitoring- We recognize that portfolios need to be
constantly monitored and periodically churned to optimize the results.
Risk Control- The portfolios are managed through a strong research
driven investment process with complete transparency and highest
standards of service.
62
Transparency- You will get regular account statements and
performance reports on a monthly basis/ That's not all; web-enabled
access ensure that you are just a click away from all information relating
to your investment.
Hassle Free Operation- Our Portfolio Management Service relieves
you from all the administrative hassles of your investments. We provide
periodic reporting on the performance and other aspects of your
portfolio.
Dedicated Relationship Manager- Our Relationship Managers
specialize in providing personal investment management services to
achieve your investment objective.
Infrastructure
A corporate office and 3 divisional offices in CBD of Mumbai which
houses state-of-the-art dealing room, research wing & management and
back offices.
All of 107 branches and franchisees are fully wired and connected to hub
at corporate office at Mumbai. Add on branches also will be wired and
connected to central hub
Web enabled connectivity and software in place for net trading.
60 operative ID’s for dealing room
State of the Art accounting and billing system, on line risk management
system in place with 100% redundancy back up.
Milestones of Karvy
63
ANALYSIS AND INTERPRETATION GRAPH
DEC-2011 TO JAN-2012 FEATURES INDEX NIFTY-50
64
DATE DAY OPEN HIGH LOW CLOSE13-Dec-11 MON 4069.00 4110.85 4060.20 4081.5014-Dec-11 TUE 4098.60 4098.60 4021.90 4069.7015-Dec-11 WED 4095.00 4167.75 4095.00 4138.6016-Dec-11 THU 4136.75 4165.35 4109.83 4144.3520-Dec-11 MON 4144.70 4197.00 4060.85 4179.4021-Dec-11 TUE 4184.25 4230.15 4126.40 4178.5522-Dec-11 WED 4179.10 4300.05 4179.10 4274.3023-Dec-11 THU 4271.00 4289.80 4193.35 4279.7024-Dec-11 FRI 4282.45 4357.10 4221.60 4287.8527-Dec-11 MON 4287.55 4338.30 4231.65 4272.0028-Dec-11 TUE 4278.10 4347.00 4142.90 4156.9529-Dec-11 WED 4166.65 4224.20 4112.55 4200.1030-Dec-11 THU 4208.80 4244.15 4172.00 4206.8031-Dec-11 FRI 4204.40 4236.40 4115.90 4218.9003-Jan-12 MON 4065.00 4065.00 4825.75 4935.7504-Jan-12 TUE 4937.95 4013.15 4880.30 4913.2005-Jan-12 WED 4907.75 4908.75 4677.00 4705.3006-Jan-12 THU 4705.00 4705.00 4977.10 4208.8007-Jan-12 FRI 4203.35 4203.35 4448.50 4899.3011-Jan-12 MON 4093.05 4328.05 4891.60 4203.4012-Jan-12 TUE 4208.00 4357.20 4995.80 4033.4512-Jan-12 WED 4035.05 4399.25 4065.05 4383.3513-Jan-12 THU 4380.95 4380.95 4071.00 4274.1017-Jan-12 MON 4279.55 4391.60 4225.25 4280.8018-Jan-12 TUE 4272.00 4359.00 3957.75 4005.2519-Jan-12 WED 4329.00 4406.90 4150.00 4389.9020-Jan-12 THU 4412.25 4412.25 4045.00 4270.0521-Jan-12 FRI 4340.00 4393.00 4216.00 4278.1524-Jan-12 MON 4152.50 4268.50 4128.00 4156.7525-Jan-12 TUE 4248.70 4253.60 4072.00 4133.25
TABLE - 1
DECEMBER III RD WEEK GRAPH
DATE DAY OPEN HIGH LOW CLOSE
65
13-Dec-11 MON 4110.00 4141.50 4097.00 4120.3014-Dec-11 TUE 4080.00 4127.00 4047.10 4118.3015-Dec-11 WED 4147.00 4178.95 4123.00 4162.9516-Dec-11 THU 4150.00 4179.95 4121.00 4156.4020-Dec-11 MON 4149.10 4236.00 4060.00 4220.1021-Dec-11 TUE 4185.65 4227.00 4155.00 4178.20
1ST MONDAY: OPEN=4611.00
HIGH=4236.00
LOW=4047.00
CLOSE=4178.00
INTERPRETATION:
DECEMBER 3RD WEAK
CLOSE
HIGH
LOW
OPEN
3950
4000
4050
4100
4150
4200
4250
MON TUE WED THU MON THU
13-12-2011 14-12-2011 15-12-2011 16/12/2011 20/12/2011 21/12/2011
DATE & DAY
NIF
TY
SH
AR
E V
AL
UE
BEP
66
In the above graph I calculated BEP:
Breakeven point (BEP) =HIGH VALUE+LOW VALUE/2
=4236.00+4047.00/2
=8283.00
=4141.50
In this graph I observed the following fluctuations. In the period of (13-12-
2011 to 21-12-2011) in these I found as BEP was 4141.00 values. Here I
observed as value share is a lose of point of Nifty-50 value was (4141.00-
4047.00=94) so here share value is decrease. Due to UN expected change in
market, politics and lack of expects of investors. Here I observed as there is a
change of Nifty-50 share value. That is period of (20-12-2011) is go’s to share
value high (4141.00-4236.00=95) so here share value is increased. And it is
good signal of investment to the buyers. So here investors get more longs.
DEC-2011 TO JAN-2012 FUTURES
67
DATE DAY OPEN HIGH LOW CLOSE13-Dec-11 MON 4110.00 4141.50 4097.00 4120.3014-Dec-11 TUE 4080.00 4127.00 4047.10 4118.3015-Dec-11 WED 4147.00 4178.95 4123.00 4162.9516-Dec-11 THU 4150.00 4179.95 4121.00 4156.4020-Dec-11 MON 4149.10 4236.00 4060.00 4220.1021-Dec-11 TUE 4185.65 4227.00 4155.00 4178.2022-Dec-11 WED 4205.00 4292.75 4203.10 4264.4523-Dec-11 THU 4170.00 4296.00 4170.00 4288.2524-Dec-11 FRI 4307.80 4331.90 4214.25 4272.8027-Dec-11 MON 4263.10 4336.00 4226.10 4264.4028-Dec-11 TUE 4279.00 4321.65 4141.10 4160.6029-Dec-11 WED 4150.35 4225.00 4115.10 4203.6030-Dec-11 THU 4205.35 4542.40 4171.25 4224.7531-Dec-11 FRI 4110.40 4342.60 4166.40 4060.4003-Jan-12 MON 4984.80 4993.80 4831.60 4947.6504-Jan-12 TUE 4931.00 4045.00 4887.00 4931.7505-Jan-12 WED 4862.00 4927.25 4700.00 4730.3506-Jan-12 THU 4691.00 4691.00 4916.00 4197.8507-Jan-12 FRI 4925.00 4997.50 4420.00 4894.0011-Jan-12 MON 4080.00 4337.00 4930.00 4166.9012-Jan-12 TUE 4272.00 4359.00 4957.75 4005.2512-Jan-12 WED 4329.00 4406.90 4150.00 4389.9013-Jan-12 THU 4412.25 4412.25 4045.00 4270.0517-Jan-12 MON 4340.00 4393.00 4216.00 4278.1518-Jan-12 TUE 4152.50 4268.50 4128.00 4156.7519-Jan-12 WED 4248.70 4253.60 4072.00 4133.2520-Jan-12 THU 4329.00 4406.90 4150.00 4389.9021-Jan-12 FRI 4412.25 4412.25 4045.00 4270.0524-Jan-12 MON 4340.00 4393.00 4216.00 4278.1525-Jan-12 TUE 4152.50 4268.50 4128.00 4156.75
TABLE - 2
DECEMBER IV TH WEEK GRAPH
68
DATE DAY OPEN HIGH LOW CLOSE22-Dec-11 WED 4185.65 4227.00 4155.00 4178.2023-Dec-11 THU 4205.00 4292.75 4203.10 4264.4524-Dec-11 FRI 4170.00 4296.00 4170.00 4288.2527-Dec-11 MON 4307.80 4331.90 4214.25 4272.8028-Dec-11 TUE 4263.10 4336.00 4226.10 4264.4029-Dec-11 WED 4279.00 4321.65 4141.10 4160.60
2ND MONDAY: OPEN=4185.00
HIGH=4336.00
LOW=4141.00
CLOSE=4160.00
INTERPRETATION:
DECEMBER 4TH WEEK
BEP
OPEN
HIGH
LOW&
CLOSE
4000
4050
4100
4150
4200
4250
4300
4350
4400
WED THU FRI MON TUE WED
22/12/2011 23/12/2011 24/12/2011 27/12/2011 28/12/2011 29/12/2011
DATE & DAY
NIF
TY
SH
AR
E V
AL
E
69
In the above graph I calculated BEP.
BREAKEVEN POINT (BEP) = HIGH VALUE+LOW VALUE/2
=4336.00+4141.00/2
=8477.00/2
=4238.50
In this graph I observed the following fluctuations. In the period of (22-12-
2011 to 29-12-2011).In these I found as BEP was 4238.00. Here I observed as
value share is a high rate so Nifty-50 value was (4238.00-4336.00=98.00)
share value is increased. So it is a good signal of investor to long to the shares.
and I observed share value is loss of point Nifty-50 was (4238.00-
4141.00=97.00) this value are investor in most loss so this is un expected
changes in market and politics and lack of expects of investors.
DEC-2011 TO JAN-2012 CONTRACT AND SWAPS
70
DATE DAY OPEN HIGH LOW CLOSE13-Dec-11 MON 4099.00 4130.00 4088.10 4109.7514-Dec-11 TUE 4051.05 4130.00 4041.00 4109.9015-Dec-11 WED 4130.00 4171.00 4115.15 4151.4516-Dec-11 THU 4138.00 4169.00 4112.35 4148.1020-Dec-11 MON 4140.00 4227.00 4056.95 4211.2021-Dec-11 TUE 4130.00 4217.00 4130.00 4174.5522-Dec-11 WED 4200.00 4287.00 4192.10 4261.6523-Dec-11 THU 4249.70 4290.00 4175.00 4284.6024-Dec-11 FRI 4320.00 4333.00 4212.00 46269.6527-Dec-11 MON 4250.00 4333.00 4227.40 4264.8528-Dec-11 TUE 4271.00 4317.00 4141.00 4161.3029-Dec-11 WED 4199.00 4222.90 4115.00 4202.3530-Dec-11 THU 4220.00 4240.00 4170.00 4224.2531-Dec-11 FRI 4210.60 4228.80 4140.80 4020.6003-Jan-12 MON 4017.70 4017.70 4834.60 4951.5004-Jan-12 TUE 4945.00 4049.00 4885.00 4933.1005-Jan-12 WED 4901.00 4927.10 4700.00 4728.9506-Jan-12 THU 4680.00 4680.00 4920.40 4204.2507-Jan-12 FRI 4900.00 4999.00 4400.00 4885.6511-Jan-12 MON 4105.00 4329.00 4925.00 4157.6612-Jan-12 TUE 4319.00 4348.00 4942.20 4996.2512-Jan-12 WED 4875.00 4395.00 4069.80 4374.9013-Jan-12 THU 4265.00 4281.00 4026.55 4252.9017-Jan-12 MON 4298.70 4376.00 4200.00 4261.0018-Jan-12 TUE 4250.00 4265.00 4102.15 4132.0019-Jan-12 WED 4200.00 4243.00 4045.00 4083.6020-Jan-12 THU 4329.00 4406.90 4150.00 4389.9021-Jan-12 FRI 4412.25 4412.25 4045.00 4270.0524-Jan-12 MON 4340.00 4393.00 4216.00 4278.1525-Jan-12 TUE 4152.50 4268.50 4128.00 4156.75
TABLE - 3
JANUARY I ST & 2 ND WEEK GRAPH
71
DATE DAY OPEN HIGH LOW CLOSE30-Dec-11 THU 4279.00 4321.65 4141.10 4160.6031-Dec-11 FRI 4150.35 4225.00 4115.10 4203.603-Jan-12 MON 4205.35 4542.40 4171.25 4224.754-Jan-12 TUE 4110.40 4342.60 4166.40 4060.405-Jan-12 WED 4984.80 4993.80 4831.60 4947.656-Jan-12 THU 4931.00 4045.00 4887.00 4931.75
TABLE – 7
3RD MONDAY : OPEN=4279.00
HIGH=4831.00
LOW=4542.00
CLOSE=4931.00
INTERPRETATION:
JANUARY 1 ST & 2 ND WEEK
CLOSE
LOW
HIGH
OPEN
BEP
3400
3600
3800
4000
4200
6400
4600
THU FRI MON TUE WED THU
30/12/2011 31/12/2011 03-01-2012 04-01-2012 05-01-2012 06-01-2012
DATE AND DAY
NIF
TY
SH
AR
E V
AL
UE
72
In the above graph I calculated BEP.
BREAKEVEN POINT (BEP) = HIGH VALUE+LOW VALUE/2
=4542.00+4831.00/2
=9373.00/2
=4686.50
In this graph I observed the following fluctuations in the period of (30-12-
2011 to 06-01-2012) in this period I found as BEP rate was 4686.00 values. So
here I observed has value share is high rate so Nifty-50 value was (4686.00-
4542.00 = 144.00). so here share value is decreased so it is a bad signal of
investor so here investor get more losses and more longs. And I observed as
share value is profit of point to Nifty-50 was (4686.00-4931.00=245). So here
share value increased here investor gets more profits and more gains. So this is
unexpected change in market and politics and lack of experts to investors.
DEC-2011 TO JAN-2012 FORWORDS
73
DATE DAY OPEN HIGH LOW CLOSE13-Dec-11 MON 4085.00 4110.60 4010.30 4090.8014-Dec-11 TUE 4070.05 4105.00 4035.00 4100.6515-Dec-11 WED 4123.70 4155.00 4110.00 4139.6016-Dec-11 THU 4129.95 4157.90 4110.00 4136.2520-Dec-11 MON 4134.00 4215.00 4050.00 4201.6521-Dec-11 TUE 4130.05 4208.00 4121.00 4162.4522-Dec-11 WED 4200.00 4275.00 4180.10 4250.6523-Dec-11 THU 4200.00 4279.70 4175.00 4272.3524-Dec-11 FRI 4299.00 4318.95 4205.00 4261.1027-Dec-11 MON 4270.00 4320.05 4215.00 4255.2028-Dec-11 TUE 4280.05 4307.90 4140.00 4155.7029-Dec-11 WED 4145.15 4214.00 4115.00 4191.3530-Dec-11 THU 4198.00 4231.00 4167.00 4214.2531-Dec-11 FRI 4210.30 4220.00 4140.80 4040.9003-Jan-12 MON 4000.00 4000.00 4835.00 4947.9504-Jan-12 TUE 4921.05 4044.50 4882.05 4927.7505-Jan-12 WED 4900.00 4923.00 4175.90 4740.1506-Jan-12 THU 4700.00 4700.00 4950.00 4195.90
07-Jan-12 FRI 4058.00 4058.00 4305.00 4896.5511-Jan-12 MON 4110.00 4329.00 4910.00 4158.3512-Jan-12 TUE 4315.00 4340.00 4949.00 4994.1512-Jan-12 WED 4195.00 4399.60 4150.05 4377.8513-Jan-12 THU 4200.00 4297.00 4029.70 4258.8517-Jan-12 MON 4349.00 4389.90 4200.10 4262.4018-Jan-12 TUE 4218.05 4249.95 4100.00 4119.1519-Jan-12 WED 4155.00 4234.00 4049.00 4066.0020-Jan-12 THU 4329.00 4406.90 4150.00 4389.9021-Jan-12 FRI 4412.25 4412.25 4045.00 4270.0524-Jan-12 MON 4340.00 4393.00 4216.00 4278.1525-Jan-12 TUE 4152.50 4268.50 4128.00 4156.75
TABLE - 4
JANUARY III RD WEEK GRAPH:
74
DATE DAY OPEN HIGH LOW CLOSE7-Jan-12 FRI 4931.00 4045.00 4887.00 4931.7510-Jan-12 MON 4862.00 4927.25 4700.00 4730.3511-Jan-12 TUE 4691.00 4691.00 4916.00 4197.8512-Jan-12 WED 4925.00 4997.50 4420.00 4894.0013-Jan-12 THU 4080.00 4337.00 4930.00 4166.9017-Jan-12 MON 4272.00 4359.00 4957.75 4005.25
TABLE – 8
4TH MONDAY: OPEN=3931.00
HIGH=4420.00
LOW=4045.00
CLOSE=4005.00
INTERPRETATION:
In the above graph I calculated BEP.
JANUARY 3 RD WEEK
CLOSELOW
HIGHOPEN
BEP
0
1000
2000
3000
4000
4500
6000
6000
FRI MON TUE WED THU MON
07-01-2012 10-01-2012 11-01-2012 12-01-2012 13-01-2012 17-01-2012
DATE & DAY
NIF
TY
SH
AR
E V
AL
UE
75
BREAKEVEN POINT (BEP) = HIGH VALUE+LOW VALUE/2
=4045.00+4420.00/2
=8465.00/2
=4232.00
In this graph I observed fluctuations in the period of (07-01-2012 to 17-01-
2012) in this graph I found as BEP was 4232.00 share value .Here I observed
as a value share is high rate so Nifty-50 value was (4232.00-4420.00=188.00)
so here share value is increased so it is good signal of investors so here
investors gets more profits and more longs and I observed share value is Nifty-
50 was (4232.00-4045.00 = 187). so here share value decreased so here
investors gets more loss and more shorts. So this is unexpected changes in
market and politics and lack of experts of investors.
JANUARY IV TH WEEK GRAPH:
76
DATE DAY OPEN HIGH LOW CLOSE18-Jan-12 TUE 4272.00 4359.00 3957.75 4005.2519-Jan-12 WED 4329.00 4406.90 4150.00 4389.9020-Jan-12 THU 4412.25 4412.25 4045.00 4270.0521-Jan-12 FRI 4340.00 4393.00 4216.00 4278.1524-Jan-12 MON 4152.50 4268.50 4128.00 4156.7525-Jan-12 TUE 4248.70 4253.60 4072.00 4133.25
TABLE – 9
5TH MONDAY: OPEN =4272.00
HIGH =4412.00
LOW =3957.00
CLOSE=4133.00
INTERPRETATION
JANUARY 4 TH WEEK
CLOSE
HIGH
LOW
OPENBEP
3700
3800
3900
4000
4100
4200
4300
4400
4500
TUE WED THU FRI MON TUE
18-01-2012 19-01-2012 20-01-2012 21-01-2012 24-01-2012 25-01-2012
DATE & DAY
NIF
TY
SH
AR
E V
AL
UE
77
In the above graph I calculated BEP.
BREAKEVEN POINT (BEP) = HIGH VALUE+LOW VALUE/2
=4412.00+ 3957.00/2
=8369.00/2
=4184.00
In this graph I observed fluctuations in the period of (18-01-2012 to 25-01-
2012) in this graph I found as BEP was 4184.00 share value .Here I observed
as a value share is high rate so Nifty-50 value was (4184.00-3957.00=227.00)
so here share value is decreased so here investors gets more losses and more
shorts .so this is unexpected change in the market and politics and lack of
expects of investors .and I observed share value is Nifty-50 was (4184.00-
4412.00 = 228.00). So here share value increased so here investors gets more
profits and more longs.
FINDINGS
78
Derivatives market is an innovation to cash market. Approximately its
daily turnover reaches to the equal stage of cash market. The average
daily turnover of the NSE derivative segments
In cash market the profit/loss of the investor depend the market price
of the underlying asset. The investor may incur Hugh profit or he may
incur Hugh profits or he may incur Hugh loss. But in derivatives
segment the investor the investor enjoys Hugh profits with limited
downside.
In cash market the investor has to pay the total money, but in
derivatives the investor has to pay premiums or margins, which are
some percentage of total money.
Derivatives are mostly used for hedging purpose.
In derivative segment the profit/loss of the option writer is purely
depend on the fluctuations of the underlying asset.
SUGGESTIONS
79
The investors can minimize risk by investing in derivatives. The use of
derivative equips the investor to face the risk, which is uncertain.
Though the use of derivatives does not completely eliminate the risk,
but it certainly lessens the risk .
It is advisable to the investor like to invest in the derivatives market
because of the greater amount of liquidity offered by the financial
derivatives and the lower transaction costs associated with the trading of
financial derivatives.
The derivative products give the investor an option or choice whether
the exercise the contract or not.
Option gives the choice to the investor to either exercise his right or
not.
If on expiry date the investor finds that the underlying asset in the
option contract is traded at a less price in the stock market then,
he has the full liberty to get out of the option contract and go ahead and
buy the asset from the stock market.
So in case of high uncertainty the investor can go for option.
However, these instruments act as a powerful instrument for
knowledge traders to expose them to the properly calculated and well
understood risks in pursuit of reward i.e profit.
80
CONCLUSION
Derivative have existed and evolved over a long time, with roots in
commodities market .In the recent years advances in financial markets
and technology have made derivatives easy for the investors.
Derivatives market in India is growing rapidly unlike equity
markets .Trading in derivatives require more than average understanding
of finance. Being now markets. Maximum numbers of investors have not
yet understood thee full implications of the trading in derivatives. SEBI
should take actions to create awareness in investors about the derivative
market.
Introduction of derivative implies better risk management. These markets
can greater depth, stability and liquidity to India capital markets.
Successful risk management with derivatives requires a through
understanding 0 principles that govern the pricing of financial derivatives.
In order to increase the derivatives market in India SEBI should revise
some of their regulation like contract size ,participation of Fill in the
derivative market. Contract size should be minimized because small
investor cannot afford this much of huge premiums.
Derivatives are mostly used for hedging purpose.
In derivative market the profit and loss of the option writer /option holder
purely depends on the fluctuations of the underlying.
81
BIBLIOGRAPHY
TEXT BOOKS
S.No Name of the
Author
Title of Book Publisher Year EDITION
1 IM PANDEY FINANCIAL
MANAGEMENT
VIKAS
PUBLISHING
HOUSE. PVT.LTD.
2008 9TH
EDITION
3RD
EDITION
6TH
EDITION
2 R MAHAJAN FUTURES & OPTIONS VISION BOOKS
PVT.LTD
2011
3 DONALD E.
FISCHER &
J. JORDAN
RONALD
SECURITY ANALYSIS
AND PORTFOLIO
MANAGEMENTPRENTICE HALL 1995
MAGAZINES:
BUSINESS TODAY
BUSINESS WORLD
WEB SITES
www.karvystock.com
www.derivativesindia.com
www.nseindia.com
www.bseindia.com
www.hseindia.com
82