Project Report of Debasish

8/7/2019 Project Report of Debasish

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A STUDY

ON

VARIOUS RISKS HEDGING (Derivatives)

IN STOCK MARKET

Submitted By

DEBASISH GUPTA

IN PARTIAL FULFILLMENT FOR THE AWARD OF THE

DEGREE

OF

BACHELOUR OF BUSINESS ADMINISTRATION (BBA)

GYAN JYOTI COLLEGE

NORTH BENGAL UNIVERSITY

GYAN JYOTI COLLEGENORTH BENGAL UNIVERSITY


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G YA N J Y O T I C O L L E G E

N O RT H B E N G A L U N I V E R S I T Y

A STUDYON

VARIOUS RISKS HEDGING TECHNIQUES (Der iva t ives )

IN

STOCK MARKET

DEBASISH GUPTA

REG.NO:-790045

ROLL.NO:-79 /BBA/080226

IN PARTIAL FULFILLMENT FOR THE AWARD OF

THE

DEGREE

OF

BACHELOUR OF BUSINESS ADMINISTRATION (BBA)

G Y A N J Y O T I C O L L E G E

NORTH BENGAL UNIVERSITY

MAY 2011


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N O RT H B E N G A L U N I V E R S I T Y

EXAMINNERS CERTIFICATE

C er t if i ed t h at p r oj e ct r e po r t A S TU DY O N VAR IO US R IS KSH E D G I NG T E C H N IQ U E S ( D e r iv a t i v es ) I N S T O C K M A R K E T i s

t h e b o n a f i d e w o r k o f M r D e b as i s h G u p t a w h o c a r r ie d t h e p r o j e c t

u nd er m y g ui da nc e. T hi s p ro je ct i s a pp ro ve d a nd i s a cc ep ta bl e

q u a l i t y a n d f o r m .

In te rna l Examiner Ex te rna l Examiner


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To whom so ever it may concern

This is to certify that the project report entitled A STUDY ON VARIOUS RISKS

HEDGING TECHNIQUES (Derivatives) IN STOCK MARKET Submitted in partial

fulfillment of the requirements for the degree of Bachelor of Business Administration in

Gyan Jyoti College under North Bengal Univercity.

Debasish Gupta Reg.No.790045 & Roll. NO. 79/BBA/080226 has worked under my

supervision and guidance and that no part of this report has been submitted for the award

of any other degree, Diploma, Fellowship or other similar titles or prizes and that the

work has not been published in any journal or Magazine.

C e r t i f i e d

n a m e

( B a c h e l o r o f B u s i n e s s A d m i n i s t r a t i o n )


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ACKNOWLEDGEMENT

O f m a ny p e op l e w h o h a ve e n or m ou s ly h e lp f ul i n c o nd u ct i ng t h is

p r o j e c t I a m e s p e c i a l l y g r a t e f u l t o T h e B r a n c h m a n a g e r M r s . Ta n i m a

G ho sh o f h is c on ti nu ed s up po rt , e nc ou ra ge me nt a nd f r i en dl y

b e h a v i o u r. I w o u l d l i k e t o t h a n k p a r t i c u l a r l y M r s . M o o n M o o n S i n g h

( S e n ) , R e g i o n a l C o - O r d i n a t o r , I N D I A B U L L S F I N A N C E LT D . F o r

d e v o t i n g h i s / h e r v a l u a b l e t i m e a n d b r i e f i n g m e o n v a r i o u s a s p e c t o f

t h e s t u d y o n v a r i o u s r i s k s h e d g i n g t e c h n i q u e s ( d e r i v a t i v e s ) .

I w o u ld l i k e t o A c k no w l ed g e m en t m y Te a c h e r M r s . M o n al i s a , B B A

F a cu l ty o f Gy an J yo t i C o ll e ge f o r h e r b e st g u id a nc e d ur i ng t h e

c o u r s e o f m y s t u d y.

I a m a l s o t h a n k f u l t o a l l t h e s t a f f s o f I N D I A B U L L S F I N A N C E LT D .

I n S i l i g u r i B r a n c h a n d a l l t h e s t a f f s o f t h o s e p a r t i c u l a r w h e r e

I a m c o n d u c t i n g t h e s t u d y f o r t h e i r a d u r i n g t h e c o u r s e o f m y p r o j e c t .

( DEBASISH GUPTA)

(Reg . No .

: - 790045 )

(R o l l . No . : -

79 /BBA/080226 )


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N O RT H B E N G A L U N I V E R C I T Y

STUDENT DECLARATION

I h er e b y d ec la re t ha t I a m D eb as is h G up ta a s tu de nt o f G YAN

J Y O TI C O LL E GE u n d e r N O RT H B E NG A L U N IV E R CI T Y, g o i n g t o

u nd er t ak e t he p ro je ct t i t le A S TU DY O N VAR IO US R IS KS

H E DG I NG T E CH N I QU E S ( D er i va t iv e s) I N S T OC K M AR K ET .

S u b m i t t e d i n p a r t i a l f u l f i l l m e n t o f t h e r e q u i r e m e n t s f o r t h e d e g r e e

o f B AC HE LO R O F B US IN ES S A DM IN IS TR AT IO N t o N ORTH

B E N G A L U N I V E R S I T Y, I N D I A , i s m y o r i g i n a l w o r k a n d w o u l d n o t b e s u b m i t t e d f o r t h e a w a r d o f a n y o t h e r d e g r e e , d i p l o m a , f e l l o w s h i p ,

o r a n y o t h e r s i m i l a r t i t l e o r p r i z e s .

P L A C E : S i l i g u r i D e b a s i s h G u p t a

D a t e : ( R e g . N o . : - 7 9 0 0 4 5 )

( R o l l . N o . : - 7 9 / B B A / 0 8 0 2 2 6 )


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N O RT H B E N G A L U N I V E R C I T Y

UNIVERSITY STUDY CENTRE CERTIFICATE

T h i s i s t o c e r t i f y t h a t t h e p r o j e c t e n t i t l e d A S T U D Y O N VA R I O U S

R I SK S H E DG I NG T E CH N IQ U E S ( D ER I VAT IV E S) I N S T OC K

M A R K E T s u b mi t t e d i n p a r ti a l f u l f il l m en t o f t h e r e q u i r e me n t s f o r

t h e D e g r e e o f B a c h e l o r o f B u s i n e s s A d m i n i s t r a t i o n o f G y a n J y o t i

C o l l e g e u n d e r N o r t h B e n g a l U n i v e r s i t y.

D E B A S I S H G U P TA h a s wo r k e d u n d e r m y s u p e r v i s i o n a n d g u i d a n c e

a n d t h a t n o p a r t o f t h i s r e p o rt h a s b e e n s u b m it t e d f o r t h e a w a r d o f

a n y o t he r d e gr e e, d i p l om a, f e l l ow s hi p o r o t h e r s i mi l ar t i t l es o r

p r i ze s a n d t h a t t h e w or k h a s n o t b e en p u b l i sh e d i n a n y j o u rn a l o r

m a g a z i n e .

C e r t i f i e d


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TABLE OFCONTENT

Subjects Page

CHAPTER 1 Introduction.1 -60

1.1 Back ground of the study

1.2 Introduction of derivatives

1.3 Objective of study

1.4 Overview of Company

CHAPTER 2 Methodology.61 - 65

2.1 Literature Review

2. 2 Type of Research

2. 3 Sampling Techniques

2. 4 Sample Description

2. 5 Instrumentation Techniques

2.6 Actual Collection Data

2.7 Tools used for Testing of Hypothesis

2. 8 Sample procedure

2. 9 Data Collection

2. 10 Focus Group Interview

2. 11 Other Software Used for Data Collection

CHAPTER 3 Analysis and interpretation66 - 117

3.1 Research Design

3.2 Presentation and Analysis of the Data

CHAPTER 4 Finding & Suggestion 118-123

CHAPTER 5 AnnexureB i b l i o g r a p h y


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Ta b l e - 1 M o n t h l y i n c o m e o f t h e R e s p o n d e n t s 7 0

Ta b l e 2 E d u c a t i o n Q u a l i f i c a t i o n s o f R e s p o n d e n t s 7 2

Ta b l e 3 P r o f e s s i o n s o f R e s p o n d e n t s . . 7 4

Ta b l e 4 S a v i n g s P a t t e r n s o f t h e R e s p o n d e n t s . 7 6

Ta b l e 5 S a v i n g s P a t t e r n s o f t h e R e s p o n d e n t s . 7 8

Ta b l e 6 R e s p o n d e n t s M e a n s o f I n v e s t m e n t . 8 0

Ta b l e 7 O b j e c t i v e o f R e s p o n d e n t s r e g a r d i n g i n v e s t m e n t 8 2

Ta b l e 8 Aw a r e n e s s o f r i s k i n s t o c k m a r k e t . . 8 4

Ta b l e 9 Aw a r e n e s s o f r i s k h e d g i n g t o o l s a v a i l a b l e i n s t o c k

Marke t.86

Ta b l e 1 0 R e s p o n d e n t s a w a r e n e s s t h a t b r o k e r i s u s i n g r i s k

h e d g i n g t e c h n i q u e . . 8 8

Ta b l e 11 Ty p e s o f r i s k h e d g i n g t e c h n i q u e u s e d b y i n v e s t o r 9 0

Ta b l e 1 2 S o u r c e o f a w a r e n e s s m e c h a n i s m r e g a r d i n g r i s k

H e d g i n g 9 2

Ta b l e 1 3 E n j o y i n g t h e b e n e f i t s b y u s i n g r i s k h e d g i n g

Te c h n i q u e . . 9 4

Ta b l e 1 4 S h o w i n g R e s p o n d e n t s a r e g e t t i n g b e n e f i t b y r i s k

h e d g i n g t e c h n i q u e s . . . . 9 6

Ta b l e 1 5 M a j o r p r o b l e m s e n c o u n t e r e d b y i n v e s t o r i n u s i n g

r i s k h e d g i n g t o o l s . . 9 8

Ta b l e 1 6 S a t i s f a c t i o n l e v e l o f i n v e s t o r u s i n g d e r i v a t i v e

r i s k h e d g i n g t o o l s . . 1 0 0

Ta b l e 1 7 S h o w i n g R e s p o n d e n t s a b o u t D e r i v a t i v e s . . 1 0 2

Ta b l e 1 8 U s e o f d e r i v a t i v e i n s t o c k m a r k e t b y b r o k e r . . 1 0 4

Ta b l e 1 9 Ty p e s o f d e r i v a t i v e t e c h n i q u e u s e d b y b r o k e r 1 0 6

Ta b l e 2 0 B r o k e r s r ec o m m e n d e d f o r d e r i v a t i v e s 1 0 8

Ta b l e 2 1 M a i n O b j e c ti v e f o r D e r i v a t i v e s . 11 0

Ta b l e 2 2 S h o w i n g R e s p o n d e n t s a w a r e n e s s o f D e r i v a t i v e s

Te c h n i q u e s . . 11 2

Ta b l e 2 3 E f f e c t i v e n e s s o f u s i n g d e r i v a t i v e s . 11 4C h a r t - 1 M o n t h l y i n c o m e o f t h e R e s p o n d e n t s 7 1


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C h a r t 2 E d u c a t i o n Q u a l i f i c a t i o n s o f R e s p o n d e n t s . 7 3

C h a r t 3 P r o f e s s i o n s O f R e s p o n d e n t s . . 7 5

C h a r t 4 S a v i n g s P a t t e r n s O f t h e R e s p o n d e n t s . 7 7

C h a r t 5 S a v i n g s P a t t e r n s O f t h e R e s p o n d e n t s . 7 9

C h a r t 6 R e s p o n d e n t s M e a n s o f I n v e s t m e n t . . 8 1

C h a r t 7 O b j e c t i v e o f R e s p o n d e n t s r e g a r d i n g i n v e s t m e n t 8 3

C h a r t 8 Aw a r e n e s s o f r i s k i n s t o c k m a r k e t . . 8 5

Chart 9 Awa renes s o f r i s k hedg ing to o l s av a i l ab l e i n s tock

Marke t87

Chart 10 R esponden t s aw arenes s t ha t b roke r i s u s ing r i sk

h e d g i n g t e c h n i q u e . 8 9

Chart 11Types o f r i s k hedg ing t ec hn iqu e used by in ves to r. .91Chart 12 S ource o f a warenes s r eg a rd ing r i sk hedg in g

M e c h a n i s m . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 3

Chart 13En jo y ing the bene f i t s by us ing r i sk hedg in g

Te c h n i q u e . 9 5

Chart 14 Sh owing Respon den t s a r e ge t t i ng bene f i t by r i s k

h e d g i n g t e c h n i q u e s 9 7

Chart 15 Ma j o r p ro b lems encoun te red by in ves to r i n u s ingr i s k h e d g i n g t o o l s . 9 9

Chart 16 Sa t i s f ac t i on l eve l o f i nves to r u s in g de r iv a t ive 101

Ta b l e 1 7 S h o w i n g R e s p o n d e n t s a b o u t D e r i v a t i v e s . . 1 0 3

Chart 18 Use o f de r iva t ive i n s toc k marke t by b roke r 105

Chart 19 Typ es o f d e r iva t i ve t ec hn ique used by b roke r. .. . .1 07

Chart 20 Broke r r ecomme nded fo r de r iva t ives ..109

Chart 21 Ma in Ob jec t i ve fo r Der iva t i ves. 111

Chart 22 S howin g Res ponden t s aw arenes s o f D er iva t i ves

Te c h n i q u e s . . . . 11 3

Chart 23 Effec t i venes s o f u s ing de r iva t ives 115


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EXCUTIVE SUMMERY

I) Introduction

India Bulls Agency the most admired broker agency, offers a wide range of investing

product. Its specialized subsidiaries and affiliates in the area of investing, ConsultantsS t o c k B r o k i n g , I n v e s t o r s S e r v i c e s , C o m p u t e r s h a r e , G l o b a l S e r v i c e s

C o m t r a d e , I n s u r a n c e B r o k i n g .

This management Research Project undertook at India Bulls Agency in Siliguri focuses

in the area of various risk hedging techniques in stock market.

The project requires understanding the different risk hedging techniques existing in the

stock market, make the proper study off ; i.e. understanding the key features, the benefits

that will offer to the investors and return that the investors can duly expect.The researcher study has been divided in different phases or steps for a fast effective and

efficient outcome.

The main parts of the projects are divided in the category, primarily as Introduction, that

includes topics like --- Background of the study, Statement of the problem, Need and

importance of the study, and also Objective of the researcher.

II) Objective:Through this survey researcher wants to the know the awareness of people about various

risks hedging technique (Derivatives) in stock market and identify the probable reason

why this derivatives are being used in stock market.

Here researcher will keep his eyes on the following mentioned objectives in his study.

To identify the method of trading in stock market.

To measure the effectiveness of stock market.


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To identify the drawback of hedging techniques.

To measure the effectiveness of derivatives.

To know different kinds of financial derivatives.

To know different types are associated with investment in stock market. To measures the awareness regard different kinds of financial

III) Methodology

Secondary, Review of The Literature which give a whole conceptual idea of the

researcher by subdividing the topics further as ---its purpose, Methodology; Its benefits,

and also conclusion from it.

Methodology that gives a ringside views as what as what are the tools and techniques

used, which includes topics like--- Types of researcher, sampling Techniques, sampling

description, instrument ion Techniques, Actual collection of data, different types of

advance tools and softwares were used for the analytical study.

Fourth one includes topics like Profiles covering the details profile of the Industry,

company, and the respondents profile in details.Fifth ones includes the whole presentation and analysis of the data interpretation of the

research study covering the sub topics as Hypothesis, Table for presentation of the data,

Explanation of the complex Table for the research and Conclusion from the whole

analytical study has been squeeze out for an effective and efficient solution of the

problems.

IV) Analysis

For the marketing research we have to few statistical tools and softwares were used to

evaluate the market status of different risk hedging techniques in a stock market. After


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collection of all the relevant datas, collected from different sources, a details analytical

study has been done. With the help of different types of tools to get the proper

wholesome view of the problem. And on the basis of analytical study, some solution and

suggestion has been drawn to overcome the detected problems. The project includes

marketing of retail products and financial services.

In the last phase of the project we were also involve in market research activities. Where

we have to collect the information in the form of database for all the institutional investor

societies, trusts and associations and also from individuals.

There are various risk hedging that are using in stock market.

F o r w a r d s

F u t u r e s

O p t i o n s

Wa r r a n t s

L E A P S

B a s k e t s

S w a p s

S w a p t i o n s

V) Conc lus ionD e ri v at i ve s i s a v e ry u s ef u l r i sk h e dg i ng t e ch n iq u es b u t h e dg i ng

d o e s n o t a l w a y s m a k e m o n e y. T h e b e s t t h a t c a n b e a c h i e v e d u s i n g

h e d g i n g i s t h e r e m o v a l o f u n w a n t e d e x p o s u r e , i . e . u n n e c e s s a r y r i s k .

T he h ed ge d p os it io n w il l ma ke l es s p ro fi t t ha n t he u nh ed ge d

p o s i t i o n , h a l f t h e t i m e . O n e s h o u l d n o t e n t e r i n t o a h e d g i n g s t r a t e g y

h o p i n g t o m a k e e x c e s s p r o f i t s f o r s u r e ; a l l t h a t c a n c o m e o u t o f

h e d g i n g i s r e d u c e d r i s k .

VI) Recommenda t ion

D e ri v at i ve s i s a v e ry u s ef u l r i sk h e dg i ng t e ch n iq u es b u t h e dg i ng

d o e s n o t a l w a y s m a k e m o n e y. T h e b e s t t h a t c a n b e a c h i e v e d u s i n g

h e d g i n g i s t h e r e m o v a l o f u n w a n t e d e x p o s u r e , i . e . u n n e c e s s a r y r i s k .


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T he h ed ge d p os it io n w il l ma ke l es s p ro fi t t ha n t he u nh ed ge d

p o s i t i o n , h a l f t h e t i m e . O n e s h o u l d n o t e n t e r i n t o a h e d g i n g s t r a t e g y

h o p i n g t o m a k e e x c e s s p r o f i t s f o r s u r e ; a l l t h a t c a n c o m e o u t o f

h e d g i n g i s r e d u c e d r i s k .

I n d e ri v at i ve s m ar k et t h er e s h ou l d b e p r op e r l e gi s la t io n s f o r t h e

e f fe c ti v e i mp l em en t at io n o f d e ri v at i ve c o nt r ac t s. T h e u t il i ty o f

d e ri v at i ve s t h ro u gh h e dg i ng c a n b e d e ri v ed , o n ly w h en , t h er e i s

t r an s pa r en c y w it h h o ne s t d e al i ng s . T he p l ay e rs i n t h e d e ri v at i ve

m a r k e t s h o u l d h a v e a s o u n d f i n a n c i a l b a s e f o r d e a l i n g s d e r i v a t i v e

t r a ns a c t io n s . W h a t i s m o r e i m p o r ta n t f o r t h e s u c c es s o f d e r i va t i ve s

i s t h e p r es c ri p ti o n o f p r op e r c a pi t al a d eq u ac y n o rm s , t r ai n in g o f

f in an ci al i nt er me di ar ie s a nd t he p ro vi si on o f w el l- e st ab l i sh ed

i nd ic es . B ro ke rs m us t a ls o b e t ra in ed i n t he i nt r i ca c i es o f t he

d e r i v a t i v e t r a n s a c t i o n s .

N o w, d e r i v at i v es h a v e b e e n i n t r od u c e d i n t h e I n d i a n M a r k et i n t h e

f o r m o f i n d e x o p t i o n s a n d i n d e x f u t u r e s . I n d e x o p t i o n s a n d i n d e x

f u t u r e s a r e b a s i c a l l y d e r i v a t e t o o l s b a s e d o n a s t o c k i n d e x . T h e y a r e

r e a l l y t h e r i s k m a n a g e m e n t t o o l s . S i n c e d e r i v a t i v e s a r e p e r m i t t e d

l e g a l l y, o n e c a n u s e t h e m t o i n s u l a t e h i s e q u i t y p o r t f o l i o a g a i n s t t h e

v a g a r i e s o f t h e m a r k e t .

E v e r y i n v e s t o r i n t h e f i n a n c i a l a r e a i s a f f e c t e d b y i n d e x

f l u ct u a t io n s . H e n c e , r i s k m a n a g e me n t u s i n g i n d e x d e r i va t i ve s i s o f

f a r m o r e i m p o r t a n c e t h a n r i s k m a n a g e m e n t u s i n g i n d i v i d u a l s e c u r i t y

o p t i o n s . M o r e o v e r , p o r t f o l i o r i s k i s d o m i n a t e d b y t h e m a r k e t r i s k ,

r e ga r dl e ss o f t h e c o mp o si t io n o f t h e p o rt f ol i o. H e nc e , i n ve s to r s

w o u l d b e m o r e i n t e r e s t e d i n u s i n g i n d e x - b a s e d d e r i v a t i v e p r o d u c t s

r a t h e r t h a n s e c u r i t y b a s e d d e r i v a t i v e p r o d u c t s .

T h e r e a r e n o d e r i v a t i v e s b a s e d o n i n t e r e s t r a t e s I n I n d i a

t o d a y. H o w e v e r , I n d i a n u s e r s o f h e d g i n g s e r v i c e s a r e a l l o w e d t o b u y

d e r i v a t i v e s i n v o l v i n g o t h e r c u r r e n c i e s o n f o r e i g n m a r k e t s . I n d i a h a s

a s t r o n g d o l l a r r u p e e f o r w a r d m a r k e t w i t h c o n t r a c t s b e i n g t r a d e d f o r o n e t o s i x m o n t h s e x p i r a ti o n . D a i l y t r a d i ng v o l u me o n t h i s f o r w ar d


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m a r ke t i s a r o u nd $ 5 0 0 m i l l io n a d a y. H e n c e, a d e r iv a t iv e a v a il a b l e

i n I n d i a i n f o r e i g n e x c h a n g e a r e a i s a l s o h i g h l y b e n e f i c i a l t o t h e

u s e r.

Aw a r e n e s s r e g a r d i n g v a r i o u s r i s k h e d g i n g t e c h n i q u e s i n t h ei n v e s t o r s h o u l d b e i m p r o v e d f o r t h a t p u r p o s e c o n c e r n o rg a n i z a t i o n

c a n t a k e h e l p f r o m a d v e r t i s e a n d p r i n t m e d i a .

To i n c r e a s e t h e a w a re n e s s i n i n v e st o r f o r l o n g t e r m i n v e st m e nt

t h e c o n c e r n e d o rg a n i z a t i o n s h o u l d t h i n k t o i m p r o v e .

P r i c e s i n a n o r g a n i z e d d e r i v a t i v e s m a r k e t r e f l e c t t h e p e r c e p t i o n

o f m ar ke t p ar t i ci pa nt s a bo ut t he f ut ur e a nd l ea d t he p ri ce s o f

u n d e r l y i n g t o t h e p e r c e i v e d f u t u r e l e v e l . T h e p r i c e s o f d e r i v a t i v e s

c o n v e rg e w i t h t h e p r i c e s o f t h e u n d e r l y i n g a t t h e e x p i r a t i o n o f t h e

d e r iv a t iv e c o n tr a c t . T h u s , d e r i va t i v es h e l p i n d i s c ov e r y o f f u t ur e

a s w e l l a s c u r r e n t p r i c e s .

T h e d e ri v at i ve s m ar k et h e lp s t o t r an s fe r r i sk s f r om t h os e w ho

h a v e t h e m b u t m a y n o t l i k e t h e m t o t h o s e w h o h a v e a n a p p e t i t e f o r

t h e m .

D er iv at iv es d ue t o t he ir i nh er en t n at ur e a re l in ke d t o t he

u n d e r l y i n g c a s h m a r k e t s . Wi t h t h e i n t r o d u c t i o n o f d e r i v a t i v e s t h e

u n d e rl y in g m a r ke t w i t ne s s e s h i g h e r t r a di n g v o l u me s b e c a us e o f

p a r t i c i p a t i o n b y m o r e p l a y e r s w h o w o u l d n o t o t h e r w i s e p a r t i c i p a n t

f o r l a c k o f a n a r r a n g e m e n t t o t r a n s f e r r i s k .

S p ec u la t iv e t r ad e s s h if t t o a m o re c o nt r ol l ed e n vi r on m en t o f

d e ri v at iv e s m ar k et . I n t h e a b se n ce o f a n o r ga n iz e d d e ri v at iv e s

m a r ke t s pe cu la to rs t ra de i n t he u nd er l yi ng c a sh ma rk e ts .

M a rg i n i n g , m o n i t o r i n g a n d s u r v e i l l a n c e o f t h e a c t i v i t i e s o f v a r i o u s

p a r ti c i p an t s b e c om e e x t r em e l y d i f f i c u lt i n t h e s e k i n d s o f m i x ed

m a r k e t s .

A n i m po r ta n t i n ci d en t al b e ne f it t h at f l ow s f r om d e ri v at i ve s

t r a d i n g i s t h a t i t a c t s a s a c a t a l y s t f o r n e w e n t r e p r e n e u r i a l a c t i v i t y.

T h e d e r i v a t iv e s h a v e a h i s t or y o f a t t ra c t in g m a n y b r i g h t c r e a t i ve

w e l l - e d u c a t e d p e o p l e w i t h a n e n t r e p r e n e u r i a l a t t i t u d e . T h e y o f t e n


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e n e r g i e s o t h e r s t o c r e a t e n e w, b u s i n e s s e s n e w p r o d u c t s a n d n e w

e m p l o y m e n t o p p o r t u n i t i es , t h e b e n e f i t s o f w h i c h a r e i m m e n s e .

D e r iv a t iv e s m a r ke t s h e l p i n c re a s e s a v i n g s a n d i n v e st m e nt i n t h e

l o n g r u n . Tr a n s f e r o f r i s k e n a b l e s m a r k e t p a r t i c i p a n t s t o e x p a n dt h e i r v o l u m e o f a c t i v i t y.

H e d g e r s f a c e r i s k a s s o c i a t e d w i t h t h e p r i c e o f a n a s s e t . T h e y u s e

f u t u r e s o r o p t i o n s m a r k e t s t o r e d u c e o r e l i m i n a t e t h i s r i s k .

S p e cu l a to r s w i s h t o b e t o n f u t u r e m o v e m en t s i n t h e p r i c e o f a n

a ss et . F ut ur es a nd o pt io ns c on tr ac ts c an g iv e t he m a n e xt ra

l e v e r a g e ; t h a t i s t h e y c a n i n c r e a s e b o t h t h e p o t e n t i a l g a i n s a n d

p o t e n t i a l l o s s e s i n a s p e c u l a t i v e v e n t u r e .

A r b i t r a g e u r s a r e i n b u s i n e s s t o t a k e a d v a n t a g e o f a d i s c r e p a n c y o f

a b e t w e e n p r i c e s i n t w o d i f f e r e n t m a r k e t s .

India Bulls as a firm should try to put more emphasis on the customer satisfaction to

the direction of achieving this end the branch should guide the investor and help them

make their investment decisions. This will make the investors a bit more confident

about their actions.

The company should make some efforts to indicate the habit of online trading among

the local masses, for this the company should adopt a proper and well targeted

marketing.

In order to increase its efficiency in operation, the firm should bring about few

organizations changes, it should be aware of the customers needs; it should bring up

more advertising techniques like campaign.


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Chapter 1

INTRODUCTION


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Background o f the s tudy

At present, a wide variety of investment avenues are open to the investors to suit their needs and nature. Knowledge about the different avenues enables the investor to choose

investment intelligently. The required levels decide the choice of the investor. Any

rational investor, before investing his or her investing his or her investible wealth in the

stock market, analyses the risk associated with the particular stock. The actual return he

receives from a stock may vary from his expected return and the risk is expected return

and the risk is expressed in terms of variability of return. The down side risk may be

caused by several factors, either common to all stocks or specific to a particular stock.

Investor in general would like to analyse the risk factor.

In the present state of the economy, there is an imperative need for the corporate clients

to protect their operating profits by shifting some of the uncontrollable financial risks to

those who are able to bear and manage them. Thus, risk management becomes a must for

survival since there is a high volatility in the present financial markets.

In the 1920s, the American stock market was booming. People got loans to buy stock,

promising their loan brokers that the stock will go up and pay the loans off. But, some

stocks didn't go up, leaving the shocked share holders in further debt. Some owners of

stock were also the owners of their own business, and had to fire their workers to pay off

the debt. This left the former workers unemployed and in poverty, unable to buy anything

from stores. Now the stores couldn't make any money, and this set off a chain reaction

across the nation which caused the Great Depression. This spread poverty,

unemployment and misery across the nation and the world, for that was a time where


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many countries needed America's financial help to recover from the devastations of

World War I. After a few years, President Franklin Roosevelt made up a plan to get

America back on it's feet. The Great Depression lasted from 1929 to 1932.

Meanwhile, marketers are experimenting with methods and strategies to boost the tradingof stocks. It has been found that India is a big market; a growing market with various

investments needs to suit an individual. Being a rapidly developing nation in all

dimensions, there is certainly no lack of demand for customized services to satisfy

individual investor with a full suite of financial services. The stock market continues to

be an excellent source of revenue for companies participating in the market, and in many

cases, the public as well.

In view of the above, it is considered necessary to study the market of a company whichis proving itself as a no. 1 Broker house in the market to keep the position static and so

devising competitive strategies to acquire new and permanent investors on the basis

of the latent needs of the investors. Hence, it would unfold the growing market and

analyze the gap existing between the services offered and the latent needs of the

customer.

In this context, derivatives occupy an important place as a risk reducing

machinery. Derivatives are useful to reduce many of the risks discussed above. In fact,

the financial service companies can play a very dynamic role in dealing with such risks.

They can ensure that the above risks are hedged by using derivatives like forwards,

futures, options, swap, leaps etc. derivatives, thus, enable the clients to transfer their

financial risks to the financial service companies. This really protects the clients from

unforeseen risks and helps them to get their due operating profits or to keep the projectwell within the budgeted costs. To hedge the various risks that one faces in the financial

market today, derivatives are absolutely essential.


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DERIVATIVES

D e r i v a t i v e i s a p r o d u c t w h o s e v a l u e i s d e r i v e d f r o m t h e v a l u e o f o n e

o r m o r e b a s i c v a r i a b l e s , c a l l e d b a s e s i n a c o n t r a c t u a l m a n n e r. T h eu n d e r l y i n g a s s e t c a n b e e q u i t y, f o r e x , c o m m o d i t y o r a n y o t h e r a s s e t .

T h e i n t e r n a t i o n a l M o n e t a r y F u n d d e f i n e s d e r i v a t i v e s a s f i n a n c i a l

i n st r um en t s t h at a r e l i nk e d t o a s p ec i fi c f i na n ci a l i n st r um e nt o r

i n d i c a t o r o r c o m m o d i t y a n d t h r o u g h w h i c h s p e c i f i c f i n a n c i a l r i s k s

c a n b e t r a d e d i n f i n a n c i a l m a r k e t s i n t h e i r o w n r i g h t . T h e v a l u e o f a

f i n a n c i a l d e r i v a t i v e d e r i v e s f r o m t h e p r i c e o f a n u n d e r l y i n g i t e m ,

s u c h a s a n a s s e t o r i n d e x . U n l i k e d e b t s e c u r i t i e s , n o p r i n c i p a l i s

a d v a n c e d t o b e r e p a i d a n d n o i n v e s t m e n t i n c o m e a c c r u e s .

T h e e m e r g e nc e o f t h e m a r k e t f o r d e r i va t i v e p r o d u c ts , m o s t n o t ab l y

f o r w a r d s f u t u r e s a n d o p t i o n s c a n b e t r a c e d b a c k t o t h e w i l l i n g n e s s

o f r is k- av er se e co no mi c a ge nt s t o g ua rd t he ms el ve s a ga in st

u n ce r ta i nt i es a r is i ng o u t o f f l uc t ua t io n s i n a s se t p r ic e s. B y t h ei r

v e r y n a t u r e , t h e f i n a n c i a l m a r k e t s a r e m a r k e d b y a v e r y h i g h d e g r e e

o f v o l a ti l i ty. T h r ou g h t h e u s e o f d e r i va t i ve p r o d uc t s , i t i s p o s s ib l e

t o p a r t i a l ly o f f u l l y t r a n s f e r p r i c e r i s k s b y l o c ki n g - i n a s s e t p r i c e s.

A s i n s t r u m e n t s r i s k m a n a g e m e n t , t h e s e g e n e r a l l y d o n o t i n f l u e n c e

t h e f l u c t u a t i o n s i n t h e u n d e r l y i n g a s s e t p r i c e s . H o w e v e r , b y l o c k - i n

a s s e t p r i c e s , d e r i v a t i v e p r o d u c t s m i n i m i z e t h e i m p a c t o f f l u c t u a t i o n s

i n a s s e t p r i ce s o n t h e p r o f i t ab i l i ty a n d c a s h f l o w s i t u a ti o n o f r i s k -

a v e r s e i n v e s t o r.


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D e r i v a t i v e i s a p r o d u c t w h o s e v a l u e i s d e r i v e d f o r m t h e v a l u e o f o n e

o r m o r e b a s i c v a r i a b l e s , c a l l e d b a s e s i n a c o n t r a c t u a l m a n n e r. T h e

u n d e r l y i n g a s s e t c a n b e e q u i t y, f o r e x , c o m m o d i t y o r a n y o t h e r a s s e t .

D e ri v at i ve p r od u ct s i n it i al l y e m er g ed a s h e dg i ng d e vi c es a g ai n st

f l u c t u a t i o n s i n c o m m o d i t y p r i c e s a n d c o m m o d i t y - l i n k e d d e r i v a t i v e s

r e m a i n e d t h e s o l e f o r m o f s u c h p r o d u c t s f o r a l m o s t t h r e e h u n d r e d

y e a rs . T h e f i n a nc i a l d e r i v at i v e s c a m e i n t o s p o t li g h t i n p o s t 1 9 7 0

p e r i o d d u e t o g r o w i n g i n s t a b i l i t y i n t h e f i n a n c i a l m a r k e t s . H o w e v e r ,

s i n c e t h e i r e m e rg e n c e , t h e s e p r o d u c t s h a v e b e c o m e v e r y p o p u l a r a n d

b y 1 9 9 0 s , t h e y a c c o u n t e d f o r a b o u t t w o - t h i r d s t o t a l t r a n s a c t i o n s i n

d er iv at iv e p ro du ct s . I n r ec en t y ea rs , t he m ar ke t f or f in an ci al

d e ri v at i ve s h a s g r ow n t r em e nd o us l y b o th i n t e rm s o f v a ri e ty o f

i ns t r um en ts a va il ab le , t he ir c om pl ex it y a nd a ls o t ur no ve r. T he

f a c t o r s g e n e r a l l y a t t r i b u t e d a s t h e m a j o r d r i v i n g f o r c e b e h i n d g r o w t h

o f f i n a n c i a l d e r i v a t i v e s a r e

( a ) I n c r e a s e d v o l a t i l i t y i n a s s e t p r i c e s i n f i n a n c i a l m a r k e t s

( b ) I n c re a s e d i n t e g r a ti o n o f n a t i on a l f i n an c i a l m a r k e t s w i t h t h e

i n t e r n a t i o n a l m a r k e t s

( c ) M ar ke d i mp ro ve me nt i n c om mu ni ca t i on f ac i l it ie s a nd s ha rp

d e c l i n e i n t h e i r c o s t s

( d ) D e ve l op m en t o f m o re s o ph i st ic a te d r i sk m an a ge me n t t o ol s ,

p r ov i di n g e c on o mi c a g en t s w i de r c h oi c e o f r i sk m an a ge m en t

s t r a t e g i e s , a n d

(e) I n n o va t i on s i n t h e d e r iv a t iv e s r e t u r n s o v e r a l a r ge n u m be r o f

f i n a n c i a l a s s e t s , l e a d i n g t o h i g h e r r e t u r n s , r e d u c e d r i s k a s w e l l a s

t r a n s a c t i o n c o s t s a s c o m p a r e d t o i n d i v i d u a l f i n a n c i a l a s s e t s . I n

t he c la ss o f e qu it y d er iv at iv es , f ut ur es a nd o pt io ns o n s to ck

i n d i c e s h a v e g a i n e d m o r e p o p u l a r i t y t h a n o n i n d i v i d u a l s t o c k s ,

e s p e ci a l ly a m o ng i n s t it u t io n a l i n v es t o r s, w h o a r e m a j or u s e r s o f

i n d e x- l i n ke d d e r iv a t i ve s . E v e n s m a ll i n v e st o r s f i n d t h e s e u s e f u l

d ue t o h ig h c or re la t i on o f t he p op ul ar i nd ic es w it h v ar io us

p o r t f o l i o s a n d e a s e o f u s e . T h e l o w e r c o s t s a s s o c i a t e d w i t h i n d e x

d e ri v at i ve s v i s- -v i s d e ri v at iv e p r od u ct s b a se d o n i n di v id u als e c u r i t i e s i s a n o t h e r r e a s o n f o r t h e i r g r o w i n g u s e .


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Types o f Der iva t ives

T h e m o st c o mm o nl y u s ed d e ri v at i ve s c o nt r ac t s a r e f o rw a rd s ,

f u t u r e s a n d o p t i o n s w h i c h t h e y w i l l d i s c u s s i n d e t a i l l a t e r.

F o r w a r d s : A f o r w ar d c o n t ra c t i s a c u s to m i ze d c o n t ra c t b e t we e nt w o e n t i t i e s w h e r e s e t t l e m e n t t a k e s p l a c e o n a s p e c i f i c d a t e i n t h e

f u t u r e a t t o d a y s p r e - a g r e e d p r i c e .

F u t u r e s : F u t u r e s c o n t r a c t i s a n a g r e e m e n t b e t w e e n t w o p a r t i e s t o

b u y o r s e l l a n a s s e t a t a c e r t a i n t i m e i n t h e f u t u r e a t a c e r t a i n

p r i c e . F u t u r e s c o n t r a c t s a r e s p e c i a l t y p e s o f f o r w a r d c o n t r a c t s i n

t he s en se t ha t t he f or me r a re s ta nd ar di ze d e xc ha ng e- t r ad ed

c o n t r a c t s .

O p t i o n s : O p t i o n s a r e o f t w o t y p e s c a l l s a n d p u t s . C a l l s g i v e t h e

b u y er t h e r i g h t b u t n o t t h e o b l i ga t i on t o b u y a g i v en q u a n ti t y o f

t h e u n d e r ly i n g a s s e t a t a g i v e n p r i ce o n o r b e f o re a g i v e n f u t u re

d a t e . P u t s g i v e t h e b u y e r t h e r i g h t b u t n o t t h e o b l i g a t i o n t o s e l l a

g i v e n q u a n t i t y o f t h e u n d e r l y i n g a s s e t a t a g i v e n p r i c e o n o r

b e f o r e a g i v e n d a t e .

Wa r r a n t s : O p t i o n s g e n e r a l l y h a v e l i v e s o f u p t o o n e y e a r , t h e

m a j o r i t y o f o p t i o n s t r a d e d o n o p t i o n s e x c h a n g e s h a v i n g m a x i m u m

m at ur it y o f n in e m on th s. Lo ng er -d at ed o pt io ns a re c al le d

w a r r a n t s a n d a r e g e n e r a l l y t r a d e d o v e r - t h e - c o u n t e r.

L E A P S : T h e a c r o n y m L EA P S m e a n s L o n g Te r m e q u i t y

A n t i c i p a t i o n S e c u r i t i e s . T h e s e a r e o p t i o n s h a v i n g a m a t u r i t y o f

u p t o t h r e e y e a r s .

B a s k e t s : B a s ke t o p t io n s a r e o p t i o n s o n p o r t fo l i o s o f u n d e rl y i ng

a s s e t s . T h e u n d e r l y i n g a s s e t i s u s u a l l y a m o v i n g a v e r a g e o r a

b as ke t o f a ss e t s . E qu it y i nd ex o pt io ns a re a f or m o f b as ke t

o p t i o n s .

S w a p s : S wa p s a r e p r iv a te a g re e me n ts b e tw e en t wo p a ri t ie s t o

e xc ha ng e c as h f lo ws i n t he f ut ur e a cc or di ng t o p re ar ra ng ed

f o r m s . T h e y c a n b e r e g a r d e d a s p o r t f o l i o s o f f o r w a r d c o n t r a c t s .

T h e t w o c o m m o n u s e d s w a p s a r e :


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I nt er es t r at e s wa ps : T he se e nt ai l s wa pp in g o nl y t he

i n t e r e s t r e l a t e d c a s h f l o w s b e t w e e n t h e p a r t i e s i n t h e s a m e

c u r r e n c y

C u r re n c y S w a p s : T h e se e n t ai l s w a p pi n g b o t h p r i n c i p a la n d i n t e r e s t b e t w e e n t h e p a r t i e s w i t h t h e c a s h f l o w s i n o n e

d ir ec ti on b ei ng i n a d if fe re nt c ur re nc y t ha n t ho se i n t he

o p p o s i t e d i r e c t i o n .

S w a p t i o n s : S w a p t i o n s a r e o p t i o n s t o b u y o r s e l l a s w a p t h a t w i l l

b e c o m e o p e r a t i v e a t t h e e x p i r y o f t h e e x p i r y o f t h e o p t i o n s . T h u s a

S w a p t i o n s i s a n o p t i o n o n a f o r w a r d s w a p . R a t h e r t h a n h a v e c a l l s

a n d p u ts t h e S wa p ti o ns m a rk e t h a s r e ce i ve r S w ap t io n s a n d p a ye r

S w a p t i o n s A r e c e i v e r S w a p t i o n s a n o p t i o n s t o r e c e i v e r f i x e d a n d p a y

f l o at i n g . A p a y er S w ap t i o ns i s a n o p t io n t o p a y f i x e d a n d r e c e i v e s

f l o a t i n g .

Der iva t ives marke t s in Ind ia

T h e f i r s t s t e p t o w a r d s i n t r o d uc t i on s o f d e r iv a t i ve s t r a di n g i n I n d ia

w a s t h e p ro mu lg at io n o f t he S e cu ri t ie s L a ws ( A m e nd me nt )

O rd in an ce 1 99 5 w hi ch w it hd re w t he p ro hi bi t i on o n o pt io ns i n

s e c u r i t i e s . T h e m a r k e t s f o r d e r i v a t i v e s h o w e v e r d i d n o t t a k e o f f a s

t h e r e w a s n o r e g u l a t o r y f r a m e w o r k t o g o v e r n t r a d i n g o f d e r i v a t i v e s .

S E B I s e t u p a 2 4 - m e m b e r c o m m i t t e e u n d e r t h e C h a i r m a n s h i p o f D r.

L . C . G u p t a o n N o v e m b e r 1 8 1 9 9 6 t o d e v e l o p a p p r o p r i a t e r e g u l a t o r y

f r a m e w o r k f o r d e r i v a t i v e s t r a d i n g i n I n d i a . T h e c o m m i t t e e s u b m i t t e d

i t s r e p o r t o n M a r c h 1 7 , 1 9 9 8 p r e s c r i b i n g n e c e s s a r y p r e - c o n d i t i o n s

f o r i n tr o du c ti o n o f d e ri v at iv e s t r ad i ng i n I n di a . T h e c o mm i tt e e

r e c o mm e n d ed t h a t d e r i v a t iv e s s h o u ld b e d e c l ar e d a s s e cu r i ti e s s o

t h a t r e g u l a t o r y f r a m e w o r k a p p l i c a b l e t o t r a d i n g o f s e c u r i t i e s c o u l d

a l s o g o v e rn t r a di n g o f s e c u ri t i es . S E B I a l s o s e t u p a g r o u p i n J u n e

1 9 9 8 u n d e r t h e C h a i r m a n s h i p o f P r o f . J . R . Va r m a , t o r e c o m m e n d

m e a s u r e s f o r r i s k c o n t a i n m e n t i n d e r i v a t i v e s m a r k e t i n I n d i a . T h e

r ep or t w hi ch w as s ub mi tt ed i n O ct ob er 1 99 8 wo rk ed o ut t he

o p e r at i o n al d e t a il s o f m a r gi n i n g s y s t e m , m e t ho d o l og y f o r c h a rg i n g


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i n i t i a l m a rg i n s , b r o k e r n e t w o r t h d e p o s i t r e q u i r e m e n t a n d r e a l - t i m e

m o n i t o r i n g r e q u i r e m e n t s .

T h e S C R S w a s a m e n d e d i n D e c e m b e r 1 9 9 9 t o i n c l u d e d e r i v a t i v e s

w i t hi n t h e a m b it o f s e cu r i t ie s a n d t h e r e g u l a t or y f r a me w o r k w e r e

d e v e l o p e d f o r g o v e r n i n g d e r i v a t i v e s t r a d i n g . T h e a c t a l s o m a d e i t

c l e a r t h a t d e r i v a t i v e s s h a l l b e l e g a l a n d v a l i d o n l y i f s u c h c o n t r a c t s

a r e t r ad e d o n a r e co g ni z ed s t oc k e x ch a ng e t h us p r ec l ud i ng O TC

d er iv at iv es . T he g ov er nm en t a ls o r es c i nd ed i n M ar ch 2 00 0, t he

t h r e e - d e c a d e o l d n o t i f i c a t i o n , w h i c h p r o h i b i t e d f o r w a r d t r a d i n g i n

s e c u r i t i e s .

D e ri v at i ve s t r ad i ng c o mm en c ed i n I n di a i n J u ne 2 0 00 a f te r S EB I

g ra nt e d t he f in al a pp r ov al t o t hi s e f fe c t i n M a y 2 0 00 . S E B I

p e r m i t t e d t h e d e r i v a t i v e s s e g m e n t s o f t w o s t o c k e x c h a n g e s . N S E a n d

B S E a n d t h e i r c l e a r in g h o u s e /c o r p or a t io n t o c o m me n c e t r a d i n g a n d

s e t t l e m e n t i n a p p r o v e d d e r i v a t i v e s c o n t r a c t s . To b e g i n w i t h S E B I

a p p r o v e d t r a d i n g i n i n d e x f u t u r e s c o n t r a c t s b a s e d o n S & P C N X N i f t y

a nd B SE -3 0 ( Se ns ex ) i nd ex . T hi s w as f ol lo we d b y a pp ro va l f or

t ra di ng i n o pt io ns c om me nc ed i n J un e 2 00 1 a nd t he t ra di ng i n

o p t i o n s o n i n d i v i d u a l s e c u r i t i e s c o m m e n c e d i n J u l y 2 0 0 1 . F u t u r e s

c o nt r ac t s o n i n di v id u al s t oc k s w e re l a un c he d i n N o ve m be r 2 0 01 .

F u t u r e s a n d O p t i o n s c o n t r a c t s o n i n d i v i d u a l s e c u r i t i e s a r e a v a i l a b l e

o n 4 1 s ec ur i t ie s s t i pu la te d b y S EB I. T ra di ng a nd s e t t l em en t i n

d e r iv a t i ve c o n t ra c t s i s d o n e a c c o r d an c e w i t h t h e r u l e s b y e la w s a n d

r eg ul a ti on s o f t h e r es pe ct iv e e xc ha n ge s a nd t h ei r c le ar i ng

h o u s e / c o r p o r a t i o n d u l y a p p r o v e d b y S E B I a n d n o t i f i e d i n t h e o f f i c i a l

g a z e t t e .

NSES der iva t ives marke t s

T h e d e r i v a t i v e s t r a d i n g o n t h e N S E c o m m e n c e d w i t h S & P C N X N i f t y

I nd ex f ut ur e s o n J u ne 1 2, 2 0 00 . Th e t ra di n g i n de x o p ti o ns

c o m m e n c e d o n J u n e 4 , 2 0 0 1 a n d t r a d i n g i n o p t i o n s o n i n d i v i d u a l

s e cu r it i es c o mm en c ed o n J u ly 2 , 2 0 01 . S in g le s t oc k f u tu r es w e re


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l a u n c h e d o n N o v e m b e r 9 , 2 0 0 1 . To d a y, b o t h i n t e r m s o f v o l u m e a n d

t u rn ov er , N S E i s t h e l a rg es t d e ri v at iv es e x ch an ge i n I nd ia .

C u r r e n t l y, t h e d e r i v a t i v e s c o n t r a c t s a r e a v a i l a b l e f o r t r a d i n g , w i t h 1

m o n t h , 2 m o n t h s a n d 3 m o n t h s e x p i r y. A n e w c o n t r a c t i s i n t r o d u c e d

o n t he n ex t t ra di ng d ay f ol lo wi ng t he e xp ir y o f t he n ea r m on th

c o n t r a c t .

Trad ing mechan i sm

T h e f u t u r e a n d o p t i o n s t r a d i n g s y s t e m o f N S E , c a l l e d N E AT- F & O

t r a d i n g s y s t e m , p r o v i d e s a f u l l y a u t o m a t e d s c r e e n - b a s e d Tr a d i n g f o r

N i f t y f u t u r e s & o p t i o n s a n d s t o c k f u t u r e s & o p t i o n s o n a n a t i o n w i d e

b a si s a n d a n o n li n e m o ni to r in g a n d s u rv e il l an c e m ec h an i sm . I t

s u p p o r t s a n a n o n y m o u s o r d e r d r i v e n m a r k e t w h i c h p r o v i d e s c o m p l e t e

t r a n s p a r e n c y o f t r a d i n g o p e r a t i o n s a n d o p e r a t e s o n s t r i c t p r i c e - t i m e

p ri or i t y. I t i s s im il ar t o t ha t o f t ra di ng o f e qu it ie s i n t he c as h

M a r k e t ( C M ) s e g m e n t . T h e N E AT- F & O t r a d i n g s y s t e m i s a c c e s s e d

b y t w o t y p e s o f u s e r s . T h e Tr a d i n g M e m b e r s ( T M ) h a v e a c c e s s t o

f u n c ti o n s s u c h a s o r d e r e n t r y, o r d e r m a t c hi n g , a n d o r d e r m a t c hi n g ,

o r d e r a n d t r a d e m a n a g e m e n t . I t p r o v i d e s t r e m e n d o u s f l e x i b i l i t y t o

u s e r s i n t e r m s o f k i n d s o r d e r s t h a t c a n b e p l a c e d o n t h e s y s t e m .

Va r i o u s c o n d i t i o n s l i k e I m m e d i a t e o r C a n c e l , L i m i t / M a r k e t p r i c e ,

s t o p l o s s , e t c . c a n b e b u i l t i n t o a n o r d e r . T h e C l e a r i n g M e m b e r s

( C M ) u s e t h e t r a d e r w o r k s t a t i o n f o r t h e p u r p o s e o f m o n i t o r i n g t h e

t r a d i n g me m b e r

( s ) f o r w h o m t h e y c l e a r t h e t r a d e s . A d d i t i o n a l l y, t h e y c a n e n t e r a n d

s e t l i m i t s t o p o s i t i o n s , w h i c h a t r a d i n g m e m b e r c a n m e m b e r c a n

t a k e .

I n t r o d u c t i o n t o f u t u r e s a n d o p t i o n

I n r e c en t y e a rs . D e r iv a t i ve s h a v e b e c o m e i n c r ea s i n gl y i m p or t a nt i n

t h e f i el d o f f i na n ce . W h il e f u tu r es a n d o p ti o ns a r e n o w a c t i ve l y

t r ad e d o n m an y e x ch a ng e s, f o rw a rd c o nt r ac t s a r e p o pu l ar o n t h e

O T C m a r k e t .

Forward con t rac t s


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A f o r w a r d c o n t r a c t i s a n a g r e e m e n t t o b u y o r s e l l a n a s s e t o n a

s pe ci fi ed d at e f or a s pe ci fi ed p ri ce . O ne o f t he p ar ti es t o t he

c o n t ra c t s a s s u m es a l o n g p o s i t io n a n d a g r e e s t o b u y t h e u n d e rl y in g

a s s e t o n a c e r t a i n s p e c i f i e d f u t u r e d a t e f o r a c e r t a i n s p e c i f i e d p r i c e .

T h o t h e r p a r t y a s s u m e s a s h o r t p o s i t i o n a n d a g r e e t o s e l l t h e a s s e t

o n t h e s a m e d a t e f o r s a m e p r i c e . O t h e r c o n t r a c t d e t a i l s l i k e d e l i v e r y

d a t e, p r i ce a n d q u a n t i t y a r e n e g o ti a t ed b i l at e r a ll y b y p a r t ie s t o t h e

c o nt r ac t . T he f o rw a rd c o nt r ac t s a r e n o rm al l y t r ad e d o u ts i de t h e

e x c h a n g e s .

H o w e v e r f o r w a r d c o n t r a c t s i n c e r t a i n m a r k e t s h a v e b e c o m e

v er y s ta nd ar di ze s , a s i n t he c as e o f f or ei gn e xc ha ng e, t he re by

r e d u c i n g t r a n s a c t i o n c o s t s a n d i n c r e a s i n g t r a n s a c t i o n s v o l u m e . T h i s

p r o c e s s o f s t a n d a r d i z a t i o n r e a c h e s i t s l i m i t i n t h e o rg a n i z e d f u t u r e s

m a r k e t .

F o r w a r d c o n t r a c t s a r e v e r y u s e f u l i n h e d g i n g a n d

s p ec u la t io n . T h e c l as s ic h e dg i ng a p pl i ca t io n w o ul d b e t h at o f a n

e x po r te r w h o e x pe c ts t o r e ce i ve p a ym e nt i n d o ll a rs t h re e m on t hs

l a te r . H e i s e x po s ed t o t h e r i s k o f e x ch a ng e r a te f l uc t ua t io n s. B y

u s i n g t h e c u r r e n c y f o r w a r d m a r k e t t o s e l l d o l l a r s f o r w a r d , h e c a n

l o o k o n t o a r a t e t o d a y a n d r e d u c e h i s u n c e r t a i n t y. S i m i l a r l y a n

i m p or t e r w h o i s r e q u ir e d t o m a k e a p a y me n t i n d o l la r s t w o m o n th s

h en ce c an r ed uc e h is e xp os ur e t o e xc ha ng e r a t e f lu c t ua ti on s b y

b u y i n g d o l l a r f o r w a r d .

I f a s pe cu la to r h as i nf or ma ti on o r a na ly si s , w hi ch f or ec as ts a n

u p t u r n i n a p r i c e , t h e n h e c a n g o l o n g o n t h e f o r w a r d m a r k e t i n s t e a d

o f c a s h m a r k e t .

T h e s p e c u la t o r w o u l d g o l o n g o n t h e f o r w ar d , w a i t f o r t h e p r i c e t o

r is e, a nd t h en t ak e a r e ve r si n g t r an s ac ti o n t o b oo k p ro f it s.

S pe cu la to rs m ay w el l b e r eq ui re d t o d ep os i t a m ar gi n u pf ro nt .

H o w e v e r , t h i s i s g e n e r a l l y a r e l a t i v e l y s m a l l p r o p o r t i o n o f t h e v a l u e

o f t h e a s s e t s u n d e r l y i n g t h e f o r w a r d c o n t r a c t . T h e u s e o f f o r w a r d

m a r k e t s h e r e s u p p l i e s l e v e r a g e t o t h e s p e c u l a t o r.F o r w a r d m a r k e t s w o r l d - w i d e a f f l i c t e d b y s e v e r a l p r o b l e m s :


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L a c k o f c e n t r a l i z a t i o n o f t r a d i n g ,

I l l i q u i d i t y, a n d

C o u n t e r p a r t y r i s k

I n t h e f i r s t t w o o f t h e s e , t h e b a s i c p r o b l e m i s t h a t o f t o o m u c hf l e x i b i l i t y a n d g e n e r a l i t y. T h e f o r w a r d m a r k e t i s l i k e a r e a l e s t a t e

m a r k e t i n t h a t a n y t w o c o n s e n t i n g a d u l t s c a n f o r m c o n t r a c t s a g a i n s t

e a c h o t h e r . T h i s o f t e n m a k e s t h e m d e s i g n t e r m s o f t h e d e a l w h i c h

a re v er y c on ve ni en t i n t ha t s pe ci fi c s i t ua ti on , b ut m ak es t he

c o n t r a c t s n o n - t r a d a b l e .

C o u n t e r p a r t y r i s k a r i s e s f r o m t h e p o s s i b i l i t y o f d e f a u l t b y a n yo n e p a r t y t o t h e t r a n sa c t io n d e c l ar e s b a n k ru p t c y, t h e o t h e r s u f f er s .

E v e n w h e n f o r w a r d m a r k e t s t r a d e s t a n d a r d i z e d c o n t r a c t s , a n d h e n c e

a v o i d t h e p r o b l e m o f i l l i q u i d i t y, s i l l t h e c o u n t e r p a r t y r i s k r e m a i n s a

v e r y s e r i o u s i s s u e .

In t roduc t ions to fu tu res

F u t u r e m a r k e t s w e r e d e s i g n e d t o s o l v e t h e p r o b l e m s t h a t e x i s t i n

f o r w a r d m a r k e t s . A f u t u r e s c o n t r a c t i s a n a g r e e m e n t b e t w e e n t w o p a r i t i e s t o b u y o r s e l l a n a s s e t a t a c e r t a i n t i m e i n t h e f u t u r e a t a

c e r t a i n p r i c e . B u t u n l i k e f o r w a r d c o n t r a c t s , t h e f u t u r e s c o n t r a c t s a r e

s t an d ar d iz e d a n d e x ch a ng e t r ad e d. To f a ci l it a te l iq u id i ty i n t h e

f ut ur es c on tr ac ts , t he e xc ha ng e s pe ci f i es c er ta in s ta nd ar di ze d

f e a t u r e s o f t h e c o n t r a c t s . I t i s a s t a n d a r d i z e d c o n t r a c t w i t h s t a n d a r d

u nd er ly in g i ns tr um en t, a s ta nd ar d q ua nt it y a nd q ua li ty o f t he

u n d e rl y in g i n s t ru m e nt t h a t c a n b e d e l i v e r ed , ( o r w h i c h c a n b e u s e d

f o r r e f e r e nc e p u r p os e s i n s e t t le m e n t) a n d a s t a nd a r d t i m i n g o f s u c h

s e t t l e m e n t . A f u t u r e s c o n t r a c t m a y b e o f f s e t p r i o r t o m a t u r i t y b y

e n t e r i n g i n t o a n e q u a l a n d o p p o s i t e t r a n s a c t i o n . M o r e t h a n 9 9 % o f

f u t u r e s t r a n s a c t i o n s a r e o f f s e t t h i s w a y.

The f i r s t f inanc ia l fu tu res marke t

T h e f i r s t e x c h a n g e t h a t t r a d e d f i n a n c i a l d e r i v a t i v e s w a s l a u n c h e d i n

C h ic a go i n t h e y ea r 1 9 72 . A d i vi s io n o f t h e C hi c ag o M e rc a nt i le

E x c h a n g e , i t w a s c a l l e d t h e I n t e r n a t i o n a l M o n e t a r y M a r k e t ( I M M ) a d


28/142

t r a de c u r re n c y f u t u re s . T h e b r a i n b e h i n d t h i s w a s a m a n c a l l ed L e o

M e l a m e d , a c k n o w l e d g e d a s t h e f a t h e r o f f i n a n c i a l f u t u r e s w h o w a s

t h e n t h e c h a i r m a n o f t h e C h i c a g o M e r c a n t i l e E x c h a n g e . B e f o r e I M M

o p en e d i n 1 9 72 , t h e C h ic a go M er c an t il e E x ch a ng e s o ld c o nt r ac t s

w h o s e v a l u e w a s c o u n t e d i n m i l l i o n s . B y 1 9 9 0 , t h e u n d e r l y i n g v a l u e

o f a l l c o n t r a c ts t r a de d a t t h e C h i c a g o M e r c a n t il e E x c ha n g e t o t a l e d

5 0 t r i l l i o n d o l l a r s .

T h e se c u r re n c y f u t u r e s p a v e d t h e w a y f o r t h e s u c c es s f u l m a r k e ti n g

o f a d i z z y i n g a r r a y o f s i m i l a r p r o d u c t s a t t h e C h i c a g o M e r c a n t i l e

E xc ha ng e, t he C hi ca go B oa rd o f T ra de , a nd t he C hi ca go B oa rd

O pt io ns E xc ha ng e. B y t he 1 99 0s , t he se e xc ha ng es w er e t ra di ng

f u t u r e s a n d o p t i o n s o n e v e r y t h i n g f r o m A s i a n a n d A m e r i c a n s t o c k

i nd ex es t o i nt er es t r at e s wa ps , a nd t he ir s uc ce ss t ra ns fo rm ed

C h i c a g o a l m o s t o v e r n i g h t i n t o t h e r i s k - t r a n s f e r c a p i t a l o f t h e Wo r l d .

T h e s t a n d a r d i z e d i t e m s i n a f u t u r e s c o n t r a c t a r e

Q u a n t i t y o f t h e u n d e r l y i n g

Q u a l i t y o f t h e u n d e r l y i n g

T h e d a t e a n d t h e m o n t h o f d e l i v e r y

T h e u n i t s o f p r i c e q u o t a t i o n a n d m i n i m u m p r i c e c h a n g e

L o c a t i o n o f s e t t l e m e n t

In t roduc t ion to op t ions

I n t h i s s e c t i o n , t h e y l o o k a t t h e n e x t d e r i v a t i v e p r o d u c t t o b e t r a d e d

o n t h e N S E, n a m el y o p t io n s . O p t i o n s a r e f u n d am e n ta l l y d i f f e r e nt

f r o m f o r w a r d a n d f u t u r e s c o n t r a c t s . A n o p t i o n g i v e s t h e h o l d e r o f

t h e o p t i o n t h e r i g h t t o d o s o m e t h i n g . T h e h o l d e r d o e s n o t h a v e t oe x e r c i s e t h i s r i g h t . I n c o n t r a s t , i n a f o r w a r d a n d f u t u r e s c o n t r a c t ,

t h e t wo p a rt i es h a ve c o mm it t ed t h em s el v es t o d o in g s o me t hi n g.

W h e r e a s i t c o s t s n o t h i n g ( e x c e p t m a rg i n r e q u i r e m e n t s ) t o e n t e r i n t o

a f u t u r e s c o n t r a c t , t h e p u r c h a s e o f a n o p t i o n r e q u i r e s a n u p - f r o n t

payment .

His to ry o f op t ions

A l t h o u g h o p t i o n s h a v e e x i t e d f o r a l o n g t i m e , t h e y w e r e t r a d e d O T C ,w i t h o u t m u c h k n o w l e d g e o f v a l u a t i o n . T h e f i r s t t r a d i n g i n o p t i o n s


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30/142

S t o ck i n d e x i s d i f f ic u l t t o m a n ip u l at e a s c o m pa r e d t o i n d iv i d u al

s t o c k p r i c e s , m o r e s o i n I n d i a , a n d t h e p o s s i b i l i t y o f c o r n e r i n g i s

r e d u ce d . T h i s i s p a r t y b e c a us e a n i n d iv i d u al s t o c k h a s a l i m it e d

s u p p l y, w h i c h c a n b e c o r n e r e d . S to ck i nd ex , b ei ng a n a ve ra ge , i s m uc h l es s v ol at il e t ha n

i n d i v i d u a l s t o c k p r i c e s . T h i s i m p l i e s m u c h l o w e r c a p i t a l a d e q u a c y

a n d m a rg i n r e q u i r e m e n t s .

I n d e x d e r i v at i v es a r e c a s h s e t t le s , a n d h e n c e d o n o t s u f f e r f r o m

s et t le me nt d el a ys a n d p ro bl e ms r e la te d t o b ad d el i ve ry ,

f o rg e d / f a k e c e r t i f i c a t e s .

Appl ica t ions o f fu tu res and op t ionsT h e p h e n o m e n a l g r o w t h o f f i n a n c i a l d e r i v a t i v e s a c r o s s t h e w o r l d i s

a t t r i bu te d t he f ul f i l l me nt o f n ee ds o f h ed ge rs , s pe cu la to rs a nd

a r b i t r a g u e r s b y t h e s e p r o d u c t s . A p a y o f f i s t h e l i k e l y p r o f i t / l o s s

t h a t w o u l d a c c r u e t o a m a r k e t p a r t i c i p a n t w i t h c h a n g e i n t h e p r i c e o f

t h e u n d e r l y i n g a s s e t .

Trad ing under ly ing ve rsus t r ad ing s tock fu tu res

T he s i ng l e s t o c k f u t u re s m a rk e t i n I n di a h a s b e e n a g r ea t s u cc e sss t o r y a c r o s s t h e w o r l d . N S E r a n k s f i r s t i n t h e w o r l d i n t e r m s o f

n um be r o f c on tr ac ts t ra de d i n s in gl e s to ck f ut ur es . O ne o f t he

r e a s o n s f o r t h e s u c c e s s c o u l d b e t h e e a s e o f t r a d i n g a n d s e t t i n g t h e s e

c o n t r a c t s .

To t r a d e s e c u ri t i es , a c u s t om e r m u s t o p e n a s e c u ri t y t r a d i n g

a cc ou nt w it h a s ec ur it ie s b ro ke r a nd a d em at a cc ou nt w it h a

s e c u r i t i e s d e p o s i t o r y. B u y i n g s e c u r i t y i n v o l v e s p u t t i n g u p a l l t h e

m on ey u pf ro nt . W it h t he p ur ch as e o f s ha re s o f a c om pa ny, t he

h ol de r b ec om es a p ar t o wn er o f t he c om pa ny. T he s ha re ho ld er

t yp i ca l ly r e ce i ve s t h e r i gh t s a n d p r iv i le g es a s so c ia t ed w i th t h e

s e c u r i t y, w h i c h m a y i n c l u d e t h e r e c e i p t o f d i v i d e n d s , i n v i t a t i o n t o

t h e a n n u a l s h a r e h o l d e r s m e e t i n g a n d t h e p o w e r t o v o t e .

S e l l i n g s e c u r i t i e s i n v o l v e s b u y i n g t h e s e c u r i t y b e f o r e s e l l i n g

i t . E v e n c a s e s w h e r e s h o r t s e l l i n g i s p e r m i t t e d , i t i s a s s u m e d t h a t t h e


31/142

s e c u r i t i e s b r o k e r o w n s t h e s e c u r i t y a n d t h e n l e n d s i t t o t h e t r a d e r

s o t h a t h e c a n s e l l i t . B e s i d e s , e v e n i f p e r m i t t e d , s h o r t s a l e s o n

s e c u r i t y c a n o n l y b e e x e c u t e d o n a n u p - t i c k .

To t ra de f ut ur es , a c us to me r m us t o pe n a f u t ur es t ra di ng

a c c o u n t w i t h a d e r i v a t i v e s b r o k e r . B u y i n g f u t u r e s s i m p l y i n v o l v e s

p u t t i n g i n t h e m a rg i n m o n e y. T h e y e n a b l e t h e f u t u r e s t r a d e r s t o t a k e

a p o si t io n i n t h e u n d e rl yi n g s e cu r it y w i th o ut h a vi n g t o o p en a n

a c c ou n t w i t h a s e c u r i t ie s b r o k e r . Wi t h t h e p u r c ha s e o f f u t u re s o n a

s e c u ri t y, t h e h o l d e r e s s en t i a ll y m a k es a l e g a ll y b i n d in g p r o mi s e o r

o b l i g a t i o n t o b u y t h e u n d e r l y i n g s e c u r i t y a t s o m e p o i n t i n t h e f u t u r e

( t h e e x p i r a t i o n d a t e o f t h e c o n t r a c t ) .

S e c u r i t y f u t u r e s d o n o t r e p r e s e n t o w n e r s h i p i n a c o r p o r a t i o n a n d t h e

h o l d e r i s t h e r e f o r e n o t r e g a r d e d a s s h a r e h o l d e r.

A f u t u r e s c o n t r a c t s r e p r e s e n t s p r o m i s e t o t r a n s a c t a t s o m e p o i n t i n

t h e f u t u r e . I n t h i s l i g h t , a p r o m i s e t o s e l l s e c u r i t y i s j u s t a s e a s y t o

m a k e a s p r o m i s e t o b u y s e c u r i t y. S e l l i n g s e c u r i t y f u t u r e s w i t h o u t

p r ev i ou s ly o w ni n g t h em s i mp l y o b li g at e s t h e t r ad e r t o s e ll i ng a

c er ta in a mo un t o f t he u nd er ly in g s ec ur i t y a t s om e p oi nt i n t he

f u t u r e . I t c a n b e d o n e j u s t e a s i l y a s b u y i n g f u t u r e s , w h i c h o b l i g a t e s

t h e t r a d e r t o b u y in g a c e r ta i n a m o u n t o f t h e u n d e r l yi n g s e c u r i ty a t

s o m e p o i n t i n t h e f u t u r e . I t c a n b e d o n e j u s t a s e a s i l y a s b u y i n g

f u t u r e s , w h i c h o b l i g a t e s t h e t r a d e r t o b u y i n g a c e r t a i n a m o u n t o f t h e

u n d e r l y i n g s e c u r i t y a t s o m e p o i n t i n t h e f u t u r e s . I n t h e f o l l o w i n g

s e c t i o n s w e s h a l l l o o k a t s o m e u s e s o f s e c u r i t y f u t u r e .

Futures payoff s

F u t u r e s c o n t r a c t s h a v e l i n e a r p a y o f f s . I n s i m p l e w o r d s , i t m e a n s t h a t

t h e l o s s e s a s w e l l a s p r o f i t s f o r t h e b u y e r a n d t h e s e l l e r o f a f u t u r e s

c o n t r a c t a r e u n l i m i t e d . T h e s e l i n e a r p a y o f f s a r e f a s c i n a t i n g a s t h e y

c a n b e c o m b i n e d w i t h o p t i o n s w i t h o p t i o n s a n d t h e u n d e r l y i n g t o

g e n e r a t e v a r i o u s c o m p l e x p a y o f f s .

P a y o ff f o r b u y e r o f f u t u r e s : L o n g f u t u r e s

T h e p a y o f f f o r a p e r s o n w h o b u y s a f u t u r e s c o n t r a c t i s s i m i l a r t o t h e

p ay of f f or a p er so n w ho h ol ds a n a ss et . H e h as a p ot en ti al ly


32/142

u n l i m i t e d u p p s i d e a s w e l l a s p o t e n t i a l l y u n l i m i t e d d o w n s i d e . Ta k e

t h e c a s e o f a s p e c u l a t o r w h o b u y s a t w o - m o n t h N i f t y i n d e x f u t u r e s

c o nt r ac t w he n N i ft y s t an d s a t 2 2 20 . T h e u n d e rl yi n g a s se t i n t h is

c as e i s t he N if ty p or tf ol io . W he n t he i nd ex m ov es u p, t he l on g

f u t u r e s p o s i t i o n s t a r t s m a k i n g p r o f i t s , a n d w h e n t h e i n d e x m o v e s

d o w n i t s t a r t s m a k i n g l o s s e s .

P a y o ff f o r s e l l e r o f f u t u r e s : S h o r t f u t u r e s

T h e p a y o f f f o r a p e r s o n w h o s e l l s a f u t u r e s c o n t r a c t i s s i m i l a r t o t h e

p ay of f f or a p er so n w ho s ho rt s a n a ss e t . H e h as a p ot en ti al ly

u n l i m i t e d u p s i d e a s w e l l a s p o t e n t i a l l y u n l i m i t e d d o w n s i d e . Ta k e t h e

c a s e o f a s p e c u l a t o r w h o s e l l s a t w o - m o n t h N i f t y i n d e x f u t u r e s

c o n t r a c t w h e n t h e N i f t y s t a n d s a t 2 2 2 0 . T h e u n d e r l y i n g a s s e t i n t h i s

c a s e i s t h e N i f t y p o r t f o l i o . W h e n t h e i n d e x m o v e s d o w n , t h e s h o r t

f u t u r e s p o s i t i o n s t a r t s m a k i n g p r o f i t s , a n d w h e n t h e i n d e x m o v e s u p ,

i t s t a r t s m a k i n g l o s s e s . T h e s h o w s t h e p a y o f f d i a g r a m f o r t h e s e l l e r

o f a f u t u r e s c o n t r a c t .

Appl ica t ion o f fu tu res

Hedging : Long secur i ty, se l l fu tu resF u t u r e s c a n b e u s e d a s a n e f f e c t i v e r i s k - m a n a g e m e n t t o o l . Ta k e t h e

c as e o f i nv es to r w ho h ol ds t he s ha re s o f a c om pa ny a nd g et s

u n c o m f o r t a b l e w i t h m a r k e t m o v e m e n t s i n t h e s h o r t r u n . H e s e e s t h e

v a l u e o f h i s s e c u r i t y f a l l i n g f r o m R s . 4 5 0 t o R s . 3 9 0 . I n t h e a b s e n c e

o f s t o c k f u t u r e s , h e w o u l d e i t h e r s u f f e r t h e d i s c o m f o r t o f a p r i c e f a l l

o r s el l t he s ec ur i t y i n a pp li ca t i on o f a m ar ke t u ph ea va l . W it h

s e cu r it y f u tu r es h e c a n m i n im i ze h i s p r i c e r i s k . A l l h a n e ed d o i s

e n t e r i n t o a n o f f s e t t i n g s t o c k f u t u r e s p o s i t i o n , i n t h i s c a s e , t a k e o n a

s h o r t p o s i t i o n . A s s u m e t h a t t h e s p o t p r i c e o f t h e s e c u r i t y h e h o l d s i s

R s .3 9 0. t wo - mo n th f u tu r es c o st h i m R s. 4 02 . F o r t h i s h e p a ys a n

i n i t i a l m a rg i n . N o w i f t h e p r i c e o f t h e s e c u r i t y f a l l s a n y f u r t h e r , h e

w i l l s u f f e r l o s s es o n t h e s e c u ri t y h e h o l d s. H o w e v e r , t h e l o s s e s h e

s u f f e r s o n t h e s e c u r i t y w i l l b e o f f s e t b y t h e p r o f i t s h e m a k e s o n h i s

s ho rt f u t ur es p os it io n . Tak e f or i ns ta nc e t ha t t he p r i ce o f h is

s e c u r i t y f a l l s t o R s . 3 5 0 . t h e f a l l i n t h e p r i c e o f t h e s e c u r i t y w i l l


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I n t h e a b s e n c e o f a d e f e r r a l p r o d u c t , t h e r e w a s n t m u c h h e c o u l d d o

t o p r o f i t f r o m h i s o p i n i o n . To d a y a l l h e n e e d s t o d o i s s e l l s t o c k

f u t u r e s .

S im p le a r bi tr a ge e n su r es t h at f u tu r es o n a n i n di v id u al s e cu r it i es

m o v e c o r r e s p o n d i n g l y w i t h t h e u n d e r l y i n g s e c u r i t y, a s l o n g a s t h e r e

i s s u f f i c i e n t l i q u i d i t y i n t h e m a r k e t f o r t h e s e c u r i t y. I f t h e s e c u r i t y

p r i ce r i s e s, s o w i l l t h e f u t u r e s p r i c e . I f t h e s e c u r i ty p r i c e f a l l s , s o

w i l l t h e f u t u r e s p r i c e. N o w t a k e t h e c a s e o f t h e t r a de r w h o e x p e ct s

t o s e e a f a l l i n t h e p r i c e o f A B C L t d . H e p a y s a s m a l l m a r g i n

c on tr ac t o f f ut ur es o n A BC a t R s. 2 40 (e ac h c on tr ac t f or 1 00

u nd er ly in g s ha re s) . H e p ay s a s ma ll m ar gi n o n t he s am e. Two

m o n t h s l a t e r , w h e n t h e f u t u r e s c o n t r a c t e x p i r e s , A B C c l o s e s a t 2 2 0 .

o n t h e d a y o f e x p i r a t i o n , t h e s p o t a n d t h e f u t u r e s p r i c e c o n v e r g e s .

H e h a s m a d e a c l e an p r o f i t o f R s . 2 0 p e r s h a r e . F o r t h e o n e c o n t r a c t

t h a t h e b r o u g h t , t h i s w o r k s o u t t o b e R s . 2 0 0 0 .

Arbi t rage : Overpr iced fu tu res : buy spo t , se l l fu tu res

A s w e d i sc u ss e a rl i er , t h e c o st - of - ca r ry e n su r es t h at t h e f u tu r es

p r i c e s t a y i n t u n e w i t h t h e s p o t p r i c e . W h e n e v e r t h e f u t u r e s p r i c e

d e v i at e s s u b s ta n t i al l y f r o m i t s f a i r v a l ue , a r b i tr a g e o p p o rt u n it i e s

a r i s e .

A BC L td . t ra de s a t R s. 1 00 0. O ne -m on th A BC f ut ur es t ra de a t

R s. 10 25 a nd s ee m o ve rp r i ce d. A s a n a rb it ra ge ur , y ou c an m ak e

r i s k l e s s p r o f i t b y e n t e r i n g i n t o t h e f o l l o w i n g s e t o f t r a n s a c t i o n s .

1 . O n d a y o n e , b o r r o w f u n d s ; b u y t h e s e c u r i t y o n t h e c a s h / s p o t

m a r k e t a t 1 0 0 0 .

2 . S i m u l t a n e o us l y, s e l l t h e f u t u r e s o n t h e s e c u r i t y a t 1 0 2 5 .

3 . Ta k e d e l i v er y o f t h e s e c u r i ty p u r c ha s e d a n d h o l d t h e s e c u ri t y

f o r a m o n t h .

4 . O n t h e f u t u re s e x p i r a t io n d a t e, t h e s p o t a n d t h e f u t ur e s p r i c e

c o n v e rg e . N o w u n w i n d t h e p o s i t i o n .

5 . S a y t h e s e c u r i t y c l o s e s a t R s . 1 0 1 5 . S e l l t h e s e c u r i t y.

6 . T h e r e s u l t i s a r i s k l e s s p r o f i t o f R s . 1 5 o n t h e s p o t p o s i t i o n a n d

R s . 1 0 o n t h e f u t u r e s p o s i t i o n .


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g e n e r a t e v a r i o u s p a y o f f s b y u s i n g c o m b i n a t i o n s o f o p t i o n s a n d t h e

u n d e r l y i n g . We l o o k h e r e a t t h e s i x b a s i c p a y o f f s .

Payoff s p ro f i l e fo r se l l e r o f a s se t : Long asse tI n t h i s b a s i c p o s i ti o n , a n i n v e st o r b u y s t h e u n d e r l yi n g a s s e t , N i f t y

f o r i n s t a n c e , f o r 2 2 2 0 , a n d s e l l s i t a t a f u t u r e d a t e a t a n u n k n o w n

p r i ce , S t . o n c e i t i s p u r c ha s e d , t h e i n v e st o r i s s a i d t o b e l o ng t h e

a s s e t .

Payoff s p ro f i l e fo r se l l e r o f a s se t : Shor t a s se t

I n t h i s b a s i c p o s i t i o n , a n i n v e s t o r s h o r t t h e u n d e r l y in g a s s e t , Ni f t y

f o r i n s t a n c e , f o r 2 2 2 0 , a n d b u y s i t b a c k a t f u t u r e d a t e a t a n u n k n o w n p r i c e , S t . O n c e i t i s s o l d , t h e i n v e s t o r i s s a i d t o b e s h o r t t h e a s s e t .

Payoff s p ro f i l e fo r buyer o f ca l l op t ions : Long ca l l

A c a l l o p t i o n g i v e s t h e b u y e r t h e r i g h t t o b u y t h e u n d e r l y i n g a s s e t a t

t h e s t r i ke p r ic e s p ec i fi e d i n t h e o p t i on . T he p r of i t / l o ss t h at t h e

b uye r m a ke s o n t h e o pt i o n d ep en d o n t h e s po t p ri c e o f t he

u n de r ly in g . I f u p on e x pi r at i on , t h e s p ot p r ic e e x ce e ds t h e s t ri k e p r i c e , h e m a k e s a p r o f i t . H i g h e r t h e s p o t p r i c e m o r e i s t h e p r o f i t h e

m a k e s . I f t h e s p o t p r i c e o f t h e u n d e r l y i n g i s l e s s t h a n t h e s t r i k e

p r i c e , h e l e t s h i s o p t i o n e x p i r e u n - e x e r c i s e d . H i s l o s s i n t h i s c a s e i s

t h e p r e m i u m h e p a i d f o r b u y i n g t h e o p t i o n .

T h e f i g u r e s h o w s t h e p r o f i t s / l o s s e s f r o m a l o n g p o s i t i o n o n t h e

i n d e x . T h e i n v e s t o r b r o u g h t t h e i n d e x a t 2 2 2 0 . I f t h e i n d e x g o e s

u p , h e p r o f i t s . I f t h e i n d e x f a l l s , h e l o s s e


37/142

P a y o f f f o r a n i n v e s t o r w h o w e n t L o n g o f N i f t y a t 2 2 2 0

T h e f i g u r e s h o w s t h e p r o f i t s / l o s s e s f r o m a s h o r t p o s i t i o n o n t h e

i n d e x . T h e i n v e s t o r s o l d t h e i n d e x a t 2 2 2 0 . I f t h e i n d e x f a l l s , h e

p r o f i t s . I f t h e i n d e x r i s e s , h e l o s s e s

P a y o f f f o r a n i n v e s t o r w h o w e n t s h o r t o f N i f t y a t 2 2 2 0

T he f ig ur e s ho w s t he p ro fi ts / l os se s f or t he b u ye r o f a t hr ee -

m o n t h N i f t y 2 2 5 0 c a l l o p t i o n . A s c a n b e s e e n , a s t h e s p o t N i f t y

r i s e s , t h e c a l l o p t i o n i s i n - t h e - m o n e y. I f u p o n e x p i r a t i o n , N i f t y

c lo se s a bo ve t he s tr ik e o f 2 25 0, t he b u ye r w ou ld e xe rc is e h i s

o pt io n a nd p ro fi t t o t he e xt en t o f t he d if fe re nc e b et we en t he

N i ft y- cl os e a nd t he s tr ik e p ri ce . T he p ro fi ts p os si bl e o n t hi s

o p t i o n a r e p o t e n t i al l y u n l i m i t e d . H o w e v e r i f N i f t y f a l l s b l o w t h e


38/142

s t r i k e o f 2 2 5 0 , h e l e t s t h e o p t i o n s e x p i r e . H i s l o s s e s a r e l i m i t e d t o

t h e e x t e n t o f t h e p r e m i u m h e p a i d f o r b u y i n g t h e o p t i o n .

f o r b u y i n g t h e o p t i o n . G i v e s t h e p a y o f f f o r t h e b u y e r o f a t h r e e

m o n t h c a l l o p t i o n ( o f t e n r e f e r r e d t o a s l o n g c a l l ) w i t h a s t r i k e o f

2 2 5 0 b r o u g h t a t a o f 8 6 . 6 0 .

Payoff s p ro f i l e fo r wr i t e r o f ca l l op t ions : Shor t a s se t

A c a l l o p t i o n g i v e s t h e b u y e r t h e r i g h t t o b u y t h e u n d e r l y i n g a s s e t a t

t h e s t r i k e p r i c e s p e c i f i e d i n t h e o p t i o n . F o r s e l l i n g t h e o p t i o n , t h e

w r i t e r o f t h e o p t i o n c h a r g e s a p r e m i u m . T h e p r o f i t / l o s s t h a t t h e


u n d e r l y i n g . W h a t e v e r i s t h e b u y e r s p r o f i t i s t h e s e l l e r s l o s s . I f

u p o n e x p i r a t i o n , t h e s p o t p r i c e e x c e e d s t h e s t r i k e p r i c e , t h e b u y e r

w il l e xe rc is e t he o pt io n o n t he w ri te r . H en ce a s t he s po t p ri ce

i n c r e a s e s t h e w r i t e r o f t h e o p t i o n s t a r t s m a k i n g l o s s e s . H i g h e r t h e

s p o t p r i c e m o r e i s t h e l o s s h e m a k e s . I f u p o n e x p i r a t i o n t h e s p o t

p r i ce o f t h e u n d e rl y i ng i s l e s s t h a n t h e s t r i k e p r i c e , t h e b u y e r l e t s

h is o pt io n e xp ir e u ne xe rc is ed a nd t he wr it er g et s t o k ee p t he

p remium.

T h e f i g u r e s h o w s t h e p r o f i t s / l o s s e s f o r t h e s e l l e r o f a t h r e e - m o n t h

N i f t y 2 2 5 0 c a l l o p t i o n . A s t h e s p o t N i f t y r i s e s , t h e c a l l o p t i o n i s

i n - t h e- m o n e y. A n d t h e w r i t e r s t a r ts m a k i n g l o s s e s . E x p i r a t i o n,

N i ft y c l os e s a b o v e t h e s t r i k e o f 2 2 50 , t h e b u y e r w o ul d e x er c is e

h i s o p t i o n a n d p r o f i t o n t h e w r i t e r w h o w o u l d s u f f e r a l o s s t o t h e

e x t e n t o f t h e d i f f e r e n c e b e t w e e n t h e N i f t y - c l o s e a n d t h e s t r i k e


39/142

p r i c e . T h e l o s s t h a t c a n b e i n c u r r e d b y t h e w r i t e r o f t h e o p t i o n i s

p o t e n t i a l l y u n l i m i t e d , w h e r e a s t h e m a x i m u m p r o f i t i s l i m i t e d t o

t h e e x t e n t o f t h e u p - f r o n t o p t i o n p r e m i u m o f R s . 8 6 . 6 0 c h a r g e d

b y h i m .

P a y o f f f o r w r i t e r o f c a l l o p t i o n

Payoff s p ro f i l e fo r buyer o f pu t op t ions : Long asse t

A p u t o p t i o n g i v e s t h e b u y e r t h e r i g h t t o s e l l t h e u n d e r l y i n g a s s e t a t

t h e s t r i ke p r ic e s p ec i fi e d i n t h e o p t i on . T he p r of i t / l o ss t h at t h e


u n d e r l y i n g . I f u p o n e x p i r a t i o n , t h e s p o t p r i c e i s b e l o w t h e s t r i k e p r i c e , h e m a k e s a p r o f i t . L o w e r t h e s p o t p r i c e m o r e i s t h e p r o f i t h e

m a k es . I f t h e s p o t p r i c e o f t h e u n d e r ly i n g i s h i g h e r t h a n t h e s t r i ke

p r i c e , h e l e t s h i s o p t i o n e x p i r e u n e x e r c i s e d . H i s l o s s i n t h i s c a s e i s

t h e p r e m i u m h e p a i d f o r b u y i n g t h e o p t i o n .

Payoff s p ro f i l e fo r wr i t e r o f pu t op t ions : Shor t pu t

A p u t o p t i o n g i v e s t h e b u y e r t h e r i g h t t o s e l l t h e u n d e r l y i n g a s s e t a t

t h e s t r i k e p r i c e s p e c i f i e d i n t h e o p t i o n . F o r s e l l i n g t h e o p t i o n , t h ew r i t e r o f t h e o p t i o n c h a r g e s a p r e m i u m . T h e p r o f i t / l o s s t h a t t h e

b u y er m a k es o n t h e o p t i o n d e p e n d o n s p o t p r i c e o f t h e u n d e r l yi n g .

W h at ev er i s t h e b uy e r s p ro fi t i s t h e s el l er s l o ss . I f u po n

e x p i ra t i on , t h e s p o t p r i c e h a p p e n s t o b e b e l o w t h e s t r ik e p r i c e , t h e

b u y e r w i l l e x e r c i s e t h e o p t i o n o n t h e w r i t e r. I f u p o n e x p i r a t i o n t h e

s p o r t p r i c e o f t h e u n d e r l y i n g i s m o r e t h a n t h e s t r i k e p r i c e , t h e b u y e r

l e t s h i s o p t i o n e x p i r e u n - e x e r c i s e d a n d t h e w r i t e r g e t s t o k e e p t h e

p remium.


40/142

Appl ica t ion o f op t ions

We l o o k h e r e a t s o m e a p p l i c a t i o n o f o p t i o n c o n t r a c t s . We r e f e r t o

s i n g l e s t o c k o p t i o n h e r e . H o w e v e r s i n c e t h e i n d e x i s n o t h i n g b u t a

s e c u r i t y w h o s e p r i c e o r l e v e l i s a w e i g h t e d a v e r a g e o f s e c u r i t i e sc o n s t i t u t i n g t h e i n d e x , a l l s t r a t e g i e s t h a t c a n b e i m p l e m e n t e d u s i n g

s t o k e f u t u r e s c a n a l s o b e i m p l e m e n t e d u s i n g i n d e x o p t i o n .

Hedging : Have under ly ing buy pu t s

O w n e r s o f s t o c k s o r e q u i t y p o r t f o l i o s o f t e n e x p e r i e n c e d i s c o m f o r t

a b o u t t h e o v e r a l l s t o c k m a r k e t m o v e m e n t . A s a n o w n e r o f s t o c k s o r

a n e qu it y p or tf o l io , s om et im es y ou m ay h av e a v ie w t ha t s to ke

p r i ce s w i l l f a l l i n t h e n e a r f u t u re . A t o t h e r t i m e s y o u m a y s e e t h a tt h e m a r k e t i s i n f o r a f e w d a y s o r w e e k s o f m a s s iv e v o l a t i li t y, a n d

y o u d o n o t h a v e a n a p p e t i t e f o r t h i s k i n d o f v o l a t i l i t y. T h e u n i o n

b u d g e t i s a c o m m o n a n d r e l i a b l e s o u r c e o f s u c h v o l a t i l i t y : m a r k e t

v o la t il i ty i s a l wa ys e n ha n ce d f o r o n e w e ek b e fo r e a n d t w o w e e k s

a f t er a b u d g et . M a n y i n v e st o r s s i m p ly d o n o t w a n t t h e f l u ct u a t io n s

o f t he se t hr ee w ee ks . O ne w ay t o p ro te ct y ou r p or tf ol io f ro m

p o t e n t i a l d o w n s i d e d u e t o a m a r k e t d r o p i s t o b u y i n s u r a n c e u s i n g

p u t o p t i o n s .

I n d e x a n d s t o k e o p t i o n a r e a c h e a p a n d e a s i l y i m p l e m e n t a b l e

w a y o f s e ek i ng t h is i n su r an c e. T he i d ea i s s i mp l e. To p r o t ec t t h e

v a l u e o f y o u r p o r t f o l i o f r o m f a l l i n g b e l o w a p a r t i c u l a r l e v e l , b u y t h e

r i g h t n u m b e r o f p u t o p t i o n s w i t h t h e r i g h t s t r i k e p r i c e . I f y o u a r e

o n l y c o n c e r n e d a b o u t t h e v a l u e o f a p a r t i c u l a r s t o k e t h a t y o u h o l d

b u y p u t o p t i o n s o n t h a t s t o c k . I f y o u a r e c o n c e r n e d a b o u t t h e o v e r a l l

p o r t fo l i o , b u y p u t o p t i o n s o n t h e i n d e x . W h e n t h e s t o c k p r i c e f a l l s

y o u r s t o c k w i l l l o s e v a l u e a n d t h e p u t o p t i o n s b o u g h t b y y o u w i l l

g a i n , e f f e c t i v e l y e n s u r i n g t h a t t h e

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