Professional Documents
Culture Documents
Ludhiana Stock Excahnge
Ludhiana Stock Excahnge
Angel broking
SUBMITTED TO
SUBMITTED BY
PUNJABI UNIVERSITY
SIMRANDEEP SINGH
PATIALA
6329
ACKNOWLEDGEMENT
Simrandeep Singh
ii
STUDENT DECLARATION
I here by Declare that study of Study of Derivatives Has been exclusively done
by us for the degree of BACHELOR OF BUSINESS ADMINISTRATION And not
for any other degree, Diploma or fellowship. This is our own study done under
the guidance of manager of the company.
I hereby declare that the contents of this report are true and best to my
knowledge.
Place: LUDHIANA
(SIMRANDEEP SINGH)
iii
PREFACE
One should always work with an objective in its mind. To accomplish that
objective efficient management of material, time and financial resources is very
important. Above this coordination is must that determines the degree of
success.
Awareness at each level of life is necessary for a human being keeping all this is
view in this report on Study of Derivatives. The rounded encouraging support
by Mr. JS Arneja towards this report has created in me confidence regarding the
approval of the subject matter.
I feel that it was a great opportunity for me to spend time in LSE and getting
myself aware of the ups and downs of capital market.
So would like to say that this report is a result of an assignment, to improve
myself and gain confidence.
iv
CONTENTS
CHAPTER 1
INTRODUCTION TO ORGANISATION
1 . STOCK EXCHANGE
2 . LUDHIANA STOCK EXCHANGE
3 . LSE SECURITIES LIMITED
CHAPTER 2
PROJECT OBJECTIVES
A
LEARNING OBJECTIVES
1
INTRODUCTION TO DERIVATIVES
2 TYPES OF DERIVATIVES
3 ECONOMIC UTILITY OF DERIVATIVES
4 OBJECTIVES OF DERIVATIVES
5 INSTRUMENTS OF DERIVATIVE TRADING
6 RISK MANAGEMENT
7 MARGIN
ANALYSIS OF DERIVATIVES
CHAPTER 3
RESEARCH METHODOLOGY
CHAPTER 4
CHAPTER 5
LIST OF TABLES
Table No.
Title Of Table
Page No.
TABLE 1.1
TABLE 1.2
TABLE 1.3
15
TABLE 1.4
19
TABLE 1.5
23
TABLE 1.6
30
vi
LIST OF DIAGRAMS
Fig. No.
Page No
28
OF LSESL
FIGURE 1.2 SOURCES OF FUND FOR THE YEAR 2004-05
29
OF LSESL
FIGURE 2.1 PAYOFF INDEX FUTURES (BUYER)
50
51
55
56
57
58
81
FIGURE 4.2
82
83
84
85
86
87
vii
88
89
90
viii
STOCK EXCHANGE
No.
1
Years
of Type of organization
establishment
Bombay Stock exchange
1875
Voluntary
Non-profit
organization
2
Ahmedabad
Stock 1897
exchange
Non-profit
organization
M.P.
Stock
Voluntary
1908
exchange, 1930
Indore
Non-profit
organization
1937
1943
1947
1957
10
U.P.
Stock
1978
exchange, 1982
Kanpur
11
1982
12
1983
13
1983
14
1984
15
1985
16
1986
17
Bhuvneshwar
Stock 1989
exchange
18
Kutch.
19
1990
N.D.
20
1991
N.D.
21
O.T.C.I.
1993
Pure demutulised
1995
Pure demutualised
23
1996
N.D.
24
1997
N.D.
BOARD OF DIRECTORS
Sh. Harjit Singh Sidhu
Prof. Rajinder Bhandari
Sh. D.K. Malhotra
Sh. G.S. Bains
Sh. B.B. Tandon
Sh. Sunil Malhotra
Sh. Yash Mahajan
Sh. S.C. Aggarwal
Sh. Sanjeev kumar Gupta
Managing Director
Public Representative
Public Representative
Public Representative
Public Representative
Public Representative
Public Representative
SEBI Nominee
Director
SEBI Nominee
Director
TABLE 1.2
CORPORATE GOVERNANCE
Although the Ludhiana Stock Exchange is not a listed Company, yet it has
followed a model of corporate governance, which is evident from the composition
of the Statutory Committees, the Investor Services Committee and Audit
Committee. The Investor Services Committee comprises of four public
Representatives and one broker member. It is headed by Sh. D.K. Malhotra, a
legal expert. Statutory Committees are represented by brokers and non-brokers
in 20:80 ratios.
10
LISTING
Listing is one of the major functions of a Stock Exchange wherein the securities
of the Companies are enlisted for trading purpose. Any Company incorporated
under Companies Act, 1956, coming out with an IPO, has to mandatory list its
shares on a Stock Exchange.
The Listing Department of Ludhiana Stock Exchange deals with listing of
securities, further listing of issues like bonus and rights issues, post-listing
compliance of the companies, which are already listed with Ludhiana Stock
Exchange. The Companies desirous of listing its securities on the Exchange
have to sign a Listing Agreement with the Stock Exchange. After getting the
listing approval, the Company has to ensure and report compliance of the post
listing requirements. The listing section of the LSE monitors the post-listing
compliance of all the listed companies and follows up with the companies, which
are found deficient in compliance.
11
prepare for such an eventuality, stock exchanges set up a broking armed in the
name of LSE Securities Ltd (a subsidiary company of stock exchange) in January
2000 and built infrastructure and IT based sophisticated systems to enable its
members and investors to trade on NSE and BSE through the subsidiary route.
LSEAL HAS:OWN BUILDING
LSEAL has its own six stories ultra modern building at Feroze Gandhi market at
Ludhiana. It started its operation on 16 th Aug, 1983.
OWN BULLETIN
LESAL is continuously publishing LSEAL Bulletin at the interval of quarter. It is
also publishing LSE annual report which provides information to the various
members and investors of stock exchanges.
SCREEN BASED TRADING
It was started at LSE on Nov. 18, 1996. The requisite software is developed by
CMC Ltd. This screen Based Trading is based on VECTOR (Versatile Engine for
Centralized Trading and on line reporting System) this system displays funds with
respect of opening prices of the stock exchanges as well as the last traded
prices.
ON LINE TRADING THROUGH VSAT
LSEAL has chalked out an ambitious program to expand online trading through
V-SAT to untie other than Ludhiana and plans to take the trading facility to
doorstep of investors in this year. The Board of Directors of LSE have approved
the plan for expansion of online trading through VSAT with the object of broad
base business opportunities to the investor and members, the exchange has set
up 30 trading terminals at remote sites and union territory of Chandigarh. Trading
through V-SAT has been smoothly conducted in October 1999.
12
13
benefited the investors of the region but has also proved to be a source of
income for the company.
14
15
16
Chairman
Vice Chairman
Director
Director
Director
Director
Public Representative
Public Representative
Public Representative
Public Representative
Public Representative
TABLE 1.3
DEPARTMENTS OF LSE
17
The main aim of LUDHIANA STOCK EXCHANGE is to ensure the safety and
security to the investments of the investors and to provide the proper services
under the prescribed guidelines of SE 131. So to maintain the proper system of
working of exchange, there are so many different departments in which particular
functions are performed, assigned to those departments. Following in the list of
various departments of LSE:OPERATIONAL DEPARTMENTS
1. Margin Section
2. Clearing House
3. Market Surveillance
4. Computer Section and information System Department
SERVICE DEPARTMENTS
1. Legal Department
2. Secretarial Department.
3. I.G.C. (Investor Grievance Cell)
4. Listing Section
5. Accounting Section
6. Membership Department/Personnel Department
All the section perform specific functions. There is no duplication of work;
even then all the sections are interconnected with each other. There is an
organized network of recording of activities performed there. But before studying
the inter dependence of section) here is the details of all department i.e. actually
what function is performed by each and every section.
MARGIN SECTION
18
Margin Section is an important section. This section apart from dealing in the
regulating the trading of brokers keeps a check on excessive trading in
speculation. Margin is the amount, which is collected from brokers for the safety
of transactions. As the transactions are to be finalized on basis, in the mean time
the rates may fluctuate which may lead to default. So to make the transaction
safe, daily margins are collected from brokers. When a member gets registered
in the exchange and with Securities Exchange Board of India (SEBI), then before
starting trading he is supposed to deposit some amount fixed by SEBI as
security. Now as SEBIs rolling settlement prevails. Ultimately margin is the
difference between the limit and trade done by the member. The security
deposited by a member is called Base Minimum Capital. If any member wants to
trade beyond his trading limit, he can do so by depositing Additional Base
Minimum Capital.
TYPES OF MARGINS
As we have discussed earlier margins, collected from members to
avoid the losses and to provide security to the investors. There are different types
of margins, which are imposed given as follows:MARK TO MARKET MARGIN
The exchange collects this margin on daily basis, broker-wise
100% notional loss of each member for every scrip, calculated as the difference
of his buying or selling price and closing of that scrip at the end of the day. This is
also called loss margin. The margin is payable in cash or in bank guarantee.
19
CLEARING HOUSE
20
Clearing house takes care of pay-in and pay-out securities. At this time there is
weekly trading system (Monday to Friday) prevails. And securities are settled by
rolling settlement. Means pay-in and pay-out of securities is settled on T+3 Basis
would commence form 1stApril, 2002. SEBI decide the following activity schedule
for exchanges for the T+3 rolling settlement.
SETTLEMENT CYCLE SCHEDULE
Sr.
Day
No.
1
2
3
T
T+2
T+3
Trade Date
Securities and funds pay-in and pay-out
Auction of shortage in delivery
TABLE 1.4
T - TRADING PERIOD.
PAY IN/PAYOUT OF SECURITIES
On trading day brokers buy and sold the securities or scrips and pay-In and pay
out of securities will be completed on T+2 basis e.g. if broker buy/sell shares on
Monday then pay in of securities will be on Wednesday, 10:30A.M. And pay out
of scrips will also on Wednesday up to 2:00 P.M., in this way pay-in/pay-out of
securities cycle will be completed.
21
In case if broker fails to deliver the scrips on T+2 delivery day. Then it is
responsibility of clearing house to settle the undelivered scrips. Then, auction will
start. In above example, auction of pending securities will be conducted on
Thursday. In auction price of securities may will fluctuate 20% high or low of that
trading day. In this way trade in auction is settled.
CLOSE OUT
In case the shares of particular scrips is not available on the date of
auction. Then it is obligation of solicitor (exchange) to give monetary benefit to
initiator (buyer) against the default of defaulter of securities in this manner
settlement schedule has completed.
COMPUTER SECTION
The growing technicalities and increase in workload has enhanced
the importance of computer section in Ludhiana stock exchange. This
department mainly referred to as EDP i.e. electronic data processing section.
This section is the backbone of entire stock exchange would come to halt if this
department becomes inactive.
It prepares several reports namely: o
new rates, once we feed new limits the whole calculation to be done through
22
computer will change. Rates are updated either daily or month wise as per the
requirements.
MANUAL OPERATIONS
It has reduced manual work. It has also eliminated approximately
the need to keep check the physical reports, which is a time consuming as well
as space consuming and requires a lot of attention.
VOLUME AND TRANSPARENCY
This system is very much transparent, as each individual involved
knows every relevant tilling . Also volume of shares being traced is very high and
increasing continuously.
LINKING CHAIN
This section acts as a linkage, which links each and every
department of the LSE with another and hence helps in working as a whole.
CHECK AND CONTROL OVER SCRIPS AND MEMBERS
This section also helps in maintaining check and control over
defaulting members and scrips. In case the member crosses his limit of trading
according to his deposited amount, the computer section switches off his terminal
and same step is taken in case of defaulted scrips.
23
The main task of this section is to see the market sanctity and
maintenance so that the investors are not cheated. So market surveillance
entails scientifically identifying points in a stock price movement or trading
volumes, which don't match with the company's fundamentals. So the price and
volume trends in stock exchange are checked for abnormalities scientifically.
INVESTORS GRIEVANCE SECTION
LSE has a separate investor's grievance cell, which receives
complaints from investors and follows up the complaints with companies and
member broker to ensure their satisfactory redressal. For providing better
services to the investors the stock exchange has maintained investor protection
fund. In this fund Rs. 500 is collected from each member annually. Apart from this
one percent of the total listing fee collected and ten percent interest covered on
company deposits is also transferred to the investor protection fund.
One more fund investor service fund has been set up. 20% of the
listing fee is transferred to it. The funds of it are used for maintenance of investor
service center, holding of seminars for investor/brokers benefit, and publication of
LSE Bulletin.
Rationale Behind Establishing Investors Grievance Cell
o To safeguard the investors interest through investors grievance section.
o To participate as monitoring authority in the public and right issue of the
company.
o To ensure that the company listed at the LSE compiles with all the listing
requirements.
o To keep a record of the inquiry base of the listed companies, their annual
financial results and any subsequent increase in the equity base.
o
LISTING SECTION
24
Companies which have paid up capital of more than Rs. 50 crores will pay
additional fee of Rs. 2800 for every increase of Rs. 5 crores or part there of. The
annual listing fees referred to above are applicable only if the exchange is a
Regional Stock Exchange otherwise the fees will be 50% of the fees indicated
above.
ACCOUNTS SECTION
Most of the work in account section LSE is done manually, although help is taken
through computers for the purpose of making Trial Balance, Income and
25
Expenditure statement and Balance Sheet. The annual report of LSE is generally
published in August every year. Some of the important polices of LSE are
o
with and din the manner specified in schedule XIV of the Companies Act 1956.
o
assets and other indirect expenditure during construction is included under work
in progress.
The company has the procedure of receiving shares, scrips of various
companies as securities against the performance of the contract. No accounting
entries in such transaction are made in respect of defaulting members by
crediting security account and debiting member's investment a/c. The shares in
such cases are valued at prices on the date of transfer deeds.
Functions of Accounts Section:The account section performs the following function.
o
financial year.
o
Sources of funds of LSE:
o
26
Annual fee from brokers (Rs. 5000) and their authorized representatives.
(Rs. 500 each) as broker member is allowed to have maximum 4
authorized representatives.
Interest income from deposits of companies for listing, which are made at
1% of issue amount and minimum capital for this purpose is Rs. 4/- crores.
Such deposits are retained until there is no dispute against the company
subject to the minimum of 6 months,
Maintenance charges Rs. 13.50 per sq. feet, per quarter from those
members having rooms and those not having rooms all those not having
rooms are charges at till rate of Rs. 1500/- pa.
Water and electricity charges Rs. 750 per quarter, whose area is less than
200 sq. feet and 900/- per quarter which is having area of more than 200
sq. feet. The members who are not having rooms are charged at the rate
of Rs. 300/- (p.a.)
above- mentioned charges. On 1st April of each year and they are to make
payment in 180 days up to 30 September. Beyond it, they are charged interest on
due amount @ 12% p.a. still in case of nonpayment, broker member is served a
show cause notice for 60 days on 1 st April next year. If member fails to, comply
with notice then he can be expelled.
Application Of Funds Of LSE:-
27
Salaries
4. 1% of listing is transferred annually to investor protection fund.
SECRETARIAL DEPARTMENT
Duties and responsibilities of personnel department are mentioned as under
which are discharge by the secretarial departments.
o
Recruitment of staff.
Maintain employee service book up to date and other detail as per the
requirements to auditors at the time of inspection (From date of joining
registration)
departments in its organizing chart. All activities relating personnel are carried out
by the secretarial departments, which has the additional charge of personnel.
LEGAL SECTION
28
When two broker or outside clients do not settle their claims in between
themselves and move to court, the legal section comes into the picture to fight for
the cause of investors and against the defaulting members. Legal section also
assist the member investor to settle their disputes through the arbitration
committee investors grievance committee.
Disciplinary committee, defaulting committee, so that there
maybe settled at the earlier without incurring heavy due on amount regarding
court fee, advocate fee etc. The objective of the legal section is to make effective
the bylaws and regulation of the stock exchange and to see that the guidelines,
circular and any amendments in rules made by the SEBI are enforced at
appropriate time so that the future complications may be reduced or avoided. As
the name legal section suggests it is clearly mentioned and understood that each
of every matter involving legality is to be solved by the legal department.
PERSONNEL DEPARTMENT
Ludhiana stock exchange does not have a personnel department in its
Organization chart. This department carries out all activities relating to the
recruitment of the personnel, whenever and wherever a vacancy arises,
maintenance of attendance register. This department also deals with the
appointment or removal of floor clerks or authorized representatives of brokers.
These departments also maintain records of leaves and overtime of employees.
MEMBERSHIP DEPARTMENT
29
Qualification:
Following requirements are for corporate members:1. Company must be registered u/s 322 of the company Act i.e. Directors
with unlimited liability.
2. Two copies of MOA & AOA.
3. Qualification & Proof of age of at least two directors, who will deal in
securities.
30
1
2
3
4
5
FIGURE 1.1
0.82%
13.27
29.03%
3.23%
53.65
31
1
2
3
4
5
FIGURE 1.2
5.10%
47.18%
31.90%
4) Depository Income
8.99%
5) Other income
6.83%
________
100
32
TABLE 1.6
Oct 1981
Aug 1983
Aug 1983
Nov 1996
April 1998
and
settlement
gurantee
Nov 1998
fund.
Trading and settlement in demat
Sep 1999
scrips
Trading at remote sites through VSAT
Jan 2000
Aug 2000
counters
Introduction of rolling settlement
Commencement of online real time
Dec 2000
depository services
Trading on N.S.E. in C.M. segment
Sep 2000
(Through NSEL)
Trading on B.S.E. in CM segment
July 2001
(Through LSEL)
Introduction of Compulsory rolling
January 2002
settlement
Complete shift of trading CM segment
Feb 2002
April 2002
April 2003
Oct 2003
March 2004
33
34
OBJECTIVES
LEARNING OBJECTIVES
It includes
1
INTRODUCTION TO DERIVATIVES
2 TYPES OF DERIVATIVES
3 ECONOMIC UTILITY OF DERIVATIVES
4 OBJECTIVES OF DERIVATIVES
35
INTRODUCTION TO DERIVATIVES
Primary market is used for raising money and secondary market is used
for trading in the securities, which have been used in primary market. But
derivative market is quite different from other markets as the market is used for
minimizing risk arising from underlying assets.
The work derivative originates from mathematics. It refers to a variable,
which has been derived from another variable.
i.e. X = f(Y)
Where X (dependent variable) = DERIVATIVE PRODUCT
36
Example : Wheat farmers may wish to sell their harvest at a future date to
eliminate the risk of change in price by that date. The price of these derivatives is
driven from spot price of wheat.
DEFINITION OF DERIVATIVE
In the Indian context the securities contracts (Regulations), Act 1956
defines Derivative to include:
37
38
39
1. Hedger :- Hedgers face risk associated with the price of an asset. They
use futures or options markets to reduce the risk. Thus, they are operation
who want to eliminate the risk composing of their portfolio.
2. Speculators : They wish to be on future movements in the price of an
asset. A speculator may buy securities in anticipation of rise in price. If this
expectation comes true he sells the securities at a higher price and makes
a profit. Usually the speculator does not take delivery of securities sold by
him. He only receives and pays the differences between the purchase and
sale prices.
3. Arbitrageurs : They are in business to take advantage of discrepancy
between price in two different markets. If for example, they see the future
price of an asset getting out of line with cash price, they will take off
setting positions in two markets to lock in profit.
TYPES OF DERIVATIVES
The most commonly used derivatives contract is forwards, futures and
options:
1. Forwards : A forward contract is a customized contract between two
entities, where settlement takes place on a specific date in the futures at
todays pre-agreed price.
40
41
42
43
In both these situations you would like to insure portfolio against any such
market fall. Such insurance is known as hedging.
Hedging is a tool to reduce the inherent risk in an investment. Various
strategies designed to reduce investment risk using call option, put
options, short selling, and futures are used for hedging. The basic purpose
of a hedge is to reduce the risk of loss.
2. Arbitrage: - The future price of an underlying asset is function of spot
price and cost of carry adjusted for any return on investment. However,
due to uncertainly about interest rates, distortions in spot prices, or
uncertainly about future income stream, prices in futures market may not
truly reflect the expected spot price in future. This imbalance in future and
spot price gives rise to arbitrage opportunities. Transactions made to take
advantage of temporary distortions in the market are known as arbitrage
transactions.
3. Speculations: - You may have very strong opinion about the future
market price of a particular asset based on past trends, current
information and future expectation. Likewise you may also have opinion
about the overall marker trend. To take advantage of such opinion,
individual asset or the entire market (index) could be sold or purchased.
44
number of market
makers, who can write the options contracts. Strict capital adequacy
norms to be out and followed.
45
46
47
Forward
Derivative
Future
Option
FORWARD CONTRACTS
It is an agreement to buy/sell an asset on a certain future date at an agreed
price.
The two parties are :
1. Who takes a long position - agreeing to buy
2. Who takes a short position agreeing to sell
The mutually agreed price is known as delivery price or forward
price. The delivery price is chosen in such a way that the value of contract for
both parties is zero at the time of entering the contract, but the contract takes a
positive or negative value for parties as the price of underlying asset moves. It
removes the future price risk. It a speculator has information or analysis, which
forecast an upturn in price, and then be can go long on the forwards market
instead of cash market.
The speculator would go long on the forward, wait for the price to rise, and
then take a reversing transaction to book profits. Speculator may well be required
48
&
Assets
Increase
Positive Value
Negative Value
Decrease
Negative Value
Positive Value
49
It is an agreement between buyer and seller for the purchase and sale of a
particular assets at a specific future date; specific size, date of delivery, place
and alternative asset. It makes obligation on both parties to fulfill the contract.
Features of Future Contract
1. Standardized contracts e.g. contract size.
2. Between two parties who do not necessarily know each other.
3. Guarantee for performance by a clearing corporation or clearing house.
Clearing house is associated with matching, processing, registering,
confirming setting, reconciling and guaranteeing the trades on the future
exchanges. Clearing house tries to eliminate risk of default by either party.
4. It has some features of Badla also.
FUTURE TERMINOLOGY
Spot Price : The price at which an asset trades in the spot market.
Future Price : The price as which the futures contract trades in the futures
market.
Contract cycle : The period over which the contract trades. The index futures
contracts on the NSE have one moth, and three-month expiry cycles, which
expire on the last Thursday of one month. Thus a January expiration contract
expires on the last Thursday of the January. On the Friday following the last
Thursday, a new contract having three-month expiry is introduced of trading.
Expiry Date : It is 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.
Basis : In the contract 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
50
for each contract. In a normal market, basis will be positive. This reflects that
futures prices normally exceed spot prices.
Initial margin : The amount that must be deposited in the margin account at a
time a future contract is first entered into is known as initial margin.
Marketing-to-market : In the futures market, at the end of each trading day, the
margin account is adjusted to reflect the investors margin gain or loss depending
upon the futures closing price.
Maintenance margin : This is somewhat lower than initial margin. This is set to
ensure that the balance in the margin account never becomes negative. If the
balance amount 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.
TYPE OF FUTURE CONTRACTS
Index Futures : Of the financial futures, index future contracts are key contracts,
introduced in U.S.A., in 1982 by the Commodity Futures Trading Commission
(CFTC) by approving the Kansas Board proposal. Index Futures began trading in
India in June 2000 of Trade (KSBT)s Futures derive its value from the underlying
index-e.g. NSEs futures. Contracts are based on S & P CNX NIFTY
At present it has become the most liquid contract in the country, the arbitrage
between the futures equity market is further expected to reduce impact cost. 8090% of retail participation is expected in India because
51
15th
Buys 200 nifty contracts with expiry date - 31th at 1220 costing
Rs. 244000 (200*1220)
31st
FIGURE 2.1
52
31st
FIGURE 2.2
53
Forward
Future
-Operational
Traded between
Trade on
Mechanism
two parties
Exchange
-Contract
Differ from
Standardized
Specifications
traded to trade
Contracts
-Counter party
Exists such
No such
Risks
risk
risk
-Liquidity
Low
High
-Price
Not
Highly
Discovery
Efficient
Efficient
-Settlement
At end of period
Daily
Margin
No such margin
Margin required
for trading
54
OPTIONS
Options are fundamentally different from forward and futures. An option gives the
holder/buyers of the option the right to do something. The holder does not have
committed himself to doing something. In contrast, in a forward or futures
contract, the two parties have committed them self to doing something. Whereas
it nothing (except margin requirement) to enter in to a futures he purchases of an
option require an up front payment.
Historical background of Option:
Although options have exercised for a long time, they were traded OTD, without
much knowledge of valuation. Today exchange-traded options are actively traded
on stocks, stock indices, foreign currencies and futures contracts.
The first trading is options began in Europe and U.S. as early as the
century. It was only in early, 1990s that a group of firms set up what is known as
the put and call brokers and dealers association with the aim of providing a
mechanism for bringing buyers and sellers together. It someone wanted to buy
an option, he or she would contract one of the member firms. The firm would
then attempt to find a seller or writer of option either from its own client of those
of other member firms. If no seller could be found, the firm would undertake to
write the option itself in return of price. The two deficiencies in above markets
were
1. No secondary market
2. No mechanism to guarantee the writer of option would honor it
In 1973, Black, Marton, Scholes invented the Black-Scholes formula. In April
1973, CBOE was set up specially for the purpose of trading options. The market
for options develop so rapidly that by early 80s number of share underlying the
What is Option ?
55
An options is the right, but not the obligation to buy to sell a specified amount
(and quality) of a commodity, index or financial instruments a to buy of sell a
specified number of underlying futures contracts, at a specified price on a before
a give date in the future.
Thus, option like futures, also provide a mechanism by which one can acquire a
certain commodity on other assets, or take position in order to make profits or
cover risk for a price. In this type of contract as well, there are two parties:
a. The buyer (or the holder, or owner of options)
b. The seller (or writer of options)
While the buyer take long position the seller take short position
So every option contract can either be call option or put option options are
created by selling and buying and for every option that is buyer and seller.
TYPES OF OPTION CONTRACTS
1. Index Options :- Index options are also financial exchange traded
contracts with the underlying assets as the index, whereby the buyer of
the options acquire the right to buy or sell predefined quantity of the index
for a consideration paid to the seller or the writer of the option. All option
contracts are also standardized and the clearing house or the cooperation
guarantees the performance of the contracts.
2. Stock Options :- These are the stock exchange traded contracts
whereby, buyer of the option gets the right to buy the contracts stocks for
a consideration paid to the seller of the option. He does not have any
obligation, but on the other hand the writer (seller) of the option is under
the obligation to honour the contract since he has received the premium in
lieu of the obligations. Stock options are similar to index options, but with
a basic difference is that the underlying assets are individual
3. TYPES OF OPTIONS
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Call Option :
It gives an owner the write to buy a specified quantity of the underlying assets at
a predetermined price i.e. the exercise price, or the specific date i.e. is the date
of maturity.
: Limited to Rs. 50
Break Even
: Rs.2390
2340
0
50
index
loss
FIGURE 2.3
57
Why sell Option : If u think market will remain neutral or slightly bearish .
Example
Sell a call with a strike price of Rs.2340(Nifty) at a premium of Rs.50
Maximum Profit Potential : Rs.50
Maximum Risk Potential : Unlimited
Break Even : Rs. 2390
Desired Movement :Market will not go down
1250
index
loss
FIGURE 2.4
Put Option
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It gives the holder the right to sell a specific quantity of underlying asses at an
agreed price on date of maturity he gets the right to sell.
Why Buy a Put Option (Buyer)
If u think market will fall
Example
Buy a Put with a strike of Rs.2360(Nifty) at a premium of Rs.25
Maximum Profit Potential : Substantial
Maximum Risk Potential.
Break Even : 2335
Desired Movement : Bearish
2360
index
loss
FIGURE 2.5
profit
2360
index
loss
FIGURE 2.6
OPTION TERMINOLOGY
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1. Buyer of an option : The buyer of an option is the one who by paying the
option premium buys the right but not the obligation exercise his option on
the seller/writer.
3. Option price : Option price is the price, which the option buyer pays to
the option seller. It is also referred as option premium.
5. Strike Price : The price specified in the options contract is known as strike
price or the exercise price.
6. American options : these are the options that can be exercised at any
time upto the expiration date. Most exchange-traded options are
Americans.
7. European options: These are the options that can be exercised only on
the expiration date itself. These are easier or analyze than American
option, and properties of American options are frequently deducted from
those of its European counterpart.
9. At-money option : (ATM) option is an option that would lead to zero cash
flow if it were exercised immediately. An option on the index is at-themoney when the current index equals the strike price.
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10. Out-of-the money option : (OTM) options is an option that would lead to
a negative cash flow it was exercised immediately. A call option on the
index is OTM when the current index stands at a level, which is less than
the strike price (spot price<strike price). If the index is much lower than the
strike price, the call is set to be deep OTM. In the case of a put, the put is
OTM if the index is above the strike price.
AMERICAN VS EUROPEAN OPTION
Its owner can exercise an American option at any time on or before the expiration
date.
A European style option gives the owner the right to use the option only on
expiration date and not before.
Option Premium
A glance at the rights and obligations of buyer and seller reveals that option
contracts are skewed. One way naturally wonder as to why the seller (writer) of
an option would always be obliged to sell/buy an asset whereas the other party
gets the right. The answer is that writer of an option receives, a consideration for
Undertaking the obligation. This is known as the price or premium to the seller for
the option.
The buyer pays the premium for the option to the seller shelter he exercise the
option is not exercised, it becomes worthless and the premium becomes the
profit of the seller.
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RISK MANAGEMENT
NSCCL have developed a comprehensive risk containment mechanism for the F
& O Segment. The salient features of risk containment mechanism of the F & O
segment are :
1. The financial soundness of the members is the key to risk management.
Therefore, the requirements for membership in term of capital adequacy
(net worth, security deposits) are quite stringent.
2. NSCCL charges an upfront initial margin for all the open positions of a
CM. It specifies the initial margin requirements for each futures/options
contract on a daily basis. It also follows value-at-risk (VAR) based
margining through SPAN. The CM in turn collects the initial margin form
the TMs and their respective clients.
3. The open positions of the members are marked based on contract
settlement price for each contract. The difference is settled in cash on T +
1 basis.
4. NSCCLs on-line position monitoring system monitors a CMs open
positions on a real-time basis. Limits are set for each CM based on his
capital deposits. The on-line position monitoring system generates alters
whenever a CM reaches a position limit set up by NSCCL. NSCCL
monitors the CMs for MTM value violation, while TMS are monitored for
contract-wise position limit violation.
5. CMs are provided a trading terminal for the purpose of monitoring the
open position of all the TMs clearing and setting through him. A CM may
set exposure limits for a TM clearing and settling through him. NSCCL
assists the Cm to monitor the intra-day exposure limits set up by a CM
and whenever a TM exceed the limits, it stops that particular TM from
further trading.
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at any point of time, will be treated as a violation of the Rules, Bye-Laws and
Regulations of NSCCL and would attract disciplinary action inter-alia including,
withdrawal of trading facility and /or clearing facility, closing out of outstanding
positions etc.
Additional Base Capital
Clearing members may provide additional margin/collateral deposit
(additional base capital) to NSCCL and/or may wish to retain deposits and/or
such amounts which are receivable from NSCCL, over and above their minimum
deposit requirements, towards initial margin and / or other obligations.
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MARGINS
NSCCL has developed a comprehensive risk containment mechanism for the
Futures & Options segment. The most critical component of a risk containment
mechanism for NSCCL is the online position monitoring and margining system.
The actual margining and position monitoring is done on-line, on an intra-day
basis. NSCCL uses the SPAN (Standard Portfolio Analysis of Risk) system for
the purpose of margining, which is a portfolio-based system.
Initial Margin
NSCCL collects initial margin up-front for all open positions of a CM based
on the margins computed by NSCCL-SPAN. A CM is in turn required to collect
the initial margin from the TMs and his respective clients. Similarly, a TM should
collect upfront margins from his clients.
Initial margin requirements are based on 99% value at risk over a one day
time horizon. However, in the case of futures contracts (on index or individual
securities), where it may not be possible to collect mark to market settlement
value, before the commencement of trading on the next day, the initial margin
may be computed over a two-day time horizon, applying the appropriate
statistical formula. The methodology for computations of Value at Risk
percentage is as per the recommendations of SEBI from time to time.
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penal charges @ 0.09% per day of the amount not paid throughout the period of
non-payment. In addition NSCCL may at its discretion and without any further
notice to the clearing member, initiate other disciplinary action, inter-alia
including, withdrawal of trading facilities and / or clearing facility closing out of
outstanding positions, imposing penalties, collecting appropriate deposits,
invoking bank guarantees / fixed deposit receipts etc
DERIVATIVES TRADING IN INDIA
The first step towards introduction of derivatives trading in India was the
promulgation of the securities laws (amendment) ordinance, 1995 which
withdrew the prohibition on options in securities. The market for derivatives,
however, did not take off, as there was no regulatory framework to govern trading
of derivatives.
SEBI set up a 24 members committee under the Chairmanship of Dr. L.C.
Gupta on 18th November, 1996 top develop appropriate regulatory framework for
derivatives trading in India. The committee submitted its report on 17 th March,
1998 prescribing necessary pre-conditions for introduction of derivatives trading
in India. The committee recommended that derivatives should be declared as
securities so that regulatory framework applicable to trading of securities could
also govern trading of securities. SEBI also set up a group in June 1998 under
the Chairmanship of Prof. J.R. Varma, to recommend measures for risk
containment in derivatives market in India. The report, which was submitted in
October, 1998, worked out the operational details of margining system,
methodology for changing initial margins, broker net worth, deposit requirement
and real time monitoring requirements.
The SCRA was amended in Dec, 1999 to include derivatives within the
ambit of securities and the regulatory framework was developed for governing
derivatives trading.
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Index Futures
Index Options
Stocks Future
Stock Options
Index Futures : Index futures are financial contracts for which the underlying is
the cash market index like the Sensex, which is the brand index of India. Index
futures contract is an agreement to buy or sell a specified quantity of underlying
index for a future date at a price agreed upon between the buyer and seller. The
contracts have standardized specifications like market lot, expiry day, tick size
and method of settlement.
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Index Options : Index Options are financial contracts whereby the right is given
by the option seller in consideration of a premium to the option buyer to buy or
sell the underlying index at a specific price (strike price) on or before a specific
date (expiry date).
Stock Futures : Stock Futures are financial contracts where the underlying asset
is an individual stock. Stock futures contract is an agreement to buy or sell a
specified quantity of underlying equity share for a future date at a price agreed
upon between the buyer and seller. Just like Index derivatives, the specifications
are pre-specified.
Stock Options : Stock Options are instruments whereby the right of purchase
and sale is given by the option seller in consideration of a premium to the option
buyer to buy or sell the underlying stock at a specific price (strike price) on or
before a specific date (expiry date).
OPERATIONAL MECHANISM OF DERIVATIVES
1. Registration with broker :
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broker would key this identification number in the system at the time of
placing the order on behalf of the investors. This ID is broker specific i.e. if
the investors chooses to deal with different brokers, he needs to sign the
client agreement with each one of them and resultantly, he would have
different Ids.
4. Risk Disclosure Documents : As stipulated in the Bye-Laws provide his
particulars to the investors. The particulars would include his SEBI
registration number, the name of the employees who would be primarily
responsible for the clients affairs, the precise nature of his liability towards
the client in respect of the business done on behalf of the investor. The
broker must also apprise the investor about the risk associated with the
business in derivative trading and the extent of his liability. This
information forms part of the Risk Disclosure document, which the broker
issues to the client. The investor should carefully read the risk disclosure
document and understand the risks involved in the derivatives trading
before committing any position in the market. The risk disclosure
document has to be sign3ed by the client and a copy of the same is
retained by the broker for his records.
5. Free Copy of Relevant Regulations : The client is also entitled to a free
copy of the extracts or relevant provisions governing the rights and
obligations of clients, relevant manuals, notifications, circulars and any
additions or amendments etc. of the derivatives segment or of any
regulatory authority to the extent it governs the relationship between the
broker and the client.
6. Placing order with the broker : The investor should place orders only
after understanding the monetary implications in the event of execution of
the trade. After the trade is executed, the investor can request for a copy
of the trade confirmation slip generated on the systems on execution of
the trade. The investor should also obtain from the broker, a contract note
for the trade executed within 24 hours. The contract note should be time
(order receipt and order execution) and price stamped. Execution prices,
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REGULATORY FRAMEWORK
73
A contract which derives its value from the prices, or index of price, of
underlying securities.
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75
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RESEARCH METHODOLOGY
77
Sources of Data:
The source of data includes primary and secondary data sources.
Primary Sources
Primary data is data collected for first
purpose for which study is being conducted i.e. the problem under study..
Secondary Sources
The secondary data is data, which is collected and compiled for the
different purpose, which are used in research for this study. The secondary data
include material collected from:
-
Newspaper
Magazine.
Internet.
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Sampling technique used was Snowball sampling was used for the purpose of
data collection as reference was taken form sample to reach other sample.
Sample Size : Sample size refers to the number of items to be selected from the
universe to constitute a sample. Due to constraints of cost and time, the sample
size selected for the research is 25 investors and 35 brokers
Sampling Unit : The sampling unit was the person who had an account and
was investing in stock market and broker who were trading in stock market
.
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80
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1.
FIGURE 4.1
From my sample of 60, 13 (22%) brokers and investors investing in
derivatives from the last 1 year and less than this. 21 (35%) are investing from
last 2 years, 7 (11%) are investing from last 3 years and only 6 (10%) have
experience of more than 3 years of investment in derivatives.
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2.
83
F & O Segment.
Cant Say.
FIGURE 4.3
Out of 35 informants, 17 have largest turnover in the capital segment i.e. 49%
and 23% have equal turnover in CM & F&O segment. No informants have its
largest turnover in F & O segment because the investor are very less aware
about the derivatives and they do not know about the derivative trading as they
much know about the CM Segment.
84
FIGURE 4.4
Out of my sample size 60, 27 (45%) investors and brokers have invested 2 lacs
normally, 9 (15%) invested between 2 lacs to 5 Lacs and 15 (25%) invested
between 5 lacs to 10 lacs, and remaining have invested in other amounts.
Reasons behind this is that those are investing from many years are taking the
risk of investing huge amount.
85
86
FIGURE 4.5
13 (22% investors and brokers are investing weekly in derivatives, 23 (38%)
investing monthly, 19 (32%) investing after more than 1 month and only 5 (8%)
investing too late after 2 months.
87
FIGURE 4.6
Out of 35 brokers , 3 (5%) of brokers said that it does not increase their customer
base because introducing small savings as investment, but derivatives increase
customer base of 24 (70%) which is more than half. It is basically beneficial for
those who are investing from last 2 or more years. In investment sector need
minimum of Rs. 2,00,000 as investment so it is basically for corporate and
investment sector only not for small investors. 8 (25%) said their customer base
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remains same because they have started just now for investing in derivatives in
future it will increase their customer base.
7.
FIGURE 4.7
Out of 60 brokers, investors 27 (45%) have the positive response towards the
relation between derivative and cash market and remaining 5 (8%) has negative
response. 28 (47%) are not able to say anything because they do not have
proper knowledge about stock market. They are investing with the guidance of
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brokers and with the support of their close relatives those are investing for last
many years.
FIGURE 4.9
90
Index future
b)
Stock future
c)
Index option
d)
Stock option
FIGURE 4.10
91
I got mix view on this question. But most of the informants i.e. 50%
are in the favour of index future and rests are having some different different
attraction .
RESULTS / FINDINGS
Brokers not dealing in derivatives at present are also not going to
adopt it in futures.
Hedging and Risk Management is the most important feature of
derivatives?
It is not for small investors.
It ahs increased brokers turnovers as well as helpful in aggregate
investment.
Brokers havent adequate knowledge about options, so most of them
are dealing in futures only.
There is a risk factor in derivative also.
Most of the investors are not investing in derivatives.
People are not aware of derivatives, even people who have invested
in it, has not adequate knowledge about it.
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93
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SUGGESTIONS
1.
LOT SIZE:
Lot size should be reduced so that the major segment of an Indian
society i.e. small saving class can come under F & O trading. There is strong
need for revision of lot sizes as the lot sizes of some of the individual scrips that
were worth of Rs. 200000 in starting, now same lot size amount to a much larger
value.
2.
SUB BROKERS
Sub-broker concept should be added and the actual brokers should
SCRIPS:
More scrips of reputed companies etc. should be introduced in
F & O Segment.
4.
TRADING PERIOD
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CONCLUSION
On the basis of overall study on derivatives it was found that
derivative products initially emerged as hedging devices against fluctuation and
commodity prices and commodity linked derivatives remained the soul form of
such products. The financial derivatives came in spotlight in 1972 due o growing
instability in financial market.
I was really surprised to see during my study that a layman or a
simple investor does not even know how to hedge and how to reduce risk on his
portfolios. All these activities are generally performed by big individual investors,
mutual funds etc.
No doubt that derivative growth towards the progress of economy is
positive. But the problem confronting the derivative market segment are giving it
a low customer base. The main problem that it confronts are unawareness and
bit lot sizes etc. these problems could be overcome easily by revising lot sizes
and also there should be seminar and general discussions on derivatives at
varied places.
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We view them as time bombs both for the parties that deal in them
and the economic system.
97
BIBLIOGRAPHY
BOOKS
NSE News.
ECONOMICS TIME
INTERNET SITES:
www.bseindia.com
www.derivativesindia.com
Derivatives
in
India:
Frequently
Asked
Questions,
http://www.mayin.org/ajayshah/PDFDOCS/ShahThomas2000_dfq.p
df
98
QUESTIONNAIRE
Dear Respondent,
I am a student of MBA . I am working on the project STUDY OF
DERIVATIVES . You are requested to fill in the questionnaire to enable, to
undertake the study on the said project
NAME:
OCCUPATION:
ADDRESS:
PHONE NO:
1)
99
2)
3)
b) 1 Year
c) 2 Year
d) 3 year
Hedging
b)
Speculation
c)
Risk Management
d)
Liquidity
4)
100
5)
a) Weekly
b) Monthly
7)
b) Decrease
c) Remains same.
8)
b) Negative
c) Cant say.
9)
c) Index option
d) Stock option
10)
_____________________________________________________________
_____________________________________________________________
102