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“TRADING IN DERIVATIVE MARKET”
In partial fulfillment of Summer Training for M.B.A Program
1. ABOUT COMPANY
Religare Securities Ltd
Religare Finvest Ltd
Religare Wealth Management Services Ltd
Religare Commodities Ltd
Religare Capital Markets Ltd
Religare Enterprises Ltd
Religare Insurance Broking Ltd
Religare Finance Ltd
Religare Venture Capital Pvt Ltd
Religare Realty Ltd
ABOUT RELIGARE & ITS GROUP COMPANIES Religare is a financial services company in India, offering a wide range of financial products and services targeted at retail investors, high net worth individuals and corporate and institutional clients. Religare is promoted by the promoters of Ranbaxy Laboratories Limited. Religare operate from six regional offices and 25 sub-regional offices and have a presence in 330 cities and towns controlling 979 locations which are managed either directly by Religare or by our Business Associates all over India, the company have a representative office in London. While the majority of Religare offices provide the full complement of its services yet it has dedicated offices for investment banking, institutional brokerage, portfolio management services and priority client services
com Religare Macquarie Wealth Management Ltd. one of India's premier independent fund houses and Religare have come together and through the JV have formed an entity.vistaarreligare.com/ Vistaar Religare -The Film Fund India's first SEBI approved Film Fund (Vistaar as a partner) For more information log on to http://www.religaremacquarie. Milestone Religare Investment Advisors Private Limited.com/ Milestone Religare .aegonreligare. Australian Financial Services major as a partner) For more information log on to http://www. For more information log on to http://www. Private Wealth business (Macquarie.com/ .milestonereligare.JOINT VENTURES AEGON Religare Life Insurance Company Life Insurance business (AEGON as a partner) For more information log on to www.Private Equity Fund Milestone.
srl. For more information log on to: http://www. The group envisages setting up a pan India world class retail network of wellness stores that would provide comprehensive solutions under one roof.com:8080/default. It is the beginning of every step and the foundation on which a person reaches for the stars.in/ Religare Wellness Limited (formerly Fortis Healthworld) is one of the leading players in the wellness retail space with a footprint of over 100 stores across India. Care. the management is aggressively working towards taking this number to a significant level in the next few years to provide quality healthcare facilities and services across the nation. each leaf of the clover has a special meaning. established in 1996 was founded on the vision of creating an integrated healthcare delivery system. including multi-specialty & super specialty centres. The dream of becoming. .OTHER GROUP COMPANIES Fortis Healthcare Limited. Super Religare Laboratories Limited (formerly SRL Ranbaxy) within 11 years of inception has become the largest Pathological Laboratory network in South Asia. For more information log on to: http://www. The first leaf of the clover represents Hope. it is the symbol of Religare. With 22 hospitals in India. It started a revolution in diagnostic services in India by ushering in the most specialized technologies. It is a symbol of Hope. Good Fortune.html For us. backed by innovation and diligence.religarewellness. The current footprint extends well beyond India in the Middle East and parts of Europe. For the world. Of new possibilities. The aspirations to succeed. Trust.
but in the bond that is built. ABOUT TOPIC DERIVATIVES DEFINED Derivative is a product whose value is derived from the value of one or more basic variables. wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. The fourth and final leaf of the clover represents Good Fortune. The truth of feeling that underlines sincerity and the triumph of diligence in every aspect. From it springs true warmth of service and the ability to adapt to evolving environments with consideration to all. To have a relationship as partners in a team. . The secret ingredient that is the cement in every relationship. not in the binding. four-leaf clover to visually symbolize the values that bind together and form the core of the Religare vision. in a contractual manner. For example. To accomplish a given goal with the balance that brings satisfaction to all. Trust. Hope. Good Fortune.The second leaf of the clover represents Trust. or reference rate). The price of this derivative is driven by the spot price of wheat which is the "underlying". All elements perfectly combine in the emblematic and rare. Signifying that rare ability to meld opportunity and planning with circumstance to generate those often looked for remunerative moments of success. The underlying asset can be equity. Such a transaction is an example of a derivative. The third leaf of the clover represents Care. index. forex. commodity or Any other asset. The ability to place one’s own faith in another. called bases (underlying asset. Care.
In the class of equity derivatives the world .In the Indian context the Securities Contracts (Regulation) Act. Derivatives are securities under the SC(R)A and hence the trading of derivatives is governed by the regulatory framework under the SC(R)A. 2. and commodity-linked derivatives remained the sole form of such products for almost three hundred years. A security derived from a debt instrument. risk instrument or contract for differences or any other form of security. or index of prices. they accounted for about two-thirds of total transactions in derivative products. A contract which derives its value from the prices. the market for financial derivatives has grown tremendously in terms of variety of instruments available. loan whether secured or unsecured. share. 1956 (SC(R)A) defines "derivative" to include1. In recent years. Financial derivatives came into spotlight in the post-1970 period due to growing instability in the financial markets. their complexity and also turnover. these products have become very popular and by 1990s. of underlying securities. However. since their emergence. 6 Derivative products initially emerged as hedging devices against fluctuations in commodity prices.
over. futures and options on stock indices have gained more popularity than on individual stocks. who are major users of index-linked derivatives. especially among institutional investors. Even small investors find these useful due to high correlation of the popular indexes with various portfolios and ease of use. DERIVATIVE PRODUCTS .
Forwards: A forward contract is a customized contract between two entities. The most common variants are Forwards. Options . options and swaps. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. where settlement takes place on a specific date in the future at today's pre-agreed Price. We take a brief look at various derivatives contracts that have come to be used. futures. Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price.Derivative contracts have several variants.
They can be regarded as portfolios of forward contracts. A payer swaption is an option to pay fixed and receive floating. with the cash flows in one direction being in a different currency than those in the opposite direction.A call option gives the buyer a right to buy the underlying that is the index or stock at the specified price on or before the expiry date. Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. Swaptions: Swaptions are options to buy or sell a swap that will become Operative at the expiry of the options.A put option on the other hand gives the right to sell at the specified price on or before expiry date. Rather than have calls and puts. The seller of the contract is called the options writer. . A receiver swaption is an option to receive fixed and pay floating. • Currency swaps: These entail swapping both principal and interest Between the parties. Thus a swaption is an option on a forward Swap. He has the right to exercise the option but not obligation & he has to pay a premium for having such right to be exercised. • Call Option .One who buys the option. • Option Buyer .Options are instruments whereby the right is given by the option seller to the option buyer to buy or sell a specific asset at a specific price on or before a specific date. • Put Option . He receives premium through the clearing house against which he is obliged to buy or sell the underlying if the buyer of the contract so desires.In any contract there are two parties. In case of an option there is a buyer to the contract and also a seller. the swaptions market has receiver swaptions and payer swaptions. • Option Seller/ Option Writer. The two commonly used swaps are: • Interest rate swaps: These entail swapping only the interest related cash Flows between the parties in the same currency.
speculators. It is therefore not surprising that financial instruments for the management of such risk have developed. Speculators wish to bet on future movements in the price of an asset. for example.A pre determined set of question were asked to know their preferences. Futures and options contracts can give them an extra leverage. that is. Hedgers face risk associated with the price of an asset. they see the futures price of an asset getting out of line with the cash price.By providing commitments to prices or rates for the future dates or by giving protection against adverse movements. they can increase both the potential gains and potential losses in a speculative venture. Arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. They use futures or options markets to reduce or eliminate this risk.RESEARCH METHODOLOGY The project study has been conducted by using both primary data as well as secondary data. they will take offsetting positions in the two markets to lock in a profit. and arbitrageurs trade in the derivatives market.hedgers. Changes in the stock market prices.1 Title Trading in Derivative market Most of the organization and individuals face financial risk. The major part was by collecting primary data through directly calling up people grom the database provided by the company. interest rates and exchange rates can have great significance. financial derivatives can be used to . Adverse changes may even threaten the survival of otherwise successful businesses. If.PARTICIPANTS IN THE DERIVATIVES MARKETS The following three broad categories of participants . These instruments are known as financial derivatives. 2. 2.
derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-adverse investors. Conversely they also provide profit opportunities for those prepared to accept risk. By their very nature. To study and incorporate the hedging tools. .2 OBJECTIVES The basic objective of my study on DERIVATIVE is mainly as under- • • • • To analyze and evaluate the complex derivative instuments. swap etc. it is possible to partially or fully transfer price risks by locking in asset prices. the financial markets are marked by a very high degree of volatility. most notably forwards. The emergence of the market for derivative products. futures and options. these generally do not influence the fluctuation in the underlying assets prices. Through the use of derivative products. Indeed. To gain knowledge about derivative market. can be traced back to the willingness of risk-adverse economic agents to guard themselves against uncertainties arising out of fluctuation in asset prices.Howevevr.reduce the extent of financial risk. at least to extent. 2. Derivatives have widely been used as they facilitate hedging. they involve the transfer of risk from those who wish to who willing to except it. As instruments of risk management. that enable fund managers of an underlying assets portfolio to transfer some parts of the risk of price changes to others who are willing to bear such risk. option. futures. option are the specific derivative instruments that give their owner the right to buy(call option holder)or to sell(put option holder) a specific number of shares (assets)at a specified prices(exercise prices)of a given underlying asset at or before a specified date(expiration date). by locking in assets prices. Various aspects of hedging like forward.
Once the researcher has specified the nature of research design. Objectives of a questionnaire Any questionnaire has three specific objectives. 11.A structured set of question has been prepared & asked to people by directly calling them & their feedback was analyzed for precise finding. and determined the scaling procedures. It must translate the information needed into a set of specific questions that the respondents can and will answer. he or she can develop a questionnaire. Method to be used: A frequency count has been done for different parameters/questions & the most important factors have suggested to the company for betterment of sales operations. RESEARCH DESIGN • • Defining the population: The population taken for the research consists of investors or prospective clients of only delhi & NCR region (both retail & institutional) Defining the sample:A random sample has been taken for the purpose of extensive market survey. To analyses how derivative instruments work. • • QUESTIONNAIRE Questionnaire is an important step in formulating a research design. .• • • To know traders prevent themselves from fluctuation in exchange rates. Size & type of samples:A random sample of size 100 people was taken for surveying. To learn how to manage the risk.
4 DATA COLLECTION PRIMARY DATA Primary data collected from religare securities personal in the fields of financial securities & index analysis.. These questionnaires were personal administered. It must uplift. 33. It should be able to minimize response errors. It was also important as researchers to respect the samples time and energy hence the questionnaire was designed in such a way. and to complete the interview. which are collected from the websites of the Bombay stock Exchange. motivate and encourage the respondent to become involved in the interview.uk etc. religares securities. money control and marketoracle. Incomplete interviews have limited usefulness at best.co. that its administration would not exceed 4-5 minutes. Interviews were conducted with pre-written questions pertinent to research work. . National Stock Exchange. 2. to cooperate. SECONDARY DATA This study is based on secondary data.22.
2. If the stock price does not rise up to the expected level.5 LIMITATION • • • • • • • The biggest disadvantage of the derivative trading is that you have a time frame to complete the selling of the stock. Many respondents were unwilling to give their contact details specially their Telephone numbers. Another limitation of derivative trading is that not all the listed stocks are available for derivative trading. The respondents selected to be interviewed were not always available and willing to cooperate. There are selected stocks in a stock exchangei. which cannot determine the investment behaviors of the total population. Respondents were apprehensive in giving their correct income level and some gave them incorrectly.e Nse and Bse in which you can do derivative trading. The sample size of our survey is only 50. . even then you have to sell off the stocks to honor the contract. Another negative aspect is that the if the stock price fall then the investor loose huge money in derivative trading as the amount of stock involved in this trading is huge.
index. commodity or any other asset. forex. or reference rate). called bases (underlying asset. The underlying asset can be equity. Some of the factors driving the growth of financial derivatives are: 1. the derivatives market has seen a phenomenal growth. . FACTORS DRIVING THE GROWTH OF DERIVATIVES Over the last three decades. A large variety of derivative contracts have been launched at exchanges across the world. in a contractual manner. Increased volatility in asset prices in financial markets.FACT & FINDING Derivative is a product whose value is derived from the value of one or more basic variables.
. Innovations in the derivatives markets. 3. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. We take a brief look at various derivatives contracts that have come to be used. which optimally combine the risks and returns over a large number of financial assets leading to higher returns. options and swaps. Development of more sophisticated risk management tools. DERIVATIVE PRODUCTS Derivative contracts have several variants. Increased integration of national financial markets with the international markets. Marked improvement in communication facilities and sharp decline in their costs. providing economic agents a wider choice of risk management strategies. 4. Forwards: A forward contract is a customized contract between two entities. Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. futures. The most common variants are forwards. and 5. reduced risk as well as transactions costs as compared to individual financial assets.2. where settlement takes place on a specific date in the future at today's pre-agreed price.
with the cash flows in one direction being in a Different currency than those in the opposite direction. Rather than have calls and puts. In recent years. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset. FORWARD CONTRACTS A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. Swaptions:Swaptions are options to buy or sell a swap that will become Operative at the expiry of the options. But not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. • Currency swaps: These entail swapping both principal and interest Between the parties. Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. derivatives have become increasingly important in the field of Finance. forward contracts are popular on the OTC market. Thus a swaption is an option on a forward swap. A payer swaption is an option to pay fixed and receive floating. A receiver swaption is an option to receive fixed and pay floating. They can be regarded as Portfolios of forward contracts. Puts give the buyer the right.Options: Options are of two types . While futures and options are now actively traded on many Exchanges. We shall study in detail these three derivative contracts. The two commonly used swaps are: • Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency.calls and puts. at a given price on or before a given future date. the swaptions market has receiver swaptions and payer swaptions. One of the parties to the contract assumes a long .
it has to compulsorily go to the same counter-party. By using the currency forward market to sell dollars forward. Other contract details like delivery date. as in the case of foreign exchange. The forward contracts are normally traded outside the exchanges. The other party assumes a short position and agrees to sell the asset on the same date for the same price. The salient features of forward contracts are: • They are bilateral contracts and hence exposed to counter-party risk. The classic hedging application would be that of an exporter who expects to receive payment in dollars three months later. • Each contract is custom designed. the contract has to be settled by delivery of the asset.position and agrees to buy the underlying asset on a certain specified future date for a certain specified pric e. price and quantity are negotiated bilaterally by the parties to the contract. . 26 Forward contracts are very useful in hedging and speculation. He is exposed to the risk of exchange rate fluctuations. • If the party wishes to reverse the contract. This process of standardization reaches its limit in the organized futures market. However forward contracts in certain markets have become very standardized. which often results in high prices being charged. thereby reducing transaction costs and increasing transactions volume. and hence is unique in terms of contract size. • The contract price is generally not available in public domain. • On the expiration date. expiration date and the asset type and quality.
Even when forward markets trade standardized contracts. still the counterparty risk remains a very serious . this is generally a relatively small proportion of the value of the assets underlying the forward contract. Similarly an importer who is required to make a payment in dollars two months hence can reduce his exposure to exchange rate fluctuations by buying dollars forward. and • Counterparty risk In the first two of these. the other suffers. LIMITATIONS OF FORWARD MARKETS Forward markets world-wide are afflicted by several problems: • Lack of centralization of trading.he can lock on to a rate today and reduce his uncertainty. The speculator would go long on the forward. The use of forward markets here supplies leverage to the speculator. which forecasts an upturn in a price. and then take a reversing transaction to book profits. When one of the two sides to the transaction declares bankruptcy. wait for the price to rise. This often makes them design terms of the deal which are very convenient in that specific situation. • Illiquidity. but makes the contracts non-tradable. Counterparty risk arises from the possibility of default by any one party to the transaction. then he can go long on the forward market instead of the cash market. Speculators may well be required to deposit a margin upfront. However. the basic problem is that of too much flexibility and generality. If a speculator has information or analysis. and hence avoid the problem of illiquidity. The forward market is like a real estate market in that any two consenting adults can form contracts against each other.
(or which can be used for reference purposes in settlement) and a standard timing of such settlement. INTRODUCTION TO FUTURES Futures markets were designed to solve the problems that exist in forward markets. The standardized items in a futures contract are: • Quantity of the underlying • Quality of the underlying • The date and the month of delivery • The units of price quotation and minimum price change • Location of settlement Merton Miller. a standard quantity and quality of the underlying instrument that can be delivered. the 1990 Nobel laureate had said that 'financial futures represent the most significant financial innovation of the last twenty years. But unlike forward contracts. the futures contracts are standardized and exchange traded. More than 99% of futures transactions are offset this way. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. acknowledged as the 'father of financial futures" who was . it was called the International Monetary Market (IMM) and traded currency futures. The brain behind this was a man called Leo Melamed. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. It is a standardized contract with standard underlying instrument." The first exchange that traded financial derivatives was launched in Chicago in the year 1972. To facilitate liquidity in the futures contracts.issue. A division of the Chicago Mercantile Exchange. the exchange specifies certain standard features of the contract.
then the Chairman of the Chicago Mercantile Exchange. Before IMM opened in 1972, the Chicago Mercantile Exchange sold contracts whose value was counted in millions. By 1990, the underlying value of all contracts traded at the Chicago Mercantile Exchange totaled 50 trillion dollars. These currency futures paved the way for the successful marketing of a dizzying array of similar products at the Chicago Mercantile Exchange, the Chicago Board of Trade, and the Chicago Board Options Exchange. By the 1990s, these exchanges were trading futures and options on everything from Asian and American stock indexes to interest-rate
swaps, and their success transformed Chicago almost overnight into the risk-transfer capital of the world. The first financial futures market DISTINCTION BETWEEN FUTURES AND FORWARDS CONTRACTS Forward contracts are often confused with futures contracts. The confusion is primarily because both serve essentially the same economic functions of allocating risk in the presence of future price uncertainty. However futures are a significant improvement over the forward contracts as they eliminate counterparty risk and offer more liquidity. FUTURES TERMINOLOGY • Spot price: The price at which an asset trades in the spot market. • Futures price: The price at which the futures contract trades in the futures market. • Contract cycle: The period over which a contract trades. The index futures contracts on the NSE have one- month, two-months and threemonths
expiry cycles which expire on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three- month expiry is introduced for trading. • Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist. • Contract size: The amount of asset that has to be delivered under one contract. Also called as lot size.
29 • Basis: In the context of financial futures, basis can be defined as the futures price minus the spot price. There will be a different basis for each delivery month for each contract. In a normal market, basis will be positive. This reflects that futures prices normally exceed spot prices. • Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset. • Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin. • Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called
marking-to-market. • Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day. INTRODUCTION TO OPTIONS In this section, we look at the next derivative product to be traded on the NSE, namely options. Options are fundamentally different from forward and
futures contracts. An option gives the holder of the option the right to do something. The holder does not have to exercise this right. In contrast, in a forward or futures contract, the two parties have committed themselves to doing something. Whereas it costs nothing (except margin requirements) to enter into a futures contract, the purchase of an option requires an up-front payment. OPTION TERMINOLOGY • Index options: These options have the index as the underlying. Some options are European while others are American. Like index futures contracts, index options contracts are also cash settled. • Stock options: Stock options are options on individual stocks. Options currently trade on over 500 stocks in the United States. A contract gives the holder the right to buy or sell shares at the specified price. • 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 to exercise his option on the seller/writer.
There are two basic types of options. the exercise date. • Put option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price. the strike date or the maturity. He pays for the option in full at the time it is purchased. call options and put options. • Strike price: The price specified in the options contract is known as the strike price or the exercise price. Most exchange-traded options are American. • American options: American options are options that can be exercised at any time upto the expiration date. It is also referred to as the option premium. and properties of an American option are frequently deduced from those of its European counterpart. FUTURES AND OPTIONS An interesting question to ask at this stage is .when would one use options instead of futures? Options are different from futures in several interesting senses. the option buyer faces an interesting situation. • Expiration date: The date specified in the options contract is known as the expiration date. • Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. European options are easier to analyze than American options. • Option price/premium: Option price is the price which the option buyer pays to the option seller. • European options: European options are options that can be exercised only on the expiration date itself. At a practical level. he only has .• Writer of an option: The writer of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him. After this.
Exchange defines the product Same as futures. which is free to enter into. The Nifty index fund industry will find it very useful to make a bundle of a Nifty index fund and a Nifty put option to create a new kind of a Nifty index fund. Linear payoff Nonlinear payoff. with novation Same as futures. Both long and short at risk Only short at risk. Price is zero Price is always positive. This is attractive to many people. This characteristic makes options attractive to many occasional market participants. There is no possibility of the options position generating any further losses to him (other than the funds already paid for the option). and to mutual funds creating "guaranteed return products". To buy a put option on Nifty is to buy insurance which reimburses the full extent to which Nifty drops below the strike price of the put option. who cannot put in the time to closely monitor their futures positions.an upside. Distinction between futures and options Futures Options Exchange traded. Buying put options is buying insurance. More generally. so anyone who feels like earning revenues by selling insurance can set himself up to do so on the index options market. Selling put options is selling insurance. but can generate very large losses. price moves. options offer "nonlinear payoffs" whereas futures only have . which gives the investor protection against extreme drops in Nifty. This is different from futures. Price is zero. strike price moves Strike price is fixed.
and the possibility of cornering is reduced. a wide variety of innovative and useful payoff structures can be created. Index derivatives offer various advantages and hence have become very popular. Pension funds in the US are known to use stock index futures for risk hedging purposes. . INDEX DERIVATIVES Index derivatives are derivative contracts which derive their value from an Underlying index. By combining futures and options. which can be cornered. Index-derivatives are more suited to them and more cost-effective than derivatives based on individual stocks. being an average. forged/fake certificates. 34 • Stock index. This implies much lower capital adequacy and margin requirements. more so in India. • Institutional and large equity-holders need portfolio-hedging facility. • Index derivatives offer ease of use for hedging any portfolio irrespective of its composition. is much less volatile than individual stock prices. Index derivatives have become very popular worldwide. • Index derivatives are cash settled. and hence do not suffer from settlement delays and problems related to bad delivery."linear payoffs". This is partly because an individual stock has a limited supply. • Stock index is difficult to manipulate as compared to individual stock prices. The two most popular index derivatives are index futures and index options.
A payoff is the likely profit/loss that would accrue to a market participant with change in the price of the underlying asset. speculators and arbitrageurs by these products.1 TRADING UNDERLYING VERSUS TRADING SINGLE . 4. In this chapter we first look at how trading futures differs from trading the underlying spot. We then look at the payoff of these contracts.APPLICATIONS OF FUTURES AND OPTIONS The phenomenal growth of financial derivatives across the world is attributed the fulfilment of needs of hedgers. This is generally depicted in the form of payoff diagrams which show the price of the underlying asset on the X-axis and the profits/losses on the Y-axis. and finally at how these contracts can be used by various entities in the economy.
the holder essentially makes a legally binding promise or obligation to buy the underlying security at some point in the future (the expiration date of the contract). Selling securities involves buying the security before selling it. it is assumed that the securities broker owns the security and then "lends" it to the trader so that he can sell it. To trade securities. One of the reasons for the success could be the ease of trading and settling these contracts. a customer must open a security trading account with a securities broker and a demat account with a securities depository. They enable the futures traders to take a position in the underlying security without having to open an account with a securities broker. Buying futures simply involves putting in the margin money. Besides. short sales on security can only be executed on an up-tick. With the purchase of futures on a security. which may include the receipt of dividends. Even in cases where short selling is permitted. 37 To trade futures. even if permitted. Buying security involves putting up all the money upfront. the holder becomes a part owner of the company.STOCK FUTURES The single stock futures market in India has been a great success story across the world. NSE ranks first in the world in terms of number of contracts traded in single stock futures. The shareholder typically receives the rights and privileges associated with the security. With the purchase of shares of a company. A futures contract represents a promise to transact at some point in the . invitation to the annual shareholders meeting and the power to vote. a customer must open a futures trading account with a derivatives broker. Security futures do not represent ownership in a corporation and the holder is therefore not regarded as a shareholder.
future. The underlying asset in this case is the Nifty portfolio. In this light. Selling security futures without previously owning them simply obligates the trader to selling a certain amount of the underlying security at some point in the future. If the index goes up. Take the case of a speculator who buys a twomonth Nifty index futures contract when the Nifty stands at 2220. the long futures position starts making profits. which obligates the trader to buying a certain amount of the underlying security at some point in the future. and when the index moves down it starts making losses. it means that the losses as well as profits for the buyer and the seller of a futures contract are unlimited. his futures position starts making profit. He has a potentially unlimited upside as well as a potentially unlimited downside. In simple words. If . FUTURES PAYOFFS Futures contracts have linear payoffs. The investor bought futures when the index was at 2220. Figure 4. a promise to sell security is just as easy to make as a promise to buy security. Payoff for buyer of futures: Long futures The payoff for a person who buys a futures contract is similar to the payoff for a person who holds an asset. These linear payoffs are fascinating as they can be combined with options and the underlying to generate various complex payoffs. 38 Payoff for a buyer of Nifty futures The figure shows the profits/losses for a long futures position.1 shows the payoff diagram for the buyer of a futures contract. It can be done just as easily as buying futures. When the index moves up. In the following sections we shall look at some uses of security future.
The underlying asset in this case is the Nifty portfolio. He has a potentially unlimited upside as well as a potentially unlimited downside. and when the index moves up. 39 Payoff for a seller of Nifty futures The figure shows the profits/losses for a short futures position. APPLICATION OF FUTURES Understanding beta The index model suggested by William Sharpe offers insights into portfolio diversification. his futures position starts showing losses. The market factors affect all . and do not affect the entire market. the death of a key employee.2 shows the payoff diagram for the seller of a futures contract. business cycles etc. a new invention. It express the excess return on a security or a portfolio as a function of market factors and non market factors. a fire breakout in a factory. Payoff for seller of futures: Short futures The payoff for a person who sells a futures contract is similar to the payoff for a person who shorts an asset. it starts making losses. . For example. If the index goes down. The investor sold futures when the index was at 2220. If the index rises. his futures position starts making profit. Non-market factors would be those factors which are specific to a company. These would include factors such as inflation.the index falls. a strike in the factory. his futures position starts showing losses. Market factors are those factors that affect all stocks and portfolios. Figure 4. Take the case of a speculator who sells a two-month Nifty index futures contract when the Nifty stands at 2220. When the index moves down. etc. the short futures position starts making profits. interest rates.
Given stock beta’s. the value of a portfolio with a beta of two will move up by twenty percent. calculating portfolio beta is simple. Similarly. measures the portfolios responsiveness to these market movements. We look here at some applications of futures contracts. Using index futures contracts. With this basic understanding. In short. the value of a portfolio with a beta of two. Similarly. will fall by twenty percent. my portfolio value will drop by five percent. beta is a measure of the systematic risk or market risk of a portfolio.75. The unexpected change in these factors cause unexpected changes in 45 the rates of returns on the entire stock market. Hedging: Long security. Each stock however responds to these factors to different extents. it is possible to hedge the systematic risk. It is nothing but the weighted average of the stock betas. If the index drops by ten percent. we look at some applications of index futures. Hence the movements of returns on a portfolio with a beta of one will be like the index. Beta of a stock measures the sensitivity of the stocks responsiveness to these market factors. responds more sharply to index movements. We refer to single stock futures. all strategies that can be implemented using stock futures can also be implemented using index futures. Beta of a portfolio. If the index moves up by ten percent. However since the index is nothing but a security whose price or level is a weighted average of securities constituting an index. Similarly if the index drops by five percent.5 percent movement in the value of the portfolio. The index has a beta of 1. If the index moves up by ten percent. sell futures . a ten percent movement in the index will cause a 7. A portfolio with a beta of two. if a portfolio has a beta of 0. my portfolio value will increase by ten percent.firms.
in this case. However. Take for instance that the price of his security falls to Rs. Take the case of an investor who holds the shares of a company and gets uncomfortable with market movements in the short run. The fall in the price of the security will result in a fall in the price of futures. Now if the price of the security falls any further. will be made up by the profits made on his short futures position. most of the portfolio risk is accounted for by index fluctuations (unlike individual securities. Hence a position LONG PORTFOLIO + SHORT NIFTY can often become one-tenth as risky as the LONG PORTFOLIO position! . For this he pays an initial margin. In the absence of stock futures. he would either suffer the discomfort of a price fall or sell the security in anticipation of a market upheaval. In the case of portfolios.40 incurred on the security he holds. Two-month futures cost him Rs. Every portfolio contains a hidden index exposure or a market exposure. The loss of Rs. will be offset by the profits he makes on his short futures position. All he need do is enter into an offsetting stock futures position.350. This statement is true for all portfolios. Futures will now trade at a price lower than the price at which he entered into a short futures position. Hence his short futures position will start making profits.390. where only 3060% of the securities risk is accounted for by index fluctuations). whether a portfolio is composed of index securities or not. With security futures he can minimize his price risk.402. the losses he suffers on the security.450 to Rs. 46 Index futures in particular can be very effectively used to get rid of the market risk of a portfolio. he will suffer losses on the security he holds. take on a short futures position. He sees the value of his security falling from Rs.Futures can be used as an effective risk-management tool.390. Assume that the spot price of the security he holds is Rs.
The best that can be achieved using hedging is the removal of unwanted exposure. Then a complete hedge is obtained by selling Rs.20. Just for the sake of comparison.1000 is undervalued and expect its price to go up in the next two-three months. His hunch proves correct and two months later the security closes at Rs. Because of the leverage they provide. 1. This works out to an annual return of 12 percent.25. . Two months later the security closes at 1010.400 on an investment of Rs. He would like to trade based on this view. unnecessary risk. he would have to buy the security and hold on to it.000. half the time.25 million of Nifty futures.20. assume that the minimum contract value is 1. He believes that a particular security that trades at Rs. One should not enter into a hedging strategy hoping to make excess profits for sure. He buys 100 security futures for which he pays a margin of Rs. Assume he buys a 100 shares which cost him one lakh rupees. security futures form an attractive option for speculators. i. the futures price converges to the spot price and he makes a profit of Rs.Suppose we have a portfolio of Rs. Warning: Hedging does not always make money. The hedged position will make less profits than the unhedged position.1000 and the two-month futures trades at 1006. This works out to an annual return of 6 percent. Speculation: Bullish security.000 for a period of two months. all that can come out of hedging is reduced risk.000. The security trades at Rs. 1 million which has a beta of 1. Let us see how this works.00. buy futures Take the case of a speculator who has a view on the direction of the market. On the day of expiration.1. How can he trade based on this belief? In the absence of a deferral product.00.000.1000 on an investment of Rs. Today a speculator can take exactly the same position on the security by using futures contracts.1010. He makes a profit of Rs.e.
ABC closes at 220. He sells one two-month contract of futures on ABC at Rs. sell futures Stock futures can be used by a speculator who believes that a particular security is over-valued and is likely to see a fall in price. He has made a clean profit of Rs. If the security price rises. there wasn't much he could do to 47 profit from his opinion.1025 and seem overpriced.2000. One. Now take the case of the trader who expects to see a fall in the price of ABC Ltd. If you notice that futures on a security that you have been observing seem overpriced. arbitrage opportunities arise. Today all he needs to do is sell stock futures. Simple arbitrage ensures that futures on an individual securities move correspondingly with the underlying security. you can make riskless . If the security price falls. the cost-of-carry ensures that the futures price stay in tune with the spot price.month ABC futures trade at Rs. As an arbitrageur.1000. the spot and the futures price converges. Let us understand how this works. this works out to be Rs. He pays a small margin on the same. On the day of expiration. Two months later.240 (each contact for 100 underlying shares). so will the futures price.Speculation: Bearish security. Arbitrage: Overpriced futures: buy spot. How can he trade based on his opinion? In the absence of a deferral product. ABC Ltd. sell futures As we discussed earlier. trades at Rs. how can you cash in on this opportunity to earn riskless profits? Say for instance. Whenever the futures price deviates substantially from its fair value. so will the futures price. For the one contract that he bought.20 per share. when the futures contract expires. as long as there is sufficient liquidity in the market for the security.
Sell the security. How can you cash in on this opportunity to earn riskless profits? Say for instance. Futures position expires with profit of Rs. Take delivery of the security purchased and hold the security for a month. . When does it make sense to enter into this arbitrage? If your cost of borrowing funds to buy the security is less than the arbitrage profit possible. 6. borrow funds. Simultaneously. the spot and the futures price converge.10. 4. In the real world. Now unwind the position. 48 Arbitrage: Underpriced futures: buy futures. On the futures expiration date. 1. Onemonth ABC futures trade at Rs.1015. Remember however. 3. As an arbitrageur. one has to build in the transactions costs into the arbitrage strategy. you can make riskless profit by entering into the following set of transactions. arbitrage opportunities arise. On day one. trades at Rs. 5. 965 and seem underpriced. This is termed as cash-and-carry arbitrage. The result is a riskless profit of Rs. Say the security closes at Rs. 7. that exploiting an arbitrage opportunity involves trading on the spot and futures market. 2. It could be the case that you notice the futures on a security you hold seem underpriced.15 on the spot position and Rs. ABC Ltd.1000. sell spot Whenever the futures price deviates substantially from its fair value. Return the borrowed funds. buy the security on the cash/spot market at 1000. 8.profit by entering into the following set of transactions.10 on the futures position. it makes sense for you to arbitrage. sell the futures on the security at 1025.
buy the futures on the security at 965. Make delivery of the security. On day one. 7. The result is a riskless profit of Rs. We look here at the six basic payoffs. exploiting arbitrage involves trading on the spot market. This is termed as reverse-cash-and-carry arbitrage. Now unwind the position. 4. however the profits are potentially unlimited. Buy back the security. it makes sense for you to arbitrage. it means that the losses for the buyer of an option are limited.1. Simultaneously. 3. His profits are limited to the option premium.25 on the spot position and Rs. As more and more players in the market develop the knowledge and skills to do cashandcarry and reverse cash-and-carry. the payoff is exactly the opposite. the spot and the futures price converge. These non-linear payoffs are fascinating as they lend themselves to be used to generate various payoffs by using combinations of options and the underlying.10.6 OPTIONS PAYOFFS The optionality characteristic of options results in a non-linear payoff for options. For a writer. 4. we will see increased volumes and lower spreads in both the cash as well as the derivatives market. In simple words. however his losses are potentially unlimited. .975. Say the security closes at Rs. As we can see. It is this arbitrage activity that ensures that the spot and futures prices stay in line with the cost-of-carry. 2. 5. On the futures expiration date. If the returns you get by investing in riskless instruments is more than the return from the arbitrage trades. The futures position expires with a profit of Rs.10 on the futures position. sell the security in the cash/spot market at 1000. 6.
6 gives the payoff for the buyer of a three month call option (often referred to as long call) with a strike of 2250 bought at a premium of 86. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. for 2220. Figure 4. Payoff for investor who went Long Nifty at 2220 The figure shows the profits/losses from a long position on the index. Payoff profile for seller of asset: Short asset In this basic position. Payoff profile for buyer of call options: Long call A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option. an investor buys the underlying asset. an investor shorts the underlying asset. and buys it back at a future date at an unknown price. and sells it at a future date at an unknown price.4 shows the payoff for a long position on the Nifty. Nifty for instance. Once it is sold. Higher the spot price. If the index falls he looses. If the index goes up. St. the investor is said to be "short" the asset. 50 Payoff for investor who went Short Nifty at 2220 . the investor is said to be "long" the asset. The investor bought the index at 2220. he lets his option expire un-exercised. Figure 4. If the spot price of the underlying is less than the strike price. he profits.5 shows the payoff for a short position on the Nifty. the spot price exceeds the strike price. If upon expiration. Once it is purchased. Nifty for instance. His loss in this case is the premium he paid for buying the option. he makes a profit. for 2220. more is the profit he makes. St.60.49 Payoff profile of buyer of asset: Long asset In this basic position. Figure 4.
Payoff for buyer of call option The figure shows the profits/losses for the buyer of a three-month Nifty 2250 call option. If upon expiration the spot price of the underlying is less than the strike price. Nifty closes above the strike of 2250. The profit/loss that the buyer makes on the option depends on the spot price of the underlying.60. the spot price exceeds the strike price. the buyer would exercise his option and profit to the extent of the difference between the Nifty-close and the strike price. Higher the spot price.The figure shows the profits/losses from a short position on the index. 7 gives the payoff for the writer of a three month call option (often referred to as short call) with a strike of 2250 sold at a premium of 86. more is the loss he makes. If upon expiration. he looses. Figure 4. For selling the option. as the spot Nifty rises. The profits possible on this option are potentially unlimited. The investor sold the index at 2220. . the buyer lets his option expire un-exercised and the writer gets to keep the premium. 51 Payoff profile for writer of call options: Short call A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option. Hence as the spot price increases the writer of the option starts making losses. he lets the option expire. If the index falls. Whatever is the buyer's profit is the seller's loss. he profits. His losses are limited to the extent of the premium he paid for buying the option. the buyer will exercise the option on the writer. As can be seen. However if Nifty falls below the strike of 2250. If upon expiration. the call option is in-the-money. If the index rises. the writer of the option charges a premium.
more is the profit he makes.60 charged by him. 52 Payoff profile for buyer of put options: Long put A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option. If upon expiration. as the spot Nifty falls. whereas the maximum profit is limited to the extent of the up-front option premium of Rs.8 gives the payoff for the buyer of a three month put option (often referred to as long put) with a strike of 2250 bought at a premium of 61. Nifty closes below the strike of 2250. the spot price is below the strike price. The profit/loss that the buyer makes on the option depends on the spot price of the underlying.70. If the spot price of the underlying is higher than the strike price. the buyer would exercise his option and profit to the extent of the difference between the strike . Nifty closes above the strike of 2250. If upon expiration. As the spot Nifty rises.Payoff for writer of call option The figure shows the profits/losses for the seller of a three-month Nifty 2250 call option.86. The loss that can be incurred by the writer of the option is potentially unlimited. Figure 4. the put option is in-the-money. Lower the spot price. If upon expiration. As can be seen. the buyer would exercise his option on the writer who would suffer a loss to the extent of the difference between the Nifty -close and the strike price. he makes a profit. Payoff for buyer of put option The figure shows the profits/losses for the buyer of a three-month Nifty 2250 put option. His loss in this case is the premium he paid for buying the option. the call option is in-the-money and the writer starts making losses. he lets his option expire un-exercised.
His losses are limited to the extent of the premium he paid for buying the option. the spot price happens to be below the strike 53 price. However if Nifty rises above the strike of 2250. he lets the option expire. Payoff for writer of put option The figure shows the profits/losses for the seller of a three-month Nifty 2250 put option. Nifty closes below the strike of 2250. Payoff profile for writer of put options: Short put A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option. Figure 4. the put option is in-the-money and the writer starts making losses. If upon expiration the spot price of the underlying is more than the strike price.9 gives the payoff for the writer of a three month put option (often referred to as short put) with a strike of 2250 sold at a premium of 61. If upon expiration. The profits possible on this option can be as high as the strike price. the buyer will exercise the option on the writer. the buyer would exercise his option on the writer who would suffer a loss to the extent of the difference between the strike price and Nifty-close.70. Whatever is the buyer's profit is the seller's loss. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. The loss that can be incurred by the writer of the option is a maximum extent of the strike price (Since the worst that can happen is that the asset price can fall to zero) whereas the maximum profit is limited to the extent of . As the spot Nifty falls. the buyer lets his option unexercised and the writer gets to keep the premium. For selling the option. If upon expiration.price and Nifty-close. the writer of the option charges a premium.
APPLICATION OF OPTIONS We look here at some applicat ions of options contracts. buy the right number of put options with the . Hedging: Have underlying buy puts Owners of stocks or equity portfolios often experience discomfort about the overall stock market movement. One way to protect your portfolio from potential downside due to a market drop is to buy insurance using put options. At other times you may see that the market is in for a few days or weeks of 55 massive volatility.61. The union budget is a common and reliable source of such volatility: market volatility is always enhanced for one week before and two weeks after a budget. . To protect the value of your portfolio from falling below a particular level. Index and stock options are a cheap and easily implementable way of seeking this insurance. Many investors simply do not want the fluctuations of these three weeks.70 charged by him. As an owner of stocks or an equity portfolio. However since the index is nothing but a security whose price or level is a weighted average of securities constituting the index. and you do not have an appetite for this kind of volatility. We refer to single stock options here. The idea is simple. all strategies that can be implemented using stock futures can also be implemented using index options.the up-front option premium of Rs. sometimes you may have a view that stock prices will fall in the near future.
or the onset of a stable government. If you are only concerned about the value of a particular stock that you hold. How does one implement a trading strategy to benefit from an upward movement in the underlying security? Using options there are two ways one can do this: 1. Sell put options We have already seen the payoff of a call option. Your hunch proves correct and the price does indeed rise. His upside however is potentially unlimited. buy put options on that stock. your portfolio will lose value and the put options bought by you will gain. This level depends on the strike price of the stock options chosen by you. it is this upside that you cash in on. Similarly when the index falls. The downside to the buyer of the call option is limited to the option premium he pays for buying the option. buy calls or sell puts There are times when investors believe that security prices are going to rise. When the stoc k price falls your stock will lose value and the put options bought by you will gain. By buying puts. If you are concerned about the overall portfolio. effectively ensuring that the total value of your stock plus put does not fall below a particular level. Buy call options. buy put options on the index. or good corporate results. This level depends on the strike price of the index options chosen by you. after a good budget. or 2. . effectively ensuring that the value of your portfolio does not fall below a particular level. For instance. the fund can limit its downside in case of a market fall. Speculation: Bullish security. Suppose you have a hunch that the price of a particular security is going to rise in a months time.right strike price. Portfolio insurance using put options is of particular interest to mutual funds who already own well-diversified portfolios.
and how much you are willing to lose should this upward movement not come about. The call with a strike of 1300 is deep-out-of-money. Hence buying this call is basically like buying a lottery. Which of these options you choose largely depends on how strongly you feel about the likelihood of the upward movement in the price. Its execution depends on the unlikely event that the underlying will rise by more than 50 points on the expiration date. The call with a strike of 1200 is deep in-the-money and hence trades at a higher premium. In the more likely event of the call expiring out-of-the-money. in which case the buyer will make profits. risk-free rate is 12% per year and volatility of the underlying security is 30%. 3. 2. Having decided to buy a call. each with a different strike price. 5. 4. what you lose is only the option premium. A one month call with a strike of 1225.1 gives the premia for one month calls and puts with different strikes. There is a small probability that it may be in-the-money by expiration. The call with a strike of 1275 is out-of-the-money and trades at a low premium. which one should you buy? Table 4. Given that there are a 56 number of one-month calls trading. Assume that the current price level is 1250. A one month call with a strike of 1275. A one month call with a strike of 1300. A one month call with a strike of 1250. the obvious question is: which strike should you choose? Let us take a look at call options with different strike prices. There are five one-month calls and five one-month puts trading in the market. A one month call with a strike of 1200.However. the buyer . The following options are available: 1. if your hunch proves to be wrong and the security price plunges down.
There are five one-month calls and five one-month puts trading in the market.20.27. If prices do rise. As a person who wants to speculate on the hunch that prices may rise. The call with a strike of 1300 is deep-out-of-money. If however your hunch about an upward movement proves to be wrong and prices actually fall. Its execution depends on the unlikely event that the price of underlying . the net loss on the trade is Rs. 57 One month calls and puts trading at different strikes The spot price is 1250. each with a different strike price. you can also do so by selling or writing puts.5. As the writer of puts. Having decided to write a put. If for instance the price of the underlying falls to 1230 and you've sold a put with an exercise of 1300.simply loses the small premium amount of Rs.50. the option premium earned by you will be higher than if you write an out-of-the-money put. then your losses directly increase with the falling price level. the obvious question is: which strike should you choose? This largely depends on how strongly you feel about the likelihood of the upward movement in the prices of the underlying. The call with a strike of 1200 is deep in-the-money and hence trades at a higher premium. Taking into account the premium earned by you when you sold the put. However the chances of an at-the-money put being exercised on you are higher as well. The call with a strike of 1275 is out-of-the-money and trades at a low premium. which one should you write? Given that there are a number of one-month puts trading.70. the buyer of the put will exercise the option and you'll end up losing Rs. you face a limited upside and an unlimited downside. If you write an at-the-money put. the buyer of the put will let the option expire and you will earn the premium.
one opt ion is in-the-money and one is out-of-the-money.50 1250 1250 49.50 49. Figure 4.80 1250 1300 27.15. Underlying Strike price of option Call Premium(Rs.15 1250 1225 63. In the more likely event of the call expiring out-of-the-money.) 1250 1200 80.11 shows the payoffs from writing puts at different strikes. Similarly. As expected.50.11.80 In the example in Figure 4. There is a small probability that it may be in-the-money by expiration in which case the buyer will profit.10 18.50 64.) Put Premium(Rs. Figure 4. The put with a strike of 1200 is deep out-ofthe-money and will only be exercised in the unlikely event that underlying falls by 50 points on the expiration date.10 shows the payoffs from buying calls at different strikes.80 whereas the out-of-the-money option has the lowest premium of Rs.65 26.64.will rise by more than 50 points on the expiration date. the put with a strike of 1300 is deep in-the-money and trades at a higher premium than the at-the-money put at a strike of 1250. 27. . at a price level of 1250. the in-the-money option fetches the highest premium of Rs. 18. Hence buying this call is basically like buying a lottery. the buyer simply loses the small premium amount of Rs.00 1250 1275 37.45 37.
what you lose is directly proportional to the rise in the price of the security. Suppose you have a hunch that the price 58 of a particular security is going to fall in a months time. the buyer of the call lets the call expire and you get to keep the premium. using options. Payoff for writer of put options at various strikes The figure shows the profits/losses for a writer of puts at various strikes. if your hunch proves to be wrong and the market soars up instead. The inthemoney option with a strike of 1300 fetches the highest premium of Rs. many people feel that the stocks prices would go down.64. Buy put options We have already seen the payoff of a call option. Sell call options. or 2. or the instability of the government.80. How does one implement a trading strategy to benefit from a downward movement in the market? Today. it is this downside that you cash in on. The upside to the writer of the call option is limited to the option premium he receives upright for writing the option. Payoff for buyer of call options at various strikes The figure shows the profits/losses for a buyer of calls at various strikes.27. His downside however is potentially unlimited.10 whereas the out-of-the-money option with a strike of 1300 has the lowest premium of Rs.80 whereas the out-of-the-money option with a strike of 1200 has the . However. The in-the-money option with a strike of 1200 has the highest premium of Rs. sell calls or buy puts Do you sometimes think that the market is going to drop? That you could make a profit by adopting a position on the market? Due to poor corporate results.Speculation: Bearish security. you have two choices: 1. When the price falls.50. Your hunch proves correct and it does indeed fall.
There is a small probability that it may be in-the-money by expiration in which case the buyer exercises and the writer suffers losses to the extent that the price is above 1300. each with a different strike price. A one month call with a strike of 1200.27. There are five one-month calls and five one-month puts trading in the market. 5. the obvious question is: which strike should you choose? Let us take a look at call options with different strike prices. 3. 2. In the more likely event of the call expiring outofthe-money. You could write the following options: 1. The call with a strike of 1200 is deep in-the-money and hence trades at a higher premium. which one should you write? Table 4. you can .15.lowest premium of Rs. 4. The call with a strike of 1275 is out-of-the-money and trades at a low premium. 18. risk-free rate is 12% per year and stock volatility is 30%.50. A one month call with a strike of 1300. Hence writing this call is a fairly safe bet. 59 Having decided to write a call. A one month call with a strike of 1250. A one month call with a strike of 1275. Given that there are a number of one-month calls trading. Its execution depends on the unlikely event that the stock will rise by more than 50 points on the expiration date. A one month call with a strike of 1225. Which of this options you write largely depends on how strongly you feel about the likelihood of the downward movement of prices and how much you are willing to lose should this downward movement not come about. Assume that the current stock price is 1250. As a person who wants to speculate on the hunch that the market may fall. the writer earns the premium amount ofRs. The call with a strike of 1300 is deep-out-of-money.2 gives the premiums for one month calls and puts with different strikes.
The call with a strike of 1275 is out-of-the-money and trades at a low premium. There are five one-month calls and five one-month puts trading in the market. If however the price does fall to say 1225 on expiration date.25.also buy puts. Having decided to buy a put. Its execution depends on the unlikely event that the price will rise by more than 50 points on the expiration date. The call with a strike of 1300 is deep-outofmoney. you simply let the put expire. If you buy an at-the-money put. The call with a strike of 1200 is deep in-the-money and hence trades at a higher premium. whic h one should you buy? Given that there are a number of one-month puts trading. the option premium paid by you will by higher than if you buy an out-of-the-money put. If for instance the security price rises to 1300 and you've bought a put with an exercise of 1250. If the price does fall. you make a neat profit of Rs. each with a different strike price. 60 One month calls and puts trading at different strikes The spot price is 1250. Hence writing this call is a fairly safe bet. If however your hunch about a downward movement in the market proves to be wrong and the price actually rises. There is a small probability that it may be in-the-money by expiration in which case the buyer exercises and the writer suffers losses to the extent . all you lose is the option premium. However the chances of an at-the-money put expiring in-the-money are higher as well. As the buyer of puts you face an unlimited upside but a limited downside. you profit to the extent the price falls below the strike of the put purchased by you. the obvious question is: which strike should you choose? This largely depends on how strongly you feel about the likelihood of the downward movement in the market.
45 37. The put with a strike of 1200 is deep out-of-themoney and will only be exercised in the unlikely event that the price falls by 50 points on the expiration date. the put with a strike of 1300 is deep in-the-money and trades at a higher premium than the at-the-money put at a strike of 1250.that the price is above 1300.50 64.10 whereas the out-of-the-money option has the lowest premium of Rs.15 1250 1225 63. The choice of which put to buy depends upon how much the speculator expects the market to fall.50. The in-themoney option has the highest premium of Rs.65 26.13 shows the payoffs from buying puts at different strikes.80 1250 1300 27.10 18.80 Payoff for seller of call option at various strikes The figure shows the profits/losses for a seller of calls at various strike prices.00 1250 1275 37.50 1250 1250 49.50 49.) 1250 1200 80. Figure 4. Price Strike price of option Call Premium(Rs.27. In the more likely event of the call expiring out-of-the-money.) Put Premium(Rs.12 shows the payoffs from writing calls at different strikes. Similarly. the writer earns the premium amount of Rs. Figure 4. .80.50. 27.
I find some very crucial things about investors thinking and perceptions (Consumer Behaviors) regarding their investment decisions. conversation with investors.80 whereas the out-of-the-money option has the lowest premium of Rs.3000 to buy the lot. The in-themoney option has the highest premium of Rs. the stock price in that cases would have been Rs. This is an option that you can not get in equity trading unless you are doing intraday trading. As you are buying the stocks in a lot the brokerage is calculated not on the unit of the stocks but on the unit of the lot.50. advertise more. Some of these findings are as follows: • Investors of FD and depositors with Banks and Post Office’s are not very much satisfied with their returns and the kind of services they get from them. For that we have to create awareness. In case of an overvalued stock that are sure to fall in near future.64. In future trading the brokerage is usually lower than the equity trading. 18. you can gain from short selling. That means you can first sell the lot of stock and then buy them back within the stipulated time to honor the contract. you are gaining more profit at a time without investing more money. • • • . In case of derivative trading you can short sell the stocks. That means if you are buying a stock of Rs. and approachability to customers. • The biggest advantage of derivative trading is that you can buy stocks in future trading by paying only 20% or 30% of the price.2000 to Rs.10000. articles from economic surveys and journals and discussions with faculty and experienced professionals in details. So.61 Payoff for buyer of put options at various strikes The figure shows the profits/losses for a buyer of puts at various strike prices. FINDINGS On analyzing all the information collected through questionnaire.10 each and the lot contains 1000 stocks you can pay only Rs.So we (stock broking company) should must try to capture this market investors. Whereas.
Analysis & interpretation Q -1 where do you invest your saving? • • • • Share Mutual funds Bonds Derivative Derivative 10% Bonds 20% Share 45% Share Mutual fund Bonds Derivative Mutual fund 25% .
Q -2 Are you aware of online religare trading? • • Yes No YES NO 45% NO YES 55% INTERPRETATION .INTERPRETATION In above pie chart we can understand easily that mostly investor invests in share then they are interested to invest in mutual fund. And in derivative market very few investor are interested to invest in derivative market.
but 53%of people are not aware of the facility of religare.They Are interested to known about the facility which is provided by the religare to investor. Q – 3 Do you know about the facilities provided by religare? • • Yes No NO 53% YES 47% YES NO INTERPRETATION HERE.In market survey we find that 55% of people are known about the religare Online trading and 45% of people are not aware of online trading in religare. 47% of people known about the facility which is provided by religare. . But lack of sources they don’t get the proper knowledge about the religare facility.
Q –4 With which company do you has demat account? • • • • • Religare ICICI Direct India bulls Sharekhan Others Others 10% Sharekhan 23% India Bulls 15% RELIGARE 25% ICICI Direct 27% RELIGARE ICICI Direct India Bulls Sharekhan Others .
Then in second no. to see the pie chart we understand easily that the ICICI Direct has maximum proportion .Which shows that investors are more interested to invest in ICICI Direct then others. Then 10 %to other companies.sharekhan company which has 23% of total market.religare comes religare have 25% of the total survey. In third no.INTERPRETATION HERE. Then 15% in India Bulls. . For above pie chart its shows that how much the investor invests their earning in share market. Q –5 what percentage of your earning do you invest in share trading? • • • • Up to 10% Up to 25% Up to 50% Above 50% Above 50% 15% Up to 50% 20% Up to 10% 35% Up to 10% Up to 25% Up to 50% Above 50% Up to 25% 30% INTERPRETATION IN Market survey we known that how much invest by investor in share market.
. ADDRESS NO:……………. CONTACT NO:…………….ANNEXURE QUESTIONNAIRE PERSONAL DETAIL NAME:……………………… AGE:………………………. 1.Heard about religare? • • Yes No ...Are you aware of online religare trading? • • Yes No 3.WHERE DO YOU INVEST YOUR SAVING? • • • • Shares Mutual funds Bonds Derivative 2.
4.8 What kind of investment risk do you prefer ? • • More Risk More Return Moderate Risk Moderate Return .Do you know about the facilities provided by religare? • • Yes No 5.Are you currently satisfied with your share trading company? • • Yes No 7. 6.With which company do you have demat account? • • • • • Religare ICICI Direct India Bulls Sharekhan Others(please specify)………………….What percentage of your earning do you invest in share trading? • • • • Upto 10% Upto 25% Upto 50% Above 50% Q.
What more facilities do you think you require with your DEMAT account? • • • ……………………………………………………………… ……………………………………………………………… ……………………………………………………………… .• Less Risk Less Return Q.10 Are you satisfied with the kind of returns and features associated with your investment ? • • Yes No 8.9 Do you survey the market risk before investing your money ? • • Yes No Q.
Big price movements can occur overnight.the growing fierce competition in the derivative markets of today certainly improves trading conveniences and lower transaction costs but at the same time this may mean increasing number of frauds.and can be effectively controlled at the macro level.10 million is deployed in a transaction.derivatives can produce disastrous results. derivative instrument are highly ‘geared’.the exchange is therefore required to keep a tight control over to check such happenings.it is quite possible to lose rs. one of the main reasons for the popularity of derivatives is its risk hedging features.this is the single most important reason why derivative transaction require a much tighter supervision and control mechanism. One should however careful while using derivatives because wrong use of the same can result in unlimited risk.the markets are open virtually on a 24 hour basis.due to the integration to various exchanges across the world.there can be no doubt that derivatives are powerful tools for risk management if used properly. .which necessitate very careful management of exposures .100 million that is.10 million the maximum loss that can be suffered is rs.10 million or there abouts. In a normal business deal.however.there are several characteristics of derivatives. if rs. with a capital of rs.however.secaondly. because of this.but a part this risk is manmade. 10 times the value of the capital put in. There is no question on the existence and need for derivatives as an instrument of risk management.Conclusion In this project I have learned about the major types of derivatives and that the derivative can be used as a risk management tool.first and foremost. derivative markets move at great speed.Every firm and individuals who uses derivatives must therefore exercise considerable caution and care in handing its derivative exposures. it is possible to lose far more than one’s original capital in a derivative transaction.
com • http:// www.com .BIBLIOGRAPHY • Rm equity training manual: religare securities ltd • Derivative module: NCFM • http:// www.commoditymarket.moneycontrol.
com .bseindia.nseindia.• http:// www.religaresecurities.com • http:// www.in • http:// www.
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