The turnover of the stock exchange has been tremendously increasing from Last 10 years. The number of trades and the number of investors, who are participating, have increased. The investors are willing to reduce their risk, so they are seeking for the risk management tools. There were no effective measures for the investors for hedging strategies in trading on underlying assets. Prior to this there were some manipulations for the traded derivative stocks which could not be resolved easily by the authorities. The evaluation and analysis of the incomes from the derivatives also became complex in the bearish and bullish markets. Hence, the analysis will be made on the above stated problem and measures are to be suggested to overcome the above stated problem
OBJECTIVES OF THE STUDY
• • • • • • To analyze the derivatives market in India. To analyze the operations of futures and options. To find the profit/loss position of futures buyer and also the option writer and option holder. To study about risk management with the help of derivatives. To study and analyze the purpose of hedging in futures and options in the derivatives market. To make suggestions to the authorities concerned regarding the effective usage of the derivatives.
SCOPE OF THE STUDY
The Study is limited to “Derivatives” with special reference to futures and Option in the Indian context and the data had been taken through INDIAINFOLINE LIMITED as a representative sample for the study. Any alteration may arise to the actual situations. The research study is only made as an attempt to evaluate derivatives market only in specified Organization. The study is based only on the Indian perspective of derivatives markets.
representing the data with graphs and making the interpretation using Data. The data for the present study is collected from primary and secondary sources.
the futures buyers
Data Collection:The data of the HINDUSTAN PETROLEUM LTD has been collected from the internet site www. The data consist of the February-March Contract and period of collection is from 29rd FEBRUARY 2011 – 27th MARCH 2011. and through the articles collected from various news papers.com. The lot is 200. Selection of the scrip:The scrip selection is done on a random and the scrip selected is HINDUSTAN PETROLEUM LTD.nseindia. relationship manager and assistant relationship manager and also through the contacts with the other staff members of the organization of indiainfoline Limited. Data
Analysis:The analysis consist of the tabulation of the data assessing the profitability Positions of the futures buyers and sellers and also option holder and the option Writer.com. PRIMARY SOURCES: The primary sources of data collection is done by personal discussions with the assistant branch manager. SECONDARY SOURCES: The secondary sources of the data is collected through the official website of the National Stock Exchange of India www. Profitability position of and seller and also the option holder and option writers is studied.
.nseindia. journals and magazines.RESEARCH METHODOLOGY
The following are the steps involved in the study.
As the futures and options are only taken for making the analysis and the outcome may not be applicable to other components of derivatives.
A full study of the hedging strategies may not be overviewed
The data collected is completely restricted to the HINDUSTAN PETROLEUM LTD of March 2011 hence this analysis is restricted only to the selected company. and is not applicable to any other company of same kind and nature. •
The scrip chosen for analysis is HINDUSTAN PETROLEUM LTD and the contract taken is March 2011 ending one-month contract.LIMITATIONS OF THE STUDY
The following are the limitations of this study.
REVIEW OF LITERATURE
The value of financial derivatives derives from the price of an underlying item. such as: interest rates. forward contracts or some combination thereof. Through the use of derivative products. by locking-in asset prices. no principal is advanced to be repaid and no investment income accrues" While some derivatives instruments may have very complex structures. and equities. commodity or index. derivatives products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. exchange rates. Unlike debt securities. futures.
. The financial markets can be subject to a very high degree of volatility. it is possible to partially or fully transfer price risks by locking-in asset prices. such as asset or index. Derivatives allow financial institutions and other participants to identify. derivatives products generally do not influence the fluctuations in the underlying asset prices. most notable forwards.
The emergence of the market for derivatives products. all of them can be divided into basic building blocks of options. commodities. isolate and manage separately the market risks in financial instruments and commodities for the purpose of hedging. options and swaps can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. As instruments of risk management. However. The International Monetary Fund defines derivatives as "financial instruments that are linked to a specific financial instrument or indicator or commodity and through which specific financial risks can be traded in financial markets in their own right. speculating. arbitraging the price differences of the investments and adjusting portfolio risks.Introduction Derivatives are financial contracts whose values are derived from the value of an underlying primary financial instrument.
The need for a derivatives market The derivatives market performs a number of economic functions: 1. They help in transferring risks from risk adverse people to risk oriented people 2. They help in the discovery of future as well as current prices 3. They catalyze entrepreneurial activity 4. They increase the volume traded in markets because of participation of risk adverse people in greater numbers 5. They increase savings and investment in the long run
Meaning of Derivatives The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived" from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities. Derivative is a product/contract which does not have any value on its own i.e. it derives its value from some underlying. As the name suggests, derivative contracts are those contracts which derives their value from the price of something else. Typically derivatives contracts derive their value from underlying cash market
Derivatives are the Investments that derive their value from underlying assets such as currencies, treasury bills, and bonds or are linked to indices such as a stock market index that can be used to speculate on market movements or to protect investments against major swings in market prices Derivatives are the financial contracts that derive their value from an underlying asset or index, such as an interest rate or foreign currency exchange rate which can be used to manage risk, reduce cost and enhance returns As the name suggests, derivative contracts are those contracts which derives their value from the price of something else. Typically derivatives contracts derive their value from underlying cash market for e.g. derivative of the Reliance, will derive its value from the cash market price of Reliance. DEFINITIONS OF DERIVATIVES “Derivatives are the Investments that derive their value from underlying assets such as currencies, treasury bills, and bonds or are linked to indices such as a stock market index that can be used to speculate on market movements or to protect investments against major swings in market prices”. “Derivatives are the financial contracts that derive their value from an underlying asset or index, such as an interest rate or foreign currency exchange rate which can be used to manage risk, reduce cost and enhance returns”. “Derivatives are the Trades that are constructed or derived from another security (stock, bond, currency, or commodity) that can be both exchange and non-exchange traded (known as Over the Counter or OTC)”. Derivatives are the financial contracts the value of which depends on the value of the underlying instrument - commodity, bond, equity, currency or a combination. Derivatives are financial instruments whose value changes in response to an underlying variable, that require little or no net initial investment and are settled at a future date.
With Securities Laws (Second Amendment) Act, 1999, Derivatives has been included in the definition of Securities. The term Derivative has been defined in Securities Contracts (Regulations) Act, as:A Derivative includes: a. a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; b. a contract which derives its value from the prices, or index of prices, of underlying securities;
Futures Contract Futures Contract means a legally binding agreement to buy or sell the underlying
security on a future date. Future contracts are the organized/standardized contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a pre-specified date which is called the expiry date of the contract. On expiry, futures can be settled by delivery of the underlying asset or cash. Cash settlement enables the settlement of obligations arising out of the future/option contract in cash.
An Option contract Options Contract is a type of Derivatives Contract which gives the buyer/holder
of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a specified period. The buyer / holder of the option purchase the right from the seller/writer for a consideration which is called the premium. The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right. The underlying asset could include securities, an index of prices of securities etc.
a galli. and includes a teji. or a right to buy and sell.e. a teji mandi. are known as Index Futures Contracts. In the beginning futures and options were permitted only on S&P Nifty and BSE Sensex. a put. As in the case of futures contracts. sectoral indices were also permitted for derivatives trading subject to fulfilling the eligibility criteria. futures contract on NIFTY Index and BSE-30 Index. securities in future. unlike Index Futures. a call or a put and call in securities. Subsequently. option contracts can be also be settled by delivery of the underlying asset or cash. However. However. are known as Index options contract. These contracts derive their value from the value of the underlying index. 1956 options on securities has been defined as "option in securities" means a contract for the purchase or sale of a right to buy or sell. they can be exercised / assigned only on the expiry date. unlike futures cash settlement in option contract entails paying/receiving the difference between the strike price/exercise price and the price of the underlying asset either at the time of expiry of the contract or at the time of exercise / assignment of the option contract. the buyer of Index Option Contracts has only the right but not the obligation to buy / sell the underlying index on expiry.Under Securities Contracts (Regulations) Act.
The Index Futures and Index Option Contracts
Futures contract based on an index i. the underlying asset is the index.e. Similarly. NOTE: An Option to buy is called Call option and option to sell is called Put option. Indices that represent the whole market are broad based indices and those that represent a particular sector are sectoral indices. the options contracts. An index in turn derives its value from the prices of securities that constitute the index and is created to represent the sentiments of the market as a whole or of a particular sector of the economy. Index Option Contracts are generally European Style options i. which are based on some index.
. a mandi. For example.
Derivative contracts may be permitted on an index if 80% of the index constituents are individually eligible for derivatives trading.1)
OPTIONS Put Option Call Option
. The index is required to fulfill the eligibility criteria even after derivatives trading on the index have begun.By its very nature. index cannot be delivered on maturity of the Index futures or Index option contracts therefore.
GENERAL STRUCTURE OF DERIVATIVES
(CHART 1. then derivative contracts on such index would be discontinued. If the index does not fulfill the criteria for 3 consecutive months. these contracts are essentially cash settled on Expiry.
Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset. warrants and are generally traded Over-the-counter.
Options are of two types-calls and puts. the majority of options traded on options exchanges having a maximum maturity of nine months.
A forward contract is a customized contract between two entities. Longer-dated options are called
The acronym LEAPS means Long-Term Equity Anticipation Securities. where settlement takes place on a specific date in the future at today’s pre-agreed price.
.DIFFERENT TYPES OF DERIVATIVES
The following are the various types of derivatives. These are options having a maturity of upto three years.
Options generally have lives of upto one year. at a given price on or before a given future date. Puts give the buyer the right. They are:
A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.
in Indian stock market currently we have futures and options.
These entail swapping both principal and interest between the parties. A payer swaption is an option to pay fixed and received floating. Equity index options are a form of basket options.
Swaps are private agreement between two parties to exchange cash flows in the future according to a pre arranged formula.
Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. with the cashflows in one direction being in a different currency than those in the opposite direction. A receiver swaption is an option to receive fixed and pay floating. They can be regarded as portfolios of forward contracts. Rather than have calls and puts. the swaptions market has receiver swaptions and payer swaptions. Thus a swaption is an option on a forward swap. The underlying asset is usually a moving average of a basket of assets. The two commonly used swaps are:
Interest rate swaps:
The entail swapping only the interest related cash flows between the parties in the same currency.
Basket options are options on portfolio of underlying assets. Although there are many types of derivatives.
jute and food grains. During the Second World War futures trading was prohibited under Defence of India Rules.
. groundnut. jute goods. “Teji”. cotton. was at its peak during this period. Futures trading in commodities particularly. References to such markets in India appear in Kautialya’s ‘Arthasastra’. 1952 was enacted. castor seed. The first organized futures market was however established in 1875 under the aegis of the Bombay Cotton Trade Association to trade in cotton contracts. By the Second World War. the subject of futures trading was placed in the Union list.. futures trading in organized form had commenced in a number of commodities such as – cotton. EVOLUTION OF COMMODITIES DERIVATIVES MARKET IN INDIA The Indian experience in commodity futures market dates back to thousands of years.. and “Phatak” have been commonly heard in Indian markets for centuries.THE DERIVATIVES OFFERS THE FOLLOWING USAGES:
Speculation: One can take a view of the market and buy or sell derivatives accordingly at a fraction of a total cost. Hedging: It reduces the risk associated with market exposure by taking a counter position in the derivatives market.e. raw jute. viz. sugar. Derivatives trading were then spread to oilseeds. wheat. “Mandi”. Arbitrage: It offers an opportunity to take an advantage of the price difference between the derivatives market and the cash market. and Forward Contracts (Regulation) Act. oilseeds and bullion. pepper and turmeric. i. After independence. precious metals like gold and silver. rice. There was a time when trading was permitted only two minor commodities. The words. The derivatives trading in India however did not have uninterrupted legal approval. However following the scarcity in various commodities. futures trading in most commodities were prohibited in mid-sixties. “Gali”. groundnut oil. between the 1920’s &1940’s.
also triggered policy changes leading to re-introduction of futures trading in commodities in India. Food-grains. to protect the commodity sector from price-volatility.Deregulation and liberalization following the forex crisis in early 1990s. 1999 the Government took a landmark decision to remove all the commodities from the restrictive list. the Government initiated steps to cajole and incentives the existing Exchanges to modernize their systems and structures. In April. Therefore. The long spell of prohibition had stunted growth and modernization of the surviving traditional commodity exchanges. (NMCE) was the first such exchange to be granted permanent recognition by the Government
.. Faced with the grudging reluctance to modernize and slow pace of introduction of fair and transparent structures by the existing Exchanges. along with liberalization of commodity futures. National Multi Commodity Exchange of India Ltd. viz. The growing realization of imminent globalization under the WTO regime and nonsustainability of the Government support to commodity sector led the Government to explore the alternative of market-based mechanism. pulses and bullion were not exceptions. Government allowed setting up of new modern. demutualised Nation-wide Multicommodity Exchanges with investment support by public and private institutions. futures markets.
dealings resembling present day derivative market transactions were seen in rice markets in Osaka. which is independent in governance and membership from the Derivative Exchange/Segment. Derivative products have been around for a long time. Japan. The first leap towards an organized derivatives market came in 1848. The clearing & settlement of all trades on the Derivative Exchange/Segment would have to be through a Clearing Corporation/House. They are hence known as:
• • •
Exchange Traded Derivatives OTC Derivatives (Over The Counter) OTC Equity Derivatives
Traditionally equity derivatives have a long history in India in the OTC market. Foreign currency options in currency pairs other than Rupee were the first options permitted by RBI. was established.The Securities Contract and Regulatory Authority (SCRA) however banned all kind of options in 1956. As early as the 1650s.
Everyone talks about derivatives these days. interest rate swaps. Derivative Exchange/Segment function as a Self-Regulatory Organization (SRO) and SEBI acts as the oversight regulator. currency swaps and other risk reductions OTC derivative products. Derivatives first came from Japanese rice markets.
. Options of various kinds (called Teji and Mandi and Fatak) in un-organized markets were traded as early as 1900 in Mumbai.STRUCTURE OF DERIVATIVE MARKETS IN INDIA Derivative trading in India takes can place either on a separate and independent Derivative Exchange or on a separate segment of an existing Stock Exchange. the largest derivative exchange in the world. those that are traded on the exchange and they traded one to one or 'over the counter'. when the Chicago Board of Trade. Derivatives markets broadly can be classified into two categories. The Reserve Bank of India has permitted options. The prohibition on options in SCRA was removed in 1995.
Dr. 1956 and the Securities and Exchange Board of India Act. currency. bullion. Derivative Exchange/Segment function as a Self-Regulatory Organisation and SEBI acts as the oversight regulator. commodities. future. L.
Derivative trading in India takes can place either on a separate and independent Derivative Exchange or on a separate segment of an existing Stock Exchange. i. live stock or anything else.
With the amendment in the definition of 'securities' under SC(R)A (to include derivative contracts in the definition of securities). 1992.
The Rules. its value is entirely "derived" from the value of the underlying asset. Bye-laws & Regulations of the Derivative Segment of the Exchanges and their Clearing Corporation/House have to be framed in line with the suggestive Bye-laws. In other words. Sebi has also laid the eligibility conditions for Derivative Exchange/Segment and its Clearing Corporation/House. The clearing & settlement of all trades on the Derivative Exchange/Segment would have to be through a Clearing Corporation/House. linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities.C Gupta Committee constituted by Sebi had laid down the regulatory framework for derivative trading in India.
The underlying asset can be securities.The eligibility conditions have been framed to ensure that Derivative
. Derivative means a forward.e. option or any other hybrid contract of pre determined fixed duration.The term "Derivative" indicates that it has no independent value. SEBI has also framed suggestive bye-law for Derivative Exchanges/Segments and their Clearing Corporation/House which lay's down the provisions for trading and settlement of derivative contracts. which is independent in governance and membership from the Derivative Exchange/Segment. derivatives trading takes place under the provisions of the Securities Contracts (Regulation) Act..
which optimally combine the risks and returns over a large number of financial assets. (d) Development of more sophisticated risk management tools. reduced risk as well as transaction costs as compared to individual financial assets. (c) Marked improvement in communication facilities and sharp decline in their costs. and (e) Innovations in the derivatives markets. safety & integrity and provide facilities for redressal of investor grievances. providing economic agents a wider choice of risk management strategies. leading to higher returns. Factors generally attributed as the major driving force behind growth of financial derivatives are: (a) Increased Volatility in asset prices in financial markets.
. (b) Increased integration of national financial markets with the international markets.Exchange/Segment & Clearing Corporation/House provide a transparent trading environment.
The rise in the economy is also estimated to lead to a four-fold increase in India's investable wealth from US$ 250 billion in 2007 to US$ 1 trillion.000 mark for the first time. wealth management revenues are expected to account for 32-37 per cent of the total full-service financial institutions by 2012.
The industry is also becoming more vibrant. the Indian stock market rose to record levels.000 points and Nifty crossing the 6. an international consultancy firm. according to a report by Celent. For example.(THE FINANCIAL SERVICE INDUSTRY) Financial Services
The Indian financial sector is on a roll.836 billion.09 billion from US$ 6.
Clearly. Significantly. the notional principal amount outstanding has more than trebled between March 2005 and June 2007 to US$ 24. with the popular sensex crossing 21. India's wealth management will rise to an estimated 42 million by 2012 from about 13 million in 2007. The market is also expected to undergo a structural transformation with organized players increasing their market share. with new types of products and services being offered to meet the needs of the booming economy. Driven by a strong investor interest and an expanding market. Simultaneously. in the derivatives market. there is huge potential in this segment.
25 billion mobilised in 2006-07 and the highest ever in the last six years.7 trillion. which is almost an eight-fold increase over US$ 926. follow-on public issues mobilised US$ 2.13 billion through issue of shares on rights issue. with an average increase of over US$ 10. At the end of 2006.07 billion has been raised through by India Inc through public issues. a whopping US$ 13. This performance of Indian stock markets has led to the total investor wealth of Bombay Stock Exchange (BSE) surging to a record high of over US$ 1.48 billion through public issues in 2007. India was also the fifth largest market in terms of number of IPOs and seventh largest in terms of the proceeds for the year.53 billion. The popular Bombay Stock Exchange (BSE) benchmark index. the National Stock Exchange (NSE) has climbed to the top spot in stock futures contracts and number-two slot in the index futures segment in the world. the total market capitalisation stood at US$ 812 billion. Simultaneously. according to data compiled by Prime Database.
.32 million raised in 2006-07. It has emerged as the third best performing market in the world with a dollar return of 71. the mobilisation of the funds in 2007-08 was more than the combined mobilisation of the preceding 12 years. also posted its highest ever absolute gain of 6500 points in over two decades. During 2007-08. which is 83 per cent higher than US$ 6. In fact. Indian companies raised a whopping US$ 11.18 million in every minute of trading during 2007. India Inc mobilised a whopping US$ 8.14 per cent). The robust performance of the Indian stock markets can also be seen in the huge increase in the funds mobilised by the corporate India. While initial public offerings mobilised US$ 10.28 billion mobilized in 2006. Simultaneously. This is almost twice that of US$ 6.Stock Markets The year 2007 saw Indian stock markets scaling new peaks. According to Ernst & Young.34 billion (about 79. sensex.23 per cent.
3 billion across 97 billion. A study by global consulting firm Boston Analytics.14 billion was mobilised through 386 deals by India Inc in 2007. And driven by the robust economic growth and attractive market valuations.Private Equity The year 2007 was a watershed for private equity market. which was 22. which has emerged as the most preferred mode of fund mobilization for India Inc. This market has been growing at a frenetic pace ever since the RBI issued revised guidelines on securitisation in 2006. During January-March 2008. private equity investments are estimated to continue strongly through 2011. India. The growth continues apace in 2008. infrastructure.8 billion in 2006. Real estate.22 per cent higher than the US$ 2. The capital mobilised through this route was higher than the funds mobilized through IPOs. topped the Asia private equity chart for the first time in 2007 in terms of aggregate deal value. banking and financial services were the dominant sectors attracting about 55 per cent of the total private equity investments.
.7 billion clocked in the corresponding period last year. Within this market. According to Grant Thornton.4 billion in 2003 to US$ 36.8 billion in 2007. the average deal size has increased from US$ 8. Asset Backed Securities (ABS) market has been the dominant segment than Residentially Market Backed Securities (RMBS). Structured Finance India has emerged as the fastest growing market in the Asia-Pacific region for structured finance. a total of US$ 17. a process of arranging funds by banks and other entities through partly selling their loan books. It was also the second largest market for domestic issuance in the structured finance market. follow-on issues and qualified institutional placements put together. private equity firms invested about US$ 3. in fact. compared to US$ 7.
11 trillion as against US$ 485. This would be on the back of 25 per cent growth rate between 1999 and 2007.
. Banking The burgeoning economy. Consequently. leading to their share in total banking business increasing from 9 per cent in 2001-02 to 16 per cent in 2006-07. The average assets under management (AUM) of the mutual fund industry for March 2008 stood at US$ 134.11 billion as of March 2002 to US$ 1175. financial sector reforms and a favourable demographic profile has led to the Indian banking industry emerging as one of the fastest growing in the world. The industry's business grew at a CAGR of 20 per cent from US$ 471. surging foreign investment. the newly licensed private sector business has grown almost twice (1.85 billion in July 2007.75 times) as that of banking industry as a whole.Mutual Funds India is also one of the fastest growing market for mutual funds industry attracting a host of global players. representing a year on year growth of 49. the number of investor folios of the MFs increased to 43.13 billion in 2006-07.76 billion as against US$ 89.93 per cent during 2007-08 to stand at US$ 1. With accelerating investor interest shown in mutual fund segment.7 million at the end of March 2008. market penetration in the MF industry would more than double by 2011 from about 4 per cent in 2007. Significantly. Simultaneously. Continuing the growth. the Indian mutual funds industry is expected to grow at a CAGR of 30 per cent in the next three years to become a US$ 241.96 per cent.108 (excluding 107 banks) till March 2008 from 54. from 27.86 billion at the end of 2006. there has been an increase in the number of distributors to 72.000 in January 2007.79 billion industry by 2011 from US$ 118.9 million at the end of January 2007 (a growth rate of 54 per cent). The combination of increasing number of fund houses (along with new schemes) and increase in the number of people parking their savings in mutual funds has resulted in total funds mobilisation increasing at a whopping 124.61 billion by March 2007.
the potential for further growth is huge considering the fact that India has second largest financially excluded households (about 135 million) in the world. compared to the world average of 2. In fact. the scope for growth is enormous. insurance penetration and entry of new players. Consequently India became the 15th largest insurance market from 19th in 2005. as per this year's Asian Banker 300 report. Clearly. This growth looks particularly impressive when seen against the fact that the combined penetration of both life and non-life is less than 2 per cent of the GDP compared to world average of 7. the Indian insurance industry is estimated to grow to US$ 50. the Indian debt market had its own share of excitement.52 per cent. India is the fastest growing incremental revenue pool in the world. seven Indian microfinance institutions find place in Forbes list of World's Top 50 Microfinance Institutions.9 per cent. India Inc increased its collections through the debt market by as much as 53. according to Boston Consulting Group. Insurance The liberalisation of the rules for the entry of domestic and foreign players has had a favourable impact on this sector.9 billion by 2011 from around US$ 12.84 per cent to US$ 20 billion in 2007 from US$ 13 billion in 2006. leading to premium collections growing by 19. The private players are likely to see a growth rate of 140 per cent during this period.
.72 billion in 2007. Debt Market While the Indian financial sector was dominated by the stellar performance of the stock markets. Despite such impressive performance. Similarly.This boom in the banking industry has propelled nine Indian banks to the list of top 50 Asian Banks. With increasing per capita income.9 per cent in 2006-07.
Local financial Institutions such as the Industrial Development Bank of India (IDBI). Morgan Stanley. Oppenheimer. but the country needs to use foreign skills and networks to be able to manage the huge sums for its development needs.
Industrial Credit and Investment Corporation of India (ICICI).
Top companies from the United Kingdom and the United States among others are
already active in India's financial markets. Morgan. nationalised suinmce 1971. Some of the big names are: Merrill Lynch.P. markets. A legislation to to this effect is expected by early 1999. Grindlays.
Foreign institutional investors (FIIs) have been allowed to invest in the stocks and
securities markets with rights of full repatriation and withdrawal.FINANCIAL SERVICES (BANKING AND NON-BANKING)
Promising sub-sectors Capital markets Consumer financing Venture banking Mutual funds
Infrastructure financing (Table3. Standard Chartered. has been opened up according to an announcenebt made in November 1998. Their presence has added a new dynamism to the market
India already has foreign exchange reserves of US$27 billion which is considered very
comfortable. Hong Kong and Shanghai Banking Corporation among others.
Tremendous scope exists for both banking and non-banking financial institutions from other countries. J. Unit Trust of India and the Shipping Credit and Investment Corporation of India have
India has one of the most developed financial markets in the developing world. The insurance sector. Industrial Finance Corporation of India.
American institutions are trying to promote American Depository Receipts (ADR) listed in New York.
Indian firms are showing increasing liking for Global Depository Receipts (GDR) listed
in London. India has finally opened up the insurance sector to private and
VOLUTION OF BROKERAGE HOUSES IN INDIA Early Years
.raised billions through the most sophisticated financial instruments including Deep Discount Bonds.
After much dithering.
Historical records show that as early as 1864. In Jul 1865. was a major financial centre having housed 31 banks. “Never Investors witnessed in any place a run so widely distributed nor such distress followed so quickly on the heels of such prosperity” An interesting aspect is that despite the collapse of the stock market. a huge sum in those days. The roots of a stock market in India began in the 1860s during the American Civil War that led to a sudden surge in the demand for cotton from India resulting in setting up of a number of joint stock companies that issued securities to raise finance. disallowed them to gather there. there were about 1. In the aftermath of the crash. which later turned into the Dalal Street. what was then used to be called the share mania ended with burst of the stock market bubble. A share of Colaba Land Company during the boom period of the 1860s rose from Rs 10. between 9 am to 7 pm at the junction of Meadows Street and Rampart Row.000 brokers with the stock markets functioning from three places in Mumbai.20.000 at par to Rs 1.000. A group of about 300 brokers formed the stock exchange in Jul 1875. thus forcing them to find a place of their own. The boom period came to an abrupt end in 1865. at that time. 20 insurance companies and 62 joint stock companies. Reports on stock markets around that time indicate that an ordinary broker in 1864 earned about Rs 200 per day. banks.The equity brokerage industry in India is one of the oldest in the Asia region. Bombay. from day break till 9 am and from 7 pm to early hours of next morning at Bazargate. most of the brokers met their payment commitments. Bombay. This trend was a kin to the rapid growth of securities markets in Europe and the North America in the background of expansion of railroads and exploration of natural resources and land development. India had an active stock market for about 150 years that played a significant role in developing risk markets as also promoting enterprise and supporting the growth of industry.000 and that of Backbay Shares went up from Rs 2. which led to the formation of a trust in 1887 known as the “Native Share and Stock Brokers Association”. Share prices rose sharply even at that time. on whose building steps share brokers used to gather to seek stock tips and share news.000 to Rs 54.
Following the establishment of the first stock exchange in Mumbai. A new set of economic and financial sector reforms that began in the early 1990s gave further impetus to the growth of the stock markets in India. was given statutory powers with the enactment of the SEBI Act. several measures were taken to streamline the processes and systems including setting up an efficient market infrastructure to enable Indian finance to grow further and mature. with the introduction of Foreign Exchange Regulation Act (FERA) that led to divestment of foreign equity by the multinational companies. unlike the banks which during the pre-independence period were owned and run by the British.A unique feature of the stock market development in India was that that it was entirely driven by local enterprise. it became imperative to strengthen the role of the capital markets that could play an important role in efficient mobilization and allocation of financial resources to the real economy. Calcutta (1908). The importance of an efficient micro market infrastructure came into focus following the incidence of market abuses in securities and banking markets in 1991 and 2001 that led to extensive investigations by two respective Joint Parliamentary Committees. tea (1880s and 1890s). namely Ahmedabad (1894). 1992. The broad objectives of the SEBI include
To protect the interests of the investors in securities To promote the development of securities markets and to regulate the securities
. which created a surge in retail investing. Towards this end. which was set up in 1988 as an administrative arrangement. As a part of the reform process. other stock exchanges came into being in major cities in India. Madras (1937). at different points of time. Uttar Pradesh and Nagpur (1940) and Hyderabad (1944). The stock markets gained from surge and boom in several industries such as jute (1870s). Beginning of a new equity culture A new phase in the Indian stock markets began in the 1970s. The early 1980s witnessed another surge in stock markets when major companies such as Reliance accessed equity markets for resource mobilisation that evinced huge interest from retail investors. The Securities and Exchange Board of India (SEBI). coal (1904 and 1908) etc.
The setting up of the National Stock Exchange brought to Indian capital markets several innovations and modern practices and procedures such as nationwide trading network. The Depositories Act 1996 was passed that allowed for dematerialisation (and rematerialisation) of securities in depositories and the transfer of securities through electronic book entry. NSE was incorporated in Nov 1992 as a tax paying company. Subsequently.The scope and functioning of the SEBI has greatly expanded with the rapid growth of securities markets in India in the last fifteen years.
. since stock exchanges earlier were trusts. NSE was recognized as a stock exchange under the Securities Contracts (Regulations) Act 1956 in Apr 1993. the first of such stock exchanges in India. It commenced operations in wholesale debt segment in Jun 1994 and capital market segment (equities) in Nov 1994. the National Stock Exchange of India (NSE) was promoted by financial institutions with an aim to provide access to investors all over the country. To speed the securities settlement process. commenced operations in Oct 1996. greater transparency in price discovery and process driven operations that had significant bearing on further growth of the stock markets in India. Faster and efficient securities settlement system is an important ingredient of a successful stock market. The National Securities Depository Limited (NSDL) set up by leading financial institutions. Central Depository Services (India) Limited promoted by Bombay Stock Exchange and other financial institutions came into being. Regulations governing selection of various types of market intermediaries as depository participations were made. Following the recommendations of the High Powered Study Group on Establishment of New Stock Exchanges. being run on no-profit basis. electronic trading.
in addition to trading in equities. Indian equity markets now offer. straight through processing. Stock exchange reforms brought in professional management separating conflicts of interest between brokers as owners of the exchanges and traders/dealers. Deutsche Borse and Singapore Stock Exchange bought equity in the Bombay Stock Exchange Ltd. Risk management became robust reducing the recurrence of payment defaults. The demutualisation and corporatisation of all stock exchanges is nearing completion and the boards of the stock exchanges now have majority of independent directors. The value of share trading witnessed a sharp jump too.
. Indian stock markets now are ranked first in stock futures and fourth in index futures. Investor base continued to grow from domestic and international markets. giving little scope for manual intervention that has been the source of market abuse in the past. Electronic Traded Funds(ETF’s) are showing gradual growth. While NYSE Group led consortium took stake in the National Stock Exchange. The stock market capitalization in mid-2007 is nearly the same size as that of the gross domestic product as compared to about 25 percent of the latter in the early 2000s. Within five years of introduction of derivatives. opportunities in trading of derivatives in futures and options in index and stocks. electronic contract notes. Indian stock markets are transaction intensive and thus rank among the top five markets in this regard. Foreign institutional investment in Indian stock markets showed continuous rise reaching about USD10 billion in each of these years between FY04 to FY06. digital certification. In the back of wide ranging reforms in regulation and market practice as also the growing participation of foreign institutional investment. Stock markets became intensely technology and process driven. online broking have emerged as major trends in technology.The last decade has been exceptionally good for the stock markets in India. Foreign institutions took stake in India’s two leading domestic stock exchanges. Electronic trading. stock markets in India have showed phenomenal growth in the early 1990s. Product expansion took place in a speedy manner.
In a span of two to three years the client list read like the who's who of Indian financial market. there would be no comebacks'. Rating agencies like CRISIL. Worse. FIIs. companies like Hindustan Lever.
. Funding disappeared completely. regardless of valuation. The name was later changed to “IndiaInfoline Limited”. D&B. There was no money available for the private equity investors at any valuation. Circa2001. The list included consulting firms like Mckinsey. They cut all the possible costs and worked on bare bone structure. life insurance and E-Broking. The company also had a crash landing and was forced to drop a number of plans including one to set up a TV channel.Circa1995. There was a core group who never lost hope. It meant that the company put up all the information on the web site and let go off all the revenues and profits. a colleague of the company had a crazy idea that if the company made all the research available free on the web. Banks like Citibank. The company rose from strength to strength to become the leading corporate agent in life insurance and among the top retail players in mutual fund and broking space. which was the tail to any business name. The objective was to provide unbiased and independent information to market intermediaries and investors. FIs. The going was smooth but not exciting! One fine morning in early1999. suddenly became the worst stigma to have. The key business lines that emerged were mutual funds. All the competitors were backed by institutions or had abundant capital. The company became heavily dependant on its E-broking business for survival. the business required incarnation. business model or management depth. A group of Professionals Formed Company called “Probity Research & Service Private Limited”.The internet bubble started bursting faster than any body could have imagined. “IndiaInfoline Limited” decided to narrow its focus on business where it could leverage its core competencies to the maximum. The dot com suffix. if the new avatar failed. The odds were against them. They survived against all odds and started capturing market share. The quality of research soon caught the imagination of all major participants in the financial market. Not broking alone mutual funds and life insurance business also grew strongly. the number of users may well jump from 250 to 2. foreign brokers as well as leading Indian brokers.5million! To make it true.
The company raised capital by the way of Initial Public Offerings (IPO’s). along with its subsidiaries is a unique one stop investment which offers every thing from information and advice to execution and service to the retail customers for the entire gamut of investment products from risk free RBI Bonds to high risk. it evolved a clear and logical risk management system. Falling interest rates are compelling people look around for advised investment. which stood the trial by fire on May 17. The management realizes that the business is highly vulnerable to lapse in risk management. The India Infoline Ltd.
. They also entered into portfolio management services and commodities broking.There are a number of opportunities on the horizon and with availability of horizon. The industry is consolidating as smaller players find it difficult to meet strict compliance standards and service customers with research and technology understandably. high reward equities and also mutual funds and life insurance. with tremendous long term promise. The company promises to continue to deliver high quality independent research and maintain high standards of integrity and compliance. investment advisory is a sunrise industry.The Story took an interesting turn. The land scape was changing every day and the road ahead is less travelled by. The management is fully conscious of the fact that with public money it is in a crucial relationship with heightened responsibilities to ensure optimum use of capital. The young 'Earning' and 'saving' class of population is growing very rapidly. competition is intense. 2004.In India. again leveraging upon their core competencies in research and technology. temptations around. Over the years.
mutual fund and portfolio management services businesses.
. India Infoline's research is available not just over the internet but also on international wire services like Bloomberg (Code: IILL). it offers Portfolio Management Services to clients.1)
A SEBI authorized Portfolio Manager. Revenue generation is through the sale of content to financial and media houses. These services are offered to clients as different schemes. which are based on differing investment strategies made to reflect the varied risk-return preferences of clients.THE PRODUCT LINES OF INDIAINFOLINE LIMITED
(CHART3. INDIA INFOLINE MEDIA AND RESEARCH SERVICES LIMITED The content services represent a strong support that drives the broking. Thomson First Call and Internet Securities where India Infoline is amongst the most read Indian brokers. commodities. It undertakes equities research which is acknowledged by none other than Forbes as 'Best of the Web' and '…a must read for investors in Asia'. Indian as well as global.
and recently acquired membership of DGCX. India Infoline Commodities Pvt Limited is engaged in the business of commodities broking. We enjoy memberships with the MCX and NCDEX. INDIA INFOLINE MARKETING & SERVICES India Infoline Marketing and Services Limited is the holding company of India Infoline Insurance Services Limited and India Infoline Insurance Brokers Limited. which is India's largest private Life Insurance Company. (b) India Infoline Insurance Brokers Limited India Infoline Insurance Brokers Limited is a newly formed subsidiary which will carry out the business of Insurance broking. We have applied to IRDA for the insurance broking licence and the clearance for the same is awaited. two leading Indian commodities exchanges. Our experience in securities broking empowered us with the requisite skills and technologies to allow us offer commodities broking as a contra-cyclical alternative to equities broking. (a) India Infoline Insurance Services Limited is a registered Corporate Agent with the Insurance Regulatory and Development Authority (IRDA).INDIA INFOLINE COMMODITIES LIMITED.
. we propose to also commence the general insurance distribution business. It is the largest Corporate Agent for ICICI Prudential Life Insurance Co Limited. Post the grant of license. We have a multi-channel delivery model. making it among the select few to offer online as well as offline trading facilities. India Infoline was the first corporate agent to get licensed by IRDA in early 2001.
This will help focused expansion and capital raising in the said subsidiaries for various lending businesses like loans against securities. the company has been initially capitalized at 1 million Singapore dollars.INDIA INFOLINE INVESTMENT SERVICES LIMITED Consolidated shareholdings of all the subsidiary companies engaged in loans and financing activities under one subsidiary. Orient Global. India Infoline Investment Services Private Limited consists of the following step-down subsidiaries.7 million for a 22. a Singapore-based investment institution invested USD 76. Recently. distribution of retail loan products. SME financing. a) India Infoline Distribution Company Limited (distribution of retail loan products) (b)Moneyline Credit Limited (consumer finance) (c) India Infoline Housing Finance Limited (housing finance) IIFL (ASIA) PRIVATE LIMITED IIFL (Asia) Private Limited is wholly owned subsidiary which has been incorporated in Singapore to pursue financial sector activities in other Asian markets. consumer finance business and housing finance business.
. Further to obtaining the necessary regulatory approvals.5% stake in India Infoline Investment Services.
1995 May. Acquired NBFC license. 2005 May. 2000
Started life insurance agency business in as a corporate agent of ICICI Prudential Life Insurance.Indiainfoline.
• • • • •
September. Launched portfolio management services.5paisa. Launched Internet Portal www.
December. Listed on NSE and BSE.
. Commenced distribution on of personal financial products like Mutual Funds and RBI Bonds in Launched Online trading in shares and securities branded as www. 2001 August.com.com.
DSP Merrill Lynch Capital subscribed to convertible bonds aggregating Rs.Their current stake in India Infoline is a little over 14% as on 31st March 2007. 2004 May 17. 2005 December.KEY MILESTONES OF THE COMPANY
YEAR • • • October 18. Acquired 100% equity of Marchmont Capital Advisors Pvt Ltd through which the company had ventured into Merchant Banking.80 crores .2005
Became a depository participant of NSDL. 1999 April2000
MILESTONE ACHIEVED Incorporated as “Probity Research and Services”.
December. 2005. January.
Bennet Coleman &Co Ltd (BCCL) invested Rs. 2007 April. Acquired IRDA license for Insurance Broking. 2007
The company became a depository participant of CSDL. Merger of India Infoline securities Pvt Limited with India Infoline Limited.
Entered into an alliance with Bank of Baroda e-trading.20 crores in India-infoline by way of preferential allotment. 2007. 2006.
In1995. He holds a B.
.Venkatraman (Executive Director) • • • R Venkatraman is the co-promoter and Executive Director of India Infoline Limited.Nirmal Jain (Chairman and managing Director) • • • • Nirmal jain is the founder and Chairman of India Infoline Limited. he handled a variety of responsibilities. During his stint with Hindustan Lever Limited. Including ICICI Securities Ltd. now known as India Infoline Ltd. • He has also held the position of Assistant Vice President with G E Capital Services India Limited in their private equity division. He holds an MBA degree from IIM Ahmedabad. He started his career in 1989 with Hindustan Lever Limited. including exports and trading in agro-commodities with Rs3bn annual turnover. he founded his own independent financial research company.Tech degree in Electronics and Electrical Communications Engineering from IIT Kharagpur and an MBA from IIM Bagalore.THE MANAGEMENT TEAM OF THE COMPANY
Mr. their investment banking joint venture with J P Morgan of USA and with BZW and Taib Capital Corporation Limited. and is a Chartered Accountant (All India Rank2) and a cost Accountant. • His work set new standards for equity research in India. He has held senior managerial positions in various divisions of ICICI Limited.
Mr. He has an impeccable professional and academic track record.
named Centennial Management consultants Private Limited. 2005. He was the founding partner of a firm of solicitiors in Singapore named Khattar Wong and at present is a Consultant in the said firm. Mr Ahuja graduated from National University of Singapore with a degree in Computer Science and is also a Certified Public Accountant. Mr Sat Pal Khattar is a lawyer by profession. He is also a director of a number of public companies in Singapore and India.2002. 2001. Mr Vikamsey was inducted as partner in M/s Khimji Kunverji& Co. Sanjiv Ahuja (Independent Director) • • • • Mr Sanjiv Ahuja joined the Board with effect from August 28. Sat Pal Khatter (Non Executive Director) • • • • Mr Sat Pal Khatter joined the Board with effect from April20.
Mr. He started his own investment advisory and consulting company in 2001. At present. a post he has held since 2002. Mr..THE BOARD OF DIRECTORS
Mr. he is also an Executive Director with Corporate Brokers International Private Limited and also a board member of the Singapore Indian Chamber of Commerce and Industry. Chartered Accountants and was in charge of the audit department till 1990 and
. Nilesh Vikamsey (Independent Director) • • • Mr Nilesh Shivji Vikamsey joined the Board with effect from February 11. In 1985. Mr Vikamsey qualified as Chartered Accountant in 1985 and has been a member of the Institute of Chartered Accountants of India since 1985.
thereafter also handles assignments related to financial services, consultancy, investigations, mergers and acquisitions, valuations etc. Mr. Kranti Sinha (Independent Director) • • • Mr Kranti Sinha joined the Board with effect from January 27, 2005. Mr Sinha graduated from the Agra University with a master’s degree. He is currently the Managing Director of the Global Institute for Financial and Eductaion Services (India) Private Limited (a sholly owned subsidiary of The Global Institute, LLC, USA). • Mr Sinha is also on the Board of Directors of Hindustan Motors Limited, L& T Limited & LICHFL Care Homes Limited.
INDIA INFOLINE TODAY
The company is a one stop investment shop where customers can meet all their advisory, investing and borrowing needs under one roof. We provide advice, offer a wide range of products to choose from, execute the orders and complete the value chain by providing constant service to all our customers.
REGULATORS OF THE COMPANY
• • • • •
Stock and Exchange Board of India (SEBI). Reserve Bank of India (RBI). Association of Mutual Funds in India (AMFI). Insurance Regulatory Development Authority (IRDA). Forward Market Commission (FMC).
THE VISION OF THE COMPANY
“The company’s vision is to be the most respected financial services company in India”. Having a vision gives an organization a sense of direction. It helps all employees of the organization to channelize their efforts in the same direction towards a common organizational goal and acts as a cornerstone to resolve conflicts. At India Infoline, they are convinced that even as a number of their peer companies are focused on emerging as the biggest and the best in the financial services space in India, there is an even more critical opportunity available in emerging as the most respected. The company needs to be most respected by their stakeholders, their customers, their employees and by society in general. Needless to emphasize, it is imperative for all of them to align our personal goals and values to the organization’s vision.
THE KEY COMPETITORS OF INDIAINFOLINE LIMITED
• • • • • •
KARVY STOCK BROKERING LIMITED SHAREKHAN SECURITIES LIMITED INDIA BULLS SECURITIES LIMITED MOTILAL OSWAL SECRITIES LIMITED KOTAK SECURITIES LIMITED ICICI DIRECT
DATA ANALYSIS & INTERPRETATION
Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. futures can be settled by delivery of the underlying asset or cash. delivery time and place for settlement on any date in future.is required to be deployed in cash market for taking a delivery the same stock if available in derivatives market can be bought by paying an average margin of around15%.FUTURES CONTRACT
Futures Contract means a legally binding agreement to buy or sell the underlying security on a future date. and also eliminates the counter party risk due to guarantee Provided by the exchange. 100/. They are standardized forward contracts.
. The contract expires on a pre-specified date which is called the expiry date of the contract. Future contracts are the organized/standardized contracts in terms of quantity. who in turn has to pay to the exchange. anonymity of trades. For example if Rs. On expiry. which are traded on the exchanges mainly BSE & NSE. on or before a specified time. 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. quality (in case of commodities). it provides them transparency. Derivative market is a leverage market since Investor/Trader has to pay only fraction of total value of the contract as a margin to his broker. liquidity. Since they are traded on the exchange on electronic platform. FUTURES FUNCTIONALITY Futures are derivative contracts to buy or sell a specified quantity or underlying assets at an agreed price. Cash settlement enables the settlement of obligations arising out of the future/option contract in cash.
the interstate is 12% and the dividend declared by the company is say0.to Rs. Generally the cost comprises interest while revenue comprises of dividend.5/. Example: say an investor has a bullish view on Reliance and hence buys a Reliance in a futures market at a start of current month at Rs.e.750/. On last Thursday of each month these contracts expires and then they are settled at a closing price of underlying cash market.i.750/. Thus.50 = 100. Supposing next day price falls by Rs. On the last day of the contract the difference will be settled bytaking the closing price in the cash market for Reliance.747/.100/in cash market then the theoretical value of this stock in the futures market should be 100 + 1 – 0.wherein price in cash market is Rs.5/. Further day to day mark to market difference is also debited/credited to the client and broker’s account by the Exchange.e. Now say for e.
The pricing of the futures depends on cash market price and the cost of carry.g.In the similar manner if investor has a bearish view on Reliance he can short sell in futures market unlike in cash market where he can sell only if he has shares in his hand. on the next day the price of the Reliance in the futures market moves uptoRs. next month and far month.755/-he will be debited by Rs. The Cost of carry is the sum of all costs incurred if a similar position is taken in cash market and carried to maturity of the futures contract less any revenue which may result in this period.747/-.in his account. unlike entire Rs.for buying the same share in cash market. for current month. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts.g.
. Say for e.then he will be credited Rs.50.He has to pay 15% margin on Rs.Currently in India we have three types of contracts available for trading i. on a daily basis his account will be debited/credited to the extent of difference in price compared to previous day.in his account (760-750).760/.10/.50ps. In India contracts are settled in cash. approx 112. on the stock that is quoting at Rs.5 per share to his broker as a margin. ARRIVAL OF FUTURE PRICE 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.
BASIS The difference between spot price and futures price is known as basis.Although generally by definition futures prices should be higher than the cash prices to the extent of the interest element (assuming no dividend). Options are of two types-calls and puts.
. many a times it is not so and it may be significantly higher or lower than the cash price because of built-in market expectations for that stock in futures prices. Although the spot price and futures price generally move in line with each other. The underlying asset could include securities. at a given price on or before a given future date. Puts give the buyer the right. the basis is never constant. The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right. The buyer / holder of the option purchase the right from the seller/writer for a consideration which is called the premium. However. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset. It gradually decreases with time and on expiry since futures and cash prices becomes equal basis becomes ‘zero’. an index of prices of securities etc.
AN OPTION CONTRACT
Options Contract is a type of Derivatives Contract which gives the buyer/holder of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a specified period. but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.
option buyer has unlimited gain potentials while option seller has a limited income potential to the extent of premium income only.750/.so if Reliance moves to Rs. Obviously he will exercise his right if cash market price is higher than Rs. irrespective of cash market price. Since he has already incurred Rs.(850-750-30) on an investment of Rs.850/.850/. 650/.750/-.in this case since it makes more sense to buy Reliance from the cash market. The risk of option buyer is limited while that of an option seller is unlimited. Although he is expecting an upward price movement.30/.and hence he loses the premium amount of Rs.750/-only.80/.as a cost for buying this right his break even point is Rs. he is expecting a price of Rs.750/.(strike price) for a price of say Rs. Example Suppose an investor is bullish on Reliance at the start of the current month when the price is Rs. Thus. are like an insurance contract whereby paying certain premium.(premium)By paying Rs.which otherwise he would have taken had he bought the Reliance from the cash market at Rs.30/what he gets is right (not an obligation) to buy Reliance at any time before the month end at Rs.30/-.OPTIONS AND THEIR FUNCTIONS Options are derivative contracts where the person gets aright (but not obligation) to buy or sell a specified quantity of the underlying asset at an agreed price (strike price) on or before the specified future date (expiration date) at an agreed Price (premium).30/. Now suppose that Reliance moves down to Rs. he wants to limit his downside risk and hence he buys an option contract of Rs. The different types of Options
.by end of the month.any time before expiry of the contract. option buyer passes on his risks to option seller.750/.30/. At the same time he avoids the downside risk of Rs.750/.100/.he makes Rs.780/. options in a way. he will not exercise his right to buy at Rs.say for e.g.(cost of buying an option). In a similar manner.
underlying asset price.e anytime between the time of purchase and the time of its expiry. The different style of Options Broadly there are two styles of options. the right to buy a specified quantity of the underlying asset at a strike price on or before expiration date. the right to sell a specified quantity of the underlying asset at a strike price on or before an expiry date. the volatility of the underlying asset. which can be exercised by the buyer on the expiration day only and not anytime before that. Difference between Futures and Options
. (a) Call Options (b) Put Options CALL OPTIONS: A call option gives the holder (option buyer). has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy. stock options are of the American style while index options are of the European style. they are strike price. which can be exercised by the buyer on or before the expiration date. the buyer).There are basically two types of option contracts. i. PUT OPTIONS: A Put Option gives the holder (i. namely American style option and European style option. The seller of the put option however has the obligation to buy the underlying asset at the strike price if the buyer decides to exercise his option to sell. An American style option is one. they are market participants varying estimates of the underlying assets future volatility and future performance. The seller however. The European kind of option is one.e. FACTORS THAT DETERMINE OPTION PRICES (PREMIUM) There are two types of factors that affect the value of the option (premium): Quantifiable factors. the time to expiration and the risk free interest rate: Non-quantifiable factors. In India.
but also by volatility and time to expiry. They are Nifty futures. it can be squared off by taking a reverse position any time before the expiry. Various derivative Strategies and their utilization Option strategies are various combinations of futures and options in such a manner that it offers optimal risk to reward ratio based on the view of a market player for e. An investor can utilize these futures as a hedging tool or for a trading based on his view about that index. to buy or sell the underlying asset. Trading of Futures & Option before the expiry date Once the position is taken in futures. Bullish and bearish option spread.The significant differences between them are as under: In case of futures. Similarly once the position is taken in the option contract. Future prices are mainly affected by the prices of underlying asset while option prices are affected by not only the prices of underlying asset. This is called a covered call writing. both the parties have an obligation to buy/sell the underlying asset. Whereas in the case of options the buyer enjoys the right and not the obligation. Index Futures and its utilization Index futures are the futures on index. The Uses/Advantages of Derivatives
. Strangle. While Nifty future is future on cash Nifty CNX IT and Bank Nifty are futures on IT and bank index respectively. an investor having a moderately bullish view on a market can buy a stock or futures and correspondingly sell call of higher price at some premium and thus not only participate in rally but also earn some premium income. Currently on NSE we have 3 types of index futures. it can be squared off by taking a reverse position any time before the expiry of the contract. In case of Futures the risk/return profile of both buyers and sellers is equal whereas in case of options the buyer has limited risk and unlimited gain potential and seller of the option has a unlimited risk and limited gain potential. CNX IT futures and Bank Nifty futures. straddle are few of other option strategies which can be utilized bythe market players.g.
High Liquidity: Derivative contracts offers very high liquidity compared to cash market. It gradually decreases with time and on expiry since futures and cash prices becomes equal basis becomes ‘zero’.
Basis is defined as the difference between cash and futures prices: Basis = Cash prices . the basis is never constant.Future prices. Basis may change its sign several times during the life of the contract. Basis can be either positive or negative (in Index futures. High Leverage: Derivative contracts enable the investor to take an exposure to the full value of underlying shares for a fraction of its value in the form of margin.e.
CONCEPT OF BASIS IN FUTURES MARKET
BASIS: The difference between spot price and futures price is known as basis. An investor can use derivative in a most Conservative to most risky manner as his risk profile dictates.Versatility: The major advantage of derivatives is their versatility. basis generally is negative). both cash and future prices converge at maturity. Basis turns to zero at maturity of the futures contract i. Although the spot price and futures price generally move in line with each other.
• • •
1) Life of the contract Operators in the derivatives market
• • •
Hedgers . CPt .Cash price of the asset. in pursuit of profit and eliminate mis-pricing. If Futures price > Fair price.Operators.Fair price of the asset at time t for time T.
. Buy in the cash market and simultaneously sell in the futures market. Cost of carry = Financing cost. who want to transfer a risk component of their portfolio.Operators who operate in the different markets simultaneously.Inflows in terms of dividend or interest between t and T.Operators.Inflows FPtT = CPt + CPt * (RtT . DtT . Storage cost and insurance cost. who intentionally take the risk from hedgers in pursuit of profit.(Chart 4. RtT .
Cost and carry model of Futures pricing
• • • • • • • •
Fair price = Spot price + Cost of carry . Arbitrageurs . Speculators .DtT) * (T-t)/365 FPtT .Interest rate at time t for the period up to T.
This arbitrage between Cash and Future markets will remain till prices in the Cash and Future markets get aligned.•
If Futures price < Fair price.
Set of assumptions
• • • • •
No seasonal demand and supply in the underlying asset. rather than a futures contract. No margin requirements. Sell in the cash market and simultaneously buy in the futures market. Storability of the underlying asset is not a problem. No transaction cost.
. No taxes. and so the analysis relates to a forward contract. The underlying asset can be sold short.
E(S) .Future prices.Market when Future prices are above cash prices. (This reflects market’s expectations) Contagion market.Spot prices.
Expectancy model says that many a times it is not the relationship between the fair price and future price but the expected spot and future price which leads the market. F .2) S .
• • •
E(S) can be above or below the current spot prices. For instance in commodities market.Market when future prices are below cash prices.Expected Spot prices. relationship between cash and future indices is described by the cost and carry model of futures pricing. Expectancy Model of Futures pricing
(Chart4. This happens mainly when underlying is not storable or may not be sold short.INDEX FUTURES AND COST AND CARRY MODEL In the normal market. Backwardation market .
. Index Funds . Margining etc. Speculators operate in the market with motive to make money. quickly. vested in the investment in securities.. Index futures are used to manage the systemic risk.. Spread positions . Leverage.
SOME SPECIFIC USES OF INDEX FUTURES
Portfolio Restructuring .Opposite positions in two future contracts. Liquidity. (Perception plays a crucial role in price determination)
Any substantial difference in the Forward and Future prices will trigger arbitrage. RISK MANAGEMENT THROUGH FUTURES
Risk managing through Futures
Basic objective of introduction of futures is to manage the price risk. This is called Passive Investment Strategy.These are the funds which imitate/replicate index with an objective to generate the return equivalent to the Index.An act of increasing or decreasing the equity exposure of a portfolio.. with the help of Index Futures.
SPECULATION IN THE FUTURES MARKET
Speculation is all about taking position in the futures market without having the underlying.RELATIONSHIP BETWEEN FORWARD & FUTURE MARKETS
Analyze the different dimensions of Forward and Future Contracts: (Risk. This is a conservative speculative strategy.Position in any future contract.) Assign value to each factor to arrive at the contract price. They take:
Naked positions .
• • •
Margins to cover the potential losses for one day.Speculators bring liquidity to the system. provide insurance to the hedgers and facilitate the price discovery in the market. Price for final settlement . MARGINING IN FUTURES MARKET
• o o • •
Whole system dwells on margins: Daily Margins Initial Margins Compulsory collection of margins from clients including institutions. Collection of margins on the Portfolio basis not allowed by L. To be collected on the basis of value at risk at 99% of the days.
Daily margins are collected to cover the losses which have already taken place on open positions.Closing price of cash index. Daily margins would be paid only in cash. Daily margins should be received by CC/CH and/or exchange from its members before the market opens for the trading on the very next day. Gupta committee.
o o •
Price for daily settlement . C.Closing price of futures index. Different initial margins on:
. ARBITRAGEURS IN FUTURES MARKET Arbitrageurs facilitate the alignment of prices among different markets through operating in them simultaneously.
Verma.5% per month of spread on the far month contract.1] Long positions 100 [1 .
Naked positions Short positions 100 [exp (3st) . minimum initial margin on naked positions shall be 5%)
• • •
Flat rate of 0. Spread positions. (For first 6 months of futures trading. rt is the return on the trading day [log(It/It-1)] Because volatility estimate st changes everyday. Min.o o
Naked long and short positions. margin of 1% and maximum margin of 3% on spread positions. Initial margin on open position will change every day. Over the last five days of trading of the near month contract. following percentages of the spread shall be treated as naked position in the far month contract:
o o o o o
100% on the day of expiry 80% one day before the expiry 60% two days before the expiry 40% three days before the expiry 20% four days before the expiry
. J. A calendar spread would be treated as open position in the far month contract as the near month contract approaches maturity. st-1 is the volatility estimates on the previous trading day. l is decay factor which determines how rapidly volatility estimates change and is taken as 0.94 by Prof. R.exp (3rd)] Where (st)2 = l(st-1)2 + (1-l)(rt2)
• • •
st is today’s volatility estimates.
Cash equivalents means cash.
Margining in Futures market Initial Margin (Value at risk at 99% of the days) Daily Margin Special Margins
. 50 Lacs.
• • o o
Liquid net-worth = Liquid asset . The mark to market value of gross open position shall not exceed 33. fixed deposits.33 times of member’s liquid net worth. bank guarantee and government securities.Initial margin Continuous requirement for a clearing member: Minimum liquid net-worth of Rs. 50% of Liquid assets must be cash or cash equivalents. bank guarantee. As the near month contract approaches expiry. fixed deposits. government securities and other approved securities.
Basis for calculation of Gross Exposure:
For the purpose of the exposure limit.Liquid assets and Broker’s net worth
Liquid assets Cash. a calendar spread shall be regarded as an open position of one third of the mark to market value of the far month contract. the spread shall be treated as a naked position in the far month contract in the same manner.
Trading member level
15% of open interest or 100 crore whichever is higher.Ms. clearing through him are within the limits specified above for T. Disclosure to exchange. is a T. should ensure that his own positions (if C.M.M.M. To be reviewed after 6 months of futures trading.3)
Striking an intelligent balance between safety and liquidity while determining margins is a million dollar point.(Chart4.
Clearing member level
No separate position limit.
Position limits in Index Futures Customer level
No position limit. C.
. also) and the positions of the T.M. if position of people acting in concert is 15% or more of open interest. However.
Reasons for making a contract click
• • • •
Risk in the underlying market. Lesser volatility Improved price discovery. Presence of both hedgers and speculators in the system. Proper margining. Arbitrage between cash and futures markets fetches additional business to cash market.•
Expected advantages of derivatives to the cash market
• o o • • •
Higher liquidity Availability of risk management products attracts more investors to the cash market. To be reviewed after 6 months of trading in futures. Right product specifications. Improvement in delivery based business.
Multiple indices trading on the same exchange even the same index with different contract designs Dedicated funds o o o
Future funds Options funds Hybrid funds
05 Rs.20.05 Range Range Rs.05 Rs. 0.05
. 0. 20% of the or Rs.05 Upper Upper Upper Operating Operating Operating Operating Range + 99% Operating Range +99% Operating Range +99% range of of base price range of of base price range of of base price 10% of the or Rs. 0.05 Rs.1)
Parameter Index Futures 6 Indices Index Options 6 Indices OPTIDX Symbol of Underlying Index DD-MMMYYYY CE / PE Strike Price Futures on Individual Securities 225 securities FUTSTK Symbol of Underlying Security DDMMMYYYY Options on Individual Securities 225 securities OPTSTK Symbol of Underlying Security DD-MMMYYYY CA / PA Strike Price Mini Index Futures S&P CNX Nifty FUTIDX MINIFTY Mini Index Options S&P CNX Nifty OPTIDX MINIFTY
Security Descriptor : Instrument FUTIDX Underlying Symbol Expiry Date Option type Strike Price Trading Cycle Expiry Day Strike Price Intervals Permitted Lost Size Price Steps Symbol of Underlying Index DD-MMMYYYY -
DD-MMMYYYY CE / PE Strike Price
3 month trading cycle – the near month (one). higher.05 Rs.20. 10% of the or Rs.05 Rs. 0.CONTRACT SPECIFICATIONS FOR FUTURES & OPTIONS
(Table4. Operating Lower Lower Range Operating Operating Rs. 0. If the last Thursday is a trading holiday. the next month (two) and the far month (three) Last Thursday of the expiry month. Lower higher. 0. then the expiry day is the previous trading day. 0.05 Rs. Depending on Depending Depending underlying on on price underlying underlying Underlying Underlying Underlying price 20 price Specific Specific Specific Underlying 20 Specific Rs. 0.20. base price whichever is base price whichever is base price whichever is higher. 0.
60 767.24 247.00 Final Settlement 41.10 3794.43 Total
Apr-2010 May-2010 Jun-2010 Jul-2010 Aug-2010 Sep-2010 Oct-2010 Nov-2010 Dec-2010 Jan-2011
4778.14 41418.96 94.80 3851.39 5752.17 203.07 498.58 4326.92 72.00 5300.84 327.17 105.38 77.61 282.13 367.60 103.50 4935.43 92.42 222.59 71.58 294.84 569.88 583.66 14884.11
(All figures in Rs.85 17472.00 14125.64 107.(STATISTICS)
Settlement Statistics (2007-2008) Monthly Settlement Statistics of Derivatives Traded For The Year 2007-2008
(Table 4. Crores) Index / Stock Options Premium Settlement 385.15 599.65 17734.90 3251.66 12150.95 Exercise Settlement 188.33 6556.2) Month/Year Index / Stock Futures MTM Settlement 4162.00 15924.41 615.00 16248.49
.20 11299.62 669.11 478.36 211.38 777.62 918.00 39768.67 143.
shall be marked to market at Final Settlement Price (for Final Settlement) and settled. who clear and settle such deals through them. closed out during the day) of a F&O Clearing Member in Futures Contracts. at the close of trading hours on the last trading day.
Daily Settlement Price shall be the closing price of the relevant Futures contract for the Trading day. created during the day.
All positions (brought forward.
All positions (brought forward. closed out during the day) of a F&O Clearing Member in Futures Contracts. shall be marked to market at the Daily Settlement Price (for Daily Mark to Market Settlement) and settled. at the close of trading hours on a day. created during the day.INTEREST RATE DERIVATIVES CLEARING AND SETTLEMENT
National Securities Clearing Corporation Limited (NSCCL) is the clearing and settlement agency for all deals executed on the Derivatives (Futures & Options) segment. NSCCL acts as legal counter-party to all deals on NSE's F&O segment and guarantees settlement. A Clearing Member (CM) of NSCCL has the responsibility of clearing and settlement of all deals executed by Trading Members (TM) on NSE. Settlement Procedure & Settlement Price Daily Mark to Market Settlement and Final settlement for Interest Rate Futures Contract
Daily Mark to Market settlement and Final Mark to Market settlement in respect of admitted deals in Interest Rate Futures Contracts shall be cash settled by debiting/ crediting of the clearing accounts of Clearing Members with the respective Clearing Bank.
the rate of interest may be the relevant MIBOR rate or such other rate as may be specified from time to time. For this purpose the notional coupon payment date shall be half yearly and commencing from the date of expiry of the relevant futures contract.e. The Zero Coupon Yield Curve (ZCYC) shall be computed by the Exchange or by any other agency as may be nominated in this regard from the prices of Government securities traded on the Exchange or reported on the Negotiated Dealing System of RBI or both taking trades of same day settlement(i. the theoretical price would be taken or such other price as may be decided by the relevant authority from time to time.•
Final settlement price for an Interest rate Futures Contract shall be based on the value of the notional bond determined using the zero coupon yield curve computed by National Stock Exchange or by any other agency as may be nominated in this regard. t = 0).
Daily Settlement Price Daily settlement price for an Interest Rate Futures Contract shall be the closing price of such Interest Rate Futures Contract on the trading day. The closing price for an interest rate futures contract shall be calculated on the basis of the last half an hour weighted average price of such interest rate futures contract. For computation of futures prices from the price of the notional bond (spot prices) thus arrived. In absence of trading in the last half an hour. Theoretical daily settlement price for unexpired futures contracts shall be the futures prices computed using the (price of the notional bond) spot prices arrived at from the applicable ZCYC Curve.
Open positions in a Futures contract shall cease to exist after its expiration day. the present value shall be obtained as the sum of present value of the principal payment discounted at the relevant zero coupon yield and the present values of the coupons obtained by discounting each notional coupon payment at the relevant zero coupon yield for that maturity.
. In respect of coupon bearing notional bond.
m Pay-in: T+1 working day on or after 12:00 p.FINAL SETTLEMENT PRICE FOR MARK TO MARKET SETTLEMENT OF INTEREST RATE FUTURES CONTRACTS Final settlement price for an Interest rate Futures Contract on zero coupon notional bond and coupon bearing bond shall be based on the price of the notional bond determined using the zero coupon yield curve computed as explained above.m (T is trading day)
SETTLEMENT VALUE IN RESPECT OF NOTIONAL T-BILL
Since the T-bills are priced at 100 minus the relevant annualised yield. In respect of notional T-bill it shall be 100 minus the annualised yield for the specified period computed using the zero coupon yield curve.m Pay-in: T+1 working day on or after 12:00 p. the settlement value shall be arrived at using the relevant multiplier factor. Currently it shall be 91/365 SETTLEMENT SCHEDULE
Settlement schedule for Interest Rate Futures Contracts
Product Interest Rate Futures Contracts Settlement Daily Mark-to-Market Settlement
(Table 4.3) Schedule Pay-in: T+1 working day on or after 11:30 a.m (T is trading day)
Interest Rate Futures Contracts
Pay-in: T+1 working day on or after 11:30 a.
Initial Margin shall include SPAN margins and such other additional margins.Risk Containment Margins
• • • •
Initial Margins Computation of Initial Margin Exposure Limits Trading Member wise/ Custodial Participant wise Position Limit
Initial Margins Initial margin shall be payable on all open positions of Clearing Members. Presently.Interest Rate Derivatives .
Computation of Initial Margin Clearing Corporation will adopt SPAN (Standard Portfolio Analysis of Risk) system or any other system for the purpose of real time initial margin computation. before the commencement of trading on the next day. in the case of futures contracts. the initial margins would be based on the zero coupon yield curve computed at the end of the day as explained above with trades of same day settlement (t =0). Provided. however. and shall be payable upfront by Clearing Members in accordance with the margin computation mechanism and/ or system as may be adopted by Clearing Corporation from time to time. at any point of time. the initial margin may be computed over a two day time horizon. applying the appropriate statistical formula. in case of large deviation between the yields generated using only t = 0 trades and all trades. initial margins revised accordingly may be computed and collected by the Clearing corporation from the members at its discretion.
. that may be specified by Clearing Corporation from time to time. upto client level. where it may not be possible to collect mark to market settlement value. Initial margin requirements shall be based on 99% value at risk over a one day time horizon. However.
• The aim of conducting the analysis is to determine whether the Investor who
brought the derivatives of the company has incurred Profit or loss. The time period in which this analysis done is from 29Feburary to 27March2011.
This analysis is based on sample data taken of HINDUSTAN PETROLEUM
LIMITED Scrip. • The other cause of conducting the analysis is to find out the nature of the
behavior of the derivatives of the company along the period of observation. • LIMITED. This analysis considered the MARCH contract of HINDUSTAN PETROLEUM
. • • The lot Size of HINDUSTAN PETROLEUM LIMITED is 200shares.ANALYSIS
The Objective of this analysis is to evaluate the profit/loss position of the futures and options.
00 263.00 263.00 288.95 Rs per share and the net loss incurred will be 45.45 259.40 279.95 * 200 = 1950 Rs.90 255.35 253.30 and if he intends to sell it on the last day of trading in the month i. SPOT PRICE* 300.45 285.10 281.05 257.70 271.00 278.DATA OF HINDUSTAN PETROLEUM LIMITED THE FUTURES AND SPOT PRICE MOVEMENTS
(TABLE 4.00 257.nseindia.00 279.80 286.95 282.50 255.35 285.e.10 285.55 281.00 270.45 287.00 279.05 Rs per share and hence he bears a loss of 45.05 FUTURE PRICE* 299.40 268.00
.com If the call option writer bought 1 lot of shares on 29-02-2011 he has to buy at a price of Rs 300.) SOURCE: The sources of the above data is collected from the official website of National Stock Exchange of India www.20 286.30 288.45 263.20 262.10 270.00 252.25 254. on 27-03-08 his investment would be priced at 255.00 254.4) DATE 29-02-2011 03-03-2011 04-03-2011 05-03-2011 06-03-2011 07-03-2011 10-03-2011 12-03-2011 13-03-2011 14-03-2011 17-03-2011 18-03-2011 19-03-2011 24-03-2011 25-03-2011 26-03-2011 27-03-2011 (* Amount in Rs.
than the buyer of a future gets profit.CHART REPRESENTING THE FUTURES AND SPOT PRICE MOVEMENTS
Price of Future and Option
310 300 290 280 270 260 250 240 230 220
Future Price Option Price
Average of Traded Dates
(Graph 4. • If the selling price of the future is less than the settlement price. then the seller incurs loss. • If the buy price of the future is less than the settlement price.
.1) Note: The dates for the above graph is in Month/Day/Year format
• The future price of HINDUSTAN PETROLEUM LIMITED is moving along with the market price.
00 16.90 13.10 7.55 10.75 0.75 29.50 11.00 6.15 10.70 4.05 FUTURE 299.00 PREMIUM* 310 9.20 2.35 2.20 6.10 0.90 0.40 268.00 288.90 10.65 21.)
The sources of the above data is collected from the official website of National
.00 0.15 0.50 255.60 8.40 3.25 21.20 0.00 280 38.20 286.00 254.75 7.60 0.85 0.40 0.35 285.00 252.35 3.00 257.00 0.00 263.50 16.80 7.05 257.75 1.95 282.25 0.10 281.00 5.00 263.45 285.10 270.85 5.25 254.90 255.75 24.00 0.15 0.80 286.35 9.00 0.40 279.85 25.00 10.70 9.55 281.25 5.45 263.20 2.40 0.00 6.80 3.70 2.00 320 6.00 279.20 262.10 0.95 0.00 270.05 5.00 278.60 3.30 288.45 287.10 285.65 1.00 5.35 253.15 0.00 279.00 300 16.00 7.55 21.00 10.35 1.CALL OPTION AT DIFFERENT STRIKES
(TABLE 4.45 259.00
(* Amount in Rs.70 0.15 0.70 271.5) PRICE* DATE 29-02-2011 03-03-2011 04-03-2011 05-03-2011 06-03-2011 07-03-2011 10-03-2011 12-03-2011 13-03-2011 14-03-2011 17-03-2011 18-03-2011 19-03-2011 24-03-2011 25-03-2011 26-03-2011 27-03-2011 SPOT 300.40 4.00 0.
75 Rs.05 Rs .Strike price 280. hence his loss is also increasing. the buyer is at aloss of Rs.75 as premium per share. Settlement price =255.Stock Exchange of India www.
SELLERS PAY OFF: • It is in the money for the buyer so it is in out of the money for seller. FORMULA: PAY OFF PRICE = SPOT PRICE – STRIKE PRICE We Know.24.com
INTERPRETATIONS BASED ON CALL OPTIONS AT DIFFERENT STRIKES
BUYERS PAY OFF :( AT Rs280 STRIKE PRICE) • As brought 1 lot of HINDUSTAN PETROLEUM LIMITED that is 200.Spot price Rs.00Rs Pay Off Price = -24.Rs.75Rs.95 pershare And he will lose the premium amount Net loss for the buyer = 38.38.05 Rs Pay off Price = Spot price 255. The profit for the seller is only the premium amount Strike price .nseindia. X 200shares (1Lot) = 7750 Rs.255.95 Rs Since the payoff price is negative.00 .280.05 = 38. those who brought at strike price at 280 paid Rs. X 200Shares (1Lot)
Settlement price =255.00 .
.Spot price X 1 Lot = Sellers Payoff Rs.50 as premium per share. X 200Shares (1Lot) = 3300Rs.Rs.05 = 44. Net loss for the buyer = 16. The profit for the seller is only the premium amount Strike price .=7750Rs. at strike price of 300. hence his loss is also increasing. the buyer paid Rs.95 per share And he will lose the premium amount.00Rs Pay Off Price = .50 Rs.255. FORMULA: PAY OFF PRICE = SPOT PRICE – STRIKE PRICE We Know.300.16.
SELLERS PAY OFF:
It is in the money for the buyer so it is in out of the money for seller.05 Rs Pay off Price = Spot price 255.44.95 Rs Since the payoff price is negative. BUYERS PAY OFF :( AT Rs300 STRIKE PRICE) If 1 lot of HINDUSTAN PETROLEUM LIMITED is brought that is 200 shares.44.Strike price 300. X 200shares (1Lot) = 3300 Rs. the buyer is at loss of Rs.05 Rs .95Rs.
05 Rs Pay off Price = Spot price 255. the buyer is at loss of Rs.BUYERS PAY OFF :( AT Rs310 STRIKE PRICE) If 1 lot of HINDUSTAN PETROLEUM LIMITED is brought that is 200 shares.Spot price X 1 Lot = Sellers Payoff Rs.00 Rs.
.00Rs.255. Settlement price =255. X 200Shares (1Lot) =1800Rs.00 as premium per share.Strike price 310.55 per share And he will lose the premium amount Net loss for the buyer = 9.00Rs Pay Off Price = .05 = 9. The profit for the seller is only the premium amount Strike price . the buyer paid Rs. FORMULA: PAY OFF PRICE = SPOT PRICE – STRIKE PRICE We Know. X 200shares (1Lot) = 1800 Rs.05 Rs .9.
SELLERS PAY OFF: • It is in the money for the buyer so it is in out of the money for seller. at strike price of 310.00 .55 Rs Since the payoff price is negative. hence his loss is also increasing.Rs.310.
00 . the buyer paid Rs.00 Rs. the buyer is at loss of Rs.BUYERS PAY OFF :( AT Rs320 STRIKE PRICE) If 1 lot of HINDUSTAN PETROLEUM LIMITED is brought that is 200 shares.Strike price 320.255.05 Rs . Settlement price =255.Rs.00 as premium per share. hence his loss is also increasing.Spot price X 1 Lot = Sellers Payoff Rs.00Rs Pay Off Price = .320.95 Rs Since the payoff price is negative.05 Rs Pay off Price = Spot price 255. X 200shares (1Lot) = 1200 Rs. FORMULA: PAY OFF PRICE = SPOT PRICE – STRIKE PRICE We Know. The profit for the seller is only the premium amount Strike price .95 per share And he will lose the premium amount Net loss for the buyer = 6.
SELLERS PAY OFF: • It is in the money for the buyer so it is in out of the money for seller. at strike price of 320.00Rs.05 = 6.64. X 200Shares (1Lot) =1200Rs
25 32.70 271.40 268.95 35.00 20.90 18.70 42.00 0.90 30.95 282.6) PRICE* DATE SPOT 29-02-2011 03-03-2011 04-03-2011 05-03-2011 06-03-2011 07-03-2011 10-03-2011 12-03-2011 13-03-2011 14-03-2011 17-03-2011 18-03-2011 19-03-2011 24-03-2011 25-03-2011 26-03-2011 27-03-2011 300.00 288.15 42.75 40.30 288.10 281.50 255.40 43.55 281.35 253.35 37.00 320 37.45 259.55 16.00 252.85 0.00 257.45 62.05 FUTURE 299.15 42.nseindia.90 255.85 17.05 50.00 300 26.35 39.55 44.35 38.95 22.00 279.60 18.05 46.) SOURCE: The sources of the above data is collected from the official website of National Stock Exchange of India www.00 263.PUT OPTION AT DIFFERENT STRIKES
(TABLE 4.70 52.35 3.00 29.05 257.00 13.90 46.00 254.00 310 31.15 24.85 0.80 34.25 254.00 263.85 0.45 285.85 36.00 280 16.35 41.75 48.80 45.10 285.10 36.25 27.65 19.00 36.30 47.65 15.80 286.10 270.40 57.15 55.80 30.85 32.40 66.55 56.00 PREMIUM*
(* Amount in Rs.45 287.35 26.60 65.40 29.95 46.00 278.00 279.20 51.80 55.95 56.15 20.40 43.00 29.40 279.30 23.80 28.35 285.10 39.45 263.00 270.20 262.05 19.com
.20 33.20 286.60 36.
CHART REPRESENTING THE PAY OFFS BASED ON THE PUT OPTIONS
9000 8000 7000 6000 5000 4000 3000 2000 1000 0 7750
Pay off Price
3300 1800 280 300 Strike Price
Buyers' pay off Sellers' P ay off
Rs 24.65 – Rs.280 . the premium payable is 16.30Rs X 200(1Lot Shares) = 1660Rs.00 .95Rs Net Loss Incurred = Rs. 255. he will get the same as the Profit amount.
Deduct Premium Amount already Paid i.05 Net pay off = Strike Price Rs 280.INTERPRETATIONS BASED ON PUT OPTIONS AT DIFFERENT STRIKES
BUYERS PAY OFF: (AT Rs280 STRIKE PRICE) • Those who have purchase put option at a strike price of 280.
SELLERS PAY OFF: • As Seller is entitled only for premium if he is in profit.30 X 200(1Lot Shares) Net Loss Incurred =1660Rs.8.16.05Rs.95 Net Loss Incurred = Rs. Total Profit = 8.Spot Price Rs. Pay off = Spot price Rs.255.05 = 24..30Rs.e.65Rs. Pay off = -24.Strike price 255.95 . • On the expiry date the spot market price enclosed at Rs.65Rs = 8.24.16.
95 X 200(1Lot Shares) =3790Rs. Pay off = Spot price Rs. 255.BUYERS PAY OFF: (AT Rs300 STRIKE PRICE)
• Those who have purchase put option at a strike price of 300.95Rs.
SELLERS PAY OFF: As Seller is entitled only for premium if he is in profit.. Pay off = 44.
.95Rs Deduct Premium Amount already Paid i.e. he will get the same as the profit amount.00Rs.300.Spot Price Rs. the premium payable is 26. • On the expiry date the spot market price enclosed at Rs.05 = 44.Strike price 255.95 – 26.18.05Rs.95Rs Net Loss Incurred = Rs 44. Rs 44.00 .00Rs =18.00Rs X 200(1Lot Shares) = Rs.95 – 26.300 . Total Profit = 18.05 Net pay off = Strike Price Rs.255.95Rs X 200(1Lot Shares) = 3790Rs.
. Pay off = Spot price Rs. the premium payable is 31.310 .05 = 54.35 X 200(1Lot Shares) = 4670Rs. • On the expiry date the spot market price enclosed at Rs.Strike price 255. Pay off = 54. X 200(1Lot Shares) = 4670Rs.95 – 26. Rs 31.60Rs.00 . 255.90Rs = 23.05 Net pay off= Strike Price Rs. 310. Total Profit = 23.95Rs Deduct Premium Amount already Paid i.. he will get the same as the profit amount.95Rs Net Loss Incurred = Rs 54.00Rs X 200(1Lot Shares) = Rs.05Rs.35Rs.255.BUYERS PAY OFF: (AT Rs310 STRIKE PRICE) • Those who have purchase put option at a strike price of 310.23.60 – 54.e.35Rs.
SELLERS PAY OFF: • As Seller is entitled only for premium if he is in profit.Spot Price Rs.
e.25 X 200(1Lot Shares) = 5450Rs. the premium payable is 37. Rs 37.25Rs.05 = 64. Total Profit = 27. • On the expiry date the spot market price enclosed at Rs.22Rs..05Rs Pay off = 64.95 – 37.Strike price 255.BUYERS PAY OFF: (AT Rs320 STRIKE PRICE)
• Those who have purchase put option at a strike price of 320.Spot Price Rs.
SELLERS PAY OFF: • As Seller is entitled only for premium if he is in profit.255.00 .27.320 . 255.95Rs Net Loss Incurred = Rs 64.7 0 – 64.70Rs. X 200(1Lot Shares) = 5450Rs. he will get the same as the profit amount Pay off = Spot price Rs.05 Net pay off=Strike Price Rs 320.95Rs Deduct Premium Amount already Paid i.70Rs X 200(1Lot Shares) = Rs.
CHART REPRESENTING THE PAY OFFS BASED ON THE PUT OPTIONS
6000 5000 5450 5 450 4670 4 670 3790 3 790 Strike P rice Buy ers P ay off P rice sellers P ay off P rice
Pay off prices
4000 3000 2000 1000 0 1 280 2 1660 1 6 60
S trike P rice
10 285.00 278.80 286.40 268.00 263.40 279.50 255.00 257.45 259.nseindia.) SOURCE: The sources of the above data is collected from the official website of National Stock Exchange of India www.45 263.70 271.00 254.00
.7) DATE 29-02-2011 03-03-2011 04-03-2011 05-03-2011 06-03-2011 07-03-2011 10-03-2011 12-03-2011 13-03-2011 14-03-2011 17-03-2011 18-03-2011 19-03-2011 24-03-2011 25-03-2011 26-03-2011 27-03-2011 (* Amount in Rs.00 288.20 286.00 279.com FUTURE PRICE* 299.TABLE SHOWING THE PRICE MOVEMENTS OF THE FUTURE PRICE
(TABLE 4.00 252.
Representation of Future Price on Traded dates Future prices
310 300 290 280 270 260 250 240 230 220
11 11 11 13 -0 320 08 11 00 320 08 11 00 320 08 21 00 320 08 27 10 320 11 11 /2 0 /2 0 3/ 20 -2 0
29 -0 2
From the above graph we could Interpret that the Future Prices of M/S.e.
. HINDUSTAN PETROLEUM LTD is not constant and is fluctuating and the price on the first traded date i.e.(Graph 4. on 29/02/2011 is more than that of the last traded date i. on 27/03/2011.
SUGGETIONS & CONCLUSIONS
6). then the seller incurs loss.
• If the selling price of the future is less than the settlement price. • In the short selling’s the futures turn out to be a cheaper option for the investors of “M/S.HINDUSTAN PETROLEUM LTD”. • In the put option as the amount of the strike price increases the amount of the premium to be paid also increases. then the buyer of a future gets profit. (This is clear from the table 4.FINDINGS
• In the call option as the amount of the strike price increases the amount of the premium to be paid decreases.HINDUSTAN PETROLEUM LTD is moving along with the market
price. • If the buy price of the future is less than the settlement price. • The future price of M/S. • The settlement price will be considered as the final price in calculating the future and options prices and the closing price of the equities will be considered as the spot price in the evaluation of F&O’s. (This is clear from the table 4.
and should encourage the participation of Foreign Institutional Investors (FII’s) in the derivatives market to encourage the active functioning of the derivatives market in India
To encourage the participation of the small investors’ measures like minimization of the Contract size should be taken care of.
If the physical settlement comes into existence the allegations of manipulation of the stocks in the derivatives segment could be easily resolved.
The authorities should revise some of their regulations with respect to the contract size.
It is suggested that the regulatory authorities allow short selling by institutional investors in the Cash market as a means of physical settlement in the F&O segment.
An introduction to short selling will help the deepening of the market (Derivatives) in terms of availability of products/stocks.
The investors need to continuously monitor and assess the effectiveness of the hedging strategies and ensure that they are in synchronization with the under lying asset profile.
It would be suggestive that the derivatives accounting be made mandatory for corporate investors to look at the derivatives exposure of the companies on the basis of accounting prudence.
As the name suggests. derivative contracts are those contracts which derives their value from the price of something else. it derives its value from some underlying.e.SUMMARY Derivative is a product/contract which does not have any value on its own i. Typically derivatives contracts derive their value from underlying cash market Derivatives are the Investments that derive their value from underlying assets such as currencies. which are some percentage of total money. The investor may incur huge profits or he may incur huge profits or he may incur huge loss. such as an interest rate or foreign currency exchange rate which can be used to manage risk. In cash market the investor has to pay the total money. In derivative segment the profit/loss of the option writer is purely dependent on the fluctuations of the underlying asset. In cash market the profit/loss of the investor depends on the market price of the underlying asset. but in derivatives the investor has to pay premiums or margins. treasury bills. Approximately its daily turnover exceeds to the turnover of cash market by 6 times in the average daily turnover of the NSE derivative segments. and bonds or are linked to indices such as a stock market index that can be used to speculate on market movements or to protect investments against major swings in market prices Derivatives are the financial contracts that derive their value from an underlying asset or index. But in derivatives segment the investor the investor enjoys huge profits with limited downside. The main purpose of trading upon the derivatives is mostly for hedging purpose. reduce cost and enhance returns
Derivatives market is an innovation to cash market.
Through the observations it could be concluded that the price of the future stock of HINDUSTAN PETROLEUM LIMITED is fluctuating throughout the traded dates that was analyzed. where as the put option writer will get more losses. • In bullish market the call option writer incurs more losses so the investor is suggested to go for a call option to hold. • In bearish market the call option holder will incur more losses so the investor is suggested to go for a call option to write. can often have disastrous results.
. it can act as a boon. but if used for speculative purposes.
• It may turn out that some times going short calls via futures would be profitable while at other times. with the intention of mitigating the underlying assets. so he is suggested to hold a put option. there by causing ineffectiveness in derivatives trading. where as the put option holder suffers in a bullish market.
Investors are unable to closely match the hedge transactions with the underlying exposures. • If Derivatives are judiciously used. it (Going short in cash market) would be feasible in derivatives. the call option writers gain more amount of profit than the put option writers due to relatively low volatility. so he is suggested to write a put option.
The analysis made on the basis of HINDUSTAN PETROLEUM LIMITED showed that.
If an option has not been exercised prior to its expiration. It is Index level * Multiplier. used to arrive at the contract size. for calculation of open Interest. Tick Size: It is the minimum price difference between two quotes of similar nature. As total long positions for market would be equal to total short positions. Expiry Day: The last day on which the contract is available for trading. only one side of the contracts is counted. Premium: The amount per share paid by the option buyer to obtain the right to buy or sell a specified quantity of the underlying share at an agreed price that an option confers. Multiplier: It is a pre-determined value.
• • •
. Index Futures market
Contract Size: The value of the contract at a specific level of Index. It is the price per index point. Open position: Outstanding/unsettled long or short position at any point of time.
• • • •
Volume: No. that is. Expiry date: The date on which the option expires. Contract Month: The month in which the contract will expire.DERIVATIVES GLOSSARY
Spot price: The price at which the underlying asset is currently trading in the market. no value. During a day. it ceases to exist after the expiration date. Short position: Outstanding/ unsettled sales position at any point of time. Futures price: The agreed price of the underlying asset at which the futures contract is traded. of contracts traded during a specific period of time. during a week or during a month. Strike price: The agreed price of the underlying asset at which the contract is entered. Long position: Outstanding/unsettled purchase position at any point of time. Open interest: Total outstanding long or short positions in the market at any specific point in time. the option holder will not longer have any right and the option.
Hedge Ratio: Number of future contracts required to hedge the position. Cross hedge: When a futures contract is not available on an asset. you hedge your position in cash market on this asset by going long or short on the futures for another asset whose prices are closely associated with that of your underlying.
.one buyer and one seller.
Naked positions: Position in any future contract. Index Futures fall in this category.
Hedge Contract Month: Maturity month of the contract through which hedge is accomplished. Alternative Delivery Procedure (ADP): Open position at the expiry of the contract is settled by two parties . quickly. This is a conservative speculative strategy. Hedge Terminology
• • •
Long hedge: When you hedge by going long in futures market. Cash settlement: Open position at the expiry of the contract is settled in cash. Short hedge: When you hedge by going short in futures market. This is called Passive Investment Strategy. delivery is low. World wide a significant portion of the energy and energy related contracts (crude oil. In futures market. at the terms other than defined by the exchange.
Portfolio Restructuring: An act of increasing or decreasing the equity exposure of a portfolio. heating and gasoline oil) are settled through Alternative Delivery Procedure.•
Physical delivery: Open position at the expiry of the contract is settled through delivery of the underlying. Spread positions: Opposite positions in two future contracts. These contracts are designated as cash settled contracts. Index Funds: These are the funds which imitate/replicate index with an objective to generate the return equivalent to the Index. with the help of Index Futures.
F&O NMCE SRO OTC SCR EFT TM CM SCM MTM IM LEAPS BSE NSE IPO ABS RMBS FIIs GDR ADR : : : : : : : : : : : : : : : : : : : : FUTURES & OPTIONS National Multi Commodity Exchange of India Ltd Self-Regulatory Organization Over The Counter Securities Contract and Regulatory Authority Electronic funds transfer Trading Member Clearing Member Self-clearing Member Mark to Market Margin Initial Margin Long-Term Equity Anticipation Securities Bombay Stock Exchange National Stock Exchange Initial Public Offering Asset Backed Securities Residentially Market Backed Securities Foreign institutional investors Global Depository Receipts American Depository Receipts
FERA SEBI FMC VaR
: : : : : : : : : : :
Foreign Exchange Regulation Act Securities and Exchange Board of India Forward Market Commission Value at Risk
Option Index Future Index
NSCCL CM TM ZCYC SPAN
National Securities Clearing Corporation Limited Clearing Member Trading Members Zero Coupon Yield Curve Standard Portfolio Analysis of Risk
indianinfoline.com www.com www. 2ND Edition Financial Markets and Services Security Analysis & Portfolio Management Derivatives Core Module Work book AUTHOR Meir Kohn Prasanna Chandra Gordan and Natrajan Donald E Fischer & Ronald R Jordan Advisors of National Stock Exchange of India NSE Press PUBLISHER Oxford University Press Tata Mc Graw Hill Tata Mc Graw Hill Prentice Hall Of India
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