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CHAPTER NO.

1 INTRODUCTION TO FINANCIAL DERIVATIVES Market
DERIVATIVE FINANCIAL MARKET

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INTRODUCTION TO DERIVATIVES
MEANING: • Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. • The underlying asset can be equity, forex, commodity or any other asset. • For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. • Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the "underlying".

DEFINITION: The term Derivative has been defined in Securities Contracts (Regulations) Act, as:Derivative includes: (i) 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; (ii) a contract which derives its value from the prices, or index of prices, of underlying securities; “Derivatives are instruments which make payments calculated using price of interest rates derived from on balance sheets or cash instruments, but do not actually employ those cash instruments to fund payments” Derivatives are bilateral contracts or payments exchange system whose value is derived from the value of underlying asset. It is an innovative tradable financial instrument derived from an underlying asset

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TYPES OF DERIVATIVES

Forwards: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today‟s pre-agreed Price. Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchangetraded contracts. Options: Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are:  Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency.

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Longerdated options are called warrants and are generally traded over-the-counter. Thus a swap options is an option on a forward swap. A payer swap options is an option to pay fixed and receive floating. the majority of options traded on options exchanges having a maximum maturity of nine months. Warrants: Options generally have lives of up to one year. the swap options market has receiver swap options and payer swap options. Baskets: Basket options are options on portfolios of underlying assets. Leaps: The acronym LEAPS means Long-Term Equity Anticipation Securities. 4 . A receiver swap options is an option to receive fixed and pay floating. These are options having a maturity of up to three years. The underlying asset is usually a moving average or a basket of assets. Rather than have calls and puts. with the cash flows in one direction being in a different currency than those in the opposite direction. Currency swaps: These entail swapping both principal and interest between the parties. Equity index options are a form of basket option Swap options: Swap options are options to buy or sell a swap that will become operative at the expiry of the options.

TYPES OF UNDERLYINGS Derivatives Commodity Derivatives Tangible Intangible Commodities Commodities Gold Silver Time Weather Real Estate Equity Derivatives Financial Derivatives Foreign Exchange Debt Derivatives GOI Secs. Bonds. T-bills Index products Derivatives on Interest rate Securities Products Index Futures Stock Options Index Options Stock Futures 5 .

2: FUTURE CONTRACT In finance.2: KINDS OF DERIVATIVES CONTRACT 2. • The contract price is generally not available in public domain. and hence is unique in terms of contract size. a futures contract is a standardized contract. • On the expiration date. Other contract details like delivery date. price and quantity are negotiated bilaterally by the parties to the contract. However forward contracts in certain markets have become very standardized. to buy or sell a certain underlying instrument at a certain date in the future.1: FORWARD CONTRACTS A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. 2. it has to compulsorily go to the same counter-party. at a pre-set price. The pre-set price is called the futures price. • If the party wishes to reverse the contract. thereby reducing transaction costs and increasing transactions volume. However futures are a significant improvement over the forward contracts as they eliminate counterparty risk and offer more liquidity. Forward contracts are often confused with futures contracts. expiration date and the asset type and quality. The other party assumes a short position and agrees to sell the asset on the same date for the same price. traded on a futures exchange.CHAPTER NO. The price of the underlying asset on the 6 . BASIC FEATURES OF FORWARD CONTRACT • They are bilateral contracts and hence exposed to counter-party risk • Each contract is custom designed. The future date is called the delivery date or final settlement date. the contract has to be settled by delivery of the asset. This process of standardization reaches its limit in the organized futures market. The forward contracts are normally traded outside the exchanges. which often results in high prices being charged. as in the case of foreign exchange. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The confusion is primarily because both serve essentially the same economic functions of allocating risk in the presence of future price uncertainty.

which differs from an options contract. Futures contracts are exchange traded derivatives. which gives the buyer the right. VI. Rajesh entertains the fear that the share price of ABC Ltd may fall in next two months resulting in a substantial loss to him. and IV. Stock Future or equity futures. being the counter party to both sides of a transaction. BASIC FEATURES OF FUTURE CONTRACT I. V. To exit the commitment. provides a mechanism that guarantees the honoring of the contract and ensuring very low level of default. These involve standardized contract terms viz. Stock Index futures. etc. and the option writer (seller) the obligation. sets margin requirements. effectively closing out the futures position and its contract obligations. There are margin requirements and daily settlement to act as further safeguard. Current (spot) price of ABC Ltd shares is Rs115 at National Stock Exchange (NSE). II.Bill Futures. The settlement price. These provide for supervision and monitoring of contract by a regulatory authority. T. The exchange acts as counterparty on all contracts. These are traded on an organized exchange like NSE. the holder of a futures position has to sell his long position or buy back his short position. etc. To give an example of a futures contract. III. This is an example of 7 . BSE. the underlying asset. suppose on November 2007 Rajesh holds 1000 shares of ABC Ltd. normally. converges towards the futures price on the delivery date. Following are the important types of financial futures contract: I. Each contract in futures market is of 100 Shares. A futures contract gives the holder the right and the obligation to buy or sell. the time of maturity and the manner of maturity etc. Futures contracts being traded on organized exchanges impart liquidity to the transaction. but not the right. Interest Rate bearing securities like Bonds. II. These are associated with a clearing house to ensure smooth functioning of the market. Almost ninety percent future contracts are settled via cash settlement instead of actual delivery of underlying asset.delivery date is called the settlement price. Currency futures. The clearinghouse. but not the obligation. III. Rajesh decides to enter into futures market to protect his position at Rs 115 per share for delivery in January 2008. IV.

to buy or sell something at a stated date at a stated price. Hence. The owner makes a profit provided he sells at a higher current price and buys at a lower future price. 2. contracts are standardized and traded on recognized exchanges. the right at the cost of option premium. In case of exchange traded options contract.equity future in which Rajesh takes short position on ABC Ltd. an optional contract. Apart from this. no option will be exercised if the future price does not increase. although occasionally preference shares. whereas OTC options are customized contracts traded privately between the parties. A call options gives the holder (buyer/one who is long call). i. Shares by selling 1000 shares at Rs 115 and locks into future price. Put and calls are almost always written on equities. at a specified price on or before a specified date is known as a „Put option‟. as the name suggests. But an options contract. has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy. An option is the right. the right to buy specified quantity of the underlying asset at the strike price on or before expiration date. at a specified price on or before a specified date is known as a „Call option‟.3: OPTION CONTRACT In case of futures contact. but not the obligation. Options contracts are of two types: CALL OPTION: A contract that gives its owner the right but not the obligation to buy an underlying asset-stock or any financial asset.e. The owner makes a profit provided he buys at a low er current price and sells at a higher future price. is in some sense. bonds and warrants become the subject of options. not the obligation. a “put option” gives one the right to sell. 8 . PUT OPTION: A contract that gives its owner the right but not the obligation to sell an underlying asset-stock or any financial asset. to buy (call options) or sell (put options) a specified asset at a set price on or before a specified date through exchanges. The seller (one who is short call) however. options can also be classified as OTC (Over the Counter) options and exchange traded options. Options are the standardized financial contract that allows the buyer (holder) of the option. both parties are under obligation to perform their respective obligations out of a contract. A “call option” gives one the right to buy.

In contrast. They can be regarded as portfolios of forward's contracts. Such cash flows are supposed to remain unaffected by subsequent changes in the exchange rates. X needs money to finance its requirements after two months which he will realize after selling 100 shares after two months. cash flows to be exchanged are determined at the spot rate at a time when swap is done. 100. has the obligation to buy the underlying asset at the strike price if the buyer decides to exercise his option to sell. The two commonly used swaps are: INTEREST RATE SWAPS: Interest rate swaps is an arrangement by which one party agrees to exchange his series of fixed rate interest payments to a party in exchange for his variable rate interest payments. Apparently. The parties to the swap contract of currency generally hail from two different countries. only the payment flows are exchanged and not the principle amount. if the market price of Infosys on the day of expiry is more than Rs. This arrangement allows the counter parties to borrow easily and cheaply in their home currencies. In case of swap. the options will be exercised. The fixed rate payer takes a short position in the forward contract whereas the floating rate payer takes a long position in the forward contract. the right to sell specified quantity of the underlying asset at the strike price on or before an expiry date. based on some notional principle amount is called as a „SWAP‟. FINANCIAL SWAPS: 9 . The seller of the put options (one who is short put) however. Under a currency swap. 3500 at a premium of Rs.4 :-SWAPS Swaps are transactions which obligates the two parties to the contract to exchange a series of cash flows at specified intervals known as payment or settlement dates. Right to sell is called a Put Options. Suppose X has 100 shares of Bajaj Auto Limited. A contract whereby two parties agree to exchange (swap) payments. CURRENCY SWAPS: Currency swaps is an arrangement in which both the principle amount and the interest on loan in one currency are swapped for the principle and the interest payments on loan in another currency.Suppose an investor buys One European call options on Infosys at the strike price of Rs. He decides to enter into option market by buying Put Option (Right to Sell) with an expiration date in May at a strike price of Rs 685 per share and a premium of Rs 15 per shares. Current price (March) of Bajaj auto shares is Rs 700 per share. 3500. a put options gives the holder (buyer/ one who is long put). 2. But he is of the fear that by next two months price of share will decline.

OTHER KINDS OF DERIVATIVES The other kind of derivatives. 10 . 2. It also allows the investors to exchange one type of asset for another type of asset with a preferred income stream. However. A payer swap option is an option to pay fixed and receive floating. the swap options market has receiver swap options and payer swap options. exchange may introduce option contracts with a maturity period of 2-3 years. These long-term option contracts are popularly known as Leaps or Long term Equity Anticipation Securities. LEAPS: Normally option contracts are for a period of 1 to 12 months. Thus a swap option is an option on a forward swap. A receiver swap option is an option to receive fixed and pay floating. the majority of options traded on options exchanges having a maximum maturity of nine months.5:. SWAP OPTIONS: Swap options are options to buy or sell a swap that will become operative at the expiry of the options. WARRANTS: Options generally have lives of up to one year. which are not. Longer-dated options are called warrants and are generally traded over-the-counter. much popular are as follows: BASKETS: Baskets options are option on portfolio of underlying asset. Rather than have calls and puts.Financial swaps constitute a funding technique which permits a borrower to access one market and then exchange the liability for another type of liability. Equity Index Options are most popular form of baskets.

NEED & IMPORTANCE OF DERIVATIVES 3. the term derivative is used to refer to a group of instruments that derive their value from some underlying commodity or market. While trading in derivative products has grown tremendously in recent times. early evidence of these types of instruments can be traced back to ancient Greece. swaps and options are all types of derivative instruments and are widely used for hedging or speculative purposes. Forwards. ORIGIN OF OPTION 11 .1 ORIGIN AND HISTORY OF DERIVATIVES In financial markets.3: HISTORY.CHAPTER NO. futures.

he did not have many financial resources at hand. thus relieving them of the need to transport large quantities of merchandise along dangerous routes with no guarantee of a buyer at the journeys end. These rice tickets were traded on the Dojima rice market near Osaka and in 12 . his losses were limited to the initial deposit he paid. ORIGIN OF FUTURES CONTRACT The first record of organized trading in futures comes from 17th century Japan. As nobody knew for certain whether the harvest would be good or bad. ORIGIN OF FORWARD CONTRACT There is evidence that the use of a type of forward contract was prevalent among merchants in medieval European trade fairs. These letters allowed merchants to trade on the basis of a sample of their goods. When the harvest proved to be bountiful. one-year ahead. Eventually.Aristotle related a story about how the Greek philosopher Talus profited handsomely from an option-type agreement around the 6th century B. The deposit gave him the right but not the obligation to hire the presses. the contracts themselves were traded among the merchants. According to the story. Thales had purchased an option. Feudal Japanese landlords would ship surplus rice to storage warehouses in the cities and then issue tickets promising future delivery of the rice. When trade began to flourish in the 12th century merchants created a forward contract called a letter de faire (letter of the fair). Thales charged a high price for their use and reaped a considerable profit A critical attribute of Thales arrangement was the fact that its merit did not depend on his forecast for a good harvest being accurate.C. Thales forecast the next olive harvest would be an exceptionally good one. Thales secured the rights to the presses at a relatively low rate. The tickets represented the right to take delivery of a certain quantity of rice at a future date at a specified price. But he used what he had to place a deposit on the local olive presses. and so demand for the presses was high. The letter acted as evidence that the full consignment of the specified commodity was being held at a warehouse for future delivery. If the harvest had failed. As a poor philosopher.

Someone holding a rice ticket but not a holder of a rice ticket but not wanting to take delivery could sell it in the market. Once investor is long on share investor can hedge the systematic risk by going short on share Futures. in future. Of course. Trading in rice tickets allowed landlords and merchants to lock the prices at which rice was bought and sold. One type is of optimistic variety. He is known as 'bear'. 13 . they may limit their losses through options. They undertake 'futures' transactions with the intention of making gains through difference in contracted prices and future cash market price prices. The other type is a pessimist.investor can go long on Index Futures. but wish to take only systematic risk . Derivatives allow you to manage these risks more efficiently by unbundling the risks and allowing either hedging or taking only one risk at a time. and sees a rise in prices in future.  Speculation Derivatives offer an opportunity to make unlimited money by way of speculation. 3. The tickets also provided flexibility. The rules governing the trading on the Dojima market were similar to those of modern-day futures markets. their expectations turn out to be true. if investors do not want to take unsystematic risk on anyone share.1730. and he sees a fall in prices. they gain and if not they lose. in future.2 NEED & IMPORTANCE OF DERIVATIVES  Managing risk There are several risks inherent in financial transactions. without buying any individual shares. He is known as 'bull'. If. On the other hand. reducing the risk they faced. Speculators are of two types.

For example. They require only a small fraction of the investment in the underlying securities. However. options and futures represent (highly) levered investments in the underlying cash instruments. where there is essentially no initial investment except margin payments  Arbitrage Arbitrageurs profit from price differential existing in two markets by simultaneously operating in two different markets. but they are temporarily mispriced. They can also be important for. 1. time to maturity and corporate benefit. Arbitrage can be done between two instruments when they are related to each other. Risk Management 14 . Efficient Allocation of Risk 2. The case is most obvious for futures. the futures price and spot price are related by the interest rate. High leverage Leverage opportunities are often expensive and complicated to implement for many investors in the cash market. Lower Cost of Hedging 3. Liquidity 4. if any. or are simply not feasible. in the interregnum.

There was a huge gap between the investors‟ aspirations of the markets and the available means of trading. To catalyze entrepreneurial activity 4. the Indian capital market had no access to the latest trading methods and was using traditional out-dated methods of trading. derivatives markets have become the most important markets in the world. To increase savings and investment in the long run 15 . 5. Today. The following point shows the need for the derivative market: 1. To help in transferring risks from risk averse people to risk oriented people 2. To help in the discovery of future as well as current prices 3. To increase the volume traded in markets because of participation of risk adverse people in greater numbers. which have developed into a very large market.NEED FOR DERIVATIVES IN INDIA TODAY In less than three decades of their coming into vogue. Until the advent of NSE. Introduction of risk management instruments in India has gained momentum in last few years thanks to Reserve Bank of India‟s efforts in allowing forward contracts. derivatives have become part and parcel of the day-to-day life for ordinary people in major part of the world. cross currency options etc. The opening of Indian economy has precipitated the process of integration of India‟s financial markets with the international financial markets.

Arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. They can increase both the potential gains and potential losses by usage of derivatives in a speculative venture.3 THE PARTICIPANTS IN A DERIVATIVES MARKET Hedgers use futures or options markets to reduce or eliminate the risk associated with price of an asset. Speculators use futures and options contracts to get extra leverage in betting on future movements in the price of an asset. 16 . for example. they see the futures price of an asset getting out of line with the cash price. they will take offsetting positions in the two markets to lock in a profit.3. If.

3. In this section. They 17 . With the introduction of derivatives. are linked to the underlying cash markets. we discuss some of them. monitoring and surveillance of the activities of various participants become extremely difficult in these kinds of mixed markets. They take a view whether prices would rise or fall in future and accordingly buy or sell futures and options to try and make a profit from the future price movements of the underlying asset. • Arbitrageurs: They take positions in financial markets to earn riskless profits.3. • Prices in an organized derivatives market reflect the perception of the market participants about the future and lead the prices of underlying to the perceived future level. well-educated people with an entrepreneurial attitude. Margining. • The derivatives market helps to transfer risks from those who have them but do not like them to those who have an appetite for them. due to their inherent nature. • Derivatives. This is because of participation by more players who would not otherwise participate for lack of an arrangement to transfer risk.4:.5:. Hedgers use the derivatives markets primarily for price risk management of assets and portfolios. creative. speculators trade in the underlying cash markets.Economic Function of the Derivative Market The derivatives market performs a number of economic functions. • Speculative trades shift to a more controlled environment in derivatives market. the underlying market witnesses higher trading volumes. The arbitrageurs take short and long positions in the same or different contracts at the same time to create a position which can generate a riskless profit. • Speculators: These are individuals who take a view on the future direction of the markets. The prices of derivatives converge with the prices of the underlying at the expiration of the derivative contract. The derivatives have a history of attracting many bright. Thus derivatives help in discovery of future as well as current prices. • An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new entrepreneurial activity.Participants in a Derivative Market The derivatives market is similar to any other financial market and has following three broad categories of participants: • Hedgers: These are investors with a present or anticipated exposure to the underlying asset which is subject to price risks. In the absence of an organized derivatives market.

new products and new employment opportunities. In a nut shell. the benefit of which are immense. derivatives markets help increase savings and investment in the long run. Transfer of risk enables market participants to expand their volume of activity CHAPTER NO.often energize others to create new businesses. 4:18 .

4. the order becomes passive and goes and sits in the respective outstanding order book in the system. 19 . This ID is common for all users of a particular trading member. The exchange notifies the regular lot size and tick size for each of the contracts traded on this segment from time to time. If it does not find a match. The exchange assigns a trading member ID to each trading member. All quantity fields are in units and price in rupees. it is an active order.1:-Futures and Options Trading System The futures & options trading system of NSE. Keeping in view the familiarity of trading members with the current capital market trading system. If it finds a match. It supports an order driven market and provides complete transparency of trading operations. The number of users allowed for each trading member is notified by the exchange from time to time. It tries to find a match on the other side of the book. It is the responsibility of the trading member to maintain adequate control over persons having access to the firm‟s User IDs. They can trade either on their own account or on behalf of their clients including participants. Order matching is essentially on the basis of security. wherein orders match automatically.2:-Entities in the trading system Following are the four entities in the trading system: • Trading members: Trading members are members of NSE. It is similar to that of trading of equities in the cash market segment. 4. When any order enters the trading system. a trade is generated. called NEAT-F&O trading system.TRADING IN DERIVATIVES MARKETS The NEAT F&O system supports an order driven market. provides a fully automated screen-based trading for Index futures & options and Stock futures & options on a nationwide basis as well as an online monitoring and surveillance mechanism. The unique trading member ID functions as a reference for all orders/trades of different users. • Clearing members: Clearing members are members of NSCCL. its price. Each trading member can have more than one user. modifications have been performed in the existing capital market trading system so as to make it suitable for trading futures and options. They carry out risk management activities and confirmation/inquiry of trades through the trading system. The software for the F&O market has been developed to facilitate efficient and transparent trading in futures and options instruments. time and quantity. Each user of a trading member must be registered with the exchange and is assigned an unique user ID.

For such orders. after the market price of the security reaches or crosses a threshold price e.g. the limit price is 1030. failing which the order is cancelled from the system.3:-Order types and conditions The system allows the trading members to enter orders with various conditions attached to them as per their requirements. 20 .00.00.Stop-loss :-This facility allows the user to release an order into the system. as a limit order of 1030. If the order is not executed during the day.00. For the stop-loss sell order. • Other conditions . the system cancels the order automatically at the end of the day. . the system determines the price. • Participants: A participant is a client of trading members like financial institutions. as the name suggests is an order which is valid for the day on which it is entered.Day order : A day order. Partial match is possible for the order. • Price condition . Typically. This order is added to the regular lot book with time of triggering as the time stamp.Immediate or Cancel (IOC): An IOC order allows the user to buy or sell a contract as soon as the order is released into the system. banks and custodians become professional clearing members and clear and settle for their trading members.• Professional clearing members: A professional clearing member is a clearing member who is not a trading member. if for stop-loss buy order. and the unmatched portion of the order is cancelled immediately. price is market price). These conditions are broadly divided into the following categories: • Time conditions • Price conditions • Other conditions • Time conditions . These clients may trade through multiple trading members but settle through a single clearing member.e. the trigger is 1027.00 and the market (last traded) price is 1023. the trigger price has to be greater than the limit price.Market price: Market orders are orders for which no price is specified at the time the order is entered (i. then this order is released into the system once the market price reaches or exceeds 1027. 4.00.

Futures and Options Market Instruments The F&O segment of NSE provides trading facilities for the following derivative instruments: a) Index based futures b) Index based options c) Individual stock options d) Individual stock futures 4.NIFTY denotes a “Futures contract on Nifty index” and The expiry date represents the last date on which the contract will be available for trading. . Derivatives Market Review Committee. CNX IT.. a new contract having a three-month expiry would be introduced for trading. Three contracts would be available for trading with the first contract expiring on the last Thursday of that month. All contracts expire on the last Thursday of every month.Pro: Pro means that the orders are entered on the trading member‟s own account. Mini Nifty etc.Contract specifications for index futures On NSE‟s platform one can trade in Nifty. On the recommendations given by the SEBI.5:. Each futures contract has a separate limit order book.1:.Limit price: Price of the orders after triggering from stop-loss book. (March. The best buy order for a given futures contract will be the order to buy the index at the highest 21 . There would be 3 quarterly expiries. Depending on the time period for which you want to take an exposure in index futures contracts. The Instrument type refers to “Futures contract on index” and Contract symbol . 5 following semi-annual months of the cycle June/December would be available. September and December) and after these. NSE also introduced the „Long Term Options Contracts‟ on CNX Nifty for trading in the F&O segment.Trigger price: Price at which an order gets triggered from the stop-loss book. two-month and three-month expiry cycles. 4. you can place buy and sell orders in the respective contracts. All passive orders are stacked in the system in terms of price-time priority and trades take place at the passive order price (similar to the existing capital market trading system). June. On the Friday following the last Thursday. BANK Nifty. . futures contracts having one-month.5. . Now option contracts with 3 year tenure are also available.Cli:-Cli means that the trading member enters the orders on behalf of a client. a January expiration contract would expire on the last Thursday of January and a February expiry contract would cease trading on the last Thursday of February. Thus.

All index options contracts are cash settled and 22 .2:-Contract specification for index options On NSE‟s index options market. a middle-month and a far-month. As can be seen.a near-month.e. The minimum tick size for an index future contract is 0. Option contracts are specified as follows: DATE-EXPIRYMONTHYEAR-CALL/PUT-AMERICAN/ EUROPEAN-STRIKE.50 (i. three contracts are available for trading . then there are minimum 3 x 13 x 2 (call and put options) i.e. 4. For example the European style call option contract on the Nifty index with a strike price of 5000 expiring on the 26th November 2009 is specified as ‟26NOV2009 5000 CE‟. 000.250.index level whereas the best sell order will be the order to sell the index at the lowest index level. two-month and three-month expiry contracts with minimum nine different strikes available for trading. then the appropriate value of a single index futures contract would be Rs.05 units. there are one-month. Contract cycle: Jan Jan 30 contract Feb 27 contract March 27 contract April 24 contract May 29 contract June 26 contract Feb. Hence.05*50 units) on an open position of 50 units. at any given point of time. March April Time This figure shows the contract cycle for futures contracts on NSE‟s derivatives market. the 26 NOV 2009 5000 CE) has its own order book and its own prices.2. if there are three serial month contracts available and the scheme of strikes is 6-1-6. once more making available three index futures contracts for trading. Example: If trading is for a minimum lot size of 50 units and the index level is around 5000. 78 options contracts available on an index. As the January contract expires on the last Thursday of the month a new three-month contract starts trading from the following day. Just as in the case of futures contracts. 0. Thus a single move in the index value would imply a resultant gain or loss of Rs.5. each option product (for instance.

expire on the last Thursday of the month. Contract specification of CNX Nifty Futures Underlying index Exchange of trading Security descriptor Contract size CNX Nifty National Stock Exchange of India Limited FUTIDX Permitted lot size shall be 50 (minimum value Rs.2 gives the contract specifications for index options trading on the NSE. Table 5.2 lakh) Price steps Price bands Re.05 paisa.05 Operating range of 10% of the base price 23 . The minimum tick for an index options contract is 0. 0. The clearing corporation does the novation.

Mark to market and final settlement will be cash settled on T+1 basis. Settlement basis Settlement price Daily settlement price will be the closing price of the futures contracts for the trading day and the final settlement price shall be the closing value of the underlying index on the last trading day of such futures contract.05 24 . Expiry day The last Thursday of the expiry month or the previous trading day if the last Thursday is a trading holiday. Contract specification of CNX Nifty Options Underlying index Exchange of trading Security descriptor Contract size Price steps CNX Nifty National Stock Exchange of India Limited OPTIDX Permitted lot size shall be 50 (minimum value Rs. 2 lakh) Re.the near month (one).Trading cycle The futures contracts will have a maximum of three month trading cycle . the next month (two) and the far month (three). 0. New contract will be introduced on the next trading day following the expiry of near month contract.

European Depending on the index level Not applicable Closing value of the index on the last trading day. the next month (two) and the far month (three). The Long Term Options Contracts on CNX Nifty were launched on March 3. Trading cycle Expiry day Settlement basis Style of option Strike price interval Daily settlement price Final settlement price Other Products in the F&O Segment The year 2008 witnessed the launch of new products in the F&O Segment of NSE. The mini contract have smaller contract size than the normal Nifty contract and extend greater affordability to individual investors and helps the individual investor to hedge risks of a smaller portfolio. The long term options have a life cycle of maximum 5 years duration and offer long term investors to take a view on prolonged price changes over a longer duration. New contract will be introduced on the next trading day following the expiry of near month contract. 2008. The Mini derivative (Futures and Options) contracts on CNX Nifty were introduced for trading on January 1.Price bands A contract specific price range based on its delta value and is computed and updated on a daily basis. Cash settlement on T+1 basis. 25 . without needing to use a combination of shorter term option contracts. Also.the near month (one). long term options have 3 quarterly and 5 half yearly The last Thursday of the expiry month or the previous trading day if the last Thursday is a trading holiday. 2008. The options contracts will have a maximum of three month trading cycle .

4. ◙The strike price. ◙The time to expiration.Option pricing model and option Greeks Factors impacting option prices The supply and demand of options and hence their prices are influenced by the following factors: ◙The underlying price. ◙The underlying asset‟s volatility. and ◙ Risk free rate ◙ Dividend 26 .6:.

As the underlying price increases. Risk free rate: 27 . Even if the underlying price is constant. this relationship remains the same.The underlying price: Call and Put options react differently to the movement in the underlying price. intrinsic value of a call increases and intrinsic value of a put decreases. the option price will still change since time reduces constantly and the time for which the risk is remaining is reducing. the time remaining in an option‟s life moves constantly towards zero. Whether we are discussing a call or a put. the smaller is the intrinsic value of a call option and the greater is the intrinsic value of a put option. The higher the strike price. The more volatile the underlying higher is the price of the option on the underlying. Obviously. Volatility is defined as the uncertainty of returns. The strike price: The strike price is specified in the option contract and does not change overtime. Volatility: Volatility is an important factor in the price of an option. Time to expiration: Time to expiration is the time remaining for the option to expire.

the larger the dividend the greater its impact OPTION GREEKS ♦ Greeks help us to measure the risk associated with derivative positions. ♦This is useful when we calculate value at risk. in general: As an underlying stock's dividend increases. On a stock's "ex-dividend date" the price of the stock paying the dividend will be lowered by the dividend amount when shares begin trading. call prices increase and put prices decrease This is logical because of the fact that a decrease in underlying stock price will generally result in lower call prices and higher put prices. ♦ Greeks also come in handy when we do local valuation of instruments. As an underlying stock's dividend decreases. call prices decrease and put prices increase. Risk free rate is the amount of return which an investor is guaranteed to get over the life time of an option without taking any risk. Dividends Regular cash dividends influence option premiums through their impact on the underlying stock price. And all other factors remaining the same. 28 .Risk free rate of return is the theoretical rate of return of an investment which has no risk (zero risk). Government securities are considered to be risk free since their return is assured by the Government. As we increase the risk free rate the price of the call option increases marginally whereas the price of the put option decreases marginally. It may however be noted that option prices do not change much with changes in the risk free rate. All other pricing factors remaining constant.

If you don't rebalance then it‟s called as static hedging or hedge-and-forget.85 if all else remained same. This is also known as dynamic hedging. Delta of a stock is 1. Vega 29 .5. It is the second partial derivative of option price with respect to asset price. You can use delta to do hedging which is also called as delta-hedging.5. In the example above. Suppose you have sold one lot of above mentioned reliance options.1 then delta of option changes by 0.5. Gamma The gamma of an option is the rate of change of option delta with respect to the price of the underlying asset. Theta is usually negative for an option. delta of reliance call option (Rs. So if you buy 87. Now your option position is hedged.35 = 87. your position remains delta hedged for only a relatively short period of time.Delta The delta of an option is defined as the rate of change of option price with respect to the price of underlying equity/asset. This is known as rebalancing. When you are doing dynamic hedging then rebalancing to keep the portfolio delta neutral need to be made infrequently. the option tends to become less valuable.3.860 Strike) is 0. as time passes with all else remaining the same. gamma is 0. Now you lose money if stock goes up. This is because. Then delta of your position is -87.10 then option price will tend to go up by Rs. If you have one lot (250 options) of the reliance options. It is also referred as the time decay of an option. Delta decreases as strike price of option increases and it increases with increasing time to expiry. It is important to realize that as delta changes. theta is -1.35 which means if the stock price goes up by Rs.5 (~88) stocks of reliance. then delta of your position is 250x0.0092 which means when stock price changes by Rs. Theta The theta of an option is the rate of change of value of option with respect to passage of time with all else remaining same. The hedge has to be adjusted periodically. value of the option decreases by Rs1. Then delta of your overall position becomes zero and position is delta neutral.85 which means that with each trading day.0092. Delta of a long call option is positive and delta of a long put option is negative. As example. In the example above.

In the example above.0.71= Rs.01x4. In the example above. Vega is 4. Rho: The rho of an option is defined as the rate of change of value of option with respect to the interest rate.The Vega of an option is defined as the rate of change of value of option with respect to volatility of underlying asset. If you wish to make your portfolio to be not dependent on volatility then you make it Vega neutral by taking appropriate option positions.04 increase in option price and vice-versa.1= Rs. Rho of a long call option is positive and rho of long put option is negative.71 which means a 1% increase in interest rate will result in 0.0.01x40.4 increase in option price and viceversa. Vega is 40.1 which means a 1% increase in volatility of reliance stock price will result in 0. Relationship between Option Greeks and Option Price Position Delta Gamma Vega Theta Rho Long Call Positive Positive Positive Negative Positive Short Call Negative Negative Negative Positive Negative Long Put Negative Positive Positive Negative Negative 30 .

Some others called trading member-cum-clearing member. 5: CLEARING AND SETTELMENT National Securities Clearing Corporation Limited (NSCCL) undertakes clearing and settlement of all trades executed on the futures and options (F&O) segment of the NSE. settlement procedure and risk management systems at the NSE for trading of derivatives contracts. It also acts as legal counterparty to all trades on the F&O segment and guarantees their financial settlement.1:. some members. The members clearing their own trades and trades of others. clear and settle their own trades as well as trades of other trading members (TMs). called self clearing members.Clearing Entities Clearing and settlement activities in the F&O segment are undertaken by NSCCL with the help of the following entities: Clearing Members In the F&O segment. 31 . and the PCMs are required to bring in additional security deposits in respect of every TM whose trades they undertake to clear and settle. called professional clearing members (PCM) who clear and settle trades executed by TMs. 5. This chapter gives a detailed account of clearing mechanism.Short Put Positive Negative Negative Positive Positive CHAPTER NO. Besides. there is a special category of members. clear and settle their trades executed by them only either on their own account or on account of their clients.

with respect to their obligations on MTM. through exchange of cash.Clearing Banks Funds settlement takes place through clearing banks. 32 .Settlement Procedure All futures and options contracts are cash settled. 3. The buy price and the sell price for contracts executed during the day and squared up. the Mark-to-Market (MTM) settlement which happens on a continuous basis at the end of each day. The underlying for index futures/options of the Nifty index cannot be delivered. it has been currently mandated that stock options and futures would also be cash settled. For the purpose of settlement all clearing members are required to open a separate bank account with NSCCL designated clearing bank for F&O segment. The settlement amount for a CM is netted across all their TMs/ clients.e.2:. premium and exercise settlement. have to be settled in cash. Settlement of Futures Contracts Futures contracts have two types of settlements. The trade price and the day‟s settlement price for contracts executed during the day but not squared up. i. MTM settlement All futures contracts for each member are marked-to-market (MTM) to the daily settlement price of the relevant futures contract at the end of each day. and the final settlement which happens on the last trading day of the futures contract. therefore. The profits/losses are computed as the difference between: 1. However. The previous day‟s settlement price and the current day‟s settlement price for brought forward contracts. These contracts. The Clearing and Settlement process comprises of the following three main activities: 1) Clearing 2) Settlement 3) Risk Management 5. 2. Futures and options on individual securities can be delivered as in the spot market.

Settlement prices for futures Daily settlement price on a trading day is the closing price of the respective futures contracts on such day. 5. Risk containment measures include capital adequacy requirements of members. The closing price for a futures contract is currently calculated as the last half an hour weighted average price of the contract in the F&O Segment of NSE. Final settlement price is the closing price of the relevant underlying index/security in the capital market segment of NSE. on the expiration day of an option contract. The investor who has long in-the-money options on the expiry date will receive the exercise settlement value per unit of the option from the investor who is short on the option.Final settlement for futures On the expiry day of the futures contracts. the seller of an option is entitled to receive the premium for the option sold by him. position limits based on capital. The premium payable amount and the premium receivable amount are netted to compute the net premium payable or receivable amount for each client for each option contract. Daily premium settlement Buyer of an option is obligated to pay the premium towards the options purchased by him. online monitoring of member positions and automatic disablement from trading when limits are breached. Final exercise settlement Final exercise settlement is effected for all open long in-the-money strike price options existing at the close of trading hours. stringent margin requirements.3:. Settlement of options contracts Options contracts have two types of settlements. The salient features of risk containment mechanism on the F&O segment are: 33 . All such long positions are exercised and automatically assigned to short positions in option contracts with the same series. Final settlement loss/profit amount is debited/ credited to the relevant CM‟s clearing bank account on the day following expiry day of the contract. Similarly. on a random basis. monitoring of member performance and track record. after the close of trading hours. daily premium settlement and final exercise settlement. on the last trading day of the contract.Risk Management NSCCL has developed a comprehensive risk containment mechanism for the F&O segment. NSCCL marks all positions of a CM to the final settlement price and the resulting profit/loss is settled in cash.

The difference is settled in cash on a T+1 basis.) A separate settlement guarantee fund for this segment has been created out of the capital of members. 7. The most critical component of risk containment mechanism for F&O segment is the margining system and on-line position monitoring. The CM in turn collects the initial margin from the TMs and their respective clients. 5. A CM may set exposure limits for a TM clearing and settling through him.) Client margins: NSCCL intimates all members of the margin liability of each of their client.) NSCCL‟s on-line position monitoring system monitors a CM‟s open positions on a real-time for all TMs and/ or custodial participants clearing and settling through the CM. It specifies the initial margin requirements for each futures/options contract on a daily basis. 34 . 1. 3. The actual position monitoring and margining is carried out on-line through Parallel Risk Management System (PRISM).There are stringent requirements for members in terms of capital adequacy measured in terms of net worth and security deposits. which holds in trust client margin monies to the extent reported by the member as having been collected form their respective clients.) CMs are provided a trading terminal for the purpose of monitoring the open positions of all the TMs clearing and settling through him. Further trading members are monitored based on positions limits. PRISM uses SPAN(r) (Standard Portfolio Analysis of Risk) system for the purpose of computation of on-line margins. 6..) NSCCL charges an upfront initial margin for all the open positions of a CM.) A member is alerted of his position to enable him to adjust his exposure or bring in additional capital. Additionally members are also required to report details of margins collected from clients to NSCCL. it stops that particular TM from further trading.) The open positions of the members are marked to market based on contract settlement price for each contract. 2. 4. Trading facility is withdrawn when the open positions of the trading member exceeds the position limit. NSCCL assists the CM to monitor the intra-day exposure limits set up by a CM and whenever a TM exceeds the limits. based on the parameters defined by SEBI.

The TM is required to collect adequate initial margins up-front from his clients.NSCCL-SPAN The objective of NSCCL-SPAN is to identify overall risk in a portfolio of all futures and options contracts for each member. • Premium margin: In addition to initial margin. till such obligations are fulfilled. 5. • Assignment margin: Assignment margin is levied in addition to initial margin and premium margin. It is required to be paid on assigned positions of CMs towards exercise settlement obligations for option contracts. Its over-riding objective is to determine the largest loss that a portfolio might reasonably be expected to suffer from one day to the next day based on 99% VaR methodology. like extremely deep out-of-the-money short positions and inter-month risk. premium margin is charged at client level. while at the same time recognizing the unique exposures associated with options portfolios. The margin is charged on the net exercise settlement value payable by a CM.4:. These are required to be paid up-front on gross basis at individual client level for client positions and on net basis for proprietary positions. This margin is required to be paid by a buyer of an option till the premium settlement is complete.Types of margins The margining system for F&O segment is explained below: • Initial margin: Margin in the F&O segment is computed by NSCCL up to client level for open positions of CMs/TMs. The system treats futures and options contracts uniformly. NSCCL collects initial margin for all the open positions of a CM based on the margins computed by NSE-SPAN. A CM is required to ensure collection of adequate initial margin from his TMs and his respective clients. 35 .

“Derivative” is defined to include: 36 . stocks. • Rights or interests in securities. 1956 SC(R)A regulates transactions in securities markets along with derivatives markets. 6: REGULATORY FRAMEWORK The trading of derivatives is governed by the provisions contained in the SC(R)A. 2007 and 2010. debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate.1:. • Security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act. issued to an investor by an issuer being a special purpose distinct entity which possesses any debt or receivable. discusses in detail the recommendation of the LC Gupta Committee for trading of derivatives in India. • Government securities • Such other instruments as may be declared by the Central Government to be securities. It also. 1999. • Derivative. The original act was introduced in 1956. 2004.CHAPTER NO. It now governs the trading of securities in India. including mortgage debt. This Chapter takes a look at the legal and regulatory framework for derivatives trading in India. It was subsequently amended in 1996. 6. debentures. bonds.Securities Contracts (Regulation) Act. assigned to such entity. • Units or any other instrument issued by any collective investment scheme to the investors in such schemes. including mortgage debt as the case may be. scrips. the rules and regulations framed under that and the rules and bye–laws of the stock exchanges. and acknowledging beneficial interest of such investor in such debt or receivable. • Any certificate or instrument (by whatever name called). The term “securities” has been defined in the amended SC(R)A under the Section 2(h) to include: • Shares. 2002 • Units or any other such instrument issued to the investor under any mutual fund scheme 1. the SEBI Act.

1992 provides for establishment of Securities and Exchange Board of India (SEBI) with statutory powers for (a) protecting the interests of investors in securities (b) promoting the development of the securities market and (c) regulating the securities market. • registering and regulating the working of stock brokers. 1992 SEBI Act. 37 . loan whether secured or unsecured. • performing such functions and exercising according to Securities Contracts (Regulation) Act.Securities and Exchange Board of India Act. as may be delegated to it by the Central Government. Section 18A of the SC(R)A provides that notwithstanding anything contained in any other law for the time being in force. in addition to all intermediaries and persons associated with securities market. or index of prices. mutual funds and other persons associated with the securities market and other intermediaries and self–regulatory organizations in the securities market.2:. conducting inquiries and audits of the stock exchanges. undertaking inspection. • A contract which derives its value from the prices. risk instrument or contract for differences or any other form of security. contracts in derivative shall be legal and valid if such contracts are: • Traded on a recognized stock exchange • Settled on the clearing house of the recognized stock exchange. of underlying securities. • promoting and regulating self-regulatory organizations. • prohibiting fraudulent and unfair trade practices relating to securities markets. in accordance with the rules and bye–laws of such stock exchanges 6. SEBI has been obligated to perform the aforesaid functions by such measures as it thinks fit. Its regulatory jurisdiction extends over corporate in the issuance of capital and transfer of securities. 1956. • calling for information from. In particular. it has powers for: • regulating the business in stock exchanges and any other securities markets.• A security derived from a debt instrument. share. sub–brokers etc.

.Regulation for Derivatives Trading SEBI set up a 24-member committee under the Chairmanship of Dr. The minimum net worth for clearing members of the derivatives clearing corporation/ house shall be Rs. The derivatives exchange/segment should have a separate governing council and representation of trading/clearing members shall be limited to maximum of 40% of the total members of the governing council. The members of an existing segment of the exchange would not automatically become the members of derivative segment. L. • The Exchange should have minimum 50 members. The exchange would have to regulate the sales practices of its members and would have to obtain prior approval of SEBI before start of trading in any derivative contract. (a) Fixed assets (b) Pledged securities (c) Member‟s card (d) Non-allowable securities (unlisted securities) 38 . • The clearing and settlement of derivatives trades would be through a SEBI approved clearing corporation/house. 1956 to start trading derivatives. The members seeking admission in the derivative segment of the exchange would need to fulfill the eligibility conditions.6. On May 11. The net worth of the member shall be computed as follows: • Capital + Free reserves • Less non-allowable assets viz. This is in addition to their registration as brokers of existing stock exchanges.3:.300 Lakh. According to this framework: • Any Exchange fulfilling the eligibility criteria can apply to SEBI for grant of recognition under Section 4 of the SC(R)A. • Derivative brokers/dealers and clearing members are required to seek registration from SEBI. C. 1998 SEBI accepted the recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with stock index futures. Gupta to develop the appropriate regulatory framework for derivatives trading in India. Clearing corporations/houses complying with the eligibility conditions as laid down by the committee have to apply to SEBI for approval.

exposure limits linked to capital adequac y and margin demands related to the risk of loss on the position will be prescribed by SEBI/Exchange from time to time. • There will be strict enforcement of “Know your customer” rule and requires that every client shall be registered with the derivatives broker. The members of the derivatives segment are also required to make their clients aware of the risks involved in derivatives trading by issuing to the client the Risk Disclosure Document and obtain a copy of the same duly signed by the client.2 Lakh. 39 .(e) Bad deliveries (f) Doubtful debts and advances (g) Prepaid expenses (h) Intangible assets (i) 30% marketable securities • The minimum contract value shall not be less than Rs. Exchanges have to submit details of the futures contract they propose to introduce. • The initial margin requirement.

Gender of the respondents Table 1: What is your Gender? Frequency Percent Valid Cumulative Percent Percent 84 84.CHAPTER NO.0 Female Total 100 100.0 100.0 40 .0 16.0 84. 7:ANALYSIS OF THE RESULTS ANALYSIS OF THE RESULTS 1.0 100.0 84.0 Male 16 16.

0 100. Age of the respondents Table 2: What is your Age? Frequency Percent Valid Percent 23 23.44 Between 45 -54 Total Cumulative Percent 23.24 Between 25 .0 91.0 22 22.0 23.0 9.0 46.Interpretation: From the questionnaire it is observed that 84% of the respondents are Male and 16% of them are Female.0 100.0 Between 18 .0 46 46.34 Between 35 .0 22. 2.0 41 .0 100 100.0 45.0 9 9.

23% of them fall under 18 -24 years were as 22% of the respondents are between the age category of 25 -34 years and 9% of the respondents are Between the age group of 45 – 54 years.0 Valid Cumulative Percent Percent 37.0 37.0 19.0 19.0 81.0 42 . Occupation of the respondents Table 3: Which of the following best describes your current Occupation? Frequency Employee Businessman Student Professional Total 37 34 10 19 100 Percent 37.0 100.0 10. 3.0 100.0 100.0 71.0 10.0 34.0 34.Interpretation: 46% of the respondents fall under the age category of 35 – 44 years.

0 100.0 21.0 33.Interpretation: From the above chart it is clear that majority of the respondents are employee with a weight age of 37% .0 100. Educational Qualification of the respondents Table 4: What is your Educational Qualification? Frequenc Percent Valid Cumulative y Percent Percent 33 33.0 43 .0 89.0 100. Next are Businessman with a total of 34% and Professionals being 19% and Students 10%.0 11.0 11. 4.0 68.0 Undergraduate Graduate Post Graduate Professional Degree Total 35 21 11 100 35.0 21.0 35.0 33.

00.0 68.0 39.000 4. Post graduates consist of 21% and Professional Degree Holders are 11%.001 4.0 15.0 100.50.0 39.0 44 .000/. 5.0 15.and Above 15 39 14 32 15.000/Between 3.Interpretation: Majority of the respondents are Graduate being 35% were are Undergraduate are closely followed with 33%.50.50.0 14.50.00.0 14.0 54.0 32.001 3. Income per Annum of the respondents Table 5: What is your approximate Income per Annum? Frequency Percent Valid Cumulativ Percent e Percent Below 1.000/Between 1.0 32.

000/.50..000/. 6.000/.Total 100 100. Percentage of monthly income available for investment in Derivatives Table 6: What percentage of your monthly household income would you invest in Derivatives? Frequenc Percent Valid Percent Cumulativ y e Percent 27 27.001 – 3.00.00.0 68.0 Between 5 .001/.0 100.50.0 41 32 41.0 27.0 Interpretation: 39% of the respondents have annual income between 1.are 15%.4.50.000/.50.0 27.0 32.are 14% and below 1.0 41.were as respondents having income above 4.10% Between 11 15% Between 16 20% 45 . between 3.0 100.0 32.are 32%.

0 77.0 34.0 100.0 43. were as 32% of the respondents would invest between 16-20% and 27% of the respondents invest between 5 – 10% in Derivatives Market.0 34.Total 100 100.0 46 .0 Cumulativ e Percent 43. Kind of risk perceive while investing in Derivatives Table 7: What kind of risk do you perceive while investing? Frequenc Percen Valid y t Percent Uncertainty of Returns Slump in Market 43 34 43. 7.0 Interpretation: 41% of the respondents invest between 11 – 15% of the monthly household income in Derivatives.

0 100.0 100.0 Interpretation: 43% of the respondents feel that Uncertainty of Returns is the major risk they perceive while investing in Derivative Market.0 100. 8.0 9.0 14.0 14. Purpose of Investing in Derivatives Market Table 8: What is the purpose of investing in Derivative Market? Frequenc Percent Valid Cumulative y Percent Percent 47 .0 86.Fear of Company Windup Others Total 9 14 100 9. were as 34% of the respondents feel Slump in Market and 9% of the respondents feel that fear of company windup is the risk they perceive while investing in Derivatives.

0 29.To Hedge Funds Risk Control Stable Income Direct Investment Total 33 29 21 17 100 33.0 83.0 Interpretation: 33% of the respondents invest in Derivatives to hedge funds.0 62.0 100.0 33.0 17.0 100.0 29. 9.0 33. 29% of them invest for risk control. Participation in different type of Derivative instrument Table 9: In which of the following would you like to participate? Frequenc Percen y t Valid Percent Cumulativ e Percent 48 .0 21.0 17.0 21.0 100. 21% of the respondents for stable income and 17% invest as a direct investment.

0 29.Index Futures Index Options Stock Futures Stock Options Currency Futures/Options Total 16 29 19 24 12 100 16.0 100.0 100.0 16.0 29.0 1 Month 49 .0 34.0 19.0 19.0 88.0 12. Stock Futures and Index Futures attract 19 and 16% respectively and respondents liking to invest in Currency Futures and Options are 12% 10.0 34.0 Interpretation: From the above chart we find that 29% of the respondent would like to participate in Index Options were as 24% of the respondents‟ would like to invest in Stock Options.0 16.0 24.0 24.0 64. Interest of investment in terms of time frame Table 10: Which contract maturity period would interest you for trading in? Frequenc Percent Valid Cumulative y Percent Percent 34 34.0 45.0 100.0 12.

11.0 70.0 27. Investment in Derivatives market Table 11: How often do you invest in Derivative Market? Frequen Percen Valid Cumulati cy t Percent ve Percent 50 .0 8.0 22.0 100.0 22. 27% of them for 3 months.0 9.0 8. 9% of the respondents for 2 months and 8% of the respondents for 1 Year.0 43.0 92. 22% of the respondents for 6 months.0 Interpretation: 34% of the respondents would like to invest their money for 1 Month.0 100.2 Months 3 Months 6 Months 1 Year Total 9 27 22 8 100 9.0 100.0 27.

0 9.0 100.0 62.0 15. Result of Investment Table 12: What was the result of your Investment? Frequency Percent Valid Percent Cumulative Percent 51 .0 15.0 76.0 Interpretation: Majority of the respondents 60% of them invest between 1 – 10 times a year in Derivatives.0 91.0 14.0 100.0 9. 15% and 9% respectively. 12.50 times Regularly Total 62 14 15 9 100 62.0 62. were as respondents investing between 11 – 25 times.0 14. 26 – 50 times and regularly are 14%.10 times Between 11 .0 100.Between 1 .25 times 26 .

52 .0 100.0 50.0 Interpretation: 50% of the respondents are moderate about their results in investing in Derivatives market.0 100.0 33.Great Results Moderate but acceptable Disappointed Total 17 50 33 100 17.0 100.0 67.0 33. 17% of the respondents have great results and 33% of the respondents are disappointed with their investment in Derivatives Market.0 17.0 50.0 17.

What is your approximate Income per Annum? * In which of the following would you like to participate? Cross Tab H0: Income and investment in different type of derivative instruments are not relate H1: Income and investment in different type of derivative instruments are related. 53 .

Count

In which of the following would you like to participate? Tota Index Index Stock Stock Currency l Future Option Future Option Futures/Optio s s s s ns

Below 1,50,000 /Between 1,50,001 3,00,000 /Between 3,00,001 4,50,000 4,50,000 /- and Above Total

3

4

2

0

6

15

What is your approxima te Income per Annum?

3

14

11

11

0

39

3

3

0

5

3

14

7 16

8 29

6 19

8 24

3 12

32 100

Value Pearson Chi-Square Likelihood Ratio Linear-by-Linear Association 28.958a 35.930 .315

df

Asymp. Sig. (2-sided)

12 .004 12 .000 1 .575

54

N of Valid Cases

100

a. 12 cells (60.0%) have expected count less than 5. The minimum expected count is 1.68.

The value of chi-squared statistic is 28.958. The chi-squared statistic has 12 degree of freedom. The p value (.004) is less than 0.05. Hence there is significant relationship between income and investment in different type of derivative instruments.

H0: Age and purpose of Investing in Derivative market are not related. H1: Age and purpose of Investing in Derivative market are related. What is your Age? * What is the purpose of investing in Derivative market? Cross Tab What is the purpose of investing in Derivative market?
55

Count

To Hedge Risk Funds Control Between 18 – 24 What is your Age? Between 25 – 34 Between 35 – 44 Between 45 -54 Total 10 3 17 3 33 0 14 12 3 29

Stable Income 8 2 8 3 21

Direct Total Investment 5 3 9 0 17 23 22 46 9 100

Chi-Square Tests

Value Pearson Chi-Square Likelihood Ratio Linear-by-Linear Association N of Valid Cases 26.109 32.568 .616 100
a

df 9 9 1

Asymp. Sig. (2-sided) .002 .000 .432

a. 8 cells (50.0%) have expected count less than 5. The minimum expected count is 1.53. The value of chi-squared statistic is 26.109. The chi-squared statistic has 9 degree of freedom. The p value (.002) is less than 0.05. Hence there is significant relationship between age and purpose of Investing in Derivative market.

H0: Income per annum and monthly income available for investment are related H1: Income per annum and monthly income available for investment are related What is your approximate Income per Annum? * What percentage of your monthly household income would you invest in Derivatives? Cross Tab What percentage of your monthly household income would you invest in Derivatives?

Count

Total

56

000 4. Hence there is significant relationship between income per annum and monthly income available for investment.00.00.50.15% 16 .000/.78.000 100 N of Valid Cases a. What contract maturity period would interest you for trading in? * What was the result of your investment? Cross Tab What was the result of your investment? Total Count 57 .001 3.50.130. The minimum expected count is 3. The p value (. The chi-squared statistic has 6 degree of freedom.50. 4 cells (33.000 . H1: Maturity period of investment and results of investment are related.000) is less than 0.3%) have expected count less than 5.000/- 15 What is your approximate Income per Annum? Between 1.50.017 df 6 6 1 Asymp.871 22.001 4. (2sided) . H0: Maturity period of investment and results of investment are no related. The value of chi-squared statistic is 30.Betwee Between Between n 11 .130a 38. Sig.000 .and Above Total 2 17 27 6 15 41 6 0 32 14 32 100 Chi-Square Tests Value Pearson Chi-Square Likelihood Ratio Linear-by-Linear Association 30.000/- 5 17 17 39 Between 3.20% 510% 3 3 9 Below 1.05.

3%) have expected count less than 5. 58 .36. The value of chi-squared statistic is 17. The p value (.085 . The minimum expected count is 1.921 a.025) is more than 0.05.Great Results 1 Month What contract maturity period would interest you for trading in? 2 Months 3 Months 6 Months 1 Year Total Moderate Disappointe but d acceptable 9 16 9 0 0 5 3 3 19 9 3 50 6 8 8 2 33 34 9 27 22 8 100 17 Chi-Square Tests Value Pearson Chi-Square Likelihood Ratio Linear-by-Linear Association N of Valid Cases 17.010 100 df 8 8 1 Asymp. Hence there is no significant relationship between maturity period of investment and results of investment.005 .583a 22.025 . The chi-squared statistic has 8 degree of freedom. Sig.583. 8 cells (53. (2sided) .

Comparison of Derivatives Turnover with Equity turnover on BSE &NSE Derivatives Turnover in BSE & NSE BSE Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 No of Contracts 105527 138037 382258 531719 203 1781220 7453371 496502 9026 5623 32222825 NSE Turnover (Cr) No of Contracts 1926 2478 12074 16112 9 59006 242308 11775 234 154 808476 4196873 16767852 57008110 77017185 157619271 216883573 425013200 657390497 677293922 1034212062 1205045464 Turnover (Cr) 101925 439865 2130468 2547053 4824251 7356270 13090477 11010482 17663655 29248221 31349732 Equity Turnover in BSE & NSE BSE Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 182196 221401 390441 477171 664455 560777 653010 739600 1136513 990777 654137 307292 314073 505053 518715 816074 956185 1578857 1100074 1378809 1105027 667498 NSE 278408 364065 713301 797685 844486 855456 1498469 1426355 2215530 1824515 1616978 513167 617989 1099534 1140072 1569558 1945287 3551038 2752023 4138023 3577410 2810893 Traded Quantity Turnover (Cr) Traded Quantity Turnover (Cr) 59 .

gov. In BSE the equity turnover is superior compared to derivatives turnover but after the financial year 2011.476crores compared to equity turnover of 6. 08. 67.498 which is 21% more of equity turnover clearly showing the emergence of derivatives market on BSE. There after Derivatives market has seen a huge growth in terms traded contracts and turnover. 60 .292. 07.in) Derivatives were introduced first time in India in 2001.926 crores compared to equity turnover of 3.12 the momentum has shifted from equity to derivatives and in the financial year 2011 – 2012 the derivatives turnover overtook the equity turnover for the 1st time ever.Table showing comparison of Derivatives Turnover and Equity Turnover in BSE 1800000 1600000 1400000 1200000 1000000 800000 600000 400000 200000 0 Turnover of Derivatives in BSE (Cr) Turnover of Equity in BSE(Cr) (source: sebi. From the above chart we can see that derivatives turnover in the year 2001 – 02 was 1. the derivatives turnover stood at 8.

There after Derivatives market has seen a huge growth in terms traded contracts and turnover.167 but after the financial year 2003 -04 derivatives has seen a huge up growth. 13. It has outperformed equity segment both in volumes and turnover.925crores compared to equity turnover of 5.Table showing comparison of Derivatives Turnover and Equity Turnover in NSE 35000000 30000000 25000000 20000000 Turnover of Derivatives in NSE(Cr) Turnover of Equity in NSE(Cr) 15000000 10000000 5000000 0 (source: sebi.49.893 which is 1015% more of equity turnover clearly showing the emergence of derivatives market on NSE. 61 .in) Derivatives were introduced first time in India in 2001. From the above chart we can see that derivatives turnover in the year 2001 – 02 was 1. In the financial year 2011 – 2012 the derivatives turnover stood at 3.01.gov.13.732crores compared to equity turnover of 28.10.

 Hypothesis test shown that there is relationship between Income and investment in different type of derivative instruments. Income per annum and monthly income available for investment  Derivatives turnover compared to Equity turnover is superior on NSE Recommendations 62 .  Most of investor‟s purpose of investing in derivative market is to hedge their funds.   Most of investors participate in Index Options. Age and purpose of Investing in Derivative market .Findings    84% of the respondents are Male and 16% of them are Female. From this survey we come to know that most of investors make a contract of 1 month maturity period. Most of the investors who invest in derivatives market are graduate.50.00/-   46% of the respondents fall under the age category of 35 – 44 years Investors generally perceive uncertainty of returns type of risk while investing in derivative market.   Investors invest 1 -10 times a year in Derivatives Market.00.001 – 3. The result of investment in derivative market is generally moderate but acceptable. Majority of the investors who invest in derivative market have a income of above 1.

ANNEXURE SURVEY QUESTIONNAIRE FOR INVESTORS 63 .  As FII play a prominent role in Derivatives trading. government policies. an individual investor should keep himself updated with various economic trends. As derivatives trading is very risky investors should have only a small portion of their portfolio consisting of derivatives.  SEBI should conduct seminars regarding the use of derivatives to educate individual investors. company and industry announcements. Knowledge needs to be spread concerning the risk and return of derivative market. especially 5 Day moving averages as derivatives trading is for a short period of time Investors should analysis their script with the help of 5 Day moving average before making their trades.  Investors‟ portfolio should only consist of 15 – 20% Derivatives contracts or scripts.  Investors should have knowledge of technical analysis.

Professional Degree Holder 64 . Gender a) Male b) Female 3. Below 18 Years b. Graduate c. Between 45 -54 Years e.Dear Sir/Mam. Undergraduate b. Above 55 Years 4. Occupation a. Post Graduate d. This questionnaire is meant for educational purposes only. Age a. Employee b. c. The information provided by you will be kept secure and confidential. d. Name: ___________________________________________ 2. Educational Qualification a. Between 18 – 24 Years c. 1. Between 25.34 Years d. Business Student Professional 5.

00.00. Uncertainty of returns b. c. d.00.000 7.000 c. d. What is the purpose of investing in Derivative market? a. Slump in stock market c. Income per Annum a.000 b.50. Index Options Stock Futures Stock Options 65 .000 – 3. More stable d.000 d.00. To hedge funds b.6.50. Direct investment 10. Above 5. Normally what percentage of your monthly household income could be available for investment? a. In which of the following would you like to participate? a. Below 1. Between 11% to 15% c. Between 5% to 10% b. Between 16% to 20% d. What kind of risk do you perceive while investing in the stock market? a. Fear of being windup of company Other 9. Index Futures b. 3.000 – 5. 1. Risk control c. Between 21% to 25% More than 25% 8. e.

1 month 2 months 3 months 6 months e. 9 months f. Disappointed Conclusion Derivatives play a very important role in the up-bringing of an organization. the Indian stock exchange market has recently rocketed up to become Asia‟s fourth largest exchange traded derivatives market. 1-10 times in a year b. b. What was the result of your Investment? a. Moderate but acceptable c. The variety of instruments in derivatives instruments available for trading is also expanding. More than 50 times d. Corporations. 12 months 12. the Indian market has exceeded or equaled many other Indian markets. 11-50 times c. What contract maturity period would interest you for trading in? a. In terms of growth of derivative markets and a variety of derivatives users. Regularly 13. Today. 66 . state-owned and smaller companies are gradually getting into the act. d. How often do you invest in Derivative market? a. Currency Futures / Options 11. it plays a major role in the equity market. Great results b. private sectors institutions. c. with the help of derivatives.e.

R. Indian Derivatives market is poised to grow at a very rapid pace in the years to come. www. lack of transparency particularly in complex products. tail risk exposures. www.Bagri. the derivatives market in India has been expanding rapidly and will continue to grow.derivative.google. N.com 67 .D.To conclude. 2. 3rd Edition.Vohra & B. difficulties in valuation. BIBLIOGRAPHY 1. counterparty exposure and hidden systemic risk. and hence improve market efficiency. Nevertheless. “Future and Options”. derivatives are very useful for hedging and risk transfer. Tata McGraw Hill.com 3. it is necessary to keep in view the risks of excessive leverage.

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