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“ FORMULATING DERIVATIVE STRATEGIES ”

INTRODUCTION
Stock markets extremely risky and volatile and hence the risk consideration is an
important concern for investors. To reduce this risk, the concept of derivatives comes into
the picture. Derivatives trading commenced in India in June 2000, SEBI permitted the
derivative segments of two stock exchanges, NSE and BSE, and their clearing
house/corporation to commence trading and settlement in derivatives contracts, The
trading in BSE Sensex options commenced on June 4, 2001 and the trading in options on
individual securities commenced in July 2001. Futures contracts on individual stocks
were launched in November 2001.
Single stock futures were launched on November 9, 2001. The index futures and options
contract on NSE are based on S&P CNX, at present Mutual Funds are permitted to
participate in the derivatives market for the purpose of hedging (minimizing risk) and rebalancing their portfolio.
The derivatives market performs a number of functions:
1. They help in transferring risks from risk averse people to risk oriented people
2. They help in the discovery of future as well as current prices
3. They give rise to entrepreneurial activity
4. They increase the volume traded in markets because of participation of risk averse
people in greater numbers
5. They increase savings and investment in the long run period
The expected outcomes from the thesis is to understand and apply how to use the
concept of equity strategies and under what market conditions one should use these
Equity market strategies and try to beat the market by hedging our holdings and implies
the use of all the popular equity derivatives strategies with practical examples .

LITERATURE REVIEW
Meaning of Derivatives:
A Derivative are types of investments whose performance are amplified from the
performance of assets (such as commodities, shares or bonds), interest rates, exchange
rates, or indices (such as a stock market index like Nifty and Sensex). This performance
can determine both the amount of the payoffs. The diverse range of underlying assets and
payoff alternatives leads to a huge range of derivatives contracts available to be traded in
the financial market. The main types of Equity derivatives are futures and options
A very simple example of derivatives is curd, which is derivative of milk. The price of
curd depends upon the price of milk which in turn depends upon the demand and supply
of milk. See it this way. And the price of Cipla warrants depends upon the price of Cipla
shares. American depository receipts/global depository receipts of ICICI, Satyam and
Infosys traded on stock exchanges in the USA and England don’t have their own values;
They draw their price from the underlying shares traded in India. Even the value of
mutual fund units changes on a day to day basis. Don’t mutual fund units draw their value
from the value of the portfolio of securities under the schemes; these examples prove that
derivatives are not so new to us.
Equity Futures :
Contracts which a investor or trader can buy to take advantage of the market and protect
against unwanted price movements ie buy hedging his portfolio against unwanted risks
arising from volatility of prices. Every time futures contract is bought a fixed margin
which is calculated per stock basis and trade on that margin basis is needed to be paid to
buy Infosys in lot sizes ie 200 or 300 lot size per stock, if bought in cash market full
amount need to be paid ,But if bought in futures it can be played on just the margin
amount and take advantage of market movements if the Infosys stock falls then the long
futures position loses But if the Infosys stock rises then the Infosys position gains

Equity Options :
Contracts which give used by traders or investors wherein a call or put options is bought
ie the equivalent of long futures and short futures but unlike the futures position which
makes profit ,if the long futures make profits when underlying share prices rise,
Options the pay-off is only when exiting our positions so its less riskier than futures
which means the loss is restricted the loss is only to the premium amount paid and the
profit position is unlimited when into a Options contract the premium is paid and if in one
week the premium rises due to underlying market movements then the position can be
exited and make profits in that position

History of “Derivatives”
Derivatives trading in 1865 by Chicago Board of Trade listed the first exchange traded
futures contract in the USA. In 1919 The Chicago Butter and Egg Board, a spin-off of
CBOT, was formed to allow futures trading. Its name was changed to Chicago Mercantile
Exchange (CME). In April 1973, the Chicago Board of Options Exchange was set up
specifically for the purpose of trading in options. The market for options developed so
rapidly that by early 80s the number of shares underlying the option contract sold each
day exceeded the daily volume of shares traded on the New York Stock Exchange.
And there has been no looking back ever since then for Derivatives. (Ref: Wikipedia)
DERIVATIVES TRADING IN INDIA
The derivatives markets has existed for centuries as a result of the need for both users and
producers of natural resources to hedge against price fluctuations in the underlying
commodities. Although trading in agricultural and other commodities has been the
driving force behind the development of derivatives exchanges, the demand for products
based on financial instruments such as bond, currencies, stocks and stock indices—have
now far outstripped that for the commodities contracts.

India has been trading derivatives contracts in silver, gold, spices, coffee, cotton and oil
etc for decades in the gray market. Trading derivatives contracts in organized market was
legal before Morarji Desai’s government banned forward contracts. Derivatives on stocks
were traded in the form of Teji and Mandi in unorganized markets. Recently futures
contract in various commodities were allowed to trade on exchanges. For example, now
cotton and oil futures trade in Mumbai, soybean futures trade in Bhopal, pepper futures in
Kochi, coffee futures in Bangalore etc. In June 2000, National Stock Exchange and
Bombay Stock Exchange started trading in futures on Sensex and Nifty. Options trading
on Sensex and Nifty commenced in June 2001.
Distinct groups of derivative contracts:
There are two groups of derivative contracts, which are distinguished by the way
that they are traded in market:
 Over-the-counter (OTC) derivatives are contracts that are traded directly
between two parties, without going through an exchange like NSE and BSE
Swaps, forward rate agreements, and exotic options are almost always traded
in this way.
 Exchange-traded derivatives are those derivatives that are traded via stock
exchanges. A stock exchange like NSE and BSE acts as an intermediary to all
transactions, and takes Initial margin from both sides of the trade to act as a
guarantee. There are host of Derivatives products available in NSE and BSE
in India.
Exchange-traded vs. OTC (Over the Counter) derivatives markets:
The OTC derivatives markets have seen sharp growth over the last years, which has
accompanied the development of commercial and investment banking and globalisation
of financial activities. The recent developments in IT have contributed to a great extent to
these developments. While both exchange-traded and OTC derivative contracts offer
many benefits, the former have rigid regulations compared to the latter. It has been

widely discussed that the highly leveraged institutions and their OTC derivative positions
were the main cause of turbulence in stock markets in the year 1998. These episodes of
turbulence revealed the risks posed to market stability coming from the features of OTC
derivative instruments and markets.
Recent Derivative products
Weekly Options:
Equity Futures & Options were introduced in India having a maximum life of months.
These options expire on the last Thursday of the expiring month. There was a need felt in
the market for options of shorter maturity. To cater to this need of the market participants
BSE launched weekly options on September 13, 2004 on 4 stocks and the BSE Sensex.
Weekly options have the same characteristics as that of the Monthly Stock Options
(stocks and indices) except that these options settle on Friday of every week. These
options are introduced on Monday of every week and have a maturity of 2 weeks,
expiring on Friday of the expiring week.

(Ref: www.bseindia.com)

The National Stock Exchange and the Bombay Stock Exchange offer such facilities for trading Futures contracts on an underlying financial instrument like stocks/shares. contracted on a futures exchange.200 shares of Satyam. Ex: Coffee grower may enter into a contract with a wholesale buyer to sell Coffee at a particular price on a future date. The pre-set price is called the futures price. at a pre-set price. 2007. Futures: Futures contract is a standardized contract.Common contract types There are three major classes of Derivatives contracts : Forwards : Which are contracts to buy or sell an asset at a future date. naturally. Example: when you are dealing in August Satyam futures contract the market lot. converges towards the settlement price on the delivery date. between two private parties Ex: Tea grower may enter into a contract with a wholesale buyer to sell Tea at a particular price on a future date.200 * 0.05) = Rs60 per contract/market lot. to buy or sell a certain underlying instrument at a certain date in the future. The price of the underlying asset on the delivery date is called the settlement price. i. the contract would be settled in cash. He / she could buy a contract through a regulated market like the Coffee Futures Exchange India Limited (COFEI).e. The futures price. The Tea buyer could have a mutually agreed contract with the seller (Forward Contract). the tick size is 5 paise per share or (1. and the closing price in the cash market on the expiry day would be settlement price . the contract would expire on May 28. the minimum quantity that you can buy or sell. is 1. the price is quoted per share. The future date is called the delivery date or final settlement date.

expiry. and mode of settlement. which is not possible in the cash market  An investor can buy and sell index instead of individual securities when he has a general idea of the direction in which the market may move in the next few months. Futures markets. Contracts on Futures markets are fixed in terms of contract size. it acts as buyer to seller and as a seller to the buyer and guarantees the trades. Counter party risk is also eliminated in the Futures market as the designated Clearinghouse becomes counter party to each trade that is. . Forward contracts are mutually agreed between two parties. however. Features of futures contracts:  Leveraged positions--only margin required for taking up positions  Trading in either direction--short/long positions  Index trading are possible  Hedging/Arbitrage opportunity exists  The settlement price is available Advantages of Futures over cash trading:  In futures the investor can short sell/buy without having the stock and carry the position for a long time. The only benefit of entering into a Forwards contract comes from the flexibility of having tailor-made contracts. Forwards are important as prices in Forward markets serve as indicator of Futures prices. provide liquidity as contracts are traded on a broader client base. product type.Difference between Forwards and Futures contract: Futures contracts are traded on an exchange. product quality.

such as stock index options. The seller of this call option who has given you the right to buy from him is under the obligation to sell 2. Alternatively he can take futures position in the stock by paying Rs30 towards initial and mark-to-market margin. He will then make Rs10 on an investment of Rs100. individual stock options etc.000 shares of HUL at Rs250 per share on or before May 28. i. which is not the case in futures. One option is to buy the stock in the cash segment by paying Rs100. giving about 10% returns. will have to be settled by physical delivery. This option gives you the right to buy 2.e about 33% returns. Here he makes Rs10 on an investment of Rs30. The next class of Derivative product is: Options : Which are contracts that give the buyer the right (but not the obligation) to buy or sell an asset at a specified future date. the positions. This means trading in stock index futures is a leveraged activity since the investor is able to control the total value of the contract with a relatively small amount of margin. For entering into an option transaction Example: Suppose you have bought a call option of 2. The investor is required to pay a small fraction of the value of the total contract as margin. Example: Suppose the investor expects a Rs100 stock to go up by Rs10.  In the case of individual stocks.  Regulatory complexity is likely to be less in the case of stock index futures compared to the other kinds of equity derivatives. 2007 whenever asked.000 shares of Hindustan Unilever Ltd (HUL) at a strike price of Rs250 per share.000 shares of HUL at Rs250 per share on or before May 28. which remain outstanding on the expiration date. 2007. .

Example: suppose you bought a put option of 2. 2009. 2007 whenever asked. When the spot / cash price (less cost) is lower than the Strike price. whereas “Seller/Writer” of the Put Option is “obliged to Buy” the underlying Stock if the buyer of Put decides to Exercise his / her Option. PUT Option: “Buyer” of a Put Option on a particular Stock “gets the right to Sell” the underlying Stock.000 shares of HUL at Rs250 per share on or before March 30. whereas “Seller / Writer” of the Call Option is “obliged to Sell” the underlying stock when the buyer of Call decides to Exercise his / her Option. This option gives its buyer the right to sell 2. The seller of this put option who has given . 2007. When the spot / cash price is higher than the Strike price (plus cost). the buyer of Put could exercise his “right to sell” at the Strike price.000 shares of HUL at Rs250 per share on or before May 30.000 shares of Hindustan Unilever Ltd (HUL) at a strike price of Rs 250 per share. the buyer of Call could exercise his “right to buy” at the Strike price. The seller of this call option who has given you the right to buy from him is under the obligation to sell 2. This option gives you the right to buy 2.000 shares of HUL at Rs250 per share on or before May 30.Features of Options:  Limited risk. unlimited profit-call options  Higher returns. higher risk-put options  Positions in all market conditions/views There are two types of Options: “CALL” and “PUT”. CALL Option: “Buyer” of a Call Option on a particular stock “gets the right to Buy” the underlying Stock.000 shares of HUL at a strike price of Rs250 per share. Example: Suppose you have bought a call option of 2.

in futures the buyer and seller have unlimited potential to gain. Difference between Options and Futures: Understanding Options requires understanding of concepts of “right” and “obligation”. 2009 whenever asked. with the cashflows in one direction being in a different currency than those in the opposite direction . On entering an Option contract the buyer “gets the right” and the seller (also called the writer) “has the obligation”/ “gives the right”.you the right to sell to him is under obligation to buy 2. Swaps : where the two parties agree to exchange cash flows.000 shares of HUL at Rs250 per share on or before March 30. But in futures. But in Options. The seller is subject to unlimited risk of losing whereas the buyer has a limited potential to lose. But in Options the seller of the option has limited potential to gain while the buyer of the has unlimited potential to gain. 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  Currency swaps : These entail swapping both principal and interest between the parties. both the buyer and the seller are under obligation to fulfill the contract and the buyer and seller are subject to unlimited risk of losing.

Ex: Take the case of investor who holds the shares of a company and gets uncomfortable with market movements in the short run . Assume that the spot price of the security he holds is Rs . 390 . .PLAYERS IN THE DERIVATIVE MARKET : The following three broad categories of participants are Hedgers: Hedgers face risk associated with the price of an asset. For this he pays an initial margin.390. A hedge is an investment that is taken out specifically to reduce or cancel out the risk in another investment. the price of crude oil). while still allowing the business to profit from an investment activity. Hedging is not confined to the private sector. with security futures he can minimize his price risk All he need to do is enter into an offsetting stock futures position .g. in its broadest sense. Governments also use it. is the act of protecting oneself against loss. futures and options can be (and are) used by governments to hedge against short-term rises in import prices (e. However the losses he suffers will be offset by the profit he makes on his short futures position. The term comes from a gambling saying "hedging your bets. Typically. Hedging. In the absence of stock futures he would either suffer the discomfort of a price fall or sell the security in anticipation of a market upheaval . Governments use this to stabilize a country’s export earnings or to protect farmers producing export crops. He sees the value of his security falling from Rs. a hedger might invest in a security that he believes is under-priced relative to its "fair value". 450 to Rs. 402. in this case take on a short futures position . They use futures or options markets to reduce or eliminate this risk. Some countries are already making extensive use of futures and options for this purpose. Two-month futures cost him Rs." Hedging is a strategy designed to minimize exposure to an unwanted business risk. Now if the price of the security he holds falls further he will suffer losses on the security he holds. Similarly.

It must be noted that the practice of speculation. it is quite conceivable that one or other group of hedgers would be unable to hedge without distorting the price because of the absence of counter parties to the transactions. reduces the costs of marketing. Arbitrageurs: Arbitrage can be described as a transaction involves buying and selling a good or asset in two different markets in order to achieve a risk less profit through the difference in price between them. we can say yes as there can be no effective hedging since the volume of demand for long and short hedging will not be equal except by occasional coincidence. . Secondly. Since. easily and without unduly affecting the market price.Based on the above explanation hedging can thereof be described as a “method of protection against uncertainty”. Let us see the main use of speculation. hedging can also be described as a form of ‘insurance’ against non-insurable risks. in practice the arbitrageur is not a separate person. by facilitating hedging. It is the speculators who take up the slack in the market and provide liquidity. The speculators have no specific interest in the commodity rather they are risk seekers whose interest stems from the profit which they expect to make from assuming the price risk. uncertainty is often referred to as ‘risk’. In a broadest sense we can say an arbitrageur is one who trades only to realize profits from discrepancies in the market. speculative activity increases the liquidity of markets thereby enabling hedgers to transact large volumes of business on the market quickly. either a hedger or a speculator can indulge in arbitrage when the opportunity arises. Of course. Speculators: If a futures market is restricted to hedgers alone. It is here that the role of the speculator becomes apparent. Arbitrage plays a big role in ensuring that prices in futures markets do not diverge from the level dictated by supply and demand and in ensuring speedy correction of any pricing anomalies. However it provides a lower degree of protection than insurance since hedges are often only partially effective. in common and less rigorous parlance.

NSE requires individual investors to maintain adequate amounts as margins against risk of loss. DERIVATIVES ARE USED WIDELY BECAUSE:  Leveraged positions  Lower margins than the margin funding  Index trading--market directional trading  Hedging of portfolio  Through index. For example: A trader could buy/sell 15 INFOSYSTCH at say . 80. This is an arbitrage transaction. the shares of TNPL are selling at Rs.Example: On a particular day. The writer is at risk of having his / her position assigned by a profitable buyer who Exercises his / her position. The risks involved in trading on derivatives are:  Futures carry similar risks as their underlying stocks. covered calls. For a seller / writer the risk increases considerably as the market moves against him / her. volatile or neutral. 2 without any risk and with hardly any capital (barring any margin required to put through the trade). Futures trading are inherently riskier than trading in cash because of the higher values of contracts involved.A stockbroker simultaneously buys the share in Delhi and sells it in Bombay. By so doing he realizes a profit of Rs. options buying  Structured products for higher yields  Allows taking position in any market condition--bullish. The maximum risk to the buyer of an Option is limited to the Premium paid. bearish. 82 in the Bombay Stock Exchange while at the same time the price in the Delhi Stock Exchange is Rs.

When a buyer Exercises his / her position a seller’s position automatically gets assigned. Exercise prices: The price at which Exercise takes place is day’s closing price of underlying stock. . Hence the total value of trade has increased from Rs.000.00 in the Futures Market.4. 1800 etc. There is no minimum/maximum Price Bands. to prevent operating errors 20% of the base price is maintained as an operating range. They could also be traded in larger quantities like 1200. Previous day’s closing price of the underlying stock acts as the base price for introduction of new Futures contracts in the beginning of a new month. In the Futures market a minimum of 100 (one lot) INFOSYSTCH has to be traded.Rs. A fall of Rs. Contract sizes are determined by the exchange. The daily Futures settlement price acts as the base price for subsequent days. each trade has to be a minimum quantity of 600 Satyam Computer stocks.60. Advanced concepts in derivatives: Stocks that can be traded in derivatives segment: Currently on the NSE 120 stocks are trading in the derivatives markets. For example the contract size for Satyam Computer is 600 stocks. That is.000.4000.2000.00 as against a loss of Rs.20. That is.00 in cash market.00 in the Futures market. they “can be exercised on any day before expiry date”. Once the position is Exercised / Assigned this position ceases to exist. Options are exercised by: Stock options on the NSE are American Options.300. That is. they “can be exercised only on the day of expiry”.00 in cash market to Rs.00 in cash market amounts to a loss of Rs. However. On the other hand NIFTY Options are European Options.00.

Meaning of At-the-money Option: Options that provide the holder zero cash flows if exercised immediately are called At-the Money options. Here. Up to 30% of total Initial margin can be paid in stocks. Initial Margin and Marked-to-market margin. Similarly. the Open interest on the scrip. The extent of exposure given on a particular margin amount depends on several factors including the Volatility of the scrip. T is the day of trading. .Meaning of In-the-money Option: Options that provide the holder positive cash flows if exercised immediately are called In-the-Money options. and the extent of Hedging used. This value determines the gross exposure to be taken by the investor. Meaning of Out-of-money Option: Ones that provide negative cash flows if exercised immediately are called Out-of-money Options. the seller of options receives the premium amount on T+1. The out flows while trading in Options are: The buyer of an option pays a small amount as Premium to the seller for privilege of getting the right to exercise his / her option. It is also the maximum amount that the buyer stands to lose when the market moves against his / her expectations. There are two levels of margins to be paid at the client level.  Mark to Market margin (MTM): A minimum percentage of Initial margin value is required to be maintained as marked-to-market margin. This margin acts as a security against intra-day losses. NSE uses software called SPAN to calculate margins.  Initial Margin amount is charged upfront. This percentage could be up to 20% of IM. This amount is due on T+1.

Money can be invested at 11% pa. Any debits/losses above the MTM margin is required to be paid on the next day of the trade (T+1). Pricing Options: An Option buyer has the right but not the obligation to exercise on the seller. r = Cost of financing (using continuously compounded interest rate) T = time till expiration in years e = 2. it’s the supply and demand in the secondary market that drives the price on an option. The fair value of a one-month futures contract on xyz is calculated as follows: F= SerT = 1150*e0. the difference between the Contract price and Closing price of the underlying scrip determines the net gain or loss on the  Contract.11*1/12 = 1160. . (See annexure) Pricing Futures: Pricing of Futures contract is very simple.71828 Example: Security xyz ltd trades in the market at rs. The worst that can happen to a buyer is the loss of the premium paid to him. This in turn would push the futures price back to its fair value. Using the cost of carry logic. arbitragers would enter into trades to capture the arbitrage profit. 1150. His downside is limited to this premium. It is by calculating the fair value of a futures contract. Every time the observed price deviates from the fair value. Just like other free markets.Variance margin: On a particular day. The cost of carry model used for pricing futures is given below: F= SerT Where. but his upside is potentially unlimited.

These linear payoffs are fascinating as they can be combined with options and the underlying to generate various complex payoffs. The underlying asset in this case is the nifty portfolio. The Black-Scholes formulas for the prices of European calls and puts on a non-dividend paying stock are: C= SN (d1) – Xe-rT N (d2) P= Xe -rT N (-d2)-SN (-d1) Where d1= In s/x + (r+2 /2) T  Where d2= d1.. In this section we shall look at the payoffs for buyers and sellers of futures and option. In simple words it means that losses as well as profits for the buyer and the seller of futures contract are unlimited.There are various models. it starts making profits and when the index moves down it starts making losses. Payoff for buyer for futures: long futures The payoff for a person who buys a futures contract is similar to the payoff for person who holds an asset. Payoff for derivatives contracts: A payoff is the likely profit/loss that would accrue to a market participant with change in the price of the underlying asset. . which help us get close to the true price of the option. Payoff for futures: Futures contract has linear payoffs. When the index moves up. He has a potentially unlimited upside as well as potentially unlimited downside take case of speculator who buys a two-month nifty index futures contract when the nifty stands 4220.

Profit 4220 0 Nifty . He has a potentially unlimited upside as well as potentially unlimited downside take case of speculator who sells a two month nifty index futures contract when the nifty stands 4220. The underlying asset in this case is the nifty portfolio. it starts making profits and when the index moves up it starts making losses. When the index moves down.Profit 4220 0 Nifty Loss Payoff for seller of futures: short futures: The payoff for a person who sells a futures contract is similar to the payoff for person who shorts an asset.

Payoff profile of buyer of asset: long asset In this basic position. however the profits are potentially unlimited. the investor is said to be “long” the asset. nifty for instance. For a writer.Loss Options payoffs The optionality characteristics of options results in a non-linear payoff for options. s`. Once it is purchased. His profits are limited to the option premium. for 4220 and sells it at a future date at unknown price. an investor buy the underlying asset. the payoff is exactly the opposite. Profit +60 0 4160 4220 4280 Nifty -60 Loss Payoff profile for seller of asset: Short asset . however his losses are potentially unlimited. In simple words. it means that the losses for the buyer of an option are limited.

for 4220. His loss in this case is the premium he paid. Higher the spot price.60 Loss Nifty . Once it is sold. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. the investor is said to be “short” the asset. Nifty for instance. an investor shorts the underlying asset. he lets his option expire un-exercised. the spot price exceeds the strike price. s`. more is the profit he makes. and buys it back at the future date at an unknown price. If the spot price of the underlying is less than the strike price. Profit +60 0 4160 4220 4280 Nifty -60 Loss Payoff profiles for buyer of call options: Long call A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option. Profit 4250 0 86. he makes a profit.In this basic position. If upon expiration.

more is the profit he makes. If upon expiration. the spot price exceeds the strike price.Payoff profiles for writer of call options: Short call A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option. the writer of the option charges a premium. Profit 86. If the spot price of the . The profit/loss that the buyer makes on the option depends on the spot price of the underlying. the buyer lets his option expire un-exercised and the writer gets to keep the premium. he makes a profit. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. For selling the option. If upon expiration the spot price of the underlying is less than the strike price. more is the loss he makes. Hence as the spot price increases the writer of the option starts making losses. the buyer will exercise the option on the writer. If upon expiration. the spot price is below the strike price. Whatever is the buyer’s profit is the seller’s loss. Higher the spot price. Lower the spot price.60 4250 0 Nifty Loss Payoff profile for buyer of put option: Long put A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option.

The profit/loss that the buyer makes on the option depends on the spot price of the underlying.70 4250 0 Loss Nifty .underlying is higher than the strike price.70 Loss Payoff profile for writer of put option: Short put A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option. His loss in this case is the premium he paid for buying the option. Profit 61. the writer of the option charges a premium. he lets his option expire un-exercised. the buyer will exercise the option on the writer. Whatever is the buyer’s profit is the seller’s loss. the buyer lets his option expire un-exercised and the writer gets to keep the premium. If upon expiration. the spot price of the underlying is more than the strike price. the spot price happens to be below the strike price. Profit 4250 0 Nifty 61. If upon expiration. For selling the option.

OR Call option is bought with a higher strike price and another call sold with a lower strike.Now we will look at the basic Equity Derivative strategies widely used BASIC STRATEGIES IN EQUITY BUY CALL When very bullish on the stock BUY PUT When very bearish on stock SELL PUT When sure that the price will not fall BULL SPREAD Call option is bought with a lower strike price of and another call option sold with a higher strike. When the stock will go up somewhat or at least is a bit more likely to rise than to fall BEAR SPREAD Put option is bought with a higher strike price and another put option sold with a lower strike. When sure that the price of the stock you hold will not fall. SELL COVERED CALL Call option against the stock holding is sold. BUY STRADDLE Call option and put option are bought with the same strike usually at-the-money. When the stock will go down somewhat or at least is a bit more likely to fall than to rise. Pay-off . OR Put option is bought with a strike of lower strike and another put sold with a higher strike.

BUY BUTTERFLY Call option with low strike bought and two call options with medium strike sold and call option with high strike bought. The same position can be created with puts. Bullish index. lend them to the market 2. When the stock price are expected to move substantially Using index futures There are eight basic modes of trading on the index futures market:  Hedging 1.When the stock is expected to move far enough in either direction in the short-term. long Nifty futures  Speculation 1. Bearish index. Have funds. short Nifty futures 4. When the stock price is expected to fluctuate in a narrow range. lend them to the market Ref: (NCFM Derivatives) . Long security. BUY STRANGLE Put option is bought with a strike A and a call option is bought with a strike B. long Nifty futures 2. long Nifty futures 3. SELL BUTTERFLY Call option with low strike sold and two call options with medium strike bought and call option with high strike sold. Short security. Have portfolio. The same position can be created with puts. short Nifty futures 2. ( A > B) When the stock is expected to move far enough from the predefined range. Have funds. short Nifty futures  Arbitrage 1. Have securities.

There is a simple way out. Once this is done. short Nifty futures A stock picker carefully purchases securities based on a sense that they are worth more than the market price. The basic point of this hedging strategy is that the stock picker proceeds with his core skill. you should sell some amount of Nifty futures. or. In this sense. 2. without any extra risk from fluctuations of the market index. Nifty drops. There is a peculiar problem here. Hedging: Short security. The position LONG RELIANCE + SHORT NIFTY is a pure play on the value of RELIANCE. When this is done. as incidental baggage. i.Hedging: Long security. picking securities. The stock picker may be thinking he wants to be LONG RELIANCE. and the company is really not worth more than the market price. When doing so. This offsets the hidden Nifty exposure that is inside every long–security position. It carries a LONG NIFTY position along with it.e. A person may buy Reliance at Rs. His understanding can be wrong. at the cost of lower risk. a LONG RELIANCE position is not a focused play on the valuation of Reliance. A few days later. but a long position on Reliance effectively forces him to be LONG RELIANCE + LONG NIFTY. The second outcome happens all the time. long Nifty futures . he faces two kinds of risks: 1.1911 thinking that it would announce good results and the security price would rise. Every time you adopt a long position on a security. Every buy position on a security is simultaneously a buy position on Nifty. the stock picker has “hedged away” his index exposure. even if his understanding of Reliance was correct. This is because a LONG RELIANCE position generally gains if Nifty rises and generally loses if Nifty drops. so he makes losses. you will have a position which is purely about the performance of the security. The entire market moves against him and generates losses even though the underlying idea was correct.

The union budget is a common and reliable source of such volatility: market volatility is always enhanced for one week before and two weeks after a budget. short Nifty futures The only certainty about the capital market is that it fluctuates! A lot of investors who own portfolios experience the feeling of discomfort about overall market movements. When you have such anxieties. His understanding can be wrong.Investors studying the market often come across a security which they believe is intrinsically Over-valued. In doing so he faces two kinds of risks: 1. or. even if his intrinsic understanding of Reliance was correct. Sometimes. A stock picker carefully sells securities based on a sense that they are worth less than the market price. A person may sell Reliance at Rs. This sentiment generates “panic selling” which is rarely optimal for the investor. The second outcome happens all the time. there are two alternatives: 1 Sell shares immediately. . There is a peculiar problem here. 2. A few days later. Many investors simply do not want the fluctuations of these three weeks. and the company is really worth more than the market price. they may have a view that security prices will fall in the near future. At other times. Nifty rises. and they do not have an appetite for this kind of volatility. Every sell position on a security is simultaneously a sell position on Nifty. so he makes losses. they may see that the market is in for a few days or weeks of massive volatility.1900 thinking that Reliance would announce poor results and the security price would fall. The entire market moves against him and generates losses even though the underlying idea was correct. Hedging: Have portfolio. It may be the case that the profits and the quality of the company make it worth a lot less than what the market thinks.

Hedging: Have funds. and sell them at a later date: or. short Nifty futures After a bad budget. long Nifty futures After a good budget. This leads to political pressures for government to “do something “when security prices fall. a third and remarkable alternative becomes available: 3 Remove your exposure to index fluctuations temporarily using index futures. he can buy selected liquid securities. It takes several weeks from the date that it becomes sure that the funds will come to the date that the funds actually are in hand  An open-ended fund has just sold fresh units and has received funds. many people feel that the index would go up. which move with the index.2 Do nothing. It allows an investor to be in control of his risk. or good corporate results. buy Nifty futures Have you ever been in a situation where you had funds. many people feel that the index would go down. whether a portfolio is composed of index securities or not. which needed to get invested in equity? Or of expecting to obtain funds in the future which will get invested in equity. Speculation: Bullish index. There is two choices sell selected liquid . or the onset of a coalition government. i. or bad corporate results.e. The land deal is slow and takes weeks to complete. instead of doing nothing and suffering the risk. suffer the pain of the volatility. An investor has two choices. buy the entire index portfolio and then sell it at a later date. or the onset of a stable government.  Suppose a person plans to sell land and buy shares. Some common occurrences of this include:  A closed-end fund that just finished its initial public offering has cash. In addition. Speculation: Bearish index. Every portfolio contains a hidden index exposure. which is not yet invested. This statement is true for all portfolios. without “panic selling” of shares. This allows rapid response to market conditions. with the index futures market.

he would either suffer the discomfort of a price fall or sell the security in anticipation of a market upheaval.390. Traditional methods of loaning money into the security market suffer from (a) price risk of shares and (b) credit risk of default of the counter-party. and without bearing any credit risk. Arbitrage: Have securities. All he need do is enter into an offsetting stock futures position. stock lending schemes that are widely accessible do not exist in India. With security futures he can minimize his price risk. sell futures Stock futures can be used as an effective risk–management tool. lend them to the market Owners of a portfolio of shares often think in terms of juicing up their returns by earning revenues from stock lending. and buy them at a later date: or. He sees the value of his security falling from Rs. In the absence of stock futures. The main advantage of the index futures market is that it supplies a technology to lend money into the market without suffering any exposure to Nifty. Take the case of an investor who holds the shares of a company and gets uncomfortable with market movements in the short run. Investor will sell off all 50 securities in Nifty and buy them back at a future date using the index futures. He can deploy this money. He will soon receive money for the shares he has sold. without suffering the risk. On this date.securities.450 to Rs. The index futures market offers a riskless mechanism for (effectively) loaning out shares and earning a positive return for them. However. Using futures on individual securities: Hedging: Long security. lend them to the market Most people would like to lend funds into the security market. Arbitrage: Have funds. as he like until the futures expiration. he would buy back his shares. sell the entire index portfolio and then buy it at a later date. The basic idea is quite simple. in . and pay for them. which move with the index.

390. Assume he buys a 100 shares which cost him one lakh rupees. Futures will now trade at a price lower than the price at which he entered into a short futures position. The fall in the price of the security will result in a fall in the price of futures. He believes that a particular security that trades at Rs.this case. the losses he suffers on the security. He would like to trade based on this view. How can he trade based on this belief? In the absence of a deferral product.1000 on an investment of Rs. Hence his short futures position will start making profits. will be made up by the profits made on his short futures position.1000 is undervalued and expect its price to go up in the next two–three months. However.40 incurred on the security he holds. buy futures Take the case of a speculator who has a view on the direction of the market. Just for the sake of . He makes a profit of Rs. Now if the price of the security falls any further.1000 and the two-month futures trades at 1006. The loss of Rs.402. The security trades at Rs.350. Assume that the spot price of the security he holds is Rs.1010. Let us see how this works.000 for a period of two months. This works out to an annual return of 6 percent. Take for instance that the price of his security falls to Rs. will be offset by the profits he makes on his short futures position. he would have to buy the security and hold on to it. His hunch proves correct and two months later the security closes at Rs.1. Two–month futures cost him Rs. Speculation: Bullish security.00. he will suffer losses on the security he holds. take on a short futures position. Today a speculator can take exactly the same position on the security by using futures contracts. For this he pays an initial margin.

How can he trade based on his opinion? In the absence of a deferral product. so will the futures price. On the day of expiration. 1. 2. ABC trades at Rs. If you notice that futures on a security that you have been observing seem overpriced. Take delivery of the security purchased and hold the security for a month. 3. Because of the leverage they provide. you can make riskless profit by entering into the following set of transactions.000. borrow funds. . how can you cash in on this opportunity to earn riskless profits. sell the futures on the security at 1025. If the security price rises. Now unwind the position. Say for instance. assume that the minimum contract value is 1. Two months later the security closes at 1010. so will the futures price. there wasn’t much he could do to profit from his opinion. sell futures Stock futures can be used by a speculator who believes that a particular security is over– valued and is likely to see a fall in price.20. As an arbitrageur. On day one. Arbitrage: Overpriced futures: buy spot. Simple arbitrage ensures that futures on an individual securities move correspondingly with the underlying security. Simultaneously.000. the spot and the futures price converge. Speculation: Bearish security.00.20. as long as there is sufficient liquidity in the market for the security.000. sell futures The cost-of-carry ensures that the futures price stay in tune with the spot price. He buys 100 security futures for which he pays a margin of Rs. Whenever the futures price deviates substantially from its fair value.1025 and seem overpriced. the futures price converges to the spot price and he makes a profit of Rs. This works out to an annual return of 12 percent.comparison. If the security price falls. arbitrage opportunities arise.1000. 4. On the futures expiration date. Let us understand how this works. Today all he needs to do is sell stock futures. One–month ABC futures trade at Rs. buy the security on the cash/spot market at 1000.400 on an investment of Rs. security futures form an attractive option for speculators.

Arbitrage: Underpriced futures: buy futures. The result is a riskless profit of Rs. Sell the security. On day one. 4.1000. Return the borrowed funds. 2. ABC trades at Rs. Say the security closes at Rs.975. Buy back the security. Now unwind the position. Remember however. When does it make sense to enter into this arbitrage? If your cost of borrowing funds to buy the security is less than the arbitrage profit possible. On the futures expiration date. it makes sense for you to arbitrage. Futures position expires with profit of Rs. 1. sell spot Whenever the futures price deviates substantially from its fair value. 7. buy the futures on the security at 965. Simultaneously.10 on the futures position. 6.10. 8.1015. It could be the case that you notice the futures on a security you hold seem underpriced. The futures position expires with a profit of Rs. One–month ABC futures trade at Rs. Make delivery of the security. The result is a risk less profit of Rs.15 on the spot position and Rs. How can you cash in on this opportunity to earn riskless profits? Say for instance. arbitrage opportunities arise. Say the security closes at Rs. As an arbitrageur. In the real world. 3. 6. 965 and seem underpriced. you can make riskless profit by entering into the following set of transactions. one has to build in the transactions costs into the arbitrage strategy. If the returns you get by investing in riskless instruments is less than the return from the .5. 5. the spot and the futures price converge.10 on the futures position.25 on the spot position and Rs. 7. sell the security in the cash/spot market at 1000. that exploiting an arbitrage opportunity involves trading on the spot and futures market. This is termed as cash–and–carry arbitrage.10.

As more and more players in the market develop the knowledge and skills to do cash–and–carry and reverse cash–and–carry. Take in this situation the spot price falls below the strike price we will exercise the option because we will have the right to sell. we will see increased volumes and lower spreads in both the cash as well as the derivatives market. . sell put option When we are bullish about the market we can buy a call option and pay premium on it. it makes sense for you to arbitrage. and get premium on it. this is because incase the market comes down we can be hedged against the losses. Using Options When we are bullish about the market: Buy call option. And the person whom we sell the call option will be under loss so he will forego the contract hence we will also keep the premium he gave us as profit. and get premium on it. this is because incase the market goes up we can be hedged against the losses. Simultaneously we can sell a put option. When we are bearish about the market: Buy put option. It is this arbitrage activity that ensures that the spot and futures prices stay in line with the cost–of–carry. Take in this situation the spot price rises above the strike price we will exercise the option because we will have the right to buy. So we will earn a profit. sell call option When we are bearish about the market we can buy a put option and pay premium on it. As we can see. And the person whom we sell the put option will be under loss so he will forego the contract hence we will also keep the premium he gave us as profit.arbitrage trades. So we will earn a profit. This is termed as reverse–cash–and– carry arbitrage. Simultaneously we can sell a call option. exploiting arbitrage involves trading on the spot market.

(RIL). for Rs.99%. Shareholding pattern of RPL is as under :-1) RIL 337. Initially. obviously. at the higher levels of Rs.00 cr. being 18. even after paying mark to market losses and incremental margins. This has resulted in reverse arbitrage.3. Conversely. short positions seems to have been created by the informed circles. from today. But now. and subsequently. and since the scrip was under ban. was also under ban. The share price of RPL has witnessed a lot of volatility. As to why F&O trading in a NIFTY 50 stock came under a ban in F&O Segment Reliance Industries Ltd. the scrip has resumed trading again in F&O.500 crores . when cash segment ruled higher than F&O. shares being 100% Rs. till last week. This has reduced stake of RIL in the RPL from 75% to 70.275 plus.223 per share. in F&O. The market report indicates that about 12 crore shares are in open interest in future segment.295 to now at Rs.4.01% stake of RPL. when share price fell from Rs. at an average price of Rs.Downside of Derivatives with few live examples A case study on recent developments in RPL. they kept continuing with open position. actual sell has been triggered by RIL in cash market.04 crores equity shares. came under ban in F&O segment.225 crores Rs.900 crores Rs. finding these price levels as unrealistic. especially in F&O segment. shares being 5% 3) Public 90. till Friday. While taking a feel of retail investors' position.50 cr. This also indicates paucity of floating stock.223 per share. This was also first instance when a scrip of NIFTY 50. for matching open interest. thus realizing an average of Rs. due to Market Wide Limit having crossed 95%. majority of them are long on the scrip.023 crores. in options segments at various rates for three months. informed circle is reported to be short in the counter.00 cr. apart from additional open interests for Put and Call.4. in the current month series of November. (RPL). holding company of Reliance Petroleum Ltd.375 crores Rs.215.50 cr shares being 75% 2) Chevron 22. has sold about 4. The scrip RPL. imposed due to higher volatility. shares being 20% Total 450.

727 crores. Chevron may not be interested in raising its stake to 29% as it would need close to Rs.6.2. including that of RPL.60 per share. on enhanced equity of Rs. Chevron. at Rs. Rs.3. being 4. for 319. and realize close to Rs. in the mega refinery.4.26. in company's 33 rd AGM held in October in Mumbai. shares at Rs.050 crores for subscribing 67. with an option to raise it to 29% by June 09. based on SEBI formula.842 crores. shares at par Rs. presently has 5% stake in RPL.3. 2) RIL would have an other income of Rs.750 crores Total RIL has almost realized its cost of Rs. had stated that the company would be capitalizing on the investments held.1.50. on which long term capital gain of Rs.RIL has acquired its 75% stake as under :-1) 270 cr. The preferential allotment can only be made.67. for its capex programme at K G Basin.200 plus.000 crores. Hence.200).842 crores. could predict this move.60 per share. So. cost per share at Rs.5 cr. 3) RIL has been able to mop up close to Rs. 5) Chevron. Since.99% stake. and keeping its stake in RPL at 70%. shares having subscribed at par were presumed to have been sold. effective cost of 71% stake in RPL. which would vastly improve the consolidated results of RIL. in April 2006. which is tax free.50 shares. post commencement of refinery. has been earned by RIL.60 per share Rs.4. post IPCL merger.000 crores. translating into.50 cr. which would give an extra EPS of Rs. post this minority stake sale: 1) The control of RIL on RPL is not affected as this is a minor dilution. . that Chairman of RIL. likely to be taken by RIL at a future date. Mukesh Ambani. Nobody.46 crores shares are Rs.8. at Rs. in quarter ending December 07.050 crores 337. Now what could be likely move and developments. would opt to offload its 5% stake in favour of RIL. One may recall.46 crore share.000 crores (tax free) when it needs funds.1.000 crores. 4) RIL may further decide to offload . The market value of this is close to Rs. and 71% stake is quite reasonable.30. investments sold are based on FIFO (first in first out) basis.453 crores.700 crores 2) 67.2. (presuming market price to remain above Rs. as per the terms of the share subscription Agreement.54 . At this rate.4. which would be at Rs.

on the next move of the management. Here is a famous case that depicts the how risky the business is. back to 75%. In nutshell. (Thursday 29 th November) to enable them to have a better close out. .350 crores. THE BARINGS BANK DEBACLE The derivative trading is not as easy as perceived.6) On happening this event. The control and risk management lessons to be learnt from this fall are the same as much to cash positions as they do to derivative ones. in this case. at a cost of just Rs. let's take a call. the market (cash and F&O) is in full control of the management. continues. Now. how share price of RPL is likely to behave. as that will have far reaching consequences. on closing day. they would opt to roll over their positions in December series. coupled with retaining majority and respectable stake. this was a calculated move. RIL would be able to raise its stake. Britain's oldest merchant bank. below Rs.000 crore plus. as market perception has changed positive. in coming times. is a example of how not to manage a derivatives operation.200 per share. tries to bring down the price on closing day. which would take direction. on the stock. having initiated shorts in F&O at an average of Rs. holding short position of close to 10 crore shares. 1) As majority of retail investors are long. by RIL. for various reasons (no need to elaborate them). 3) Since. 2) Informed circle. may not be interested in rolling over. But. as bullish outlook on the stock. Also. they may be interested to see a lower rate. lot of interested buying may be seen. weakness may not be seen from beginning of December F&O series 4) If informed circle.1. from investment and arbitrage view point. no more.1. The leverage and liquidity offered by futures contracts makes an institution fall with lightning speed. are reported to have made a gain of Rs.275 per share. whereby. The events that led to the fall of Barings. huge cost has been recovered. delivery based selling is expected on the counter. 7) The informed circles.

(www. The nominal size of these positions is breathtaking. Before the earthquake. reversing the trade when the price difference had narrowed or disappeared. which Barings called 'switching'. required Leeson to buy the cheaper contract and to sell simultaneously the more expensive one.htm) . 1995. These were unauthorised trades which he hid in an account named Error Account 88888. Nikkei traded in a range of 19. Because Leeson's official trading strategy was to take advantage of temporary price differences between the SIMEX and OSE Nikkei 225 contracts. But Leeson's Osaka position reflected only half of his sanctioned trades. This kind of arbitrage activity has little market risk as the positions were always matched. Barings had outstanding notional futures positions on Japanese equities and interest rates of US$27 billion: US$7 bn on the Nikkei 225 equity contract and US$20 bn on Japanese government bond (JGB) and Euro yen contracts.094 contracts reached about a month later.The activities of Nick Leeson on the Japanese and Singapore futures exchanges led to the downfall of Barings.karvy. But Leeson was not short on SIMEX. Barings collapsed as it could not meet the enormous trading obligations. When it went into receivership on February 27.com/articles/baringsdebacle.000 contracts on the Osaka Stock Exchange. which Leeson established in the name of the bank. This arbitrage. he had to be short twice the number of contracts on SIMEX.500. A few days after the earthquake.68 bn. 892 Nikkei put and call options with a nominal value of $6. The build-up of the Nikkei positions by Leeson went in the opposite direction to the Nikkei .as the Japanese stock market fell. Leeson sold 70. their enormity is all the more astounding when compared with the banks reported capital of about $615 million.000 to 19. He also used this account to execute all his unauthorised trades in Japanese Government Bond and Euro yen futures and Nikkei 225 options: together these trades were so large that they ultimately broke Barings. Leeson started an aggressive buying programmed which culminated in a high of 19. If Leeson was long on the OSE. infact he was long approximately the number of contracts he was supposed to be short. Leeson had long futures positions of approximately 3.

When the PCR is above 1. an extremely intriguing anomity has arisen in the Indian stock markets. is a powerful technical trading indicator that monitors the stock and stock-index bets that speculators are making at any given time. Speculators who expect individual stocks or the indices to fall in the months ahead buy put options. While I certainly wish there was an easy bullet-proof interpretation of this odd event. a PCR above 1.IMPORTANCE OF PUT-CALL PARITY RATIO (PCR) IN DERIVATIVES In just the past couple weeks. (This Pointer taken from www. and the contrarian slant on this is complex as well.00. its sudden appearance today within the context of current market conditions is a puzzling mystery. as I will outline in this essay. Translated into pure sentiment terms. Today’s high PCR anomaly is difficult to interpret.00 for the first time in at least a decade! This odd development is vexing bulls and bears alike. The Put/Call Ratio. which promise hefty payouts on higher prices. it indicates that the majority probably expects lower prices in the months ahead.zealllc. And since we humans are naturally bullish. or PCR.00 is an extraordinarily rare event. The PCR quantifies the ratio of the daily trading volume in these two opposing bets. as today. granting speculators valuable insights into what the majority happens to be expecting. Speculators who expect rising prices buy call options.com) . it literally means that the daily trading volume on puts is higher than calls. The famous Put/Call Ratio 21-day moving average has soared above 1. derivatives bets which increase in value when prices decline. Both bullish and bearish cases can be built around this surreal development.

Questionnaire survey with the various derivatives dealers and with feedback and tips were taken from Derivatives strategist team. AMC’s.bear run and heavy volatile and during consolidation trends of the market. .Research Methodology: The whole study was totally based on the primary data there was no as such formal procedure most of the research was done in the dealing room As it is one type of mechanism so a lot of time was spent to understand the concept.e. HNI’s. . Most important factor in this research was the dealing room operation. The data was primary and secondary data and collected from the Orion software and Falcon software. The main function was to look at the screen and watch how the market is basically moving with the change in time. the number of cases considered during the project for various dealings. The market methodology followed is primary data collected from a channel of network that involves independent . All over the world there are lots of stock exchanges dealing with Equity derivatives but for the purpose of the study NIFTY has been considered and various examples are quoted using Nifty and certain stock derivatives are taken for examples when strategies are quoted using examples and studying the futures and options market during different market times and trying to adopt different strategies for different types of market conditions like Bull run . .Also dealing room operations.Financial institutions. Banks. The total sample size was 50 i. The dealings of the firm with its client investors was properly observed and studied in detail.The dealings of the firm with its client investors will properly observed and studied in detail. Brokers who use these derivative strategies or use them on behalf of their clients.

000 shares of Hindustan Lever Ltd (HLL) at a strike price of Rs 250 per share. whereas “Seller / Writer” of the Call Option is “obliged to Sell” the underlying stock when the buyer of Call decides to Exercise his / her Option. Stock: INFOSYSTCH View: Bullish Strategy: LONG (BUY) CALL . Example: Suppose you have bought a call option of 2. 2007 whenever asked. The seller of this call option who has given you the right to buy from him is under the obligation to sell 2. and Derivatives materials The expected outcomes from the thesis is to understand and apply how to use the concept of equity strategies and under what market conditions we should use these Equity market strategies and try to beat the market by hedging our holdings and implies the use of all the popular equity derivatives strategies with practical examples it has been illustrated well for even a layman can understand and try to grasp how these strategies are useful in the stock markets DATA ANALYSIS AND INTERPRETATION The conditions under which the use of equity derivative strategies can be analyzed by the help of using questionnaire to collect data are: 1) Strategies you normally use when market view is highly bullish Buy Call Option CALL Option: “Buyer” of a Call Option on a particular stock “gets the right to Buy” the underlying Stock. This option gives you the right to buy 2.000 shares of HLL at Rs250 per share on or before March 30.And secondary data from a host of book materials. When the spot / cash price is higher than the Strike price (plus cost).000 shares of HLL at Rs250 per share on or before March 30. the buyer of Call could exercise his “right to buy” at the Strike price. 2007.

4.. the call option appreciated to Rs. strike price + premium paid MAXIMUM PROFIT: Unlimited MAXIMUM LOSS: Rs.2230/- Strategy: Bought INFOSYSTECH 2250 June CA @ Rs.e. Long Call: Initiated on 24th Mar Spot Price: Rs .Rationale: Technically the stock has given an upward breakout & should find a target of around 2300 in the next few trading sessions.70 as the stock price rose and we sold off the position resulting in a profit.2295 i.45 (Lot size = 100) Result: In about a weeks’ time.500 per lot . A graphical representation of this option position is given below BREAK EVEN POINT: Rs.

i... The put option was profitable and the call option expired worthless resulting in a net profit. strike price – premiums paid MAXIMUM PROFIT: Unlimited MAXIMUM LOSS: Total premium amount paid . BREAK EVEN POINTS: 4300. strike price + premiums paid 3900.110 (Lot size = 50) Result: NIFTY broke the crucial support level of 4050 and trended downward to 3800 levels.2) Strategies you use when the stock is expected to move far enough in either direction in the short-term Index: NIFTY Outlook: Highly Volatile Strategy: LONG STRADDLE (Buy an equal number of calls and puts of the same strike price and same expiry) Rationale: Due to global markets the NIFTY Index is expected to volatile Long Straddle: Initiated on 1st May Spot Value: 4090 levels Strategy: Buy NIFTY 4100 May CA @ Rs.e. i.e. This strategy is profitable if NIFTY is above 4300 or below 3900.90 (Lot size = 50) Buy NIFTY 4100 May PA @ Rs.

7. Now.e. BREAK EVEN POINTS: 520.e.10 (Lot size = 675) Buy TISCO Feb 450 PA @ Rs.10 (Lot size = 675) Result: TISCO stock responded positively to this strategy and rallied to 510-520 levels where we cleared our call and sold it at Rs.28. i..3) Strategy to be used when market is highly volatile : Stock: TISCO Outlook: Highly Volatile Strategy: LONG (Buy) STRANGLE (Buy an equal number of calls and puts at different strike prices and same expiry) Rationale: The stock could respond either way with high volatility due to the Corus takeover.. We therefore realized a net profit of Rs. upper strike price + premiums paid 430. lower strike price – premiums paid MAXIMUM PROFIT: Unlimited MAXIMUM LOSS: Total premium amount paid . after the Corus deal TISCO stock took a hit and spiraled all the way down to 450 levels where we sold off the put for Rs. Long Strangle: Spot Price: Strategy: Initiated on 23rd Jan 470 levels Buy TISCO Feb 500 CA @ Rs. i.15 per lot.

A graphical representation of this strategy is given below suggesting Result: BREAK EVEN POINT:Rs.21 per lot.32.42 (Lot size = 250) Sell SBI 1230 April CA @ Rs.4) Strategy to be used when the market is moderately bullish Stock: Outlook: Strategy: SBIN Moderately Bullish BULL SPREAD (Buy a call and sell a call at a higher strike) Rationale: The overall banking sector is looking attractive for buying.14.8000 per lot (250 x 32) . hence resulting in a net profit of Rs.1172 (Lower Strike + Net debit) MAXIMUM PROFIT: Rs.85 and bought back the 1230 call for Rs.1140/Buy SBI 1140 April CA @ Rs. Bull Spread: Spot Price: Strategy: Initiated on 31st Mar Rs .Technical indicators are strong upward move in SBIN with strong resistance at 1230-1250 levels.10 (Lot size = 250) After executing this strategy. We sold the 1140 call for Rs. SBI rallied higher and we realized a net profit in this strategy.500 per lot (250 x 58) MAXIMUM LOSS: Rs.

Premium received MAXIMUM PROFIT: Premium received MAXIMUM LOSS: Unlimited.1.90) as the stock went down and this resulted in a loss of Rs. .5) Strategies you use when market view is bullish to stagnant : Stock: SAIL Outlook: Bullish to stagnant Strategy: SHORT (Sell) PUT Rationale: The stock is trading in a oversold zone along with massive increase in the open interest in call options of strike prices in 115 & 118.3.50. Our outlook was wrong and SAIL stock fell along with the general market. A graphical representation of this strategy is given below. 107.50 (Lot size = 2700) Result: This is one example where our strategy resulted in a loss.114/Strategy: Sold SAIL 110 April PA @ Rs.We had to buy back our put at a higher price (at Rs. 2. BREAK EVEN POINT: Rs. Short Put: Initiated on 9th Apr Spot Price:Rs .40 per lot. Strike price .

the 1440 call was bought back at Rs.2 resulting in a net profit of Rs. Bull Call Ratio Spread: View: Spot Price: Strategy: Initiated on 31st feb Moderately Bullish on Reliance Rs.15 (Lot size = 150) Sell RIL Mar 1470 CA @ Rs. BREAK EVEN POINT: MAXIMUM PROFIT: MAXIMUM LOSS: 1390 & 1520 Rs.10 and the 1470 call was bought back at Rs.57. 7500 per spread Rs.6 ) Strategy to be used when market is mildly bullish Stock: RELIANCE Outlook: Mildly Bullish Strategy: BULL CALL RATIO SPREAD (Buy a call and sell/three two higher strike calls) Rationale: The overall market is positive and RELIANCE is trading at its 50% retracement levels and may show an upward move with resistance at 1440 and 1470.10 (Lot size = 150) Result: Reliance rallied to levels most profitable for this strategy. When reliance was at 1420 levels profits on the 1380 call were booked at Rs.1360 levels Buy RIL Mar 1380 CA @ Rs. 1500 on the downside & Unlimited above 1520 .35 per lot.35 (Lot size = 150) Sell RIL Mar 1440 CA @ Rs.

40 per contract.7) Strategy to be used when market is moderately bullish Stock: Outlook: Strategy: HINDALCO Moderately Bullish PROTECTIVE PUT (Own stock/futures. Our loss was limited because of the protective put. The stock came down to 140 levels but our loss was limited only to Rs.40 per lot .7. The put option appreciated to Rs.187.40 MAXIMUM PROFIT: Unlimited MAXIMUM LOSS: Rs.40 and the futures closed at 140 levels during expiry.7. and buy a put) Rationale: The momentum in stock is good along with positive movement in the RSI. EXAMPLE: HINDALCO Protective Put Spot Price: 180 levels Strategy: Buy HINDALCO futures @ 185 levels (Lot size = 1595) Buy HINDALCO Feb 180 PA @ Rs. BREAK EVEN POINT: Rs. without which we would have incurred huge losses.40 (Lot size = 1595) Result: Hindalco stock was dented as a result of the Novelis takeover. Technically the stock is bullish with a target price of 190-195.2.

RECOMMENDATIONS Major findings: 1) Due to more transparency and new policies implemented by SEBI players in this market is increasing at a very high rate and the new comers are well-equipped to compete with others. So most of the share broking firms are trying to grab new customers in derivatives as well as to retain the old ones. so this requires fine ad favourable brokerage charges as well as excellent service to their customers and they have a separate desk for formulating or using equity derivatives 2) Broking firms should shift from Equity research to Derivatives research to be able to compete with the foreign broking house when FDI in retail broking opens for these foreign players 3) Few dealers are not professionally qualified to understand strategies to play on behalf of their clients. This leads to reduction in the cliental base be it institutional or broking. 4) During the recent market trend (where sensex has witnessed correction of 1500 points and nifty by 800 points) the broking houses successfully employed these strategies and this was a huge benefit for its clients .

2) Proper training has to be conducted for the dealers on time to time basis to make them more knowledgeable and efficient to properly deal with the clients.Recommendations: 1) The broking houses needs to recruit few more Derivatives analysts in their research department to cope with the growth in Derivatives segment. 6) Reducing margins for easier access to f&o rather than heavy margins at present 7) SEBI should consider longer expiration contracts like 6 months expiry to 3 years expiry contracts 8) Derivatives are weapons of mass destruction as said by millionaire investor Warren Buffet so only an professional should be employing these derivatives strategies 9) Derivatives lot sizes on individual scrips should be reduced to mini contracts from existing contract sizes . chota sensex ( 5 lot size) etc. And to give proper advice in market crashes 3) Broking houses should have specialty software package to deal with Derivatives strategies at all levels of the firm even to the dealers so they can employ these strategies 4) Making the importance of derivatives understandable to retail clients by organizing investor camps 5) Bringing in more small size contracts for retail public to hedge their positions like mini nifty (20 lot size) . .

Warren Buffet.CONCLUSION Derivatives as a risk management tool should be employed after understanding the risk profile of yourelf or your clients or it will lead to increased risk if not used at the right time or without understanding the market trend. The advent of Derivatives trading in the country will change the face of the Indian capital market very soon in terms of the volume of transactions. One should avoid using derivatives in a very volatile market that would magnify the losses to a greater extent as we buy or sell in lot sizes and should use proper strategies required in a volatile market and derivatives trading will soon surpass the daily turnover in the cash segment in both BSE and NSE currently derivatives trading is dominated by NSE in terms of turnover. The growth of Derivatives as a mass trading technique in the country is unstoppable. the nature and settlement of trade. When retail broking space is opened to FDI we will be able to see more use of complex derivatives product available in the market in India which is currently not available Then we will be able to see retail public trading more in the derivatives segment than the institutional trading which holds a majority of the chunk in the Derivatives trading segment in India. I personally don’t think many of our colleagues in the business have really understood the impact that Derivatives can have on the broking business. and the profile of market participants. who will be able to trade and speculate better than in the cash market With Derivatives one needs to apply common sense and take small positions in the market rather than taking exuberant positions and losing the entire capital deployed in the F&O segment “DERIVATIVES ARE TO BE VIEWED AS WEAPONS OF MASS DESTRUCTION” as said by the great investor of all times Mr. When it ultimately gathers momentum. going by the indicators available and the signals for the future. . the biggest beneficiary will be the traders and speculators.