A derivative security is a security whose value depends on the value of together more basic underlying variable these are also known as contingent claims. Securities have been very successful in innovation in capital markets.
The emergence of the market for derivatives product most notably forward, future and option can be traced back to willingness of risk averse economic agents to guard themselves against uncertain arising out of fluctuation in asset prices. By their very nature, financial markets are market by a very high degree of volatility. Though the use of derivatives products, it is possible to partially or fully transfer price risks by locking in asset prices. As instrument of risk management these generally don’t influence the fluctuation in underlying asset prices.
However, by locking-in asset prices, derivatives products minimize the impact of fluctuation in assets prices on the profitability and cash- flow situation of risk-averse investor. Derivatives are risk management instruments which derives their value from an underlying asset. Underlying assets can be bullion, index, share, currency, bonds, interest, etc.
Objectives of the Study
To understand the concept of the Financial Derivatives such as Futures and Options. To examine the advantage and the disadvantages of different strategies along with situations. To study the different ways of buying and selling of Options.
The study has only made humble attempt at evaluating Derivatives markets only in Indian context. any alternation may come.
. The study is not based on the international perspective of the Derivatives Markets.4
SCOPE OF THE STUDY
The study is limited to “Derivatives” with special reference to future and option in the Indian context and the India info line has been taken as representative sample for the study. The study cannot be said as totally perfect.
. study was confined to conceptual understanding of Derivatives market in India. As the time was limited. Limitations: The study was conducted in Hyderabad only. Magazines and Internet.e.5
Research Methodology The type of research adopted is descriptive in nature and the data collected for this study is the secondary data i. from Newspapers.
Com has been the only India Website to have been listed by none other than Forbes in it's 'Best of the Web' survey of global website.. software supply services. selling advertisement space on the site. India Infoline Commodities pvt Ltd.indiainfoline. Mutual Funds. a must read for investors in south Asia is how they choose to describe India info line. GOI Relief bonds.. software product development and marketing.7
THE INDIA INFOLINE LIMITED
India info line was founded in 1995 by a group of professional with impeccable educational qualifications and professional credentials. To engage or undertake software and internet based services. Commodities broking. www. which is India' No. Its institutional investors include Intel Capital (world's) leading technology company. India Infoline is the leading corporate agent of ICICI Prudential Life Insurance Company.. It has been rated as No.1 Private sector life insurance Company. Fixed Deposits. India info line group offers the entire gamut of investment products including stock broking. computer consultancy services. Stock and Commodities broking is offered under the trade name 5paisa. holds membership of MCX and NCDEX
Main Objects of the Company
Main objects as contained in its Memorandum or Association are: 1. not just once but three times in a row and counting. data processing IT enabled services. web consulting and related services including web designing and web maintenance. software development services.l the category of Business News in Asia by Alexia rating. ICICI. CDC (promoted by UK government).. E-Commerce of all types including
. Post office savings and life Insurance. a wholly owned subsidiary of India Infoline Ltd. TDA and Reeshanar.
capital funding proposals. Mortgages. study. probe. 3. industries. debentures. investigation. foreign financial institutions. financial institutions. B. bond. help. competitive analysis. Distribution: 1. Equities 2. Govt of India bonds.
A. developmental work on economy. Fixed deposits C. PMS E. secondary equity market. survey. Derivatives 3. Insurance D. market research. Distribution C. agricultural and mineral. corporate business houses.
Products: the India Infoline pvt ltd offers the following products
A. To undertake. 2. ventures. Mutual funds 2. VISION STATEMENT OF THE COMPANY: “our vision is to be the most respected company in the financial services space in India”. preparations of corporate / industry profile etc. carry on.8
electronic financial intermediation business and E-broking. capital market on matters related to investment decisions primary equity market. Commodities B. E-broking. promote any kind of research. Derivatives and Commodities brand name of 5paisa 1. conduct. E-Broking: It refers to Electronic Broking of Equities. Insurance: under the
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Ltd. etc. India Info line Ltd. Health insurance
THE CORPORATE STRUCTURE
The India Info line group comprises the holding company. Is the corporate agent of ICICI Prudential Life Insurance.com. is a registered commodities broker MCX and offers futures trading in commodities.
. NSE and DP with NSDL. Mobilizes Mutual Funds and other personal investment products such as bonds. General insurance 3. Ltd. India Info line Ltd owns and managers the web properties www. India Infoline.com Distribution Company. it also undertakes research. The parent company.Com and www.5paisa. fixed deposits. The corporate structure has evolved to comply with oddities of the regulatory framework but still beautifully help attain synergy and allow flexibility to adapt to dynamics of different businesses. Life insurance policies 2. Customized and off-the-shelf. India Info line Insurance Services Ltd. which has 5 wholly-owned subsidiaries. engaged in selling Life Insurance products?
India Info line Commodities Pvt. engaged in engaged in distinct yet complementary businesses which together offer a whole bouquet of products and services to make your money grow.9
1. Indian Info line Securities Pvt.Indiainfoline. Its business encompasses securities broking Portfolio Management services. is a member of BSE.
.10 India info line services Pvt Ltd.
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Management of India info line Ltd.Venkataraman Director. India infoline. He spent eight fruitful years in equity research sales and private equity with the cream of financial houses such as ICICI group. Mukesh sing Seshadri Bharathan S sriram Sandeepa Vig Arora Darmesh Pandya Toral Munshi Anil mascarenhas Pinkesh soni Harshad Apte Director. kharagpur.Cost Account . Alternative channel Vice president. Nirmal jain .
India infoline is a professionally managed company /s day to day affairs as executive Directors have impeccable academic professional track record . Singapore the key management team comprises seasoned and qualified professionals.is a Chartered Account . Satpal khattar –Reeshanar investment. Later he was CEO of an equity research organization.E capital. And an Electronic engineering degree from IIT. Technology Vice president. Barclays de Zoette and G. Research Chief Editor Financial controller Chief Marketing officer
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Without having an interest in the underlying product market. by locking –in asset prices. In financial sense. futures and options. Through of derivatives of products. However. as: A. loan
whether secure or unsecured. these generally do not influence the fluctuations underlying prices. share. The term Derivative has been defined in Securities Contracts (Regulation) Act 1956. which has been derived from another variable. a measure of weight in pound could be derived from a measure of weight in kilograms by multiplying by two. derivatives products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk–averse investors.
. DEFINITION Understanding the word itself. As instruments of risk management. risk instrument or contract for differences or any other form of security. the financial markets are marked by a very high degree of volatility. The word originates in mathematics and refers to a variable. of underlying securities. Index or a Commodity. For example. By their very nature. Underlying asset can a Stock. A security derived from a debt instrument.13
The emergence of the market for derivative products. Without the underlying product and market it would have no independent existence. most notably forwards. B. Currency. Some one may take an interest in the derivative products. Bond. can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. which derives its value from the prices. A contract. but the two are always related and may therefore interact with each other. these are contracts that derive their value from some underlying asset. it is possible to partially or fully transfer price risks by locking –in asset prices. or index of prices. Derivatives is a key to mastery of the topic.
currency. which may be a share. It is so because. derivatives would not create any risk. They simply manipulate the risks and transfer to those who are willing to bear these risks. More over. If does not take insurance. he runs a big risk. Derivatives instruments can be used to minimize risk. Mr. For example. actual delivery of the underlying asset is not at all essential for settlement purposes. Similarly. Derivatives are used to separate risks and transfer them to parties willing to bear these risks. when we use derivatives for hedging.14
IMPORTANCE OF DERIVATIVES
Derivatives are becoming increasingly important in world markets as a tool for risk management. Suppose he buys insurance [a derivative instrument on the bike] he reduces his risk. having an insurance policy reduces the risk of owing a bike. hedging through derivatives reduces the risk of owing a specified asset. Thus.
. A owns a bike. etc. The kind of hedging that can be obtained by using derivatives is cheaper and more convenient than what could be obtained by using cash instruments.
RATIONALE BEHIND THE DEVELOPMENT OF DERIVATIVES
Holding portfolio of securities is associated with the risk of the possibility that the investor may realize his returns.
These forces are to a large extent controllable and are termed as “Non-systematic Risks”. There are other types of influences. Sum are internal to the firm bike: Industry policy Management capabilities Consumer’s preference
Labour strike.systematic risks by having a well-diversified portfolio spread across the companies. being able to buy & sell relatively large amounts quickly without substantial price concessions. industries and groups so that a loss in one may easily be compensated with a gain in other. We therefore quite often find stock prices falling from time to time in spite of company’s earnings rising and vice –versa. Liquidity means. and they are termed as “systematic risks”. Price or dividend (interest). Rational behind the development of derivatives market is to manage this systematic risk. There are various influences. 2. For instance inflation interest rate etc. which would be much lesser than what he expected to get. Political 3. which are external to the firm. Their effect is to cause the prices of nearly all individual stocks to move together in the same manner. Economic 2. 1. Those are 1. Sociological changes are sources of Systematic Risk.
. cannot be controlled. liquidity. which affect the returns. etc. An investor can easily manage such non.
CHARACTERISTICS OF DERIVATIVES
1. etc. Debt instruments are also finite life securities with limited marketability due to their small size relative to many common stocks. currency. a need was felt to introduce financial products like other financial markets in the world. They are leveraged instruments. These factors favor for the purpose of both portfolio hedging and speculation.16 In debt market. They are vehicles for transferring risk.
. It was until recently a cash market with facility to carry forward positions in actively traded “A” group scrips from one settlement to another by paying the required margins and barrowing money and securities in a separate carry forward sessions held for this purpose. 3. 2. Their value is derived from an underlying instrument such as stock index. a much larger portion of the total risk of securities is systematic. However. India has vibrant securities market with strong retail participation that has evolved over the years.
3. Hedgers. Arbitrageurs.
. They are willing to take risks and they bet upon whether the markets would go up or come down. They could be making money even with out putting their own money in. Speculators: They are traders with a view and objective of making profits. 1. Speculators. and such opportunities often come up in the market but last for very short time frames. which manages the risk. Arbitrageurs: Risk less profit making is the prime goal of arbitrageurs. They are specialized in making purchases and sales in different markets at the same time and profits by the difference in prices between the two centers. Hedgers: The party. is known as “Hedger”. 2.17
MAJOR PLAYERS IN DERIVATIVE MARKET
There are three major players in their derivatives trading. Hedgers seek to protect themselves against price changes in a commodity in which they have an interest.
the majority of options traded on options exchanges having a maximum maturity of nine months. The underlying asset is usually a moving average of a basket of assets. Warrants: Longer – dated options are called warrants and are generally traded over – the – counter. Options generally have lives up to one year.
. Equity index options are a form of basket options Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a pre-arranged formula. They can be regarded as portfolios of forward contracts. 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. LEAPS: The acronym LEAPS means Long Term Equity Anticipation Securities. Futures contracts are special types of forward contracts in the sense. Forward contracts offer tremendous flexibility to the party’s to design the contract in terms of the price. 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.18
TYPES OF DERIVATIVES
Most commonly used derivative contracts are: Forwards: A forward contract is a customized contract between two entities where settlement takes place on a specific date in the futures at today’s pre-agreed price. delivery. Options: Options are two types . that the former are standardized exchange traded contracts.Calls and Puts. time and place. The two commonly used swaps are: Interest rare swaps: These entail swapping only the interest related cash flows between the parties in the same currency. Liquidity and default risk are very high. Baskets: Basket options are options on portfolios of underlying assets. 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. quality. These are options having a maturity of up to three years. quantity.
it differs with different instruments.
C. with the cash flows in one direction being in a different currency than those in opposite direction. The fundamental risks involved in derivative business includes
A. Related to the funding of activities of the firm including derivatives.
D. therefore the legal aspects
associated with the deal should be looked into carefully. Also known as default or counterpart risk. Market Risk: Market risk is a risk of financial loss as result of adverse movements
of prices of the underlying asset/instrument.
. Credit Risk: This is the risk of failure of a counterpart to perform its obligation as
per the contract. A firm faces two types of liquidity risks: Related to liquidity of separate products.
RISKS INVOLVED IN DERIVATIVES
Derivatives are used to separate risks from traditional instruments and transfer these risks to parties willing to bear these risks. Legal Risk: Derivatives cut across judicial boundaries. Liquidity Risk: The inability of a firm to arrange a transaction at prevailing market
prices is termed as liquidity risk.19 Currency swaps: These entail swapping both the principal and interest between the parties.
around the time India became independent men in mumbai gambled on the price of cotton in New York. they got Rs.2Lakhs by Securities and Exchange Board of India. emerging from a long history of stock market and foreign exchange controls. with the launch index Futures on sensex and nifty futures respectively.Gamblers preferred using the New York cotton price because the cotton market at home was less liquid and could easily be manipulated. by using fully automated screen based exchange. stock options in July 2001.20
DERIVATIVES IN INDIA
Indian capital markets hope derivatives will boost the nations economic prospects. Fifty years ago. Index Options was launched in june2001. If they guessed the last number. The country. A hybrid over the counter derivatives market is expected to develop along side. is one of the last major economies in Asia. Now. For example sensex is 6750 then the contract value of a futures index having sensex as underlying asset
. and stock futures in November 2001.7/.for every Rupee layout. This difference of market lot arises due to a minimum specification of a contract value of Rs. 2000 BSE and NSE became the first exchanges in India to introduce trading in exchange traded derivative products. They bet on the last one or two digits of the closing price on the New York cotton exchange. NIFTY is the underlying asset of the index futures at the futures and options segment of NSE with a market lot of 100 and BSE 30 sensex is the underlying stock index in BSE with a market lot of 30. Over the last couple of years the National Stock Exchange has pushed derivatives trading.72/. If they matched the last two digits they got Rs. which was established by India's leading institutional investors in 1994 in the wake of numerous financial & stock market scandals. India is about to acquire own market for risk. to refashion its capital market to attract western investment.
Derivatives Segments In NSE & BSE
On June 9.
which is to be paid on next day. For instance on July 1. viz.21 will 30x6750 = 202500. Thus. As long as the position is open. As per SEBI
. index futures at NSE shall be traded in multiples of 100 and a BSE in multiples of 30. last Thursday) shall closed out by the exchanged at the final settlement price which will be the closing spot value of the underlying asset.
The settlement of all derivative contracts is in cash mode.
There are two types of margins collected on the open position. June futures contract becomes invalidated and a September futures contract gets activated. For example in the month of June 2005 one can enter into their June futures contract or July futures contract or august futures contract. When futures contract gets expired. The last Thursday of the month specified in the contract shall be the final settlement date for the contract at both NSE as well as BSE.. Any position which remains open at the end of the final settlement day (i. July futures contract and august futures contract respectively. There is daily as well as final settlement. Out standing positions of a contract can remain open till the last Thursday of that month. The June 30. Every transaction shall be in multiples pf market lot. initial margin which is collected upfront and mark to market margin. July 28 and august 25 shall be the last trading day or the final settlement date for June futures contract. if Nifty is 2100 its futures contract value will be 100x2100=210000. Similarly. the same will be marked to market at the daily settlement price. the difference will be credited or debited accordingly and the position shall be brought forward to the next day at the daily settlement price.
At any point of time there will be always be available nearly 3months contract periods.e. a new futures contract will get introduced automatically.
Members of F&O segment:
There are three types of members in the futures and options segment. The professional clearing member is a clearing member who is not a trading member. Therefore. and 5 percent of notional value of futures and short option position in stocks is additionally adjusted from the liquid net worth of a clearing member on a real time basis. The clearing members are the members of the clearing corporation who deal with payments of margin as well as final settlements. It is mandatory for every member of the derivatives segment to have approved users who passed SEBI approved derivatives certification test. trading cum clearing member and professional clearing members.22 guidelines it is mandatory for clients to give margins. Position limits are imposed at the customer level. They are trading members. fail in which the outstanding positions or required to be closed out.
The national value of gross open positions at any point in time for index futures and short index option contract shall not exceed 33. banks and custodians become professional clearing members. The position limits are applicable on the cumulative combined position in all the derivatives contracts on the same underlying at an exchange. Typically.
It refers to the maximum no of derivatives contracts on the same underlying security that one can hold or control. Position limits are imposed with a view to detect concentration of position and market manipulation.33 times the liquid net worth of a clearing member. In case of futures and options contract on stocks the notional value of futures contracts and short option position any time shall not exceed 20 times the liquid net worth of the member. clearing member level and market levels are different. Trading members are the members of the derivatives segment and carrying on the transactions on the respective exchange. 3 percent notional value of gross open position in index futures and short index options contracts. to spread awareness among investors.
which monitors positions. price and volumes in real time so as to detect market manipulations. • Information about traded quantities and quotes should be disseminated by the exchange in the real time over at least two information-vending networks. Position limits be used for improving market quality. which are accessible to the investors in the country. The members of an existing segment of the exchange will not automatically become the members of derivatives segment. • • The exchange should have at least 50 members to start derivatives trading. • • • Trading should take place through an online screen based trading system. then he should not carry on any broking and dealing on any exchange during his tenure. An independent clearing corporation should do the clearing of the derivative market.23
Considering the constraints in infrastructure facilities the existing stock exchanges are permitted to trade derivatives subject to the following conditions. The derivatives trading should be done in a separate segment with a separate membership. The exchange must have an online surveillance capability.
. • The derivatives market should have a separate governing council and representation of trading/clearing members shall be limited to maximum of 40% of total members of the governing council. • The chairman of the governing council of the derivative division/exchange should be a member of the governing council. If the chairman is broker/dealer.
One of the parties in a forward contract assumes a long position i. In other words. agrees to buy the underlying asset on a specified future date at a specified future price. it costs nothing to the either party to hold the long/short position. For example. A forward contract is settled at maturity. This delivery price is chosen so that the value of the forward contract is equal to zero for both the parties. Therefore.25
Forwards are the simplest and basic form of derivative contracts.e. A forward contract can therefore. The forward price for a certain contract is defined as that delivery price which would make the value of the contract zero. These are instruments are basically used by traders/investors in order to hedge their future risks. The holder of the short position delivers the asset to the holder of the long position in return for cash at the agreed upon rate.e. that is the value of the contract is positive for him. This specified price referred to as the delivery price. if the price of the asset prices rises sharply after the two parties have entered into the contract. the forward price and the delivery price are equal on the day that the contract is
. assume a positive/negative value depending on the moments of the price of the asset. the party holding the long position stands to benefit. To explain further. agrees to sell the asset on the same date at the same price. a key determinate of the value of the contract is the market price of the underlying asset. It is an agreement to buy/sell an asset at a certain in future for a certain price. Conversely the value of the contract becomes negative for the party holding the short position. The concept of forward price is also important. They are private agreements mainly between the financial institutions or between the financial institutions and corporate clients. The other party assumes short position i.
quantity. thanks to the economic and financial reforms. On the expiration date the contract will settle by delivery of the asset. Has a further step to widen and deepen the securities market the government has notified that with effect from March 1 st 2000 the ban on forward trading in shares and securities is lifted to facilitate trading in forwards and futures. During the past few years. the forward price is liable to change while the delivery price remains the same. delivery time and place. 3. If the party wishes to reverse the contract. it is to compulsorily go to the same counter party. there have been many healthy developments in the securities markets. to be performed in the future. This is a step in the right direction to promote the sophisticated market segments as in the western countries. Contract price is generally not available in public domain. which often results high prices. 6. has allowed the trading in derivative products in India.26 entered into. 2. 4. with the terms decided today. quality. The lifting of ban on forward deals in securities will help to develop index futures and other types of derivatives and futures on stocks. Forward contracts suffer from poor liquidity and default risk. Forward contracts offer tremendous flexibility to the parties to design the contract in terms of the price. Over the duration of the contract.
Forward Trading in Securities:
The Securities Contract (amendment) Act of 1999. A forward contract is a Bi-party contract.
Essential features of Forward Contracts:
1. It may be recalled that the ban on forward trading in securities was imposed in 1986 to curb certain unhealthy trade practices and trends in the securities market.
financial instruments and currencies.29
The future contract is an agreement between two parties two buy or sell an asset at a certain specified time in future for certain specified price. In this. and interest bearing instruments like treasury bills and bonds and other innovations like futures contracts in stock indexes are relatively new developments. However. there are a no of differences between forwards and futures.counter market. Futures exchanges are where buyers and sellers of an expanding list of commodities. These relate to the contractual futures. have existed for a long time. financial instruments and currencies come together to trade. A futures contract is a more organized form of a forward contract. Standardization: In the case of forward contracts the amount of commodities to be delivered and the maturity date are negotiated between the buyer and seller and can be tailor made to buyer’s requirement. Thus. cotton. The option buyer knows the exact risk. For instance a contract is struck between capital A and B. upon entering into the
. Organized Exchanges: Unlike forward contracts which are traded in an over. kind of participants in the markets and the ways they use the two instruments.the. Trading has also been initiated in options on futures contracts. currencies. these are traded on organized exchanges. silver. the way the markets are organized. The futures market described as continuous auction markets and exchanges providing the latest information about supply and demand with respect to individual commodities. which is unknown to the futures trader. Clearing House: The exchange acts a clearinghouse to all contracts struck on the trading floor. it is similar to a forward contract.
Features of Futures Contracts
The principal features of the contract are as fallows. option buyers participate in futures markets with different risk. This provides a ready. In a futures contract both these are standardized by the exchange on which the contract is traded. Futures contracts in physical commodities such as wheat. liquid market which futures can be bought and sold at any time like in a stock market. gold. futures are traded on organized exchanges with a designated physical location where trading takes place. etc. Futures in financial assets. cattle. etc. profiles of gains and losses.
Margins: In order to avoid unhealthy competition among clearing members in reducing margins to attract customers. The enforces the delivery for the delivery of contracts held for until maturity and protects itself from default risk by imposing margin requirements on traders and enforcing this through a system called marking – to – market. where it is a buyer to seller. Forward contracts are entered into for acquiring or disposing of a commodity in the future for a gain at a price known today. Initial margins on both the buyer as well as the seller. In other words the exchange interposes itself in every contract and deal. Actual delivery is rare: In most of the forward contracts. i. The concept of margin here is same as that of any other trade. The stock exchange imposes margins as fallows: 1. The advantage of this is that A and B do not have to under take any exercise to investigate each other’s credit worthiness. to ensure performance of the contract and to cover day to day adverse fluctuations in the prices of the securities. this is immediately replaced by two contracts. The members collect margins from their clients has may be stipulated by the stock exchanges from time to time and pass the margins to the clearing house on the net basis i. The accounts of buyer and seller are marked to the market daily.e. It also guarantees financial integrity of the market. Such a stop insures the market against serious liquidity crises arising out of possible defaults by the clearing members. the commodity is actually delivered by the seller and is accepted by the buyer. this most of the contracts entered into are nullified by the matching contract in the opposite direction before maturity of the first. To achieve. one between A and the clearing house and the another between B and the clearing house. In contrast to this. to introduce a financial stake of the client.e. The margin for future contracts has two components: • • Initial margin Marking to market
. a mandatory minimum margins are obtained by the members from the customers. in most futures markets. actual delivery takes place in less than one percent of the contracts traded. and seller to buyer. 2. at a stipulated percentage of the net purchase and sale position.30 records of the exchange. Futures are used as a device to hedge against price risk and as a way of betting against price movements rather than a means of physical acquisition of the underlying asset.
Accordingly. The concept being used by NSE to compute initial margin on the futures transactions is called “value. This reflects that futures prices normally exceed spot prices.31
Initial margin: In futures contract both the buyer and seller are required to perform the contract. For instance contract size on NSE futures market is 100 Nifties. Futures price: The price at which the futures contract trades in the futures market. Contract Size: The amount of asset that has to be delivered under one contract. In formal market. The initial margin is also known as the “performance margin” and usually 5% to 15% of the purchase price of the contract. at the end of which it will cease to exist. Cost of Carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. Basis/Spread: In the context of financial futures basis can be defined as the futures price minus the spot price. debiting or crediting the client’s equity accounts with the losses/profits of the day. Marking to Market: Marking to market means. The margin is set by the stock exchange keeping in view the volume of business and size of transactions as well as operative risks of the market in general. Base price shall be the previous day’s closing Nifty value.
. Settle price is the purchase price in the new contract for the next trading day.at –Risk”(VAR) where as the options market had SPAN based margin system”. Expiry Date: It is the date specified in the futures contract. based on which margins are sought. both the buyers and the sellers are required to put in the initial margins.
Spot price: The price at which an asset trades in spot market. basis will be positive. There ill be a different basis for each delivery month for each contract. die clearinghouse substitutes each existing futures contract with a new contract that has the settle price or the base price. This is the last day on which the contract will be traded. It is important to note that through marking to market process. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.
The stock index futures market should ideally have more depth. They are called hedgers. the chances of manipulation are much lesser. Stock index is the apt hedging asset since. would refer trade in stock index futures. Short position: Out standing/unsettled sales position at any time point of time. who own portfolio of securities and are exposed to systematic risk. it is too early to base any conclusions on
. Stock index futures contract is an agreement to buy or sell a specified amount of an underlying stock traded on a regulated futures exchange for a specified price at a specified time in future. only one side of the contract is counted. used to arrive at the contract size. Open Interest: Total outstanding long/short positions in the market in any specific point of time. given the speculative nature of our markets and overwhelming retail participation expected to be fairly high. However. Long position: Outstanding/Unsettled purchase position at any point of time. The advantage to the equity or cash market is in the fact that they would become less volatile as most of the speculative activity would shift to stock index futures. The brokerage cost on index futures will be much lower. In the near future stock index futures will definitely see incredible volumes in India. volumes and act as a stabilizing factor for the cash market. As total long positions for market would be equal to total short positions for calculation of open Interest. which have been used to hedge or manage systematic risk by the investors of the stock market. The stock index futures are expected to be extremely liquid. The market is conditioned to think in terms of the index and therefore. The impact cost will be much lower incase of stock index futures as opposed to dealing in individual scrips. the rise or fall due to systematic risk is accurately shown in the stock index.
Stock index Futures:
Stock index futures are most popular financial futures. It is the price per index point. It will be a blockbuster product and is pitched to become the most liquid contract in the world in terms of contracts traded. Stock index futures will require lower capital adequacy and margin requirement as compared to margins on carry forward of individual scrip’s. Savings in cost is possible through reduced bid-ask spreads where stocks are traded in packaged forms. Further. Tick Size: It is the minimum price difference between two quotes of similar nature.32 Multiplier: it is a pre-determined value.
A futures contract represents a promise to transact at same point in the future. a cash settlement of Rs. a contract struck at this level could work Rs. we made a profit of Rs.30. If the price really increases to Rs.e. Example: If the current price of the ACC share is Rs. it means that the losses as well as profits for the buyer and the seller of a futures contract are unlimited. If ACC share goes up to Rs.170 per share. we still earn Rs. In the above example if the margin is 20%.
. which obligates the trader to buy a certain amount of the underlying security at some point in future. Selling security futures without previously owing them simply obligates the trader to sell a certain amount of the underlying security at same point in the future. In simple words. In this light.
With the purchase of futures on a security.200 and we buy ACC shares. The difference between stock index futures and most other financial futures contracts is that settlement is made at the value of the index at maturity of the contract. we would pay only Rs. We believe that in one month it will touch Rs. we get the same position as ACC in the cash market. a return of 18%.33 the volume are to form any firm trend.30 as profit. It can be done just as easily as buying futures. Security futures do not represent ownership in a corporation and the holder is therefore not regarded as a shareholder.30 i. If at the expiration of the contract.200.34 initially to enter into the futures contract. the BSE sensex is at 6850. a promise to sell security is just as easy to make as a promise to buy security.204000 (6800x30).1500 is required (6850-6800) x30).
Payoff for Futures contracts
Futures contracts have linear payoffs. but we have to pay the margin not the entire amount. If we buy ACC futures instead. Example: If BSE sensex is at 6800 and each point in the index equals to Rs. the holder essentially makes a legally binding promise or obligation to buy the underlying security at same point in the future (the expiration date of the contract).200 as expected. These linear payoffs are fascinating as they can be combined with options and the underlying to generate various complex payoffs.
When the index moves up.
Payoff for a buyer of Nifty futures
Payoff for seller of futures: Short futures The payoff for a person who sells a futures contract is similar to the payoff for a person who shorts an asset. the long futures position starts making profits. The underlying asset in this case is Nifty portfolio. Payoff for a seller of Nifty futures
1220 0 Nifty
. He has a potentially unlimited upside as well as potentially unlimited downside. and when index moves down it starts making losses.34 Payoff for buyer of futures: Long futures The payoff for a person who buys a futures contract is similar to the payoff for a person who holds an asset. Take the case of a speculator who buys a two-month Nifty index futures contract when Nifty stands at 1220. He has potentially unlimited upside as well as potentially unlimited downside.
F=S+C Where F Futures S Spot price C Holding cost or Carry cost This can also be expressed as F = S (1+r) T Where r Cost of financing T Time till expiration Pricing index futures given expected dividend amount: The pricing of index futures is also based on the cost of carry model where the carrying cost is the cost of financing the purchase of the portfolio underlying the index. This is the basis for the cost-of-carry model where the price of the contract is defined as fallows. the short futures position starts making profits. two and three month contracts.35
Take the case of a speculator who sells a two-month Nifty index futures contract when the Nifty stands at 1220.
Cost of Carry Model: We use fair value calculation of futures to decide the no arbitrage limits on the price of the futures contract. When the index moves down. and when index moves up. Money can be barrowed at a rate of 15% per annum. The underlying asset in this case is the Nifty portfolio. minus the present value of the dividends obtained from the stocks in the index portfolio. What will be the price of a new two-month futures contract on Nifty?
. Example Nifty futures trade on NSE as one. it starts making losses.
.e.1200 i. 3. The spot value of Nifty is 1200.e.per share after 15 days of purchasing of contract.1221.02) 60/365 = Rs.10/. it is useful to calculate the annual dividend yield.16800 i.1224. (120x10). Current value of Nifty is 1200 and Nifty trade with a multiplier of 200. (240000x0. its value in Nifty is Rs. 5. 7. Since Nifty is traded in multiples of 200 value of the contract is 200x1200=240000. If ACC as weight of 7% in Nifty. Hence. To calculate the futures price we need to reduce the cost of carry to the extent of dividend received is Rs. F = S (1+ r-q) T Where F Futures price S Spot index value
r Cost of financing q Expected dividend yield T Holding period
Example: A two-month futures contract trades on the NSE. Pricing index futures given expected dividend yield If the dividend flow through out the year is generally uniform. i. If the market price of ACC is Rs. The cost of financing is 15% and the dividend yield on Nifty is 2% annualized. then a traded unit of Nifty involves 120 shares of ACC i. (16800/140). To calculate the futures price we need to compute the amount of dividend received for unit of Nifty.07). if there are few historical cases of clustering of dividends in any particular month.80. we dividend the compounded figure by 200. Thus futures price F = 1200(1.e. 6. 2. Let us assume that ACC will be declaring a dividend of Rs.15) 60/365 – (120x10(1. What is the fair value of the futures contract? Fair value = 1200(1+0.140.36 1. The dividend is received 15 days later and hence compounded only for the remainder of 45 days.15-0.15) 45/365)/200 = Rs. 4.
2. Example: ACC futures trade on NSE as one.08.15) 60/365 – 10(1.140/3.per share after 15 days pf purchasing contract. Example: SBI futures trade on NSE as one. two and three month contracts. Like.37
Pricing stock futures
A futures contract on a stock gives its owner the right and the obligation to buy or sell the stocks. If no dividends are expected during the life of the contract.15) 45/365 = Rs. minus the present value of the dividends obtained from the stock. we need to reduce the cost of carrying to the extent of dividend received.10/-.10/. Assume that the market price of ACC is Rs.
.223. compounded only for the remaining 45 days.133. Pricing stock futures when no dividend is expected The pricing of stock futures is also based on the cost of carry model. 4. Thus. where the carrying cost is the cost of financing the purchase of the stock. Money can be barrowed at 15% per annum. To calculate the futures price. minus the present value of the dividends obtained from the stock. futures price F = 228(1. What will be the price of a unit of new two-month futures contract on ACC if dividends are expected during the period? 1. What will be the price of a unit of new two-month futures contract on SBI if no dividends are expected during the period? 1. stock futures are also cash settled: There is no delivery of the underlying stock. pricing involves reducing the cost of carrying to the extent of the dividends. The net carrying cost is the cost of financing the purchase of the stock.
Pricing stock futures when dividends are expected When dividends are expected during the life of futures contract. Thus. It simply involves the multiplying the spot price by the cost of carry. the futures price F = 140 (1.15) 60/365 = Rs.228.30. Let us assume that ACC will be declaring a dividend of Rs. two and three month contracts. The dividend is received 15 days later and hence. Assume that the spot price of SBI is Rs. The amount of dividend received is Rs. 2. pricing futures on that stock is very simple. index futures.
OCC has a certain risk that the seller of the option can’t full the contract. It assures that OCC will get its money. the OCC takes over it. he can buy a put option meaning a right to sell an asset after a certain period of time. its value is derived from something else. I notify my broker. If I want to exercise an ACC November 100-call option. It is the responsibility of the OCC who over sees the obligations to fulfill the exercises. An option is valuable if and only if the prices are varying. Lastly. An option by definition has a fixed period of life. The brokerage firm customer can be chosen in two ways.e.39
An option is a derivative instrument since its value is derived from the underlying asset. which is short one ACC stock.
. Thirdly. He can be chosen at random or FIFO basis. Secondly. he can buy a call option meaning a right to buy an asset after a certain period of time. its value is based on the underlying index.
Options clearing corporation
The Options Clearing Corporation (OCC) is guarantor of all exchange-traded options once an option transaction has been completed. That brokerage firm then notifies one of its customers who have written one ACC November 100 call option and exercises it. Firstly. usually three to six months. he can write a call option meaning he can sell the right to buy an asset to another investor. It is essentially a right. Because. Definition: An option is a derivative i. the OCC then randomly selects a brokerage firm. Options can be a call option (right to buy) or a put option (right to sell). An option is a wasting asset in the sense that the value of an option diminishes has the date of maturity approaches and on the date of maturity it is equal to zero. but not an obligation to buy or sell an asset. In the case of the index option. My broker notifies the OCC. This margins requirement act as a performance Bond. strict margin requirement are imposed on sellers. In the case of the stock option its value is based on the underlying stock (equity). Out of the above four cases in the first two cases the investor has to pay an option premium while in the last two cases the investors receives an option premium. Once a seller has written an option and a buyer has purchased that option. An investor in options has four choices before him. he can write a put option meaning he can sell a right to sell to another investor.
A call option in the index is said to be in the money when the current index stands at higher level that the strike price (i. A call option on the index is out of he money when the current index stands at a level. If the index is much higher than the strike price the call is said to be deep in the money. Strike Price: The price specified in the option contract is known as the strike price or the exercise price. An option on the index is at the money when the current index equals the strike price (I.e.
Call Option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. American option: American options are the options that the can be exercised at the time up to the expiration date. the exercise date. In the case of a put.40
. which the option buyer pays to the option seller. If the index is much lower than the strike price the call is said to be deep OTM. In the case of a put option. spot price = strike price). At-the-money option: An At-the-money option (ATM) is an option that would lead to zero cash flow if it exercised immediately.e. Most exchange-traded options are American. the straight date or the maturity date.e. In-the-money option: An in-the-money option (ITM) is an option that would lead to a positive cash flow to the holder if it were exercised immediately. which is less than the strike price (i. the put is OTM if the index is above the strike price. Expiration date: The date specified in the option contract is known as the expiration date. spot price > strike price). the put is in the money if the index is below the strike price. European options are easier to analyze that the American options and properties of an American option are frequently deduced from those of its European counter part. It is also referred to as the option premium. Put option: A put option gives the holder the right but the not the obligation to sell an asset by a certain date for a certain price. Out-of-the-money option: An out of the money (OTM) option is an option that would lead to a negative cash flow if it were exercised immediately. European options: European options are the options that can be exercised only on the expiration date itself. Option price: Option price is the price. spot price < strike price).
41 Intrinsic value of an option: It is one of the components of option premium. The intrinsic value of a call is the amount the option is in the money, if it is in the money. If the call is out of the money, its intrinsic value is Zero. For example X, take that ABC November-call option. If ABC is trading at 102 and the call option is priced at 2, the intrinsic value is 2. If ABC November-100 put is trading at 97 the intrinsic value of the put option is 3. If ABC stock was trading at 99 an ABC November call would have no intrinsic value and conversely if ABC stock was trading at 101 an ABC November-100 put option would have no intrinsic value. An option must be in the money to have intrinsic value. Time value of an option: The value of an option is the difference between its premium and its intrinsic value. Both calls and puts time value. An option that is OTM or ATM has only time value. Usually, the maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an options time value. At expiration an option should have no time value. Characteristics of Options The following are the main characteristics of options: 1. Options holders do not receive any dividend or interest. 2. Options only capital gains. 3. Options holder can enjoy a tax advantage. 4. Options holders are traded an O.T.C and in all recognized stock exchanges. 5. Options holders can controls their rights on the underlying asset. 6. Options create the possibility of gaining a windfall profit. 7. Options holders can enjoy a much wider risk-return combinations. 8. Options can reduce the total portfolio transaction costs. 9. Options enable with the investors to gain a better return with a limited amount of investment.
An option that grants the buyer the right to purchase a designed instrument is called a call option. A call option is contract that gives its owner the right but not the obligation, to buy a specified asset at specified prices on or before a specified date.
42 An American call option can be exercised on or before the specified date. But, a European option can be exercised on the specified date only. The writer of the call option may not own the shares for which the call is written. If he owns the shares it is a ‘Covered Call’ and if he des not owns the shares it is a ‘Naked call’ Strategies: The following are the strategies adopted by the parties of a call option. Assuming that brokerage, commission, margins, premium, transaction costs and taxes are ignored. A call option buyer’s profit/loss can be defined as follows: At all points where spot price < exercise price, here will be loss. At all points where spot prices > exercise price, there will be profit. Call Option buyer’s losses are limited and profits are unlimited. Conversely, the call option writer’s profits/loss will be as follows: At all points where spot prices < exercise price, there will be profit At all points where spot prices > exercise price, there will be loss Call Option writer’s profits are limited and losses are unlimited. Following is the table, which explains In the-money, Out-of-the-money and At-the-money position for a Call option. Exercise call option Do not exercise Exercise/Do not exercise Example: The current price of ACC share is Rs.260. Holder expect that price in a three month period will go up to Rs.300 but, holder do fear that the price may fall down below Rs.260. To reduce the chance of holder risk and at the same time, to have an opportunity of making profit, instead of buying the share, the holder can buy a three-month call option on ACC share at an agreed exercise price of Rs.250. Spot price>Exercise price Spot price<Exercise price Spot price=Exercise price In-The-Money Out-of the-Money At-The-Money
43 1. If the price of the share is Rs.300. then holder will exercise the option since he get a share worth Rs.300. by paying a exercise price of Rs.250. holder will gain Rs.50. Holder’s call option is In-The-Money at maturity. 2. If the price of the share is Rs.220. then holder will not exercise the option. Holder will gain nothing. It is Out-of-the-Money at maturity. Payoff for buyer of call option: Long call The profit/loss that the buyer makes on the option depends on the spot price of the underlying. If upon expiration, the spot price exceeds the strike price, he makes a profit. Higher the spot price, more is the profit he makes. If the spot price of the underlying is less than the strike price, he lets his option un-exercise. His loss in this case is the premium he paid for buying the option. Payoff for buyer of call option
The figure shows the profit the profits/losses for the buyer of the three-month Nifty 1250(underlying) call option. As can be seen, as the spot nifty rises, the call option is InThe-money. If upon expiration Nifty closes above the strike of 1250, the buyer would exercise his option and profit to the extent of the difference between the Nifty-close and strike price. However, if Nifty falls below the strike of 1250, he lets the option expire and his losses are limited to the premium he paid i.e. 86.60.
44 Payoff for writer of call option: Short call For selling the option. This loss that can be incurred by the writer of the option is potentially unlimited. Whatever is the buyer’s profit is the seller’s loss. If upon expiration Nifty closes above the strike of 1250. the buyer would exercise his option on the writer would suffer a loss to the extent of the difference between the Nifty-close and the strike price. If upon expiration. but not the obligation to sell a specified number of shares at a specified price on or before a specified date. the buyer lets his option un-exercised and the writer gets to keep the premium. the writer of the option charges premium.86. If upon expiration the spot price is less than the strike price.
An option that gives the seller the right to sell a designated instrument is called put option. Hence as the spot price increases the writer of the option starts making losses. the buyer will exercise the option on the writer. the spot price exceeds the strike price.
. A put option is a contract that gives the owner the right. Payoff for writer of call option
86. Higher the spot price more is the loss he makes.60. The maximum profit is limited to the extent of up-front option premium Rs.60 1250 0 Nifty
The figure shows the profits/losses for the seller of a three-month Nifty 1250 call option.
Holder by a three month put option at exercise price of Rs. If the market/Spot price of the ACC share is Rs. he lets his option expire un-exercised.260. Payoff for buyer of put option: Long put. (Holder will Exercise his option only if the market price/ spot price is less than the exercise price). there will be gain.45 An American put option can be exercised on or before the specified date. A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option. Means put option holder will buy the share for Rs. a European option can be exercised on the specified date only. At all points where spot price>exercise price. there will be loss. the put option writer’s profit/loss will be as follows: At all points where spot price<exercise price. there will be profit. The following are the strategies adopted y the parties of a put option. then the holder will exercise the option.. If the spot price of the underlying is higher than the strike price. Spot price<Exercise price Spot price>Exercise price Spot price=Exercise price In-The-Money Out-of-The-Money At-The-Money
. which explains In-the-money. At all points where spot price>exercise price. Conversely.245. But. A put option buyer’s profit/loss can be defined as follows: At all points where spot price<exercise price.245.250.260. Out-of-the Money and At-the-money positions for a Put option. there will be loss.. Following is the table. the holder will gain Rs. In the market and deliver it to the option writer for Rs. the spot price is below the strike price. Exercise put option Do not Exercise Exercise/Do not Exercise Example: The current price of ACC share is Rs.15 from the contract. he makes a profit. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. If upon the expiration. Lower the spot price more is the profit he makes.
As can be seen.
Payoff for writer of put option
. the put option is In-The-Money.70 Nifty
The figure shows the profits/losses for the buyer of a three-month Nifty 1250 put option. The profits possible on this option can be as high as the strike price. as the spot Nifty falls. the buyer would exercise his option and profit to the extent of the difference between the strike price and Nifty-close. As the spot Nifty falls. if Nifty rises above the strike of 1250.46
Payoff for buyer of put option
1250 0 61. Payoff for writer of put option: Short put The figure below shows the profit/losses for the seller/writer of a three-month put option. If upon expiration. he lets the option expire. However. Nifty closes below the strike of 1250. His losses are limited to the extent of the premium he paid. the put option is In-The-Money and the writer starts making losses. the buyer would exercise his option on writer who would suffer losses to the extent of the difference between the strike price and Nifty-close. If upon expiration. Nifty closes below the strike of 1250.
61. The buyer of a put option receives exercise price and therefore as the interest increases. The present value of the exercise price will be less if the time to expiration is longer and consequently value of the option will be higher. the value of the put option will decrease.70 1250
The loss that can be incurred by the writer of the option is to a maximum extent of strike price. Time to Expiration: The present value of the exercise price also depends on the time to expiration of the option. They are Historical Volatility and Implied Volatility. Volatility: The volatility part of the pricing model is used to measure fluctuations expected in the value of the underlying security or period of time.
Factors determining options value: Exercise price and Share price: If the share price is more than the exercise price then the holder of the call option will get more net payoff. the present value of the exercise price will fall. means the value of the call option is more. The more volatile the underlying security. If the share price is less then the exercise price then the holder of the put option will get more net pay-off. There are two different kinds of volatility. Longer the time to expiration higher is the possibility of the option to be more in the money. Since. The effect is reversed in the case of a put option. the greater is the price of the option. Interest Rate: The present value of the exercise price will depend on the interest rate. Historical volatility estimates
. Maximum profit is limited to premium charged by him. The value of the call option will increase with the rise in interest rates.
48 volatility based on past prices.
Black scholes pricing models:
The principle that options can completely eliminate market risk from a stock portfolio is the basis of Black Scholes pricing model in 1973. 1.D (sqrt(T) VC= value of call option VP= value of put option PS= current price of the share
. 4. The risk from interest rate is constant.D)2 / 2] / S.PX/(e (RF)(T)) N (d2) The value of Put option as per Black scholes formula: VP=PX/(e (RF)(T)) N (-d2 )-PS N (-d1) Where d1= In [PS/PX]+T[RF+(S. It doesn’t promise to produce the exact prices that show up in the market. 2.D (sqrt (T)) d2= d1-S. Implied volatility starts with the option price as a given. There are no transaction costs and taxes. The options price for a call. The markets are always open and trading is continues. 5. and works backward to ascertains the theoretical value of volatility which is equal to the market price minus any intrinsic value. computed as per the following Black Scholes formula: VC =PS N (d1). During the option period the firm should not pay any dividend. 3. The stock pays no dividend. it tells us what is important and what is not. before Black and Scholes came up with their option pricing model. but certainly does a remarkable job of pricing options within the framework of assumptions of the model. The beauty of black and scholes model is that like any good model. there was a wide spread belief that the expected growth of the underlying ought to effect the option price. The option must be European option. The following are the assumptions. There are no short selling constraints and investors get full use of short sale proceeds. 6. Black and Scholes demonstrate that this is not true. Interestingly.
risk free rate and time to expiration in the black scholes formula. it is some times optimal to exercise the option just before the underlying stock goes exdividend. we must however. The assumption is that the investors can purchase the underlying stocks in the exact amount necessary to replicate the index: i. To use the black scholes formula for index options. this merely involves the replacing the current index value S in the model with S/eqT where q is the annual dividend and T is the time of expiration in years. S. strike price. value normal distribution area is to be identified. when valuing options on dividend paying stocks we should consider exercised possibilities in two situations. However. index options should be valued in the way as ordinary options on common stock. unlike European options.D= risk rate of the share In = Natural log value of ratio of PS and PX
Pricing Index Option:
Under the assumptions of Black Scholes options pricing model. One-just before the underlying stock goes Exdividend. value normal distribution area is to be identified. If the dividend payment is sufficiently smooth. N (d2)= after calculation of d2. when dividends are expected during the life of the options. Pricing American options becomes a little difficult because. When no dividends are expected during the life of options the options can be valued simply by substituting the values of the stock price. Hence. make adjustments for the dividend payments received on the index stocks. stock volatility.
Pricing Stock Options:
The Black Scholes options pricing formula that we used to price European calls and puts. Two – at expiration of the options contract.e. with some adjustments can be used to price American calls and puts & stocks. American options can be exercised any time prior to expiration. stocks are infinitely divisible and that the index follows a diffusion process such that the continuously compounded returns distribution of the index is normally distributed.49 PX= exercise of the share RF= Risk free rate T= time period remaining to expiration N (d1)= after calculation of d1. Therefore. owing an option on a dividend paying stock today is like owing to options one in long maturity option with a
. and other is a short maturity with a time to maturity from today till just before the stock goes Ex-dividend.50 time to maturity from today till the expiration date.
2. 5. 2. 4.
. Only the seller (writer) is obligated perform. The buyer limits the downside risk to the option premium but retain the upside potential.51
Difference between the Futures and Options
Futures Options 1. In options premium are to be paid. to perform. 5. 4. They are approximately 15 to 20% on the current stock price. The buyer of an options contract can exercise the option at any time prior to expiration date. Both the parties are obligated to 1. But they are less as compare to margin in futures. The parties to the futures contract must perform at the settlement date only. In options the buyer pays the seller a premium. The holder of the contract is exposed to the entire spectrum of downside risk and had the potential for all the upside return. In futures margins are to be paid. In futures either parties pay premium. They are obligated to perform the date. 3. 3.
Currency swaps. which are fixed and floating in nature. Interest rate swaps. as a name suggest involves an exchange of different payment streams. Types of swaps: All Swaps involves exchange of a series of payments between two parties. which a permit a barrower to access one market and then exchange the liability for another type of liability. Such an exchange is referred to as an exchange of barrowings. The most widely prevalent swaps are 1. The barrower might other wise as found this too expensive or even inaccessible. It must be noted that the swaps by themselves are not a funding instrument: They are device to obtain the desired form of financing indirectly. At the same time.53
Financial swaps are a funding technique. Swaps are used to transform the fixed rate loan into a floating rate loan. Global financial markets present barrowers and investors with a variety of financing and investment vehicles in terms of currency and type of coupon – fixed or floating. The currencies of the two sets of interest cash flows are the same. For example. ‘B’ to pay the other party ‘A’ cash flows equal to interest at a pre-determined fixed rate on a notional principal for a number of years. The two payment streams estimated to have identical present values at the outset when discounted at the respective cost of funds in the relevant markets. A swap transaction usually involves an intermediary who is a large international financial institution. 2.
. party ‘A’ agrees to pay ‘B’ cash flows equal to interest at a floating rate on the same notional principal for the same period of time. A common explanation for the popularity of swaps concerns the concept of comparative advantage.
Interest rate swaps
Interest rate swaps. The life of the swap can range from two years to fifty years. The basis principle is that some companies have a comparative advantage when barrowing in fixed markets while other companies have a comparative advantage in floating markets.
Swap spreads tend to fall. They swap to achieve the desired currency to the benefit of all concerned. it is difficult to envisage a situation where two companies contact a financial institution at a exactly same with a proposal to take opposite positions in the same swap.
Currency swaps involves exchanging principal and fixed interest payments on a loan in one currency for principal and fixed interest payments on an approximately equivalent loan in another currency. In real life. Also suppose that sterling rates are higher than the dollar rates. Therefore. If the reverse is true. Example: Suppose that a company ‘A’ and company ‘B’ are offered the fixed five years rates of interest in US $ and Sterling.54 Usually two non-financial companies do not get in touch with each other to directly arrange a swap. the swaps spread tend to rise. They are chosen such that they are equal at the exchange rate at the beginning of the life of the swap. the swaps spreads are determined by supply and demand. They each deal with a financial intermediary such as a bank. This creates an ideal situation for a currency swap. though company ‘A’ has a better deal. The deal could be structured such that the company ‘B’ barrows in the market in which it has a lower disadvantage and company ‘A’ in which it has a higher advantage. In both the currency markets. company ‘A’ a better credit worthiness then company ‘B’ as it is offered better rates on both dollar and sterling. Like interest swap. currency swaps are frequently ware housed by financial institutions that carefully monitor their exposure in various currencies so that they can change hedge currency risk
. The principal amounts are usually exchanged at the beginning and the end of the life of the swap. A point to note is that the principal must be specified at the outset for each of the currencies. Also. What is important to the trader who structures the swap deal is that the difference in the rates offered to the companies on both currencies is not same. company ‘B’ does enjoy a comparative lower disadvantage in one of the markets. At any given point of time. If no participants in the swaps market want to receive fixed rather than floating.
42 19.57 16.22 28146.34 48141.76 22.5 31470.05
97917.98 28099.82 20.5 35467.45 75081.09 48117.27 27358.42 47597 63438.32 23.99 21.16 24.36 54493.79 18.72 19.07 24.89 60265.33 32. 2008 Symbol Mlot
LUPIN M&M MAHLIFE PFC PNB POLARIS POWERGRID PRAJIND PUNJLLOYD PURVA SASKEN BALLARPUR BAJAJ-AUTO MAHSEAMLES CNX100 CNXIT JUNIOR MINIFTY NFTYMCAP50 NIFTY WOCKPHARMA WWIL YESBANK ZEEL VOLTAS WELGUJ WIPRO TATASTEEL TATATEA TATAMOTORS TATAPOWER TCS TECHM TITAN TRIVENI TTML TULIP TVSMOTOR ULTRACEMCO UNIONBANK 700 312 350 1200 600 2800 1925 1100 750 500 1100 7300 200 600 50 50 25 20 75 50 600 3150 1100 700 900 800 600 382 275 412 200 250 200 206 1925 5225 250 2950 400 2100
20.91 40392.24 18.73 41804.16 16.32 53218.75 30677.1 12.47 21004.81 66106.21 24573.93 19.36 33495.25 9825.35 19.53 18.55
CURRENTLY AVAILABLE FUTURE IN NSE
Span Margin:: May 30.5 73359.08 23.81 34.51 15.78 19.2 27984.23 25.9 49941.51 17.61 40234.2 58724.11 15.2 12.33 22.22 36947.65 24695.08 55144.73 10.13 37586.07 49098.73 18 10.55 23590.33
.27 24.72 27.89 45815.28 28.53 43.81 20.49 22.12 55350 64029.44 59872.62 24.44 24.11 10.31 50775.12 10.4 25256 26499.
89 30.98 19.77 64941.5 15.71 19.08 22.06 57264.9 30322.15 30988.03 33368.48 63820 39324.18 21.56
UNIPHOS UNITECH VIJAYABANK STAR STER STERLINBIO STRTECH SUNPHARMA SUNTV SUZLON SYNDIBANK TATACHEM TATACOMM SESAGOA SHREECEM SIEMENS SKUMARSYNF SOBHA SRF SATYAMCOMP SBIN SCI ROLTA RPL RPOWER SAIL RECLTD REDINGTON RELINFRA RELCAPITAL RELIANCE RENUKA RNRL RAJESHEXPO RANBAXY RCOM NUCLEUS OMAXE ONGC ORCHIDCHEM ORIENTBANK PANTALOONR PARSVNATH PATELENG PATNI PENINLAND PETRONET MARUTI MATRIXLABS MCDOWELL-N 700 900 3450 850 219 2500 1050 225 1000 1000 1900 675 525 75 200 376 1900 350 1500 600 132 800 900 1675 500 1350 1950 500 138 138 75 5000 1788 1650 800 350 550 650 225 1050 1200 500 700 250 650 2750 2200 200 1250 125 16.42 55616.45 17.75 51687.94 98318.72 69628 41185 34261.84 38.54 20.31 27.34 38318.32 20.75 38.41 26.18 28.73 30534.31 18.52 29582.65 21.33 44017.18 21.87 24.64 20.8 24045 89014.61 38039.38 175780.07 31861.61 27.98 22.17 51318.25 53168.33 25.31 20.39 22.36 16.82 30.54 22.24 16.37
.62 18.22 87743.62 58316.29 21.83 18.68 24.79 22.35 18.5 35808.68 39998 53168.9 42607.51 37.75 60006.01 35597.19 17.1 41218.89 16.41 17.9 30742.4 30958.88 22.83 23438.46 32533.66 60274.5 46460.49 40723.2 50167.16 46528.44 67888.12 20.85 23.61 22268 61256.52 21.35 58020.67 15.32 15.25 22.7 63426.02 55420.4 61719.22 15.51 40.07 17.74 27.05 50726.
.04 24.11 16.95 44286.66 24.85 28.08 28406.25 39912.82 55846 38541.3 38048.78 19.15 74003.57
MOSERBAER INFOSYSTCH IOB IOC IRB ISPATIND ITC JINDALSAW JINDALSTEL JPASSOCIAT JPHYDRO JSTAINLESS JSWSTEEL KESORAMIND KOTAKBANK KPIT KTKBANK IVRCLINFRA IVRPRIME J&KBANK JETAIRWAYS IDBI IDEA IDFC IFCI INDHOTEL INDIACEM INDIAINFO INDIANB INDUSINDBK GDL GESHIP GITANJALI GLAXO GMRINFRA GNFC GRASIM GTL GTOFFSHORE GUJALKALI HAVELLS HCC HCLTECH HDFC HDFCBANK HDIL HEROHONDA HINDALCO HINDOILEXP HINDPETRO 825 200 1475 600 1100 4150 1125 250 160 750 3125 1000 275 500 275 1650 1250 500 800 300 400 1200 2700 1475 1970 1899 725 250 1100 1925 2500 600 500 300 1250 1475 88 750 250 1400 400 1400 650 75 200 400 400 1595 1600 1300 23.01 48546.38 27284.83 54124.25 34802.5 35349.13 52752.96 17.54 39546.7 20.46 30.12 18.91 57113.6 22.08 17.32 66925.75 33810 21374.19 16.39 20.3 15.53 35599.82 37819.22 16.27 39687.67 19.45 30114.97 30789.73 46707.25 45242.86 45.19 28.36 25.72 23.22 18.24 52943.05 38431.99 16.94 49386.13 31.19 15.13 27.1 19.64 27.25 20.94 45192.63 15.45 19.74 48797 71380.69 49565.84 23.17 44798 91804.25 22.69 23.43 103176.7 22.01 23.39 56255.07 30828 38081.25 35509.51 34263.75 47263.07 20.13 47520.34 15.95 64386.96 17.84 67583.19 16.76 39.38 18.64 27438.73 19.15 51851.58 25.13 30529.38 25.27 24.96 20.73 67782.7 31.55 29849.23 23584.91 20.
74 32163.44 62881.56 29396.58 44.74 16.72 15.06 56013.17 45425.44 21788.42 48003.75 34187.17 17.83 16.17 65074.82 36.03 18.4 67873.29 15.92 46027 46115.28 15.93 44.86 60673.75 38216.64 33641.12 18.44 40689 31760.04 15.19 21.15 20.95 25.64 15.28 20.53 33422.43 34458.04 91901.29 22.77 13.55 29988.74 17.32 21613.7 19.9 28.6 18.79 15.02 22.15 46790.11 40180.04 129217.13 43652.72 54736.48 31.25 20.93 43661.54 15.5 38130 22073.93 22813.73 27.89 16.12 47380.18 37495 43678.91 25.58 23.79 62822.07 42213 40240.65 36.1 31841.58
HINDUJAVEN HINDUNILVR HINDZINC HOTELEELA HTMTGLOBAL I-FLEX BEML BHARATFORG BHARTIARTL BHEL BHUSANSTL BINDALAGRO BIOCON BIRLAJUTE BOMDYEING BONGAIREFN BOSCHLTD BPCL GAIL IBN18 BANKNIFTY BRFL BRIGADE CAIRN CANBK CENTRALBK CENTURYTEX CESC CHAMBLFERT CHENNPETRO CIPLA CMC COLPAL CORPBANK CROMPGREAV CUMMINSIND DABUR DCB DENABANK DIVISLAB DLF DRREDDY EDELWEISS EDUCOMP EKC ESCORTS ESSAROIL FEDERALBNK FINANTECH 3IINFOTECH 500 1000 250 3750 500 150 125 1000 250 75 250 4950 450 850 300 2250 50 550 750 1250 25 1150 550 1250 800 2000 212 550 3450 900 1250 200 550 600 500 475 2700 1400 2625 155 400 400 250 75 1000 2400 1412 851 150 2700 36.7 20.42 20.75 38084.64 20.48 22.21 16.56 104838.11 33075.88 103116.33 40475.35 20.82 30.35 52524.63 64169.75 26.99 77011.01
.96 34464.55 23.7 32.23 25.63 22.82 18.27 16.93 53535.53 50649.47 15.11 25.66 23271.
82 21.38 38933.55 62757.77 15.7 41189.63 47318.88 18.89 27757.27 50382.19 25.71 21.92 35664.04 44482.91 17.86 45537.16 49074.67 18.05 61664.5 25610.5 19511.94 42.81 42329.41 29.21 69574.53 37859.04 32973.36 26.71 16.2 27.39 27616.94 37088.25
.72 28.27 28.05 16.55 36612.63 69809.99 19.71 28.73 55988.59
ABAN ABB ABIRLANUVO ACC ADLABSFILM AIAENG AIRDECCAN ALBK ALOKTEXT AMBUJACEM AMTEKAUTO ANDHRABANK ANSALINFRA APIL APTECHT ARVINDMILL ASHOKLEY AUROPHARMA AXISBANK BAJAJHIND BAJAJHLDNG BALRAMCHIN BANKBARODA BANKINDIA BATAINDIA BEL NIITTECH NTPC MPHASIS MRPL ICICIBANK MTNL NAGARCONST NAGARFERT NATIONALUM NAUKRI NDTV NETWORK18 NEYVELILIG NICOLASPIR NIITLTD LAXMIMACH LICHSGFIN LITL LT 50 250 200 188 225 200 850 2450 3350 2062 600 2300 1300 200 650 4300 4775 700 225 950 250 2400 700 950 1050 138 1200 1625 800 2225 175 1600 1000 3500 575 150 550 500 1475 750 1450 100 850 425 50 24.83 28.69 65216.32 22.95 27.98 18.3 39333.11 59477.22 45315.23 27933.28 43576.44 18.97 45840.5 29407.93 22.2 29946 31697.91 24.55 22.93 62621.74 28863.12 47146.03 15.42 39272.98 52847.13 48489.97 19.92 27.5 28992.92 20.87 30.72 19.94 36.54 27.61 15.32 53407.25 19.31 25.54 22.73 23.86 44746.69 32.3 33.04 17.2 61327.35 25524.96 69537.03 18.79 15.22 16.01 42045.
We expect the share price to rise significantly and want to make a profit from the increase. Sell 1 Jan contract (expiry) 2.
Share price (Cash market)
28 April 28 July Rs.40000. If CIPLA shares go up we can close the position either by selling the option back to the market or exercising the right to buy the underlying shares at the exercise price. Premium Paid = Rs. 1. So.14.14 (premium). and the July Rs.62
BASIC OPTION STRATEGIES
Long call Market View Action Profit Potential Loss Potential Bullish Buy a call option Unlimited Limited
To make a profit from an expected increase in the price of an underlying share during option’s life: Situation: On 28th April.40000.254. Net outlay is
Rs. Return 18%
units =m Rs. Net gain Rs.254 Rs.46.40000. CIPLA is quoting at Rs. Market lot for CIPLA is 1000. cost = 14000.14.14000.14000 (14x1000). Option sale =
Rises by Rs.300
Buy 1 July 260 call at Rs.26000. Net Profit = Rs.260 (strike price) Call costs Rs.300 Option worth Rs. Closing the
Possible Outcome at Expiry
Share price Rs. Action: Buy 1CIPLA calls at Rs.
25000 (25x1000) 1. Action: Buy 1 July 240-call option CIPLA at Rs.
To establish a maximum cost at which to purchase shares at a lesser date if funds are not available immediately: Situation: On 28th April.300
Buy Jan 240 call @ Rs. If the share price increases. Sell 1 Jan 240 call option (or) 2. He does not have the sufficient funds to buy the shares and decides to again exposure to the stocks and therefore participate in the rise by buying a call option. the option expiry day.274.254 Rs. by whatever amount the share price exceeds Rs.25 for total outlay of Rs. The loss is Rs.26000 Share price<260 Share price>274 Option expires worthless.63 position now will produce a net profit of Rs.25000 and purchase share on 28th July.
Share price (Cash market)
28 Apr 28 July Rs. an investor takes the view that CIPLA’s share price is likely to rise over the coming months. selling the call option releases income to offset the higher share to be acquired at the exercise price that is below the share price. Exercise 1 Jan 240 call and purchase 1000 shares at 240000.14000 (premium paid) Net profit = Intrinsic value of (Break even = 260+14) option i.e.
46 (300-254) 1.
To hedge against a fall in share value over coming months:
. Firstly.e.265/share. In gaining exposure to stock through call option. Sale of option Net profit = Rs.240000 Net outlay Rs. Share price < 240 Option expires worthless.265 values.35000.25000 (Cost of purchase) This simple strategy provides investor with maximum effective buying price of Rs. Secondly.e.60000 = Rs. Option purchase = Rs. he guarantees exposure for limited outlay (i. Break-even value.265 Break even (240+25) Net profit = Intrinsic value of the option less cost of purchase i. the amount by which the share price exceeds breakeven Share price = Rs.25 rather than Rs.25 per share) and if the share does not rise as anticipated.64 Analysis Rises by Rs. the maximum loss is limited to the premium paid. the investor has secured two major advantages.
Cost of purchase = Rs. Total loss Rs.25 (265-240). Option worth is Rs.25000 2. Rs.265 (240+25) in three-month time.254 per share helps cash flow. the payment of Rs.25000 Exercise option =Rs.265000
Possible outcome at Expiry
Share price > Rs. = Rs.
254. Sell the option for any intrinsic value to recover some of their cost.40x10000 = 400000 (254-214 = 40). Action: Sell 10000 CIPLA shares at Rs. sell 10000 shares Buy 10 July 260 call at
Possible outcome at expiry Share price < Rs. Sell the option for intrinsic value and take more profit.200.140000. He has made a considerable gain of his investment and he is concerned that he should not lose any of that profit.14 Rs.2554000.140000 (premium paid) instead of Rs.14 worth Rs.140000.260 Option expires worthless creating
maximum loss. number of market lots = 10000/1000 = 10) 260-calls at Rs.34
. which originally purchased at Rs. Option expires worthless Total loss = Rs.340000 (original share holding of 10000 if nor sold). However. Rs. he does not want to miss out that profit. the investor books profit of Rs.220 Fall of Rs. believes that the share price may decrease soon.254 each.254 each and buy 10 (for 10000 shares.65 Situation: An investor holding 10000 CIPLA share at Rs. which is equal to the Share price between 260 & 274 Share price > 274 amount of premium paid. if the price continues to rise instead.
Share price (Cash market)
28 Apr 28 July Analysis for Rs. (Or) Exercise option. The released money is now available for re-investment and a small proportion will fund the call purchase.
Option expires worthless Profit = Rs.254.
Market View Action: Profit Potential Loss Potential
Bullish Sell call against an existing shareholding Limited Limited
Situation: On 28th April CIPLA share is trading at Rs. he decides to write call option against this shareholding. in terms of premium received on writing the option (Covered short call).254
Sell 10 July 260 calls @ Rs.66
To earn additional income from a static shareholding.140000 (Option Premium received)
28 July Analysis
Rs. he does not expect their price to move very much in the next few months.14 Income = Rs.260 each if the holder exercises the option
Share price (Cash market)
28 Apr Rs. So.254 No change in shareholding
.140000 and takes on the obligation to deliver 10000 shares at Rs. He received an option premium of Rs.14 and investor sells 10 contracts (one contract = 1000 shares). over and above any dividend earnings. Action: The July 260 calls are trading at Rs. an investor holds 10000 shares.140000 (14x10000).
406. Buy 1000 Reliance shares at Rs. At investor thinks that the shares have a long-term price rise potential. The option expires worthless.
Sell 1 Reliance call at Rs. For 1000 shares
Total outlay = Rs.23 on the original purchase price. The option will be exercised and the shares have to be sold at Rs.67 Possible Outcome at Expiry Share > Rs. but before the end of the July he does not expect the share to go above Rs. thus effectively reducing the original cost of the shares to Rs.429. The investor as a writer will sell shares originally purchased for Rs. (260+14).274 Share price < 260 To reduce the cost of stock purchase: Situation: It is early April and Reliance share is trading at Rs.420 The option will not be exercised and the investor will retain both the shares and the option premium. an increase of Rs.9000 (1000x9)
(Cash market) Rs.9 (premium) Income = Rs.420 (406-9).
.406 per share and sell Reliance July 420 call at Rs.420 Action.397 Share price > Rs.406.420.9. This effectively produced a total sale price of Rs.406000
Possible Outcome at Expiry Share price < Rs.260 The holder will exercise his option.254 at Rs.
Possible Outcome at Expiry Share price = Rs.20000. which gives a profit of Rs.20. Net gain = Rs.
Share price (Cash market)
28 Apr Rs.68 Long put Market View Action Profit Potential Loss Potential Bearish Buy a Put option Unlimited Limited
To make profit.12000.8 for a total consideration of Rs. from a fall in value of share price: Situation: Current price of GAIL is Rs. Action: Buy 1 GAIL July Rs. He therefore decides to buy Put option to gain exposure to its anticipated fall.270. Total outlay = Rs.20 (260-240) x 1000 (Lot)] Option purchase = Rs.
Rs.8000.240 The put will be trading at Rs. if the
Fall of share price Rs.30.8000. An investor thinks GAIL share is overvalued and may fall substantially.12 (20-8). Sell 1 July contract.8000 Option sale = Rs.8.260 Put at Rs. Net profit = Rs.270
Buy 1 GAIL July put at Rs.20000 [Rs.
Share purchase =Rs. = Rs. Since.240. Cost = Rs.18000 By buying the put option simultaneously the investor’s loss is decreased to Rs.8.8000 (8x1000) Exercise the Rs260 put option. He feels that he could effort to see the shares as low as Rs. he will buy 1000 shares for Rs. Recover intrinsic value premium.240 Total worth = Rs.270 each and buy one GAIL July 260 put at Rs.27000 20 July Rs.217. When the share price in cash market is Rs.69 position is closed out.8 per share) Less.270 buy 1000 shares at Buy 1 July Rs.30000.
Share price (Cash market)
28 Apr Rs.240. Action: Buy 1000 shares of GAIL at Rs. the investor holds the stock. Sale of option = Rs.8000 (premium Rs.260 put option.260000 Net Loss instead of Rs.240000 Analysis: In cash market the share price decreased to Rs. If the investor purchases the Rs. but he is concerned about its short-term performance. Then Loss = 30000 (27000-24000). If the investor does not purchase the Rs.270000 Add. he participates in any further rise in the share price above Rs.240 each in cash market and will sell the same in the options market by exercising the Rs.270 in the expectation that the share price will rise.260 put option.
Share price between 240 & 260
Protect a share purchase by simultaneously buying put options: Situation: An investor wants to buy GAIL shares at the current price of Rs.250.18000
Rs.260 put option.8. Buying option = Rs.260 put @
The put option will be exercised and the stock will have to be purchased for Rs.70
Market View Action Profit Potential Loss Potential Bearish Sell put option Limited Unlimited
To generate earnings on portfolio of shares: Situation: An investor owns 10000 shares of NIIT and also has cash holding of around Rs.400000 (premium received).40.550 Profit = Rs. Share price < Rs. Thus he received a premium of Rs.400000 (40x10000 shares). Situation: The shares of L&T are currently trading at Rs.242.6000000.
Action: Sell 10 L&T July Rs.550 puts at Rs.5100000 (5500000-400000). To buy a stock at a price which is lower than the current available price in the market. Action: The investor decides to generate some additional income on his portfolio writes 10 NIIT Rs.550 The investor’s expectation is correct and the put will expire unexercised. Possible Outcome at Expiry Share price > (or) = Rs. In early April he feels that the share price of NIIT will either remain constant or slightly rise.240 puts at Rs.
Share price (Cash market) Option market
Possible Outcome at Expiry Share price < Rs.e.71 28 Apr Rs.242 Sell 10 July Rs.10 below the current Share price > Rs.
. Rs.230 i.100000 Option is exercised. 28 July Rs. The option will not be exercised and the investor keeps the premium.10.240 The put writer will take delivery of the stock at Rs.240 puts at Rs.230 Total outlay = Rs.240 market price.
ALBK ANDHRABANK ARVINDMILLS ASHOKLEYLAND BAJAJ AUTO BANK OF BARODA BANK OF INDIA BHARAT ELECTRICALS BHARATFORG BHARTI BHEL BPCL CADILAHC CANARA BANK CENTURY TEXTILES CHENNAI PETRO CIPLA COCHIN REFINARY COLGATE DABUR Dr. REDDY GAIL GE SHIPPING GLAXO GRASIM Market Lot 100 100 200 750 2450 2300 2150 9550 200 1400 1900 550 200 1000 300 550 500 1600 850 950 1000 1300 1050 1800 200 1500 1350 300 175
LOT SIZES OF DIFFERENT COMPANIES
Index/Scrip CNXIT NIFTY ABB ASSOCIATED CEMENT COMPANIES.
73 GUJARATH AMBUJA CEMENT HCL TECH HDFC HDFC BANK HERO HONDA HINDALCO HLL HPCL I-FLEX ICICI BANK IDBI INDHOTEL INDRAYON INFOSYS INDIAN OVERSEAS BANK INDIAN OIL CORPORATION IPCL ITC JET AIRWAYS JINDAL STEEL JP HYDRO KIRLOSKCUM LIC HOUSING FINANCE M&M MARUTI UDYOG MATRIX LABS MRPL MTNL NALCO NEYVELI LIGNITE NICOLASPIR NTPC 550 650 300 400 400 150 2000 650 300 700 2400 350 500 100 2950 600 1100 150 200 250 6250 1900 850 625 400 1250 4450 1600 1150 2950 950 3250
.74 ONGC ORIENTAL BANK OF COMMERCE PATNI PUNJAB NATIONAL BANK POLARIS RANBAXY RELIANCE RELIANCE CAPITAL RELIANCE INDUSTRIES LTD. In the recent years advances in financial markets and the technology have made derivatives easy for the investors. with roots in commodities market. SATYAM STATE BANK OF INDIA SCI SIEMENS STER SUN PHARMA SYNDICATE BANK TATA CHEMICALS TATA MOTORS TATA POWER TATA TEA TATA CONSULTANCT SERVICES TISCO UNION BANK OF INDIA UTI BANK VIJAYA BANK VSNL WIPRO WOCKPHARMA 300 600 650 600 1400 200 550 1100 600 600 500 1600 150 350 450 3800 1350 825 800 550 250 675 2100 900 3450 1050 300 600
Derivatives have existed and evolved over a long time.
Introduction of derivatives implies better risk management. Being new to markets maximum number of investors have not yet understood the full implications of the trading in derivatives. Trading in derivatives require more than average understanding of finance. participation of FII in the derivative market. Contract size should be minimized because small investor cannot afford this much of huge premiums.75 Derivatives market in India is growing rapidly unlike equity markets. These markets can give greater depth. SEBI should take actions to create awareness in investors about the derivative market. In order to increase the derivatives market in India SEBI should revise some of their regulation like contract size. Successful risk management with derivatives requires a through understanding of principles that govern the pricing of financial derivatives.
. stability and liquidity to Indian capital markets.
these instruments act as a powerful instrument for knowledgeable traders to expose them to the properly calculated and well understood risks in pursuit of reward i. If an expiry date the investor finds that the underlying asset in the option contract is traded at a less price in the stock market then. Options give the choice to the investor to either exercise his right or not.
. Though the use of derivatives does not completely eliminate the risk. The derivatives products give the investor an option or choice whether to exercise the contract or not.76
Suggestions to Investors
The investors can minimize risk by investing in derivatives. The use of derivative equips the investor to face the risk. It is advisable to the investor to invest in the derivatives market because of the greater amount of liquidity offered by the financial derivatives and the lower transactions costs associated with the trading of financial derivatives. profit. So in case of high uncertainty the investor can go for options. However. but it certainly lessens the risk.e. he has the full liberty to get out of the option contract and go ahead and buy the asset from the stock market. which is uncertain.
Indian financial system Investment management Publications of National Stock Exchange Websites www.com www. Khan .com www.com www.org .moneycontrol.K.com www.nseindia.sebi.hseindia.gov.V.com www.in www.Y.sharekhan.indianfoline.org www.com www.M.