Evolution of derivatives in India

 Commodities futures trading in India was initiated long back

in 1950.
 The 1960s marked a period of great decline in futures trading.
 Market after market was closed because different commodities
prices increases were attributed to speculation on these
markets.
 Central government imposed the ban on trading in derivatives
in 1969 under a notification issue.
 Late 1990s shows this signs of opposite trends, a large scale
revival of futures markets in India.
 Central government revoked the ban on futures trading in
October 1995.
 Civil supplies ministry agreed in principle for starting of
futures trading in Basmati rice.
 In 1996 the government granted permission to the Indian Pepper
and Spice Trade Association to convert its Pepper Futures
Exchange into an International Pepper Exchange.
 On November 17, 1997, India’s first international futures
exchange at kochi, known as the India pepper and spice trade
association – International Commodity Exchange (IPSTA- ICE)
was established.
 The Cochin Oil Millers Association, in June 1996, demanded the
introduction of futures trading in coconut oils.
 Central minister for agriculture announced in June 1996, the
introduction of futures trading both domestic and international.
 A new coffee futures exchange (the Coffee Futures Exchange of
India) is being started at Bangalore.
 In August 1997, the central government proposed that Indian
companies with commodity prices exposure should be allowed to
use foreign futures and option markets
 Reserve Bank of India set up the Sodhani Expert Group which
recommended major liberalization of the forward exchange
market and had urged the setting up of rupee-based derivatives in
financial instruments.
 The Securities and Exchange Board of India (SEBI) appointed a
committee named Dr.L.C.Gupta committee by its resolution,
dated November 18, 1996 in order to develop appropriate
regulatory frame work for derivatives trading in India.
 Committee’s focus was on equity derivatives but it had
maintained a broad perspective of derivatives in general.
 In December, 1999, the new frame work has been approved and
‘Derivatives’ have been accorded the status of ‘securities’.
 In June, 2000, the National Stock Exchange and Bombay Stock
Exchange started stock index based futures trading in India.
 Benefits of Derivatives in India
 India’s financial market system will strongly benefits from
smoothly functioning index derivatives markets.
 Launch of derivatives has been associated with substantial
improvements in market quality on the underlying equity market.
 Liquidity and market efficiency on India's equity market will
improve once the derivatives commence trading.
 Risks in the financial markets can be eliminated by diversification.
 Index derivatives are special in, can be used by investor to protect
themselves from the one risk in the equity market that cannot be
diversified away.
 Once the investor use index derivatives, they will suffer less when
fluctuations in the market index take place.
 Foreign investors coming into India would be more comfortable if
the hedging vehicles routinely used by them worldwide are
available to them.
 Launch of derivatives is a logical next step in the development
of human capital in India.
 Skills in the financial sector have grown tremendously.
 Categories of Derivatives Traded in India
 Commodities futures for coffee, oil seeds, oil, gold, silver, pepper,
cotton, jute and jute goods are traded in the commodities futures.
 Forward markets commission regulates the trading of commodities
futures.
 Index futures based on Sensex and NIFTY index are also traded
under the supervision of securities and exchange board of India.
 RBI has permitted banks, financial institutions and primary dealers
to enter into forward rate agreement (FRA)/ interest rate swap in
order to facilitate hedging of interest rate risk and ensuring orderly
development of derivatives market.
 National Stock Exchange (NSE) became the first exchange to
launch trading in options on individual securities.
 Trading in options on individual securities commenced from July,
2001.
 Options contract are American style and cash settled and are
available in about 40 securities.
 NSE commenced trading in futures on individual securities on
November 9, 2001. The futures contract are available in about
31 securities.
 BSE started trading in stock options and futures around at the
same time as the NSE.
 NSE commenced trading in interest rate future on June 2003.
 Interest rate futures contract are available on 91-day T-bills,
10 years bonds and 10-years zero coupon bonds as specified
by the SEBI.
 Structure of Derivatives Markets in India
 Derivatives markets in India categorized into two markets
namely:- 1. Financial derivatives 2. Commodities futures markets.
 Financial derivatives markets deal the financial future instruments
like stock futures, index futures, stock options, index options,
interest rate futures, currency, forwards and futures, financial
swaps, etc.
 Commodity futures markets deals with commodity instruments
like agricultural products, food grains, cotton and oil; metals like
gold, copper and steel and other assets like livestock, vegetables
and so on.
 Financial derivatives markets in India are regulated and controlled
by the Securities and Exchange Board of India (SEBI).
 SEBI is authorized under the SEBI Act to frame rules and
regulations for financial futures trading on the stock exchanges
with the objectives to protect the interest of the investors .
 Carry forward trading (Badla trading) is also regulated by the SEBI
which is traded on the stock exchanges.
 Other financial derivatives like currency options and futures and
interest rate futures are controlled by the Reserve Bank of India .
These are dealt on Over-the -Counter (OTC)
 RBI is the apex body to regulate currencies and interest rates in India.
 Financial derivatives relating to foreign currencies and interest rates
are come under the RBI regulation.
 Stock exchanges in India, under the regulation of the SEBI , trade in
two kinds of futures products, namely equity and carry forwards.
 Equity futures include stock futures, index futures, stock options and
index options. Currently these are traded on National Stock Exchange
and Bombay Stock Exchange.
 Commodity futures markets are regulated in India by Forward Market
Commission (FMC) .
 Important Eligibility/ Regulatory Conditions
Specified by SEBI
 Derivatives trading to take place through an on-line screen based
trading system.
 Derivatives exchange/ segment should have on-line surveillance
capability to monitor positions, prices and volumes on a real time
basis.
 Derivatives exchange/ segment should have arrangements for
dissemination of information about trades, quantities and quotes
on a real time basis.
 Derivatives exchange/ segment should have arbitration and
investor grievances redressal mechanism operatives from all the
regions of the country.
 Derivatives exchange/ segment should have satisfactory system of
monitoring investor complaints and preventing irregularities in
trading.
 Derivatives segment of the exchange would have a separate
Investor Protection Fund.
 The clearing house should have the capacity to monitor the
overall position of members across both derivatives market .
 Level of initial margin on index futures contracts will be related
to the risk of loss on the position.
 Clearing house will establish facilities for electronic funds
transfer (EFT) for swift (fast) movement of margin payment.
 A member defaulting in meeting its liabilities, the clearing house
shall transfer client positions and assets to another solvent
member or close-out all open position.
 The clearing house should have capabilities to segregate initial
margins deposited by clearing members for trades on their own
account and on account of his client.
 Regulatory Instruments
 Margin variation:
 Value which has to be paid in cash or securities by the seller or
the buyer in the futures market.
 Objective of such margin is to ensure the safety of the contract or
preventing from the defaults caused by one of the parties to the
contract.
 Higher margin will have more safety for the parties but at the
higher cost.
 Increase or decrease in margin will affect the volume of trading
in that asset.
 Imposition of special margins:
 Imposed by the regulatory authorities over and above the
ordinary margin as referred.
 The volume of speculative trading in the market has crossed its
normal limits, and the market has become explosive then to
check this excessiveness, the special margin in addition to
normal margin may be levied.
 Special margins are imposed with ‘threshold’ prices, they are
imposed only when prices are higher or lower to specified
limits.
 Daily or weekly limits on price changes:
 Basic objective of this tool is to keep the prices of the futures
instruments in a particular band (group) or limits, e.g. 10 per
cent upper and lower band of the normal price.
 Idea is to put limits temporarily on the price fluctuations or
blind price movements.
 Limits on open position:
 Relates to the limit on volume of trading for a particular
instrument for the traders in the market.
 Basic idea of making such restriction on open positions of the
market participants is just to avoid manipulation or excessive
speculation by the large operators.
 Temporary suspension of trading:
 The regulatory authority stops the trading in particular asset
temporarily for a particular period.
 Basic objective is to curb speculation, over dose (amount,
quantity) of speculative manipulation which rendered the
markets completely out of tune (alter, adjust) with reality.
 Authority can close out all the existing futures contract at a fixed
rate which does not give the ‘offending’ (wrong) parties the
speculative gain for which such deals were initiated.
 Changes in number and /or timing of contracts:
 Related to change in number and timings of the futures contracts
being traded because it is not well suited to the seasonality of
supply or demand of the particular asset or commodity.
 Example, regulatory authority may change the trading months
from February, March to April, May, etc.
 Fixation of price limits:
 Regulatory authority fixes the price limits, i.e. maximum and /or
minimum, which the futures market is not allowed to move.
 Limits are reached then in that case all the transactions can be
undertaken at the price or within the acceptable price range.
 Basic idea of this technique is to protect the markets at the time of
shortage or glut.(excess, surplus)
 Indefinite suspension or banning of trading:
 The futures market reached in such position where trading is to be
stopped indefinitely or till further order of the authority for
restarting of the trading.
 This is done in rare cases where the authority feels that no other
alternative is available except indefinite suspension of trading in
the market.
 Contract terminology and specifications for index
based futures
 Index futures are futures contracts on an index, like the Nifty. The
underlying asset in case of index futures is the index itself. For
example, Nifty futures traded in NSE track spot Nifty returns.
 If the Nifty index rises, so does the pay off of the long position in
Nifty futures. Apart from Nifty other indices such as CNX IT,
Bank Nifty etc. are also traded on the NSE.
 They have one-month, two-month, and three-month expiry cycle: a
one-month Nifty futures contract would expire in the current
month, a two-month contract the next month, and a three-month
contract the month after.
 All contracts expire on the last Thursday of every month, or the
previous trading day if the last Thursday is a trading holiday.
 Contract Specification for S&P Nifty Index Futures:
Underlying Index S&P CNX Nifty
Exchange of trading National Stock Exchange of India Limited

Security Descriptor FUTIDX NIFTY

Contract Size Permitted lot size is 50 (minimum value Rs
2 lakhs)

Trading Cycle The future contracts have

a maximum of three
month
trading cycle - the near month
(one), the next
month (two),
and the far month (three). New
contracts
are introduced on the
next trading day following
• Expiry Day The last Thursday of the expiry
month or the previous trading
day if the last Thursday is a
trading holiday
• Settlement Basis Mark-to-market and final
settlement are cash settled on
T+1 basis
• Settlement Price Daily Settlement price is the
closing price of the future
contracts for the trading day
and the final settlement price
is the value of the underlying
index on the last trading day
 Contract Specification for Stock Futures
• Underlying
• Exchange of Trading
• Security Descriptor
• Contract Size
• Trading Cycle
Individual Securities
NSE
FUTSTK
As specified by the exchange
(minimum value of Rs. 2 lakhs)
The futures contracts have a
maximum of three month
trading cycle---the near month
(one), the next month (two),
and the far month (three).
New contracts are introduced
on the next trading day
following the expiry of the
near month contract
• Expiry Day The last Thursday of the
expiry
month or the previous day if
Thursday is a trading holiday
• Settlement Basis Mark to market and final
settlement is cash settled on
T+1 basis
• Settlement Price Daily settlement price is the
closing price of the futures
contracts for the trading day
and the final settlement price
is the closing price of the
underlying security on the last
trading day.
 Contract Specification for Stock Options
• Underlying Individual Securities available
for trading in cash market
• Security Descriptor OPTSTK
• Style of Option European
• Contract size As specified by the exchange
(minimum value of Rs 2 lakhs)
• Trading Cycle The options contracts have a
maximum of three month
trading cycle—the near month
(one), the next month (two),
and the far month (three). New
contracts are introduced on the
next trading day following the
expiry of near month contract
• Expiry Day The last Thursday of the expiry
month or the previous trading
day if the last Thursday is a
trading holiday
• Settlement Basis Daily Settlement on T+1 basis
and final option exercice
settlement on T+1 basis
• Daily Settlement Premium value (net)
• Final Settlement price Closing price of underlying on
exercise day or on expiry day