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OF THE STUDY OBJECTIVES LIMITATIONS COMPANY PROFILE DERIVATIVE AS HEDGING TECHNIQUE DERIVATIVE INTRODUCTION HISTORY OF DERIVATIVE MOTIVES OF USING DERIVATIVES PLAYERS IN THE MARKET TYPES OF DERIVATIVES FORWARD MARKET FUTURES MARKET DIFFERENCE BETWEEN FORWARD AND FUTURE CONTRACT. OPTIONS MARKET
FINDINGS & SUGGESTIONS FINDINGS SUGGESTIONS .
The study can¶t be said as totally perfect. Any alteration may come the study has only made a humble attempt at evaluation derivatives market only in India context. Sector Financial report Budget Individual performances Graphs . OBJECTIVES This project has been taken up to study the Derivatives Futures and Option in detail with the idea of suggesting the strategies in this markets and an Technical analysis of oil sector using graphs and suggesting the buy or sell decision to the investor by using: 1. The study is not based on the international perspective of derivatives market which exists in NASDAQ CBOT etc. 2. Information about the history and various factors affecting the price performance has been studied from various Internet sites. SCOPE OF THE STUDY: The study is limited to Derivatives with special reference to futures and option in the Indian context and KOTAK SECURITIES LIMITED has been taken as a representative sample for the study. 4. NEED OF THE STUDY: The need of the study is to know the performance of derivative hedging and its working. Secondary data was provided by the organization and was gathered from the official websites of the respective organizations. 3. The data was sorted to find out the various factors that help in suggesting the decision taking for the individuals to buy and sell in this sector.SOURCES OF DATA Primary data was collected from the respondents who are trading in Indian Markets.
gold. index. Let¶s see it in this way. HISTORY OF DERIVATIVES The Derivatives market has existed from centuries as need for both users and producers of natural resources to hedge against price fluctuations in underlying commodities. option. which in turn depends upon the demand. Trading in derivatives market was legal before Morarji Desai¶s Government had banned forward contracts. stocks and stock indices had outstripped the commodities markets. Pepper futures in Kochi. soyabean. the demand for products based on financial instruments ± such as bond. Although trading in agriculture and other commodities has been the driving force behind the development of Derivatives market in India. the price of the Reliance Triple Option Convertible debentures. India has been trading in derivatives market in Silver. collars.DERIVATIVES AS HEDING TECHNIQUE A Derivative is a financial instrument that derives its value from an underlying asset. Coffee futures in Mangalore etc. The most popular derivative instruments are futures and options. These assets can be anything ranging from share. currencies. sugar crude. coffee etc. Derivatives can of different types like forwards. caps. . cotton. futures. which is derivative of milk. Example: A very simple example of derivative is curd. these contracts are legally binding agreements made on trading screens of stock exchanges to buy or sell an asset in the future. cotton and in oil markets for decades gray market. Derivatives on stocks were traded in the form of Teji and mandi in unorganized markets. and supply of milk. Recently futures contracts various commodities were allowed to be on various exchanges. Derivative on its own does not have any value. For Example Cotton and Oil futures were traded in Mumbai. bond. rupee dollar exchange rate. Soya bean futures in Bhopal. coffee. swaps. spices. It is considered important because of its underlying asset. The price of curd depends upon the price of milk. floor etc. Derivative is an financial contract whose price/value is dependent upon price of one or more basic underlying asset.
For other parties involved in the trading process.342 crore in 2002-03. Thus the former was about 16 percent of the total trading volume in the equity cash market.03. and does not pose any peculiar accounting problems. say shares. The volume of turnover in derivatives market has increased from a paltry sum. clearing members and clearing corporations. 8. futures and options on stock indices have gained more popularity than on individual stocks Accounting of Derivatives The Institute of Chartered Accountants of India (ICAI) has issued guidance notes on accounting of index futures contracts from the view point of parties who enter into such futures contracts as buyers or sellers.42. 4.20. Features of derivatives Derivatives are contracts that have no independent value They derive their value from their underlying assets They are used as ³ risk shifting´ or hedging instruments MOTIVES OF USING DERIVATIVES Spreads trade . of Rs. while the turnover in cash equity markets in India was Rs. a trade in equity index futures is similar to a trade in. In class of equity derivatives. like brokers. the total turnover in equity derivatives on BSE and NSE recently was of the order of Rs. 4038 crore in 2000-01 to Rs.complexity and also turnover. 1. trading members. The former is soon expected to exceed the latter. Growth of Derivatives During 2001-02.849 crore.459 Crore.
an importer has to pay US $ to buy goods and rupee is expected to fall to Rs. Players in the derivative market (1) Hedgers: Hedgers face risk associated with the price of an asset. 350 and make profits. Future and Options contracts can give them an extra leverage.50/$ from Rs. that is. one can buy a one-month future of Reliance at Rs.48/$. then the importer can minimize his losses by buying a currency future at Rs. Hedgers: People who buy or sell to minimize their losses. For example. if you will the stock price of Reliance is expected to go up to Rs.Currency risk management. Interest risk Real time trading in the market ( Treasury Activities) Players in the Market Speculators: People who buy or sell in the market to make profits. 400 in one month.49/$. they can increase both the potential gains and losses in a speculative venture. Players in the derivative market (2) Speculators : They are people who wish to bet on future movements in the price of the asset. They use futures or options markets to reduce or eliminate this risk. For example. Players in the derivative market (3) .
e. asset type. For eg. 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.After 1 month it is trading at Rs. In case one of the two parties wishes to reverse a contract. the exchange gives a counter guarantee even if the counter party defaults you will receive Rs. he has to compulsorily go to the other party. you will now entitled to your gains. Futures contracts are special .120. eg: Trade takes place between A&B@ 100 to buy & sell x commodity.as a gain. A contract has to be settled in delivery or cash on expiration date.Arbitrageurs: Arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. 20 & B Loose Rs. asset quality etc. In case of Future. If A was he buyer he would gain Rs. In case B defaults you are exposed to counter party Risk i. where settlement takes place on specific date in the future at today¶s pre-agreed price Features of forward contract It is a negotiated contract between two parties and hence exposed to counter party risk. If they see the futures price of an asset getting out of line with the cash price. expiration date.20. Types of Derivatives Forwards:A forward contract is a customized contract between two entities. The counter party being in a monopoly situation can command the price he wants. they will take offsetting positions in the two markets to lock in a profit. Each contract is custom designed and hence unique in terms of contract size.20/.
200 shares of Satyam. The standard Feature in any futures contract Obligation to buy or sell Stated quantity At a specific price Stated date (Expiration Date) Marked to Market on a daily basis For example: when you are dealing in March 2002 Satyam futures contract. the price is quoted per share.types of forward contracts in the sense that the former are standardized exchangetraded contra Functions of futures Help to determine the future prices Help transfer risk Higher trading volumes in underlying securities Reduces speculation in the cash market Increase saving and investment. the contract would be settled in cash and the closing price in the cash market on expiry day would be the settlement price. 2002. the tick size is 5 paise per share or (1200*0.05) = Rs60 per contract/ market lot. you know that the market lot. the contract would expiry on March 28. ie the minimum quantity you can buy or sell. Motives behind using Futures . is 1.
The futures market has two main types of foreseeable risk: .price risk . Customised vs Standardised contract: Counter Party Risk Liquidity Squaring off: How to use futures You can "open" a futures position by either buying or selling a future. Positions in futures Long Short Long Position .Hedging: It provides an insurance against an increase in the price. In practice. You can "close" your futures position by doing the opposite .either selling or buying the same future. at a predetermined future date and a price agreed upon between parties DIFFERENCE BETWEEN FORWARD AND FUTURE CONTRACT. most futures contract positions are "closed out" before they expire.quantity risk Interest Rate Futures An interest rate futures contract is an agreement to buy or sell a standard quantity of specific interest bearing instruments.
which commits you to take delivery of the underlying shares.the amount of the underlying commodity which is represented by the contract. financial instrument. currency. at a prearranged price and by a certain date Why use futures? You can profit in a falling market as well as a rising market Cost efficiency How are futures priced? Fair equity futures price = today's share price + interest costs . For instance. 1 corn futures represents 5. Short Position If your view is that the share prices for the underlying asset will fall.this is the maximum and minimum fluctuations that the contract can take.000 barrels.known as a SHORT futures position . while 1 crude oil futures contract usually represents 1. To prevent massive volatility many futures contracts are limited in the . or index.known as a LONG futures position . or equivalent cash value.dividends received Standardisation in Futures Each futures contract has a standard set of specifications: Underlying asset . Price Fluctuation . you could sell futures .000 bushels. or equivalent cash value.which commits you to deliver the underlying shares.what does the futures contract represent? Is it a commodity.If you hold a view that the underlying asset will rise you could buy futures . Standardisation in Futures Size . at a pre-arranged price and by a certain date.
this is the specified months for which the particular futures contract can be traded.the date by which the futures trading month ceases to exist at which all obligations are terminated. if the price reaches the upper or lower limit then the contract will be halted until the next trading day. Expiration Date .the quality of commodity that is to be delivered. this varies. Standardisation in Futures Deliverable Grade .the terms of the physical delivery of the underlying item or of the cash payment. Delivery Location . For example many crude contracts specify the amount of sulfur that can be in the oil.amount their price can fluctuate in one trading day.where the physical commodity is to be delivered. Standardisation in Futures Trading Months . Standardisation in Futures Settlement Mechanism . Options: Options are of two types ü Call option ü Put option .
at a given price on or before a given future date. Writer of call options : short call .Pay-off for Options« Buyer of call options : long call Writer of call options : short call Buyer of put options : long put Writer of call options : short put Buyer of call options : long call Call option gives the buyer the right but not the obligation to buy a given quantity of the underlying asset.
but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Buyer of put options : long put .Put option gives the buyer the right.
Writer of call options : short put .
FORWARD MARKET Introduction to Forwards In the recent years. the majority of options traded on options exchanges having a maximum maturity of nine months. . While futures and options are now actively traded on many exchanges. derivatives have become increasingly important in the field of finance. Equity index options are a form of basket options.Warrants: Options generally have lives of unto one year. The underlying asset is usually a moving average or a basket of assets. Longerdated options are called warrants and are generally traded over the years. Baskets: Basket options are on portfolios of underlying assets.
Counter party risk FUTURES MARKET: Introduction to Futures contracts: In the Derivatives market Futures contract is most actively traded contract. Limitations of Forward markets: Forward markets world-wide are afflicted by several problems: 1.Quantity of the underlying asset 2. 1. Lack of centralization of trading 2. and 3. It is one of the most popular types of contracts for the traders in the world. 1.Quality of the underlying asset (not required in case of financial futures) Expiration date The unit of price quotation (not the price) .Liquidity. after forwards contract were banned in some parts of the world. Here we shall study in detail about these three derivative contracts.forward contracts are popular on the OTC market. It has gained its momentum in recent years. FORWARD CONTRACTS: A Forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One party to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified future time.
Greeks include: · Delta · Gamma · Vega · Theta · Rho DELTA: Delta is the rate of change in the price of the stock option to a change in the price of the underlying. They can be used as indicators to help monitor and analyze the risks associated with portfolio which includes options.Minimum fluctuation in price (tick size) DERIVATIVES¶ GREEKS GREEKS: Greeks are statistical values that show the sensitivity of the price of an option to the factors that determine the value of an option. A delta of 0. 1 increase in the price of the underlying asset will increase the price of the option by approximately Re. .5 means that a Re. 0.50.
The theta of an option measures the unit change in the option price for a 1. VEGA: Vega is also known as kappa or lambda. 47. delta changes slowly whereas if gamma is large delta is very sensitive to the price of the underlying THETA: Theta is the rate of change of the value of the portfolio with respect to the passage of time.GAMMA: Gamma is the rate of change of delta with respect to the underlying asset price. 49.52 +0. For a buyer of the option.07 Rs. Vega is the rate of change of the value of the portfolio with respect to the change in volatility. .0 Rs.35 0.45 +0. 48. For example: Spot Price XYZ Aug 50 call Delta Gamma +0.0 Rs. this decay works against him while for a seller of the option it works in his favour.day decrease in the days remaining to option.0 If gamma is small. Theta is also referred to as time decay of an option.
. A Vega of 0.12 with every 1% increase/decrease in volatility RHO: Rho is the rate of change of the value of the portfolio with respect to the interest rate. 0.12 indicates that an option¶s value will increase/decrease by Re.