CHAPTER 1

INTRODUCTION

1
 1. INTRODUCTION
According to Securities contract, act “Derivatives” is defined as:
 A security derived from a debt instrument, share, loan whether secured or
unsecured, risk instrument or contract for differences or any other form of
security.
 A contract which derives its value from the prices, or index of prices,
ofunderlying securities.
 Section 18A provides that notwithstanding anything contained in any other
law for the time being in force, contracts in derivative shall be legal and
valid if such contractsare:
 Traded on a recognized stockexchange
 Settled on the clearing house of the recognized stock exchange, in
accordance with the rules and bye–laws of such stockexchanges.

In general, Derivative is a contract or a product whose value is derived from value

of some other asset known as underlying. Derivatives are based on wide range of
underlying assets.
These include:
 Metals such as Gold, Silver, Aluminum, Copper, Zinc, Nickel, Tin,Lead
 Energy resources such as Oil and Gas, Coal,Electricity
 Agri commodities such as wheat, Sugar, Coffee, Cotton, Pulsesand
 Financial assets such as Shares, Bonds and ForeignExchange. The products
in derivativemarket:
a. FORWARD
b. FUTURES
c. OPTIONS
d. SWAPS
e. WARRANTS

2
There are three major players in the financial derivatives trading:
Hedgers:
Hedgers are traders who use derivatives to reduce the risk that they face from
potential movements in a market variable and they want to avoid exposure to adverse
movements in the price of an asset. Majority of the participants in derivatives market
belongs to this category.

Speculators:
Speculators are traders who buy/sell the assets only to sell/buy them back profitably at
a later point in time. They want to assume risk. They use derivatives to bet on the
future direction of the price of an asset and take a position in order to make a quick
profit. They can increase both the potential gains and potential losses by usage of
derivatives in a speculative venture.
Arbitrageurs:
Arbitrageurs are traders who simultaneously buy and sell the same (or different, but
related) assets in an effort to profit from unrealistic price differentials. They attempt to
make profits by locking in a riskless trading by simultaneously entering into
transaction in two or more markets. They try to earn riskless profit from discrepancies
between futures and spot prices and among different futures prices.

3
OBJECTIVE OF STUDY

1. To study the origin and growth of Equity Derivatives Market in India.

2. To study and understand the strategies and sentiments of people who are
operating in derivativemarket.
3. To study the awareness of investors regarding derivative market.

4
SCOPE OF STUDY
 According to the analysis made, three parameters are the study has been
done to know the different types of derivatives and also to know the
derivative market inIndia.
 This study also covers the recent developments in the derivative market
taking into account the trading in pastyears.
 Through this study I came to know the trading done in derivatives and their
use in the stock markets.
 The scope of my research survey is restricted to students, house-wives and
the people who were trading at the work place. They were self-trading
member, dealer,analyst.

5
IMPORTANCE OF STUDY
 The project covers the derivatives market and its instruments. For better
understanding various
strategies with different situations and actions have been given. It includes the
data collected in the recent years and also the market in the derivatives in the
recent years. This study extends to the trading of derivatives done in the
National Stock Markets.
 To know the investors perception towards investment in Derivative Market
Toknow different types of Derivatives instruments.

6
LIMITATION OF STUDY

 Due to wider range of equity derivative market only the basic knowledge
related to various terms such as limit, options, future, stop loss open
position and so on were studied by me. Time is critical factor limiting the
study as it was only around 60days.
 While comparing the investment in stock market I was able to find that
many people invested in banks, real estate as compared to minor investment
in derivative market.The survey is restricted to sample size of50.

7
6. RESEARCHMETHODOLOGY
DATA COLLECTION METHOD
 Primary Data
 SecondaryData

Primary Data- Primary research consists of a collection of original primary data

collected by the researcher. It is often undertaken after the researcher has gained some
insight into the issue by reviewing secondary research or by analyzing previously
collected primary data.

Secondary Data- Under Secondary sources, information was collected from internal
& external sources. I made use of Internet sources.

SAMPLING DESIGN
 Sampling Size:50
 Sampling Method: Convenience Sampling

The report is based on primary data. One of the most important uses of research
methodology is that it helps in identifying the problem, collecting, analyzing, the
required information and providing alternative solution to the problem. It also helps in
collecting the vital information that is required by the investors to assist them for
better decision making and help them understanding how equity derivative
marketwork.

8
 CHAPTER 2
INDUSTRY PROFILE
COMPANY PROFILE

9
 2. INDUSTRY PROFILE
Financial services financial services are the economic services provided by the
finance industry, which encompasses a broad range of organizations that manage
money, including credit unions, banks, credit card companies, insurance companies,
consumer finance companies, stock brokerages, investment funds and some
government sponsored enterprises.
History of Stock Market in India
The Indian broking industry is one of the oldest trading industries that have been
around even before the establishment of BSE in 1875. BSE is the oldest stock market
in India. The history of India stock trading starts with 318 people taking membership
in Native share and Stock Brokers Association, which we know by the name Bombay
Stock Exchange or BSE in short. In 1965, BSE got permanent recognition from the
Government of India. BSE and NSE represent themselves as synonyms of India stock
market. The history of India stock market is almost the same as the history of BSE
The regulations and reforms been laid down in the equity market has resulted in rapid
growth and development. Basically, the growth in the equity market is largely due to
the effective intermediaries. The broking houses not only act as an intermediate link
for the equity market but also for the commodity market, the foreign currency
exchange market and many more. The broking houses have also made an impact on
foreign investors to invest in India to certain extent. In the last decade, the Indian
brokerage industry has undergone a dramatic transformation. Large and fixed
commissions have been replaced by wafer thin margins, with competition driving
down the brokerage fees, in some cases to a few basis points. There have also been
major changes in the way the business is conducted. The scope of services has
enhanced from being equity products to a wide range of financial services. Financial
Products the survey also revealed that in the past couple of years, apart from trading,
the firms have started various investment value services. The sustained growth of the
economy in past couple of years has resulted in broking firms offering many
diversified services related to IPO ‘s, mutual funds, company research etc.
However, the core trading activity is still the predominant form of business, forming
90% of the firms in the sample. 67% firms are engaged in offering IPO related
services. The broking industry seems to have capitalized on the growth of the mutual
fund industry, which pegged at 40% in 2006. More than 50% of the sample broking

10
 houses deal in mutual fund investment services. The average growth in assets under
management in last two years is almost 48% company research services. Additionally,
a host of other value-added services such as fundamental and technical analysis,
investment banking, arbitrage etc. are offered by the firms at
different levels.
Capital Market
Capital market is a market for securities (debt or equity), where business enterprises
(companies) and governments can raise long-term funds. Capital market may be
classified as primary markets and secondary markets.
 In primary market new stock or bond issues are sold to investor via a
mechanismknown asunderwriting.
 In secondary markets, existing securities are sold and brought among investors
ortraders, usually on a security exchange, over the counter or elsewhere. The capital
market includes e stock market (equity securities) and Bond market (debt).
Primary and Secondary Capital Markets: A company cannot easily attract
investors to invest in their securities if the investors cannot subsequently trade these
securities at will.In other words, securities cannot have a good primary market unless
it is ensured of an active secondarymarket.
PrimaryMarket
Securities generally have two stages in their lifespan. The first stage is when the
company initially issues the security directly from its treasury at a predetermined
offering price.
Primary market is the market for issue of new securities. It therefore essentially
consists of the companies’ issuing securities, the public subscribing to these
securities, the regulatory agencies like SEBI and the Government, and the
intermediaries such as brokers, merchant bankers and banks who underwrite the
issues and help in collecting subscription money from the public. It is referred to as
Initial Public offer (IPO). Investment dealers frequently buy initial offering on the
primary market and the securities on the secondary market.
Secondary Market
The second stage is when an investor or dealer makes the shares, bought from a
company treasury, available for sale to other investors on the secondary market.
Secondary market is the market for trading in existing securities, after they have been

11
created in the primary market. It essentially consists of the public who are buyers and
sellers of securities, brokers, mutualfunds, and most importantly, the stock exchanges
where the trading takes place, such as the BSE (Bombay Stock Exchange) or NSE
(National Stock Exchange).

Indian StockExchange
Stock Market

A stock market or equity market is a public entity (a loose network of economic

transaction, not a physical facility or discrete entity) for the trading of company stock
(shares) and derivatives at an agreed price; these are securities listed on a stock
exchange as well as those only traded privately.
Stock exchange
A stock exchange provides services for stock brokers and traders to trade stocks,
bonds and other securities. Stock exchanges also provide facilities for issue and
redemption of securities and other financial instruments and capital events including
the payment of income and dividends. Securities traded on stock exchange include
shares issued by companies, unit trusts, derivatives, pooled investment products and
bonds.
Equity/Share
Total equity capital of a company is divided into equal units of small denominations,
each called a share. For example, in a company the total equity capital of Rs.
2,00,00,000 is divided into 20,00,000 units of Rs 10 each. Each such unit of Rs. 10 is
called a share. Thus, the company then is said to have 20, 00,000 equity share of Rs
10 each. The holders of such shares are members of the company and have voting
rights. There are now stock markets in virtually every developed and most developing
economy, with the world ‘s biggest being in the United States, UK, Germany, France,
India and Japan.

Market participants
Market participants include individual retail investors, institutional investors such as
mutual funds, banks, insurance companies and hedge funds, and also public ally
traded corporations trading in their own shares.

12
 Trading Participants
In the stock market range from small individual stock investors to large hedge fund
traders, who can be based anywhere.
Listing
Listing means admission of securities of an issuer to trading privileges on a stock
exchange through a formal agreement. The prime objective of admission to dealing on
the Exchange is to provide liquidity and marketability to securities.
Securities
A Security gives the holder an ownership interest in the assets of a company. For
example, when a company issues security in the form of stock, they give the
purchaser an interest in the
company’s assets in exchange for money. There are a number of reasons why a
company issues securities: meeting a short – term cash crunch or obtaining money for
an expansion is just two.

WHAT IS SEBI AND WHAT IS ITS ROLE?

In 1988 the Securities and Exchange Board of India (SEBI) was established by the
Government of India through an executive resolution, and was subsequently upgraded
as a fully autonomous body (a statutory Board) in the year 1992 with the passing of
the Securities and Exchange Board of India Act (SEBI Act) on 30th January 1992. In
place of Government Control, a statutory and autonomous regulatory board with
defined responsibilities, to cover both development & regulation of the market, and
independent powers has been set up. Paradoxically this is a positive outcome of the
Securities Scam of 1990-91.

OBJECTIVES OF SEBI
The promulgation of the SEBI ordinance in the parliament gave status to SEBI in
1992. According to the preamble of the SEBI, the three main objectives are:
 To protect the interests of the investors insecurities
 To promote the development of securitiesmarket
 To regulate the securitiesmarket

13
 FUNCTIONS OF SEBI
The main functions entrusted with SEBI are:
 Regulating the business in stock exchange and any other securities market
 Registering and regulating the working of stock brokers, share transfer agents,
bankers tothe issue, trustees of trust deed, registrars to an issue, merchant bankers,
underwriters, portfolio managers, investment advisers and such other intermediaries
who may be associated with securities market in anymanner.
 Registering and regulating the working of collective investment schemes including
mutual funds Promoting and regulating self-regulatoryorganizations
 Prohibiting fraudulent and unfair trade practices in the securitiesmarket
 Promoting investors education and training of intermediaries in securitiesmarket
 Prohibiting insiders trading insecurities
 Regulating substantial acquisition of shares and takeover ofcompanies
 Calling for information, undertaking inspection, conducting enquiries and audits of the
stock exchanges, intermediaries and self-regulatory organizations in the securities
market.
Since its inception SEBI has been working targeting the securities and is
attending to the fulfillment of its objectives with commendable zeal and dexterity.
The improvements in the securities markets like capitalization requirements,
margining, establishment of clearing corporations etc. reduced the risk of credit and
also reduced the market.

SEBI has introduced the comprehensive regulatory measures, prescribed registration

norms, the eligibility criteria, the code of obligations and the code of conduct for
different intermediaries like, bankers to issue, merchant bankers, brokers and sub-
brokers, registrars, portfolio managers, credit rating agencies, underwriters and others.
It has framed by-laws, risk identification and risk management systems for Clearing
houses of stock exchanges, surveillance system etc. which has made dealing in
securities both safe and transparent to the end investor.
Another significant event is the approval of trading in stock indices (like S&P CNX
Nifty & Sensex) in 2000. A market Index is a convenient and effective product
because of the following reasons:

14
 It acts as a barometer for marketbehavior;
 It is used to benchmark portfolioperformance;
 It is used in derivative instruments like index futures and indexoptions;
 It can be used for passive fund management as in case of IndexFunds
Two broad approaches of SEBI are to integrate the securities market at the national
level, and also to diversify the trading products, so that there is an increase in number
of traders including banks, financial institutions, insurance companies, mutual funds,
primary dealers etc. to transact through the Exchanges. In this context the introduction
of derivatives trading through Indian Stock Exchanges permitted by SEBI in 2000 AD
is a real landmark.
SEBI appointed the L. C. Gupta Committee in 1998 to recommend the regulatory
framework for derivatives trading and suggest bye-laws for Regulation and Control of
Trading and Settlement of Derivatives Contracts. The Board of SEBI in its meeting
held on May 11, 1998 accepted the recommendations of the committee and approved
the phased introduction of derivatives trading
in India beginning with Stock Index Futures. The Board also approved the
"Suggestive Bye- laws" as recommended by the Dr LC Gupta Committee for
Regulation and Control of Trading and Settlement of Derivatives Contracts. SEBI
then appointed the J. R. Verma Committee to recommend Risk Containment
Measures (RCM) in the Indian Stock Index Futures Market. The report was submitted
in November1998.

However, the Securities Contracts (Regulation) Act, 1956 (SCRA) required

amendment to include "derivatives" in the definition of securities to enable SEBI to
introduce trading in derivatives. The necessary amendment was then carried out by
the Government in 1999. The Securities Laws (Amendment) Bill, 1999 was
introduced. In December 1999 the new framework was approved. Derivatives have
been accorded the status of `Securities'. The ban imposed on trading in derivatives in
1969 under a notification issued by the Central Government was revoked. Thereafter
SEBI formulated the necessary regulations/bye-laws and intimated the Stock
Exchanges in the year 2000. The derivative trading started in India at NSE in 2000
and BSE started trading in the year 2001.

15
BOMBAY STOCK EXCHANGE (BSE)
Established in 1875, BSE (formerly known as Bombay Stock Exchange Ltd.), is
Asia's first & the Fastest Stock Exchange in world with the speed of 6 micro seconds
and one of India's leading exchange groups. Over the past 141 years, BSE has
facilitated the growth of the Indian corporate sector by providing it an efficient
capital-raising platform. Popularly known as BSE, the bourse was established as "The
Native Share & Stock Brokers' Association" in 1875. Today BSE provides an efficient
and transparent market for trading in equity, currencies, debt instruments, derivatives,
mutual funds. It also has a platform for trading in equities of small-and-medium
enterprises (SME). India INX, India's 1st international exchange, located at GIFT
CITY IFSC in Ahmadabad is a fully owned subsidiary of BSE. BSE is also the 1st
listed stock exchange of India.
BSE provides a host of other services to capital market participants including
risk management, clearing, settlement, market data services and education. It has a
global reach with customers around the world and a nation-wide presence. BSE
systems and processes are designed to safeguard market integrity, drive the growth of
the Indian capital market and stimulate innovation and competition across all market
segments. BSE is the first exchange in India and second in the world to obtain an ISO
9001:2000 certifications. It is also the first
Exchange in the country and second in the world to receive Information Security
Management System Standard BS 7799-2-2002 certification for its On-Line trading
System (BOLT). It operates one of the most respected capital market educational
institutes in the country (the BSE Institute Ltd.). BSE also provides depository
services through its Central Depository Services Ltd. (CDSL) arm. BSE's popular
equity index - the S&P BSE SENSEX - is India's most widely tracked stock market
benchmark index. It is traded internationally on the EUREX as well as leading
exchanges of the BRCS nations (Brazil, Russia, China and South Africa).
NATIONAL STOCK EXCHANGE (NSE)
The National Stock Exchange of India is a stock Exchange that is located in Mumbai,
Maharashtra. The National Stock Exchange basically function in three market
sections, that is, (CM) the Capital Market Section); F&Q (The Future and Options
Market Sections) and WDM (Wholesale Debt Market Segment). It is important place
where the trading of shares, debt etc. takes place. It was in year 1992 that the National

16
stock Exchange was for the first time incorporated in India. It was not regarded as a
stock exchange at once. Rather, the national Stock exchange was incorporated as a tax
paying company and had got the recognition of a stock exchange only in year 1993
the recognition was given under the provisions of the Securities Contracts
(Regulation) Act, 1956. The National Stock exchange is highly active in the field of
market capitalization and thus aiming it the ninth largest stock exchange in the said
field.
Similarly, the trading of the stock exchange in equities and derivatives is so high that
it has resulted in high turnovers and thus making it the largest stock exchange in
India. It is the stock exchange wherein there is the facility of electronic exchange
offering investors. This facility is available in almost types of equitable transactions
such as equities, debentures, etc. it is also the largest stock exchange if calculated in
the terms of traded values.
ORIGIN AND HISTORY OF THE NATIONAL STOCK
EXCHANGE
The National Stock exchange was incorporated for the first time in November, 1992.
The national stock exchange was not incorporated as the national stock exchange;
rather, it had got the recognition of the recognized stock exchange in April, 1993. The
National stock Exchange has increased its trading facilities in June 1994 when the
WDM (Wholesale Debt Market Segment) was gone live. It is basically one of the
three market segments in which the national stock Exchange works. In the same year,
1994 November, the Capital Market (CM) segment of the stock exchange goes live
through VSAT.

The National Stock Exchange has become the first Clearing Corporation in India by
the
introduction of NSCCL in April 1995. In the same year, 1995 July, it has introduced
the Investor protection fund which is a very important function introduced by the
national Stock Exchange.
The National stock Exchange had grown with leaps and bounds and had shown
tremendous growth mainly in all the fields and thus making it the largest stock
exchange of India by October, 1995. The concept of NSCCL was extended by the
introduction of clearing and settlement with the help of NSCCL in year 1996. The

17
National stock Exchange has introduced its Index for the first time in year April 1996.
The index was known as the S&P Nifty Index. In year June 1996, it has introduced
the Settlement Guarantee Fund. The National Securities Depositor Fund was launched
by the National Stock exchange in year 1996, November, and thus making it the first
stock exchange who becomes the first depository in India. Because of the efforts and
introduction of new concept in the field of trading, the National stock Exchange has
received the
BEST IT USAGE award by the computer Society of India in the year November,
1996. It has also received an award for the TOP IT USER in the name of ―Dataquest
award‖ in year December, 1996.
The National stock exchange has also introduced another index in year December
1996 in the name of CNX Nifty Junior in year 1996. It had again received an award
for the BEST IT USAGE award by the computer Society of India in the year
December, 1996. In May, 1998 it had launched its first website. Further in October
1999, it had launched the NSE.IT LTD. Further in year October, 2002, it had
launched the Government securities index. The growth of the National Stock
Exchange has been tremendous in every field. It had introduced several programmers
and has achieved various achievements and awards while working best in the field in
which it is working. The efforts and hard work that is contributed by the National
Stock exchange has been tremendous and thus making an important and unique stock
exchange in India.
TYPES OF MARKET
Two important terms before discussing derivatives, it would be useful to be familiar
with two terminologies relating to the underlying markets. These are as follows:
Spot Market
In the context of securities, the spot market or cash market is a securities market in
which securities are sold for cash and delivered immediately. The delivery happens
after the settlement period. Let us describe this in the context of India. The NSE ‘s
cash market segment is known as the Capital Market (CM) Segment. In this market,
shares of SBI, Reliance, Infosys, ICICI Bank, and other public listed companies are
traded. The settlement period in this market is on a T+2
bases i.e., the buyer of the shares receives the shares two working days after trade date
and the seller of the shares receives the money two working days after the trade date.

18
Index
Stock prices fluctuate continuously during any given period. Prices of some stocks
might move up while that of others may move down. In such a situation, what can we
say about the stock market as a whole? Has the market moved up or has it moved
down during a given period?
Similarly, have stocks of a particular sector moved up or down? To identify the
general trend in the market (or any given sector of the market such as banking), it is
important to have a reference barometer which can be monitored. Market participants
use various indices for this purpose. An index is a basket of identified stocks, and its
value is computed by taking the weighted average of the prices of the constituent
stocks of the index. A market index for example consists of a group of top stocks
traded in the market and its value changes as the prices of its constituent stocks
change. In India, Nifty Index is the most popular stock index and it is based on the top
50 stocks traded in the market. Just as derivatives on stocks are called stock
derivatives, derivatives on indices such as Nifty are called indexderivatives.

19
 COMPANY’SPROFILE
NG RATHI INVESTRADES PVT LTD is one of the most renowned brokerage
houses in Hyderabad. The promoters share 16 years of rich experience in the broking
segment. It is a fully integrated capital markets intermediary dedicated towards
providing you with a technology driven investment platform.
NGRIPL is a member of National Stock Exchange (NSE), Bombay Stock Exchange
(BSE) as well as the leading commodity exchange of India i.e., MCX. NGRIPL is
also registered as a Depository Participant of CDSL.
The management at NGRIPL is the CRUX of our foundation. Nitin M Rathi
(Chairman)
Mr. Nitin M Rathi a man of substance, versatile in business. He is Bachelors of
Electronics but his interest brought him to this field and now he contributes his rich
experience of more than 16 years in the capital markets with a focus on the
derivatives segment, to the growth of Dreams Investrades Pvt. Ltd. He has evolved as
a catalyst in nurturing business for NG Rathi Investrades Pvt. Ltd. He is a Director of
Dreams Capital Pvt. Ltd
Girish Madhukar Rathi (Managing Director)

Mr. Girish Rathi has a rich and varied experience of more than 10 years in all aspects
of the Equity Capital Markets. Being the founder member of Dreams Group, he has
nurtured the group as his own child. He is one of the Board members of the Dreams
Group. He is a former member of Hyderabad Stock Exchange.
Neha Nitin Rathi (Director)
Mrs. Neha Rathi has done her Masters in Commerce. She is a multifaceted personality
with a rich experience of more than 10 years in the capital markets. She gives credit
for her knowledge in the markets to her husband, Mr. Nitin Rathi.
USP OF NG RATHI INVESTRADES ARE:
 Personalized service
 Expert'sadvice
 Dedicated researchteam
 Experiencedpromoters
 Training platform
Products and Services delivered by them for Wealth creation of their investors and

20
traders:
Equitymarket-
WEALTH CREATION” a motive of each individual. NG Rathi Investrades Pvt. Ltd.
Provides support for this motive of yours. In true sense, Equity markets in India are
very volatile but undoubtedly the best source for WEATLH CREATION. Just with a
little bit of guidance from an expert at NGRIPL you can successfully achieve your
motive. Make the most out of it, help us serve you the best.
Derivativemarket-
Higher the risk better the returns, that is what a risk to return model suggests. Have
the appetite for higher risk, trade in the F&O segment. NGRIPL offers you the best
platforms for trading in F&O with the largest exchange in the country, NSE (National
Stock exchange of India).
With SEBI permitting delivery in F&O segment now the segment has become all the
more alluring. Today you can, to lower your risk Hedge your open position in Cash
(spot) market or F&O market using Derivative Instruments, traders can speculate, if
you prefer playing safe you can take advantage of the arbitrage opportunities.

Online Trading-
When the world we get on the Internet why not WEALTH? At your fingertips, with
the comfort of your home/office or on the move, stay in touch with the market. Buy or
sell, keep trading, CREATE WEALTH, NG Rathi Investrades Pvt. Ltd. will always
be there for you.
4.Free Trading Calls-

The other diversified business that the company is dealing into is construction, under
the name N.G.Rathi and Associates.

21
 CHAPTER 3
LITERATURE REVIEW

22
 LITERATUREREVIEW
 Barua et al (1994)1 undertakes a comprehensive assessment of the private corporate
debt market, the public sector bond market, the govt. securities market, the housing
finance and other debt markets in India. This provides a diagnostic study of the state
of the Indian debt market, recommending necessary measures for the development of
the secondary market for debt. It highlights the need to integrate the regulated debt
market with the free debt market, the necessity for market making for financing and
hedging options and interest rate derivatives, and tax reforms.
 Abhyankar (1995) compared the FTSE 100 stock index with the stock index futures
market. He found support for the hypothesis that lower transaction costs are the
primary reason for traders with market wide information to use the futures market.
 Anna A. Merika’s et.al. (1999) studied the factors that influence individual investor
behavior in the Greek Stock Exchange. The results revealed that there is a certain
degree of correlation between the factors that behavioral finance theory and previous
empirical evidence identify as the influencing factors for the average equity investors,
and the individual behavior of active investors in the Athens Stock Exchange.
 Oliveira and Armada (2001)6 did not find any significant change on the spot market
volatility of the Malaysia and Portuguese stock markets respectively.
 Chuang (2003) examined the price discovery Stock Exchange Capitalization
Weighted Index Futures) and MSCI (Morgan Stanley Capital International Taiwan
Index Futures) during 1998-99 and found strong statistical evidence of market
efficiency in its weak form.
 Bandivadekar and Ghosh, Sah and Omkarnath (2003) also investigated the behaviour
of volatility in cash market in futures trading era. They also found that futures trading
has led to reduction in volatility in the underlying asset market but they attributed the
degree of decline in volatility in the underlying market to the trading volume in
futures market. They inferred that as the trade volume in the Futures and Options
segment of BSE is very low, the volatility in BSE has not significantly declined;
whereas in the case of NSE (where the trade volume is at the peak), the volatility in
NIFTY has reduced significantly
 Raju and Karande (2003) found a reduction in spot market volatility after the
introduction of index futures in National Stock Exchange, India.

23
 Snehal Bandivadekar and Saurabh Ghosh (2003) have studied on the impact of
introduction of index futures on spot market volatility on both S&P CNX Nifty and
BSE Sensex using ARCH/GARCH technique.
 Shenbagraman (2004) reviewed the role of some non-price variables such as open
interests, trading volume and other factors, in the stock option market for determining
the price of underlying shares in cash market. The study covered stock option
contracts for four months from Nov. 2002 to Feb. 2003 consisting 77 trading days.
The study concluded that net open interest of stock option is one of the significant
variables in determining future spot price of underlying share. The results clearly
indicated that open interest-based predictors are statistically more significant than
volume-based predictors in Indian context.
 Pok and Poshakwale (2004) in their studies on the KOSPI200 index of the Korean
market and KLSE on the Malaysian one, found that while the derivatives increased
the volatility of the underlying market, they simultaneously improved its effectiveness
as well by increasing the speed at which information was impounded into the spot
market prices.
 Gupta and Singh (2006) also made an attempt to investigate the price discovery
efficiency of the Nifty futures by considering lengthy time frame and their results
showed the evidences that futures market has been an efficient price discovery
vehicle.
 Mallikarjunappa and Afsal (2007) studied the volatility implications of the
introduction of derivatives on the stock market in India using S&P CNX IT index and
found that clustering and persistence of volatility in different degrees before and after
derivatives and the listing in futures has increased the market volatility.
 Alexakis, P. (2007) examined the stock market volatility before and after the
introduction of index futures. He found that index futures had no significant effect on
the spot markets.
 Paul Dawson (2007) in his journal provides with effective hedging techniques for
covering foreign exchange risk in overseas equity investments.
 Sascha Wilkens (2007) in her journal throws light empirically on returns of index call
and put options traded at the Eurexi.e., European Exchange.

24
 Patrícia Teixeira Lopes (2007) in her journal focuses on accounting of energy
derivatives in context of introduction of MIBEL derivatives market. This paper
brought out that energy producers and users who hedge their risks using exchange
traded futures are coping up with compliance of IAS 39 hedge accounting, as it ‘s easy and
straightforward
 Reddy and Sebastin (2008) studied the temporal relationship between the equities
market and the derivatives market segments of the stock market using various
methods and by identifying lead-lag relationship between the value of a representative
index of the equities market and the price of a corresponding index futures contract in
the derivatives market. The study observed that price innovations appeared first in the
derivatives market and were then transmitted to the equities market. The dynamics of
such information transport between stock market and derivatives market were studied
using the information theoretic concept of entropy, which captures non-linear
dynamic relationship also.
 A new study of Kasman (2008) examined the impact of futures on volatility of the
underlying asset (via GARCH model) including the question of whether a co
integrating relation exists between spot prices and futures prices (via ECM model).
They used the Istanbul Stock Price Index 30 (ISE 30) futures and spot prices and
concluded that there is a long run relation (nearly one-to-one) between spot and
futures prices and causality runs from spot prices to future prices, but not vice versa.
 Bodla and Kiran (2008) investigated the impact of index derivatives on the return,
efficiency and volatility of the S&P CNX Nifty. The results of the study indicate
increased market efficiency and reduced volatility with no price change in the
underlying market due to introduction of derivatives. However, a significant increase
in volatility on the expiration day of derivative contracts has been observed.
 Satya Swaroop Debasish (2009) in his paper investigated the effect of Nifty Futures
trading on the volatility and operating efficiency of Indian Stock Market in general
and the underlying stock in particular. The study covers a period of fourteen years i.e.
from 1995 to 2009. The author has applied event study approach to test the change in
volatility and efficiency of stock returns by making a comparison between pre and
post introduction of Nifty Index Futures. The study revealed mixed results i.e.,
reduced spot volatility and reduced trading efficiency and in the short run, there is a
trade-off gains and costs associated with the introduction of derivatives. The study
concluded that the derivatives have led to market stabilization cut the market has to

25
 pay a price for it in the future of loss in the market efficiency.
 Prof Pasqualina Porretta, Luca Ferraro, Massimo Proietti and Mario Rosati (2009) has
indicated the size and complexity of financial derivatives traded over OTC has shown
an upward trend. In relation to this the size of interest rate derivatives has increased
due its speculative nature, arbitrage and hedging strategies.

 Debasish (2011)25 examines the long-term relationship between spot prices and
futures prices. The study finds a single long-term relationship for each of the selected
companies across the six sectors.

 Parantap Basu and William T. Gavin (2011)26 in their article throws light on the
massive trading on commodity derivatives in the past decade.

26
 DERIVATIVESMARKET
Derivative is a value of a product derived from an underlying asset.
HISTORY & EVOLUTION OF DERIVATIVES MARKET – History of
Derivatives may be mapped back to the several centuries. Some of thespecific
milestones in evolution of Derivatives Market Worldwide are givenbelow:
GLOBAL HISTORY OF DERIVATIVE MARKET
 12th Century
- In European trade fairs, sellers signed contracts promising future delivery of the items
theysold.
 13th Century
- There are many examples of contracts entered into by EnglishCistercian
 Monasteries, who frequently sold their wool up to 20 years in advance, toforeign
merchants
 In 1975, CBOT introduced Treasury bill futures contract. It was the first
successfulpure Interest ratefutures.
 In 1977, CBOT created T -bond futurescontract.
 In 1982, CME created Eurodollar futurescontract.
 In 1982, Kansas City Board of Trade launched the first stock indexfutures
 In 1983, Chicago Board Options Exchange decided to create an option on an indexof
stocks

REGULATION OF DERIVATIVES TRADING IN INDIA

 The regulatory frame work in India is based onL.C.
 Gupta Committee report and J.R. Varma Committee report. It is most consistent
withthe international organization of securities commission(IUSCO).
 The L.C. Gupta Committee report provides a perspective on division of regulatory
responsibility between the exchange and SEBI. It recommends that SEBI‟s role
shouldbe restricted to approving rules, bye laws and regulations of a derivatives
exchange as also to approving the proposed derivatives contracts before
commencement of their trading. It emphasizes the supervisory and advisory role of
SEBI. It also suggests establishment of a separate clearingcorporation.

27
 DERIVATIVES MARKET IN INDIA
 In India, there are two major markets namely National Stock Exchange (NSE) and
Bombay Stock
 Exchange (BSE) along with other Exchanges of India are the market for derivatives.
Here we may discuss the performance of derivatives products in Indianmarket.
 The BSE started derivatives trading on June 9, 2000 when it launched
“Equityderivatives (Index futures-SENSEX) firsttime.
 The NSE started derivatives trading on June 12, 2000 when it launched “Index
Futures S & P CNX Nifty” firsttime.
 India is one of the most successful developing countries in terms of a vibrant
marketfor exchange-traded derivatives. There is an increasing sense that the equity
derivatives market plays a major role in shaping pricediscovery.

MILESTONE DEVELOPMENT IN INDIAN DERIVATIVE

MARKET

November 18, 1996 L.C. Gupta Committee set up to draft a policy framework for
introducing derivatives

May 11, 1998 L.C. Gupta committee submits its report on the policy Framework

May 25, 2000 SEBI allows exchanges to trade in index futures

June 12, 2000 Trading on Nifty futures commences on the NSE

June4, 2001 Trading for Nifty options commences on the NSE

July 2, 2001
Trading on Stock options commences on the NSE
November 9, 2001
Trading on Stock futures commences on the NSE
August 29, 2008
Currency derivatives trading commences on the NSE
August 31, 2009
Interest rate derivatives trading commences on the NSE
February 2010
Launch of Currency Futures on additional currency pairs
October 28, 2010
Introduction of European style Stock Options

28
 October 29, 2010
Introduction of Currency Options
FACTORS DRIVING THE GROWTH OFDERIVATIVES
Over the last three decades, the derivatives market has seen a
phenomenal growth. A large variety of derivative contracts have been
launched at exchanges across the world. Some of the factors driving the
growth of financial derivatives are:
1. Increased volatility in asset prices in financialmarkets,
2. Increased integration of national financial markets with the
internationalmarkets,
3. Marked improvement in communication facilities and sharp decline in
theircosts,
4. Development of more sophisticated risk management tools,
providing economic agents a wider choice of risk management
strategies,and
5. Innovations in the derivatives markets, which optimally combine the
risks and returns overa large number of financial assets leading to higher
returns, reduced risk as well as transactions costs as compared to
individual financialassets.
DERIVATIVE PRODUCTS –
5.4.1 TYPES AND CLASSIFICATION
On the basis of linear and non-linear: On the basis of this classification the financial
derivatives can be classified into two big class namely linear and non-
linearderivatives:
(a) Linear derivatives: Those derivatives whose Over-the-counter (OTC)
traded derivative: These values depend linearly on the underling’s value are
called linear derivatives. They arefollowing:
(i) Forwards
(ii) Futures
(iii)Swaps

(b) Non-linear derivatives:

Those derivatives whose value is a non-linear function of the underlying are called

29
non-linear derivatives. They are following:
(i) Options
(ii) Convertibles
(iii)Equity linked bonds
(iv)Reinsurance

1. On the basis of financial and non-financial: On the basis of this

classification the
derivatives can be classified into two category namely financial derivatives andnon-
financialderivatives.
(a) Financial derivatives: Those derivatives which are of financial nature
are calledfinancial derivatives. They arefollowing:
(i) Forwards
(ii) Futures
(iii) Options (iv)Swaps
The above financial derivatives may be credit derivatives, forex, currency fixed-
income, interest, insider trading and exchange traded.
(b) Non-financial derivatives: Those derivatives which are not of financial
nature are called non- financial derivatives. They are following:
(i) Commodities
(ii) Metals
(iii) Weather (iv)Others
Derivative contracts have several variants as seen above; the most
common variants are forwards, futures, options and swaps. We take a brief
look at various derivatives contracts that have come to be used.
Forwards:
A forward contract is a customized contract between two entities, where
settlement takes place on a specific date in the future at today's pre-
agreed price. They are linear in nature.
Futures:
A futures contract is an agreement between two parties to buy or sell an
asset at a certain time in the future at a certain price. Futures contracts are
special types of forward contracts in the sense that the former are

30
 standardized exchange traded contracts.
Options are non-linear product. Options are of two types - calls and puts.
 Calls give the buyer the right but not the obligation to buy
a given quantity of the underlying asset, at a given price on
or before a given futuredate.
 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 givendate.
Warrants:
Options generally have lives of up to one year; the majority of options traded on
options exchanges having a maximum maturity of nine months. Longer-dated options
are called warrants and are generally traded over-the-counter.
Swaps:
Swaps are private agreements between two parties to exchange cash flows in the future
according to a prearranged formula. They can be regarded as portfolios of forward
contracts. The two commonly used swaps are:
• Interest rateswaps:
This entail swapping only the interest related cash flows between the parties in the
same currency.
• Currencyswaps:
This entail swapping both principal and interest between the parties, with the cash
flows in one direction being in a different currency than those in the opposite
direction.

OVER THE COUNTER

In the modern world, there is a huge variety of derivative products available. They are
either traded on organized exchanges (called exchange traded derivatives) or agreed
directly between the contracting counterparties over the telephone or through
electronic media (called over the- counter (OTC) derivatives). Few complex products
are constructed on simple building blocks like forwards, futures, options and swaps to
cater to the specific requirements of customers.
Over-the-counter market is not a physical marketplace but a collection of broker-
dealers scattered across the country. Main idea of the market is more a way of doing

31
business than a place. Buying and selling of contracts is matched through negotiated
bidding process over a network of telephone or electronic media that link thousands
of intermediaries. OTC derivative markets have witnessed a substantial growth over
the past few years, very much contributed by
the recent developments in information technology. The OTC derivative markets
have banks, financial institutions and sophisticated market participants like hedge
funds, corporations and high net-worth individuals. OTC derivative market is less
regulated market because these transactions occur in private among qualified
counterparties, who are supposed to be capable enough to take care of themselves.
The OTC derivatives markets–transactions among the dealing counterparties have
following features compared to exchange traded derivatives:
 Contracts are tailor made to fit in the specific requirements of
dealingCounterparties.
 The management of counter-party (credit) risk is decentralized and located
within individualinstitutions.
 There are no formal centralized limits on individual positions, leverage,
ormargining.
 There are no formal rules or mechanisms for risk management to ensure
marketstability and integrity, and for safeguarding the collective interest of
marketparticipants.
 Transactions are private with little or no disclosure to the entire market. On
the contrary, exchange-traded contracts are standardized, traded on
organized exchanges with prices determined by the interaction of buyers and
sellers through anonymous auctionplatform. A clearing house/ clearing
corporation, guarantees contract performance (settlement of transactions).
SIGNIFICANCE OFDERIVATIVES
Inspite of the fear and criticism with which the derivative markets are commonly
looked at, these markets perform a number of economic functions.
1. Prices in an organized derivatives market reflect the perception of market
participants about the future and lead the prices of underlying to the perceived future
level. The prices of derivatives converge with the prices of the underlying at the
expiration of the derivativecontract. Thus, derivatives help in discovery of future as
well as currentprices.

32
 2. The derivatives market helps to transfer risks from those who have them
but may not like them to those who have an appetite forthem.
3. Derivatives, due to their inherent nature, are linked to the underlying cash
markets, with the introduction of derivatives, the underlying market witnesses’
higher trading volumes because of participation by more players who would not
otherwise participate for lack of an arrangementto transfer risk.
4. Speculative trades shift to a more controlled environment of derivatives market.
In the absence of an organized derivatives market, speculators trade in the
underlying cash markets.Margining,
monitoring and surveillance of the activities of various participants become
extremely difficult in these kinds of mixed markets.
5. An important incidental benefit that flows from derivatives trading is that it acts
as a catalyst for new entrepreneurial activity. The derivatives have a history of
attracting many bright, creative, well-educated people with an entrepreneurial
attitude. They often energize others to create new businesses, new products and new
employment opportunities, the benefit of which are immense. In a nut shell,
derivatives markets help increase savings and investment in the long run. Transfer of
risk enables market participants to expand their volume ofactivity.

VARIOUS RISK FACED BY THE PARTICIPANTS

INDERIVATIVES
Market Participants must understand that derivatives, being leveraged
instruments, have risks like
 Counterparty Risk (default bycounterparty),
 Price Risk (loss on position because of pricemove),
 Liquidity Risk (inability to exit from aposition),
 Legal Or Regulatory Risk (enforceability of contracts),
 Operational Risk (fraud, inadequate documentation, improper
execution, etc.) and may not be an appropriate avenue for
someone of limited resources, trading experience and low
risktolerance.
A market participant should therefore carefully consider whether such
trading is suitable for him/her based on these parameters. Market

33
participants, who trade in derivatives are advised to carefully read the
Model Risk Disclosure Document, given by the broker to his clients
at the time of signing agreement.
Model Risk Disclosure Document is issued by the members of
Exchanges and contains important information on trading in
Equities and F&O Segments of exchanges.
All prospective participants should read this document before trading
on Capital Market/Cash Segment or F&O segment of the Exchanges.
INTRODUCTION OF INDEX
 Index is a statistical indicator that measures changes in the
economy in general or in particular areas. In case of financial
markets, an index is a portfolio of securities that represent a
particular market or a portion of a market. Each Index has its
owncalculation methodology and usually is expressed in terms of a
change from a base value. The base value might be as recent as the
previous day or many years in the past. Thus, the percentage
change is more important than the actual numericvalue.
 Financial indices are created to measure price movement of
stocks, bonds, T-bills and other type of financial securities. More
specifically, a stock index is created to provide market
participants with the information regarding average share price
movement inthe market. Broad indices are expected to capture
the overall behavior of equity market and need to represent the
return obtained by typical portfolios in thecountry.

FUNCTIONS OF INDEX
 A stock index is an indicator of the performance of overall market or a
particularsector.
 It serves as a benchmark for portfolio performance- Managed
portfolios, belongingeither to individuals or mutual funds; use the
stock index as a measure for evaluation of their performance.
 It is used as an underlying for financial application of derivatives–Various
 Products in OTC and exchange traded markets are based on indices as

34
 underlyingasset.
 Each stock contains a mixture of two elements - stock news and
index news. When we take an average of returns on many stocks,
the individual stock news tends to cancel out and the only thing
Left is news that is common to allstocks.
 The news that is common to all stocks is news about the
economy. That is what agood index captures. The correct
method of averaging is that of taking a weighted average, giving
each stock a weight proportional to its marketcapitalization.
 Example: Suppose an index contains two stocks, A and B. A has
a marketcapitalization of Rs.1000 crore and B has a market
capitalization of Rs.3000 crore. Then we attach a weight of 1/4 to
movements in A and 3/4 to movement inB.
TYPES OF INDEX
Market capitalization weighted index or price weighted index:
Market capitalization is the market value of a company, calculated
by multiplying the total number of shares outstanding to its current
market price.
In the example below we can see that each stock affects the index
value in proportion to the market value of all the outstanding shares.
In the present example,
The base index = 1000 and the index value works out to be 1002.60

 Market capitalization weightedindex:

In this type of index, the equity price is weighted by the
market capitalization of the company (share price * number
of outstanding shares).
Hence each constituent stock in the index affects the index value
in proportion to the market value of all the outstanding shares.
This index forms the underlying for a lot of index-based
products like index funds and index futures.
In the market capitalization weighted method, where:

35
Company Current Market Base Market
Capitalization Capitalization

Grasim Inds 1,668,791.10 1,654,247.50

Telco 872,686.30 860,018.25

SBI 1,452,587.65 1,465,218.80

Wipro 2,675,613.30 2,669,339.55

Bajaj 660,887.85 662,559.30

Total 7,330,566.20 7,311,383.40

INDEX= 7,330,566.20 *1000= 1002.62

7,311,383.40
 Current market capitalization = Sum of (current market price *
outstanding shares) of all securities in theindex.
 Base market capitalization = Sum of (market price * issue
size) of all securities as on basedate.
 Price weightedindex:
In a price weighted index each stock is given a weight proportional to its
stock price. A stock index in which each stock influences the index in
proportion to its price. Stocks with a higher price will be given more
weight and therefore, will have a greater influence over the performance of
the index.

36
MAJOR INDICES ININDIA
These are few popular indices in India.
•BSESensex
•BSEMidcap
•BSE-100
•BSE-200
•BSE-500
S&P CNX Nifty
•CNX NiftyJunior
•S&P CNXDefty
•CNXMidcap
•S&P CNX500
APPLICATION OF INDICES
Traditionally, indices were used as a measure to understand the overall direction of
stock market. However, few applications on index have emerged in the investment
field.
Few of the applications are explained below:
 Index Funds
These types of funds invest in a specific index with an objective to generate returns
equivalent to the return on index. These funds invest in index stocks in the
proportions in which these stocks exist in the index. For instance, Sensex index
fund would get the similar returns as that of Sensex
index. Since Sensex has 30 shares, the fund will also invest in these 30 companies
in the proportion in which they exist in the Sensex.
 Index Derivatives
Index Derivatives are derivative contracts which have the index as the underlying
asset. Index Options and Index Futures are the most popular
Derivative contracts worldwide. Index derivatives are useful as a tool to hedge
against the market risk.
 Exchange TradedFunds
Exchange Traded Funds (ETFs) is basket of securities that trade like individual
stock, on an exchange. They have number of advantages over other mutual funds as
they can be bought and sold on the exchange. Since, ETFs are traded on exchanges

37
 intraday transaction is possible.
Further, ETFs can be used as basket trading in terms of the smaller denomination
and low transaction cost. The first ETF in Indian Securities Market was the Nifty
BeES, introduced by the Benchmark Mutual Fund in December
2001. Prudential ICICI Mutual Fund introduced SPIcE in January2003, which was
the first ETF on Sensex.
FORWARD CONTRACT:

A forward contract is an agreement to buy or sell an asset on a specified date for

a specified price. One of the parties to the contract assumes a long position and agrees
to buy the underlying asset on a certain specified future date for a certain specified
price. The other party assumes a short position and agrees to sell the asset on the same
date for the same price. Other contract details like delivery date, price and quantity are
negotiated bilaterally by the parties to the contract. The forward contracts are
normally traded outside the exchanges. The salient features of forward contracts are:
• They are bilateral contracts and hence exposed to counter-party risk
• Each contract is custom designed, and hence is unique in terms of contract size,
expiration date and the asset type andquality.
• The contract price is generally not available in publicdomain.
• On the expiration date, the contract has to be settled by delivery of theasset.
• If the party wishes to reverse the contract, it has to compulsorily go to the
samecounter-party, which often results in high prices beingcharged.
i. Limitations of ForwardContract
Forward markets world-wide are afflicted by several problems:
 Lack of centralization oftrading,
 Illiquidity,
 Counterparty
 Risk
In the first two of these, the basic problem is that of too much flexibility and
generality. The forward market is like a real estate market in that any two consenting
adults can form contracts against each other. This often makes them design terms of
the deal which are very convenient in that specific situation, but makes the contracts
non-tradable. Counterparty risk arises from the possibility of default by any one party

38
 to the transaction. When one of the two sides to the transaction declares bankruptcy,
the other suffers. Even when forward markets trade standardized contracts, and hence
avoid the problem of illiquidity, still the counter party risk remains a very serious
issue. Exchange TradedDerivative"
ii. FUTURESCONTRACT
Futures markets were innovated to overcome the limitations of forwards. A futures
contract is an agreement made through an organized exchange to buy or sell a fixed
amount of a commodity or a financial asset on a future date at an agreed price.
Simply, futures are standardized forward contracts that are traded on an exchange.
The clearinghouse associated with the exchange guarantees settlement of these trades.
A trader, who buys futures contract, takes a long position and the one, who sells
futures, takes a short position. The words buy and sell are figurative only because no
money or underlying asset changes hand, between buyer and seller, when the deal is
signed.
iii. FEATURES OF FUTURES CONTRACT
In futures market, exchange decides all the contract terms of the contract other than
price. Accordingly, futures contracts have following features:
•Contract between two parties throughExchange
•Centralized trading platform i.e.,exchange
•Price discovery through free interaction of buyers andsellers
•Margins are payable by both theparties
•Quality decided today (standardized)
•Quantity decided today (standardized)

D. FUTURESTERMINOLOGIES
a) Spot Price: The price at which an asset trades in the cash market. This is
theunderlying value of Nifty on August 9, 2010 which is5486.15.

b) Futures Price: The price of the futures contract in the futures market. The closing
price of Nifty in futures trading is Rs. 5482. Thus Rs. 5482 is the future price of Nifty,
on a closing basis.

39
c) Contract Cycle: It is a period over which a contract trade. On August 9, 2010, the
maximum number of index futures contracts is of 3 months contractcycle.
d) Expiration Day: The day on which a derivative contract ceases to exist. It is
lasttrading day of the contract. It is the last Thursday of the expiry month. If the last
Thursday isa
trading holiday, the contracts expire on the previous trading day. On expiry date, all
the contracts are compulsorily settled. If a contract is to be continued then it must be
rolled to the near future contract. For a long position, this means selling the expiring
contract and buying the next contract. Both the sides of a roll over should be executed
at the same time. Currently, all equity derivatives contracts (both on indices and
individual stocks) on NSE are cash settled whereas on BSE, derivative contracts on
indices are cash settled while the contracts on individual stocks are delivery settled.

e) Tick Size: It is minimum move allowed in the price quotations. Exchanges decide the
tick sizes on traded contracts as part of contract specification. Tick size for
Niftyfutures is 5
Contract Size and contract value: Futures contracts are traded in lots and to arrive at
the contract value we have to multiply the price with contract multiplier or lot size or
contract size. For S&P CNX Nifty, lot size is 50 and for Sensex Index futures
contract, it is 15.

f) Basis: The difference between the spot price and the futures price is calledbasis

g) Cost of Carry: Cost of Carry is the relationship between futures prices and
spotprices.

h) Margin Account: As exchange guarantees the settlement of all the trades, to protect
itself against default by either counterparty, it charges various margins from brokers.
Brokers in turn charge margins from theircustomers.

40
i) Initial Margin: The amount one needs to deposit in the margin account at the time
entering a futures contract is known as the initial margin. Let us take an example -On
August 7, 2010 a person decided to enter into a futures contract. He expects the
marketto go up so he takes a long Nifty Futures position for August expiry. On
August 7, 2010 Nifty closes at5439.25.
The contract value = Nifty futures price * lot size
= 5439.25 * 50 = Rs.2, 71,962.50. Therefore, Rs 2, 71,962.50 is the contract value of
one Nifty Future contract expiring on August 26, 2010.
Assuming that the broker charges 10% of the contract value as initial margin, the
person
has to pay him Rs. 27,196.25 as initial margin. Both buyers and sellers pay
initialmargin, as there is an obligation on both the parties to honor the contract. The
initial margin is dependent on price movement of the underlying asset. As high
volatility assets carry more risk, exchange would charge higher initial margin onthem.

j) Marking to Market (MTM): In futures market, while contracts have maturity of

several months, profits and losses are settled on day-to-day basis –called mark to
market (MTM) settlement. The exchange collects these margins (MTM margins) from
the loss-making participants and pays to the gainers on day-to-daybasis.

Long Position: Outstanding/ unsettled buy position in a contract is called “Long

Position”. For instance, if Mr. X buys 5 contracts on Sensex futures, then he would be
long on 5 contracts on Sensex futures. If Mr. Y buys 4 contracts on Pepper futures,
then he would be long on 4 contracts on pepper.

k) Short Position: Outstanding/ unsettled sell position in a contract is called “Short

Position”. For instance, if Mr. X sells 5 contracts on Sensex futures, then he would be
short on 5 contracts on Sensex futures. If Mr. Y sells 4 contracts on Pepper
futures,then he would be short on 4 contracts onpepper.
l) Open Position: Outstanding/ unsettled either long (buy) or short (sell) position
invarious derivative contracts is called “OpenPosition”

41
m) Opening Position: Opening a position means either buying or selling a
contract,which increases client’s open position (long orshort).

n) Closing Position: Closing a position means either buying or selling a contract;this

essentially results in reduction of client’s open position (long orshort).

iv. COMPARISON OF FORWARDS ANDFUTURES

Trade on organized exchanges No Yes

Use standardized contract terms No Yes
Use associate clearinghouses to guarantee contract fulfillment No Yes
Require margin payments and daily settlements No Yes

Markets are transparent

No
Yes
Marked to market daily
No
Yes
Closed prior to delivery
No
Mostly
Profits or losses realized daily
No
Yes
OPTIONSCONTRACT
As seen earlier, forward/futures contract is a commitment to buy/sell the
Underlying and has a linear payoff, which indicates unlimited losses and profits.
Some market participants desired to ride upside and restrict the losses. Accordingly,
options emerged as a financial instrument, which restricted the losses with a
provision of unlimited profits on buy or sell of underlying asset.

42
 I. OPTION CONTRACTS:
An Option is a contract that gives the right, but not an obligation, to buy or sell the
underlying asset on or before a stated date/day, at a stated price, for a price. The
party taking a long position
buying the option s called buyer/ holder of the option and the party taking a
short positioni.e., selling the option is called the seller/ writer of theoption.
The option buyer has the right but no obligation with regards to buying or selling
the underlying asset, while the option writer has the obligation in the contract.
Therefore, option buyer/ holder will exercise his option only when the situation is
favorable to him, but, when he decides to exercise, option writer would be legally
bound to honor the contract.
Options may be categorized into two main types:
 Cal Option, which gives buyer a right to buy the underlying asset, is called
Calloption Options.
 Put Options, is the option which gives buyer a right to sell the underlying
asset, iscalled Putoption.

II. OPTION TERMINOLOGY

There are several terms used in the options market. They areas fallows:
1) Index option: These options have index as the underlying asset. For example,
options on Nifty, Sensex,etc.

2) Stock option: These options have individual stocks as the underlying asset.
Forexample, option on ONGC, NTPCetc.
3) Buyer of an option: The buyer of an option is one who has a right but not the
obligation in the contract. For owning this right, he pays a price to the seller of
this right called ‘option premium’ to the optionseller.

4) Writer of an option: The writer of an option is one who receives the option
premium andis thereby obliged to sell/buy the asset if the buyer of option
exercises hisright.

43
5) American option: The owner of such option can exercise his right at any time
on or before the expiry date/day of the contract.

6) European option: The owner of such option can exercise his right only on the
expiry date/day of the contract. In India, Index options areEuropean.

7) Option price/Premium: It is the price which the option buyer pays to the
option seller.In our examples, option price for call option is Rs. 221.20 and for
put option is Rs.88.75.
8) Premium traded is for single unit of nifty and to arrive at the total premium in a
contract,we need to multiply this premium with the lotsize.

9) Lot size: Lot size is the number of units of underlying asset in a contract. Lot
size of Nifty option contracts is 50. Accordingly, in our examples, total
premium for call optioncontract would be Rs. 221.20*50= 11060 and total
premium for put option contract would be Rs. 88.75*50 = 4437.5.

10) Expiration Day: The day on which a derivative contract ceases to exist. It is
the lasttrading date/day of the contract. In our example, the expiration day of
contracts is the last Thursday of October month i.e., 28 October,2010.

11) Spot price (S): It is the price at which the underlying asset trades in the spot
market. Inour examples, it is the value of underlying viz.6029.95.
12) Strike price or Exercise price (X): Strike price is the price per share for which
the underlying security may be purchased or sold by the option holder. In our
examples,strike price for both call and put options is5900.
13) In the money (ITM) option: This option would give holder a positive cash
flow, if it were exercised immediately. A call option is said to be ITM, when
spot price is higher thanstrike price. And, a put option is said to be ITM when
spot price is lower than strike price. In our examples, call option is in themoney.

44
 14) At the money (ATM) option: At the money option would lead to zero cash-
flow if it were exercised immediately. Therefore, for both call and put ATM
options, strike price is equalto spotprice.

Note:
MONEYNESS:Conceptthatreferstothepotentialprofitorlossfromtheexerci
seofthe
option.Anoptionmaybeinthemoney,outofthemoney,oratthemoney
Call Option Put Option

In the money Spot price > strike Spot price< strike price

At the money Spot price = strike Spot price = strike price

Out of themoney Spot price < strike Spot price > strike

15) Out of the money (OTM) option: Out of the money option is one
with strike price worse than the spot price for the holder of option. In
other words, this option would give the holder a negative cash flow if
it were exercised immediately. A call option is said to be OTM,when
spot price is lower than strike price. And a put option is said to be
OTM when spot price is higher than strike price. In our example’s, put
option is out of themoney.

16) Intrinsic value: Option premium, defined above, consists of two

components -intrinsic value and timevalue.

17) Time value: It is the difference between premium and intrinsic value,
if any, of an option. ATM and OTM options will have only time value
because the intrinsic value of suchoptions iszero.
18) Open Interest: As discussed in futures section, open interest is the
total number ofoption contracts outstanding for an underlyingasset.

45
19) Exercise of Options: In case of American option, buyers can exercise
their option anytime before the maturity of contract. All these options
are exercised with respect to the settlement value/ closing price of the
stock on the day of exercise ofoption.

20) Assignment of Options: Assignment of options means the allocation

of exercised optionsto one or more option sellers. The issue of
assignment of options arises only in case of American options because
a buyer can exercise his options at any point oftime.

21) Opening Position: An opening transaction is one that adds to, or

creates a new trading position. It can be either a purchase or a sale.
With respect to an option transaction, wewill consider both:
 Opening purchase (Long on option) –A transaction in which
the purchaser’sintention is to create or increase a long position
in a given series ofoptions.
 Opening sale (Short on option) – A transaction in which the
seller’s intention isto create or increase a short position in a
given series ofoptions.

22) Closing Position: A closing transaction is one that reduces or

eliminates an existingposition by an appropriate offsetting purchase or
sale. This is also known as “squaring off” your position. With respect
to an optiontransaction:
Closing purchase – A transaction in which the purchaser’s intention is
to reduce or eliminate a short position in a given series of options.
This transaction is frequently referred to as “covering” a short
position.
Closing sale –A transaction in which the seller’s intention is to
reduce or eliminate a long position in a given series of options.

46
  Note: An investor does not close out a long call position by
purchasing a put (or any other similar transaction). A closing
transaction for an option involves the purchase or sale of an
option contract with the sameterms.

23) Leverage: An option buyer pays a relatively small premium for market
exposure inrelation

to the contract value. This is known as leverage.

USES OFDERIVATIVES
a) RISK MANAGEMENT
The most important purpose of the derivatives market is risk management.
Risk management for an investor comprises of the following three
processes:
 Identifying the desired level of risk that the investor is willing to
take on his investments; Identifying and measuring the actual level
of risk that the investor is carrying;and
 Making arrangements which may include trading (buying/selling)
of derivatives contracts that allow him to match the actual and
desired levels ofrisk.
b) MARKETEFFICIENCY
Efficient markets are fair and competitive and do not allow an investor to
make risk free profits. Derivatives assist in improving the efficiency of the
markets, by providing a self- correcting mechanism. Arbitrageurs are one
section of market participants who trade whenever there is an opportunity
to make risk free profits till the opportunity ceases to exist. Risk free profits
are not easy to make in more efficient markets. When trading occurs, there
is a possibility that some amount of mispricing might occur in the markets.
The arbitrageur’s step in to take advantage of this mispricing by buying
from the cheaper market and selling in the higher market. Their actions
quickly narrow the prices and thereby reducing the inefficiencies.

47
48
 c) PRICEDISCOVERY
One of the primary functions of derivatives markets is price discovery. They
provide valuable information about the prices and expected price fluctuations of the
underlying assets in two ways:
First, many of these assets are traded in markets in different geographical
locations. Because of this, assets may be traded at different prices in different
markets. In derivatives markets, the price of the contract often serves as a proxy for
the price of the underlying asset. For example, gold may trade at different prices in
Mumbai and Delhi but a derivatives contract on gold would have one value and so
traders in Mumbai and Delhi can validate the prices of spot markets in their
respective location to see if it is cheap or expensive and trade accordingly.
Second, the prices of the futures contracts serve as prices that can be used to get
a sense of the market expectation of future prices. For example, say there is a
company that produces sugar and
expects that the production of sugar will take two months from today. As sugar
prices fluctuate daily, the company does not know if after two months the price of
sugar will be higher or lower than it is today. How does it predict where the price of
sugar will be in future? It can do this by monitoring prices of derivatives contract
on sugar (say a Sugar Forward contract). If the forward price of sugar is trading
higher than the spot price that means that the market is expecting the sugar spot
price to go up in future. If there were no derivatives price, it would have to wait for
two months before knowing the market price of sugar on that day. Based on
derivatives price the management of the sugar company can make strategic and
tactical decisions of how much sugar to produce and when.
d) What is Open Interest (OI) and Contract in the enclosedcharts?
Open interest is the total number of options and/or futures contracts that are not
closed out on a particular day, that is contracts that have been purchased and are
still outstanding and not been sold and vice versa. A common misconception is that
open interest is the same thing as volume of options and futures trades. This is not
correct since there could be huge volumes but if the volumes are just because of
participants squaring off their positions then the open interest would not be large.
On the other hand, if the volumes are large because of fresh positions being created
then the open interest would also be large. The Contract column tells us about the

49
strike price of the call or put and the date of their settlement. For example, the first
entry in the Active Calls section (4500.00-August) means it is a Nifty call with Rs
4500 strike price, that would expire in August. It is interesting to note from the
newspaper extract given above is that it is possible to have a number of options at
different strike prices but all of them have the same expiry date.
There are different tables explaining different sections of the F&O markets.
1. Positive trend: It gives information about the top gainers in the
futuresmarket.
2. Negative trend: It gives information about the top losers in the
futuresmarket.
3. Future OI gainers: It lists those futures whose % increases in open interest
areamong the highest on that day
4. Future OI losers: It lists those futures whose % decreases in open interest
are amongthe highest on thatday.
5. Active Calls: Calls with high trading volumes on that particularday.
6. Active Puts: Puts with high trading volumes on that particularday.
SETTLEMENT OFDERIVATIVES
Settlement refers to the process through which trades are cleared by the
payment/receipt of currency, securities or cash flows on periodic payment dates and
on the date of the final settlement. The settlement process is somewhat elaborate for
derivatives instruments which are exchange traded. (They have been very briefly
outlined here. For a more detailed explanation, please refer to NCFM Derivatives
Markets (Dealers) Module). The settlement process for exchange traded derivatives
is standardized and a certain set of procedures exist which take care of the
counterparty risk posed by these instruments. At the NSE, the National Securities
Clearing Corporation Limited (NSCCL) undertakes the clearing and settlement of
all trades executed on the F&O segment of NSE. It also acts as a legal counterparty
to all trades on the F&O segment and guarantees their financial settlement. There
are two clearing entities in the settlement process: Clearing Members and Clearing
Banks.
Clearing members
A Clearing member (CM) is the member of the clearing corporation i.e., NSCCL.
These are the members who have the authority to clear the trades executed in the

50
F&O segment in the exchange. There are three types of clearing members with
different set of functions:
1) Self-clearing Members: Members who clear and settle trades
executed by them only ontheir own accounts or on account of theirclients.
2) Trading cum Clearing Members: They clear and settle their own
trades as well as trades of other trading members(TM).
3) Professional Clearing Members (PCM): They only clear and settle
trades of others but do not trade themselves. PCMs are typically Financial
Institutions or Banks who are admitted bythe Clearing Corporation
asmembers.
Clearing banks
Some commercial banks have been designated by the NSCCL as Clearing Banks.
Financial settlement can take place only through Clearing Banks. All the clearing
members are required to open a separate bank account with an NSCCL designated
clearing bank for the F&O segment.
The clearing members keep a margin amount in these bank accounts.
Settlement of Futures
When two parties trade a futures contract, both have to deposit margin money
which is called the initial margin. Futures contracts have two types of settlement:
(I) the mark-to- market (MTM) settlement which happens on a continuous basis at
the end of each day, and (ii) the final settlement which happens on the last trading
day of the futures contract i.e., the last Thursday of the expiry month.

Mark to market settlement

To cover for the risk of default by the counterparty for the clearing corporation, the
futures contracts are marked-to-market on a daily basis by the exchange. Mark to
market settlement is the process of adjusting the margin balance in futures account
each day for the change in the value of the contract from the previous day, based on
the daily settlement price of the futures contracts (Please refer to the Tables given
below.). This process helps the clearing corporation in managing the counterparty
risk of the future contracts by requiring the party incurring a loss due to adverse
price movements to part with the loss amount on a daily basis. Simply put, the
partyin the loss position pays the clearing corporation the margin money to cover

51
for the shortfall in cash. In extraordinary times, the Exchange can require a mark to
market more frequently (than daily). To ensure a fair mark-to-market process, the
clearing corporation computes and declares the official price for determining daily
gains and losses. This price is called the ―settlement price and represents the
closing price of the futures contract. The closing price for any contract of any given
day is the weighted average trading price of the contract in the last half hour of
trading.
Final settlement for futures
After the close of trading hours on the expiry day of the futures contracts, NSCCL
marks all positions of clearing members to the final settlement price and the
resulting profit/loss is settled in cash. Final settlement loss is debited and final
settlement profit is credited to the relevant clearing bank accounts on the day
following the expiry date of the contract. Suppose the above contract closes on day
6 (that is, it expires) at a price of Rs. 1040, then on the day of expiry, Rs.
100 would be debited from the seller (short position holder) and would be
transferred to the buyer (long position holder).
Settlement of Option:
In an options trade, the buyer of the option pays the option price or the option
premium. The options seller has to deposit an initial margin with the clearing
member as he is exposed to unlimited losses. There are basically two types of
settlement in stock option contracts: daily premium settlement and final exercise
settlement. Options being European style, they cannot be exercised before expiry.
Daily premium settlement
Buyer of an option is obligated to pay the premium towards the options purchased
by him. Similarly, the seller of an option is entitled to receive the premium for the
options sold by him. The same person may sell some contracts and buy some
contracts as well. The premium payable and the premium receivable are netted to
compute the net premium payable or receivable for each client for each options
contract at the time of settlement.
Exercise settlement
Normally most option buyers and sellers close out their option positions by an
offsetting closing transaction but a better understanding of the exercise settlement
process can help in making better judgment in this regard. Stock and index options

52
 can be exercised only at the end of the contract.

Final Exercise Settlement

On the day of expiry, all in the money options are exercised by default. An investor who
has a long position in an in-the-money option on the expiry date will receive the exercise
settlement value which is the difference between the settlement price and the strike price.
Similarly, an investor who has a short position in an in-the-money option will have to pay
the exercise settlement value.

TAX IMPLICATIONS IN DERIVATIVE TRADING Income from F&O

deals is almost always treated as business income. This treatment is irrespective of the
frequency or volume of your transactions. That may come as a surprise if you are
salaried and have never run a business. Taxpayers who have business income have to
file ITR-4.

As per Indian tax laws, incomes are reported under five heads—salary, house
property, capital gains, business and profession and other sources (any residual
income that cannot be classified in other heads). F&O trade is reported under
the head ‘businesses in your tax return.

Reporting F&O trade as a business means:

*You can claim expenses from your business income
*As a result, you may earn a profit or incur a loss
*Losses must be reported and losses have tax benefits
*Your total income (from all five heads) continues to be taxed at slab rates.
Businesses may be speculative or non-speculative, and the tax treatment is
different. The income tax Act says that F&O trade is considered as a non-
speculative business. Intra-day stock trades are treated as a speculative business.

Remember that cost indexation and capital gains exemptions are only allowed
on sale of capital assets such as equity shares, mutual funds, land, house, and
others. Since F&O trades are considered a business, tax rules of capital gains
rules do not apply.

53
Calculate gross income from F&O trades; take your transaction statement for
the whole year. Look at your receipts; these may be a positive or a negative
value. Sum these up for the whole year. Expenses can be deducted from your
gross income. Some expenses that you can deduct include rent or maintenance
expenses of premises used for the business; mobile or telephone; internet
charges; demat account charges; broker commission; depreciation on laptop
used for trading; and any other expense directly related to your work. Business
income
is calculated for the financial year for which you are filing your return. You will
also have to prepare a balance sheet which is reported in ITR-4. It is basically a
statement of your assets and liabilities.

Many people get confused when they have more than one type of dealing in the
stock market. Some do intra-day stock transactions along with F&O trades.
Some may hold stocks as long- term investments and also invest in mutual
funds. In such a situation, you should calculate your business income from all of
these separately.

F&O trade income and intra-day stock trading will have separate expenses.
Don’t worry if you have consolidated expenses; for example, you use the same
premises to trade in both, or use a single phone. Simply bifurcate these expenses
on a reasonable basis. You can allocate them using a ratio based on time spent.

If you invest in stocks for the longer run, you can treat them as capital assets.
These will not be reported as business if you don’t trade in them often.

There is an element of judgments involved and the main criteria are your intent.
So, choose carefully.

If you have some stocks that you trade often and some that you hold for longer,
you can separate them into business and capital assets.

Remember to choose on a fair basis and apply your choice consistently. You

54
have to report gains from capital assets under the head ‘capital gains’, which
has different tax rules.

You will end up paying higher tax if you do not report your losses since losses
have tax benefits and reduce your total taxable income.

Losses from F&O can be set off from income from other heads (except salary
income). Say, your loss from F&O business is Rs.1 lakh, salary income is Rs.5
lakh, income from rent is Rs.2 lakh, and interest income is Rs.50, 000. Your
total taxable income shall be Rs.6.5 lakh.

If losses are not fully set off in the same year, you can carry them forward for 8
years. However, in the following 8 years, it can only be set off from non-
speculative business income.
If you have F&O loss, you must get your accounts audited. Audit is also
mandatory if your turnover exceeds Rs.1 crore. If accounts are not audited, a
minimum penalty of 0.5% of turnover may be levied (maximum Rs.1.5 lakh).

The due date of filing of tax returns for financial year 2015-16, where audit is
mandatory, is 30 September 2016.

55
CONTRACTSPECIFICATION

SR. NO TERMINOLOGIES Remark Futures Options

1. LOT SIZE Minimum 50 50
quantity traded
in lot decided
by exchange
2. SPOT PRICE Price prevailing 5500 5500
in derivative
market
3. FUTURE/STRIKE Price prevailing 5550 5550
PRICE in future/price
for which call or
put option
exercise

4. OPTION PREMIUM Amount decided - 100

by the exchange
on the basis of
strike price and
spot price

5. EXPIRY DATE Last Thursday of Last Last

a month Thursday Thursday

6. CONTRACT Next Three Feb, March, Feb, March,

Month April April

56
 COST OF TRADING INDERIVATIVE

Sr. Taxes Rates Futures Options

Buy 1 Lot of Nifty at 6000, Contract Size (50shares*
6000) / Buy 6000 call option at 60Rs 3,00,000 3,000
premium(50shares*60)

1. Brokerage 0.03% On 90Rs (0.03% on 75 Rs (2.5% on

Contract 1 3,00,000) 3,000)
Size/2.5% on
Option
Premium
(Both Side)

2. Service Tax 10.36% on 9.32(10.36% on 7.75% (10.36%

Brokerage 90Rs) on 75Rs)
Amount (both
side)
25.50 (0.0085%
3. Securities transaction tax 0.017% on on 2.55(0.0085%
Contract on 3000Rs)
Size (only
3, 00,000Rs.)
on selling
side)

4. Stamp duty 0.004% on 12(0.004% on 1.2(0.004%

Contract 3,00,000 Rs) *3,000Rs)
(both side)
2% on Tax
5. Education CSS Amount 0.93(2% on 0.23(2% *
9.32+25.50+12) 7.77+2.55 +1.2)
1% on 0.014 (1% on
Education Cess 0.0028 (1% on

57
6. Higher education cess 0.93) 0.23)

7 Total 137.76 86.75

58
 CHAPTER 4
DATA ANALYSIS AND
INTERPRETATION

59
 4. DATA ANALYSIS AND INTERPRETATION
1. Gender of the respondents

Interpretation: From the questionnaire it is observed that 74.1%of the

respondents are Male and 25.9% of them are Female.

60
2. Occupation of therespondents\

Interpretation: From the above chart it is clear that majority of the

respondents are employee with a weightage of 40.7%, Next are students
with a total of 25.9% and business men being 18.5% and others. (House-
wives, government officers etc.)

3. Medium of investments

Interpretation: It seems that many people invest in share market

nowadays as the percentage indicates that 59.3% invest in NSE and only
14.8%invest in BSE, these are the people who invest in fixed deposits,
mutual funds, insurance for 25.9% in aggregate. The people here, who
invest in BSE, NSE mostly trade in cash market as compared to derivate.

61
4. In which securities you makeinvestments

Interpretation: From the above respondents those who invest in

share market either through NSE/BSE which were around 74.9%
only 18.5% invest in derivative market whereas majority
33.3%invest in cash market and only 11.1%invest in commodity
market whereas other make investments in fixed deposits, gold,
government bonds, etc.
5. Income per Annum of the respondents

Interpretation: 14.8%of the respondents have annual income between

1,00,000 – 2,00,000/- were as respondents having income above 3,00,000/-
are 25.9%, between 2,00,001/- - 3,00,000/- are 11.1% and no income group
are around 22.2%.

62
6. Percentage of monthly income available for investment inDerivatives

Interpretation: Out of above 33.3% of the respondents who invest

only in derivative market, finds that they have between 11 – 15%
of the monthly household income in Derivatives, were as 38.1% of
the respondents would invest between 10-30% and 27% of the
respondents invest between 5 – 10% in Derivatives Market.

7. Kind of risk perceive while investing inDerivatives

Interpretation: 17.4% of the respondents feel that system risk is the major
risk they perceive while investing in Derivative Market, were as 17.4% of
the respondents feel legal risk in Market and 39.1% of the respondents
feel that fear of settlement risk is the risk they perceive while investing in
Derivatives.

63
8. Purpose of Investing in DerivativesMarket

Interpretation: 30.4% of the respondents invest in Derivatives for margin

money and flexibility, 21.7% of them invest for easy in transaction,
17.4% of the respondents for different variety in contracts.
9. Participation in different type of Derivativeinstrument

Interpretation: From the above chart we find that 18.2% of the

respondent would like to participate in Index Options were as 18.2%
of the respondents would like to invest in Stock Options, Stock
Futures and Index Futures attract 18.2% and 31.8% respectively.

64
10. Interest of investment in terms of timeframe.

Interpretation: 43.5% of the respondents would like to invest their

money for short term 34.8% of them for long term, 21.7% of the
respondents for medium term. Here, short term is assumed for 3
months contract, medium is assumed to be of 6 months -12 months
contract and 12 months and more for long term.
11. Expected return from Investment in Derivativesmarket

Interpretation: Majority of the respondents 34.8% of them expect between 14-

17% times a year in Derivatives, where as 21.7% respondents expects the
returns between 10-14%, many respondents feel that they get returns around 5-
10% and 13% respondents feel that they get more than 25% return, these are the
investors who have taken large amount of portfolio for trading in derivative.

65
 Interpretation: From the above graph, it can be seen that
respondents have invested in derivative segment. The table
given below gives proper explanation to graph:

Most preferred High return

Somewhat preferred Hedge the risk (accepting various
contracts)
Neutral More reliable
Not preferred Very risky

66
SECONDARY DATA FROM ANNUAL REPORT ON NSE
DERIVATIVES CONTRACT IN INDIA
Comparison of equity market and equity derivative market on NSE.

As on Oct 04, 2017 15:30:30 IST Traded volume PERCENTAGE

Equity market 23,340.70 3.99947

Index futures 17,079.37 2.92658

Stock futures 36,879.91 6.319437

Index option 4,84,370.02 82.99765

Stock option 21,924.89 3.756868

TOTAL 5,83,594.89

40,000.00

35,000.00

30,000.00

25,000.00

20,000.00

15,000.00 Traded volume

PERCENTAGE
10,000.00

5,000.00

0.00
t es es n n
ke ur ur tio tio
ar t t p p
m fu fu o o
ity ex ock dex ock
u d t In St
Eq In S

67
 Comparison of equity market and equity derivatives on BSE.

ORDERS

Equity Orders 22,73,59,072

Equity Derivatives Orders 28,71,266
Total 23,02,30,338

Equity 98.75287

F&O 1.247128

120

100

80

60 Column1
ORDERS

40

20

0
Equity Derivatives Orders Total Equity F&O

68
CATEGORY TOTAL DATE OF RECORD
STOCK OPTION TARDED 53,692.53 13-JAN 2016
VALUE
INDEX OPTION TRADED 1047401.81 31-MAR 2016
VALUE
TOTAL F&O TRADED 648505.58 31-MAR 2016
VALUE

1,200,000.00

1,000,000.00

800,000.00

600,000.00
TOTAL
DATE OF RECORD
400,000.00

200,000.00

0.00
STOCK OPTION TARDED VALUE INDEX OPTION TRADED VALUE

69
 CHAPTER 5
FINDINGS, SUGGESTIONS AND
CONCLUSIONS

70
 FINDINGS
 The study of research says that the majority of investors makes investment
inIndex options by 82.9% more than any other equity derivative product
and also the equity market on NSE.
 As per NSE ANNUAL REPORT IN 2015-16 option market on National
Stock Exchange ranked 1setamong all the derivative market in world and the
index futures of NSE stand 6thein wholeworld.
 As per the ratio stated in research methodology states that the trade on
otherderivative product is more as compared to equity market onNSE.
 The research tells that the equity market is more by 98% on BSE as
compared to 2% of equity derivativemarket.
 As per the survey of closed group research, nearby 43.7% of people consist
ofsalaried persons and house wives in which salaried people are 40.7% who
trade in equity derivative very frequently with fewer amounts between the
limit of 300000-500000 yearly as they feel that there is ease in transactions.
 The investment made by other professionals who include government
employees,legal practitioners etc., and students taken together comprises of
about 44.4% who make investment of about more than 500000 and less
than 100000respectively.
 Investors generally perceive uncertainty of returns type of risk while
investing in derivative market. As per the result purpose of investing in
derivative market is toearn higher return by taking high risk.
 As per the survey, 34.8% of investors who invest in equity derivative
frequently feels that it gives 14%-17% who includes professionals and
salaried people as well as house wives feels that they get between 5% to
14%which together account for 34.7% (21.7%+13%) of return from
investments made in equity derivative market and remaining investors feel
that they get more than 17% accounts for about around30%.
 From this survey, the 26.1% investors feel that there is counterparty risk
these arethose
who are not trading in equity derivative frequently? But the majority feels
that there is settlement risk as there is the component of mark to market and
the initial margin. The other fell that there is legal risk and system risk

71
 which together accounts for 34.8%.
 The result of investment in derivative market is generally moderate but
acceptable

 The test shown that there is relationship between Income and investment in
differenttype of derivative instruments, income category and purpose of
Investing in Derivative market, Income per annum and monthly income
available for investment

72
 SUGGESTIONS

 Knowledge needs to be spread concerning the risk and return of

derivativemarket.
 Investors should have knowledge of technical analysis, especially 5 Day
movingaverages as derivatives trading is for a short period of time Investors
should analysis their script with the help of 5 Day moving average before
making theirtrades.
 Investors’ portfolio should only consist of 15 – 20% Derivatives contracts or
scripts. As derivatives trading is very risky investors should have only a
small portion of their portfolio consisting of derivatives.
 SEBI should conduct seminars regarding the use of derivatives to educate
individual investors.
 As FII play a prominent role in Derivatives trading, an individual investor
should keep himself updated with various economic trends, government
policies, and company and industry announcements.
 Speculation should be discouraged because it affects the market condition
badly and new investors are reducing their interest in the market.
 There must be more derivatives instrument aimed at individual investors.
 There is a need to have smaller contract size in futures and options. We can
review the contract size from Rs. 2 lakhs to 1lakh.
 People have very little knowledge of option market which is less risky as
compared to futures and I think SEBI should conduct the seminars for option
traders.
 Derivatives should be developed in order to keep it at par with other
derivative market in the world. As per the research, we can see that
nowadays more number of investors are showing their interest in derivatives
because it includes high return bearing highrisk.
 RBI should play a greater role in supporting derivatives. Because
nowadaysderivatives market is increasing rapidly and plays a major role in
call securitiesmarket.
 Derivatives product should even be traded on equity market as maximum
potential lies in future as compared to present andpast.

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 CONCLUSIONS
 Derivative market growth continues almost irrespective of equity cash
market turnover growth. Since 2000, cash equity turnover has fallen in
developedmarkets, but equity derivative turnover continues to rise
steeply andsteadily.
 People should learn first and then investor should consult their financial
advisor before investing. If people have adequate knowledge, then they
can earn good return in equity derivativemarket.
 Intra trading should not be traded by normal man as they lose money due
to volatility in the market. People invest in stock market as long term
investors rather than short term because in short term risk is more and
profit is less. F&O do cover risk of future so my advice is those have
adequate knowledge should invest inF&O.
 Derivative market should be developed in order to keep it at par with
other equity derivative market in the world. Nowadays a greater number
of investors are showntheir interest in derivatives market because it
includes high return by bearing highrisk.
 RBI should play a greater role in supporting derivatives, because
nowadaysderivative markets are increasing rapidly and it plays a major
role in whole securitiesmarket.

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 BIBLIOGRAPHY

 Pok and Poshakwale (2004) in their studies on the KOSPI200 index of the
Korean market and KLSE on the Malaysian one.

 Gupta and Singh (2006) also made an attempt to investigate the price
discovery efficiency of the Nifty futures by considering lengthy time frame.

 Mallikarjunappa and Afsal (2007) studied the volatility implications of the

introduction of derivatives on the stock market in India using S&P CNX IT
index.

 Alexakis, P. (2007) examined the stock market volatility before and after the
introduction of index futures.

 Paul Dawson (2007) in his journal provides with effective hedging techniques
for covering foreign exchange risk in overseas equity investments.

 nseindia.com
 bseindia.com
 sebi.gov.in
 moneycontrol.com
 NISM book on equity derivative certification VIII
 ANNUAL REPORT ONBSE
 ANNUAL REPORT OFNSE

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