INDIAN STOCK MARKET DERIVATIVES

INTRODUCTION TO DERIVATIVES
The main instruments under the derivatives are: 1. Forward contract 2. Future contract 3. Options 4. Swaps

DEVELOPMENT OF DERIVATIVES MARKET IN INDIA

Business growth of futures and options market: NSE Turnover (Rs.cr) Index futures 35 119 237 381 590 Stock futures Index options 196 Stock options -

Month Jun-00 Sep-00 Dec-00 01-Mar 01-Jun

Total 35 119 237 381 785

01-Sep
01-Dec 02-Mar 2001-02

2857
2339 2185 21482

7515 13989 51516

559
405 360 3766

2012
2660 3957 25163

5281
12919 20490 101925

Instruments available in India

Products Index Futures Index Options Futures on Individual Securities 31 securities stipulated by SEBI Options on Individual Securities

Underlying Instrument Type

S&P CNX Nifty

S&P CNX Nifty

31 securities stipulated by SEBI

American

European maximum of 3-month trading cycle. At any point in time, there will be 3 contracts available : 1) near month, 2) mid month & 3) far month duration Last Thursday of the expiry month Permitted lot size is 200 & multiples thereof

Trading Cycle

Same as index futures

Same as index futures

Same as index futures

Expiry Day

Same as index futures Same as index futures

Same as index futures As stipulated by NSE (not less than Rs.2 lacs)

Same as index futures As stipulated by NSE (not less than Rs.2 lacs)

Contract Size

OPTIONS
The Parties to an Option The options are of two styles. 1) European option and 2) American option The options are of two types. 1) Call option and 2) Put option.

In-the-Money, At-the-Money, Out-theMoney

CALL OPTION PUT OPTION

In-the-money

Strike price < Spot price

Strike price > Spot price

At-the-money

Strike price = Spot price

Strike price = Spot price

Out-the-money

Strike price > Spot price

Strike price < Spot price

Option value

Intrinsic value and Time value.

Factors affecting the value of an option

Factor Option Type Impact on Option Value Component of Option Value

Share price moves up Share price moves down Share price moves up Share prices moves down Time to expire is high Time to expire is low Time to expire is high Time to expire is low

Call Option Call Option Put Option Put Option Call Option Call Option Put Option Put Option

Option Value will also move up Option Value will move down Option Value will move down Option Value will move up Option Value will be high Option Value will be low Option Value will be high Option Value will be low

Intrinsic Value Intrinsic Value Intrinsic Value Intrinsic Value Time Value Time Value Time Value Time Value

Volatility is high
Volatility is low Volatility is high Volatility is low

Call Option
Call Option Put Option Put Option

Option Value will be high

Option Value will be low Option Value will be high Option Value will be low

Time Value
Time Value Time Value Time Value

OPTIONS ON NIFTY & INDIVIDUAL SECURITIES Trading cycle Expiry day Strike Price Intervals Contract size

DERIVATIVES TRADING STRATEGIES USING OPTIONS

Classification Of Strategies According To Market View

When market to be bullish:

Buy index/ stock futures Buy call option Sell put option Bull call spread Bull put spread Bullish calendar spread

When market to be bearish:

Sell index/ stock futures Sell call option Buy put option Bear call spread Bear put spread Bearish calendar spread

 When market to be uncertain but expects to move in either direction sharply:

Long straddle Long strangle Covered call Strips Straps

When market to remain stable:

Short straddle Short strangle Butterfly spreads Neutral calendar spread

BULL CALL SPREAD:

buy a call and sell a call with different strike price and same expiry date with sell call strike price higher than the buy call strike price.

P r o f i t

8 4 BEP= 142

150
140 146 Profit/loss of Short call

L o s -2 s -6

Profit/loss of Long call

Example: Assumptions: Spot price of ACC - Rs 142, Mutiplier : 1500 Buy ACC April 140 call @ Rs 6 & Sell ACC April 150 call @ Rs 4 Break-even point: Rs 142 There are four scenarios at the expiry date: ACC <= 140. Loss = Rs 3000 (limited to the extent of premium paid - premium received) ACC > 140 and <=142. Loss= (142closing spot price at expiry)*1500 ACC>142 and <=150. Profit= (closing spot price at expiry142)*1500 ACC > 150. Profit = (150 142) * 1500 Limited risk: since the loss can be maximum to the extent of net premium paid. Limited Profit: maximum being the difference between higher strike price option and lower strike price option after deducting the net premium paid.

BEAR CALL SPREAD:

Buy a call and sell a call with different strike price and same expiry date with sell call strike price lower than the buy call strike price.

Profit/loss of short call 6 P r 2 o f i t

140 142

Profit/loss of Long call

150

L o -4 s s -8

Example: Assumptions: Spot price of ACC - Rs 142 Sell ACC April 140 call @ Rs 6 & Buy ACC April 150 call @ Rs 4 Mutiplier : 1500 Break-even point: Rs 142 There are four scenarios at the expiry date: ACC <= 140. Profit = Rs 3000 (limited to the extent of premium received - premium paid) ACC>140 and <=142. Profit=(142closing spot price at expiry) * 1500 ACC>142 and <=150. Loss=(closing spot price at expiry142) * 1500 ACC > 150. Loss = (150 142) * 1500 Limited risk: since the loss can be maximum of Rs 12000. Limited Profit: maximum being the difference between premium received and premium paid.

LONG STRANGLE:

Buy a call and buy a put with same expiry date but different strike price, with the put strike price lower than the call strike price and when one is uncertain about the market but expects it to move in either direction sharply.

Long Put

Long Call

P r o f i t L -2 o s -3 s -5

138

140

150

153

135

155

Example: Assumptions : Spot price of the ACC Rs 145 , Multiplier : 1500 Buy ACC Sep. 140 put @ 2 & Buy ACC Sep. 150 call @ 3 Break-even point : Rs 155 for call option/ Rs 135 for put option There are five scenarios at the expiry date. ACC <= 135 profit = (135- closing price at expiry)*1500 ACC > 135 & <= 140. Loss = (colsing price at expiry -135)*1500 ACC >140 & <=150 Loss = maximum to the extent of premium paid = Rs 7500 ACC>150 & <155. Loss= (155- closing spot price at expiry)*1500 ACC>= 155. Profit = (closing price at expiry 155)*1500 Limited risk: since loss can be limited to the extent of premium paid. Returns : unlimited as the maximum gain could be greater if sharp movement occur.

SHORT STRADDLE:

Sell a call and sell a put with the same strike price and same expiry date when prices are expected to be stable.

L o s s Sell Put

Example Assumptions: Multiplier: 1600 Sell Tata Sept. 140 call @ 9 & Sell Tata Sept. 140 put @ 8

Break-even point : 157 for call option/ 123 for put option Tata <=123 loss = (123- closing at expiry)*1600 Tata> 123 & <=140 . profit = ( closing at expiry - 123)*1600 Tata > 140 & <= 157. Profit = ( 157 closing spot price at expiry)*1600 Tata >157. Loss = (closing spot price at expiry - 157)*1600 Risk: the maximum risk could be greater if sharp movements occur. Limited profit: since profit can be limited to the extent of premium received. Max. profit is Rs. 27200(17*1600) at a price of 140

P r o f i t

17

9
123 157

140 132 149

Sell Call

Put/Call Ratio
P/C ratio
Less than 0.35 Greater than 0.75 Greater than 0.35 and less than 0.75

Indication
Extremely bullish Extremely bearish Uncertain

OPEN INTEREST (An indicator)

Some interpretations using Open Interest:
Rising open interest in an uptrend is bullish Declining open interest in an uptrend is bearish. Rising open interest in a downtrend is bearish. Declining open interest in a downtrend is bullish. Within an uptrend, a sudden leveling off or decline in open interest often warns a change in trend. Very high open interest at market tops is dangerous and can intensify downside pressure.

FUTURES
DIFFERENCE BETWEEN FUTURES AND OPTIONS

Futures
Risk exposure and profit potential are unlimited for both the parties. There is no premium Impose obligations on both the parties Both the parties have to put in margins.

Options
Risk exposure and profit potential are limited for the seller. The buyers have to pay a premium to the sellers. Impose obligations on the sellers only. Only the sellers have to put in margins.

 Types of Futures
Agricultural Metallurgical Interest Bearing Assets Indexes Foreign Currencies

Margin Money
Different Types of Margins:
Initial Margin Mark-to-Market Margin Maintenance Margin Additional Margin Cross Margining

THE BLACK -SCHOLES MODEL

(An option pricing model)

FINDINGS
Growth:
Cash market- turnover-3692 cr. (BSE & NSE) Derivatives market- traded value - 2417 cr.

Factors that hinder the growth of Derivatives Market in India:

Market is dominated by few large players. Very high minimum contract size. Initial investment. Number of scrips available for trading is 31. Cash settlement only.

Thank you