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INTRODUCTION

A derivative security is a security whose value depends on the value of together more basic underlying variable these are also known as contingent claims. Securities have been very successful in innovation in capital markets.

The emergence of the market for derivatives product most notably forward, future and option can be traced back to willingness of risk averse economic agents to guard themselves against uncertain arising out of fluctuation in asset prices. By their very nature, financial markets are market by a very high degree of volatility. Though the use of derivatives products, it is possible to partially or fully transfer price risks by locking in asset prices. As instrument of risk management these generally dont influence the fluctuation in underlying asset prices.

However, by locking-in asset prices, derivatives products minimize the impact of fluctuation in assets prices on the profitability and cash- flow situation of risk-averse investor. Derivatives are risk management instruments which derives their value from an underlying asset. Underlying assets can be bullion, index, share, currency, bonds, interest, etc.

Objectives of the Study

To understand the concept of the Financial Derivatives such as Futures and Options. To examine the advantage and the disadvantages of different strategies along with situations. To study the different ways of buying and selling of Options.

SCOPE OF THE STUDY

The study is limited to Derivatives with special reference to future and option in the Indian context and the India info line has been taken as representative sample for the study. The study cannot be said as totally perfect, any alternation may come. The study has only made humble attempt at evaluating Derivatives markets only in Indian context. The study is not based on the international perspective of the Derivatives Markets.

Research Methodology The type of research adopted is descriptive in nature and the data collected for this study is the secondary data i.e. from Newspapers, Magazines and Internet. Limitations: The study was conducted in Hyderabad only. As the time was limited, study was confined to conceptual understanding of Derivatives market in India.

THE INDIA INFOLINE LIMITED

Origin:
India info line was founded in 1995 by a group of professional with impeccable educational qualifications and professional credentials. Its institutional investors include Intel Capital (world's) leading technology company, CDC (promoted by UK government), ICICI, TDA and Reeshanar. India info line group offers the entire gamut of investment products including stock broking, Commodities broking, Mutual Funds, Fixed Deposits, GOI Relief bonds, Post office savings and life Insurance. India Infoline is the leading corporate agent of ICICI Prudential Life Insurance Company, which is India' No.1 Private sector life insurance Company. www.indiainfoline. Com has been the only India Website to have been listed by none other than Forbes in it's 'Best of the Web' survey of global website, not just once but three times in a row and counting... a must read for investors in south Asia is how they choose to describe India info line. It has been rated as No.l the category of Business News in Asia by Alexia rating. Stock and Commodities broking is offered under the trade name 5paisa. India Infoline Commodities pvt Ltd., a wholly owned subsidiary of India Infoline Ltd., holds membership of MCX and NCDEX

Main Objects of the Company

Main objects as contained in its Memorandum or Association are: 1. To engage or undertake software and internet based services, data processing IT enabled services, software development services, selling advertisement space on the site, web consulting and related services including web designing and web maintenance, software product development and marketing, software supply services, computer consultancy services, E-Commerce of all types including

electronic financial intermediation business and E-broking, market research, business and management consultancy. 2. To undertake, conduct, study, carry on, help, promote any kind of research, probe, investigation, survey, developmental work on economy, industries, corporate business houses, agricultural and mineral, financial institutions, foreign financial institutions, capital market on matters related to investment decisions primary equity market, secondary equity market, debentures, bond, ventures, capital funding proposals, competitive analysis, preparations of corporate / industry profile etc. and trade / invest in researched securities. VISION STATEMENT OF THE COMPANY: our vision is to be the most respected company in the financial services space in India.

Products: the India Infoline pvt ltd offers the following products
A. E-broking. B. Distribution C. Insurance D. PMS E. Mortgages.

A. E-Broking: It refers to Electronic Broking of Equities, Derivatives and Commodities brand name of 5paisa 1. Equities 2. Derivatives 3. Commodities B. Distribution: 1. Mutual funds 2. Govt of India bonds. 3. Fixed deposits C. Insurance: under the

1. Life insurance policies 2. General insurance 3. Health insurance

THE CORPORATE STRUCTURE

The India Info line group comprises the holding company, India Info line Ltd, which has 5 wholly-owned subsidiaries, engaged in engaged in distinct yet complementary businesses which together offer a whole bouquet of products and services to make your money grow. The corporate structure has evolved to comply with oddities of the regulatory framework but still beautifully help attain synergy and allow flexibility to adapt to dynamics of different businesses. The parent company, India Info line Ltd owns and managers the web properties www.Indiainfoline.Com and www.5paisa.com. it also undertakes research. Customized and off-the-shelf. Indian Info line Securities Pvt. Ltd. is a member of BSE, NSE and DP with NSDL. Its business encompasses securities broking Portfolio Management services. India Infoline.com Distribution Company. Mobilizes Mutual Funds and other personal investment products such as bonds, fixed deposits, etc. India Info line Insurance Services Ltd. Is the corporate agent of ICICI Prudential Life Insurance, engaged in selling Life Insurance products?
India Info line Commodities Pvt. Ltd. is a registered commodities broker MCX and offers futures trading in commodities.

10 India info line services Pvt Ltd., is proving margin funding and NBFC services to the customers of India info line Ltd.,

Pictorial Representation of India infoline Ltd

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Management of India info line Ltd.,

India infoline is a professionally managed company /s day to day affairs as executive Directors have impeccable academic professional track record . Nirmal jain , chairman and managing director ,is a Chartered Account ,(All Indian Rank 2 );Cost Account , (All India rank 1)and has a post-graduate management degree from IIM Ahmedabad .He had successful career with Hindustan Lever , where he inter alia handle commodities trading and export business . Later he was CEO of an equity research organization. R.Venkataraman Director, is armed with a post-graduate management degree from IIM Bangalore, And an Electronic engineering degree from IIT, kharagpur. He spent eight fruitful years in equity research sales and private equity with the cream of financial houses such as ICICI group, Barclays de Zoette and G.E capital. The non-executive directors on the board bring a wealth of experienced and expertise. Satpal khattar Reeshanar investment, Singapore the key management team comprises seasoned and qualified professionals. Mukesh sing Seshadri Bharathan S sriram Sandeepa Vig Arora Darmesh Pandya Toral Munshi Anil mascarenhas Pinkesh soni Harshad Apte Director, India infoline securities Pvt Ltd. Director, India infoline.com distribution co Ltd Vice president, Technology Vice president, portfolio Management Services Vice president , Alternative channel Vice president, Research Chief Editor Financial controller Chief Marketing officer

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DERIVATIVES
The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through of derivatives of products, it is possible to partially or fully transfer price risks by locking in asset prices. As instruments of risk management, these generally do not influence the fluctuations underlying prices. However, by locking in asset prices, derivatives products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of riskaverse investors. DEFINITION Understanding the word itself, Derivatives is a key to mastery of the topic. The word originates in mathematics and refers to a variable, which has been derived from another variable. For example, a measure of weight in pound could be derived from a measure of weight in kilograms by multiplying by two. In financial sense, these are contracts that derive their value from some underlying asset. Without the underlying product and market it would have no independent existence. Underlying asset can a Stock, Bond, Currency, Index or a Commodity. Some one may take an interest in the derivative products. Without having an interest in the underlying product market, but the two are always related and may therefore interact with each other. The term Derivative has been defined in Securities Contracts (Regulation) Act 1956, as: A. A security derived from a debt instrument, share, loan

whether secure or unsecured, risk instrument or contract for differences or any other form of security. B. A contract, which derives its value from the prices, or index of prices, of underlying securities.

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IMPORTANCE OF DERIVATIVES
Derivatives are becoming increasingly important in world markets as a tool for risk management. Derivatives instruments can be used to minimize risk. Derivatives are used to separate risks and transfer them to parties willing to bear these risks. The kind of hedging that can be obtained by using derivatives is cheaper and more convenient than what could be obtained by using cash instruments. It is so because, when we use derivatives for hedging, actual delivery of the underlying asset is not at all essential for settlement purposes. More over, derivatives would not create any risk. They simply manipulate the risks and transfer to those who are willing to bear these risks. For example, Mr. A owns a bike. If does not take insurance, he runs a big risk. Suppose he buys insurance [a derivative instrument on the bike] he reduces his risk. Thus, having an insurance policy reduces the risk of owing a bike. Similarly, hedging through derivatives reduces the risk of owing a specified asset, which may be a share, currency, etc.

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RATIONALE BEHIND THE DEVELOPMENT OF DERIVATIVES

Holding portfolio of securities is associated with the risk of the possibility that the investor may realize his returns, which would be much lesser than what he expected to get. There are various influences, which affect the returns. 1. Price or dividend (interest). 2. Sum are internal to the firm bike: Industry policy Management capabilities Consumers preference

Labour strike, etc.

These forces are to a large extent controllable and are termed as Non-systematic Risks. An investor can easily manage such non- systematic risks by having a well-diversified portfolio spread across the companies, industries and groups so that a loss in one may easily be compensated with a gain in other. There are other types of influences, which are external to the firm, cannot be controlled, and they are termed as systematic risks. Those are 1. Economic 2. Political 3. Sociological changes are sources of Systematic Risk. For instance inflation interest rate etc. Their effect is to cause the prices of nearly all individual stocks to move together in the same manner. We therefore quite often find stock prices falling from time to time in spite of companys earnings rising and vice versa. Rational behind the development of derivatives market is to manage this systematic risk, liquidity. Liquidity means, being able to buy & sell relatively large amounts quickly without substantial price concessions.

16 In debt market, a much larger portion of the total risk of securities is systematic. Debt instruments are also finite life securities with limited marketability due to their small size relative to many common stocks. These factors favor for the purpose of both portfolio hedging and speculation. India has vibrant securities market with strong retail participation that has evolved over the years. It was until recently a cash market with facility to carry forward positions in actively traded A group scrips from one settlement to another by paying the required margins and barrowing money and securities in a separate carry forward sessions held for this purpose. However, a need was felt to introduce financial products like other financial markets in the world.

CHARACTERISTICS OF DERIVATIVES
1. Their value is derived from an underlying instrument such as stock index, currency, etc. 2. They are vehicles for transferring risk. 3. They are leveraged instruments.

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MAJOR PLAYERS IN DERIVATIVE MARKET

There are three major players in their derivatives trading. 1. Hedgers. 2. Speculators. 3. Arbitrageurs. Hedgers: The party, which manages the risk, is known as Hedger. Hedgers seek to protect themselves against price changes in a commodity in which they have an interest. Speculators: They are traders with a view and objective of making profits. They are willing to take risks and they bet upon whether the markets would go up or come down. Arbitrageurs: Risk less profit making is the prime goal of arbitrageurs. They could be making money even with out putting their own money in, and such opportunities often come up in the market but last for very short time frames. They are specialized in making purchases and sales in different markets at the same time and profits by the difference in prices between the two centers.

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TYPES OF DERIVATIVES
Most commonly used derivative contracts are: Forwards: A forward contract is a customized contract between two entities where settlement takes place on a specific date in the futures at todays pre-agreed price. Forward contracts offer tremendous flexibility to the partys to design the contract in terms of the price, quantity, quality, delivery, time and place. Liquidity and default risk are very high. 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 standardized exchange traded contracts. Options: Options are 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 future date. Puts give the buyer the right but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Warrants: Longer dated options are called warrants and are generally traded over the counter. Options generally have lives up to one year, the majority of options traded on options exchanges having a maximum maturity of nine months. LEAPS: The acronym LEAPS means Long Term Equity Anticipation Securities. These are options having a maturity of up to three years. Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a pre-arranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are: Interest rare swaps: These entail swapping only the interest related cash flows between the parties in the same currency.

19 Currency swaps: These entail swapping both the principal and interest between the parties, with the cash flows in one direction being in a different currency than those in opposite direction.

RISKS INVOLVED IN DERIVATIVES

Derivatives are used to separate risks from traditional instruments and transfer these risks to parties willing to bear these risks. The fundamental risks involved in derivative business includes

A. Credit Risk: This is the risk of failure of a counterpart to perform its obligation as
per the contract. Also known as default or counterpart risk, it differs with different instruments.

B. Market Risk: Market risk is a risk of financial loss as result of adverse movements
of prices of the underlying asset/instrument.

C. Liquidity Risk: The inability of a firm to arrange a transaction at prevailing market

prices is termed as liquidity risk. A firm faces two types of liquidity risks: Related to liquidity of separate products. Related to the funding of activities of the firm including derivatives.

D. Legal Risk: Derivatives cut across judicial boundaries, therefore the legal aspects
associated with the deal should be looked into carefully.

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DERIVATIVES IN INDIA
Indian capital markets hope derivatives will boost the nations economic prospects. Fifty years ago, around the time India became independent men in mumbai gambled on the price of cotton in New York. They bet on the last one or two digits of the closing price on the New York cotton exchange. If they guessed the last number, they got Rs.7/- for every Rupee layout. If they matched the last two digits they got Rs.72/- Gamblers preferred using the New York cotton price because the cotton market at home was less liquid and could easily be manipulated. Now, India is about to acquire own market for risk. The country, emerging from a long history of stock market and foreign exchange controls, is one of the last major economies in Asia, to refashion its capital market to attract western investment. A hybrid over the counter derivatives market is expected to develop along side. Over the last couple of years the National Stock Exchange has pushed derivatives trading, by using fully automated screen based exchange, which was established by India's leading institutional investors in 1994 in the wake of numerous financial & stock market scandals.

Derivatives Segments In NSE & BSE

On June 9, 2000 BSE and NSE became the first exchanges in India to introduce trading in exchange traded derivative products, with the launch index Futures on sensex and nifty futures respectively. Index Options was launched in june2001, stock options in July 2001, and stock futures in November 2001. NIFTY is the underlying asset of the index futures at the futures and options segment of NSE with a market lot of 100 and BSE 30 sensex is the underlying stock index in BSE with a market lot of 30. This difference of market lot arises due to a minimum specification of a contract value of Rs.2Lakhs by Securities and Exchange Board of India. For example sensex is 6750 then the contract value of a futures index having sensex as underlying asset

21 will 30x6750 = 202500. Similarly, if Nifty is 2100 its futures contract value will be 100x2100=210000. Every transaction shall be in multiples pf market lot. Thus, index futures at NSE shall be traded in multiples of 100 and a BSE in multiples of 30.

Contract Periods:
At any point of time there will be always be available nearly 3months contract periods. For example in the month of June 2005 one can enter into their June futures contract or July futures contract or august futures contract. The last Thursday of the month specified in the contract shall be the final settlement date for the contract at both NSE as well as BSE. The June 30, July 28 and august 25 shall be the last trading day or the final settlement date for June futures contract, July futures contract and august futures contract respectively, When futures contract gets expired, a new futures contract will get introduced automatically. For instance on July 1, June futures contract becomes invalidated and a September futures contract gets activated.

Settlement:
The settlement of all derivative contracts is in cash mode. There is daily as well as final settlement. Out standing positions of a contract can remain open till the last Thursday of that month. As long as the position is open, the same will be marked to market at the daily settlement price, the difference will be credited or debited accordingly and the position shall be brought forward to the next day at the daily settlement price. Any position which remains open at the end of the final settlement day (i.e. last Thursday) shall closed out by the exchanged at the final settlement price which will be the closing spot value of the underlying asset.

Margins:
There are two types of margins collected on the open position, viz., initial margin which is collected upfront and mark to market margin, which is to be paid on next day. As per SEBI

22 guidelines it is mandatory for clients to give margins, fail in which the outstanding positions or required to be closed out.

Members of F&O segment:

There are three types of members in the futures and options segment. They are trading members, trading cum clearing member and professional clearing members. Trading members are the members of the derivatives segment and carrying on the transactions on the respective exchange. The clearing members are the members of the clearing corporation who deal with payments of margin as well as final settlements. The professional clearing member is a clearing member who is not a trading member. Typically, banks and custodians become professional clearing members. It is mandatory for every member of the derivatives segment to have approved users who passed SEBI approved derivatives certification test, to spread awareness among investors.

Exposure limit:
The national value of gross open positions at any point in time for index futures and short index option contract shall not exceed 33.33 times the liquid net worth of a clearing member. In case of futures and options contract on stocks the notional value of futures contracts and short option position any time shall not exceed 20 times the liquid net worth of the member. Therefore, 3 percent notional value of gross open position in index futures and short index options contracts, and 5 percent of notional value of futures and short option position in stocks is additionally adjusted from the liquid net worth of a clearing member on a real time basis.

Position limit:
It refers to the maximum no of derivatives contracts on the same underlying security that one can hold or control. Position limits are imposed with a view to detect concentration of position and market manipulation. The position limits are applicable on the cumulative combined position in all the derivatives contracts on the same underlying at an exchange. Position limits are imposed at the customer level, clearing member level and market levels are different.

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Regulatory Framework:
Considering the constraints in infrastructure facilities the existing stock exchanges are permitted to trade derivatives subject to the following conditions. Trading should take place through an online screen based trading system. An independent clearing corporation should do the clearing of the derivative market. The exchange must have an online surveillance capability, which monitors positions, price and volumes in real time so as to detect market manipulations. Position limits be used for improving market quality. Information about traded quantities and quotes should be disseminated by the exchange in the real time over at least two information-vending networks, which are accessible to the investors in the country. The exchange should have at least 50 members to start derivatives trading. The derivatives trading should be done in a separate segment with a separate membership. The members of an existing segment of the exchange will not automatically become the members of derivatives segment. The derivatives market should have a separate governing council and representation of trading/clearing members shall be limited to maximum of 40% of total members of the governing council. The chairman of the governing council of the derivative division/exchange should be a member of the governing council. If the chairman is broker/dealer, then he should not carry on any broking and dealing on any exchange during his tenure.

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Forwards
Forwards are the simplest and basic form of derivative contracts. These are instruments are basically used by traders/investors in order to hedge their future risks. It is an agreement to buy/sell an asset at a certain in future for a certain price. They are private agreements mainly between the financial institutions or between the financial institutions and corporate clients. One of the parties in a forward contract assumes a long position i.e. agrees to buy the underlying asset on a specified future date at a specified future price. The other party assumes short position i.e. agrees to sell the asset on the same date at the same price. This specified price referred to as the delivery price. This delivery price is chosen so that the value of the forward contract is equal to zero for both the parties. In other words, it costs nothing to the either party to hold the long/short position. A forward contract is settled at maturity. The holder of the short position delivers the asset to the holder of the long position in return for cash at the agreed upon rate. Therefore, a key determinate of the value of the contract is the market price of the underlying asset. A forward contract can therefore, assume a positive/negative value depending on the moments of the price of the asset. For example, if the price of the asset prices rises sharply after the two parties have entered into the contract, the party holding the long position stands to benefit, that is the value of the contract is positive for him. Conversely the value of the contract becomes negative for the party holding the short position. The concept of forward price is also important. The forward price for a certain contract is defined as that delivery price which would make the value of the contract zero. To explain further, the forward price and the delivery price are equal on the day that the contract is

26 entered into. Over the duration of the contract, the forward price is liable to change while the delivery price remains the same.

Essential features of Forward Contracts:

1. A forward contract is a Bi-party contract, to be performed in the future, with the terms decided today. 2. Forward contracts offer tremendous flexibility to the parties to design the contract in terms of the price, quantity, quality, delivery time and place. 3. Forward contracts suffer from poor liquidity and default risk. 4. Contract price is generally not available in public domain. 5. On the expiration date the contract will settle by delivery of the asset. 6. If the party wishes to reverse the contract, it is to compulsorily go to the same counter party, which often results high prices.

Forward Trading in Securities:

The Securities Contract (amendment) Act of 1999, has allowed the trading in derivative products in India. Has a further step to widen and deepen the securities market the government has notified that with effect from March 1 st 2000 the ban on forward trading in shares and securities is lifted to facilitate trading in forwards and futures. It may be recalled that the ban on forward trading in securities was imposed in 1986 to curb certain unhealthy trade practices and trends in the securities market. During the past few years, thanks to the economic and financial reforms, there have been many healthy developments in the securities markets. The lifting of ban on forward deals in securities will help to develop index futures and other types of derivatives and futures on stocks. This is a step in the right direction to promote the sophisticated market segments as in the western countries.

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FUTURES
The future contract is an agreement between two parties two buy or sell an asset at a certain specified time in future for certain specified price. In this, it is similar to a forward contract. A futures contract is a more organized form of a forward contract; these are traded on organized exchanges. However, there are a no of differences between forwards and futures. These relate to the contractual futures, the way the markets are organized, profiles of gains and losses, kind of participants in the markets and the ways they use the two instruments. Futures contracts in physical commodities such as wheat, cotton, gold, silver, cattle, etc. have existed for a long time. Futures in financial assets, currencies, and interest bearing instruments like treasury bills and bonds and other innovations like futures contracts in stock indexes are relatively new developments. The futures market described as continuous auction markets and exchanges providing the latest information about supply and demand with respect to individual commodities, financial instruments and currencies, etc. Futures exchanges are where buyers and sellers of an expanding list of commodities; financial instruments and currencies come together to trade. Trading has also been initiated in options on futures contracts. Thus, option buyers participate in futures markets with different risk. The option buyer knows the exact risk, which is unknown to the futures trader.

Features of Futures Contracts

The principal features of the contract are as fallows. Organized Exchanges: Unlike forward contracts which are traded in an over- the- counter market, futures are traded on organized exchanges with a designated physical location where trading takes place. This provides a ready, liquid market which futures can be bought and sold at any time like in a stock market. Standardization: In the case of forward contracts the amount of commodities to be delivered and the maturity date are negotiated between the buyer and seller and can be tailor made to buyers requirement. In a futures contract both these are standardized by the exchange on which the contract is traded. Clearing House: The exchange acts a clearinghouse to all contracts struck on the trading floor. For instance a contract is struck between capital A and B. upon entering into the

30 records of the exchange, this is immediately replaced by two contracts, one between A and the clearing house and the another between B and the clearing house. In other words the exchange interposes itself in every contract and deal, where it is a buyer to seller, and seller to buyer. The advantage of this is that A and B do not have to under take any exercise to investigate each others credit worthiness. It also guarantees financial integrity of the market. The enforces the delivery for the delivery of contracts held for until maturity and protects itself from default risk by imposing margin requirements on traders and enforcing this through a system called marking to market. Actual delivery is rare: In most of the forward contracts, the commodity is actually delivered by the seller and is accepted by the buyer. Forward contracts are entered into for acquiring or disposing of a commodity in the future for a gain at a price known today. In contrast to this, in most futures markets, actual delivery takes place in less than one percent of the contracts traded. Futures are used as a device to hedge against price risk and as a way of betting against price movements rather than a means of physical acquisition of the underlying asset. To achieve, this most of the contracts entered into are nullified by the matching contract in the opposite direction before maturity of the first. Margins: In order to avoid unhealthy competition among clearing members in reducing margins to attract customers, a mandatory minimum margins are obtained by the members from the customers. Such a stop insures the market against serious liquidity crises arising out of possible defaults by the clearing members. The members collect margins from their clients has may be stipulated by the stock exchanges from time to time and pass the margins to the clearing house on the net basis i.e. at a stipulated percentage of the net purchase and sale position. The stock exchange imposes margins as fallows: 1. Initial margins on both the buyer as well as the seller. 2. The accounts of buyer and seller are marked to the market daily. The concept of margin here is same as that of any other trade, i.e. to introduce a financial stake of the client, to ensure performance of the contract and to cover day to day adverse fluctuations in the prices of the securities. The margin for future contracts has two components: Initial margin Marking to market

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Initial margin: In futures contract both the buyer and seller are required to perform the contract. Accordingly, both the buyers and the sellers are required to put in the initial margins. The initial margin is also known as the performance margin and usually 5% to 15% of the purchase price of the contract. The margin is set by the stock exchange keeping in view the volume of business and size of transactions as well as operative risks of the market in general. The concept being used by NSE to compute initial margin on the futures transactions is called value- at Risk(VAR) where as the options market had SPAN based margin system. Marking to Market: Marking to market means, debiting or crediting the clients equity accounts with the losses/profits of the day, based on which margins are sought. It is important to note that through marking to market process, die clearinghouse substitutes each existing futures contract with a new contract that has the settle price or the base price. Base price shall be the previous days closing Nifty value. Settle price is the purchase price in the new contract for the next trading day.

Futures Terminology:
Spot price: The price at which an asset trades in spot market. Futures price: The price at which the futures contract trades in the futures market. Expiry Date: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist. Contract Size: The amount of asset that has to be delivered under one contract. For instance contract size on NSE futures market is 100 Nifties. Basis/Spread: In the context of financial futures basis can be defined as the futures price minus the spot price. There ill be a different basis for each delivery month for each contract. In formal market, basis will be positive. This reflects that futures prices normally exceed spot prices. Cost of Carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.

32 Multiplier: it is a pre-determined value, used to arrive at the contract size. It is the price per index point. Tick Size: It is the minimum price difference between two quotes of similar nature. Open Interest: Total outstanding long/short positions in the market in any specific point of time. As total long positions for market would be equal to total short positions for calculation of open Interest, only one side of the contract is counted. Long position: Outstanding/Unsettled purchase position at any point of time. Short position: Out standing/unsettled sales position at any time point of time.

Stock index Futures:

Stock index futures are most popular financial futures, which have been used to hedge or manage systematic risk by the investors of the stock market. They are called hedgers, who own portfolio of securities and are exposed to systematic risk. Stock index is the apt hedging asset since, the rise or fall due to systematic risk is accurately shown in the stock index. Stock index futures contract is an agreement to buy or sell a specified amount of an underlying stock traded on a regulated futures exchange for a specified price at a specified time in future. Stock index futures will require lower capital adequacy and margin requirement as compared to margins on carry forward of individual scrips. The brokerage cost on index futures will be much lower. Savings in cost is possible through reduced bid-ask spreads where stocks are traded in packaged forms. The impact cost will be much lower incase of stock index futures as opposed to dealing in individual scrips. The market is conditioned to think in terms of the index and therefore, would refer trade in stock index futures. Further, the chances of manipulation are much lesser. The stock index futures are expected to be extremely liquid, given the speculative nature of our markets and overwhelming retail participation expected to be fairly high. In the near future stock index futures will definitely see incredible volumes in India. It will be a blockbuster product and is pitched to become the most liquid contract in the world in terms of contracts traded. The advantage to the equity or cash market is in the fact that they would become less volatile as most of the speculative activity would shift to stock index futures. The stock index futures market should ideally have more depth, volumes and act as a stabilizing factor for the cash market. However, it is too early to base any conclusions on

33 the volume are to form any firm trend. The difference between stock index futures and most other financial futures contracts is that settlement is made at the value of the index at maturity of the contract. Example: If BSE sensex is at 6800 and each point in the index equals to Rs.30, a contract struck at this level could work Rs.204000 (6800x30). If at the expiration of the contract, the BSE sensex is at 6850, a cash settlement of Rs.1500 is required (6850-6800) x30).

Stock Futures:
With the purchase of futures on a security, the holder essentially makes a legally binding promise or obligation to buy the underlying security at same point in the future (the expiration date of the contract). Security futures do not represent ownership in a corporation and the holder is therefore not regarded as a shareholder. A futures contract represents a promise to transact at same point in the future. In this light, a promise to sell security is just as easy to make as a promise to buy security. Selling security futures without previously owing them simply obligates the trader to sell a certain amount of the underlying security at same point in the future. It can be done just as easily as buying futures, which obligates the trader to buy a certain amount of the underlying security at some point in future. Example: If the current price of the ACC share is Rs.170 per share. We believe that in one month it will touch Rs.200 and we buy ACC shares. If the price really increases to Rs.200, we made a profit of Rs.30 i.e. a return of 18%. If we buy ACC futures instead, we get the same position as ACC in the cash market, but we have to pay the margin not the entire amount. In the above example if the margin is 20%, we would pay only Rs.34 initially to enter into the futures contract. If ACC share goes up to Rs.200 as expected, we still earn Rs.30 as profit.

Payoff for Futures contracts

Futures contracts have linear payoffs. In simple words, it means that the losses as well as profits for the buyer and the seller of a futures contract are unlimited. These linear payoffs are fascinating as they can be combined with options and the underlying to generate various complex payoffs.

34 Payoff for buyer of futures: Long futures The payoff for a person who buys a futures contract is similar to the payoff for a person who holds an asset. He has a potentially unlimited upside as well as potentially unlimited downside. Take the case of a speculator who buys a two-month Nifty index futures contract when Nifty stands at 1220. The underlying asset in this case is Nifty portfolio. When the index moves up, the long futures position starts making profits, and when index moves down it starts making losses.

Payoff for a buyer of Nifty futures

profit

1220
0 Nifty

LOSS

Payoff for seller of futures: Short futures The payoff for a person who sells a futures contract is similar to the payoff for a person who shorts an asset. He has potentially unlimited upside as well as potentially unlimited downside. Payoff for a seller of Nifty futures
Profit

1220 0 Nifty

LOSS

35

Take the case of a speculator who sells a two-month Nifty index futures contract when the Nifty stands at 1220. The underlying asset in this case is the Nifty portfolio. When the index moves down, the short futures position starts making profits, and when index moves up, it starts making losses.

PRICING FUTURES
Cost of Carry Model: We use fair value calculation of futures to decide the no arbitrage limits on the price of the futures contract. This is the basis for the cost-of-carry model where the price of the contract is defined as fallows. F=S+C Where F Futures S Spot price C Holding cost or Carry cost This can also be expressed as F = S (1+r) T Where r Cost of financing T Time till expiration Pricing index futures given expected dividend amount: The pricing of index futures is also based on the cost of carry model where the carrying cost is the cost of financing the purchase of the portfolio underlying the index, minus the present value of the dividends obtained from the stocks in the index portfolio. Example Nifty futures trade on NSE as one, two and three month contracts. Money can be barrowed at a rate of 15% per annum. What will be the price of a new two-month futures contract on Nifty?

36 1. Let us assume that ACC will be declaring a dividend of Rs.10/- per share after 15 days of purchasing of contract. 2. Current value of Nifty is 1200 and Nifty trade with a multiplier of 200. 3. Since Nifty is traded in multiples of 200 value of the contract is 200x1200=240000. 4. If ACC as weight of 7% in Nifty, its value in Nifty is Rs.16800 i.e. (240000x0.07). 5. If the market price of ACC is Rs.140, then a traded unit of Nifty involves 120 shares of ACC i.e. (16800/140). 6. To calculate the futures price we need to reduce the cost of carry to the extent of dividend received is Rs.1200 i.e. (120x10). The dividend is received 15 days later and hence compounded only for the remainder of 45 days. To calculate the futures price we need to compute the amount of dividend received for unit of Nifty. Hence, we dividend the compounded figure by 200. 7. Thus futures price F = 1200(1.15) 60/365 (120x10(1.15) 45/365)/200 = Rs.1221.80. Pricing index futures given expected dividend yield If the dividend flow through out the year is generally uniform, i.e. if there are few historical cases of clustering of dividends in any particular month, it is useful to calculate the annual dividend yield. F = S (1+ r-q) T Where F Futures price S Spot index value

r Cost of financing q Expected dividend yield T Holding period

Example: A two-month futures contract trades on the NSE. The cost of financing is 15% and the dividend yield on Nifty is 2% annualized. The spot value of Nifty is 1200. What is the fair value of the futures contract? Fair value = 1200(1+0.15-0.02) 60/365 = Rs.1224.35

37

Pricing stock futures

A futures contract on a stock gives its owner the right and the obligation to buy or sell the stocks. Like, index futures, stock futures are also cash settled: There is no delivery of the underlying stock. Pricing stock futures when no dividend is expected The pricing of stock futures is also based on the cost of carry model, where the carrying cost is the cost of financing the purchase of the stock, minus the present value of the dividends obtained from the stock. If no dividends are expected during the life of the contract, pricing futures on that stock is very simple. It simply involves the multiplying the spot price by the cost of carry. Example: SBI futures trade on NSE as one, two and three month contracts. Money can be barrowed at 15% per annum. What will be the price of a unit of new two-month futures contract on SBI if no dividends are expected during the period? 1. Assume that the spot price of SBI is Rs.228.

2. Thus, futures price F = 228(1.15) 60/365 = Rs.223.30.

Pricing stock futures when dividends are expected When dividends are expected during the life of futures contract, pricing involves reducing the cost of carrying to the extent of the dividends. The net carrying cost is the cost of financing the purchase of the stock, minus the present value of the dividends obtained from the stock. Example: ACC futures trade on NSE as one, two and three month contracts. What will be the price of a unit of new two-month futures contract on ACC if dividends are expected during the period? 1. Let us assume that ACC will be declaring a dividend of Rs.10/- per share after 15 days pf purchasing contract. 2. Assume that the market price of ACC is Rs.140/3. To calculate the futures price, we need to reduce the cost of carrying to the extent of dividend received. The amount of dividend received is Rs.10/-. The dividend is received 15 days later and hence, compounded only for the remaining 45 days. 4. Thus, the futures price F = 140 (1.15) 60/365 10(1.15) 45/365 = Rs.133.08.

38

39

OPTIONS
An option is a derivative instrument since its value is derived from the underlying asset. It is essentially a right, but not an obligation to buy or sell an asset. Options can be a call option (right to buy) or a put option (right to sell). An option is valuable if and only if the prices are varying. An option by definition has a fixed period of life, usually three to six months. An option is a wasting asset in the sense that the value of an option diminishes has the date of maturity approaches and on the date of maturity it is equal to zero. An investor in options has four choices before him. Firstly, he can buy a call option meaning a right to buy an asset after a certain period of time. Secondly, he can buy a put option meaning a right to sell an asset after a certain period of time. Thirdly, he can write a call option meaning he can sell the right to buy an asset to another investor. Lastly, he can write a put option meaning he can sell a right to sell to another investor. Out of the above four cases in the first two cases the investor has to pay an option premium while in the last two cases the investors receives an option premium. Definition: An option is a derivative i.e. its value is derived from something else. In the case of the stock option its value is based on the underlying stock (equity). In the case of the index option, its value is based on the underlying index.

Options clearing corporation

The Options Clearing Corporation (OCC) is guarantor of all exchange-traded options once an option transaction has been completed. Once a seller has written an option and a buyer has purchased that option, the OCC takes over it. It is the responsibility of the OCC who over sees the obligations to fulfill the exercises. If I want to exercise an ACC November 100-call option, I notify my broker. My broker notifies the OCC, the OCC then randomly selects a brokerage firm, which is short one ACC stock. That brokerage firm then notifies one of its customers who have written one ACC November 100 call option and exercises it. The brokerage firm customer can be chosen in two ways. He can be chosen at random or FIFO basis. Because, OCC has a certain risk that the seller of the option cant full the contract, strict margin requirement are imposed on sellers. This margins requirement act as a performance Bond. It assures that OCC will get its money.

40

Options Terminology.
Call Option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. Put option: A put option gives the holder the right but the not the obligation to sell an asset by a certain date for a certain price. Option price: Option price is the price, which the option buyer pays to the option seller. It is also referred to as the option premium. Expiration date: The date specified in the option contract is known as the expiration date, the exercise date, the straight date or the maturity date. Strike Price: The price specified in the option contract is known as the strike price or the exercise price. American option: American options are the options that the can be exercised at the time up to the expiration date. Most exchange-traded options are American. European options: European options are the options that can be exercised only on the expiration date itself. European options are easier to analyze that the American options and properties of an American option are frequently deduced from those of its European counter part. In-the-money option: An in-the-money option (ITM) is an option that would lead to a positive cash flow to the holder if it were exercised immediately. A call option in the index is said to be in the money when the current index stands at higher level that the strike price (i.e. spot price > strike price). If the index is much higher than the strike price the call is said to be deep in the money. In the case of a put option, the put is in the money if the index is below the strike price. At-the-money option: An At-the-money option (ATM) is an option that would lead to zero cash flow if it exercised immediately. An option on the index is at the money when the current index equals the strike price (I.e. spot price = strike price). Out-of-the-money option: An out of the money (OTM) option is an option that would lead to a negative cash flow if it were exercised immediately. A call option on the index is out of he money when the current index stands at a level, which is less than the strike price (i.e. spot price < strike price). If the index is much lower than the strike price the call is said to be deep OTM. In the case of a put, the put is OTM if the index is above the strike price.

41 Intrinsic value of an option: It is one of the components of option premium. The intrinsic value of a call is the amount the option is in the money, if it is in the money. If the call is out of the money, its intrinsic value is Zero. For example X, take that ABC November-call option. If ABC is trading at 102 and the call option is priced at 2, the intrinsic value is 2. If ABC November-100 put is trading at 97 the intrinsic value of the put option is 3. If ABC stock was trading at 99 an ABC November call would have no intrinsic value and conversely if ABC stock was trading at 101 an ABC November-100 put option would have no intrinsic value. An option must be in the money to have intrinsic value. Time value of an option: The value of an option is the difference between its premium and its intrinsic value. Both calls and puts time value. An option that is OTM or ATM has only time value. Usually, the maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an options time value. At expiration an option should have no time value. Characteristics of Options The following are the main characteristics of options: 1. Options holders do not receive any dividend or interest. 2. Options only capital gains. 3. Options holder can enjoy a tax advantage. 4. Options holders are traded an O.T.C and in all recognized stock exchanges. 5. Options holders can controls their rights on the underlying asset. 6. Options create the possibility of gaining a windfall profit. 7. Options holders can enjoy a much wider risk-return combinations. 8. Options can reduce the total portfolio transaction costs. 9. Options enable with the investors to gain a better return with a limited amount of investment.

Call Option
An option that grants the buyer the right to purchase a designed instrument is called a call option. A call option is contract that gives its owner the right but not the obligation, to buy a specified asset at specified prices on or before a specified date.

42 An American call option can be exercised on or before the specified date. But, a European option can be exercised on the specified date only. The writer of the call option may not own the shares for which the call is written. If he owns the shares it is a Covered Call and if he des not owns the shares it is a Naked call Strategies: The following are the strategies adopted by the parties of a call option. Assuming that brokerage, commission, margins, premium, transaction costs and taxes are ignored. A call option buyers profit/loss can be defined as follows: At all points where spot price < exercise price, here will be loss. At all points where spot prices > exercise price, there will be profit. Call Option buyers losses are limited and profits are unlimited. Conversely, the call option writers profits/loss will be as follows: At all points where spot prices < exercise price, there will be profit At all points where spot prices > exercise price, there will be loss Call Option writers profits are limited and losses are unlimited. Following is the table, which explains In the-money, Out-of-the-money and At-the-money position for a Call option. Exercise call option Do not exercise Exercise/Do not exercise Example: The current price of ACC share is Rs.260. Holder expect that price in a three month period will go up to Rs.300 but, holder do fear that the price may fall down below Rs.260. To reduce the chance of holder risk and at the same time, to have an opportunity of making profit, instead of buying the share, the holder can buy a three-month call option on ACC share at an agreed exercise price of Rs.250. Spot price>Exercise price Spot price<Exercise price Spot price=Exercise price In-The-Money Out-of the-Money At-The-Money

43 1. If the price of the share is Rs.300. then holder will exercise the option since he get a share worth Rs.300. by paying a exercise price of Rs.250. holder will gain Rs.50. Holders call option is In-The-Money at maturity. 2. If the price of the share is Rs.220. then holder will not exercise the option. Holder will gain nothing. It is Out-of-the-Money at maturity. Payoff for buyer of call option: Long call The profit/loss that the buyer makes on the option depends on the spot price of the underlying. If upon expiration, the spot price exceeds the strike price, he makes a profit. Higher the spot price, more is the profit he makes. If the spot price of the underlying is less than the strike price, he lets his option un-exercise. His loss in this case is the premium he paid for buying the option. Payoff for buyer of call option
Profit

1250

0
86.60

Nifty

Loss

The figure shows the profit the profits/losses for the buyer of the three-month Nifty 1250(underlying) call option. As can be seen, as the spot nifty rises, the call option is InThe-money. If upon expiration Nifty closes above the strike of 1250, the buyer would exercise his option and profit to the extent of the difference between the Nifty-close and strike price. However, if Nifty falls below the strike of 1250, he lets the option expire and his losses are limited to the premium he paid i.e. 86.60.

44 Payoff for writer of call option: Short call For selling the option, the writer of the option charges premium. Whatever is the buyers profit is the sellers loss. If upon expiration, the spot price exceeds the strike price, the buyer will exercise the option on the writer. Hence as the spot price increases the writer of the option starts making losses. Higher the spot price more is the loss he makes. If upon expiration the spot price is less than the strike price, the buyer lets his option un-exercised and the writer gets to keep the premium. Payoff for writer of call option
Profit

86.60 1250 0 Nifty

LOSS

The figure shows the profits/losses for the seller of a three-month Nifty 1250 call option. If upon expiration Nifty closes above the strike of 1250, the buyer would exercise his option on the writer would suffer a loss to the extent of the difference between the Nifty-close and the strike price. This loss that can be incurred by the writer of the option is potentially unlimited. The maximum profit is limited to the extent of up-front option premium Rs.86.60.

Put option
An option that gives the seller the right to sell a designated instrument is called put option. A put option is a contract that gives the owner the right, but not the obligation to sell a specified number of shares at a specified price on or before a specified date.

45 An American put option can be exercised on or before the specified date. But, a European option can be exercised on the specified date only. The following are the strategies adopted y the parties of a put option. A put option buyers profit/loss can be defined as follows: At all points where spot price<exercise price, there will be gain. At all points where spot price>exercise price, there will be loss. Conversely, the put option writers profit/loss will be as follows: At all points where spot price<exercise price, there will be loss. At all points where spot price>exercise price, there will be profit. Following is the table, which explains In-the-money, Out-of-the Money and At-the-money positions for a Put option. Exercise put option Do not Exercise Exercise/Do not Exercise Example: The current price of ACC share is Rs.250. Holder by a three month put option at exercise price of Rs.260. (Holder will Exercise his option only if the market price/ spot price is less than the exercise price). If the market/Spot price of the ACC share is Rs.245., then the holder will exercise the option. Means put option holder will buy the share for Rs.245. In the market and deliver it to the option writer for Rs.260., the holder will gain Rs.15 from the contract. Payoff for buyer of put option: Long put. A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. If upon the expiration, the spot price is below the strike price, he makes a profit. Lower the spot price more is the profit he makes. If the spot price of the underlying is higher than the strike price, he lets his option expire un-exercised. Spot price<Exercise price Spot price>Exercise price Spot price=Exercise price In-The-Money Out-of-The-Money At-The-Money

46

Payoff for buyer of put option

Profit

1250 0 61.70 Nifty

Loss

The figure shows the profits/losses for the buyer of a three-month Nifty 1250 put option. As can be seen, as the spot Nifty falls, the put option is In-The-Money. If upon expiration, Nifty closes below the strike of 1250, the buyer would exercise his option and profit to the extent of the difference between the strike price and Nifty-close. The profits possible on this option can be as high as the strike price. However, if Nifty rises above the strike of 1250, he lets the option expire. His losses are limited to the extent of the premium he paid. Payoff for writer of put option: Short put The figure below shows the profit/losses for the seller/writer of a three-month put option. As the spot Nifty falls, the put option is In-The-Money and the writer starts making losses. If upon expiration, Nifty closes below the strike of 1250, the buyer would exercise his option on writer who would suffer losses to the extent of the difference between the strike price and Nifty-close.

Payoff for writer of put option

47

Profit

61.70 1250

Nifty

Loss

The loss that can be incurred by the writer of the option is to a maximum extent of strike price. Maximum profit is limited to premium charged by him.

Pricing Options
Factors determining options value: Exercise price and Share price: If the share price is more than the exercise price then the holder of the call option will get more net payoff, means the value of the call option is more. If the share price is less then the exercise price then the holder of the put option will get more net pay-off. Interest Rate: The present value of the exercise price will depend on the interest rate. The value of the call option will increase with the rise in interest rates. Since, the present value of the exercise price will fall. The effect is reversed in the case of a put option. The buyer of a put option receives exercise price and therefore as the interest increases, the value of the put option will decrease. Time to Expiration: The present value of the exercise price also depends on the time to expiration of the option. The present value of the exercise price will be less if the time to expiration is longer and consequently value of the option will be higher. Longer the time to expiration higher is the possibility of the option to be more in the money. Volatility: The volatility part of the pricing model is used to measure fluctuations expected in the value of the underlying security or period of time. The more volatile the underlying security, the greater is the price of the option. There are two different kinds of volatility. They are Historical Volatility and Implied Volatility. Historical volatility estimates

48 volatility based on past prices. Implied volatility starts with the option price as a given, and works backward to ascertains the theoretical value of volatility which is equal to the market price minus any intrinsic value.

Black scholes pricing models:

The principle that options can completely eliminate market risk from a stock portfolio is the basis of Black Scholes pricing model in 1973. Interestingly, before Black and Scholes came up with their option pricing model, there was a wide spread belief that the expected growth of the underlying ought to effect the option price. Black and Scholes demonstrate that this is not true. The beauty of black and scholes model is that like any good model, it tells us what is important and what is not. It doesnt promise to produce the exact prices that show up in the market, but certainly does a remarkable job of pricing options within the framework of assumptions of the model. The following are the assumptions; 1. There are no transaction costs and taxes. 2. The risk from interest rate is constant. 3. The markets are always open and trading is continues. 4. The stock pays no dividend. During the option period the firm should not pay any dividend. 5. The option must be European option. 6. There are no short selling constraints and investors get full use of short sale proceeds. The options price for a call, computed as per the following Black Scholes formula: VC =PS N (d1)- PX/(e (RF)(T)) N (d2) The value of Put option as per Black scholes formula: VP=PX/(e (RF)(T)) N (-d2 )-PS N (-d1) Where d1= In [PS/PX]+T[RF+(S.D)2 / 2] / S.D (sqrt (T)) d2= d1-S.D (sqrt(T) VC= value of call option VP= value of put option PS= current price of the share

49 PX= exercise of the share RF= Risk free rate T= time period remaining to expiration N (d1)= after calculation of d1, value normal distribution area is to be identified. N (d2)= after calculation of d2, value normal distribution area is to be identified. S.D= risk rate of the share In = Natural log value of ratio of PS and PX

Pricing Index Option:

Under the assumptions of Black Scholes options pricing model, index options should be valued in the way as ordinary options on common stock. The assumption is that the investors can purchase the underlying stocks in the exact amount necessary to replicate the index: i.e. stocks are infinitely divisible and that the index follows a diffusion process such that the continuously compounded returns distribution of the index is normally distributed. To use the black scholes formula for index options, we must however, make adjustments for the dividend payments received on the index stocks. If the dividend payment is sufficiently smooth, this merely involves the replacing the current index value S in the model with S/eqT where q is the annual dividend and T is the time of expiration in years.

Pricing Stock Options:

The Black Scholes options pricing formula that we used to price European calls and puts, with some adjustments can be used to price American calls and puts & stocks. Pricing American options becomes a little difficult because, unlike European options, American options can be exercised any time prior to expiration. When no dividends are expected during the life of options the options can be valued simply by substituting the values of the stock price, strike price, stock volatility, risk free rate and time to expiration in the black scholes formula. However, when dividends are expected during the life of the options, it is some times optimal to exercise the option just before the underlying stock goes exdividend. Hence, when valuing options on dividend paying stocks we should consider exercised possibilities in two situations. One-just before the underlying stock goes Exdividend, Two at expiration of the options contract. Therefore, owing an option on a dividend paying stock today is like owing to options one in long maturity option with a

50 time to maturity from today till the expiration date, and other is a short maturity with a time to maturity from today till just before the stock goes Ex-dividend.

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Difference between the Futures and Options

Futures Options 1. Both the parties are obligated to 1. Only the seller (writer) is obligated perform. 2. In futures either parties pay premium. 3. The parties to the futures contract must perform at the settlement date only. They are obligated to perform the date. 4. The holder of the contract is exposed to the entire spectrum of downside risk and had the potential for all the upside return. 5. In futures margins are to be paid. They are approximately 15 to 20% on the current stock price. 5. In options premium are to be paid. But they are less as compare to margin in futures. 4. The buyer limits the downside risk to the option premium but retain the upside potential. to perform. 2. In options the buyer pays the seller a premium. 3. The buyer of an options contract can exercise the option at any time prior to expiration date.

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53

Swaps
Financial swaps are a funding technique, which a permit a barrower to access one market and then exchange the liability for another type of liability. Global financial markets present barrowers and investors with a variety of financing and investment vehicles in terms of currency and type of coupon fixed or floating. It must be noted that the swaps by themselves are not a funding instrument: They are device to obtain the desired form of financing indirectly. The barrower might other wise as found this too expensive or even inaccessible. A common explanation for the popularity of swaps concerns the concept of comparative advantage. The basis principle is that some companies have a comparative advantage when barrowing in fixed markets while other companies have a comparative advantage in floating markets. Swaps are used to transform the fixed rate loan into a floating rate loan. Types of swaps: All Swaps involves exchange of a series of payments between two parties. A swap transaction usually involves an intermediary who is a large international financial institution. The two payment streams estimated to have identical present values at the outset when discounted at the respective cost of funds in the relevant markets. The most widely prevalent swaps are 1. Interest rate swaps. 2. Currency swaps.

Interest rate swaps

Interest rate swaps, as a name suggest involves an exchange of different payment streams, which are fixed and floating in nature. Such an exchange is referred to as an exchange of barrowings. For example, B to pay the other party A cash flows equal to interest at a pre-determined fixed rate on a notional principal for a number of years. At the same time, party A agrees to pay B cash flows equal to interest at a floating rate on the same notional principal for the same period of time. The currencies of the two sets of interest cash flows are the same. The life of the swap can range from two years to fifty years.

54 Usually two non-financial companies do not get in touch with each other to directly arrange a swap. They each deal with a financial intermediary such as a bank. At any given point of time, the swaps spreads are determined by supply and demand. If no participants in the swaps market want to receive fixed rather than floating, Swap spreads tend to fall. If the reverse is true, the swaps spread tend to rise. In real life, it is difficult to envisage a situation where two companies contact a financial institution at a exactly same with a proposal to take opposite positions in the same swap.

Currency Swaps
Currency swaps involves exchanging principal and fixed interest payments on a loan in one currency for principal and fixed interest payments on an approximately equivalent loan in another currency. Example: Suppose that a company A and company B are offered the fixed five years rates of interest in US $ and Sterling. Also suppose that sterling rates are higher than the dollar rates. Also, company A a better credit worthiness then company B as it is offered better rates on both dollar and sterling. What is important to the trader who structures the swap deal is that the difference in the rates offered to the companies on both currencies is not same. Therefore, though company A has a better deal. In both the currency markets, company B does enjoy a comparative lower disadvantage in one of the markets. This creates an ideal situation for a currency swap. The deal could be structured such that the company B barrows in the market in which it has a lower disadvantage and company A in which it has a higher advantage. They swap to achieve the desired currency to the benefit of all concerned. A point to note is that the principal must be specified at the outset for each of the currencies. The principal amounts are usually exchanged at the beginning and the end of the life of the swap. They are chosen such that they are equal at the exchange rate at the beginning of the life of the swap. Like interest swap, currency swaps are frequently ware housed by financial institutions that carefully monitor their exposure in various currencies so that they can change hedge currency risk

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CURRENTLY AVAILABLE FUTURE IN NSE

Span Margin:: May 30, 2008 Symbol Mlot

LUPIN M&M MAHLIFE PFC PNB POLARIS POWERGRID PRAJIND PUNJLLOYD PURVA SASKEN BALLARPUR BAJAJ-AUTO MAHSEAMLES CNX100 CNXIT JUNIOR MINIFTY NFTYMCAP50 NIFTY WOCKPHARMA WWIL YESBANK ZEEL VOLTAS WELGUJ WIPRO TATASTEEL TATATEA TATAMOTORS TATAPOWER TCS TECHM TITAN TRIVENI TTML TULIP TVSMOTOR ULTRACEMCO UNIONBANK 700 312 350 1200 600 2800 1925 1100 750 500 1100 7300 200 600 50 50 25 20 75 50 600 3150 1100 700 900 800 600 382 275 412 200 250 200 206 1925 5225 250 2950 400 2100

TotMgn%
20.16 16.16 24.49 22.82 20.23 25.51 17.33 32.35 19.53 43.81 34.78 19.32 23.73 18 10.1 12.2 12.11 10.12 10.73 10.11 15.72 27.07 24.51 15.81 20.44 24.79 18.24 18.57 16.99 21.72 19.42 19.76 22.27 24.28 28.08 23.93 19.62 24.53 18.33 22.05

TotMgnPerLt
97917.75 30677.36 54493.22 36947.89 60265.5 73359.36 33495.81 66106.89 45815.9 49941.08 55144.09 48117.22 28146.5 35467.55 23590.2 27984.65 24695.25 9825.47 21004.21 24573.98 28099.5 31470.73 41804.4 25256 26499.45 75081.12 55350 64029.61 40234.31 50775.32 53218.07 49098.13 37586.2 58724.44 59872.91 40392.34 48141.27 27358.42 47597 63438.33

56
UNIPHOS UNITECH VIJAYABANK STAR STER STERLINBIO STRTECH SUNPHARMA SUNTV SUZLON SYNDIBANK TATACHEM TATACOMM SESAGOA SHREECEM SIEMENS SKUMARSYNF SOBHA SRF SATYAMCOMP SBIN SCI ROLTA RPL RPOWER SAIL RECLTD REDINGTON RELINFRA RELCAPITAL RELIANCE RENUKA RNRL RAJESHEXPO RANBAXY RCOM NUCLEUS OMAXE ONGC ORCHIDCHEM ORIENTBANK PANTALOONR PARSVNATH PATELENG PATNI PENINLAND PETRONET MARUTI MATRIXLABS MCDOWELL-N 700 900 3450 850 219 2500 1050 225 1000 1000 1900 675 525 75 200 376 1900 350 1500 600 132 800 900 1675 500 1350 1950 500 138 138 75 5000 1788 1650 800 350 550 650 225 1050 1200 500 700 250 650 2750 2200 200 1250 125 16.68 24.64 20.51 40.31 20.45 17.31 27.35 18.54 20.79 22.89 16.98 22.12 20.25 22.33 25.36 16.18 28.19 17.85 23.07 17.62 18.54 22.18 21.29 21.83 18.65 21.24 16.82 30.87 24.74 27.22 15.89 30.61 27.39 22.32 15.71 19.51 37.88 22.5 15.75 38.18 21.08 22.52 21.98 19.41 17.41 26.32 20.67 15.84 38.31 18.68 39998 53168.03 33368.06 57264.49 40723.22 87743.75 60006.35 58020.44 67888.7 63426.61 22268 61256.25 53168.72 69628 41185 34261.4 61719.9 30742.1 41218.02 55420.5 35808.17 51318.66 60274.77 64941.34 38318.16 46528.01 35597.75 51687.9 42607.5 46460.52 29582.38 175780.05 50726.46 32533.48 63820 39324.42 55616.73 30534.9 30322.94 98318.33 44017.2 50167.15 30988.83 23438.4 30958.62 58316.07 31861.8 24045 89014.61 38039.37

57
MOSERBAER INFOSYSTCH IOB IOC IRB ISPATIND ITC JINDALSAW JINDALSTEL JPASSOCIAT JPHYDRO JSTAINLESS JSWSTEEL KESORAMIND KOTAKBANK KPIT KTKBANK IVRCLINFRA IVRPRIME J&KBANK JETAIRWAYS IDBI IDEA IDFC IFCI INDHOTEL INDIACEM INDIAINFO INDIANB INDUSINDBK GDL GESHIP GITANJALI GLAXO GMRINFRA GNFC GRASIM GTL GTOFFSHORE GUJALKALI HAVELLS HCC HCLTECH HDFC HDFCBANK HDIL HEROHONDA HINDALCO HINDOILEXP HINDPETRO 825 200 1475 600 1100 4150 1125 250 160 750 3125 1000 275 500 275 1650 1250 500 800 300 400 1200 2700 1475 1970 1899 725 250 1100 1925 2500 600 500 300 1250 1475 88 750 250 1400 400 1400 650 75 200 400 400 1595 1600 1300 23.96 17.1 19.38 18.67 19.85 28.12 18.25 22.19 28.13 27.58 25.73 19.69 23.22 16.38 25.86 45.3 15.72 23.76 39.64 27.19 15.7 20.11 16.91 20.7 31.99 16.39 20.27 24.7 22.36 25.25 20.6 22.07 20.34 15.84 23.66 24.63 15.7 15.78 19.96 20.19 16.04 24.45 19.22 18.96 17.13 31.19 16.01 23.46 30.08 17.53 35599.95 64386.5 35349.75 47263.27 39687.82 37819.95 44286.13 30529.43 103176.73 46707.94 49386.38 27284.15 74003.64 27438.01 48546.82 55846 38541.13 47520.84 67583.13 52752.75 33810 21374.69 49565.25 45242.54 39546.51 34263.23 23584.94 45192.45 30114.3 38048.15 51851.73 67782.55 29849.24 52943.25 39912.39 56255.97 30789.08 28406.25 35509.83 54124.07 30828 38081.05 38431.25 34802.17 44798 91804.74 48797 71380.32 66925.91 57113.47

58
HINDUJAVEN HINDUNILVR HINDZINC HOTELEELA HTMTGLOBAL I-FLEX BEML BHARATFORG BHARTIARTL BHEL BHUSANSTL BINDALAGRO BIOCON BIRLAJUTE BOMDYEING BONGAIREFN BOSCHLTD BPCL GAIL IBN18 BANKNIFTY BRFL BRIGADE CAIRN CANBK CENTRALBK CENTURYTEX CESC CHAMBLFERT CHENNPETRO CIPLA CMC COLPAL CORPBANK CROMPGREAV CUMMINSIND DABUR DCB DENABANK DIVISLAB DLF DRREDDY EDELWEISS EDUCOMP EKC ESCORTS ESSAROIL FEDERALBNK FINANTECH 3IINFOTECH 500 1000 250 3750 500 150 125 1000 250 75 250 4950 450 850 300 2250 50 550 750 1250 25 1150 550 1250 800 2000 212 550 3450 900 1250 200 550 600 500 475 2700 1400 2625 155 400 400 250 75 1000 2400 1412 851 150 2700 36.04 15.73 27.19 21.65 36.11 25.29 15.83 16.74 17.6 18.29 22.48 31.79 15.7 20.9 28.48 22.47 15.7 19.28 15.82 36.77 13.91 25.58 44.23 25.35 20.17 17.58 23.12 18.93 44.42 20.64 15.75 26.21 16.89 16.28 20.54 15.72 15.82 30.02 22.82 18.25 20.27 16.95 25.63 22.15 20.55 23.7 32.03 18.74 16.64 20.06 56013.18 37495 43678.96 34464.17 65074.35 52524.44 21788.13 43652.5 38130 22073.12 47380.86 60673.74 32163.75 38084.99 77011.55 29988.11 33075.75 38216.15 46790.93 53535.93 22813.88 103116.17 45425.04 91901.53 33422.56 29396.64 33641.53 50649.04 129217.44 62881.07 42213 40240.11 40180.75 34187.66 23271.32 21613.44 40689 31760.1 31841.33 40475.42 48003.92 46027 46115.4 67873.79 62822.72 54736.56 104838.43 34458.93 43661.63 64169.01

59
ABAN ABB ABIRLANUVO ACC ADLABSFILM AIAENG AIRDECCAN ALBK ALOKTEXT AMBUJACEM AMTEKAUTO ANDHRABANK ANSALINFRA APIL APTECHT ARVINDMILL ASHOKLEY AUROPHARMA AXISBANK BAJAJHIND BAJAJHLDNG BALRAMCHIN BANKBARODA BANKINDIA BATAINDIA BEL NIITTECH NTPC MPHASIS MRPL ICICIBANK MTNL NAGARCONST NAGARFERT NATIONALUM NAUKRI NDTV NETWORK18 NEYVELILIG NICOLASPIR NIITLTD LAXMIMACH LICHSGFIN LITL LT 50 250 200 188 225 200 850 2450 3350 2062 600 2300 1300 200 650 4300 4775 700 225 950 250 2400 700 950 1050 138 1200 1625 800 2225 175 1600 1000 3500 575 150 550 500 1475 750 1450 100 850 425 50 24.03 15.71 16.61 15.71 28.73 23.41 29.44 18.91 24.82 21.91 17.03 18.19 25.54 22.87 30.2 27.67 18.99 19.31 25.3 33.54 27.72 28.25 19.93 22.71 21.04 17.95 27.22 16.27 28.36 26.92 20.05 16.72 19.94 36.55 22.83 28.77 15.94 42.92 27.79 15.88 18.98 18.32 22.69 32.97 19.16 49074.3 39333.13 48489.5 19511.7 41189.96 69537.5 29407.53 37859.98 52847.04 44482.2 29946 31697.22 45315.5 25610.97 45840.73 55988.04 32973.42 39272.86 44746.05 61664.81 42329.2 61327.94 37088.93 62621.92 35664.74 28863.12 47146.86 45537.32 53407.27 50382.23 27933.35 25524.38 38933.55 62757.21 69574.28 43576.55 36612.63 47318.11 59477.01 42045.5 28992.39 27616.69 65216.63 69809.89 27757.25

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BASIC OPTION STRATEGIES

Long call Market View Action Profit Potential Loss Potential Bullish Buy a call option Unlimited Limited

To make a profit from an expected increase in the price of an underlying share during options life: Situation: On 28th April, CIPLA is quoting at Rs.254. and the July Rs.260 (strike price) Call costs Rs.14 (premium). We expect the share price to rise significantly and want to make a profit from the increase. Action: Buy 1CIPLA calls at Rs.14; Market lot for CIPLA is 1000. So, Net outlay is

Rs.14000 (14x1000). If CIPLA shares go up we can close the position either by selling the option back to the market or exercising the right to buy the underlying shares at the exercise price.

Share price (Cash market)

28 April 28 July Rs.254 Rs.300

Option market
Buy 1 July 260 call at Rs.14; cost = 14000. 1. Sell 1 Jan contract (expiry) 2. Net gain Rs.40 (300-260)*1000

Analysis

Rises by Rs.46. Return 18%

Gain:

units =m Rs.40000. Option sale =

Rs.40000. Premium Paid = Rs.14000. Net Profit = Rs.26000.

Possible Outcome at Expiry

Share price Rs.300 Option worth Rs.40000. Closing the

63 position now will produce a net profit of Rs.26000 Share price<260 Share price>274 Option expires worthless. The loss is Rs.14000 (premium paid) Net profit = Intrinsic value of (Break even = 260+14) option i.e. by whatever amount the share price exceeds Rs.274.

To establish a maximum cost at which to purchase shares at a lesser date if funds are not available immediately: Situation: On 28th April, an investor takes the view that CIPLAs share price is likely to rise over the coming months. He does not have the sufficient funds to buy the shares and decides to again exposure to the stocks and therefore participate in the rise by buying a call option. If the share price increases, selling the call option releases income to offset the higher share to be acquired at the exercise price that is below the share price. Action: Buy 1 July 240-call option CIPLA at Rs.25 for total outlay of Rs.25000 and purchase share on 28th July, the option expiry day.

Share price (Cash market)

28 Apr 28 July Rs.254 Rs.300

Option market
Buy Jan 240 call @ Rs.25000 (25x1000) 1. Sell 1 Jan 240 call option (or) 2. Exercise 1 Jan 240 call and purchase 1000 shares at 240000.

64 Analysis Rises by Rs.46 (300-254) 1. Sale of option Net profit = Rs.60000 = Rs.35000.

Cost of purchase = Rs.25000 2. Option purchase = Rs.25000 Exercise option =Rs.240000 Net outlay Rs.265/share. = Rs.265000

Possible outcome at Expiry

Share price > Rs.265 Break even (240+25) Net profit = Intrinsic value of the option less cost of purchase i.e. the amount by which the share price exceeds breakeven Share price = Rs.265 values. Break-even value. Option worth is Rs.25 (265-240). Share price < 240 Option expires worthless. Total loss Rs.25000 (Cost of purchase) This simple strategy provides investor with maximum effective buying price of Rs.265 (240+25) in three-month time. In gaining exposure to stock through call option, the investor has secured two major advantages. Firstly, he guarantees exposure for limited outlay (i.e. Rs.25 per share) and if the share does not rise as anticipated, the maximum loss is limited to the premium paid. Secondly, the payment of Rs.25 rather than Rs.254 per share helps cash flow.

To hedge against a fall in share value over coming months:

65 Situation: An investor holding 10000 CIPLA share at Rs.254 each, which originally purchased at Rs.200, believes that the share price may decrease soon. He has made a considerable gain of his investment and he is concerned that he should not lose any of that profit. However, if the price continues to rise instead, he does not want to miss out that profit. Action: Sell 10000 CIPLA shares at Rs.254 each and buy 10 (for 10000 shares, number of market lots = 10000/1000 = 10) 260-calls at Rs.14 worth Rs.140000. the investor books profit of Rs.40x10000 = 400000 (254-214 = 40). The released money is now available for re-investment and a small proportion will fund the call purchase.

Share price (Cash market)

28 Apr 28 July Analysis for Rs.2554000. Rs.220 Fall of Rs.34

Option market
Rs.14 Rs.140000. Option expires worthless Total loss = Rs.140000 (premium paid) instead of Rs.340000 (original share holding of 10000 if nor sold).

Rs.254, sell 10000 shares Buy 10 July 260 call at

Possible outcome at expiry Share price < Rs.260 Option expires worthless creating

maximum loss, which is equal to the Share price between 260 & 274 Share price > 274 amount of premium paid. Sell the option for any intrinsic value to recover some of their cost. Sell the option for intrinsic value and take more profit. (Or) Exercise option.

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Short call
To earn additional income from a static shareholding, over and above any dividend earnings, in terms of premium received on writing the option (Covered short call).

Market View Action: Profit Potential Loss Potential

Bullish Sell call against an existing shareholding Limited Limited

Situation: On 28th April CIPLA share is trading at Rs.254. an investor holds 10000 shares, he does not expect their price to move very much in the next few months. So, he decides to write call option against this shareholding. Action: The July 260 calls are trading at Rs.14 and investor sells 10 contracts (one contract = 1000 shares). He received an option premium of Rs.140000 and takes on the obligation to deliver 10000 shares at Rs.260 each if the holder exercises the option

Share price (Cash market)

28 Apr Rs.254

Option market
Sell 10 July 260 calls @ Rs.14 Income = Rs.140000 (14x10000). Option expires worthless Profit = Rs.140000 (Option Premium received)

28 July Analysis

Rs.254 No change in shareholding

67 Possible Outcome at Expiry Share > Rs.260 The holder will exercise his option. The investor as a writer will sell shares originally purchased for Rs.254 at Rs.274 Share price < 260 To reduce the cost of stock purchase: Situation: It is early April and Reliance share is trading at Rs.406. At investor thinks that the shares have a long-term price rise potential, but before the end of the July he does not expect the share to go above Rs.420 Action; Buy 1000 Reliance shares at Rs.406 per share and sell Reliance July 420 call at Rs.9. (260+14). The option expires worthless.

Share price
28 Apr

Option market
Sell 1 Reliance call at Rs.9 (premium) Income = Rs.9000 (1000x9)

(Cash market) Rs.406. For 1000 shares

Total outlay = Rs.406000

Possible Outcome at Expiry Share price < Rs.420 The option will not be exercised and the investor will retain both the shares and the option premium, thus effectively reducing the original cost of the shares to Rs.397 Share price > Rs.420 (406-9). The option will be exercised and the shares have to be sold at Rs.420. This effectively produced a total sale price of Rs.429, an increase of Rs.23 on the original purchase price.

68 Long put Market View Action Profit Potential Loss Potential Bearish Buy a Put option Unlimited Limited

To make profit, from a fall in value of share price: Situation: Current price of GAIL is Rs.270. An investor thinks GAIL share is overvalued and may fall substantially. He therefore decides to buy Put option to gain exposure to its anticipated fall. Action: Buy 1 GAIL July Rs.260 Put at Rs.8 for a total consideration of Rs.8000.

Share price (Cash market)

28 Apr Rs.270

Option market
Buy 1 GAIL July put at Rs.8. Total outlay = Rs.8000. Sell 1 July contract. Net gain = Rs.20000 [Rs.20 (260-240) x 1000 (Lot)] Option purchase = Rs.8000 Option sale = Rs.20000. Net profit = Rs.12000.

28 July

Rs.240

Analysis

Fall of share price Rs.30.

Possible Outcome at Expiry Share price = Rs.240 The put will be trading at Rs.20, which gives a profit of Rs.12 (20-8), if the

69 position is closed out. Recover intrinsic value premium.

Share price between 240 & 260

Protect a share purchase by simultaneously buying put options: Situation: An investor wants to buy GAIL shares at the current price of Rs.270 in the expectation that the share price will rise, but he is concerned about its short-term performance. He feels that he could effort to see the shares as low as Rs.250. Action: Buy 1000 shares of GAIL at Rs.270 each and buy one GAIL July 260 put at Rs.8. Since, the investor holds the stock, he participates in any further rise in the share price above Rs.217.

Share price (Cash market)

28 Apr Rs.27000 20 July Rs.240 Total worth = Rs.240000 Analysis: In cash market the share price decreased to Rs.240. If the investor does not purchase the Rs.260 put option. Then Loss = 30000 (27000-24000). If the investor purchases the Rs.260 put option. When the share price in cash market is Rs.240, he will buy 1000 shares for Rs.240 each in cash market and will sell the same in the options market by exercising the Rs.260 put option. Share purchase =Rs.270000 Add. Buying option = Rs.8000 (premium Rs.8 per share) Less. Sale of option = Rs.260000 Net Loss instead of Rs.30000. = Rs.18000 By buying the put option simultaneously the investors loss is decreased to Rs.18000

Option market
Rs.8. Cost = Rs.8000 (8x1000) Exercise the Rs260 put option.

Rs.270 buy 1000 shares at Buy 1 July Rs.260 put @

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Short put
Market View Action Profit Potential Loss Potential Bearish Sell put option Limited Unlimited

To generate earnings on portfolio of shares: Situation: An investor owns 10000 shares of NIIT and also has cash holding of around Rs.6000000. In early April he feels that the share price of NIIT will either remain constant or slightly rise. Action: The investor decides to generate some additional income on his portfolio writes 10 NIIT Rs.550 puts at Rs.40. Thus he received a premium of Rs.400000 (40x10000 shares). Possible Outcome at Expiry Share price > (or) = Rs.550 The investors expectation is correct and the put will expire unexercised. Share price < Rs.550 Profit = Rs.400000 (premium received). The put option will be exercised and the stock will have to be purchased for Rs.5100000 (5500000-400000). To buy a stock at a price which is lower than the current available price in the market. Situation: The shares of L&T are currently trading at Rs.242.

Action: Sell 10 L&T July Rs.240 puts at Rs.10.

Share price (Cash market) Option market

71 28 Apr Rs.242 Sell 10 July Rs.240 puts at Rs.10. 28 July Rs.230 Total outlay = Rs.100000 Option is exercised.

Possible Outcome at Expiry Share price < Rs.240 The put writer will take delivery of the stock at Rs.230 i.e. Rs.10 below the current Share price > Rs.240 market price. The option will not be exercised and the investor keeps the premium.

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LOT SIZES OF DIFFERENT COMPANIES

Index/Scrip CNXIT NIFTY ABB ASSOCIATED CEMENT COMPANIES.LTD. ALBK ANDHRABANK ARVINDMILLS ASHOKLEYLAND BAJAJ AUTO BANK OF BARODA BANK OF INDIA BHARAT ELECTRICALS BHARATFORG BHARTI BHEL BPCL CADILAHC CANARA BANK CENTURY TEXTILES CHENNAI PETRO CIPLA COCHIN REFINARY COLGATE DABUR Dr. REDDY GAIL GE SHIPPING GLAXO GRASIM Market Lot 100 100 200 750 2450 2300 2150 9550 200 1400 1900 550 200 1000 300 550 500 1600 850 950 1000 1300 1050 1800 200 1500 1350 300 175

73 GUJARATH AMBUJA CEMENT HCL TECH HDFC HDFC BANK HERO HONDA HINDALCO HLL HPCL I-FLEX ICICI BANK IDBI INDHOTEL INDRAYON INFOSYS INDIAN OVERSEAS BANK INDIAN OIL CORPORATION IPCL ITC JET AIRWAYS JINDAL STEEL JP HYDRO KIRLOSKCUM LIC HOUSING FINANCE M&M MARUTI UDYOG MATRIX LABS MRPL MTNL NALCO NEYVELI LIGNITE NICOLASPIR NTPC 550 650 300 400 400 150 2000 650 300 700 2400 350 500 100 2950 600 1100 150 200 250 6250 1900 850 625 400 1250 4450 1600 1150 2950 950 3250

74 ONGC ORIENTAL BANK OF COMMERCE PATNI PUNJAB NATIONAL BANK POLARIS RANBAXY RELIANCE RELIANCE CAPITAL RELIANCE INDUSTRIES LTD. SATYAM STATE BANK OF INDIA SCI SIEMENS STER SUN PHARMA SYNDICATE BANK TATA CHEMICALS TATA MOTORS TATA POWER TATA TEA TATA CONSULTANCT SERVICES TISCO UNION BANK OF INDIA UTI BANK VIJAYA BANK VSNL WIPRO WOCKPHARMA 300 600 650 600 1400 200 550 1100 600 600 500 1600 150 350 450 3800 1350 825 800 550 250 675 2100 900 3450 1050 300 600

CONCLUSION
Derivatives have existed and evolved over a long time, with roots in commodities market. In the recent years advances in financial markets and the technology have made derivatives easy for the investors.

75 Derivatives market in India is growing rapidly unlike equity markets. Trading in derivatives require more than average understanding of finance. Being new to markets maximum number of investors have not yet understood the full implications of the trading in derivatives. SEBI should take actions to create awareness in investors about the derivative market. Introduction of derivatives implies better risk management. These markets can give greater depth, stability and liquidity to Indian capital markets. Successful risk management with derivatives requires a through understanding of principles that govern the pricing of financial derivatives. In order to increase the derivatives market in India SEBI should revise some of their regulation like contract size, participation of FII in the derivative market. Contract size should be minimized because small investor cannot afford this much of huge premiums.

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Suggestions to Investors
The investors can minimize risk by investing in derivatives. The use of derivative equips the investor to face the risk, which is uncertain. Though the use of derivatives does not completely eliminate the risk, but it certainly lessens the risk. It is advisable to the investor to invest in the derivatives market because of the greater amount of liquidity offered by the financial derivatives and the lower transactions costs associated with the trading of financial derivatives. The derivatives products give the investor an option or choice whether to exercise the contract or not. Options give the choice to the investor to either exercise his right or not. If an expiry date the investor finds that the underlying asset in the option contract is traded at a less price in the stock market then, he has the full liberty to get out of the option contract and go ahead and buy the asset from the stock market. So in case of high uncertainty the investor can go for options. However, these instruments act as a powerful instrument for knowledgeable traders to expose them to the properly calculated and well understood risks in pursuit of reward i.e. profit.

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Bibliography
Indian financial system Investment management Publications of National Stock Exchange Websites www.nseindia.org www.bseindia.com www.sharekhan.com www.sebi.gov.in www.moneycontrol.com www.geojit.com www.indianfoline.com www.icicidirect.com www.hseindia.org - M.Y. Khan - V.K. Bhalla