A PROJECT REPORT ON A STUDY ON FUTURE AND OPTION IN DERIVATIVES AT

SANAARI SOFTWARE SOLUTIONS PVT LTD

MASTER OF BUSINESS ADMINISTRATION BY K.ARJUN GOUD H.T.NO:07107114 Under the guidance of Ms ARUNA REDDY

DEPARTMENT OF BUSINESS MANAGEMENT MALLAREDDY INSTITUE OF MANAGEMENT (Affiliated to Osmania University) Hyderabad 2006-2008

DECLARATION

I here by declare that the project report entitled A STUDY ON FUTURE AND OPTION IN DERIVATIVES has been carried out the year 2007-2009 at SANAARI SOFTWARE SOLUTION PVT LIMITED. It is an Original and bonafide work undertaken by me in partial fulfillment of the Requirement of MASTER OF BUSINESS ADMINISTRATION, Osmania University.

This project report has not been submitted to any other University for the award Of any degree or diploma.

(K.ARJUN GOUD)

SUPERVISORS CERTIFICATE

This is to certify that Mr. K,ARJU GOUD no 07107114 has supervision undergone project

student of

MALLA REDDY INSTITUE OF MANAGEMENT being Hall ticket work under my in A STUDY ON FUTURE AND OPTION IN . He has been a

DERIVATIVES for the partial fulfillment of Master of Business Administration from Osmania University found to be very good. Student during the period 2006-2008 and his conduct was

This project work is the outcome of his own effort and has been Done under My guidance recommended that the same may be sent be for evaluation.

MRS. ARUNA (Assistant professor in finance)

ABSTRACT
Derivatives markets in India and developed nations play a large and growing role in their financial markets and overall economic activity. Of special importance in Indias ETC market in securities exchange derivatives which has become an established market with brokers, high liquidity and low bid-ask spreads. These derivatives have helped many FIs and FIIs lowered their risks and lower their borrowing costs.At the same time, they pose new challenges to the stability of Indian as well as developed countries economy. This report focuses on India to provide an analytical description of the growth of derivatives markets and an economic analysis of their role in the economy. Using a unique data base of derivatives daily stock prices for India, provide by the NSE, we analyze their impact on option prices during particular periods. There are six factors affecting the value of stock option: The current stock price, the strike price, the expiration date, the stock price volatility, the risk free interest rate, and the dividends during the life of the option. The future markets were originally developed to meet the needs of the farmers and merchants. As a farmer are uncertain about the price that you are likely to receive you will be happy if you can know the price you are likely to receive beforehand with certainty. The Contract specifies the quality, price and the date of delivery, and will enable you both to eliminate or minimize the risk, which otherwise will be based due to uncertain price fluctuations of the future price of corn. The value of the call generally increases as the current stock price, the time of expiration, the volatility and the risk free interest rate increases and vice versa. The value of a put generally increases as the strike price, the time of expiration, the volatility and the expected dividends increase and vice versa. Futures Contracts are designed in such a way so that their prices should always reflect the prices of underlying cash market.

ACKNOWLEDGEMENT

I am very thankful to the entire team of this project would not have been possible.

SANAARI SOFTWARE

SOLUTIONS PVT LIMITED for their cooperation, without which completion of

I am extremely grateful to Mr.SAMBASIVA RAO (Manager) for providing me with valuable insights about the base metals. I would like to thank him for the patience shown by him and being of such a great help to all my queries. I express my sincere gratitude to Mr .P.SRINIVASA SASTRY, Principal of MALLA REDDY INSTITUE OF MANAGEMENT. For giving to me this opportunity to carry out this project. I would like to thank Mrs. Aruna faculty in finance, for her valuable guidance and encouragement and constructive suggestions throughout the project work. Finally I thank to my friends for their continue support and help in the completion of my project.

TABLE OF CONTENTS
CONTENTS
PAGE NUMBERS

List of Tables
List of Figures

I II 1 8 8 8

1) INTRODUCTION A. Objectives of the study B. Scope and limitations of the study C. Methodology
2) 3) 4) REVIEW OF LITERATURE THE COMPANY PROFILE DATA ANALYSIS AND INTERPRETATION

10 39 52

5) FINDINGS 6). CONCLUSIONS 7) RECOMMENDATIONS 8). BIBILIOGRAPHY

70 72 74 76

LIST OF TABLES
TABLE 1. Maruthi Futures Put option Call option Page numbers

54 55 56

2. BHARATI AIRTEL Futures Put option Call option 3. NTPC Futures Put option Call option 4. IDBI Futures Put option Call option 5. TATA TEA Futures Put option Call option

57 58 59

60 61 62

63 64 65

66 67 68

LIST OF GRAPHS

1. Graph on Maruthi futures call option put option 2. Graph on Bharati Airtel futures call option put option 3. Graph on NTPC Futures Put option Call option 4. Graph on IDBI futures call option put option 5. Graph on TATA TEA futures call option put option

54 55 56

57 58 59

60 61 62

63 64 65

66 67 68

DERIVATIVES

A Derivative is a financial instrument that derives its value from an

underlying asset.

Derivative is an financial contract whose price/value is dependent upon price of one or more basic underlying asset, these contracts are legally binding agreements made on trading screens of stock exchanges to buy or sell an asset in the future. These assets can be anything ranging from share, index, bond, rupee dollar exchange rate, sugar crude, soyabean, cotton, coffee etc. Derivative on its own does not have any value. It is considered important because of its underlying asset. Derivatives can of different types like forwards, futures, option, swaps, collars, caps, floor etc. The most popular derivative instruments are futures and options. Example: A very simple example of derivative is curd, which is derivative of milk. The price of curd depends upon the price of milk, which in turn depends upon the demand, and supply of milk. Lets see it in this way, the price of the Reliance Triple Option Convertible debentures (Reliance TOCD) varies upon the price of the Reliance Shares, similarly the price of TELCO Warrants depends upon the price of the TELCO shares. The American Depository Receipts (ADR) and Global Depository Receipts (GDR) Of ICICI, Satyam and Infosys Traded on stock exchanges in NASDAQ of USA, draw their values from the prices of shares traded in India. Similarly in mutual funds the prices of mutual fund units depends upon the prices of portfolio of securities under that scheme.

History of Derivatives The Derivatives market has existed from centuries as need for both users and producers of natural resources to hedge against price fluctuations in underlying commodities. Although trading in agriculture and other commodities has been the driving force behind the development of Derivatives market in India, the demand for products based on financial instruments such as bond, currencies, stocks and stock indices had outstripped the commodities markets. India has been trading in derivatives market in Silver, spices, gold, coffee, cotton and in oil markets for decades gray market. Trading in derivatives market was legal before Morarji Desais Government had banned forward contracts. Derivatives on stocks were traded in the form of Teji and mandi in unorganized markets. Recently futures contracts various commodities were allowed to be on various exchanges. For Example Cotton and Oil futures were traded in Mumbai, Soya bean futures in Bhopal, Pepper futures in Kochi, Coffee futures in Bangalore etc. In June 2000, National stock exchange and Bombay stock exchange started trading in futures in Sensex and Nifty. Options trading on Sensex and Nifty commenced in June 2001. Very soon thereafter trading began on futures and options on 31 prominent stocks in the month of July and November respectively, currently there are 41 stocks trading in NSE derivatives and the list keeps growing. Derivatives products initially emerged has hedging devices against fluctuations in commodity prices and commodity linked derivatives remained the sole form of such products for almost three hundred years. The financial derivatives came into spotlight in post 1970 period, due to the in stability in the financial markets. Financial derivatives are instruments that their value from financial assets. These assets can be stocks, bonds, currency etc. These Derivatives can be Forward rate agreements, Futures, Options, and Swaps. As stated earlier the most traded instruments are futures and options. However these products became very popular and by 1990s, they accounted for about two-thirds of total transactions in derivatives products. In recent years, the market for financial derivatives has grown tremendously

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both in terms of variety of instruments available, their complexity and also turnover. In class of equity derivatives, futures and options on stock indices have gained more popularity than on individual stocks, especially among the institutional investors, who are major users of index-linked derivatives. Even small investors find these useful due to high correlation of popular indices with various portfolios and ease of use. The following factors have been driving the growth of financial derivatives:

Increased volatility in asset prices in financial markets. Increased integration of national financial markets with the international markets. Marked improvement in communication facilities and sharp decline in their costs. Innovations in the derivatives markets, which optimally combine the risks and returns over a large number of financial assets, leading to higher returns, reduced risks as well as transactions costs as compared to individual financial assets.

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PLAYERS IN THE MARKET The following are the players in the Derivatives markets: Speculators: People who buy or sell in the market to make profits. For example, if you will the stock price of Reliance is expected to go up to Rs. 400 in one month; one can buy a one-month future of Reliance at Rs. 350 and make profits. Hedgers: People who buy or sell to minimize their losses. For example, an importer has to pay US $ to buy goods and rupee is expected to fall to Rs.50/$ from Rs.48/$, then the importer can minimize his losses by buying a currency future at Rs.49/$. Arbitrageurs: People who buy or sell to make money on price differentials in different markets. For example, a futures price is simply the current price plus the interest cost. If there is any change in the interest, it presents an arbitrage opportunity. We will examine this in detail when we look at futures in a separate chapter. Basically, every investor assumes one or more of the above and derivatives are a very good option for him.

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TYPES OF DERIVATIVES The most commonly used derivatives contracts are forwards, futures and options, which we shall discuss in detail later. Here we take a brief look at various derivatives contracts that have come to be used. Forwards: A forward contract is a customized contract between two entities, where settlement takes place on specific date in the future at todays pre-agreed price. 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 of two types Call option Put option Call option gives 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. Put option gives 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: Options generally have lives of unto one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over the years. Baskets: Basket options are on portfolios of underlying assets. The underlying asset is usually a moving average or 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 prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are: Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency. Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.

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NATURE OF THE PROBLEM The turnover of the stock exchange has been tremendously increasing from last 10 years. The number of trades and the number of investors, who are participating, have increased. The investors are willing to reduce their risk, so they are seeking for the risk management tools. Prior to SEBI abolishing the BADLA system, the investors had this system as a source of reducing the risk, as it has many problems like no strong margining system, unclear expiration date and generating counter party risk. In view of this problem SEBI abolished the BADLA system. After the abolition of the BADLA system, the investors are seeking for a hedging system, which could reduce their portfolio risk. SEBI thought the introduction of the derivatives trading, as a first step it has set up a 24 member committee under the chairmanship of Dr. L.C. Gupta to develop the appropriate framework for derivatives trading in India, SEBI accepted the recommendation of the committee on may 11, 1998 and approved the phase introduction of the derivatives trading beginning with stock index futures. There are many investors who are willing to trade in the derivatives segment, because of its advantages like limited loss unlimited profit by paying the small premiums.

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SCOPE OF THE STUDY: The study is limited to Derivatives with special reference to futures and option in the Indian context and the Inter-Connected Stock Exchange has been taken as a representative sample for the study. The study cant be said as totally perfect. Any alteration may come. The study has only made a humble attempt at evaluation derivatives market only in India context. The study is not based on the international perspective of derivatives markets, which exists in NASDAQ, CBOT etc.

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OBJECTIVES OF THE STUDY: To analyze the derivatives market in India.

To analyze the operations of futures and options by calculating the intrinsic values.

To study about risk management with the help of derivatives.

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LIMITATIONS OF THE STUDY: The following are the limitation of this study.

The Scope of the study is limited to Indian market only

Brokerage and taxes are not calculated

Trading cost is not included in the contract

There is no lack of Buyers and Sellers in the Future and Option

The data is collected from National Stock Exchange

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DESCRIPTION OF THE METHOD: The following are the steps involved in the study. 1. Selection of the scrip:The scrip selection is done on a random and the scrip selected is MARUTHI, BHARATI AIRTEL,IDBI, NTPC, TATA TEA. Profitability position of the futures buyer and seller and also the option holder and option writer is studied. 2. Data Collection:The data of the MARUTHI, BHARATI AIRTEL,IDBI, NTPC, TATA TEA has been collected from the web site of National Stock Exchange i.e. www.nseindia.com. The data consist of the December contract and the period of data collection is from 1 st Oct 2008 - 27th DEC 2008. 3. Analysis:The analysis consist of the tabulation of the data assessing the profitability positions of the futures buyer and seller and also option holder and the option writer, representing the data with graphs and making the interpretation using data.

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REVIEW OF LITERATURE

DERIVATIVES:The emergence of the market for derivatives products, most notably forwards, futures and options, can be tracked 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 the use of derivative 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 in the underlying asset prices. However, by locking-in asset prices, derivative product minimizes the impact of fluctuations in asset prices on the profitability and cash flow situation of riskaverse investors. Derivatives are risk management instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, share, bonds, currency, interest, etc.. Banks, Securities firms, companies and investors to hedge risks, to gain access to cheaper money and to make profit, use derivatives. Derivatives are likely to grow even at a faster rate in future. INTRODUCTION TO FUTURES CONTRACTS: In the Derivatives market Futures contract is most actively traded contract. It has gained its momentum in recent years, after forwards contract were banned in some parts of the world. It is one of the most popular types of contracts for the traders in the world. FUTURES CONTRACT: Futures contract was designed to solve limitations that existed in forward contracts. Futures contract is an agreement between two parties to buy or sell an asset at a certain time in future at a certain price. To make it simple Futures are exchange-traded contracts to buy or sell an asset in future at a price agreed upon today. The asset can be share, index, interest rate, bond, rupee-dollar exchange rate, sugar, crude oil, soybean, cotton, coffee etc.

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To facilitate liquidity in the futures contract, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument. The following are the Standard terms in any Futures contract: Quantity of the underlying asset Quality of the underlying asset (not required in case of financial futures) Expiration date The unit of price quotation (not the price) Minimum fluctuation in price (tick size) Settlement style Example: when you are dealing in March 2002 Satyam futures contract, you know that the market lot, i.e. the minimum quantity you can buy or sell, is 1,200 shares of Satyam, the contract would expiry on March 28, 2002, the price is quoted per share, the tick size is 5 paisa per share or (1200*0.05) = Rs 60 per contract/ market lot, the contract would be settled in cash and the closing price in the cash market on expiry date would be the settlement price. TERMINOLOGY USED IN FUTURES MARKET: The terminologies used in futures market are as follows: SPOT PRICE: The price at which an asset trades in the spot market. FUTURE PRICE: The price at which the futures contract trades in the futures CONTRACT CYCLE: The period over which a contract trades. BASIS : It is the difference between future price and the spot price. Popularly termed as spread among the trading community. market.

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INITIAL MARGIN: The amount deposited in the margin account, when the future contract is first entered. MARKING TO MARKET: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investors gain or loss depending upon the futures closing price. This is called as marking to market. MAINTENANCE MARGIN: It is the minimum margin the investor has to keep in his account, so that it never shows negative balance. PRICING FUTURES THEORYTICALY: The theoretical price of a futures contract is spot price of the underlying plus the cost of carry. Please note that futures are not about predicting future prices of the underlying assets. In general, Futures Price = Spot Price + Cost of Carry The Cost of Carry is the sum of all costs incurred if a similar position is taken in cash market and carried to expiry of the futures contract less any revenue that may arise out of holding the asset. The cost typically includes interest cost in case of financial futures (insurance and storage costs are also considered in case of commodity futures). Revenue may be in the form of dividend. Though one can calculate the theoretical price, the actual price may vary depending upon the demand and supply of the underlying asset. Example: Suppose Reliance shares are quoting at Rs 300 in the cash market. The interest rate is about 12% per annum. The cost of carry for one month would be about Rs 3. As such a Reliance future contract with one-month maturity should quote at nearly Rs303. Similarly Nifty level in the cash market is about 1100. One month Nifty future should quote at about 1111. However it has been observed on several occasions that futures quote at a discount or premium to their theoretical price, meaning below or above the theoretical price. This is due to demand-supply pressures. Every time a Stock Future trades over and above its cost of carry i.e. above Rs. the arbitragers would step in and reduce the extra premium commanded by the future due to demand. E.g.: would buy in the cash market and sell the equal amount in the future, Hence creating a risk free arbitrage, vice-versa for the discount.

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When the future contract approaches expiry date, the cost of carry reduces as the time to expiry reduces; thus futures and cash prices start converging. On expiry date, futures price should equal cash market price.

Settlement in Futures markets: Presently both stock and index futures are settled in cash. The closing price in the cash segment is considered as the settlement price. The difference between the trade price and the settlement price is ultimately your profit/loss. In case of delivery based settlement Stock-based derivatives are expected to be settled in delivery. On expiry of the futures contract, the buyer/seller of the future would receive a long/short position at the closing price in the cash segment on the next trading day. This position in the cash segment would merge with any other position the buyer/seller has. In case the buyer/seller wants he can square up this position by selling/buying the shares. Or else he would be required to deliver/receive the underlying shares on the settlement day (e.g. T+2) in the cash segment. The aforesaid methodology is not final yet. Sebi guidelines in this regard are awaited. You can call exchanges and me to know the exact methodology once the regulator. Index based Derivatives would continue to be settled in cash

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USAGE of Futures contracts: You can do directional trading using futures. In case you are bullish on the underlying stock or index, you can simply buy futures on stock/index. Similarly if you are bearish on the underlying, you can sell futures on stock/index. There are eight basic modes of trading on the index futures market:Hedging H1 Long stock, short Nifty futures H2 Short stock, long Nifty futures H3 Have portfolio, short Nifty futures H4 Have funds, long Nifty futures S1 Bullish index, long Nifty futures S2 Bearish index, short Nifty futures ave funds, lend them to market A2 Have securities, lend to the market

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Advantages of trading in Index futures: After listening to the news and other happenings in the economy, you take a view that the market would go up. You substantiate your view after talking to your near and dear ones. When the market opens, you express your view by buying ABC stock. The whole market goes up as you expected but the price of ABC stock falls due to some bad news related to the company. This means that while your view was correct, its expression was wrong. Using Nifty/Sensex futures you can express your view on the market as a whole. In this case you take only market risk without exposing yourself to any company specific risk. Though trading on Nifty or Sensex might not give you a very high return as trading in stock can, yet at the same time your risk is also limited as index movements are smooth, less volatile with unwanted swings. When trading futures in cash the biggest advantage of futures is that you can short sell without having stock and you can carry your position for a long time, which is not possible in the cash segment because of rolling settlement. Conversely you can buy futures and carry the position for a long time without taking delivery, unlike in the cash segment where you have to take delivery because of rolling settlement.

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Further futures positions are leveraged positions, meaning you can take an Rs 100 position by paying Rs 25 margin and daily mark-to-market loss, if any. This can enhance the return on capital deployed. For example, you expect an Rs 100 stock to go up by Rs 10. One way is to buy the stock in the cash segment by paying Rs 100. You make Rs 10 on investment of Rs 100, giving about 10% returns. Alternatively you take futures position in the stock by paying about Rs 30 toward initial and mark-to-market margin. You make Rs 10 on investment of Rs 30, i.e. about 33% returns. Please note that taking leveraged position is very risky, you can even lose your full capital in case the price moves against your position. You can square up your future at any time once you have initiated the position, you need not wait until its expiry you can book profits or cut losses. One can use volume and open interest rates to predict the movement of the market this is done like this, the total outstanding position in the market is called open interest. In case volumes are rising and the open interest is also increasing, it suggests that more and more market participants are keeping their positions outstanding. This implies that the market participants are expecting a big move in the price of the underlying. However to find in which direction this move would be, one needs to take help of charts. In case the volumes are sluggish and the open interest is almost constant, it suggests that a lot of day trading is taking place. This implies sideways price movement in the underlying. When Corporate Dividends are announced: In the event of such corporate announcements, the exchanges adjust the position such that economical value of your position on cum-benefit and on ex-benefit day is the same. While calculating the theoretical price of a futures contract, the interest rate should be taken as net of dividend yield. So on announcement of the dividend, the futures price should be discounted by the dividend amount. However as per the policy of Sebi and stock exchanges, if the dividend is more than 10% of the market price of the stock on the day of dividend announcement, the futures price is adjusted. The exchanges roll over the positions from last-cum-dividend day to the exdividend day by reducing the settlement price by dividend. In such a case, the announcement of such exceptional dividends does affect the price of futures.

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Suppose Reliance is trading at Rs 300 and a two-month Reliance future which has 45 days to maturity is trading at Rs 304. Reliance declares 50% dividend, i.e. Rs 5. The dividend amount is less than 10% of the market price of Reliance, so the exchange would not adjust the position. As such the market adjusts this dividend in the market price and the futures price goes down by Rs 5 to Rs 299. In case of Bonus the lot size of the stock that gives bonus gets adjusted according to the ratio of the bonus. The position is transferred from cum-bonus to ex-bonus day by adjusting the settlement price to neutralize the effect of bonus. For example: the current lot size of Cipla is 200. Suppose Cipla announces a bonus of 1:1. You are long on 200 shares of Cipla and the settlement price of Cipla on cum-bonus day is Rs 1,000. On ex-bonus day your position becomes long on 400 shares at Rs 500. Thereafter the lot size of Cipla would be 400. Hedging of stock positions using futures: Suppose you are holding a stock that has futures on it and for two to three weeks the stock does not look good to you. You do not want to lose the stock but at the same time you want to hedge against the expected adverse price movement of the stock for two to three weeks. One option is to sell the stock and buy it back after two to three weeks. This involves a heavy transaction cost and issue of capital gain taxes. Alternatively you can sell futures on the stock to hedge your position in the stock. In case the stock price falls, you make profit out of your short position in the futures. Using stock futures you would virtually sell your stock and buy it back without losing it. This transaction is much more economical as it does not involve cost of transferring the stock to and from depository account. You might say that if the stock had moved up, you would have made profit without hedging. However it is also true that in case of a fall, you might have lost the value too without hedging. Please remember that a hedge is not a device to maximize profits, it is a device to minimize losses. As they say, a hedge does not result in better outcome but in predictable outcome.

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You can hedge your cash market position in stocks that do not have stock futures by using index futures. Before we go any further, we need to understand the term called beta. Beta of a stock is nothing but the movement of the stock relative to the index. So suppose a stock X moves up by 2% when the Nifty moves up by 1% and it goes down by 2% when the Nifty falls by 1%, the beta of this stock is 2. Beta is crucial in deciding how much position should be taken in index futures to hedge the cash market position. Suppose you have a long position in ABB worth Rs 2 lakh. The beta of ABB is 1.1. To hedge this position in the cash market you need to take an opposite position in Nifty futures worth 1.1 x 2, i.e. worth Rs 2.2 lakh. Suppose Nifty futures are trading at 1100 and the market lot for Nifty futures is 200. Then each market lot of Nifty is worth Rs 2.2 lakh. Therefore to hedge your position in ABB you need to sell one contract of Nifty futures. Hedging with index futures are not perfect, Hedging is like marriage and one should not expect it to be perfect. The beta taken in the calculation of the position of Nifty futures is historical and there is no guarantee that it will be the same in future. So, any deviation of beta makes the hedge imperfect. Suppose you want to hedge your position in ABB for 15 days and

during those 15 days ABB becomes very volatile and the beta goes up as high as 1.5. In this case your hedging position of one contract is not sufficient and you will be under hedged. It is very difficult (in fact impossible) to get perfect hedge but one can improve the perfection by adjusting the position in Nifty futures from time to time.

Demystifying Stock Futures Here we try to solve some myths about futures When some liquid money is available to you and you are trying to buy future stocks for risk free interest.

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Using stock futures you can deploy this money to earn risk-free interest. Suppose Satyam is quoting at Rs 300 in the cash segment and one-month future is quoting at 305, you can earn riskfree interest by following the steps mentioned below: Buy Satyam in cash market at Rs 300 and simultaneously sell Satyam future at Rs 305. Pay Rs 300 to take delivery of Satyam stock in cash market. On expiry of Satyam future contract, the short position would be transferred to your account in the cash segment and a delivery order would be issued against you. Deliver the Satyam stock. Whatever happens to the price of Satyam, you earn Rs 305 - 300 = 5 on Rs 300 for one month. Need to have mark-to-mark margins in your account, incase Satyam moves up. If required the future position can be rolled over to the next month position with a difference of Rs 4-5. This roll-over process can continue till you want to get your money back. The above example was about how earn risk free interest when liquid cash is available with you, when the futures stock is going down in futures market but going up in the cash segment then we can do the following: Suppose one-month SBI future is quoting at 200 while SBI is quoting at Rs 205 in the cash segment. Follow the steps mentioned below to make risk-free money. Sell SBI in the cash market at Rs 205 and simultaneously buy SBI future at 200. Receive Rs 205 and make delivery of SBI stock in the cash market. On expiry of the SBI future contract, the long position would be transferred to your account in the cash segment and a receive order would be issued to you. Get your SBI stock back. Whatever happens to the price of SBI, you earn Rs 205 200 = 5 on your stock. rrow against the future stock and that is the advantage of futures. Instead of going to the banker and complying with a whole lot of formalities, you can in fact just call me to help you raise money against your shares using futures.

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Suppose ACC is quoting at Rs 150 in the cash segment and one-month ACC futures are quoting at 152. Follow the steps mentioned below to raise money against your ACC shares. Sell ACC in the cash market at Rs 150 and simultaneously buy ACC futures at 152. Receive Rs 150 and make delivery of ACC stock in the cash market. On expiry of the ACC futures contract, the long position would be transferred to your account in the cash segment and a receive order would be issued to you. Get your ACC stock back. Whatever happens to the price of ACC, you lose Rs 152 150 = 2 to raise money against your shares as cfuture price varies in the intra day trading, in that case you can do arbitrage to raise money in that situations. When the futures are quoting at a premium to their theoretical price, one can buy cash and short futures. When the prices come in line, that is when the difference between the futures and cash prices comes down, reverse the positions. Conversely when the futures are quoting at a discount to the theoretical price, one can sell cash and buy futures. When the prices come in line, that is the difference between the futures and cash prices goes up, reverse the positions. This way it is possible to take advantage of fluctuations in the basis. Please note that there is the risk of execution of order. Also you need to decide the arbitration band depending on the transaction cost you bear.

INTRODUCTION TO OPTIONS MARKET: In this section, we look at the next Derivative product to be traded at NSE, namely Options. Options are fundamentally different from Forward and Futures contracts. An option gives the holder the right do something; the holder does not have to exercise this price. OPTIONS MARKET: Options are contracts that give the buyers the right (but not the obligation) to buy or sell a specified quantity of certain underlying asset at a specified price on or before a specified date. On the other hand, the seller is under obligation to perform the contract (buy or sell the

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underlying). The underlying asset can be share, index, interest rate, bond, rupee-dollar exchange rate, sugar, crude oil, soybean, cotton, coffee etc. For example: A railway ticket is an option in daily life. Using the ticket, a passenger has an option to travel. In case he decides not to travel, he can cancel the ticket and get a refund. But he has to pay a cancellation fee, which is analogous to the premium paid in an option contract. The railways on the other hand have an obligation to carry the passenger if he decides to travel and refund his money if he decides not to travel. In case the passenger decides to travel the railways get the ticket fare. In case he does not then they get the cancellation fee. The passenger on the other hand, by booking ticket he has hedged his position in case he has to travel as anticipated. In case the travel does not materialize, he can get out of the position by canceling the ticket at a cost, which is the cancellation fee. Example 2: Suppose you have a right to buy 1,000 shares of Hindustan Lever at Rs 250 per share on or before March 28, 2002. In other words you are a buyer of a call option on Hindustan Lever. The option gives you the right to buy 1,000 shares. You have the right to buy Hindustan Lever shares at Rs250 per share. The seller of this call option who has given you the right to buy from him is under obligation to sell 1,000 shares of Hindustan Lever at Rs250 per share on or before March 28, 2002 whenever asked. Option Terminology: There are some basic terminologies used in options, they are as follows: Index option: These options have the index as the underlying. Some options are European options while others are American options. Indexed option contracts settled in cash. Stock option: Stock options are options on individual stocks. Options currently traded on more than 500 stocks in the United States. The contract gives the holder the right to buy or sell shares. Option holder: Buyer if the option who has the right. Option writer: Seller of the option who has the obligation. Premium: The consideration paid by the buyer for the right.

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 Call option: Option that gives the holder the right to buy. Put option: The option that gives the holder the right to sell. American option: These are options that are exercised at any point till the expiration date. European option: These are option that can be exercised only on the expiration date. In the money: It is an option that would lead to profits if it were exercised immediately. Out of money: It is an option that would lead to loss if exercised immediately. At the money: It is an option that would even the holders option if exercised immediately. How money is made in the option market? The money made in the option market is known as option pay off. There can be two types of option pay off. Call option Put option Call option: A call option gives the holder the right to buy shares. The option holder will make money if the spot price is higher than the strike price. The pay off assumes that the option holder will buy at the strike price and sell immediately at the spot price. But if the spot price is lower than

the strike price the holder can simply ignore the option. Here the profits for the option holder are unlimited while the losses are limited. Example1: Suppose you have a right to buy 1,000 shares of Hindustan Lever at Rs250 per share on or before March 28, 2002. In other words you are a buyer of a call option on Hindustan Lever. The option gives you the right to buy 1,000 shares. You have the right to buy Hindustan Lever shares at Rs250 per share. The seller of this call option who has given you the right to buy from

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him is under obligation to sell 1,000 shares of Hindustan Lever at Rs250 per share on or before March 28, 2002 whenever asked. Example2: Assume you have the right to buy 200 Nifty units at 1100. In other words, you are a buyer of a call option on Nifty. The option gives you the right to buy 200 Nifty units. You have the right to buy 200 units of Nifty at 1100. The seller of this call option who has given you the right to buy from him is under obligation to sell 200 units of Nifty.

Put Option: The put option gives the right to sell. The option holder will make money if the spot price is lower than the strike price. The pay off assumes that the option holder will buy at spot price and sell at strike price. But if the spot price is higher than the strike price, the option holder will simply ignore the option, it will be beneficial to sell it in the market. But if the spot price falls dramatically then he can make wind fall profits. Thus the profits of the option holder are unlimited and his losses are capped to the extent of the premium. Example1: Suppose you have the right to sell 1,600 shares of Bharat Heavy Electrical at Rs 140 per share on or before March 28, 2002. In other words you are a buyer of a put option on Bharat Heavy Electrical. The option gives you the right to sell 1,600 shares. You have the right to sell Bharat Heavy Electrical shares at Rs140 per share. The seller of this put option who has given you the right to sell to him is under obligation to buy 1,600 shares of Bharat Heavy Electricals at Rs140 per share on or before March 28, 2002 whenever asked. Example2: Suppose you have the right to sell 200 Nifty units at 1200. In other words you are a buyer of a put option on Nifty. The option gives you the right to sell 200 Nifty units. You have the right to sell 200 units of Nifty at 1200. The seller of this call option who has given you the right to sell to him is under obligation to buy 200 units of nifty. Option contracts have an expiry date specified by exchanges. The buyer enjoys the right and the seller is under obligation to fulfill the right till the option contract expires. March 28, 2002 is the expiry date in the aforesaid example. Normally as per the contract specifications of options given by the National Stock Exchange and Bombay Stock Exchange,

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last Thursday of the contract month is the expiry day. In case the last Thursday of a month is a holiday, the previous business day is considered as the expiry day. However you must check with the dealer about the expiry date before placing the order for buying or selling options. There are one-, two- and three-month contracts available presently. It is expected that once these contracts become liquid, the exchanges would introduce contracts of longer-term expiry/maturity. Who decides the strike price? The exchanges decide the strike price at which call and put options are traded. Generally to simplify matters, the exchanges specify the strike price interval for different levels of underling prices, meaning the difference between one strike price and the next strike price over and below it. For example the strike price interval for Bharat Heavy Electricals is Rs10. This means that there would be strike prices available with an interval of Rs10. Typically you can see options on Bharat Heavy Electricals with strike prices of Rs150, Rs160, Rs170, Rs180, and Rs190 etc.

Strike price intervals specified by the exchanges: Strike price intervals specified by the exchanges are as follows: Price level of Underlying Less than or equal to 50 Above 50 to 250 Above 250 to 500 Above 500 to 1000 Above 1000 to 2500 Above 2500 Strike Price Interval (in Rs) 2.5 5.0 10.0 20.0 30.0 50.0

Options Market Process:

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Call and put options are traded on-line on the trading screens of the National Stock Exchange and Bombay Stock Exchange like any other securities. The price of options is decided between the buyers and sellers on the trading screens of the exchanges in a transparent manner. You can see the best five orders by price and quantity. You can place market, limit and stop loss order etc. You can modify or delete your pending orders. The whole process is similar to that of trading in shares. You are not compelled to wait till expiry of the option once you have bought or sold an option. Instead you can buy an option and square up the position by selling the identical option (same expiry and same strike) at any time before the contract expires. You can sell an option and square up the position by buying an identical option. You can buy first and sell later or you can initiate your position by selling and then buying there is no restriction on direction. The difference between the selling and buying prices is your profit/loss. The process is similar to that of trading in shares. Factors affecting the price of option: There are five fundamental factors that affect the price of an option. These are: 1. Price of the underlying stock or index 2. Strike price/exercise price of the option 3. Time to expiration of the option 4. Risk-free rate of interest 5. Volatility of the price of underlying stock or index Adjust the price for dividend expected during the term of the option to arrive atfine prices. Consider this: suppose a stock is trading at Rs70. There is 40% probability that the stock price would move to Rs80. Similarly the probabilities of the price being Rs90, Rs100, Rs110 and Rs120 are 25%, 15%, 10% and 5% respectively. What would be your expected return if you were the buyer of a call option with a strike price of Rs100? If the stock price were to finish at Rs80, Rs90 and Rs100, the call option would expire worthless. If the stock price were to finish at Rs110 or Rs120, you would gain Rs10 and Rs20 respectively. Your expected return from the call would be: (40%*0)+(25%*0)+(15%*0)+(10%*10)+(5%*20) = 11.

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This means that you would like to pay anything less than Rs11 for this option to make a profit and the seller would always like to get anything more than Rs11 for giving you this option. Settlement: Presently stock options are settled in cash. This means that when the buyer of the option exercises an option, he receives the difference between the spot price and the strike price in cash. The seller of the option pays this difference. It is expected that stock options would be settled by delivery of the underlying stock. This means that on exercise of a call option, a long position of the underlying stock effectively at the strike price would be transferred in the cash segment in the account of the buyer of the call option who has the right to buy. An opposite short position at effectively the strike price would be transferred in the cash segment in the account of the seller of the call option who has obligation to sell. Similarly on exercise of a put option, a short position in the underlying stock effectively at the strike price would be transferred in the cash segment in the account of the buyer of the put option who has the right to sell. An opposite long position at effectively the strike price would be transferred in the cash segment in the account of the seller of the put option who has the obligation to buy. However guidelines in this regard are awaited from SEBI. Please check the exact method of delivery-based settlement once the regulator and exchanges announce it.

Varying time value for at-, in- and out-of-the-money options? The following graph shows how the premium of 30-day maturity, Rs260 strike price call option on Reliance varies with the movement of the spot price of Reliance. Study the price movement of the option carefully. You would find that the time value is the highest when the spot price is equal to the strike price; the option is at the money. As the spot price rises above the strike price, the option becomes in the money and its intrinsic value increases but its time value decreases. In the same way as the spot price falls below the strike price, the option becomes out of the money and its intrinsic value becomes zero while its time value decreases.

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Premium Varying with the Price of the Option: The buyers of longer maturity options enjoy the right to longer duration and the sellers are subject to risk of price movement of the underlying during a longer term, since the price of both call and put options increases as the time to expiry increases. The following graph shows the prices of 15- and 30-day maturity, Rs260 strike price call options on Reliance when the spot price of Reliance is Rs260.

Difference between Options and Futures: In case of futures, both the buyer and the seller are under obligation to fulfill the contract. They have unlimited potential to gain if the price of the underlying moves in their favour. On the 36

contrary, they are subject to unlimited risk of losing if the price of the underlying moves against their views. In case of options, however, the buyer of the option has the right and not the obligation. Thus he enjoys an asymmetric risk profile. He has unlimited potential to profit if the price of the underlying moves in his favour. But a limited potential to lose, to the extent of the premium paid, in case the price of the underlying moves against the view taken. Similarly the seller of the option is under obligation. He has limited potential to profit, to the extent of the premium received, in case the price of the underlying moves in his favour. But an unlimited risk of losing in case the price of the underlying moves against the view taken. PRICE BEHEVIOUR OF AN OPTION OR GREEK OPTION: We need to understand and appreciate various option Greeks like delta, gamma, theta, vega and rho to completely comprehend the behavior of option prices. DELTA of an Option and its Significances: For a given price of underlying, risk-free interest rate, strike price, time to maturity and volatility, the delta of an option is a theoretical number. If any of the above factors changes, the value of delta also changes. The delta of an option tells you by how much the premium of the option would increase or decrease for a unit change in the price of the underlying. For example, for an option with delta of 0.5, the premium of the option would change by 50 paise for an Rs1 change in the price of the underlying. Delta is about 0.5 for near/at the- money options. As the option becomes in the money, the value of delta increases. Conversely as the option becomes out of the money, the value of delta decreases. In other words, delta measures the sensitivity of options with respect to change in the price of the underlying. Deep out-of-the-money options are less sensitive in comparison to at-the-money and deep in-themoney options. Delta is positive for a bullish position (long call and short put) as the value of the position increases with rise in the price of the underlying. Delta is negative for a bearish position (short call and long put) as the value of the position decreases with rise in the price of the underlying. Delta varies from 0 to 1 for call options and from 1 to 0 for put options. Some people refer to delta as 0 to 100 numbers.

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The Delta is an important piece of information for a option Buyer because it can tell him much of an option & buyer he can expect for short-term moves by the underlying stock. This can help the Buyer of an option which call / Put option should be bought. The factors that can change the Delta of an option are Stock price, Volatility and Number of days.

THETA of an option and its Significance: The theta of an option is an extremely significant theoretical number for an option trader. Like the other Greek terms you can calculate theta using option calculator. Theta tells you how much value the option would lose after one day, with all the other parameters remaining the same. Suppose the theta of Infosys 30-day call option with a strike price of Rs3,900 is 4.5 when Infosys is quoting at Rs3,900, volatility is 50% and the risk-free interest rate is 8%. This means that if the price of Infosys and the other parameters like volatility remain the same and one day passes, the value of this option would reduce by Rs4.5. Theta is always negative for the buyer of an option, as the value of the option goes down each day if his view is not realized. Conversely theta is always positive for the seller of an option, as

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the value of the position of the seller increases as the value of the option goes down with time. Consider options as depreciating assets because of time decay and appreciating due to favorable price movements. If the rate of appreciation is more than that of depreciation hold the option, else sell it off. Further, time decay of option premium is very steep near expiry of the option. The following graph would make it clearer.

VEGA of an Option and its Significance: Vega is also a theoretical number that can be calculated using an option calculator for a given set of values of underlying price, time to expiry, strike price, volatility and interest rate etc. Vega indicates how much the option premium would change for a unit change in annual volatility of the underlying. Suppose the Vega of an option is 0.6 and its premium is Rs15 when volatility of the underlying is 35%. As the volatility increases to 36%, the premium of the option would change upward to Rs15.6. Vega is positive for a long position (long call and long put) and negative for a short position (short call and short put). Simply put, for the buyer it is advantageous if the volatility increases after he has bought the option. On the other hand, for the seller any increase in volatility is dangerous as the probability of his option getting in the money increases with any rise in volatility.

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Sometimes you might have observed that though seven to ten days have passed after you bought an option, the underlying price is almost in the same range while the premium of the option has increased. This clearly indicates that volatility of the underlying might have increased.

GAMMA of an option and its Significances: Gamma is a sophisticated concept. You need patience to understand it, as it is important too. Like delta, the gamma of an option is a theoretical number. Feeding the price of underlying, risk-free interest rate, strike price, time to maturity and volatility, the gamma of an option tells you how much the delta of an option would increase or decrease for a unit change in the price of the underlying. For example, assume the gamma of an option is 0.04 and its delta is 0.5. For a unit change in the price of the underlying, the delta of the option would change to 0.5 + 0.04 = 0.54. The new delta of the option at changed underlying price is 0.54; so the rate of change in the premium has increased.

If I were to explain in very simple terms: if delta is velocity, then gamma is acceleration. Delta tells you how much the premium would change; gamma changes delta and tells you how much the next premium change would be for a unit price change in the price of the underlying. Gamma is positive for long positions (long call and long put) and negative for short positions (short call and short put). Gamma does not matter much for options with long maturity. However for options with short maturity, gamma is high and the value of the options changes very fast with swings in the underlying prices.

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STRATEGY IN THE OPTION MARKET: When Bullish When you are very bullish, buy a call option. When you are very bullish on the market as a whole, buy a call option on indices (Nifty/Sensex). When you are very bullish on a particular stock, buy a call option on that stock. The more bullish you are, the more out of the money (higher strike price) should be the option you buy. No other position gives you as much leveraged advantage in a rising market with limited downside.

Upside potential: The price of the option increases as the price of the underlying rises. You can book profit by selling the same option at higher price whenever you think that the underlying price has come to the level you expected. At expiration the break-even underlying price is the strike price plus premium paid for buying the option.

41

Downside risk: your loss is limited to the premium you have paid. The maximum you can lose is the premium, if the underlying price is below the strike price at expiry of the option. Time decay characteristic: options are wasting assets in the hands of a buyer. As time passes, the value of the position erodes. If volatility increases, erosion slows down; if volatility decreases, erosion hastens. When NO Rise When you firmly believe that the underlying is not going to rise, sell a call option. When you firmly believe that index (Nifty/Sensex) is not going to rise, sell a call option on index. When you firmly believe that a particular stock is not going to rise, sell call option on that stock. Sell out-of-the-money (higher strike price) options if you are only somewhat convinced; sell atthe-money options if you are very confident that the underlying would remain at the current level or fall.

Upside potential: your profit is limited to the premium received. At expiration the break-even is strike price plus premium. Maximum profit is realised if the underlying price is below the strike price. Downside risk: the price of the option increases as the underlying rises. You can cut your losses by buying the same option if you think that your view is going wrong. Losses keep on increasing as the underlying rises and are virtually unlimited. Such a position must be monitored closely.

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Time decay characteristic: options are growing assets in the hands of a seller. As time passes, the value of position increases as the option loses its time value. You get maximum profit if the option is at the money. When Bearish When you are very bearish, buy a put option. When you are very bearish on the market as a whole, buy put option on indices (Nifty/Sensex). When you are very bearish on a particular stock, buy put option on that stock. The more bearish you are, the more out of the money (lower strike price) should be the option you buy. No other position gives you as much leveraged advantage in a falling market with limited down side.

Upside potential: the price of the option increases as the price of the underlying falls. You can square up your position by selling the same option at a higher price whenever you think that the underlying price has come to the level you expected. At expiration the break-even underlying price is the strike price minus premium paid for buying the option. Downside risk: your loss is limited to the premium you have paid. The maximum you can lose is the premium, if the underlying price is above the strike price at expiry of the option.

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Time decay characteristic: options are wasting assets in the hands of a buyer. As time passes, the value of the position erodes. If the volatility increases, erosion slows; if the volatility decreases, erosion hastens. When NO Fall When you firmly believe that the underlying is not going to fall, sell a put option. When you firmly believe that index (Nifty/Sensex) is not going to fall, sell a put option on the index. When you firmly believe that a particular stock is not going to fall, sell put option on that stock. Sell out-of-the-money (lower strike price) options if you are only somewhat convinced; sell atthe-money options if you are very confident that the underlying would remain at the current level or rise.

Upside potential: your profit is limited to the premium received. At expiration the break-even is strike price minus premium. Maximum profit is realised if the underlying price is above the strike price. Downside risk: the price of the option increases as the underlying falls. You can cut your losses by buying the same option if you think that your view is going to be wrong. Losses keep on increasing as the underlying falls and are virtually unlimited. Such a position must be monitored closely.

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Time decay characteristic: options are growing assets in the hands of a seller. As time passes, the value of the position increases as the option loses its time value. Maximum profit is realised if the option is at the money. Moderately Bullish When you think the underlying index or stock will go up somewhat or is at least more likely to rise than fall, Bull Spread is the best strategy. Strategy implementation: a call option is bought with a lower strike price and another call option is sold with a higher strike price, producing a net initial debit. Or a put option is bought with a lower strike price and another put sold with a higher strike price, producing a net initial credit.

Upside potential: profit is limited. Calls: difference between strikes minus initial debit. Puts: net initial credit. Maximum profit if underlying price at expiry is above the higher strike. Downside risk: loss is limited. Calls: net initial debit. Puts: difference between strikes minus initial credit. Maximum loss if the underlying price at expiry is below the lower strike. Time decay characteristic: time value erosion is not too significant because of balanced position. Moderately Bearish

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When you think the underlying index or stock will go down somewhat or is at least more likely to fall than rise, Bear Spread is the best strategy. Strategy implementation: a call option is sold with a lower strike price and another call option is bought with a higher strike price, producing a net initial credit or a put option is sold with a lower strike price and another put bought with a higher strike, producing net initial debit.

Upside potential: profit is limited. Calls: net initial credit. Puts: difference between strikes minus initial debit. Maximum profit if the market is below the lower strike at expiry. Downside risk: profit is limited. Calls: difference between strikes minus initial credit. Puts: net initial debit Maximum loss if the market is above the higher strike at expiry. Time decay characteristic: time value erosion is not too significant because of balanced position.

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DATA ANALYSIS & INTERPRETATION CALCULATION OF INTRINSIC VALUE The Intrinsic Values are calculated on the basis on the principles a) In - the money b) Out of - the money 47

In-The-Money:- A call option is in-the-money when the strike prices below the current spot price of the underlying asset; a put option is in-the-money when the strike price is above the current spot price of the underlying asset. Out-of-The-Money:- A call option is said to be out-of-the-money when the strike price is above the spot price of the underlying asset or a put option is said to be out-of themoney when the strike price is below the spot price of the underlying asset. The buyer makes a loss when he exercises the option out-of-the-money. INTRINSIC VALUE:- Intrinsic Value of an option is the value of the profits that are likely from the option. It consists of the prfit that will accrue, if the option is exercised today or the present value of the porofit. The Intrinsic value is also value of an option takes when it is in- the- Money. For a CALL it is max(0,S-X) and for PUT it is max ( 0, X-S) where S and X are Spot price and Strike price of the underlying assets respectively.

MARUTHI FUTURE STOCK Date 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 strike price 640 640 640 640 640 closing price 725.75 725.75 690.8 690.8 535.1 Strike price lot call size money closing price margin -85.75 -8575 -85.75 -8575 7150 -50.8 -5080 5080 -50.8 -5080 5080 104.9 1049 -

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5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008

640 640 640 640 640 640 640 640

605.25 547.35 512.05 531 480.6 517.7 508.25 503.1 total

34.75 92.65 127.95 109 159.4 122.3 131.75 136.9 746.5 40000 30000 74650 64000

0 3475 9265 1279 5 1090 0 1594 0 1223 0 1317 5 1369 0

--

Initial amount Minimum Intrinsic value 746.5 x 100 Strike price 640 x 100

INTRINSIC VALUE
PRICE 200 100 0 -100 1 3 5 7 DATE 9 11 13 Series1

INTERPRETATION In the above contract Maruthi should deposit an initial amount of Rs.40,000 at the clearing house. In that amount Maruthi should maintain Rs.30,000 as minimum amount in the clearing house. From the above table, it is clearly visible the there is deficit for the minimum amount. As a result Maruthi has to deposit Rs.7150, Rs.5080, Rs. 5080 as call money margin in second, third, fourth week transaction respectively. In the above case, Maruthi intrinsic value ( Rs.74,650) is greater than strike value (Rs.64,000) therefore the future contract can be made, hence it is beneficial to the buyer MARUTHI CALL OPTION Date strike closing strike price lot size call

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price 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008 640 640 640 640 640 640 640 640 640 640 640 640 640

price 111.8 95.7 76.15 118.7 58.85 85.5 86.4 67.6 58.85 85.5 85.5 76.15 58.85 total

closing price 528.2 544.3 563.85 521.3 581.15 554.5 553.6 572.4 581.15 554.5 554.5 563.85 581.15 7254.45

52820 54430 56385 52130 58115 55450 55360 57240 58115 55450 55450 56385 58115 72544 5

money margin -

Initial amount Minimum Intrinsic value Strike price

7254.45 x 100 640 x 100

100000 30000 725445 64000

INTRINSIC VALUE
PRICE 600 550 500 450 1 3 5 7 DATE 9 11 13 Series1

INTERPRETATION In the above contract we can see that the strike price of the Maruthi Call Option is Rs.640 where the highest closing price during the period of 3months i.e. from 1st October 2008 to 31st December is Rs.111.8. Where in this contract the highest profit is Rs.581.15 on 29th Oct, 26th Nov and 24th dec. so the above contract is beneficiary to the option buyer.

MARUTHI PUT OPTION

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Date 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008

Closing strike price price 32.3 66.85 7.45 26.25 53.9 32.3 18.9 23.85 23.85 19.55 19.55 19.55 19.55 640 640 640 640 640 640 640 640 640 640 640 640 640 total

closing price lot size call money strike price margin -607.7 -60770 10770 -573.15 -57315 57315 -632.55 -63255 63255 -613.75 -61375 61375 -586.1 -58610 58610 -607.7 -60770 60770 -621.1 -62110 62110 -616.15 -61615 61615 -616.15 -61615 61615 -620.45 -62045 62045 -620.45 -62045 62045 -620.45 -62045 62045 -620.45 -62045 62045 -7956.15 79561 5

Intial amount 100000 Minimum 50000 Intrinsic value 7956.15 x 100 795615 Strike price 640 x 100 64000
I NT RI NSI C V ALUE

-540 -550 -560 -570 -580 -590 -600 -610 -620 -630 -640 D A T E Ser i es 1 1 2 3 4 5 6 7 8 9 10 11 12 13

INTERPRETATION In the above Maruthi put option contract the intrinsic values are negative so it is under valued to the holder. From the beginning of the contract the intrinsic value are negative only. Where the strike price remains constant (Rs.640) then the closing price of these contracts as not crossed the strike price. The highest closing price of this contract is Rs.66.85 on 8th Oct 2008.so the contract is under valued. BHARATHI AIRTEL FUTURE STOCK Date Strike closing strike price 51 lot size call

price 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008 860 860 860 860 860 860 860 860 860 860 860 860 860

price 813.75 813.75 813.75 759 620 680.9 633.75 608.9 657 665.55 739.35 711.6 688.75 total

closing price 46.25 46.25 46.25 101 240 179.1 226.25 251.1 203 194.45 120.65 148.4 171.25 1973.95

4625 4625 4625 10100 24000 17910 22625 25110 20300 19445 12065 14840 17125 19739 5

money margin -

Initial amount 200000 Minimum 90000 Intrinsic value 1973.95 x 100 197395 Strike price 860 x 100 86000 INTRINSIC VALUE
PRICE 300 200 100 0 1 3 5 7 DATE 9 11 13 Series1

INTERPRETATION In the above contract Bharathi Airtel should deposit an initial amount of Rs.200000 at the clearing house. In that amount Bharathi Airtel should maintain Rs.90000 as minimum amount in the clearing house. There is no deficit in the above contract so the contract is beneficiary to Bharathi Airtel because in the above case, Bharathi Airtel Intrinsic value (Rs.1,97,395) is greater than strike value (Rs.86,000) therefore the future contract can be made, hence it is beneficial to the buyer. The highest profit in the above contract is Rs.226.25 on 12th nov 2008. BHARATHI AIRTELL CALL OPTION Date strike closing strike price lot size call

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price 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008 860 860 860 860 860 860 860 860 860 860 860 860 860

price 110.75 99.55 99.55 88.85 79.05 54.5 121 19.9 30 88.85 112.3 102.85 102.85 Total

closing price 749.25 760.45 760.45 771.15 780.95 805.5 739 840.1 830 771.15 747.7 757.15 757.15 10070

74925 76045 76045 77115 78095 80550 73900 84010 83000 77115 74770 75715 75715 100700 0

money margin -

Initial amount 200000 Minimum 90000 Intrinsic value 10070 x 100 1007000 Strike price 860 x 100 86000

INTRINSIC VALUE
850 800 750 700 650 1 3 5 7 DATE 9 11 13 PRICE

Series1

INTERPRETATION In the above contract we can see that the strike price of the Bharathi Airtel Call Option is Rs.640 where the highest closing price during the period of 3months i.e. from 1st October 2008 to 31st December is Rs.121. Where in this contract the highest profit is Rs.840.1 on 9th nov. so the above contract is beneficiary to the option buyer.

BHARATHI PUT OPTION

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Date 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008

closing strike price price 47.3 47.3 47.3 56.05 65.65 76.15 76.15 76.15 76.15 99.45 56.05 56.05 85 860 860 860 860 860 860 860 860 860 860 860 860 860 Total

closing price lot size Call money margin strike price -812.7 -81270 -812.7 -81270 52570 -812.7 -81270 81270 -803.95 -80395 80395 -794.35 -79435 79435 -783.85 -78385 78385 -783.85 -78385 78385 -783.85 -78385 78385 -783.85 -78385 78385 -760.55 -76055 76055 -803.95 -80395 80395 -803.95 -80395 80395 -775 -77500 77500 -10315.3 103152 5 200000 90000 1031525 86000

Initial amount Minimum Intrinsic value 10315 x 100 Strike price 860 x 100

INTRINSIC VALUE
PRICE -700 -750 -800 -850 DATE 1 3 5 7 9 11 13 Series1

INTERPRETATION In the above Bharathi Airtel put option contract the intrinsic values are negative so it is under valued to the holder. From the beginning of the contract the intrinsic value are negative only. Where the strike price remains constant (Rs.860) then the closing price of these contract as not crossed the strike price. The highest closing price of this contract is Rs.99.45 on 3rd dec 2008.so the contract is under valued.

IDBI FUTURE STOCK

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Date 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008

strike closing price price 95 95 95 95 95 95 95 95 95 95 95 95 95 82.25 82.25 82.25 82.25 82.25 65.75 65.75 62.35 60.5 55.65 59.3 68.95 65.45 total

strike price lot call size money closing price margin 12.75 1275 12.75 1275 12.75 1275 12.75 1275 12.75 1275 29.25 2925 29.25 2925 32.65 3265 34.5 3450 39.35 3935 35.7 3570 26.05 2605 29.55 2955 320.05 3200 5 30000 3000 32005 9500 INTRINSIC VALUE

Initial amount Minimum Intrinsic value 320.05 x 100 Strike price 95 x 100

PRICE

60 40 20 0 1 3 5 7 DATE 9 11 13 Series1

INTERPRETATION In the above contract IDBI should deposit an initial amount of Rs.40,000 at the clearing house. In that amount IDBI i should maintain Rs.30,000 as minimum amount in the clearing house. There is no deficit in the above contract so the contract is beneficiary to IDBI because in the above case, IDBI Intrinsic value (Rs.32,005) is greater than strike value (Rs.9,500) therefore the future contract can be made, hence it is beneficial to the buyer. The highest profit in the above contract is Rs.39.25 on 3rd dec 2008.

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IDBI CALL OPTION Date 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008 Strike closing price price 95 95 95 95 95 95 95 95 95 95 95 95 95 19.75 19.75 19.75 19.75 11.05 7.2 5.75 5.75 5.75 2.95 1.8 4.25 0.75 total strike price lot size call money closing price margin 75.25 7525 75.25 7525 75.25 7525 75.25 7525 83.95 8395 87.8 8780 89.25 8925 89.25 8925 89.25 8925 92.05 9205 93.2 9320 90.75 9075 94.25 9425 1110.75 11107 5 30000 10000 111075 9500

Initial amount Minimum Intrinsic value Strike price

1110.75 x 100 95 x 100

INTRINSIC VALUE
PRICE 100 50 0 1 3 5 7 DATE 9 11 13 Series1

INTERPRETATION In the above contract we can see that the strike price of the IDBI Call Option is Rs.95 where the highest closing price during the period of 3months i.e. from 1st October 2008 to

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31st December is Rs.19.75. Where in this contract the highest profit is Rs.94.25 on 24th dec. so the above contract is beneficiary to the option buyer. IDBI PUT OPTION Date closing strike price price 6.55 3 3 3 4.55 2.35 18.2 3 4.55 8.9 15 15 0.05 total Initial amount Minimum Intrinsic value Strike price 95 95 95 95 95 95 95 95 95 95 95 95 95 closing lot size call price money margin strike price -88.45 -8845 -92 -9200 8045 -92 -9200 9200 -92 -9200 9200 -90.45 -9045 9045 -92.65 -9265 9265 -76.8 -7680 7680 -92 -9200 9200 -90.45 -9045 9045 -86.1 -8610 8610 -80 -8000 8000 -80 -8000 8000 -94.95 -9495 9495 -1147.85 114785 40000 30000 114785 9500

1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008

1147.85 x 100 95 x 100

INTRINSIC VALUE
PRICE 0 1 -50 -100 DATE 3 5 7 9 11 13 Series1

INTERPRETATION In the above IDBI put option contract the Intrinsic values are negative so it is under valued to the holder. From the beginning of the contract the intrinsic value are negative only. Where the strike price remain constant (Rs.95) then the closing price of these

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contract as not crossed the strike price. The highest closing price of this contract is Rs.18.2 on 12th Nov 2008.so the contract is under valued. NTPC FUTURE STOCK Date 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008 Initial amount Minimum Intrinsic value Strike price strike closing price price 185 185 185 185 185 185 185 185 185 185 185 185 185 174.75 174.95 170.2 147.5 133.3 146.5 147.75 134.65 163.15 157.05 169.45 174.75 177.5 total strike price lot size closing price 10.25 10.05 14.8 37.5 51.7 38.5 37.25 50.35 21.85 27.95 15.55 10.25 7.5 333.5 50000 30000 33350 18500
INTRINSIC VALUE
PRICE 60 40 20 0 1 3 5 7 DATE 9 11 13 Series1

1025 1005 1480 3750 5170 3850 3725 5035 2185 2795 1555 1025 750 33350

call money margin -

333.5 x 100 185 x 100

INTERPRETATION In the above contract NTPC should deposit an initial amount of Rs.50,000 at the clearing house. In that amount NTPC should maintain Rs.30,000 as minimum amount in the clearing house. There is no deficit in the above contract so the contract is beneficiary to NTPC because in the above case, NTPC Intrinsic value (Rs.33,350) is greater than strike value (Rs.18,500) therefore the future contract can be made, hence it is beneficial to the buyer. The highest profit in the above contract is Rs.51.7 on 29th oct 2008 58

NTPC CALL OPTION Date strike price 185 185 185 185 185 185 185 185 185 185 185 185 185 closing price 19.3 19.3 19.3 12 10.5 10.5 19.3 1.9 6.15 0.6 1 0.45 0.05 total strike price lot size call money closing margin price 165.7 16570 165.7 16570 165.7 16570 173 17300 174.5 17450 174.5 17450 165.7 16570 183.1 18310 178.85 17885 184.4 18440 184 18400 184.55 18455 184.95 18495 2284.65 228465 50000 30000 228465 18500

1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008 Initial amount Minimum Intrinsic value Strike price

2284.65 x 100 185 x 100

INTRINSIC VALUE
PRICE 190 180 170 160 150 1 3 5 7 DATE 9 11 13

Series1

INTERPRETATION In the above contract we can see that the strike price of the NTPC Call Option is Rs.185 where the highest closing price during the period of 3months i.e. from 1st October 2008 to

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31st December is Rs.19.3. Where in this contract the highest profit is Rs.184.95 on 24th dec. so the above contract is beneficiary to the option buyer. NTPC PUT OPTION Date 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008 closing strike price price 12.6 12.6 10.3 7.85 17.95 10.3 12.6 6.15 7.85 17.95 17.95 0.25 14.5 185 185 185 185 185 185 185 185 185 185 185 185 185 total strike price lot size call money closing price margin -172.4 -17240 -172.4 -17240 14480 -174.7 -17470 17470 -177.15 -17715 17715 -167.05 -16705 16705 -174.7 -17470 17470 -172.4 -17240 17240 -178.85 -17885 17885 -177.15 -17715 17715 -167.05 -16705 16705 -167.05 -16705 16705 -184.75 -18475 18475 -170.5 -17050 17050 -2256.15 225615 50000 30000 225615 18500 INTRINSIC VALUE
PRICE -150 -160 -170 -180 -190 DATE 1 3 5 7 9 11 13 Series1

Initial amount Minimum Intrinsic value 2256.15 x 100 Strike price 185 x 100

INTERPRETATION In the above NTPC put option contract the intrinsic values are negative so it is under valued to the holder. From the beginning of the contract the intrinsic value are negative only. Where the strike price remains constant (Rs.185) then the closing price of these contracts as not crossed the strike price. The highest closing price of this contract is Rs.17.95 on 29th Oct, 3rd Dec 10th Dec 2008.so the contract is under valued.

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TATA TEA FUTURES STOCK Date 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008 strike closing price price 720 720 720 720 720 720 720 720 720 720 720 720 720 713.1 713.1 713.1 713.1 713.1 545 545 545 479.85 526.85 537.65 531.4 593.25 total strike price lot size closing price 6.9 6.9 6.9 6.9 6.9 175 175 175 240.15 193.15 182.35 188.6 126.75 1490.5 100000 80000 899615 72000
INTRINSIC VALUE
PRICE 300 200 100 0 1 3 5 7 DATE 9 11 13 Series1

690 690 690 690 690 17500 17500 17500 24015 19315 18235 18860 12675 149050

call money margin -

Initial amount Minimum Intrinsic value 8996.15 x 100 Strike price 720 x 100

INTERPRETATION In the above contract TATA TEA should deposit an initial amount of Rs.1,00,000 at the clearing house. In that amount TATA TEA should maintain Rs.80,000 as minimum amount in the clearing house. There is no deficit in the above contract so the contract is beneficiary to TATA TEA because in the above case, TATA TEA Intrinsic value (Rs.8,99,615) is greater than strike value (Rs.72,000) therefore the future contract can be made, hence it is beneficial to the buyer. The highest profit in the above contract is Rs.240.15 on 26th nov 2008 61

TATA TEA CALL OPTION Date 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008 strike closing price price 720 720 720 720 720 720 720 720 720 720 720 720 720 68.6 56 81.6 92.7 27.7 27.7 21.2 21.2 21.2 56 35.6 35.6 35.6 total strike price lot size call money closing price margin 651.4 65140 664 66400 638.4 63840 627.3 62730 692.3 69230 692.3 69230 698.8 69880 698.8 69880 698.8 69880 664 66400 684.4 68440 684.4 68440 684.4 68440 8779.3 87793 0 100000 80000 877930 72000
IN TR IN SIC V ALU E PRICE 720 700 680 660 640 620 600 580 1 3 5 7 9 11 13 D ATE Series 1

Initial amount Minimum Intrinsic value 8779.3 x 100 Strike price 720 x 100

INTERPRETATION In the above contract we can see that the strike price of the TATA TEA Call Option is Rs.720 where the highest closing price during the period of 3months i.e. from 1st October 2008 to 31st December is Rs.92.7. Where in this contract the highest profit is Rs.698.8 from 12th nov to 26th nov. so the above contract is beneficiary to the option buyer.

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TATA TEA PUT OPTION Date 1/10/2008 8/10/2008 15-10-2008 22-10-2008 29-10-2008 5/11/2008 12/11/2008 19-11-2008 26-11-2008 3/12/2008 10/12/2008 17-12-2008 24-12-2008 closing strike price price 32.3 66.85 7.45 26.25 53.9 32.3 18.9 23.85 23.85 19.55 19.55 19.55 19.55 720 720 720 720 720 720 720 720 720 720 720 720 720 Total Initial amount Minimum Intrinsic value 8996.15 x 100 Strike price 720 x 100 closing price Lot size call money strike price margin -687.7 -68770 48770 -653.15 -65315 65315 -712.55 -71255 71255 -693.75 -69375 69375 -666.1 -66610 66610 -687.7 -68770 68770 -701.1 -70110 70110 -696.15 -69615 69615 -696.15 -69615 69615 -700.45 -70045 70045 -700.45 -70045 70045 -700.45 -70045 70045 -700.45 -70045 70045 -8996.15 -899615 100000 80000 899615 72000 INTRINSIC VALUE
PRICE -600 -650 -700 -750 DATE 1 3 5 7 9 11 13 Series1

INTERPRETATION In the above TATA TEA put option contract the intrinsic values are negative so it is under valued to the holder. From the beginning of the contract the intrinsic value are

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negative only. Where the strike price remains constant (Rs.720) then the closing price of these contracts as not crossed the strike price. The highest closing price of this contract is Rs.66.85 on 8th Oct 2008.so the contract is under valued. SUMMARY Derivates market is an innovation to cash market. Approximately its daily turnover reaches to the equal stage of cash market. The average daily turnover of the NSE derivative segments In cash market the profit/loss of the investor depend the market price of the underlying asset. The investor may incur huge profits or he may incur huge profits or he may incur huge loss. But in derivatives segment the investor the investor enjoys huge profits with limited downside. In cash market the investor has to pay the total money, but in derivatives the investor has to pay premiums or margins, which are some percentage of total money. Derivatives are mostly used for hedging purpose. In derivative segment the profit/loss of the option writer is purely depend on the fluctuations of the underlying asset.

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FINDINGS

RECORDS ACHIEVED IN THE FUTURE AND OPTION SEGMENT PRODUCT Index futures Stock futures Index options Stock options Interest rate futures Total f&o trade value TRADED VALUE ( RS IN CRORES) 34,583 71,195 11804 3746 140 110564 DATE 18-10-2008 01-11-2008 18-10-2008 18-10-2008 24-06-2008 18-10-2008

CONCLUSIONS

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 In bullish market, the call option writer incurs more losses so the investor is suggested to go for a call option to hold, where as the put option holder suffers in a bullish market, so he is suggested to write a put option. In bearish market the call option holder will incur more losses so the investor is suggested to go for a call option to write, where as the put option writer will get more losses, so he is suggested to hold a put option. In the above analysis the market price of HLL is having low volatility, so the call option writers enjoy more profits to holders.

RECOMMENDATIONS

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 SEBI has to take steps to create awareness among the investors about the derivative segment. SEBI should revise some of their regulations like contract size, participation of FII in the derivatives market. Contract size should be minimized because small investors cannot afford this much of huge premiums. SEBI has to take further steps in the risk management mechanism. SEBI has to take measures to use effectively the derivatives segment as a tool of hedging.

BIBILOGRAPHY

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WEBSITES www.derivativesindia.com www.indianinfoline.com www.nseindia.com www.bseindia.com www.5paisa.com

BOOKS: Derivatives Core Module Workbook NCFM material Financial Markets and Services Gordan and Natrajan Financial Management Prasanna Chandra

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