DERIVATIVE MARKETS

CONTENTS

S.

PAGE
TOPICS

No.

NO.

1.

Executive

Summary 06

2.

......
Company

10

3.

Profile...................
Introduction

16

4.

...................
Need of the Study............................................................................ 17

5.

Literatural

18

6.

Review............................................................................

19

7.

Objective

8.

Study.....................................................................

9.

Scope of the Study.......................................................................... 22

of

the 20
21

Research
Methodology....................................................................
Limitations

of

Study.........................................................................
1

10. Main Topics of Study

1)
Introduction to Derivative............................................................. 23
2)
Derivative 24
Defined.........................................................................
3)
Types
of
Derivatives 25
Market...........................................................
4)
Types of Derivatives...................................................................... 25
Forward Contracts...................................................................... 26
i)
Future Contracts........................................................................ 27
ii)
i

Options....................................................................................... 32

ii)

Swap.......................................................................................

iv)
5)

Other

Kinds

33

of 34

11.

Derivatives.........................................................
History

12.

Derivatives.........................................................................
Indian Derivative Market .... 38

......
1)
Need

of

Derivatives

in

India

of 35

today....... 39

2) .........................
Myths
i)

39
and

realities

derivatives..................
Derivatives increase speculation and do not serve any
2

about
40
41

economic purpose ..................................................................... 43

ii)

Indian

Market

is

not

ready

for

derivative 45

3)

trading.........................

47

4)

Comparison of New System with Existing System.........

5)

Exchange-traded vs. OTC derivatives markets...............................

Factors

Contributing

To

The

Growth

Of

Derivatives........................
Price 47
i)

Volatility..............................................................................
Globalisation

ii)

of 48

Markets..............................................................

49

Technological Advances..............................................................
iii)
Advances

in

Financial 49

iv)
13.

Theories........................................
Development
of
Derivative

14.

India.......
Benifits of Derivatives...................................

1)

Risk

Markets

in 50

54

2 Management............................................................................
)

54

54

Price Discovery..............................................................................

54

3 Operational Advantages.................................................................

55

Market

55

4 Efficiency............................................................................
)

Easy

to

5 Speculation.........................................................................
)
15.

National

59

16.

Exchanges.........................................................................
Present Status.................................................................................

60

17.

Status

18.

Market.................

19.

Business

20.

(NSE).............................

21.

Findings

Report

of

Growth

the

development

in

Derivative 62
69

in

Derivatives

segment 81
82
& 83

Conclusion.....................................................................
Recommendations & Suggestions..................................................
Bibliography
22.

........
Abbrevations................................................................................... 84

EXECUTIVE SUMMARY

Firstly I am briefing the current Indian market and compairing it with it past.
I am also giving brief data about foreign market. Then at the last I am giving
my suggestions and recommendations.

With over 25 million shareholders, India has the third largest investor base in
the world after USA and Japan. Over 7500 companies are listed on the
Indian stock exchanges (more than the number of companies listed in
developed markets of Japan, UK, Germany, France, Australia, Switzerland,
Canada and Hong Kong.). The Indian capital market is significant in terms
of the degree of development, volume of trading, transparency and its
tremendous growth potential.
Indias market capitalization was the highest among the emerging markets.
Total market capitalization of The Bombay Stock Exchange (BSE), which,
as on July 31, 1997, was US$ 175 billion has grown by 37.5% percent every
twelve months and was over US$ 834 billion as of January, 2007. Bombay
Stock Exchanges (BSE), one of the oldest in the world, accounts for the
largest number of listed companies transacting their shares on a nationwide
online trading system. The two major exchanges namely the National Stock
Exchange (NSE) and the Bombay Stock Exchange (BSE) ranked no. 3 & 5
in the world, calculated by the number of daily transactions done on the
exchanges.
The Total Turnover of Indian Financial Markets crossed US$ 2256 billion in
2006 An increase of 82% from US $ 1237 billion in 2004 in a short span

of 2 years only. Turnover in the Spot and Derivatives segment both in NSE
& BSE was higher by 45% into 2006 as compared to 2005. With daily
average volume of US $ 9.4 billion, the Sensex has posted excellent returns
in the recent years. Currently the market cap of the Sensex as on July
4th, 2009 was Rs 48.4 Lakh Crore with a P/E of more than 20.

Derivatives trading in the stock market have been a subject of enthusiasm of

research in the field of finance the most desired instruments that allow
market participants to manage risk in the modern securities trading are
known as derivatives. The derivatives are defined as the future contracts
whose value depends upon the underlying assets. If derivatives are
introduced in the stock market, the underlying asset may be anything as
component of stock market like, stock prices or market indices, interest
rates, etc. The main logic behind derivatives trading is that derivatives
reduce the risk by providing an additional channel to invest with lower
trading cost and it facilitates the investors to e

xtend their settlement through the future contracts. It provides extra liquidity
in the stock market.

Derivatives are assets, which derive their values from an underlying asset.
These underlying assets are of various categories like
Commodities including grains, coffee beans, etc.
Precious metals like gold and silver.
Foreign exchange rate.
Bonds of different types, including medium to long-term negotiable debt
securities issued by governments, companies, etc.
Short-term debt securities such as T-bills.
Over-The-Counter (OTC) money market products such as loans or
deposits.
Equities
For example, a dollar forward is a derivative contract, which gives the buyer
a right & an obligation to buy dollars at some future date. The prices of the
derivatives are driven by the spot prices of these underlying assets.
However, the most important use of derivatives is in transferring market
risk, called Hedging, which is a protection against losses resulting from
unforeseen price or volatility changes. Thus, derivatives are a very important
tool of risk management.

There are various derivative products traded. They are;

1. Forwards
2. Futures
3. Options
4. Swaps

A Forward Contract is a transaction in which the buyer and the seller

agree upon a delivery of a specific quality and quantity of asset usually a
commodity at a specified future date. The price may be agreed on in
advance or in future.

A Future contract is a firm contractual agreement between a buyer and

seller for a specified as on a fixed date in future. The contract price will
vary according to the market place but it is fixed when the trade is made.
The contract also has a standard specification so both parties know exactly
what is being done.

An Options contract confers the right but not the obligation to buy (call
option) or sell (put option) a specified underlying instrument or asset at a
specified price the Strike or Exercised price up until or an specified future
date the Expiry date. The Price is called Premium and is paid by buyer of
the option to the seller or writer of the option.

A call option gives the holder the right to buy an underlying asset by a
certain date for a certain price. The seller is under an obligation to fulfill the
contract and is paid a price of this, which is called "the call option premium
or call option price".
A put option, on the other hand gives the holder the right to sell an
underlying asset by a certain date for a certain price. The buyer is under an
obligation to fulfill the contract and is paid a price for this, which is called
"the put option premium or put option price".

Swaps are transactions which obligates the two parties to the contract to
exchange a series of cash flows at specified intervals known as payment or
settlement dates. They can be regarded as portfolios of forward's contracts. A
contract whereby two parties agree to exchange (swap) payments, based on

10

some notional principle amount is called as a SWAP. In case of swap, only

the payment flows are exchanged and not the principle amount

I had conducted this research to find out whether investing in the

derivative market is beneficial or not? You will be glad to know that
derivative market in India is the most booming now days.
So the person who is ready to take risk and want to gain more should
invest in the derivative market.
On the other hand RBI has to play an important role in derivative
market. Also SEBI must encourage investment in derivative market so
that the investors get the benefit out of it. Sorry to say that today even
educated persons are not willing to invest in derivative market because
they have the fear of high risk.

So, SEBI should take necessary steps for improvement in Derivative

Market so that more investors can invest in Derivative market.

11

COMPANY PROFILE

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organizations providing individuals and corporates with customized
financial management solutions.
At IIL, we believe in "Realizing your goals together". You will find in us - a
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understanding of the financial markets results in appropriate investment
solutions for you.
Our strong team of Relationship Managers, Customer Service Executives,
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12

by in-depth research, knowledge and expertise to customers across the

country.

Vision
To become a long term prefferd long term financial to a wide base of
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Mission
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Corporate action
An approach to business that reflects responsibility, transparency and ethical
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Respect for employee client and stake holder group.

13

Retail Business
Retail offerings of IIL seek to cover all financial
planning requirements of individuals, which
include

providing

management

personalised

services

including

investment
planning,

advisory, execution and monitoring of the full

range of investment services. Broadly the retail
services are divided into two broad categories.

Advisory

Services:

Portfolio Management Services, Mutual

Funds, Insurance.

Trading

Services:

Equities, Derivatives, IPOs

These services are offered across our network of
over 300 offices across the country. You can
also enjoy the convenience of availing these
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www.investsmartonline.com
14

15

Institutional Business
IILs Institutional business thrives on the strong relationships we have built among
domestic mutual funds, banks, financial institutions, insurance companies and
private sector funds over the past few years. Efficient execution, quality research
and high degree of compliance with stock exchange regulations and ethical
business standards back IILs services to institutional investors.
Our Institutional services can be broadly categorized as follows.
Merchant

Banking

We offer financial advisory and capital-raising services to corporates. Having

successfully managed IPOs, Follow-on offerings, Open Offers, Mergers, etc, IILs
Merchant Banking business has been growing from strength-to-strength.
Institutional

Equity

&

Debt

Combining the efforts of a top-drawer research team & dynamic sales

professionals, we are committed to offer timely & proactive investing & trading
strategies. We are presently empanelled with more than 100 institutions and service
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Promoters
IL&FS Investsmart Limited (IIL) is one of Indias leading companies in the
Financial Services industry. It was promoted in 1997 by Infrastructure Leasing &
Financial Services (IL&FS), one of India's leading infrastructure development and
16

17

18

Value Added Products for You!

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Increase your Market Exposure

Limit Against Shares

Margin

19

is

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securities you have in your Demat

for trading.

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Convenience to trade over the

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phone

Call & Trade is a service offered by

Investsmart online for its customers,
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SmartSecure
State-of-the-art Security Platforms

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At IL&FS Investsmart, we place a
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developed

20

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Whether you are day trader or a
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Sell Receivable Shares

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will not have to wait till the time he
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Exchange

21

thus

increasing

his

liquidity.
INTRODUCTION
A Derivative is a financial instrument whose value depends on other,
more basic, underlying variables. The variables underlying could be
prices of traded securities and stock, prices of gold or copper.
Derivatives have become increasingly important in the field of finance,
Options and Futures are traded actively on many exchanges, Forward
contracts, Swap and different types of options are regularly traded outside
exchanges by financial intuitions, banks and their corporate clients in
what are termed as over-the-counter markets in other words, there is no
single market place or organized exchanges.

22

NEED OF THE STUDY

The study has been done to know the different types of derivatives and
also to know the derivative market in India. This study also covers the
recent developments in the derivative market taking into account the
trading in past years.
Through this study I came to know the trading done in derivatives and
their use in the stock markets.

23

LITERATURE REVIEW
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 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 products minimize the impact of
fluctuations in asset prices on the profitability and cash flow situation of
risk-averse investors.
Derivative products initially emerged, as 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 growing
instability in the financial markets. However, since their emergence, these
products have become very popular and by 1990s, they accounted for about
two-thirds of total transactions in derivative products. In recent years, the
market for financial derivatives has grown tremendously both in terms of

24

variety of instruments available, their complexity and also turnover. In the

class of equity derivatives, futures and options on stock indices have gained
more popularity than on individual stocks, especially among institutional
investors, who are major users of index-linked derivatives.
Even small investors find these useful due to high correlation of the popular
indices with various portfolios and ease of use. The lower costs associated
with index derivatives vis-vis derivative products based on individual
securities is another reason for their growing use.
As in the present scenario, Derivative Trading is fast gaining
momentum, I have chosen this topic.

25

OBJECTIVES OF THE STUDY

To understand the concept of the Derivatives and Derivative Trading.

To know different types of Financial Derivatives
To know the role of derivatives trading in India.
To analyse the performance of Derivatives Trading since 2001with
special reference to Futures & Options

26

SCOPE OF THE PROJECT

The project covers the derivatives market and its instruments. For better
understanding various strategies with different situations and actions
have been given. It includes the data collected in the recent years and also
the market in the derivatives in the recent years. This study extends to the
trading of derivatives done in the National Stock Markets.

27

RESARCH METHODOLOGY

Method of data collection:Secondary sources:It is the data which has already been collected by some one or an
organization for some other purpose or research study .The data for study
has been collected from various sources:
Books
Journals
Magazines
Internet sources
Time:
2 months
Statistical Tools Used:
Simple tools like bar graphs, tabulation, line diagrams have been used.

28

LIMITAITONS OF STUDY

1. LIMITED TIME:
The time available to conduct the study was only 2 months. It being a
wide topic had a limited time.
2. LIMITED RESOURCES:
Limited resources are available to collect the information about the
commodity trading.
3. VOLATALITY:
Share market is so much volatile and it is difficult to forecast any thing
about it whether you trade through online or offline

29

4. ASPECTS COVERAGE:
Some of the aspects may not be covered in my study.

MAIN TOPICS OF STUDY

1. INTRODUCTION TO DERIVATIVE

30

The origin of derivatives can be traced back to the need of farmers to protect
themselves against fluctuations in the price of their crop. From the time it
was sown to the time it was ready for harvest, farmers would face price
uncertainty. Through the use of simple derivative products, it was possible
for the farmer to partially or fully transfer price risks by locking-in asset
prices. These were simple contracts developed to meet the needs of farmers
and were basically a means of reducing risk.

A farmer who sowed his crop in June faced uncertainty over the price
he would receive for his harvest in September. In years of scarcity, he would
probably obtain attractive prices. However, during times of oversupply, he
would have to dispose off his harvest at a very low price. Clearly this meant
that the farmer and his family were exposed to a high risk of price
uncertainty.

On the other hand, a merchant with an ongoing requirement of grains

too would face a price risk that of having to pay exorbitant prices during
dearth, although favourable prices could be obtained during periods of
oversupply. Under such circumstances, it clearly made sense for the farmer
and the merchant to come together and enter into contract whereby the price

31

of the grain to be delivered in September could be decided earlier. What they

would then negotiate happened to be futures-type contract, which would
enable both parties to eliminate the price risk.

In 1848, the Chicago Board Of Trade, or CBOT, was established to

bring farmers and merchants together. A group of traders got together and
created the to-arrive contract that permitted farmers to lock into price
upfront and deliver the grain later. These to-arrive contracts proved useful as
a device for hedging and speculation on price charges. These were
eventually standardized, and in 1925 the first futures clearing house came
into existence.

Today derivatives contracts exist on variety of commodities such as

corn, pepper, cotton, wheat, silver etc. Besides commodities, derivatives
contracts also exist on a lot of financial underlying like stocks, interest rate,
exchange rate, etc.

2. DERIVATIVE DEFINED
A derivative is a product whose value is derived from the value of one or
more underlying variables or assets in a contractual manner. The underlying

32

asset can be equity, forex, commodity or any other asset. In our earlier
discussion, we saw that wheat farmers may wish to sell their harvest at a
future date to eliminate the risk of change in price by that date. Such a
transaction is an example of a derivative. The price of this derivative is
driven by the spot price of wheat which is the underlying in this case.
The Forwards Contracts (Regulation) Act, 1952, regulates the
forward/futures contracts in commodities all over India. As per this the
Forward Markets Commission (FMC) continues to have jurisdiction over
commodity futures contracts. However when derivatives trading in securities
was introduced in 2001, the term security in the Securities Contracts
(Regulation) Act, 1956 (SCRA), was amended to include derivative
contracts in securities. Consequently, regulation of derivatives came under
the purview of Securities Exchange Board of India (SEBI). We thus have
separate regulatory authorities for securities and commodity derivative
markets.
Derivatives are securities under the SCRA and hence the trading of
derivatives is governed by the regulatory framework under the SCRA. The
Securities Contracts (Regulation) Act, 1956 defines derivative to include-

33

A security derived from a debt instrument, share, loan whether secured or

unsecured, risk instrument or contract differences or any other form of
security.
A contract which derives its value from the prices, or index of prices, of
underlying securities.
3. TYPES OF DERIVATIVES MARKET

Exchange Traded Derivatives

National Stock

Over The Counter Derivatives

Bombay Stock

National

Commodity &
Exchange

Exchange
Exchange

34

Derivative

Index Future

Index option

Stock option

Stock future

Figure.1 Types of Derivatives Market

4. TYPES OF DERIVATIVES

Derivatives

Future

Option

Forward

35

Swaps

Figure.2 Types of Derivatives

(i)

FORWARD CONTRACTS

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

date for a specified price. One of the parties to the contract assumes a
long position and agrees to buy the underlying asset on a certain
specified future date for a certain specified price. The other party
assumes a short position and agrees to sell the asset on the same date
for the same price. Other contract details like delivery date, price and
quantity are negotiated bilaterally by the parties to the contract. The
forward contracts are n o r m a l l y traded outside the exchanges.
BASIC FEATURES OF FORWARD CONTRACT

They are bilateral contracts and hence exposed to counter-party risk.

Each contract is custom designed, and hence is unique in terms of

contract

size, expiration date and the asset type and quality.

The contract price is generally not available in public domain.

On the expiration date, the contract has to be settled by delivery of the

asset.

36

If the party wishes to reverse the contract, it has to compulsorily go

to the same counter-party, which often results in high prices being
charged.

However forward contracts in certain

markets have

become very

standardized, as in the case of foreign exchange, thereby reducing

transaction costs and increasing transactions volume. This process of
standardization reaches its limit in the organized futures market. Forward
contracts are often confused with futures contracts. The confusion is
primarily because both serve essentially the same economic
functions of allocating risk in the presence of future price uncertainty.
However futures are a significant
contracts

as

they

improvement

eliminate counterparty

risk

over the forward

and

offer

more

liquidity.
(ii)

FUTURE CONTRACT

In finance, a futures contract is a standardized contract, traded on a futures

exchange, to buy or sell a certain underlying instrument at a certain date in
the future, at a pre-set price. The future date is called the delivery date or
final settlement date. The pre-set price is called the futures price. The price
of the underlying asset on the delivery date is called the settlement price.

37

The settlement price, normally, converges towards the futures price on the
delivery date.
A futures contract gives the holder the right and the obligation to buy or sell,
which differs from an options contract, which gives the buyer the right, but
not the obligation, and the option writer (seller) the obligation, but not the
right. To exit the commitment, the holder of a futures position has to sell his
long position or buy back his short position, effectively closing out the
futures position and its contract obligations. Futures contracts are exchange
traded derivatives. The exchange acts as counterparty on all contracts, sets
margin requirements, etc.
BASIC FEATURES OF FUTURE CONTRACT
1. Standardization:
Futures contracts ensure their liquidity by being highly standardized, usually
by specifying:
The underlying. This can be anything from a barrel of sweet crude oil
to a short term interest rate.
The type of settlement, either cash settlement or physical settlement.

38

 The amount and units of the underlying asset per contract. This can be
the notional amount of bonds, a fixed number of barrels of oil, units of
foreign currency, the notional amount of the deposit over which the
short term interest rate is traded, etc.
The currency in which the futures contract is quoted.
The grade of the deliverable. In case of bonds, this specifies which
bonds can be delivered. In case of physical commodities, this specifies
not only the quality of the underlying goods but also the manner and
location of delivery. The delivery month.
The last trading date.
Other details such as the tick, the minimum permissible price
fluctuation.
2. Margin:
Although the value of a contract at time of trading should be zero, its price
constantly fluctuates. This renders the owner liable to adverse changes in
value, and creates a credit risk to the exchange, who always acts as
counterparty. To minimize this risk, the exchange demands that contract
owners post a form of collateral, commonly known as Margin requirements
are waived or reduced in some cases for hedgers who have physical

39

ownership of the covered commodity or spread traders who have offsetting

contracts balancing the position.
Initial Margin: is paid by both buyer and seller. It represents the loss on
that contract, as determined by historical price changes, which is not likely
to be exceeded on a usual day's trading. It may be 5% or 10% of total
contract price.
Mark to market Margin: Because a series of adverse price changes may
exhaust the initial margin, a further margin, usually called variation or
maintenance margin, is required by the exchange. This is calculated by the
futures contract, i.e. agreeing on a price at the end of each day, called the
"settlement" or mark-to-market price of the contract.
To understand the original practice, consider that a futures trader, when
taking a position, deposits money with the exchange, called a "margin". This
is intended to protect the exchange against loss. At the end of every trading
day, the contract is marked to its present market value. If the trader is on the
winning side of a deal, his contract has increased in value that day, and the
exchange pays this profit into his account. On the other hand, if he is on the
losing side, the exchange will debit his account. If he cannot pay, then the
margin is used as the collateral from which the loss is paid.

40

3. Settlement
Settlement is the act of consummating the contract, and can be done in one
of two ways, as specified per type of futures contract:

Physical delivery - the amount specified of the underlying asset of the

contract is delivered by the seller of the contract to the exchange, and by
the exchange to the buyers of the contract. In practice, it occurs only on
a minority of contracts. Most are cancelled out by purchasing a covering
position - that is, buying a contract to cancel out an earlier sale (covering
a short), or selling a contract to liquidate an earlier purchase (covering a
long).

Cash settlement - a cash payment is made based on the underlying

reference rate, such as a short term interest rate index such as Euribor, or
the closing value of a stock market index. A futures contract might also
opt to settle against an index based on trade in a related spot market.
Expiry is the time when the final prices of the future are determined. For
many equity index and interest rate futures contracts, this happens on the
Last Thursday of certain trading month. On this day the t+2 futures contract
becomes the t forward contract.

41

PRICING OF FUTURE CONTRACT

In a futures contract, for no arbitrage to be possible, the price paid on
delivery (the forward price) must be the same as the cost (including interest)
of buying and storing the asset. In other words, the rational forward price
represents the expected future value of the underlying discounted at the risk
free rate. Thus, for a simple, non-dividend paying asset, the value of the
future/forward,
time to maturity

, will be found by discounting the present value

at

by the rate of risk-free return .

This relationship may be modified for storage costs, dividends, dividend

yields, and convenience yields. Any deviation from this equality allows for
arbitrage as follows.
In the case where the forward price is higher:
1. The arbitrageur sells the futures contract and buys the underlying
today (on the spot market) with borrowed money.
2. On the delivery date, the arbitrageur hands over the underlying, and
receives the agreed forward price.
3. He then repays the lender the borrowed amount plus interest.
4. The difference between the two amounts is the arbitrage profit.

42

In the case where the forward price is lower:

1. The arbitrageur buys the futures contract and sells the underlying
today (on the spot market); he invests the proceeds.
2. On the delivery date, he cashes in the matured investment, which has
appreciated at the risk free rate.
3. He then receives the underlying and pays the agreed forward price
using the matured investment. [If he was short the underlying, he
returns it now.]
4. The difference between the two amounts is the arbitrage profit.

43

TABLE 1DISTINCTION BETWEEN FUTURES AND FORWARDS CONTRACTS

FEATURE

FORWARD

FUTURE CONTRACT

Operational

CONTRACT
Traded directly between Traded on the exchanges.

Mechanism

two parties (not traded

Contract

on the exchanges).
Differ from trade

Specifications
Counter-party

trade.
Exists.

to Contracts

are

standardized

contracts.
Exists. However, assumed by the

risk

clearing corp., which becomes the

counter party to all the trades or
unconditionally guarantees their

Liquidation

settlement.
Low, as contracts are High,
as

Profile

tailor

made

contracts

contracts standardized

exchange

are
traded

catering to the needs of contracts.

the needs of the parties.
Price discovery Not efficient, as markets Efficient,
are scattered.

as

markets

are

centralized and all buyers and

sellers

44

come

to

common

platform to discover the price.

Examples

Currency

market

in Commodities,

India.

Futures

and

Futures in India.

45

futures,

Index

Individual

stock

OPTIONS A derivative transaction that gives the option holder the right but not the
obligation to buy or sell the underlying asset at a price, called the strike
price, during a period or on a specific date in exchange for payment of a
premium is known as option. Underlying asset refers to any asset that is
traded. The price at which the underlying is traded is called the strike price.

There are two types of options i.e., CALL OPTION & PUT OPTION.

CALL OPTION:

A contract that gives its owner the right but not the obligation to buy an
underlying asset-stock or any financial asset, at a specified price on or before
a specified date is known as a Call option. The owner makes a profit
provided he sells at a higher current price and buys at a lower future price.

PUT OPTION:

A contract that gives its owner the right but not the obligation to sell an
underlying asset-stock or any financial asset, at a specified price on or before

46

a specified date is known as a Put option. The owner makes a profit

provided he buys at a lower current price and sells at a higher future price.
Hence, no option will be exercised if the future price does not increase.

Put and calls are almost always written on equities, although occasionally
preference shares, bonds and warrants become the subject of options.

47

SWAPS Swaps are transactions which obligates the two parties to the contract to
exchange a series of cash flows at specified intervals known as payment or
settlement dates. They can be regarded as portfolios of forward's contracts. A
contract whereby two parties agree to exchange (swap) payments, based on
some notional principle amount is called as a SWAP. In case of swap, only
the payment flows are exchanged and not the principle amount. The two
commonly used swaps are:

INTEREST RATE SWAPS:

Interest rate swaps is an arrangement by which one party agrees to exchange
his series of fixed rate interest payments to a party in exchange for his
variable rate interest payments. The fixed rate payer takes a short position in
the forward contract whereas the floating rate payer takes a long position in
the forward contract.

CURRENCY SWAPS:
Currency swaps is an arrangement in which both the principle amount and
the interest on loan in one currency are swapped for the principle and the

48

interest payments on loan in another currency. The parties to the swap

contract of currency generally hail from two different countries. This
arrangement allows the counter parties to borrow easily and cheaply in their
home currencies. Under a currency swap, cash flows to be exchanged are
determined at the spot rate at a time when swap is done. Such cash flows are
supposed to remain unaffected by subsequent changes in the exchange rates.

FINANCIAL SWAP:
Financial swaps constitute a funding technique which permit a borrower to
access one market and then exchange the liability for another type of
liability. It also allows the investors to exchange one type of asset for
another type of asset with a preferred income stream.

5. OTHER KINDS OF DERIVATIVES

The other kind of derivatives, which are not, much popular are as
follows:

49

BASKETS -

Baskets options are option on portfolio of underlying asset. Equity Index

Options are most popular form of baskets.

LEAPS -

Normally option contracts are for a period of 1 to 12 months.

However, exchange may introduce option contracts with a maturity period of
2-3 years. These long-term option contracts are popularly known as Leaps or
Long term Equity Anticipation Securities.

WARRANTS -

Options generally have lives of up to one year, the majority of options traded
on options exchanges having a maximum maturity of nine months. Longerdated options are called warrants and are generally traded over-the-counter.

SWAPTIONS -

50

Swaptions are options to buy or sell a swap that will become operative at the
expiry of the options. Thus a swaption is an option on a forward swap.
Rather than have calls and puts, the swaptions market has receiver swaptions
and payer swaptions. A receiver swaption is an option to receive fixed and
pay floating. A payer swaption is an option to pay fixed and receive floating.

51

11. HISTORY OF DERIVATIVES:

The history of derivatives is quite colourful and surprisingly a lot longer

than most people think. Forward delivery contracts, stating what is to be
delivered for a fixed price at a specified place on a specified date, existed in
ancient Greece and Rome. Roman emperors entered forward contracts to
provide the masses with their supply of Egyptian grain. These contracts were
also undertaken between farmers and merchants to eliminate risk arising out
of uncertain future prices of grains. Thus, forward contracts have existed for
centuries for hedging price risk.
The first organized commodity exchange came into
existence in the early 1700s in Japan. The first formal commodities
exchange, the Chicago Board of Trade (CBOT), was formed in 1848 in the
US to deal with the problem of credit risk and to provide centralised
location to negotiate forward contracts. From forward trading in
commodities emerged the commodity futures. The first type of futures
contract was called to arrive at. Trading in futures began on the CBOT in
the 1860s. In 1865, CBOT listed the first exchange traded derivatives
contract, known as the futures contracts. Futures trading grew out of the
need for hedging the price risk involved in many commercial operations.

52

The Chicago Mercantile Exchange (CME), a spin-off of CBOT, was formed

in 1919, though it did exist before in 1874 under the names of Chicago
Produce Exchange (CPE) and Chicago Egg and Butter Board (CEBB).
The first financial futures to emerge were the currency in 1972 in the US.
The first foreign currency futures were traded on May 16, 1972, on
International Monetary Market (IMM), a division of CME. The currency
futures traded on the IMM are the British Pound, the Canadian Dollar, the
Japanese Yen, the Swiss Franc, the German Mark, the Australian Dollar, and
the Euro dollar. Currency futures were followed soon by interest rate futures.
Interest rate futures contracts were traded for the first time on the CBOT on
October 20, 1975. Stock index futures and options emerged in 1982. The
first stock index futures contracts were traded on Kansas City Board of
Trade on February 24, 1982.The first of the several networks, which offered
a trading link between two exchanges, was formed between the Singapore
International Monetary Exchange (SIMEX) and the CME on September 7,
1984.

Options are as old as futures. Their history also dates back to ancient Greece
and Rome. Options are very popular with speculators in the tulip craze of
seventeenth century Holland. Tulips, the brightly coloured flowers, were a

53

symbol of affluence; owing to a high demand, tulip bulb prices shot up.
Dutch growers and dealers traded in tulip bulb options. There was so much
speculation that people even mortgaged their homes and businesses. These
speculators were wiped out when the tulip craze collapsed in 1637 as there
was no mechanism to guarantee the performance of the option terms.
The first call and put options were invented by an
American financier, Russell Sage, in 1872. These options were traded over
the counter. Agricultural commodities options were traded in the nineteenth
century in England and the US. Options on shares were available in the US
on the over the counter (OTC) market only until 1973 without much
knowledge of valuation. A group of firms known as Put and Call brokers and
Dealers Association was set up in early 1900s to provide a mechanism for
bringing buyers and sellers together.
On April 26, 1973, the Chicago Board options Exchange
(CBOE) was set up at CBOT for the purpose of trading stock options. It was
in 1973 again that black, Merton, and Scholes invented the famous BlackScholes Option Formula. This model helped in assessing the fair price of an
option which led to an increased interest in trading of options. With the
options markets becoming increasingly popular, the American Stock

54

Exchange (AMEX) and the Philadelphia Stock Exchange (PHLX) began

trading in options in 1975.

The market for futures and options grew at a rapid pace in the eighties and
nineties. The collapse of the Bretton Woods regime of fixed parties and the
introduction of floating rates for currencies in the international financial
markets paved the way for development of a number of financial derivatives
which served as effective risk management tools to cope with market
uncertainties.

The CBOT and the CME are two largest financial exchanges in the world on
which futures contracts are traded. The CBOT now offers 48 futures and
option contracts (with the annual volume at more than 211 million in
2001).The CBOE is the largest exchange for trading stock options. The
CBOE trades options on the S&P 100 and the S&P 500 stock indices. The
Philadelphia Stock Exchange is the premier exchange for trading foreign
options.
The most traded stock indices include S&P 500, the Dow Jones
Industrial Average, the Nasdaq 100, and the Nikkei 225. The US indices and

55

the Nikkei 225 trade almost round the clock. The N225 is also traded on the
Chicago Mercantile Exchange.

56

12. INDIAN DERIVATIVES MARKET

Starting from a controlled economy, India has moved towards a world where
prices fluctuate every day. The introduction of risk management instruments
in India gained momentum in the last few years due to liberalisation process
and Reserve Bank of Indias (RBI) efforts in creating currency forward
market. Derivatives are an integral part of liberalisation process to manage
risk. NSE gauging the market requirements initiated the process of setting up
derivative markets in India. In July 1999, derivatives trading commenced in
India
Table 2. Chronology of instruments
1991
Liberalisation process initiated
14 December 1995 NSE asked SEBI for permission to trade index
futures.
18 November 1996 SEBI setup L.C.Gupta Committee to draft a policy
11 May 1998
7 July 1999

framework for index futures.

L.C.Gupta Committee submitted report.
RBI gave permission for OTC forward rate

24 May 2000

agreements (FRAs) and interest rate swaps.

SIMEX chose Nifty for trading futures and options

25 May 2000

on an Indian index.
SEBI gave permission to NSE and BSE to do index

9 June 2000
12 June 2000

futures trading.
Trading of BSE Sensex futures commenced at BSE.
Trading of Nifty futures commenced at NSE.

57

25

September Nifty futures trading commenced at SGX.

2000
2 June 2001

Individual Stock Options & Derivatives

(1) Need for derivatives in India today

In less than three decades of their coming into vogue, derivatives markets
have become the most important markets in the world. Today, derivatives
have become part and parcel of the day-to-day life for ordinary people in
major

part

of

the

world.

Until the advent of NSE, the Indian capital market had no access to the latest
trading methods and was using traditional out-dated methods of trading.
There was a huge gap between the investors aspirations of the markets and
the available means of trading. The opening of Indian economy has
precipitated the process of integration of Indias financial markets with the
international financial markets. Introduction of risk management instruments
in India has gained momentum in last few years thanks to Reserve Bank of

58

Indias efforts in allowing forward contracts, cross currency options etc.

which have developed into a very large market.
(2) Myths and realities about derivatives
In less than three decades of their coming into vogue, derivatives markets
have become the most important markets in the world. Financial derivatives
came into the spotlight along with the rise in uncertainty of post-1970, when
US announced an end to the Bretton Woods System of fixed exchange rates
leading to introduction of currency derivatives followed by other
innovations including stock index futures. Today, derivatives have become
part and parcel of the day-to-day life for ordinary people in major parts of
the world. While this is true for many countries, there are still apprehensions
about the introduction of derivatives. There are many myths about
derivatives but the realities that are different especially for Exchange traded
derivatives, which are well regulated with all the safety mechanisms in
place.
What are these myths behind derivatives?
Derivatives increase speculation and do not serve any economic
purpose
Indian Market is not ready for derivative trading

59

 Disasters prove that derivatives are very risky and highly leveraged
instruments.
Derivatives are complex and exotic instruments that Indian investors
will find difficulty in understanding
Is the existing capital market safer than Derivatives?
(i) Derivatives increase speculation and do not serve any economicpurpose:
Numerous studies of derivatives activity have led to a broad consensus, both
in the private and public sectors that derivatives provide numerous and
substantial benefits to the users. Derivatives are a low-cost, effective method
for users to hedge and manage their exposures to interest rates, commodity
prices or exchange rates. The need for derivatives as hedging tool was felt
first in the commodities market. Agricultural futures and options helped
farmers and processors hedge against commodity price risk. After the fallout
of Bretton wood agreement, the financial markets in the world started
undergoing radical changes. This period is marked by remarkable
innovations in the financial markets such as introduction of floating rates for
the currencies, increased trading in variety of derivatives instruments, online trading in the capital markets, etc. As the complexity of instruments
increased many folds, the accompanying risk factors grew in gigantic

60

proportions. This situation led to development derivatives as effective risk

management tools for the market participants.

Looking at the equity market, derivatives allow corporations and

institutional investors to effectively manage their portfolios of assets and
liabilities through instruments like stock index futures and options. An
equity fund, for example, can reduce its exposure to the stock market
quickly and at a relatively low cost without selling off part of its equity
assets by using stock index futures or index options.

By providing investors and issuers with a wider array of tools for

managing risks and raising capital, derivatives improve the allocation of
credit and the sharing of risk in the global economy, lowering the cost of
capital formation and stimulating economic growth. Now that world markets
for trade and finance have become more integrated, derivatives have
strengthened these important linkages between global markets, increasing
market liquidity and efficiency and facilitating the flow of trade and finance

(ii) Indian Market is not ready for derivative trading

61

Often the argument put forth against derivatives trading is that the Indian
capital market is not ready for derivatives trading. Here, we look into the
pre-requisites, which are needed for the introduction of derivatives, and how
Indian market fares:
TABLE 3.
PRE-REQUISITES
INDIAN SCENARIO
Large
market India is one of the largest market-capitalised
Capitalisation

countries in Asia with a market capitalisation of

more than Rs.765000 crores.

High Liquidity in the The daily average traded volume in Indian

underlying

capital market today is around 7500 crores.

Which means on an average every month 14%
of the countrys Market capitalisation gets
traded. These are clear indicators of high
liquidity in the underlying.

Trade guarantee

The first clearing corporation guaranteeing

trades has become fully functional from July
1996 in the form of National Securities Clearing
Corporation (NSCCL). NSCCL is responsible
for guaranteeing all open positions on the
62

National Stock Exchange (NSE) for which it

does the clearing.
A Strong Depository

National

Securities

Depositories

Limited

(NSDL) which started functioning in the year

1997 has revolutionalised the security settlement
in our country.
A Good legal guardian

In the Institution of SEBI (Securities and

Exchange Board of India) today the Indian
capital market enjoys a strong, independent, and
innovative legal guardian who is helping the
market to evolve to a healthier place for trade
practices.

(3) Comparison of New System with Existing System

Many people and brokers in India think that the new system of Futures &
Options and banning of Badla is disadvantageous and introduced early, but I
feel that this new system is very useful especially to retail investors. It
increases the no of options investors for investment. In fact it should have
been introduced much before and NSE had approved it but was not active
because of politicization in SEBI.
63

The figure 3.3a 3.3d shows how advantages of new system (implemented
from June 20001) v/s the old system i.e. before June 2001
New System Vs Existing System for Market Players

Figure 3.3a
Speculators

Existing

Approach

SYSTEM

Peril &Prize Approach

1) Deliver based

1) Both profit &

New

Peril &Prize
1)Buy &Sell stocks

1)Maximum
Trading, margin

loss to extent of

on delivery basis

loss

price change.

2) Buy Call &Put

to

possible
trading & carry
premium
forward transactions.

by paying

64

paid

2) Buy Index Futures

premium

hold till expiry.

Advantages
Greater Leverage as to pay only the premium.
Greater variety of strike price options at a given time.

Figure 3.3b

Arbitrageurs

Existing

SYSTEM

65

New

Approach

Peril &Prize

Approach

Peril &Prize

1) Buying Stocks in 1) Make money

1) B Group more

1) Risk free

one and selling in

promising as still

game.

whichever way

another exchange.

the Market moves.

forward transactions.

in weekly settlement
2) Cash &Carry

2) If Future Contract

arbitrage continues

more or less than Fair price

Fair Price = Cash Price + Cost of Carry.

Figure 3.3c

Hedgers

Existing

SYSTEM

66

New

Approach

Peril &Prize

1) Difficult to

Approach

1) No Leverage

Peril &Prize
1)Fix price today to buy

1)

Additional
offload holding

available risk

latter by paying premium.

cost is only
during adverse

reward dependant

2)For Long, buy ATM Put

premium.
market conditions

on market prices

Option. If market goes up,

as circuit filters

long position benefit else

limit to curtail losses.

exercise the option.

3)Sell deep OTM call option
with underlying shares, earn
premium + profit with increase

prcie

Advantages
Availability of Leverage

Figure 3.3d
Small Investors
67

Existing

Approach

SYSTEM

Peril &Prize

1) If Bullish buy

Approach

1) Plain Buy/Sell

New

Peril &Prize
1) Buy Call/Put options

1)

Downside
stocks else sell it.

implies unlimited

based on market outlook

remains
profit/loss.

2) Hedge position if

protected &
holding underlying
upside
stock
unlimited.
Advantages
Losses Protected.

68

4. Exchange-traded vs. OTC derivatives markets

The OTC derivatives markets have witnessed rather sharp growth over the
last few years, which has accompanied the modernization of commercial and
investment banking and globalisation of financial activities. The recent
developments in information technology have contributed to a great extent
to these developments. While both exchange-traded and OTC derivative
contracts offer many benefits, the former have rigid structures compared to
the latter. It has been widely discussed that the highly leveraged institutions
and their OTC derivative positions were the main cause of turbulence in
financial markets in 1998. These episodes of turbulence revealed the risks
posed to market stability originating in features of OTC derivative
instruments and markets.

The OTC derivatives markets have the following features compared to

exchange-traded derivatives:
1. The management of counter-party (credit) risk is decentralized and
located within individual institutions,
2. There are no formal centralized limits on individual positions,
leverage, or margining,
3. There are no formal rules for risk and burden-sharing,

69

4. There are no formal rules or mechanisms for ensuring market stability

and integrity, and for safeguarding the collective interests of market
participants, and
5. The OTC contracts are generally not regulated by a regulatory
authority and the exchanges self-regulatory organization, although
they are affected indirectly by national legal systems, banking
supervision and market surveillance.

Some of the features of OTC derivatives markets embody risks to financial

market stability.

The following features of OTC derivatives markets can give rise to

instability in institutions, markets, and the international financial system: (i)
the dynamic nature of gross credit exposures; (ii) information asymmetries;
(iii) the effects of OTC derivative activities on available aggregate credit;
(iv) the high concentration of OTC derivative activities in major institutions;
and (v) the central role of OTC derivatives markets in the global financial
system. Instability arises when shocks, such as counter-party credit events
and sharp movements in asset prices that underlie derivative contracts, occur
which significantly alter the perceptions of current and potential future credit

70

exposures. When asset prices change rapidly, the size and configuration of
counter-party exposures can become unsustainably large and provoke a rapid
unwinding of positions.

There has been some progress in addressing these risks and perceptions.
However, the progress has been limited in implementing reforms in risk
management, including counter-party, liquidity and operational risks, and
OTC derivatives markets continue to pose a threat to international financial
stability. The problem is more acute as heavy reliance on OTC derivatives
creates the possibility of systemic financial events, which fall outside the
more formal clearing house structures. Moreover, those who provide OTC
derivative products, hedge their risks through the use of exchange traded
derivatives. In view of the inherent risks associated with OTC derivatives,
and their dependence on exchange traded derivatives, Indian law considers
them illegal.

71

5. FACTORS CONTRIBUTING TO THE GROWTH OF DERIVATIVES:

Factors contributing to the explosive growth of derivatives are price

volatility, globalisation of the markets, technological developments and
advances in the financial theories.

A.} PRICE VOLATILITY

A price is what one pays to acquire or use something of value. The objects
having value maybe commodities, local currency or foreign currencies. The
concept of price is clear to almost everybody when we discuss commodities.
There is a price to be paid for the purchase of food grain, oil, petrol, metal,
etc. the price one pays for use of a unit of another persons money is called
interest rate. And the price one pays in ones own currency for a unit of
another currency is called as an exchange rate.

72

Prices are generally determined by market forces. In a market, consumers

have demand and producers or suppliers have supply, and the collective
interaction of demand and supply in the market determines the price. These
factors are constantly interacting in the market causing changes in the price
over a short period of time. Such changes in the price are known as price
volatility. This has three factors: the speed of price changes, the frequency
of price changes and the magnitude of price changes.

The changes in demand and supply influencing factors culminate in market

adjustments through price changes. These price changes expose individuals,
producing firms and governments to significant risks. The break down of the
BRETTON WOODS agreement brought and end to the stabilising role of
fixed exchange rates and the gold convertibility of the dollars. The
globalisation of the markets and rapid industrialisation of many
underdeveloped countries brought a new scale and dimension to the markets.
Nations that were poor suddenly became a major source of supply of goods.
The Mexican crisis in the south east-Asian currency crisis of 1990s has also
brought the price volatility factor on the surface. The advent of
telecommunication and data processing bought information very quickly to

73

the markets. Information which would have taken months to impact the
market earlier can now be obtained in matter of moments.
Even equity holders are exposed to price risk of corporate share fluctuates
rapidly.
These price volatility risks pushed the use of derivatives like futures and
options increasingly as these instruments can be used as hedge to protect
against adverse price changes in commodity, foreign exchange, equity shares
and bonds.

B.} GLOBALISATION OF MARKETS

Earlier, managers had to deal with domestic economic concerns; what
happened in other part of the world was mostly irrelevant. Now globalisation
has increased the size of markets and as greatly enhanced competition .it has
benefited consumers who cannot obtain better quality goods at a lower cost.
It has also exposed the modern business to significant risks and, in many
cases, led to cut profit margins

In Indian context, south East Asian currencies crisis of 1997 had affected the
competitiveness of our products vis--vis depreciated currencies. Export of
certain goods from India declined because of this crisis. Steel industry in

74

1998 suffered its worst set back due to cheap import of steel from south East
Asian countries. Suddenly blue chip companies had turned in to red. The
fear of china devaluing its currency created instability in Indian exports.
Thus, it is evident that globalisation of industrial and financial activities
necessitates use of derivatives to guard against future losses. This factor
alone has contributed to the growth of derivatives to a significant extent.

C.} TECHNOLOGICAL ADVANCES

A significant growth of derivative instruments has been driven by
technological breakthrough. Advances in this area include the development
of high speed processors, network systems and enhanced method of data
entry. Closely related to advances in computer technology are advances in
telecommunications.

Improvement

in

communications

allow

for

instantaneous worldwide conferencing, Data transmission by satellite. At the

same time there were significant advances in software programmes without
which computer and telecommunication advances would be meaningless.
These facilitated the more rapid movement of information and consequently
its instantaneous impact on market price.

75

Although price sensitivity to market forces is beneficial to the economy as a

whole resources are rapidly relocated to more productive use and better
rationed overtime the greater price volatility exposes producers and
consumers to greater price risk. The effect of this risk can easily destroy a
business which is otherwise well managed. Derivatives can help a firm
manage the price risk inherent in a market economy. To the extent the
technological developments increase volatility, derivatives and risk
management products become that much more important.

D.} ADVANCES IN FINANCIAL THEORIES

Advances in financial theories gave birth to derivatives. Initially forward
contracts in its traditional form, was the only hedging tool available. Option
pricing models developed by Black and Scholes in 1973 were used to
determine prices of call and put options. In late 1970s, work of Lewis
Edeington extended the early work of Johnson and started the hedging of
financial price risks with financial futures. The work of economic theorists
gave rise to new products for risk management which led to the growth of
derivatives in financial markets.
The above factors in combination of lot many factors led to growth of
derivatives instruments

76

13. DEVELOPMENT OF DERIVATIVES MARKET IN INDIA

The first step towards introduction of derivatives trading in India was the
promulgation of the Securities Laws (Amendment) Ordinance, 1995, which
withdrew the prohibition on options in securities. The market for derivatives,
however, did not take off, as there was no regulatory framework to govern
trading of derivatives. SEBI set up a 24member committee under the
Chairmanship of Dr.L.C.Gupta on November 18, 1996 to develop
appropriate regulatory framework for derivatives trading in India. The
committee submitted its report on March 17, 1998 prescribing necessary
preconditions for introduction of derivatives trading in India. The
committee recommended that derivatives should be declared as securities
so that regulatory framework applicable to trading of securities could also
govern trading of securities. SEBI also set up a group in June 1998 under the
Chairmanship of Prof.J.R.Varma, to recommend measures for risk
containment in derivatives market in India. The report, which was submitted
in October 1998, worked out the operational details of margining system,
methodology for charging initial margins, broker net worth, deposit
requirement and realtime monitoring requirements. The Securities Contract
Regulation Act (SCRA) was amended in December 1999 to include

77

derivatives within the ambit of securities and the regulatory framework

were developed for governing derivatives trading. The act also made it clear
that derivatives shall be legal and valid only if such contracts are traded on a
recognized stock exchange, thus precluding OTC derivatives. The
government also rescinded in March 2000, the three decade old notification,
which prohibited forward trading in securities. Derivatives trading
commenced in India in June 2000 after SEBI granted the final approval to
this effect in May 2001. SEBI permitted the derivative segments of two
stock exchanges, NSE and BSE, and their clearing house/corporation to
commence trading and settlement in approved derivatives contracts. To
begin with, SEBI approved trading in index futures contracts based on S&P
CNX Nifty and BSE30 (Sense) index. This was followed by approval for
trading in options based on these two indexes and options on individual
securities.

The trading in BSE Sensex options commenced on June 4, 2001 and the
trading in options on individual securities commenced in July 2001. Futures
contracts on individual stocks were launched in November 2001. The
derivatives trading on NSE commenced with S&P CNX Nifty Index futures
on June 12, 2000. The trading in index options commenced on June 4, 2001

78

and trading in options on individual securities commenced on July 2, 2001.

Single stock futures were launched on November 9, 2001. The index futures
and options contract on NSE are based on S&P CNX Trading and settlement
in derivative contracts is done in accordance with the rules, byelaws, and
regulations of the respective exchanges and their clearing house/corporation
duly approved by SEBI and notified in the official gazette. Foreign
Institutional Investors (FIIs) are permitted to trade in all Exchange traded
derivative products.

The following are some observations based on the trading statistics provided
in the NSE report on the futures and options (F&O):

Single-stock futures continue to account for a sizable proportion of the

F&O segment. It constituted 70 per cent of the total turnover during June
2002. A primary reason attributed to this phenomenon is that traders are
comfortable with single-stock futures than equity options, as the former
closely resembles the erstwhile badla system.

On relative terms, volumes in the index options segment continue to

remain poor. This may be due to the low volatility of the spot index.

79

Typically, options are considered more valuable when the volatility of the
underlying (in this case, the index) is high. A related issue is that brokers do
not earn high commissions by recommending index options to their clients,
because low volatility leads to higher waiting time for round-trips.

Put volumes in the index options and equity options segment have

increased since January 2002. The call-put volumes in index options have
decreased from 2.86 in January 2002 to 1.32 in June. The fall in call-put
volumes ratio suggests that the traders are increasingly becoming pessimistic
on the market.

Farther month futures contracts are still not actively traded. Trading in

equity options on most stocks for even the next month was non-existent.

Daily option price variations suggest that traders use the F&O

segment as a less risky alternative (read substitute) to generate profits from

the stock price movements. The fact that the option premiums tail intra-day
stock prices is evidence to this. If calls and puts are not looked as just
substitutes for spot trading, the intra-day stock price variations should not
have a one-to-one impact on the option premiums.

80

The spot foreign exchange market remains the most important

segment but the derivative segment has also grown. In the derivative
market foreign exchange swaps account for the largest share of the
total turnover of derivatives in India followed by forwards and
options. Significant milestones in the development of derivatives market
have been (i) permission to banks to undertake cross currency derivative
transactions subject to certain conditions (1996) (ii) allowing corporates
to undertake long term foreign currency swaps that contributed to
the development of the term currency swap market (1997) (iii) allowing
dollar rupee options (2003) and (iv) introduction of currency futures
(2008). I would like to emphasise that currency swaps allowed
companies with ECBs to swap their foreign currency liabilities into
rupees. However, since banks could not carry open positions the risk was
allowed to be transferred to any other resident corporate. Normally such
risks should be taken by corporates who have natural hedge or have
potential foreign exchange earnings.

But often corporate assume these

risks due to interest rate differentials and views on currencies.

81

This period has also witnessed several relaxations in regulations relating

to forex markets and also greater

liberalisation

in capital account

regulations leading to greater integration with the global economy.

Cash settled exchange traded currency futures have made foreign

currency a separate asset class that can be traded without any underlying
need or exposure a n d on a leveraged basis on the recognized stock
exchanges with credit risks being assumed by the central counterparty
Since the commencement of trading of currency futures in all the three
exchanges, the value of the trades has gone up steadily from Rs 17, 429
crores in October 2008 to Rs 45, 803 crores in December 2008. The
average daily turnover in all the exchanges has also increased from
Rs871 crores to Rs 2,181 crores during the same period. The turnover in
the currency futures market is in line with the international scenario,
where I understand the share of futures market ranges between 2 3 per
cent.

Table 4.1ForexMarketActivity

82

April05- April06- April07-

April08-

Total turnover (USD billion)

Mar06
4,404

Mar07
6,571

Mar08
12,304

Dec08
9,621

Inter-bank to Merchant ratio

2.6:1

2.7:1

2.37: 1

2.66:1

Spot/Total Turnover (%)

50.5

51.9

49.7

45.9

Forward/Total Turnover (%)

19.0

17.9

19.3

21.5

Swap/Total Turnover (%)

30.5

30.1

31.1

32.7

Source: RBI

14. BENEFITS OF DERIVATIVES

Derivative markets help investors in many different ways:
1.]

RISK MANAGEMENT

Futures and options contract can be used for altering the risk of investing in
spot market. For instance, consider an investor who owns an asset. He will
always be worried that the price may fall before he can sell the asset. He can
protect himself by selling a futures contract, or by buying a Put option. If the
spot price falls, the short hedgers will gain in the futures market, as you will
see later. This will help offset their losses in the spot market. Similarly, if the
spot price falls below the exercise price, the put option can always be
exercised.
2.]

PRICE DISCOVERY

83

Price discovery refers to the markets ability to determine true equilibrium

prices. Futures prices are believed to contain information about future spot
prices and help in disseminating such information. As we have seen, futures
markets provide a low cost trading mechanism. Thus information pertaining
to supply and demand easily percolates into such markets. Accurate prices
are essential for ensuring the correct allocation of resources in a free market
economy. Options markets provide information about the volatility or risk of
the underlying asset.
3.]

OPERATIONAL ADVANTAGES

As opposed to spot markets, derivatives markets involve lower transaction

costs. Secondly, they offer greater liquidity. Large spot transactions can
often lead to significant price changes. However, futures markets tend to be
more liquid than spot markets, because herein you can take large positions
by depositing relatively small margins. Consequently, a large position in
derivatives markets is relatively easier to take and has less of a price impact
as opposed to a transaction of the same magnitude in the spot market.
Finally, it is easier to take a short position in derivatives markets than it is to
sell short in spot markets.

84

4.]

MARKET EFFICIENCY

The availability of derivatives makes markets more efficient; spot, futures

and options markets are inextricably linked. Since it is easier and cheaper to
trade in derivatives, it is possible to exploit arbitrage opportunities quickly
and to keep prices in alignment. Hence these markets help to ensure that
prices reflect true values.

5.]

EASE OF SPECULATION

Derivative markets provide speculators with a cheaper alternative to

engaging in spot transactions. Also, the amount of capital required to take a
comparable position is less in this case. This is important because facilitation
of speculation is critical for ensuring free and fair markets. Speculators
always take calculated risks. A speculator will accept a level of risk only if
he is convinced that the associated expected return is commensurate with the
risk that he is taking.

The derivative market performs a number of economic functions.

85

 The prices of derivatives converge with the prices of the underlying at

the expiration of derivative contract. Thus derivatives help in
discovery of future as well as current prices.
An important incidental benefit that flows from derivatives trading is
that it acts as a catalyst for new entrepreneurial activity.
Derivatives markets help increase savings and investment in the long
run. Transfer of risk enables market participants to expand their
volume of activity.

15. National Exchanges

In enhancing the institutional capabilities for futures trading the idea
of setting up of National Commodity Exchange(s) has been pursued since
1999. Three such Exchanges, viz, National Multi-Commodity Exchange of
India Ltd., (NMCE), Ahmedabad, National Commodity & Derivatives
Exchange (NCDEX), Mumbai, and Multi Commodity Exchange (MCX),
Mumbai have become operational. National Status implies that these
exchanges would be automatically permitted to conduct futures trading in all

86

commodities subject to clearance of byelaws and contract specifications by

the FMC. While the NMCE, Ahmedabad commenced futures trading in
November 2002, MCX and NCDEX, Mumbai commenced operations in
October/ December 2003 respectively.

MCX
MCX (Multi Commodity Exchange of India Ltd.) an independent
and de-mutulised multi commodity exchange has permanent recognition
from Government of India for facilitating online trading, clearing and
settlement operations for commodity futures markets across the country. Key
shareholders of MCX are Financial Technologies (India) Ltd., State Bank of
India, HDFC Bank, State Bank of Indore, State Bank of Hyderabad, State
Bank of Saurashtra, SBI Life Insurance Co. Ltd., Union Bank of India, Bank
of

India, Bank of

Baroda,

Canera

Bank,

Corporation

Bank

Headquartered in Mumbai, MCX is led by an expert management

team with deep domain knowledge of the commodity futures markets. Today
MCX is offering spectacular growth opportunities and advantages to a large
cross section of the participants including Producers / Processors, Traders,

87

Corporate, Regional Trading Canters, Importers, Exporters, Cooperatives,

Industry Associations, amongst others MCX being nation-wide commodity
exchange, offering multiple commodities for trading with wide reach and
penetration and robust infrastructure.

MCX, having a permanent recognition from the Government of

India, is an independent and demutualised multi commodity Exchange.
MCX, a state-of-the-art nationwide, digital Exchange, facilitates online
trading, clearing and settlement operations for a commodities futures
trading.
NMCE
National Multi Commodity Exchange of India Ltd. (NMCE) was
promoted

by

Central

Warehousing

Corporation

(CWC),

National

Agricultural Cooperative Marketing Federation of India (NAFED), Gujarat

Agro-Industries Corporation Limited (GAICL), Gujarat State Agricultural
Marketing Board (GSAMB), National Institute of Agricultural Marketing
(NIAM), and Neptune Overseas Limited (NOL). While various integral
aspects of commodity economy, viz., warehousing, cooperatives, private and
public sector marketing of agricultural commodities, research and training
were adequately addressed in structuring the Exchange, finance was still a

88

vital missing link. Punjab National Bank (PNB) took equity of the Exchange
to establish that linkage. Even today, NMCE is the only Exchange in India to
have such investment and technical support from the commodity relevant
institutions.

NMCE facilitates electronic derivatives trading through robust and

tested trading platform, Derivative Trading Settlement System (DTSS),
provided by CMC. It has robust delivery mechanism making it the most
suitable for the participants in the physical commodity markets. It has also
established fair and transparent rule-based procedures and demonstrated
total commitment towards eliminating any conflicts of interest. It is the only
Commodity Exchange in the world to have received ISO 9001:2000
certification from British Standard Institutions (BSI). NMCE was the first
commodity exchange to provide trading facility through internet, through
Virtual Private Network (VPN).

NMCE follows best international risk management practices. The

contracts are marked to market on daily basis. The system of upfront
margining based on Value at Risk is followed to ensure financial security of
the market. In the event of high volatility in the prices, special intra-day

89

clearing and settlement is held. NMCE was the first to initiate process of
dematerialization and electronic transfer of warehoused commodity stocks.
The unique strength of NMCE is its settlements via a Delivery Backed
System, an imperative in the commodity trading business. These deliveries
are executed through a sound and reliable Warehouse Receipt System,
leading to guaranteed clearing and settlement.
NCDEX
National Commodity and Derivatives Exchange Ltd (NCDEX) is a
technology driven commodity exchange. It is a public limited company
registered under the Companies Act, 1956 with the Registrar of Companies,
Maharashtra in Mumbai on April 23,2003. It has an independent Board of
Directors and professionals not having any vested interest in commodity
markets. It has been launched to provide a world-class commodity exchange
platform for market participants to trade in a wide spectrum of commodity
derivatives

driven

by

best

global

practices,

professionalism

and

transparency.

Forward Markets Commission regulates NCDEX in respect of

futures trading in commodities. Besides, NCDEX is subjected to various

90

laws of the land like the Companies Act, Stamp Act, Contracts Act, Forward
Commission (Regulation) Act and various other legislations, which impinge
on its working. It is located in Mumbai and offers facilities to its members in
more than 390 centres throughout India. The reach will gradually be
expanded

to

more

centres.

NCDEX currently facilitates trading of thirty six commodities

- Cashew, Castor Seed, Chana, Chilli, Coffee, Cotton, Cotton Seed Oilcake,
Crude Palm Oil, Expeller Mustard Oil, Gold, Guar gum, Guar Seeds, Gur,
Jeera, Jute sacking bags, Mild Steel Ingot, Mulberry Green Cocoons, Pepper,
Rapeseed - Mustard Seed ,Raw Jute, RBD Palmolein, Refined Soy Oil, Rice,
Rubber, Sesame Seeds, Silk, Silver, Soy Bean, Sugar, Tur, Turmeric, Urad
(Black Matpe), Wheat, Yellow Peas, Yellow Red Maize & Yellow Soybean
Meal.
TABLE4: THE CURRENT PROFILE OF FUTURES TRADING IN INDIA
WITH RESPECT TO THE VARIOUS EXCHANGES IN INDIA:-

91

16. The Present Status:

92

Presently futures trading is permitted in all the commodities. Trading

is taking place in about 78 commodities through 25 Exchanges/Associations
as given in the table below:TABLE 4 Registered commodity exchanges in India

No.
1.

Exchange
COMMODITY
India Pepper & Spice Trade Pepper (both domestic
Association, Kochi (IPSTA)

and

international

2.

contracts)
Vijai Beopar Chambers Ltd., Gur, Mustard seed

3.

Muzaffarnagar
Rajdhani Oils

4.

Exchange Ltd., Delhi

& oilcake
Bhatinda Om & Oil Exchange Gur

&

Oilseeds Gur, Mustard seed its oil

Ltd.,
5.

Bhatinda
The Chamber

6.

Hapur
Mustard seed
The Meerut Agro Commodities Gur

7.

Exchange Ltd., Meerut

The
Bombay
Commodity Oilseed Complex, Castor

8.

Exchange Ltd., Mumbai

oil international contracts
Rajkot Seeds, Oil & Bullion Castor seed, Groundnut,

of

Commerce, Gur,

Merchants Association, Rajkot

93

Potatoes

and

its oil & cake, cottonseed,

its oil & cake, cotton

(kapas)
Ahmedabad

palmolein.
Commodity Castorseed,

and

9.

The

10.

Exchange, Ahmedabad
its oil and oilcake
The East India Jute & Hessian Hessian & Sacking

11.

Exchange Ltd., Calcutta

The
East
India

12.

Association Ltd., Mumbai

The Spices & Oilseeds Exchange Turmeric

13.

Ltd., Sangli.
National Board of Trade, Indore

RBD

cottonseed,

Cotton Cotton

Soya seed, Soyaoil and

Soya

meals,

Rapeseed/Mustardseed its
oil and oilcake and RBD
14.

Palmolien
The First Commodities Exchange Copra/coconut, its oil &

15.

of India Ltd., Kochi

oilcake
Central
India
Commercial Gur and Mustard seed

16.
17.

Exchange Ltd., Gwalior

E-sugar India Ltd., Mumbai
Sugar
National
Multi-Commodity Several Commodities
Exchange

18.

of

India

Ltd.,

Ahmedabad
Coffee Futures Exchange India Coffee

94

19.

Ltd., Bangalore
Surendranagar Cotton

20.

Oilseeds, Surendranagar
E-Commodities Ltd., New Delhi

21.

National

Oil

Commodity

Derivatives,

Exchange

& Cotton,

Cottonseed,

Kapas
Sugar (trading yet to

commence)
& Several Commodities
Ltd.,

22.

Mumbai
Multi Commodity Exchange Ltd., Several Commodities

23.

Mumbai
Bikaner commodity

Exchange Mustard seeds its oil &

Ltd., Bikaner
24.

Haryana

oilcake, Gram. Guar seed.

Guar Gum
Ltd., Mustard seed complex

Commodities

Hissar
25.
Bullion Association Ltd., Jaipur
Mustard seed Complex
17. STATUS REPORT OF THE DEVELOPMENTS IN THE DERIVATIVE
MARKET
1. The Board at its meeting on November 29, 2002 had desired that a
quarterly report be

submitted to the Board on the developments in the

derivative market. Accordingly, this memorandum presents a status report

for the quarter July-September 2008-09 on the developments in the
derivative market.

95

2. Equity Derivatives Segment

A. Observations on the quarterly data for July-September, 2008-09
During July-September 2008-09, the turnover at BSE was Rs.1,510
crore, which was insignificant as compared to that of NSE at Rs. 3,315,491
crore.

Refer Table 1

Volume (no. of contracts) increased by 42.06% to 1,698.7 lakh

while turnover increased by 24.77% to Rs. 3,317 thousand crore in
July-September 2008-09 over April-June 2008-09.
Futures (Index Future + Stock Future) constituted 67.20% of the total
number of contracts traded in the F&O Segment. Stock Future and
Index Future accounted for 35.26% and 31.94% respectively.
Options constituted 32.80% of the total volumes.

This mainly

comprised of trading in Index Option (30.68%).

Turnover at F&O segment was 4.19 times that of its cash segment.

Reliance, Reliance Capital Ltd, Reliance Petro. Ltd, State Bank of

India and ICICI Bank Ltd were the most actively traded scrips in

96

the

derivatives

segment. Together they contributed 25.12% of

derivatives turnover in individual stocks.

Client trading constituted 60.17%, Propriety trading constituted
31.07% and FII trading constituted remaining 8.76% of the total turnover.

Refer Table 2

Volume in longer dated derivative contracts (contracts with maturity

of more than three months and up to 3 years) was 3.99 lakh and
total turnover was Rs. 9870 crore.

Total volume in shorter dated derivative contracts (contracts with

maturity up to 3months) was 1,695 lakh and total turnover was Rs.
3,307 thousand crore.

Refer Table 3

97

 Volume in Mini Nifty (contracts with minimum lot size of Rs.1

lakh) was 44 lakh and total turnover was Rs. 37 thousand crore.

Refer Table 4

During July-September, 2008, S&P CNX Nifty futures recorded

highest average daily volatility of 2.85% in July 2008.

Refer Table 5

The volume (in terms of no. of contracts traded) of Nifty Future at

SGX as a percentage of the volume of Nifty Future at NSE
was 8.55% during July- September 2008-09.

Refer Table 6

India stands 2nd in Stock Futures, 2nd in Index Futures, 16th in

98

Stock Option and

4th in Index Options (as on November 10, 2008) in World

Derivatives Market

(in terms of volume) at the end of September

2008.

Derivative contracts were launched on 38 securities at National

Stock Exchange during July-September 2008-09.

Table-5: Fact file of July-September 2008-09 with respect to the previous

Market Depth

quarter

PRODUCT

APRIL-JUNE 2008-09
No.
of Turnover

JULY-SEPTEMBER2008-09
No.
of Turnover

Contracts(

Contracts(Lak

(Rs. 000)

Lakh)
VOLUME & TURNOVER
Index Future
415.7

h)
935.
6
571.

240.1
Stock

1,077.
542.6

Index Option
Single

(Rs. 000)

5
1,130.
521.2

3
1,093.

514.5

99

599.0

9
1,039.

Depth

Future
Stock Option
Total

1
25.5

58.3
2,658.

1,195.8

35.9

69.1
3,317.

1,698.7
4

Market Share ( %)
Index Future
35.2

1,077.5

31.94
0
21.4

Index Option

8
34.0
30.68

1,130.9
Single

32.4

9
41.1

Stock

Future
Stock Option
69.1
Turnover in F&O as

9
31.3
35.26

1,039.3

2
2.19

2.11

3
2.08

multiple of turnover in
4.19

Market Concentration

cash segment

3.26

Five

- Reliance

- Reliance Petro. Ltd.

- Reliance Capital Ltd

- Tata Steel

- Reliance Petro. Ltd

- Reliance Capital Ltd

- State Bank of India

most

active scrips in
the

F&O

Segment active
scrips

- Reliance

in

the

F&O Segment

100

- Infosys Tech. Ltd

- ICICI Bank Ltd

Contribution
of
five

the above
to total

(avg. of three monthsin

derivatives

23.72

25.12

turnover (%)
Client
(excluding FII

59.77

60.17

trades)
Proprietary
27.88
31.07
FII
12.35
8.76
Table-6: Data for Shorter Dated and Longer Dated derivative contracts

Time
Period

Trades in Shorter

Trades in Longer Dated

Dated derivative derivative contracts

101

contracts

(up

t o 3 more than 3 months)

Months)
No

(more
of

No

of

Turnover

Turnover

contracts

July-

contracts

September
Apr-Jun 20081,194.97

2,655.88

4.83

Table-7: Data for Mini Nifty derivative contracts

Time

Period No

of Turnover (Rs.

contract
JulySeptember

102

12.5

Apr-Jun 200829.4

103

27.7

Table-8: Minimum, Maximum and Average Daily Volatility of the F&O

segment at

NSE for S&P CNX Nifty since April 2008

Average

Maximum

Minimum

April-08
May-08
June-08
July-08
August-08

2.47
1.71
1.80
2.85
2.27

2.98
1.99
2.28
3.08

September-

2.2

2.5
1

08

2.6

2.05
1.56
1.61
2.38
2.10
2.09

Table-9: SGX volume as a percentage of NSE volume for Nifty Future in

terms of no. of contracts for the period April September, 2008-09

104

NSE
Volume

SGX
Volume

Month
July-

September
Apr-Jun
2008-

105

SGX
as

volume

Table-10: Standing of India in World Derivatives Market (in terms of

volume)

Septembe
r
Products
July 2008
Stock
1 August 2008
1
2
Index
2
2
2
Future
Stock
9
15
16
Future
Index
4
4
4
Option
Option
Source: www.world-exchanges.org (as on November 10, 2008)

Salient points for the 2nd quarter 2008-09

The volume (no. of contracts) and open interest in the derivatives

market has increased even when the underlying market is witnessing a
downward trend. This indicates that there are sufficient long

106

position holders who anticipate value proposition in a falling

market. Falling or rising markets on the back of low volumes may
be a cause of concern from the point of market integrity. However, as
observed from the data, under the present scenario the fall in the
market has been accompanied by high volumes.

In Index Option, there is a sharp increase in turnover (97.95%)

and volume (117.08%) during July-September 2008-09 over AprilJune 2008-09. Possible reasons for increase in options trading
activity can be attributed to increase in volatility. Market observers
believe that conditions across markets and asset classes have
become more volatile and uncertain in the recent past. Generally in
such conditions, many

people believe that options act as

"insurance" against adverse price movements while offering the

flexibility to benefit from possible favourable price movements at
the same time. Another reason which can be attributed to the
increase in activity is the new directive as per the Budget 2008-09
which states that STT would now be levied on the Option premium
instead of the strike price.

107

 In Index Future, both turnover (15.17%) and volume (30.53%)

have increased during July-September 2008-09 as compared to
April-June 2008-09.

There is a decrease in turnover (4.92%) in Single Stock Futures

during July- September 2008-09 as compared to April-June 2008-09.

Except Index Option, the market share of all other products has
decreased (both in terms of volume and turnover) in second quarter
of 2008-09 as compared to the first quarter of 2008-09.

There is a decrease in turnover (21.04%) and volume (17.39%) in

Longer Dated derivative contracts in second quarter of 2008-09 as
compared to the first quarter of 2008-09.

108

 Longer dated derivatives were launched in March 2008, but the

volumes have not picked up consequently.

For shorter dated derivative contracts, turnover increased by

24.52% whereas volume increased by 4.81% in second quarter of
2008-09 as compared to the first quarter of 2008-09.
During 2008-09, Mini Nifty volumes increased by 49.15% and
turnover increased by 33.43% during July-September 2008-09 over
April-June 2008-09.

109

18. Business Growth in Derivatives segment (NSE)

TABLE 11A Index futures
Year

No. of contracts

2008-09

4116649

2007-08

156598579

2006-07

81487424

2005-06

58537886

2004-05

21635449

2003-04

17191668

2002-03

2126763

2001-02

1025588

FIGURE 11A Number of contracts per year

110

INTERPRETATION: From the data and the bar diagram above, there is
high business growth in the derivative segment in India. In the year 2001-02,
the number of contracts in Index Future were 1025588 where as a significant
increase of 4116679 is observed in the year 2008-09.

Table 11B No of turnovers

Year

Turnover (Rs. Cr.)

2008-09

925679.96

2007-08

3820667.27

2006-07

2539574

2005-06

1513755

2004-05

772147

111

2003-04

554446

2002-03

43952

2001-02

21483

FIGURE 11B Turnover in Rs. Crores

INTERPRETATION:
From the data and above bar chart, there is high turn over in the derivative
segment in India. In the year 2001-02 the turnover of index future was
21483 where as a huge increase of 92567996 in the year 2008-09 are
observed.

112

TABLE 12A STOCK FUTURES

Year
2008-09
2007-08
2006-07
2005-06
2004-05
2003-04
2002-03
2001-02
2000-01

No. of contracts
51449737
203587952
104955401
80905493
47043066
32368842
10676843
1957856
-

FIGURE 12A Number of contracts per year in stock future

INTERPRETATION:
From the data and bar diagram above there were no stock futures available
but in the year 2001-02, it predominently increased to 1957856. Then there

113

was a huge increase of 20, 35, and 87,952 in the year 2007-08 but there was
a steady decline to 51449737 in the year 2008-09.

TABLE 12B NO OF TURNOVERS

Year

Turnover

(Rs. Crores)
2008-09
1093048.26
2007-08
7548563.23
2006-07
3830967
2005-06
2791697
2004-05
1484056
2003-04
1305939
2002-03
286533
2001-02
51515
2000-01
FIGURE 12B Turnover in Rs. Crores

114

INTERPRETATION:
From the data and bar chart above, there were no stock futures available in
the year 2000-01. There was a steady increase of stock future 51515 in the
year 2001-02. but in the year there was a huge increae of 7548563.23 in the
year 2007-08 with a considerable decline of 1093048.26 in the year 2008-09.

TABLE 13A INDEX OPTIONS

Year
2008-09
2007-08
2006-07
2005-06
2004-05
2003-04
2002-03
2001-02
2000-01

No. of contracts
24008627
55366038
25157438
12935116
3293558
1732414
442241
175900
-

FIGURE 13A Number of contracts per year

115

Interpretation:
From the data and bar chart above, the no of contracts of index option was
nil in the year 2000-2001. But there was a predominant increase of 1,75,900
in the year 2001-2002. In the year 2007-2008 there was a huge increase in
the index option contracts to 55366038 and a decline of 24008627 in the
year 2008-2009.

TABLE 13B Turnover per year in Rs. Crores

Turnover
Year
2008-09
2007-08

Crores)
71340.02
1362110.88
116

(Rs.

2006-07
2005-06
2004-05
2003-04
2002-03
2001-02
2000-01

791906
338469
121943
52816
9246
3765
-

FIGURE 13B Turnover per year in Rs. Crores

Interpretation:
From the data and bar chart above, there was no turnover in the year 20002001 for Index option. It slowly started increasing in the year 2000-2001 to
3765.But in the year 2007-2008 there was a huge increase of 1362110.088
and a sudden decline to 71340.02 observed in 2008-2009.

117

TABLE 14A STOCK OPTIONS

Year
2008-09
2007-08
2006-07
2005-06
2004-05
2003-04
2002-03
2001-02
2000-01

No. of contracts
2546175
9460631
5283310
5240776
5045112
5583071
3523062
1037529
-

FIGURE 14A Number of contracts traded per year in stock option

INTERPRETATION:
From the data and bar chart above the no of contracts of stock option in the
year 2000-2001 was nil. But there was a huge increase of 1037529 observed

118

in the year 2001-2002. It was 9460631 which was the the highest in the year
2007-2008. But a gradual decline of 2546175 in the year 2008-2009.

TABLE 14B National turnover in Rs. Crores per year

Year

Notional

2008-09
2007-08
2006-07
2005-06
2004-05
2003-04
2002-03
2001-02
2000-01

crores)
58335.03
359136.55
193795
180253
168836
217207
100131
25163
-

turnover

FIGURE 14B National turnover in Rs. Crores per year

119

(Rs.

Interpretation:
From the chart and the bar diagram above the stock option turnover in the
year 2000-2001 was nil. There was a slow increase of 25163 in the year
2001-2002. But a phenomenal increase of 359136.55 in the year 2007-2008,
and a decline of 58355.03 in the year 2008-2009.

TABLE 15A OVERALL TRADING

Year
2008-09
2007-08
2006-07
2005-06
2004-05
2003-04
2002-03

No. of contracts
119171008
425013200
216883573
157619271
77017185
56886776
16768909
120

Turnover (Rs. cr.)

2648403.30
13090477.75
7356242
4824174
2546982
2130610
439862

2001-02
2000-01

4196873
90580

101926
2365

FIGURE 15A Average daily turnovers in Rs. Crores

Interpretation:
From the data and bar chart above, the overall trading contracts in the year
2000-2001 was 90580 and huge increase of 119171008 in the year 20082009.
From the data and bar chart above the overall trading turnover in the year
2000-2001 was as low as 2365 but a predominant increase of 2648403.30
observed in the year 2008-2009.

121

TABLE 16 Overall trade description under NSE

Interest
Index

Stock

Index

Stock

Rate
Total

Futures

Futures

Options

Options

Future
s
No. Tu No.

Y No.

Turno No.

Turno No.

Notio

No.

Notio

ver

of

ver

of

nal

of

nal

a cont

(Rs.

contr

(Rs.

contr Turno contr

Turno co

r ract

cr.)

acts

cr.)

acts

ver

ntr er

(Rs.

(Rs.

act (R

cr.)

cr.)

s.

cr.

of

ver

acts

of rn

T
of u

ov contra
cts

r
n

(
R
s
.

c
122

r
.
92567

)
2

9.96

2
4
0
8
0
41166

51449

10930

2400

57134

25461

58335.

0.

119171 4

0
469

737

48.26

8627

0.02

75

03

00 008

3
0
.
9
3
2 15659

38206

20358

75485

5536

13621

94606

35913

0 8579

67.27

7952

63.23

6038

10.88

31

6.55

0.

0
425013 1

00 200

7
7

123

.
7
2

5
7

5
81487

25395

10495

38309

2515

79190

52833

19379

216883
0

424

74

5401

67

7438

10

6
573

7
2

2
4

2
58537

15137

80905

27916

1293

33846

52407

18025

157619
0

886

55

493

97

5116

76

4
271

6
2 21635

77214

47043

14840

3293

12194

50451

16883

0 449

066

56

558

12

4
770171 2
85

9
124

5
2

2
2

10
17191

55444

32368

13059

1732

55830

21720

52816
668

842

39

414

3
20 568867

78
71

0
2

76

4
2

0
4

0
3
0
21267
2

10676

28653

4422

43952
63

35230

10013

9246
843

41

167689 9
-

62

09

6
0
2
3
2 10255
0 88

21483

19578
56

51515

1759

3765

00

10375
29

25163

419687 1
3

6
125

2
2
0
2
0
3
0 90580

2365

90580
6

5
0
1

TABLE 17 AVERAGE DAILY TURNOVERS

Year

Av.

daily

2008-09

Crores)
45390.21

2007-08
2006-07

52153.30
29543

2005-06
2004-05
2003-04

19220
10167
8388

2002-03
2001-02

1752
410126

2000-01

11

turnover

(Rs.

Note:
Notional Turnover = (Strike Price + Premium) * Quantity
Index Futures, Index Options, Stock Options and Stock Futures were
introduced in June 2000, June 2001, July 2001 and November 2001
respectively.

127

FINDINGS & CONCLUSION

From the above analysis it can be concluded that:

1. Derivative market is growing very fast in the Indian Economy. The

turnover of Derivative Market is increasing year by year in the Indias
largest stock exchange NSE. In the case of index future there is a
phenomenal increase in the number of contracts. But whereas the
turnover is declined considerably. In the case of stock future there was
a slow increase observed in the number of contracts whereas a decline
was also observed in its turnover. In the case of index option there was
a huge increase observed both in the number of contracts and
turnover.

128

2. After analyzing data it is clear that the main factors that are driving
the growth of Derivative Market are Market improvement in
communication facilities as well as long term saving & investment is
also possible through entering into Derivative Contract. So these
factors encourage the Derivative Market in India.
3. It encourages entrepreneurship in India. It encourages the investor to
take more risk & earn more return. So in this way it helps the Indian
Economy by developing entrepreneurship. Derivative Market is more
regulated & standardized so in this way it provides a more controlled
environment. In nutshell, we can say that the rule of High risk & High
return apply in Derivatives. If we are able to take more risk then we
can earn more profit under Derivatives.

Commodity derivatives have a crucial role to play in the price risk

management process for the commodities in which it deals. And it can be
extremely beneficial in agriculture-dominated economy, like India, as the
commodity market also involves agricultural produce. Derivatives like
forwards, futures, options, swaps etc are extensively used in the country.
However, the commodity derivatives have been utilized in a very limited

129

scale. Only forwards and futures trading are permitted in certain commodity
items.
RELIANCE is the most active future contracts on individual
securities traded with 90090 contracts and RNRL is the next most active
futures contracts with 63522 contracts being traded.

RECOMMENDATIONS & SUGGESTIONS

RBI should play a greater role in supporting derivatives.

Derivatives market should be developed in order to keep it at par with

other derivative markets in the world.

Speculation should be discouraged.

There must be more derivative instruments aimed at individual

investors.

130

 SEBI should conduct seminars regarding the use of derivatives to

educate individual investors.

After study it is clear that Derivative influence our Indian

Economy up to much extent. So, SEBI should take necessary steps
for improvement in Derivative Market so that more investors can
invest in Derivative market.
There is a need of more innovation in Derivative Market because
in today scenario even educated people also fear for investing in
Derivative Market Because of high risk involved in Derivatives.

131

BIBLIOGRAPHY

Books referred:
Options Futures, and other Derivatives by John C Hull
Derivatives FAQ by Ajay Shah
NSEs Certification in Financial Markets: - Derivatives Core module
Financial Markets & Services by Gordon & Natarajan

Reports:
Report of the RBI-SEBI standard technical committee on exchange
traded Currency Futures
Regulatory Framework for Financial Derivatives in India by
Dr.L.C.GUPTA

Websites visited:
www.nse-india.com
www.bseindia.com
www.sebi.gov.in

132

 www.ncdex.com
www.google.com
www.derivativesindia.com

133

ABBREVATIONS
A
AMEX- America Stock Exchange
B
BSE- Bombay Stock Exchange
BSI- British Standard Institute
C
CBOE - Chicago Board options Exchange
CBOT - Chicago Board of Trade
CEBB - Chicago Egg and Butter Board
CME - Chicago Mercantile Exchange
CNX- Crisil Nse 50 Index
CPE - Chicago Produce Exchange
CWC- Central Warehousing Corporation
D
DTSS- Derivative Trading Settlement System
F
FIIs- Foreign Institutional Investors
F & O Future and Options
FMC- Forward Markets Commission

134

FRAs- Forward Rate Agreements

G
GAICL-Gujarat Agro Industries Corporation Limited
GSAMB- Gujarat State Agricultural Marketing Board
I
IMM - International Monetary Market
IPSTA- India Pepper & Spice Trade Association
M
MCX Multi Commodity Exchange

135

N
NAFED-National Agricultural Co-Operative Marketing Federation Of India
NCDEX National Commodities and Derivatives Exchange
NIAM- National Institute Of Agricultural Marketing
NMSE- National Multi Commodity Exchange
NOL- Neptune Overseas Limited
NSCCL- National Securities Clearing Corporation
NSDL- National Securities Depositories Limited
NSE - National Stock Exchange
O
OTC- Over The Counter
P
PHLX - Philadelphia Stock Exchange
PNB- Punjab National Bank
R
RBI- Reserve Bank Of India
S
SC(R) A - Securities Contracts (Regulation) Act, 1956
SEBI- Securities Exchange Board Of India
SGX- Singapore Stock Exchange

136

SIMEX - Singapore International Monetary Exchange

V
VPN- Virtual Private Network

137