INDIAN INSTITUTE OF PLANNING AND MANAGEMENT

CHENNAI

THESIS
ON
FORMULATING THE USE OF DERIVATIVES STRATEGIES
IN
EQUITY MARKET

SUBMITTED BY
REUBEN DAVIS .J
UNDER THE GUIDANCE OF MR. BHASKAR REDDY
FINANCE
BATCH - PGP/FW/05-07
ALUMNI ID FW/FIN/00423

ABSTRACT
Financial markets are extremely volatile and hence the risk factor is an important concern
for financial agents. To eliminate this risk, the concept of derivatives comes into the
picture. During 2005 month of may stock market saw an historic crash, and investors lost
heavily because most of these investors did not hedge their risks by using equity
derivatives. And which strategies to use in growing, static, declining market.
Given the importance of derivatives in an emerging market like India it is no wonder that
share broking firms are investing heavily in building up infrastructure and mining up
cliental base to increase market share. The latest trend in the market shows retail
investors are responding in line with the institutional investors which requires efficient
traders to make them understand about the F&O strategies. Indian stock market is also act
in line with performance of the overseas markets; recent market trend clearly gives an
indication, where proper derivative strategies could have saved investors from huge
losses. Now as the market is showing a growth trend there is an ample opportunity to the
investors to take proper strategies to play in the market and adhere to the popular saying
BE FEARFUL WHEN OTHERS ARE GREEDY, AND BE GREEDY WHEN OTHERS
ARE FEARFUL ie take proper hedging positions even when the market is in uptrend,
Hence Equity derivatives are very important for a volatile market like in India,
As Nowadays traders are aware of these popular strategies but they are not aware of
which situations to apply these derivatives strategies in the market
The market methodology followed is primary data collected from a channel of network
that involves independent
- Large retailers, Financial institutions, Banks, HNIs, Fund houses, Brokers who use
these derivative strategies or use them on behalf of their clients.
- Also dealing room operations.The dealings of the firm with its client investors will
properly observed and studied in detail.
-

Questionnaire survey.

And secondary data from a host of book materials, and Derivatives materials
The expected outcomes from the thesis is to understand and apply how to use the concept
of equity strategies and under what market conditions these should be used. Equity
market strategies and try to beat the market by hedging positions and implies the use of
all the popular equity derivatives strategies with practical examples

THE INDIAN INSTITUTE OF PLANNING AND MANAGEMENT

CHENNAI

CERTIFICATE
This is to certify that the Thesis entitled Formulating the use of Derivatives strategies in
Equity Market is the original work and has been successfully carried out by Reuben
Davis.J in partial fulfillment of Post Graduate Diploma in Management under my
guidance during the academic year 05-07.

Date:

Prof. BHASKAR REDDY

(External Guide)

ACKNOWLEDGEMENTS
This Thesis has given me immense insights about the practical aspect of Derivative
strategies and its working. I got to learn a lot about the derivatives trading and the way
they handle their clients and projects. This project also helped me to improve my report
making skills and the true understanding of derivatives
Foremost I would like to thank my internal guide Prof R.Krishnan for approving this
topic and guiding me throughout the project. Then I would like to thank my external
guide Mr. Bhaskar Reddy without whom this project wouldnt be a success. He helped
me at each and every stage of this project.

Next I would like to thank all the respondents and all my colleagues at Motilal Oswal
Financial services who gave their valuable time and their insights on the research topic
without which it would be impossible.
Last but not the least want to thank God whose grace and mercy was with me throughout
this thesis preparation.

Reuben Davis.J

THESIS TOPIC APPROVAL (FIN) FW / 05-07

Dear Reuben,
I have received your synopsis as well as the confirmation that Prof. Bhasker Reddy
would guide you through the thesis. This letter is a formal approval to the topic proposed
by you Formulation of strategies in the use of Derivatives in equity market.
Please go ahead with the thesis.
Remember to register yourself at the IIPM-Chennai Library with Mr. Sekar
( r.sekar@iipm.edu ) and send me the id number for my records. Furthermore, you are
required to send me at least 6 Thesis Guidance Response Sheets every time you interact
with your Guide during the course of the Thesis. Once you send me the id number, I shall
email the thesis response sheet to you.
Regards,
R. Krishnan

TABLE OF CONTENTS
SR.NO
1
1.1
1.2
1.3
1.4
1.5
2
2.1
2.2
3
4
5
6
7
7.1
7.2
7.3
7.4

PARTICULARS
INTRODUCTORY ITEMS
Abstract
Signatory Page
Acknowledgement
Topic Approval Letter
Table of Contents
CONTENTS
Introduction
Literature Review
RESEARCH METHODOLOGY
RESEARCH ANALYSIS
RECOMMENDATION
CONCLUSION
ANNEXURE
Thesis Synopsis
Response Sheets
Questionnaire
Bibliography

PAGE NO.
2-8
2
4
5
6
7
8 - 10
11 - 50
51 - 53
54 - 70
71 - 73
74 - 75
76
77 - 78
79 84
85 - 88
89 - 90

2.1 INTRODUCTION

INTRODUCTION
Stock markets extremely risky and volatile and hence the risk consideration is an
important concern for investors. To reduce this risk, the concept of derivatives comes into
the picture. Derivatives trading commenced in India in June 2000, SEBI permitted the
derivative segments of two stock exchanges, NSE and BSE, and their clearing
house/corporation to commence trading and settlement in derivatives contracts, 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.
Single stock futures were launched on November 9, 2001. The index futures and options
contract on NSE are based on S&P CNX, at present Mutual Funds are permitted to
participate in the derivatives market for the purpose of hedging (minimizing risk) and rebalancing their portfolio.
The derivatives market performs a number of functions:
1. They help in transferring risks from risk averse people to risk oriented people
2. They help in the discovery of future as well as current prices
3. They give rise to entrepreneurial activity
4. They increase the volume traded in markets because of participation of risk averse
people in greater numbers
5. They increase savings and investment in the long run period

The market methodology followed is primary data collected from a channel of network
that involves independent
-

Large retailers, Financial institutions, Banks, HNIs, Fund houses, Brokers

who use these derivative strategies or use them on behalf of their clients.

- Also dealing room operations.The dealings of the firm with its client
investors will properly observed and studied in detail.
-

Questionnaire survey.

And secondary data from a host of book materials, and Derivatives materials
The expected outcomes from the thesis is to understand and apply how to use the concept
of equity strategies and under what market conditions one should use these Equity market
strategies and try to beat the market by hedging our holdings and implies the use of all
the popular equity derivatives strategies with practical examples

10

2.2 LITERATURE REVIEW

11

LITERATURE REVIEW
Meaning of Derivatives:
A Derivative are types of investments whose performance are amplified from the
performance of assets (such as commodities, shares or bonds), interest rates, exchange
rates, or indices (such as a stock market index like Nifty and Sensex). This performance
can determine both the amount of the payoffs. The diverse range of underlying assets and
payoff alternatives leads to a huge range of derivatives contracts available to be traded in
the financial market. The main types of Equity derivatives are futures and options
A very simple example of derivatives is curd, which is derivative of milk. The price of
curd depends upon the price of milk which in turn depends upon the demand and supply
of milk. See it this way. And the price of Cipla warrants depends upon the price of Cipla
shares. American depository receipts/global depository receipts of ICICI, Satyam and
Infosys traded on stock exchanges in the USA and England dont have their own values;
They draw their price from the underlying shares traded in India. Even the value of
mutual fund units changes on a day to day basis. Dont mutual fund units draw their value
from the value of the portfolio of securities under the schemes; these examples prove that
derivatives are not so new to us.
Equity Futures :
Contracts which a investor or trader can buy to take advantage of the market and protect
against unwanted price movements ie buy hedging his portfolio against unwanted risks
arising from volatility of prices. Every time futures contract is bought a fixed margin
which is calculated per stock basis and trade on that margin basis is needed to be paid to
buy Infosys in lot sizes ie 200 or 300 lot size per stock, if bought in cash market full
amount need to be paid ,But if bought in futures it can be played on just the margin
amount and take advantage of market movements if the Infosys stock falls then the long
futures position loses But if the Infosys stock rises then the Infosys position gains

12

Equity Options :
Contracts which give used by traders or investors wherein a call or put options is bought
ie the equivalent of long futures and short futures but unlike the futures position which
makes profit ,if the long futures make profits when underlying share prices rise,
Options the pay-off is only when exiting our positions so its less riskier than futures
which means the loss is restricted the loss is only to the premium amount paid and the
profit position is unlimited when into a Options contract the premium is paid and if in one
week the premium rises due to underlying market movements then the position can be
exited and make profits in that position

History of Derivatives
Derivatives trading in 1865 by Chicago Board of Trade listed the first exchange traded
futures contract in the USA. In 1919 The Chicago Butter and Egg Board, a spin-off of
CBOT, was formed to allow futures trading. Its name was changed to Chicago Mercantile
Exchange (CME). In April 1973, the Chicago Board of Options Exchange was set up
specifically for the purpose of trading in options. The market for options developed so
rapidly that by early 80s the number of shares underlying the option contract sold each
day exceeded the daily volume of shares traded on the New York Stock Exchange.
And there has been no looking back ever since then for Derivatives. (Ref: Wikipedia)

13

DERIVATIVES TRADING IN INDIA

The derivatives markets has existed for centuries as a result of the need for both users and
producers of natural resources to hedge against price fluctuations in the underlying
commodities. Although trading in agricultural and other commodities has been the
driving force behind the development of derivatives exchanges, the demand for products
based on financial instruments such as bond, currencies, stocks and stock indiceshave
now far outstripped that for the commodities contracts.
India has been trading derivatives contracts in silver, gold, spices, coffee, cotton and oil
etc for decades in the gray market. Trading derivatives contracts in organized market was
legal before Morarji Desais government banned forward contracts. Derivatives on stocks
were traded in the form of Teji and Mandi in unorganized markets. Recently futures
contract in various commodities were allowed to trade on exchanges. For example, now
cotton and oil futures trade in Mumbai, soybean futures trade in Bhopal, pepper futures in
Kochi, coffee futures in Bangalore etc. In June 2000, National Stock Exchange and
Bombay Stock Exchange started trading in futures on Sensex and Nifty. Options trading
on Sensex and Nifty commenced in June 2001.
Distinct groups of derivative contracts:
There are two groups of derivative contracts, which are distinguished by the way
that they are traded in market:
Over-the-counter (OTC) derivatives are contracts that are traded directly
between two parties, without going through an exchange like NSE and BSE
Swaps, forward rate agreements, and exotic options are almost always traded
in this way.
Exchange-traded derivatives are those derivatives that are traded via stock
exchanges. A stock exchange like NSE and BSE acts as an intermediary to all
transactions, and takes Initial margin from both sides of the trade to act as a
guarantee. There are host of Derivatives products available in NSE and BSE
in India.

14

Exchange-traded vs. OTC (Over the Counter) derivatives markets:

The OTC derivatives markets have seen sharp growth over the last years, which has
accompanied the development of commercial and investment banking and globalisation
of financial activities. The recent developments in IT have contributed to a great extent to
these developments. While both exchange-traded and OTC derivative contracts offer
many benefits, the former have rigid regulations 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 stock markets in the year 1998. These episodes of
turbulence revealed the risks posed to market stability coming from the features of OTC
derivative instruments and markets.
Recent Derivative products
Weekly Options:
Equity Futures & Options were introduced in India having a maximum life of months.
These options expire on the last Thursday of the expiring month. There was a need felt in
the market for options of shorter maturity. To cater to this need of the market participants
BSE launched weekly options on September 13, 2004 on 4 stocks and the BSE Sensex.
Weekly options have the same characteristics as that of the Monthly Stock Options
(stocks and indices) except that these options settle on Friday of every week. These
options are introduced on Monday of every week and have a maturity of 2 weeks,
expiring on Friday of the expiring week.

(Ref: www.bseindia.com)

15

Common contract types

There are three major classes of Derivatives contracts :
Forwards : Which are contracts to buy or sell an asset at a future date, between two
private parties Ex: Tea grower may enter into a contract with a wholesale buyer to sell
Tea at a particular price on a future date. The Tea buyer could have a mutually agreed
contract with the seller (Forward Contract).
Futures: Futures contract is a standardized contract, contracted 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. The futures price, naturally, converges towards the settlement price
on the delivery date.
Ex: Coffee grower may enter into a contract with a wholesale buyer to sell Coffee at a
particular price on a future date. He / she could buy a contract through a regulated market
like the Coffee Futures Exchange India Limited (COFEI). The National Stock Exchange
and the Bombay Stock Exchange offer such facilities for trading Futures contracts on an
underlying financial instrument like stocks/shares. Example: when you are dealing in
August Satyam futures contract the market lot, i.e. the minimum quantity that you can
buy or sell, is 1,200 shares of Satyam; the contract would expire on May 28, 2007; the
price is quoted per share; the tick size is 5 paise per share or (1,200 * 0.05) = Rs60 per
contract/market lot; the contract would be settled in cash; and the closing price in the
cash market on the expiry day would be settlement price

16

Difference between Forwards and Futures contract:

Futures contracts are traded on an exchange. Forward contracts are mutually agreed
between two parties. The only benefit of entering into a Forwards contract comes from
the flexibility of having tailor-made contracts. Forwards are important as prices in
Forward markets serve as indicator of Futures prices. Contracts on Futures markets are
fixed in terms of contract size, product type, product quality, expiry, and mode of
settlement. Futures markets, however, provide liquidity as contracts are traded on a
broader client base. Counter party risk is also eliminated in the Futures market as the
designated Clearinghouse becomes counter party to each trade that is, it acts as buyer to
seller and as a seller to the buyer and guarantees the trades.
Features of futures contracts:

Leveraged positions--only margin required for taking up positions

Trading in either direction--short/long positions

Index trading are possible

Hedging/Arbitrage opportunity exists

The settlement price is available

Advantages of Futures over cash trading:

In futures the investor can short sell/buy without having the stock and carry the
position for a long time, which is not possible in the cash market

An investor can buy and sell index instead of individual securities when he has a
general idea of the direction in which the market may move in the next few
months.

The investor is required to pay a small fraction of the value of the total contract as
margin. This means trading in stock index futures is a leveraged activity since the
investor is able to control the total value of the contract with a relatively small
amount of margin.

17

Example: Suppose the investor expects a Rs100 stock to go up by Rs10. One option
is to buy the stock in the cash segment by paying Rs100. He will then make Rs10 on
an investment of Rs100, giving about 10% returns. Alternatively he can take futures
position in the stock by paying Rs30 towards initial and mark-to-market margin. Here
he makes Rs10 on an investment of Rs30, i.e about 33% returns.

In the case of individual stocks, the positions, which remain outstanding on the
expiration date, will have to be settled by physical delivery, which is not the case
in futures.

Regulatory complexity is likely to be less in the case of stock index futures

compared to the other kinds of equity derivatives, such as stock index options,
individual stock options etc.

The next class of Derivative product is:

Options : Which are contracts that give the buyer the right (but not the obligation) to
buy or sell an asset at a specified future date. For entering into an option transaction
Example: Suppose you have bought a call option of 2,000 shares of Hindustan
Unilever Ltd (HUL) at a strike price of Rs250 per share. This option gives you the
right to buy 2,000 shares of HUL at Rs250 per share on or before May 28, 2007. The
seller of this call option who has given you the right to buy from him is under the
obligation to sell 2,000 shares of HUL at Rs250 per share on or before May 28, 2007
whenever asked.

18

Features of Options:

Limited risk, unlimited profit-call options

Higher returns, higher risk-put options

Positions in all market conditions/views

There are two types of Options: CALL and PUT.

CALL Option: Buyer of a Call Option on a particular stock gets the right to Buy
the underlying Stock, whereas Seller / Writer of the Call Option is obliged to Sell the
underlying stock when the buyer of Call decides to Exercise his / her Option. When the
spot / cash price is higher than the Strike price (plus cost), the buyer of Call could
exercise his right to buy at the Strike price.
Example: Suppose you have bought a call option of 2,000 shares of Hindustan Unilever
Ltd (HUL) at a strike price of Rs 250 per share. This option gives you the right to buy
2,000 shares of HUL at Rs250 per share on or before May 30, 2007. The seller of this call
option who has given you the right to buy from him is under the obligation to sell 2,000
shares of HUL at Rs250 per share on or before May 30, 2007 whenever asked.

PUT Option: Buyer of a Put Option on a particular Stock gets the right to Sell the
underlying Stock, whereas Seller/Writer of the Put Option is obliged to Buy the
underlying Stock if the buyer of Put decides to Exercise his / her Option. When the spot /
cash price (less cost) is lower than the Strike price, the buyer of Put could exercise his
right to sell at the Strike price.

19

Example: suppose you bought a put option of 2,000 shares of HLL at a strike price of
Rs250 per share. This option gives its buyer the right to sell 2,000 shares of HLL at
Rs250 per share on or before March 30, 2007. The seller of this put option who has given
you the right to sell to him is under obligation to buy 2,000 shares of HLL at Rs250 per
share on or before March 30, 2007 whenever asked.
Difference between Options and Futures:
Understanding Options requires understanding of concepts of right and obligation.
On entering an Option contract the buyer gets the right and the seller (also called the
writer) has the obligation/ gives the right. But in futures, both the buyer and the seller
are under obligation to fulfill the contract and the buyer and seller are subject to
unlimited risk of losing. But in Options, The seller is subject to unlimited risk of losing
whereas the buyer has a limited potential to lose, in futures the buyer and seller have
unlimited potential to gain, But in Options the seller of the option has limited potential to
gain while the buyer of the has unlimited potential to gain.
Swaps : where the two parties agree to exchange cash flows. The two commonly used
swaps are :
Interest rate swaps: These entail swapping only the interest related
cash flows between the parties in the same currency
Currency swaps : These entail swapping both principal and interest
between the parties, with the cashflows in one direction being in a
different currency than those in the opposite direction

20

PLAYERS IN THE DERIVATIVE MARKET :

The following three broad categories of participants are
Hedgers: Hedgers face risk associated with the price of an asset. They use futures or
options markets to reduce or eliminate this risk. A hedge is an investment that is taken out
specifically to reduce or cancel out the risk in another investment. The term comes from a
gambling saying "hedging your bets." Hedging is a strategy designed to minimize
exposure to an unwanted business risk, while still allowing the business to profit from an
investment activity. Typically, a hedger might invest in a security that he believes is
under-priced relative to its "fair value".

Ex: Take the case of investor who holds the shares of a company and gets uncomfortable
with market movements in the short run , He sees the value of his security falling from
Rs. 450 to Rs. 390 . In the absence of stock futures he would either suffer the discomfort
of a price fall or sell the security in anticipation of a market upheaval . with security
futures he can minimize his price risk All he need to do is enter into an offsetting stock
futures position , in this case take on a short futures position . Assume that the spot price
of the security he holds is Rs .390. Two-month futures cost him Rs. 402. For this he pays
an initial margin. Now if the price of the security he holds falls further he will suffer
losses on the security he holds. However the losses he suffers will be offset by the profit
he makes on his short futures position. Hedging, in its broadest sense, is the act of
protecting oneself against loss.

Hedging is not confined to the private sector, Governments also use it. Governments use
this to stabilize a countrys export earnings or to protect farmers producing export crops.
Some countries are already making extensive use of futures and options for this purpose.

21

Similarly, futures and options can be (and are) used by governments to hedge against
short-term rises in import prices (e.g. the price of crude oil).
Based on the above explanation hedging can thereof be described as a method of
protection against uncertainty. Since, in common and less rigorous parlance,
uncertainty is often referred to as risk, hedging can also be described as a form of
insurance against non-insurable risks. However it provides a lower degree of protection
than insurance since hedges are often only partially effective.
Speculators: If a futures market is restricted to hedgers alone, it is quite conceivable that
one or other group of hedgers would be unable to hedge without distorting the price
because of the absence of counter parties to the transactions. It is here that the role of the
speculator becomes apparent. It is the speculators who take up the slack in the market
and provide liquidity. The speculators have no specific interest in the commodity rather
they are risk seekers whose interest stems from the profit which they expect to make from
assuming the price risk.
Let us see the main use of speculation, we can say yes as there can be no effective
hedging since the volume of demand for long and short hedging will not be equal except
by occasional coincidence. It must be noted that the practice of speculation, by
facilitating hedging, reduces the costs of marketing. Secondly, speculative activity
increases the liquidity of markets thereby enabling hedgers to transact large volumes of
business on the market quickly, easily and without unduly affecting the market price.

Arbitrageurs: Arbitrage can be described as a transaction involves buying and selling a

good or asset in two different markets in order to achieve a risk less profit through the
difference in price between them. In a broadest sense we can say an arbitrageur is one
who trades only to realize profits from discrepancies in the market. Of course, in practice
the arbitrageur is not a separate person; either a hedger or a speculator can indulge in
arbitrage when the opportunity arises. Arbitrage plays a big role in ensuring that prices in

22

futures markets do not diverge from the level dictated by supply and demand and in
ensuring speedy correction of any pricing anomalies.

Example:
On a particular day, the shares of TNPL are selling at Rs. 82 in the Bombay Stock
Exchange while at the same time the price in the Delhi Stock Exchange is Rs. 80.A
stockbroker simultaneously buys the share in Delhi and sells it in Bombay. By so doing
he realizes a profit of Rs. 2 without any risk and with hardly any capital (barring any
margin required to put through the trade). This is an arbitrage transaction.

DERIVATIVES ARE USED WIDELY BECAUSE:

Leveraged positions

Lower margins than the margin funding

Index trading--market directional trading

Hedging of portfolio

Through index, covered calls, options buying

Structured products for higher yields

Allows taking position in any market condition--bullish, bearish, volatile or

neutral.

The risks involved in trading on derivatives are:

Futures carry similar risks as their underlying stocks. The maximum risk to the
buyer of an Option is limited to the Premium paid. For a seller / writer the risk
increases considerably as the market moves against him / her. The writer is at risk
of having his / her position assigned by a profitable buyer who Exercises his / her
position. NSE requires individual investors to maintain adequate amounts as
margins against risk of loss.

23

Futures trading are inherently riskier than trading in cash because of the higher
values of contracts involved. For example: A trader could buy/sell 15
INFOSYSTCH at say Rs.4000.00 in cash market. In the Futures market a
minimum of 100 (one lot) INFOSYSTCH has to be traded. Hence the total value
of trade has increased from Rs.60,000.00 in cash market to Rs.4,00,000.00 in the
Futures Market. A fall of Rs.20.00 in cash market amounts to a loss of Rs.300.00
as against a loss of Rs.2000.00 in the Futures market.

Advanced concepts in derivatives:

Stocks that can be traded in derivatives segment:

Currently on the NSE 120 stocks are trading in the derivatives markets. Contract sizes are
determined by the exchange. For example the contract size for Satyam Computer is 600
stocks. That is, each trade has to be a minimum quantity of 600 Satyam Computer stocks.
They could also be traded in larger quantities like 1200, 1800 etc.
Previous days closing price of the underlying stock acts as the base price for introduction
of new Futures contracts in the beginning of a new month. The daily Futures settlement
price acts as the base price for subsequent days. There is no minimum/maximum Price
Bands. However, to prevent operating errors 20% of the base price is maintained as an
operating range.
Options are exercised by:
Stock options on the NSE are American Options. That is, they can be exercised on any
day before expiry date. On the other hand NIFTY Options are European Options. That
is, they can be exercised only on the day of expiry.
Exercise prices:

24

The price at which Exercise takes place is days closing price of underlying stock. When
a buyer Exercises his / her position a sellers position automatically gets assigned. Once
the position is Exercised / Assigned this position ceases to exist.
Meaning of In-the-money Option:
Options that provide the holder positive cash flows if exercised immediately are called
In-the-Money options.
Meaning of At-the-money Option:
Options that provide the holder zero cash flows if exercised immediately are called At-the
Money options.
Meaning of Out-of-money Option:
Ones that provide negative cash flows if exercised immediately are called Out-of-money
Options.
The out flows while trading in Options are:
The buyer of an option pays a small amount as Premium to the seller for privilege of
getting the right to exercise his / her option. It is also the maximum amount that the buyer
stands to lose when the market moves against his / her expectations. This amount is due
on T+1. Similarly, the seller of options receives the premium amount on T+1. Here, T is
the day of trading.
There are two levels of margins to be paid at the client level. Initial Margin and
Marked-to-market margin.

Initial Margin amount is charged upfront. This value determines the gross
exposure to be taken by the investor. The extent of exposure given on a particular
margin amount depends on several factors including the Volatility of the scrip, the
Open interest on the scrip, and the extent of Hedging used. NSE uses software
called SPAN to calculate margins. Up to 30% of total Initial margin can be paid in
stocks.

25

Mark to Market margin (MTM): A minimum percentage of Initial margin value

is required to be maintained as marked-to-market margin. This margin acts as a
security against intra-day losses. This percentage could be up to 20% of IM.

Variance margin: On a particular day, the difference between the Contract price
and Closing price of the underlying scrip determines the net gain or loss on the
contract. Any debits/losses above the MTM margin is required to be paid on the
next day of the trade (T+1). (See annexure)

Pricing Futures:
Pricing of Futures contract is very simple. Using the cost of carry logic, It is by
calculating the fair value of a futures contract. Every time the observed price deviates
from the fair value, arbitragers would enter into trades to capture the arbitrage profit. This
in turn would push the futures price back to its fair value. The cost of carry model used
for pricing futures is given below:
F= SerT
Where,
r = Cost of financing (using continuously compounded interest rate)
T = time till expiration in years
e = 2.71828
Example: Security xyz ltd trades in the market at rs. 1150. Money can be invested at 11%
pa. The fair value of a one-month futures contract on xyz is calculated as follows:
F= SerT
= 1150*e0.11*1/12 = 1160.

26

Pricing Options:
An Option buyer has the right but not the obligation to exercise on the seller. The worst
that can happen to a buyer is the loss of the premium paid to him. His downside is limited
to this premium, but his upside is potentially unlimited. Just like other free markets, its
the supply and demand in the secondary market that drives the price on an option.
There are various models, which help us get close to the true price of the option.. The
Black-Scholes formulas for the prices of European calls and puts on a non-dividend
paying stock are:

C= SN (d1) Xe-rT N (d2)

P= Xe -rT N (-d2)-SN (-d1)
Where d1=

In s/x + (r+2 /2) T

Where d2=

d1-

27

Payoff for derivatives contracts:

A payoff is the likely profit/loss that would accrue to a market participant with change in
the price of the underlying asset. In this section we shall look at the payoffs for buyers
and sellers of futures and option.
Payoff for futures:
Futures contract has linear payoffs. In simple words it means that losses as well as profits
for the buyer and the seller of futures contract are unlimited. These linear payoffs are
fascinating as they can be combined with options and the underlying to generate various
complex payoffs.

Payoff for buyer for futures: long futures

The payoff for a person who buys a futures contract is similar to the payoff for person
who holds an asset. He has a potentially unlimited upside as well as potentially unlimited
downside take case of speculator who buys a two-month nifty index futures contract
when the nifty stands 4220. The underlying asset in this case is the nifty portfolio. When
the index moves up, it starts making profits and when the index moves down it starts
making losses.
Profit

4220

28

Nifty

Loss

Payoff for seller of futures: short futures:

The payoff for a person who sells a futures contract is similar to the payoff for person
who shorts an asset. He has a potentially unlimited upside as well as potentially unlimited
downside take case of speculator who sells a two month nifty index futures contract when
the nifty stands 4220. The underlying asset in this case is the nifty portfolio. When the
index moves down, it starts making profits and when the index moves up it starts making
losses.

Profit

4220
0
Nifty
Loss

Options payoffs

29

The optionality characteristics of options results in a non-linear payoff for options. In

simple words, it means that the losses for the buyer of an option are limited; however the
profits are potentially unlimited. For a writer, the payoff is exactly the opposite. His
profits are limited to the option premium; however his losses are potentially unlimited.

Payoff profile of buyer of asset: long asset

In this basic position, an investor buy the underlying asset, nifty for instance, for 4220
and sells it at a future date at unknown price, s`. Once it is purchased, the investor is said
to be long the asset.
Profit

+60
0

4160

4220

4280
Nifty

-60
Loss
Payoff profile for seller of asset: Short asset
In this basic position, an investor shorts the underlying asset, Nifty for instance, for 4220,
and buys it back at the future date at an unknown price, s`. Once it is sold, the investor is
said to be short the asset.
Profit

+60

30

4160

4220

4280
Nifty

-60
Loss

Payoff profiles for buyer of call options: Long call

A call option gives the buyer the right to buy the underlying asset at the strike price
specified in the option. The profit/loss that the buyer makes on the option depends on the
spot price of the underlying. If upon expiration, the spot price exceeds the strike price, he
makes a profit. Higher the spot price, more is the profit he makes. If the spot price of the
underlying is less than the strike price, he lets his option expire un-exercised. His loss in
this case is the premium he paid.
Profit

4250
0

Nifty

86.60
Loss

Payoff profiles for writer of call options: Short call

A call option gives the buyer the right to buy the underlying asset at the strike price
specified in the option. For selling the option, the writer of the option charges a premium.
The profit/loss that the buyer makes on the option depends on the spot price of the
underlying. Whatever is the buyers profit is the sellers loss. If upon expiration, the spot
price exceeds the strike price, the buyer will exercise the option on the writer. Hence as
the spot price increases the writer of the option starts making losses. Higher the spot
3

31

price, more is the loss he makes. If upon expiration the spot price of the underlying is less
than the strike price, the buyer lets his option expire un-exercised and the writer gets to
keep the premium.

Profit
86.60
4250
0
Nifty

Loss

Payoff profile for buyer of put option: Long put

A put option gives the buyer the right to sell the underlying asset at the strike price
specified in the option. The profit/loss that the buyer makes on the option depends on the
spot price of the underlying. If upon expiration, the spot price is below the strike price, he
makes a profit. Lower the spot price, more is the profit he makes. If the spot price of the
underlying is higher than the strike price, he lets his option expire un-exercised. His loss
in this case is the premium he paid for buying the option.

Profit

4250
0

Nifty

61.70

32

Loss

Payoff profile for writer of put option: Short put

A put option gives the buyer the right to sell the underlying asset at the strike price
specified in the option. For selling the option, the writer of the option charges a premium.
The profit/loss that the buyer makes on the option depends on the spot price of the
underlying. Whatever is the buyers profit is the sellers loss. If upon expiration, the spot
price happens to be below the strike price, the buyer will exercise the option on the
writer. If upon expiration, the spot price of the underlying is more than the strike price,
the buyer lets his option expire un-exercised and the writer gets to keep the premium.

Profit
61.70
4250
0

Nifty

Loss

33

Now we will look at the basic Equity Derivative strategies widely used
BASIC STRATEGIES IN EQUITY
BUY CALL

Pay-off

When very bullish on the stock

BUY PUT
When very bearish on stock
SELL PUT
When sure that the price will not fall
BULL SPREAD
Call option is bought with a lower strike price of and
another call option sold with a higher strike,
OR
Put option is bought with a strike of lower strike and
another put sold with a higher strike.
When the stock will go up somewhat or at least is a bit more
likely to rise than to fall
BEAR SPREAD
Put option is bought with a higher strike price and another
put option sold with a lower strike,
OR
Call option is bought with a higher strike price and another
call sold with a lower strike.
When the stock will go down somewhat or at least is a bit
more likely to fall than to rise.
3

34

SELL COVERED CALL

Call option against the stock holding is sold.
When sure that the price of the stock you hold will not fall.
BUY STRADDLE
Call option and put option are bought with the same strike usually at-the-money.
When the stock is expected to move far enough in either
direction in the short-term.
BUY STRANGLE
Put option is bought with a strike A and a call option is
bought with a strike B. ( A > B)
When the stock is expected to move far enough from the
predefined range.
BUY BUTTERFLY
Call option with low strike bought and two call options with
medium strike sold and call option with high strike bought.
The same position can be created with puts.
When the stock price is expected to fluctuate in a narrow
range.
SELL BUTTERFLY
Call option with low strike sold and two call options with
medium strike bought and call option with high strike sold.
The same position can be created with puts.
When the stock price are expected to move substantially

35

Using index futures

There are eight basic modes of trading on the index futures market:

Hedging

1. Long security, short Nifty futures

2. Short security, long Nifty futures
3. Have portfolio, short Nifty futures
4. Have funds, long Nifty futures

Speculation

1. Bullish index, long Nifty futures

2. Bearish index, short Nifty futures

Arbitrage

1. Have funds, lend them to the market

2. Have securities, lend them to the market

Ref: (NCFM Derivatives)

Hedging: Long security, short Nifty futures

A stock picker carefully purchases securities based on a sense that they are worth more
than the market price. When doing so, he faces two kinds of risks:
1. His understanding can be wrong, and the company is really not worth more than the
market price; or,
2. The entire market moves against him and generates losses even though the underlying
idea was correct.
The second outcome happens all the time. A person may buy Reliance at Rs.1911
thinking that it would announce good results and the security price would rise. A few
days later, Nifty drops, so he makes losses, even if his understanding of Reliance was
correct.
There is a peculiar problem here. Every buy position on a security is simultaneously a
buy position on Nifty. This is because a LONG RELIANCE position generally gains if
Nifty rises and generally loses if Nifty drops. In this sense, a LONG RELIANCE position
3

36

is not a focused play on the valuation of Reliance. It carries a LONG NIFTY position
along with it, as incidental baggage. The stock picker may be thinking he wants to be
LONG RELIANCE, but a long position on Reliance effectively forces him to be LONG
RELIANCE + LONG NIFTY.
There is a simple way out. Every time you adopt a long position on a security, you should
sell some amount of Nifty futures. This offsets the hidden Nifty exposure that is inside
every longsecurity position. Once this is done, you will have a position which is purely
about the performance of the security. The position LONG RELIANCE + SHORT
NIFTY is a pure play on the value of RELIANCE, without any extra risk from
fluctuations of the market index. When this is done, the stock picker has hedged away
his index exposure. The basic point of this hedging strategy is that the stock picker
proceeds with his core skill, i.e. picking securities, at the cost of lower risk.

Hedging: Short security, long Nifty futures

Investors studying the market often come across a security which they believe is
intrinsically Over-valued. It may be the case that the profits and the quality of the
company make it worth a lot less than what the market thinks. A stock picker carefully
sells securities based on a sense that they are worth less than the market price. In doing so
he faces two kinds of risks:
1. His understanding can be wrong, and the company is really worth more than the
market price; or,
2. The entire market moves against him and generates losses even though the underlying
idea was correct.
The second outcome happens all the time. A person may sell Reliance at Rs.1900
thinking that Reliance would announce poor results and the security price would fall. A
few days later, Nifty rises, so he makes losses, even if his intrinsic understanding of
Reliance was correct. There is a peculiar problem here. Every sell position on a security
is simultaneously a sell position on Nifty.

37

Hedging: Have portfolio, short Nifty futures

The only certainty about the capital market is that it fluctuates! A lot of investors who
own portfolios experience the feeling of discomfort about overall market movements.
Sometimes, they may have a view that security prices will fall in the near future. At other
times, they may see that the market is in for a few days or weeks of massive volatility,
and they do not have an appetite for this kind of volatility. The union budget is a common
and reliable source of such volatility: market volatility is always enhanced for one week
before and two weeks after a budget. Many investors simply do not want the fluctuations
of these three weeks.
When you have such anxieties, there are two alternatives:
1 Sell shares immediately. This sentiment generates panic selling which is rarely
optimal for the investor.
2 Do nothing, i.e. suffer the pain of the volatility. This leads to political pressures for
government to do something when security prices fall. In addition, with the index
futures market, a third and remarkable alternative becomes available:
3 Remove your exposure to index fluctuations temporarily using index futures. This
allows rapid response to market conditions, without panic selling of shares. It allows an
investor to be in control of his risk, instead of doing nothing and suffering the risk.
Every portfolio contains a hidden index exposure. This statement is true for all portfolios,
whether a portfolio is composed of index securities or not.

38

Hedging: Have funds, buy Nifty futures

Have you ever been in a situation where you had funds, which needed to get invested in
equity? Or of expecting to obtain funds in the future which will get invested in equity.
Some common occurrences of this include:

A closed-end fund that just finished its initial public offering has cash, which is
not yet invested.

Suppose a person plans to sell land and buy shares. The land deal is slow and
takes weeks to complete. It takes several weeks from the date that it becomes sure
that the funds will come to the date that the funds actually are in hand

An open-ended fund has just sold fresh units and has received funds.

Speculation: Bullish index, long Nifty futures

After a good budget, or good corporate results, or the onset of a stable government, many
people feel that the index would go up. An investor has two choices, he can buy selected
liquid securities, which move with the index, and sell them at a later date: or, buy the
entire index portfolio and then sell it at a later date.

Speculation: Bearish index, short Nifty futures

After a bad budget, or bad corporate results, or the onset of a coalition government, many
people feel that the index would go down. There is two choices sell selected liquid

39

securities, which move with the index, and buy them at a later date: or, sell the entire
index portfolio and then buy it at a later date.

Arbitrage: Have funds, lend them to the market

Most people would like to lend funds into the security market, without suffering the risk.
Traditional methods of loaning money into the security market suffer from (a) price risk
of shares and (b) credit risk of default of the counter-party. The main advantage of the
index futures market is that it supplies a technology to lend money into the market
without suffering any exposure to Nifty, and without bearing any credit risk.

Arbitrage: Have securities, lend them to the market

Owners of a portfolio of shares often think in terms of juicing up their returns by earning
revenues from stock lending. However, stock lending schemes that are widely accessible
do not exist in India. The index futures market offers a riskless mechanism for
(effectively) loaning out shares and earning a positive return for them.
The basic idea is quite simple. Investor will sell off all 50 securities in Nifty and buy
them back at a future date using the index futures. He will soon receive money for the
shares he has sold. He can deploy this money, as he like until the futures expiration. On
this date, he would buy back his shares, and pay for them.
Using futures on individual securities:
Hedging: Long security, sell futures
Stock futures can be used as an effective riskmanagement tool. Take the case of an
investor who holds the shares of a company and gets uncomfortable with market

40

movements in the short run. He sees the value of his security falling from Rs.450 to
Rs.390. In the absence of stock futures, he would either suffer the discomfort of a price
fall or sell the security in anticipation of a market upheaval. With security futures he can
minimize his price risk. All he need do is enter into an offsetting stock futures position, in
this case, take on a short futures position. Assume that the spot price of the security he
holds is Rs.390. Twomonth futures cost him Rs.402. For this he pays an initial margin.
Now if the price of the security falls any further, he will suffer losses on the security he
holds. However, the losses he suffers on the security, will be offset by the profits he
makes on his short futures position. Take for instance that the price of his security falls to
Rs.350. The fall in the price of the security will result in a fall in the price of futures.
Futures will now trade at a price lower than the price at which he entered into a short
futures position. Hence his short futures position will start making profits. The loss of
Rs.40 incurred on the security he holds, will be made up by the profits made on his short
futures position.
Speculation: Bullish security, buy futures
Take the case of a speculator who has a view on the direction of the market. He would
like to trade based on this view. He believes that a particular security that trades at
Rs.1000 is undervalued and expect its price to go up in the next twothree months. How
can he trade based on this belief? In the absence of a deferral product, he would have to
buy the security and hold on to it. Assume he buys a 100 shares which cost him one lakh
rupees. His hunch proves correct and two months later the security closes at Rs.1010. He
makes a profit of Rs.1000 on an investment of Rs.1,00,000 for a period of two months.
This works out to an annual return of 6 percent. Today a speculator can take exactly the
same position on the security by using futures contracts. Let us see how this works. The
security trades at Rs.1000 and the two-month futures trades at 1006. Just for the sake of
comparison, assume that the minimum contract value is 1,00,000. He buys 100 security
futures for which he pays a margin of Rs.20,000. Two months later the security closes at
1010. On the day of expiration, the futures price converges to the spot price and he makes
a profit of Rs.400 on an investment of Rs.20,000. This works out to an annual return of

41

12 percent. Because of the leverage they provide, security futures form an attractive
option for speculators.

Speculation: Bearish security, sell futures

Stock futures can be used by a speculator who believes that a particular security is over
valued and is likely to see a fall in price. How can he trade based on his opinion? In the
absence of a deferral product, there wasnt much he could do to profit from his opinion.
Today all he needs to do is sell stock futures. Let us understand how this works. Simple
arbitrage ensures that futures on an individual securities move correspondingly with the
underlying security, as long as there is sufficient liquidity in the market for the security. If
the security price rises, so will the futures price. If the security price falls, so will the
futures price.

Arbitrage: Overpriced futures: buy spot, sell futures

The cost-of-carry ensures that the futures price stay in tune with the spot price. Whenever
the futures price deviates substantially from its fair value, arbitrage opportunities arise. If
you notice that futures on a security that you have been observing seem overpriced, how
can you cash in on this opportunity to earn riskless profits. Say for instance, ABC trades
at Rs.1000. Onemonth ABC futures trade at Rs.1025 and seem overpriced. As an
arbitrageur, you can make riskless profit by entering into the following set of
transactions.
1. On day one, borrow funds, buy the security on the cash/spot market at 1000.
2. Simultaneously, sell the futures on the security at 1025.
3. Take delivery of the security purchased and hold the security for a month.

42

4. On the futures expiration date, the spot and the futures price converge. Now unwind
the position.
5. Say the security closes at Rs.1015. Sell the security.
6. Futures position expires with profit of Rs.10.
7. The result is a risk less profit of Rs.15 on the spot position and Rs.10 on the futures
position.
8. Return the borrowed funds.
When does it make sense to enter into this arbitrage? If your cost of borrowing funds to
buy the security is less than the arbitrage profit possible, it makes sense for you to
arbitrage. This is termed as cashandcarry arbitrage. Remember however, that
exploiting an arbitrage opportunity involves trading on the spot and futures market. In the
real world, one has to build in the transactions costs into the arbitrage strategy.

Arbitrage: Underpriced futures: buy futures, sell spot

Whenever the futures price deviates substantially from its fair value, arbitrage
opportunities arise. It could be the case that you notice the futures on a security you hold
seem underpriced. How can you cash in on this opportunity to earn riskless profits? Say
for instance, ABC trades at Rs.1000. Onemonth ABC futures trade at Rs. 965 and seem
underpriced. As an arbitrageur, you can make riskless profit by entering into the
following set of transactions.
1. On day one, sell the security in the cash/spot market at 1000.
2. Make delivery of the security.
3. Simultaneously, buy the futures on the security at 965.
4. On the futures expiration date, the spot and the futures price converge. Now unwind
the position.
5. Say the security closes at Rs.975. Buy back the security.
6. The futures position expires with a profit of Rs.10.

43

7. The result is a riskless profit of Rs.25 on the spot position and Rs.10 on the futures
position.
If the returns you get by investing in riskless instruments is less than the return from the
arbitrage trades, it makes sense for you to arbitrage. This is termed as reversecashand
carry arbitrage. It is this arbitrage activity that ensures that the spot and futures prices stay
in line with the costofcarry. As we can see, exploiting arbitrage involves trading on the
spot market. As more and more players in the market develop the knowledge and skills to
do cashandcarry and reverse cashandcarry, we will see increased volumes and lower
spreads in both the cash as well as the derivatives market.
Using Options
When we are bullish about the market:
Buy call option, sell put option
When we are bullish about the market we can buy a call option and pay premium on it,
Simultaneously we can sell a put option, and get premium on it, this is because incase the
market comes down we can be hedged against the losses, Take in this situation the spot
price rises above the strike price we will exercise the option because we will have the
right to buy. So we will earn a profit. And the person whom we sell the put option will be
under loss so he will forego the contract hence we will also keep the premium he gave us
as profit.

When we are bearish about the market:

Buy put option, sell call option
When we are bearish about the market we can buy a put option and pay premium on it,
Simultaneously we can sell a call option, and get premium on it, this is because incase the
market goes up we can be hedged against the losses, Take in this situation the spot price
falls below the strike price we will exercise the option because we will have the right to
sell. So we will earn a profit. And the person whom we sell the call option will be under

44

loss so he will forego the contract hence we will also keep the premium he gave us as
profit.

Downside of Derivatives with few live examples

A case study on recent developments in RPL. As to why F&O trading in a NIFTY 50
stock came under a ban in F&O Segment
Reliance Industries Ltd. (RIL), holding company of Reliance Petroleum Ltd. (RPL), has
sold about 4.01% stake of RPL, being 18.04 crores equity shares, for Rs.4,023 crores, at
an average price of Rs.223 per share. This has reduced stake of RIL in the RPL from 75%
to 70.99%.
The share price of RPL has witnessed a lot of volatility, especially in F&O segment, in
the current month series of November, when share price fell from Rs.295 to now at
Rs.215. The scrip RPL, was also under ban, till Friday, in F&O, due to Market Wide
Limit having crossed 95%. But now, from today, the scrip has resumed trading again in
F&O. This was also first instance when a scrip of NIFTY 50, came under ban in F&O
segment.
The market report indicates that about 12 crore shares are in open interest in future
segment, apart from additional open interests for Put and Call, in options segments at
various rates for three months. While taking a feel of retail investors' position, majority of
them are long on the scrip, and since the scrip was under ban, they kept continuing with
open position, even after paying mark to market losses and incremental margins, imposed
due to higher volatility. Conversely, informed circle is reported to be short in the counter,
for matching open interest.
Initially, short positions seems to have been created by the informed circles, at the higher
levels of Rs.275 plus, obviously, finding these price levels as unrealistic, and
subsequently, actual sell has been triggered by RIL in cash market, thus realizing an
average of Rs.223 per share. This has resulted in reverse arbitrage, till last week, when
cash segment ruled higher than F&O. This also indicates paucity of floating stock.
Shareholding pattern of RPL is as under :-4

45

1)
2)
3)

RIL
Chevron
Public
Total

337.50 cr shares being 75%

22.50 cr. shares being 5%
90.00 cr. shares being 20%
450.00 cr. shares being 100%

Rs.3,375 crores
Rs.225 crores
Rs.900 crores
Rs.4,500 crores

RIL has acquired its 75% stake as under :-1)

270 cr. shares at par

Rs.2,700 crores

2)

67.5 cr. shares at Rs.60 per share

Rs.4,050 crores

337.50 cr.

Rs.6,750 crores

Total

RIL has almost realized its cost of Rs.4,050 crores for subscribing 67.50 shares, in April
2006, at Rs.60 per share. Since, investments sold are based on FIFO (first in first out)
basis, shares having subscribed at par were presumed to have been sold, on which long
term capital gain of Rs.3,842 crores, has been earned by RIL, which is tax free.
So, effective cost of 71% stake in RPL, for 319.46 crores shares are Rs.2,727 crores,
translating into, cost per share at Rs.8.54 . The market value of this is close to Rs.67,000
crores.
One may recall, that Chairman of RIL, Mukesh Ambani, in company's 33

rd

AGM held in

October in Mumbai, had stated that the company would be capitalizing on the
investments held, including that of RPL. Nobody, could predict this move, likely to be
taken by RIL at a future date.
Now what could be likely move and developments, post this minority stake sale: 1)

The control of RIL on RPL is not affected as this is a minor dilution, and 71%

stake is quite reasonable, in the mega refinery, which would vastly improve the
4

46

consolidated results of RIL.

2)

RIL would have an other income of Rs.3,842 crores, in quarter ending December

07, which would give an extra EPS of Rs.26.50, on enhanced equity of Rs.1,453 crores,
post IPCL merger.

3)

RIL has been able to mop up close to Rs.4,000 crores (tax free) when it needs

funds, for its capex programme at K G Basin.

4)

RIL may further decide to offload .99% stake, being 4.46 crore share, and realize

close to Rs.1,000 crores, and keeping its stake in RPL at 70%.

5)

Chevron, presently has 5% stake in RPL, with an option to raise it to 29% by June

09, post commencement of refinery. The preferential allotment can only be made, based
on SEBI formula, which would be at Rs.200 plus, (presuming market price to remain
above Rs.200). At this rate, Chevron may not be interested in raising its stake to 29% as it
would need close to Rs.30,000 crores. Hence, Chevron, would opt to offload its 5% stake
in favour of RIL, at Rs.60 per share, as per the terms of the share subscription Agreement.

6)

On happening this event, RIL would be able to raise its stake, back to 75%, at a

cost of just Rs.1,350 crores.

7)

The informed circles, having initiated shorts in F&O at an average of Rs.275 per

share, are reported to have made a gain of Rs.1,000 crore plus.

Now, let's take a call, how share price of RPL is likely to behave, in coming times.
1)

As majority of retail investors are long, they would opt to roll over their positions

47

in December series, as bullish outlook on the stock, continues, for various reasons (no
need to elaborate them).
2)

Informed circle, holding short position of close to 10 crore shares, may not be

interested in rolling over, as market perception has changed positive, on the stock. But, in
this case, they may be interested to see a lower rate, on closing day, (Thursday 29

th

November) to enable them to have a better close out.

3)

Since, no more, delivery based selling is expected on the counter, weakness may

not be seen from beginning of December F&O series

4)

If informed circle, tries to bring down the price on closing day, lot of interested

buying may be seen, below Rs.200 per share, from investment and arbitrage view point.
In nutshell, this was a calculated move, by RIL, whereby, huge cost has been recovered,
coupled with retaining majority and respectable stake. Also, the market (cash and F&O)
is in full control of the management, which would take direction, on the next move of the
management, as that will have far reaching consequences.
THE BARINGS BANK DEBACLE
The derivative trading is not as easy as perceived. Here is a famous case that depicts the
how risky the business is. The events that led to the fall of Barings, Britain's oldest
merchant bank, is a example of how not to manage a derivatives operation. The control
and risk management lessons to be learnt from this fall are the same as much to cash
positions as they do to derivative ones. The leverage and liquidity offered by futures
contracts makes an institution fall with lightning speed.
The activities of Nick Leeson on the Japanese and Singapore futures exchanges led to the
downfall of Barings. The build-up of the Nikkei positions by Leeson went in the opposite
direction to the Nikkei - as the Japanese stock market fell. Before the earthquake, Nikkei
4

48

traded in a range of 19,000 to 19,500. Leeson had long futures positions of approximately
3,000 contracts on the Osaka Stock Exchange. A few days after the earthquake, Leeson
started an aggressive buying programmed which culminated in a high of 19,094 contracts
reached about a month later.
Barings collapsed as it could not meet the enormous trading obligations, which Leeson
established in the name of the bank. When it went into receivership on February 27,
1995, Barings had outstanding notional futures positions on Japanese equities and interest
rates of US$27 billion: US$7 bn on the Nikkei 225 equity contract and US$20 bn on
Japanese government bond (JGB) and Euro yen contracts. Leeson sold 70, 892 Nikkei
put and call options with a nominal value of $6.68 bn. The nominal size of these positions
is breathtaking; their enormity is all the more astounding when compared with the banks
reported capital of about $615 million.
But Leeson's Osaka position reflected only half of his sanctioned trades. If Leeson was
long on the OSE, he had to be short twice the number of contracts on SIMEX. Because
Leeson's official trading strategy was to take advantage of temporary price differences
between the SIMEX and OSE Nikkei 225 contracts. This arbitrage, which Barings called
'switching', required Leeson to buy the cheaper contract and to sell simultaneously the
more expensive one, reversing the trade when the price difference had narrowed or
disappeared. This kind of arbitrage activity has little market risk as the positions were
always matched. But Leeson was not short on SIMEX, infact he was long approximately
the number of contracts he was supposed to be short. These were unauthorised trades
which he hid in an account named Error Account 88888. He also used this account to
execute all his unauthorised trades in Japanese Government Bond and Euro yen futures
and Nikkei 225 options: together these trades were so large that they ultimately broke
Barings.

(www.karvy.com/articles/baringsdebacle.htm)

IMPORTANCE OF PUT-CALL PARITY RATIO (PCR) IN DERIVATIVES

49

In just the past couple weeks, an extremely intriguing anomity has arisen in the Indian
stock markets. The famous Put/Call Ratio 21-day moving average has soared above 1.00
for the first time in at least a decade! This odd development is vexing bulls and bears
alike.
The Put/Call Ratio, or PCR, is a powerful technical trading indicator that monitors the
stock and stock-index bets that speculators are making at any given time. Speculators
who expect individual stocks or the indices to fall in the months ahead buy put options,
derivatives bets which increase in value when prices decline. Speculators who expect
rising prices buy call options, which promise hefty payouts on higher prices.
The PCR quantifies the ratio of the daily trading volume in these two opposing bets,
granting speculators valuable insights into what the majority happens to be expecting.
When the PCR is above 1.00, as today, it literally means that the daily trading volume on
puts is higher than calls. Translated into pure sentiment terms, it indicates that the
majority probably expects lower prices in the months ahead. And since we humans are
naturally bullish, a PCR above 1.00 is an extraordinarily rare event.
Todays high PCR anomaly is difficult to interpret, as I will outline in this essay. Both
bullish and bearish cases can be built around this surreal development, and the contrarian
slant on this is complex as well. While I certainly wish there was an easy bullet-proof
interpretation of this odd event, its sudden appearance today within the context of current
market conditions is a puzzling mystery. (This Pointer taken from www.zealllc.com)

50

3. RESEARCH METHODOLOGY

51

Research Methodology:
The whole study was totally based on the primary data there was no as such formal
procedure most of the research was done in the dealing room
As it is one type of mechanism so a lot of time was spent to understand the concept. Most
important factor in this research was the dealing room operation. The dealings of the firm
with its client investors was properly observed and studied in detail.
The total sample size was 50 i.e. the number of cases considered during the project for
various dealings.
The main function was to look at the screen and watch how the market is basically
moving with the change in time. The data was primary and secondary data and collected
from the Orion software and Falcon software. All over the world there are lots of stock
exchanges dealing with Equity derivatives but for the purpose of the study NIFTY has
been considered and various examples are quoted using Nifty and certain stock
derivatives are taken for examples when strategies are quoted using examples and
studying the futures and options market during different market times and trying to adopt
different strategies for different types of market conditions like Bull run ,bear run and
heavy volatile and during consolidation trends of the market.
The market methodology followed is primary data collected from a channel of network
that involves independent
- Financial institutions, Banks, HNIs, AMCs, Brokers who use these
derivative strategies or use them on behalf of their clients.
- Also dealing room operations.The dealings of the firm with its client
investors will properly observed and studied in detail.
- Questionnaire survey with the various derivatives dealers and with feedback
and tips were taken from Derivatives strategist team.

52

And secondary data from a host of book materials, and Derivatives materials
The expected outcomes from the thesis is to understand and apply how to use the concept
of equity strategies and under what market conditions we should use these Equity market
strategies and try to beat the market by hedging our holdings and implies the use of all
the popular equity derivatives strategies with practical examples it has been illustrated
well for even a layman can understand and try to grasp how these strategies are useful in
the stock markets

53

4. DATA ANALYSIS AND INTERPRETATION

54

DATA ANALYSIS AND INTERPRETATION

The conditions under which the use of equity derivative strategies can be analyzed by the
help of using questionnaire to collect data are:
1) Strategies you normally use when market view is highly bullish
Buy Call Option
CALL Option: Buyer of a Call Option on a particular stock gets the right to
Buy the underlying Stock, whereas Seller / Writer of the Call Option is
obliged to Sell the underlying stock when the buyer of Call decides to Exercise
his / her Option. When the spot / cash price is higher than the Strike price (plus
cost), the buyer of Call could exercise his right to buy at the Strike price.
Example: Suppose you have bought a call option of 2,000 shares of Hindustan
Lever Ltd (HLL) at a strike price of Rs 250 per share. This option gives you the
right to buy 2,000 shares of HLL at Rs250 per share on or before March 30, 2007.
The seller of this call option who has given you the right to buy from him is under
the obligation to sell 2,000 shares of HLL at Rs250 per share on or before March
30, 2007 whenever asked.
Stock:

INFOSYSTCH

View:

Bullish

Strategy:

LONG (BUY) CALL

Rationale:

Technically the stock has given an upward

breakout & should find a target of around 2300 in the next few trading sessions.
Long Call:

Initiated on 24th Mar

Spot Price:

Rs .2230/-

55

Strategy:

Bought INFOSYSTECH 2250 June CA @ Rs.45

(Lot size = 100)

Result: In about a weeks time, the call option appreciated to Rs.70 as the stock
price rose and we sold off the position resulting in a profit. A graphical
representation of this option position is given below

BREAK EVEN POINT: Rs.2295 i.e., strike price + premium paid

MAXIMUM PROFIT: Unlimited
MAXIMUM LOSS:
Rs.4,500 per lot

56

2) Strategies you use when market view is highly bearish

But Put Option
PUT Option: Buyer of a Put Option on a particular Stock gets the right to
Sell the underlying Stock, whereas Seller/Writer of the Put Option is obliged
to Buy the underlying Stock if the buyer of Put decides to Exercise his / her
Option. When the spot / cash price (less cost) is lower than the Strike price, the
buyer of Put could exercise his right to sell at the Strike price.
Example: suppose you bought a put option of 2,000 shares of HLL at a strike
price of Rs 250 per share. This option gives its buyer the right to sell 2,000 shares
of HLL at Rs 250 per share on or before March 30, 2007. The seller of this put
option who has given you the right to sell to him is under obligation to buy 2,000
shares of HLL at Rs 250 per share on or before March 30, 2007 whenever asked.
Index: NIFTY
Outlook: Bearish
Strategy: LONG (Buy) PUT
Rationale: The NIFTY Index has shown a shooting star on the weekly chart which
a sign of strong trend reversal.
Long Put:

Initiated on 23rd April

Spot value:

3930 levels

Strategy:

Bought NIFTY 3900 May PA @ Rs.120 (Lot size = 50)

57

Result: The put option appreciated to Rs.134 as the index fell and we sold off the
position resulting in a profit. A graphical representation of this strategy position is
given below

BREAK EVEN POINT:

3780, i.e.,strike price -premium paid

MAXIMUM PROFIT:

Unlimited

MAXIMUM LOSS:

Rs.6000 per lot

58

3)

Strategies you use when market view is bearish to stagnant

Stock: ACC
Outlook: Bearish to stagnant
Strategy: SHORT (Sell) CALL
Rationale: The government has imposed a cut in the import duty on
cement. This would be detrimental for the cement sector. Also the stock is
trading in a oversold zone.
Short Call:

Initiated on 28 April

Spot Price:

Rs .1020/-

Strategy: Sold ACC 1050 May CA @ Rs.20 (Lot size = 375)

Result: Our conviction was right and cement stocks

trended downwards.

We therefore kept the premium that we collected which was our net profit. A
graphical representation of this strategy position is given below

59

BREAK EVEN POINT:

Rs.1070, i.e., strike price + premium received

MAXIMUM PROFIT: Premium received

MAXIMUM LOSS:

Unlimited

4) Strategies you use when market view is bullish to stagnant :

Stock:

SAIL

Outlook: Bullish to stagnant

Strategy: SHORT (Sell) PUT
Rationale: The stock is trading in a oversold zone along with massive increase
in the open interest in call options of strike prices in 115 & 118.
Short Put: Initiated on 9th Apr
Spot Price:Rs .114/Strategy: Sold SAIL 110 April PA @ Rs. 2.50 (Lot size = 2700)
Result: This is one example where our strategy resulted in a loss. Our outlook
was wrong and SAIL stock fell along with the general market.We had to buy
back our put at a higher price (at Rs.3.90) as the stock went down and this
resulted in a loss of Rs.1.40 per lot.
A graphical representation of this strategy is given below.

BREAK EVEN POINT: Rs. 107.50, Strike price - Premium received

MAXIMUM PROFIT: Premium received
MAXIMUM LOSS:
Unlimited.

60

5) Strategies you use when the stock is expected to move far enough in either
direction in the short-term
Index:
NIFTY
Outlook: Highly Volatile
Strategy: LONG STRADDLE (Buy an equal number of calls and puts of
the same strike price and same expiry)
Rationale: Due to global markets the NIFTY Index is expected to volatile
Long Straddle: Initiated on 1st May
Spot Value:
4090 levels
Strategy:
Buy NIFTY 4100 May CA @ Rs.90 (Lot size = 50)
Buy NIFTY 4100 May PA @ Rs.110 (Lot size = 50)
Result:
NIFTY broke the crucial support level of 4050 and
trended downward to 3800 levels. The put option
was profitable and the call option expired worthless
resulting in a net profit. This strategy is profitable if
NIFTY is above 4300 or below 3900.

BREAK EVEN POINTS: 4300, i.e., strike price + premiums paid

61

3900, i.e., strike price premiums paid

MAXIMUM PROFIT: Unlimited
MAXIMUM LOSS:
Total premium amount paid

6) Strategy to be used when market is stagnant to range-bound:

Index:
Outlook:
Strategy:

NIFTY
Stagnant to range-bound
SHORT (Sell) STRADDLE (Sell an equal number of calls
and puts of the same strike price and same expiry)
Rationale: The market is expected to be in a consolidation
phase for the next 10-15 trading sessions.

for both

Short Straddle: Initiated on 10th April

View:
Range bound and stabilizing
Spot Value:
3970 levels
Strategy:
Sell NIFTY 3950 April CA @ Rs.60 (Lot size = 50)
Sell NIFTY 3950 April PA @ Rs.40 (Lot size = 50)
Result:
NIFTY stayed range bound between 4050 and 3850
resulting in a net profit. Premiums received
put and call options were retained.
A graphical representation of this strategy is given
below

62

BREAK EVEN POINTS: 4050, i.e., strike price + premiums paid

3850, i.e., strike price premiums paid
MAXIMUM PROFIT: Limited to the premiums received
MAXIMUM LOSS: Unlimited

7) Strategy to be used when market is highly volatile :

Stock:
TISCO
Outlook:
Highly Volatile
Strategy:
LONG (Buy) STRANGLE (Buy an equal number
of calls and puts at different strike prices and same expiry)
Rationale: The stock could respond either way with high volatility due to
the Corus takeover.
Long Strangle:
Spot Price:
Strategy:

Initiated on 23rd Jan

470 levels
Buy TISCO Feb 500 CA @ Rs.10 (Lot size = 675)
Buy TISCO Feb 450 PA @ Rs.10 (Lot size = 675)
Result:
TISCO stock responded positively to this strategy
and rallied to 510-520 levels where we cleared our call and sold it at
Rs.28. Now, after the Corus deal TISCO stock took a hit and spiraled all
the way down to 450 levels where we sold off the put for Rs.7. We
therefore realized a net profit of Rs.15 per lot.

63

BREAK EVEN POINTS: 520, i.e., upper strike price + premiums paid
430, i.e., lower strike price premiums paid
MAXIMUM PROFIT: Unlimited
MAXIMUM LOSS:
Total premium amount paid

8) Strategy to be adopted when market outlook is stagnant to range-bound:

Stock:
ITC
Outlook:
Stagnant to range-bound
Strategy:
SHORT (Sell) STRANGLE
(Sell an equal number of calls and puts at different strike prices and same
expiry)
Rationale:
ITC has been trading in a range of 160180 for quite sometime and we expect it
continue trading in the same
consolidation range.
Example:
Spot Price:
Strategy:

ITC Short Strangle

170 levels
Sell ITC 180 Mar CA @ Rs.4 (Lot size = 675)
Sell ITC 160 Mar PA @ Rs.7 (Lot size = 675)

Result:

ITC remained range-bound and the premiums

collected were realized as net profit.

BREAK EVEN POINTS: 191, i.e., upper strike price + premiums paid

64

149, i.e., lower strike price premiums paid

MAXIMUM PROFIT: Limited to the premiums received
MAXIMUM LOSS: Unlimited

9) Strategy to be used when the market is moderately bullish

Stock:
Outlook:
Strategy:

SBIN
Moderately Bullish
BULL SPREAD
(Buy a call and sell a call at a higher strike)

Rationale:

The overall banking sector is looking attractive

for buying.Technical indicators are
strong upward move in SBIN with strong
resistance at 1230-1250 levels.

Bull Spread:
Spot Price:
Strategy:

Initiated on 31st Mar

Rs .1140/Buy SBI 1140 April CA @ Rs.42 (Lot size = 250)
Sell SBI 1230 April CA @ Rs.10 (Lot size = 250)
After executing this strategy, SBI rallied higher and
we realized a net profit in this strategy. We sold the
1140 call for Rs.85 and bought back the 1230 call
for Rs.32, hence resulting in a net profit of Rs.21
per lot. A graphical representation of this strategy is
given below

suggesting

Result:

65

BREAK EVEN POINT:Rs.1172 (Lower Strike + Net debit)

MAXIMUM PROFIT: Rs.14,500 per lot (250 x 58)
MAXIMUM LOSS: Rs.8000 per lot (250 x 32)
10) Strategy to be used when market is moderately bearish
Index:
Outlook:
Strategy:
Rationale:

Bear Spread:
Spot Value:
Strategy:
Result:
resulting in

NIFTY
Moderately Bearish
BEAR SPREAD
(Buy a put and sell a put at a lower strike)
The short term trend for the NIFTY Index
is down & it finds strong support around
4000 levels.
Initiated on 12th Mar
4100 levels
Buy NIFTY April 4100 PE @ Rs.52 (Lot size = 50)
Sell NIFTY April 4000 PE @ Rs.28 (Lot size = 50)
Nifty headed lower after this strategy and the puts
increased in value. We sold the 4100 put for Rs.104
and bought back the 4000 put for Rs.51,
a net profit of Rs.29 per lot. A graphical
representation of this option position is

given below

66

BREAK EVEN POINT:Rs.4076 (Upper strike Net Debit)

MAXIMUM PROFIT: Rs.3800 per lot (50 x 76), Nifty below 4000
MAXIMUM LOSS: Rs.1200 per lot (50 x 24), Nifty above 4100
11) Strategy to be used when market is mildly bullish
Stock:
RELIANCE
Outlook: Mildly Bullish
Strategy: BULL CALL RATIO SPREAD
(Buy a call and sell/three two higher strike calls)
Rationale: The overall market is positive and RELIANCE is trading at its 50%
retracement levels and may show an upward move with resistance at 1440 and 1470.
Bull Call Ratio Spread:
View:
Spot Price:
Strategy:

Initiated on 31st feb

Moderately Bullish on Reliance
Rs.1360 levels
Buy RIL Mar 1380 CA @ Rs.35 (Lot size = 150)
Sell RIL Mar 1440 CA @ Rs.15 (Lot size = 150)
Sell RIL Mar 1470 CA @ Rs.10 (Lot size = 150)
Result:
Reliance rallied to levels most profitable for this strategy.
When reliance was at 1420 levels profits on the 1380 call were booked at Rs.57. the 1440
call was bought back at Rs.10 and the 1470 call was bought back at Rs.2 resulting in a net
profit of Rs.35 per lot.

67

BREAK EVEN POINT:

MAXIMUM PROFIT:
MAXIMUM LOSS:

1390 & 1520

Rs. 7500 per spread
Rs. 1500 on the downside & Unlimited above 1520

12) Strategy to be used when market is mildly bearish

Stock:
Outlook:
Strategy:
Rationale:
EXAMPLE:
Spot Price:
Strategy:
Result:

INFOSYSTCH
Mildly Bearish
Bear Put Ratio Spread
(Buy a put and sell/three lower strike puts)
The strategy acts as a hedge upto the level of 2100 in
INFOSYSTCH.
Infosys Tech Bear Put Ratio Spread
Rs.2240 levels
Buy INFOSYSTECH Mar 2230 PA @ Rs.60 (Lot size = 100)
Sell INFOSYSTECH Mar 2190 PA @ Rs.40 (Lot size = 100)
Sell INFOSYSTECH Mar 2160 PA @ Rs.30 (Lot size = 100)
Infosys Tech trended downwards and the 2230 put was profitable. After
clearing out all positions, net profit was made for this trade.

BREAK EVEN POINT: 2110

MAXIMUM PROFIT: Rs.5000 per lot
MAXIMUM LOSS:
Unlimited below 2110

68

13) Strategy to be used when market is moderately bullish

Stock:
Outlook:
Strategy:

HINDALCO
Moderately Bullish
PROTECTIVE PUT
(Own stock/futures, and buy a put)
Rationale:
The momentum in stock is good along with positive movement in
the RSI. Technically the stock is bullish with a target price of 190-195.
EXAMPLE:
HINDALCO Protective Put
Spot Price:
180 levels
Strategy: Buy HINDALCO futures @ 185 levels (Lot size = 1595)
Buy HINDALCO Feb 180 PA @ Rs.2.40 (Lot size = 1595)
Result: Hindalco stock was dented as a result of the Novelis takeover. The stock
came down to 140 levels but our loss was limited only to Rs.7.40 per contract. The
put option appreciated to Rs.40 and the futures closed at 140 levels during expiry.
Our loss was limited because of the protective put, without which we would have
incurred huge losses.

69

BREAK EVEN POINT: Rs.187.40

MAXIMUM PROFIT: Unlimited
MAXIMUM LOSS:
Rs.7.40 per lot

14) Strategy to be used when market view is moderately bearish :

Index:
Outlook:
Strategy:

NIFTY
Moderately bearish
PROTECTIVE CALL
(Sell futures and buy a call)
Rationale:
Technically the Index is looking weak. The Union Budget will be a
major trigger for deciding the trend of NIFTY.
EXAMPLE:
Spot Value:
Strategy:

NIFTY Protective call

3990 levels
Sell NIFTY futures @ 3980 levels
Buy NIFTY 4100 Mar CA @Rs.70
Result:
Nifty trended downwards and our futures position appreciated in
value. Note that we bought the call to protect ourselves from excessive losses if the
Nifty index went up.

BREAK EVEN POINT: 3890

70

MAXIMUM PROFIT: Unlimited

MAXIMUM LOSS:

5. RECOMMENDATIONS

71

RECOMMENDATIONS
Major findings:
1) Due to more transparency and new policies implemented by SEBI players in this
market is increasing at a very high rate and the new comers are well-equipped to
compete with others. So most of the share broking firms are trying to grab new
customers in derivatives as well as to retain the old ones, so this requires fine ad
favourable brokerage charges as well as excellent service to their customers and
they have a separate desk for formulating or using equity derivatives
2) Broking firms should shift from Equity research to Derivatives research to be able
to compete with the foreign broking house when FDI in retail broking opens for
these foreign players
3) Few dealers are not professionally qualified to understand strategies to play on
behalf of their clients. This leads to reduction in the cliental base be it institutional
or broking.
4) During the recent market trend (where sensex has witnessed correction of 1500
points and nifty by 800 points) the broking houses successfully employed these
strategies and this was a huge benefit for its clients

72

Recommendations:
1)

The broking houses needs to recruit few more Derivatives analysts in their
research department to cope with the growth in Derivatives segment.

2)

Proper training has to be conducted for the dealers on time to time basis to
make them more knowledgeable and efficient to properly deal with the clients.
And to give proper advice in market crashes

3)

Broking houses should have specialty software package to deal with

Derivatives strategies at all levels of the firm even to the dealers so they can
employ these strategies

4)

Making the importance of derivatives understandable to retail clients by

organizing investor camps

5)

Bringing in more small size contracts for retail public to hedge their positions
like mini nifty (20 lot size) , chota sensex ( 5 lot size) etc.

6)

Reducing margins for easier access to f&o rather than heavy margins at present

7)

SEBI should consider longer expiration contracts like 6 months expiry to 3

years expiry contracts

73

8)

Derivatives are weapons of mass destruction as said by millionaire investor

Warren Buffet so only an professional should be employing these derivatives
strategies

9)

Derivatives lot sizes on individual scrips should be reduced to mini contracts

from existing contract sizes .

6. CONCLUSION

74

CONCLUSION

Derivatives as a risk management tool should be employed after understanding the risk
profile of yourelf or your clients or it will lead to increased risk if not used at the right
time or without understanding the market trend. One should avoid using derivatives in a
very volatile market that would magnify the losses to a greater extent as we buy or sell in
lot sizes and should use proper strategies required in a volatile market and derivatives
trading will soon surpass the daily turnover in the cash segment in both BSE and NSE
currently derivatives trading is dominated by NSE in terms of turnover .
When retail broking space is opened to FDI we will be able to see more use of complex
derivatives product available in the market in India which is currently not available
Then we will be able to see retail public trading more in the derivatives segment than the
institutional trading which holds a majority of the chunk in the Derivatives trading
segment in India.
The advent of Derivatives trading in the country will change the face of the Indian capital
market very soon in terms of the volume of transactions, the nature and settlement of
trade, and the profile of market participants. I personally dont think many of our
colleagues in the business have really understood the impact that Derivatives can have on
the broking business. The growth of Derivatives as a mass trading technique in the
country is unstoppable, going by the indicators available and the signals for the future.
When it ultimately gathers momentum, the biggest beneficiary will be the traders and
speculators, who will be able to trade and speculate better than in the cash market

75

With Derivatives one needs to apply common sense and take small positions in the
market rather than taking exuberant positions and losing the entire capital deployed in the
F&O segment DERIVATIVES ARE TO BE VIEWED AS WEAPONS OF MASS
DESTRUCTION as said by the great investor of all times Mr. Warren Buffet.

7. ANNEXURE

76

7.1 THESIS SYNOPSIS

NAME:

Reuben Davis.J

BATCH:

PGP/FW/05-07/FINANCE/61

SPECIALIZATION:

Finance & Marketing

CONTACT NUMBER:

9833320959,43538048

EMAIL ID:

r9reuben@gmail.com

RESEARCH AREA:

Equity market

TITLE OF THE THESIS: Formulating the use of derivative strategies in equity

market.
THESIS EXTERNAL GUIDE:

Mr.Bhaskar reddy (external faculty iipm)

PROBLEM DEFINITION:
Financial markets are, by nature, extremely volatile and hence the risk factor is an
important concern for financial agents. To reduce this risk, the concept of derivatives
comes into the picture. During last year in the month of may stock market saw an historic
crash, and investors lost heavily because most of these investors did not hedge their risks
by using equity derivatives. And which strategies to use in growing, static, declining
market.
LITERATURE RELATING TO THE PROBLEM IN BRIEF:
Given the importance of derivatives in an emerging market like India it is no wonder that
share broking firms are investing heavily in building up infrastructure and mining up

77

cliental base to increase market share. The latest trend in the market shows retail
investors are responding in line with the institutional investors which requires efficient
traders to make them understand about the F&O strategies. Indian stock market is also act
in line with performance of the overseas markets; recent market trend clearly gives an
indication, where proper derivative strategies could have saved investors from huge
losses. Now as the market is showing a recovery trend there is an ample opportunity to
the investors to take proper strategies to play in the market.

SCOPE OF THE STUDY:

A channel of network that involves independent F&O Experts, large retailers, Financial
institutions, Banks, HNIs, Brokers who use these derivative strategies or use them on
behalf of their clients.
JUSTIFICATION:
Few dealers are not professionally qualified to understand strategies to play on behalf of
their clients. This leads to reduction in the cliental base. By having a more practical
knowledge on how to use these derivative strategies, they will benefit from it.
RESEARCH METHODOLOGY:
PRIMARY RESEARCH:
A channel of network that involves independent
- Large retailers, Financial institutions, Banks, HNIs, Brokers who use these derivative
strategies or use them on behalf of their clients.
- Also dealing room operations. The dealings of the firm with its client investors will
properly observed and studied in detail.
- Questionnaire survey.
SECONDARY RESEARCH:
Books, NCFM guide to Derivatives, web materials.

78

SAMPLING METHODOLOGY:
SAMPLE SIZE:
Large retailers-10
Financial institutions-10
Banks-10
HNIs-2
Brokers-8
F&O experts-10

TOTAL SAMPLE SIZE-50

7.2 RESPONSE SHEETS

RESPONSE SHEET 1

1) Name: J.REUBEN DAVIS

2) ID Number: FW/00423/Fin
3) The Topic of the study: Formulation of strategies in the use of
Derivatives in Equity market
4) Date when the Guide was consulted: February 17th
5) The outcome of the discussion:
Discussed about questionnaire and sample audience and insight in the
Derivatives market
6) The Progress of the Thesis:
Preparation of the thesis questionnaire on and collection of primary
data
7

79

RESPONSE SHEET 2
1) Name: J.REUBEN DAVIS
2) ID Number: FW/00423/Fin
3) The Topic of the study: Formulation of strategies in the use of
Derivatives in Equity market
4) Date when the Guide was consulted: June 26
5) The outcome of the discussion:
Feedback about questionnaire and materials about the basic study
6) The Progress of the Thesis:
Finished Questionnaire and collecting secondary data

80

RESPONSE SHEET 3

1) Name: J.REUBEN DAVIS

2) ID Number: FW/00423/Fin
3) The Topic of the study: Formulation of strategies in the use of
Derivatives in Equity market
4) Date when the Guide was consulted: August 9th
5) The outcome of the discussion:
Feedback about analysis & interpretation
6) The Progress of the Thesis:
Finished analysis and interpretation

81

RESPONSE SHEET 4
1) Name: J.REUBEN DAVIS
2) ID Number: FW/00423/Fin
3) The Topic of the study: Formulation of strategies in the use of
Derivatives in Equity market
4) Date when the Guide was consulted: August 23
5) The outcome of the discussion:
Feedback on recommendations and findings
6) The Progress of the Thesis:
Finished recommendations now working on conclusion.

82

RESPONSE SHEET 5
1) Name: J.REUBEN DAVIS
2) ID Number: FW/00423/Fin
3) The Topic of the study: Formulation of strategies in the use of
Derivatives in Equity market
4) Date when the Guide was consulted: September 20th
5) The outcome of the discussion:
Feedback on project content and final additions and deletions
6) The Progress of the Thesis:
Finished thesis related work now working on presentations of final
thesis

83

RESPONSE SHEET 6
1) Name: J.REUBEN DAVIS
2) ID Number: FW/00423/Fin
3) The Topic of the study: Formulation of strategies in the use of
Derivatives in Equity market
4) Date when the Guide was consulted: October 1st
5) The outcome of the discussion:
Feedback on final additions and deletions
6) The Progress of the Thesis:
Finished thesis related work now working on annexure,bibliography of
final thesis

84

7.2 QUESTIONAIRE

85

Formulating the use of Derivative Strategies in Equity market

Name:
Designation:
Company:
1) What Strategies you normally use when market view is highly bullish?
Would you always hedge your cash positions or will you be speculative and use
naked positions when highly bullish on the market?
a) Buy call
b) Sell put
c) Buy futures
Reasons :
_______________________________________________________________
_______________________________________________________________
2) What Strategies you use when market view is highly bearish?
Would you hedge your positions by shorting in F&O Segment or hold till markets
turn in your favour?
a) Buy put
b) Sell call
c) Sell futures
Reasons :
_______________________________________________________________
_______________________________________________________________
3) What Strategies you use when market view is mildly bullish? To maximize your
returns in a range bound market would you use Derivatives to maximize returns ?
a) Bull Spread
b) Bull Call Ratio Spread
Reasons :

86

_______________________________________________________________
_______________________________________________________________
4) What Strategies you use when market view is mildly bearish? To minimize your
losses would you use Derivatives to minimize losses?
a) Bear Spread
b) Bear Call Ratio Spread
Reasons :
______________________________________________________
_______________________________________________________________
_______________________________________________________________
_________
5) What strategies you use when the stock is expected to move far enough in either
direction in the short-term? Would you venture into Derivatives in a highly rangebound market? If Yes Give Reasons
a) Buy Straddle
Reasons:__________________________________________________________
_______________________________________________________________
____________________________________________________________
6) What strategies you use when the stock is expected to move far enough from the
Predefined range? Would you venture into Derivatives in a highly volatile
market? If Yes Give Reasons
a) Buy Strangle
Reasons:_______________________________________________________
_______________________________________________________________
_______________________________________________________________
7) What strategies when the stock price is expected to fluctuate in a narrow range.?
Would you venture into Derivatives in a highly range-bound market? If Yes Give
Reasons?
a) Buy Butterfly
Reasons:_______________________________________________________
_______________________________________________________________
_______________________________________________________________
8) What strategies when the stock price are expected to move substantially?
Would you venture into Derivatives in a highly volatile market? If Yes Give
Reasons?

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a) Sell Butterfly
Reasons:_______________________________________________________
_______________________________________________________________
_______________________________________________________________

9) When to use Bull call ratio spread? Under which market conditions to use?
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
10) When to use Bear call ratio spread? Under which market conditions to use?
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________

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7.3 BIBLIOGRAPHY

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BIBLIOGRAPHY
www.numa.com
Ncfm Book on Derivatives
Demystifying Derivatives Sharekhan
www.bseindia.com
www.nseindia.com
www.wikipedia.com
www.karvy.com/articles/baringsdebacle.htm
www.zealllc.com

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