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UNDERSTANDING DERIVATIVES MARKET IN INDIA

Submitted By

JIGNA A. SHAH

UNDER THE GUIDANCE OF

PROF. ARUN CHANDARANA

A PROJECT SUBMITTED IN PART COMPLETION OF MMS TO THE

Chetanas R. K. Institute of Management & Research


Bandra (East), Mumbai 400 051

July 2011

UNDERSTANDING DERIVATIVES MARKET IN INDIA

July 2011

DECLARATION

This is to declare that the study presented by me to Chetanas R. K. Institute of Management and Research, in part completion of the M.M.S under the title Understanding Derivatives Market in India had been done under the guidance of Prof. Arun Chandarana.

Signature of the Student Jigna A. Shah

ACKNOWLEDGEMENTS

There are many people who helped me in doing this project. I can never express in words how much I am grateful to Zodiac Broking Pvt. Ltd for their continuous support. Mr. Jaimesh Seth and Mrs. Sweta Madam helped me in gathering right information for my derivatives. I would extend sincere thanks to them for providing me with all the facilities, valuable guidance and encouragement to complete the project well in time.

I essentially feel a sense of gratitude towards my project guide Mr. Arun Chandarana and other faculties for providing me all the guidance needed and solving queries. I am whole heartedly indebted to them.

Finally I would like to mention that many persons have directly or indirectly contributed in successful completion of this project. This has been wonderful experience for me and I would like to thank all of them for the same.

JIGNA SHAH

CERTIFICATE

This is to certify that the study presented by JIGNA A. SHAH to the Chetanas R. K. Institute of Management and Research, in part completion of the MMS under the title Understanding Derivatives Market in India has been done under the guidance of Prof. ARUN CHANDARANA.

The project is in the nature of original work that has not so far been submitted for any Diploma of Chetanas R. K. Institute of Management & Research or any other University/ Institute. References of work and related sources of information have been given at the end of each chapter.

Signature of the Guide Prof. Arun Chandarana

Signature of the Director Dr. Firdous Shroff

CERTIFICATE

fromcompany

EXECUTIVE SUMMARY

Everyone talks about derivatives these days. Derivative products have been around for a long time. Do you know derivatives first came about in Japanese rice markets? Yes, as early as the 1650s, dealings resembling present day derivative market transactions were seen in rice markets in Osaka, Japan. The first leap towards an organized derivatives market came in 1848, when the Chicago Board of Trade, the largest derivative exchange in the world, was established. Today, equity and commodity derivative markets are rapidly gaining in size in India. Starting from a controlled economy, India has moved towards a world where prices fluctuate every day. This has increased risk for investors. Risk is a characteristic feature of most commodity and capital markets. A derivative is widely used instrument in India for hedging purposes. In India, the emergence and growth of derivatives market is relatively a recent phenomenon. Since its inception in June 2000, derivatives market has exhibited exponential growth both in terms of volume and number of traded contracts. The market turn-over has grown from Rs.2365 crore in 2000-2001 to Rs. 11010482.20 crore in 2008-2009. Within a short span of eight years, derivatives trading in India has surpassed cash segment in terms of turnover and number of traded contracts. In terms of popularity too, these markets are catching on like a forest fire. So, what are these markets all about? What are the products that they trade in? Why do people feel the need to trade in such products and how one can minimize risks with use of these instruments? This are the questions thrown by everyone. Therefore, understanding the basic fundamentals of Derivatives plays an important role. This project covers the basic fundamentals of derivatives instruments like futures, forwards and options. Understanding these basic concepts will help investing in any one of the above instruments. This project covers some aspects on how derivatives started trading in India, how futures and options works and some basic terminologies associated with these instruments Also, as mentioned above that price fluctuates on a daily basis, some space has been given for strategies to minimize risk. Although these strategies cannot completely reduce risk, but if used widely can reduce risk to large extent. Nothing is perfect in this world and so the derivatives trading in India are no exception. Some suggestions have been given from my side on how to increase awareness and trading process.

TABLE OF CONTENT
1. Introduction 1.1 1.2 1.3 1.4 Company Profile Definition and purpose of project Scope and objective of project Outline of project report 1-2 1 1 2 2 3 4

2. Review of Literature 3. Research Methodology

3.1 3.2 3.3

Research Design Company Fundamental analysis Company Valuation analysis

4 5 5 5-11 5 6 6 7 8 9 9 10 12-13 12 12 12

4. Introduction to derivatives 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 The definition of a derivative Factors driving the growth of derivatives Functions performed by derivatives market About futures, forwards, options and swaps History of Derivatives Markets in India Derivatives in India: Chronology Participants in Derivatives Markets Exchange Traded v/s Over the counter Derivatives

5. Introduction to Forward Contracts 5.1 Definition Limitations of Forward Markets Terminating a position prior to expiration

5.2
5.3

6. Introduction to Futures 6.1 6.2 6.3 6.4 6.5 6.6 Introduction Futures Terminology How futures work Difference between Cash segment and Futures Future Payoffs Futures in India

14-21 14 14 15 16 18 19

7. Introduction to Options 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 What are Options Options v/s Stocks Understanding Calls and Puts Participants in the options market Terminologies involved Understanding payoffs for call and put options Pricing Options Strategies - Bullish Speculation - Neutral - Bearish Speculation

22 - 45 22 23 24 24 24 27 29 31 31 35 40 46 47

8. Suggestions 9. Limitations of project

LIST OF FIGURES

Figure 6.1 Figure 6.2 Figure 7.1 Figure 7.2 Figure 7.3 Figure 7.4 Figure 7.5 Figure 7.6 Figure 7.7 Figure 7.8 Figure 7.9 Figure 7.10 Figure 7.10

Payoff for buyer of Nifty Future Payoff for seller of Nifty Future Payoff for buyer of Call Option Payoff for writer of call option Payoff for buyer of put option Payoff for seller of put option

18 19 27 28 28 29

Profits/losses for a buyer of calls at various strikes (Bullish speculation) 32 Profits/losses for a writer of puts at various strikes (Bullish speculation) 33 Payoff for a bull spread created using call options Profit and risks by using Long Strangle Profit and risks by using Short Strangle Payoff for seller of call option at various strikes (Bearish speculation) Payoff for buyer of call option at various strikes (Bearish speculation) 34 38 40 42 42

LIST OF TABLES

Table 7.1 Table 7.2 Table 7.3

One month calls and puts trading at different strikes Expiration day cash flows for a Bull spread using two-month calls Expiration day cash flows for a Bear spread using two-month calls

32 35 44