SHREE GANESH INVESTMENT

C-33, Gautam Nagar, L. T. Road, Borivali(West), Mumbai-400 092.

Phones: 5682 7967, 2898 1783 Mobile 98205 72612

Understanding Derivatives
Share Market is a Platform To Make Profit by Trading in Shares or Securities. Of
course, sometimes, profit may be negative. THE SMALL In this article, the phrase The Small stands for people with small fund or small holding capacity. THE BIG In this article, the phrase The Big stands for people with large or unlimited fund or large holding capacity. Besides Moneyed Individuals, FIIs, Big Institutions like LIC, UTI, MUTUAL FUNDS etc. can be regarded as THE BIG. In order to trade, it is necessary to do a transaction. A transaction is a pair of Buy & Sale. In order to make transactions in Share Market, we have two segments. One is CASH SEGMENT & the other is DERIVATIVE SEGMENT.

SEGMENTS

CASH SEGMENT

DERIVATIVE SEGMENT

CASH SEGMENT . This is the most preferred segment. This is safe one. Those who have enough fund, should go for this segment. This segment is good for both THE SMALL & THE BIG.

In this segment you can buy shares within your capacity by making 100 % payment and taking delivery. You have to wait till you get your favorable rates and then sell the shares. You can buy back the same shares when the rates are reasonably low. Your ownership of position remains with you unless and until you have squared off. Such people are known as Investors. They dont undergo frequent or day-to-day trading. It is observed that investors earn a good percentage of profit and that also without any tension. POINTS TO REMEMBER 1. In Cash Segment do not buy all of your required quantity at a time. Buy in certain units. If you desire to buy 500 shares, buy 100 at a time so that you can have fund to buy if the shares are available at lower rates. 2. Similarly while selling do not sell all the shares at a time. If you want to sell 500 shares, sell in the unit of 100 shares so that you may get higher rates for the remaining lots. 3. Do not square off at a very low profit. Try to earn substantial profit. This strategy will help you when you are about to make a substantial loss. 4. Do not do the next transaction in the same item at a very narrow interval of profit. Try to get at least 5 % gain. 5. Try to accumulate a reasonable quantity of a volatile share like RELIANCE at various downward rates. You can do profit churning in Reliance with a quantity of say unit of 50 shares in an open ended way. DERIVATIVE SEGMENT This is the segment where one can do higher volume with less fund compared to Cash Segment. There are two parts in this segment. (1) Future Trading & (2) Option Trading

CASH SEGMENT 1. 100 % payment is to be made for buying and similarly 100 % payment is received while selling 2. Ownership Ownership remains with you unless and until you have squared off the position. 3. Quantity Any quantity of shares can be bought or sold. There is no compulsion

DERIVATIVES 1. Prefixed Margin say 20-40 % is to be paid as Deposit (known as margin) to meet with any risk or liability due to the trade done. 2. Ownership of the position remains with you until you have squared off or till the last Thursday of the Contract Month. 3. One cannot buy any odd quantity but has to buy or sell the Lot in prefixed size.

4. Delivery is to be given or taken.

4. There is nothing like delivery.

DERIVATIVES

FUTURE TRADING

OPTION TRADING

FUTURE TRADING Future Trading is jut like Cash Segment Trading. In Future Trading you are not to pay 100 % payment as you have to do in Cash Segment and there is nothing like delivery. MARGINS In order to trade in Future, you are required to pay two types of margins. (1) Initial Margin (2) Daily Margin. Initial Margin is to be paid initially while taking the position. Suppose you buy One Contract of Reliance Future. At that time say the rate is Rs. 400/-. The lot of Reliance is of 600. So the total value of the lot will be Rs. 2,40,000/. Suppose the Initial Margin fixed for Reliance is say 25 %. So you will have to pay Rs. 60,000/- initially as Initial Margin. The next day the rate becomes Rs. 398/-. So book loss of Rs. 1200/- appears to be there. So you will have to pay this difference to your broker and this amount you pay is known as Daily Margin. Again on the next of the next day, the rate becomes Rs. 395 which means further book loss of Rs. 3 amounting to Rs. 1,800/-. You will have to pay this as Daily Margin. Remember the margin is one kind of Deposit in order to safeguard against any default. Similarly on the third day say the rate becomes Rs. 403 and so your F&O account will be credited with Rs. 4,800/- as there is a book profit of Rs. 8/- per share. In order to avoid daily Give & Take, the client is advised to keep something more than the margin amount that might be required. In case of continuous loss situation when you are not in position to pay margin, your transaction is squared off and the respective loss is debited to your account. In Case of Profit situation you can decide when to square off the transaction.

Future Trading is the most Dangerous One. The people with low funding capacity should not even think of Future Trading.
OPTION TRADING In option Trading you can take either of the positions viz. BUYERS POSITION SELLERS POSITION (ALSO KNOWN AS WRITER) GENERAL EXAMPLE IN A LAYMANS LANUGAGE Let us consider an example. Say Rameshbhai & Sureshbhai are two friends, both dealing in shares. Now Rameshbhai feels that Reliance will be trading at Rs. 500 at the close of the month. At present it is available at Rs. 400 but Rameshbhai does not have fund to buy the lot of 600 shares of Reliance. His friend Sureshbhai is a rich capable person and so Rameshbhai explains Sureshbhai his feelings about Reliance. Rameshbhai says to Sureshbhai that he(Rameshbhai) may buy Reliance from him(Sureshbhai) at the rate of Rs. 410/- later during the month before the expiry date provided that Sureshbhai agrees to make the arrangement. Rameshbhai also gives temptation that he will give him non-refundable commission of Rs. 7 per share immediately in advance. Sureshbhai agrees to take the responsibility of providing Rameshbhai 600 shares of Reliance if he demands the shares and accepts the commission of Rs. 7/- per share from Rameshbhai. Thus Rameshbhai succeeded in getting the right of buying 600 Shares of Reliance at Rs. 410 and for getting the right he had to pay the not-refundable commission of Rs. 7 per share in advance. In this example, in derivative language, Rameshbhai is the option buyer and Sureshbhai is option-seller or option-writer. The word commission is known as premium. The pre-decided price of Rs. 410 is known as Strike Price. The right to buy is known as Call. Hence we can say that Rameshbhai bought a Reliance Call with the strike price of Rs. 410 at a premium of Rs. 7/-. Now the Reliance will cost Rs. 410+7=417 to Rameshbhai. When the rates of Reliance is more than Rs. 417, it will be a time for Rameshbhai to exercise his right at a proper time he likes. BUYER Buyer of the option has a chance of limited loss in an unfavorable situation and unlimited profit in the favorable situation. Generally those with small fund should be buyer of the option so that he occurs a pre-decided or pre-imagined loss or limited loss in an odd situation but can have unlimited profit in a favorable situation. OR

SELLER (WRITER) Seller of the option has a chance of limited profit in a favorable situation and unlimited loss in an unfavorable situation. Generally those, with large stock with them purchased at a very low rate and with good funding arrangement, become Seller of the option. If one does not have fund arrangement, one should not be seller or writer.

OPTION BUYER 1. He has right of buying or selling. 2. He has no obligation.

OPTION SELLER/WRITER 1. He has no right. 2. He has obligation (responsibility) to provide the buyer with the position. 3. He receives premium. 4. Chance of Unlimited Loss. 5. Chance of Limited Profit.

3. He has to pay premium. 4. Chance of Limited Loss. 5. Chance of Unlimited Profit.

OPTION

CALL

PUT

CALL Call means a right to buy. If you expect TEJI, you should buy a Call. PUT Put means a right to sell. If you expect MANDI, you should buy a Put.

PREMIUM Premium is the amount payable by an Option-Buyer. The rates of premium are different for different strike price. STRIKE PRICE Strike Price is the price at which the option-buyer desires to buy the shares.

TOP 9 TRADING STRATEGIES IN DERIVATIVES

1. BUY CALL When market is down, buy just out of money Call. 2. BUY PUT When market is Up and correction is due, buy Put. 3. BUY FUTURE AND SELL CALL When you are bullish but at the same time you want to cover any downward. 4. BULL SPREAD When market is in narrow range, buy IN THE MONEY CALL and sell OUT OF MONEY CALL. 5. CALENDER SPREAD When you want to take TEJI POSITION for the next month, Sell Current Month CALL and Buy Next month Call. 6. STRANGLE When you are not sure in which direction the market will go, Buy CALL & PUT of the same strike price. 7. STRADDLE When results are expected and you do not know in which direction the stock will move, Buy OUT OF MONEY Call and OUT OF MONEY Put.

8. STOCK INSURANCE Buy Future and Buy PUT to cover down side.

9. SELL CALL & PUT In the last days of the Contract Period, Sell naked OUT OF MONEY Call & Put.

Examples of Some Complex Transactions TEST YOURSELF 1. Mukesh expects Teji from now. He buys a Realince Future @ Rs. 439 and sells Reliance 450 Call (with 450 strike price) at the premium of Rs. 9. At the close of contract period, Reliance was Rs. 462. Could Mukesh make profit? If yes, how much ? (Lot Size = 600) 2. Popatlal expects Teji ahead. He buys HLL 180 Call at premium of Rs. 12 and sells 190 Call at the premium of Rs. 8. At the time of settlement end, HLL was trading at 196. Explain Popatlals position. (Lot Size = 2000) 3. Manubhai expects Teji ahead. He buys a Realince Future @ Rs. 437 and sells Reliance 450 Call at the premium of Rs. 6. At the close of contract period, Reliance was Rs. 435. Could Manubhai make profit? If yes, how much ? (Lot Size = 600) 4. Lalu expects Teji ahead. He buys HLL 180 Call at premium of Rs. 11 and sells 190 Call at the premium of Rs. 9. At the time of settlement end, HLL was trading at 191. Explain Lalus position. (Lot Size = 2000)

5. Dhondiba bought a Reliance 450 Call at Rs. 12 and sold Reliance Future @ Rs. 465. What would be his position when Reliance was quoting at Rs. 445/- ? (Lot Size = 600) 6. Dhakkan sold HLL 180 Call at Rs. 11 and bought HLL 190 call at Rs. 6. What will be his position when HLL is trading at Rs. 189 ? (Lot Size = 2000) 7. Makaiwala sold HLL 180 call at Rs. 6 and HLL 190 PUT at Rs. 7 ? What will he occur when HLL is trading at Rs. 175 ? (Lot Size = 2000) 8. Bhikhamchand sold HLL 190 call at Rs. 5 and HLL 190 PUT at Rs. 6 ? What will be his profit range of rates of HLL? When will he start making loss? (Lot Size = 2000) 9. Deepak sells Infosys 4500 call @ Rs. 75 and buys Infosys future at Rs. 4400. What will be his position when the rate of Infosys suddenly falls to Rs. 3800. (Lot Size = 50) 10. Manoj buys Infosys Future at Rs. 4600 and buys Infosys 4500 PUT at Rs. 50. What will be his position when the rate is Rs. 3850 ? Lot quantity for Infosys is 100. (Lot Size = 50) 11. Pradeep bought HLL 180 CALL at Rs. 12 and sold HLL 190 PUT for Rs. 17, both at a time. What will be his position when HLL is trading at Rs. 185 ? (Lot Size = 2000) 12. Manali sold HLL 180 PUT at Rs. 6/-. She also sold HLL 190 CALL at Rs. 3/-. What will be her position when HLL is about to close at Rs. 184? (Lot Size = 2000) 13. Nitin bought INFOSYS 4400 CALL at Rs. 90/-. He sold INFOSYS 4600 CALL at Rs. 60/-. What will be his position when INFOSYS is about to close at Rs. 4685/- ? (Lot Size = 50)

14. Bhavesh bought Infosys 4400 CALL at Rs. 120/- and Infosys 4400 PUT at Rs. 105. What will be his profit zone ? (Lot Size = 50) 15. Rachana sold HLL 180 CALL at Rs. 12 and HLL 180 PUT at Rs. 10/-. What will be her profit zone? (Lot Size = 2000) 16. Kishor bought Arvind Mills Future at Rs. 44 and sold Arvind Mills 50 Call at Rs. 3/-. How much profit or loss will he occur when the closing rate is Rs. 38 ? (Lot Size = 4300) 17. Bharat bought SATYAM FUTURE @ 286.00. He sold SATYAM 300 CALL at the premium of Rs. 5/-. He also bought SATYAM 280 PUT at the premium of Rs. 4/-. What will be his position when SATYAM closes at Rs. 292? (Lot Size = 1200) 18. Ravindra sold INFOSYS 5000 PUT at premium of Rs. 85/-. He sold INFOSYS FUTURE at Rs. 5300/-. What will be his position if INFOSYS finally closes at Rs. 5050/-? (Lot Size = 50) 19. Ashok bought HLL 130 CALL at premium of Rs. 4.00 and HLL 130 PUT at premium of Rs. 6.00. What will be final effect on him when HLL closes at Rs. 119/-? (Lot Size = 2000) 20. Vijay sold ACC FUTURE at Rs. 238/-. He also sold ACC 230 PUT at the premium of Rs. 8.00. What will be final effect on him when ACC closes at Rs. 219/-? (Lot Size = 1500) 21. What have I done, TEJI or MANDI, in the following situations: 1. 2. 3. 4. 5. 6. 7. 8. When I bought a CALL? When I have sold a CALL? When I have bought a PUT? When I have bought both CALL & PUT? When I have sold both CALL & PUT? When I have sold a PUT & bought a CALL? When I have bought a PUT & sold a CALL? When I have sold a PUT? Answers of Question-21. 1. TEJI 2. MANDI 3. MANDI 4. TEJI & MANDI 5. MANDI & TEJI 6. TEJI & TEJI 7. MANDI & MANDI 8. TEJI Note: Lot Sizes of Contracts given at end.

Note: + means incoming value and - means outgoing value.

ANSWERS OF COMPLEX EXAMPLES

Sr 1 Details Initially Buying Reliance Future Selling Reliance 450 Call Finally Squaring off Reliance Future Loss Due 450 Call Profit 2 Initially Buying HLL 180 Call Selling HLL 190 Call Finally Due to Buying HLL 180 Call Due to Selling HLL 190 Call Profit 3 Initially Buying Reliance Future Selling Reliance 450 Call Finally Squaring off Reliance Future Due to Expiry of 450 Call At 435 -262200.00 3600.00 261000.00 600 600 435.00 0.00 600 600 -437.00 6.00 -24000.00 16000.00 32000.00 -12000.00 12000.00 2000 2000 16.00 -6.00 2000 2000 -12.00 8.00 -263400.00 5400.00 277200.00 -7200.00 12000.00 600 600 462.00 -12.00 600 600 -439.00 9.00 Value Qty Rate

Profit 4 Initially Buying HLL 180 Call Selling HLL 190 Call Finally Due to Buying HLL 180 Call Due to Selling HLL 190 Call Profit 5 Initially Buying Reliance 450 Call Selling Reliance Future Finally Due to Expiry of 450 Call At 445 Squaring off Reliance Future Profit 6 Initially Selling HLL 180 Call Buying HLL 190 Call Finally Due to Selling HLL 180 Call Due to Expiry of 190 Call At 189 Loss 7 Initially Selling HLL 180 Call Selling HLL 190 Put

2400.00

-22000.00 18000.00 22000.00 -2000.00 16000.00

2000 2000

-11.00 9.00

2000 2000

11.00 -1.00

-7200.00 279000.00 -267000.00 4800.00

600 600

-12.00 465.00

600 600

0.00 -445.00

22000.00 -12000.00 -18000.00 -8000.00

2000 2000

11.00 -6.00

2000 2000

-9.00 0.00

12000.00 14000.00

2000 2000

6.00 7.00

Finally Due to Expiry of 180 Call At 175 Due to Selling HLL 190 Put Loss 8 Initially Selling HLL 190 Call Selling HLL 190 Put Finally

-30000.00 -4000.00 2000 2000 0.00 -15.00

10000.00 12000.00

2000 2000

5.00 6.00

Break Even for Call is 195 and for Put is 184. He will make profit when HLL remains between 184 and 195. Profit Range : 184 to 195 9 Initially Selling INFOSYS 4500 Call Buying INFOSYS Future @ 4400.00 Finally Due to Expiry of 4500 Call At 3850 Squaring Off INFOSYS Future Loss 10 Initially Buying INFOSYS Future @ 4600.00 Buying INFOSYS 4500 Put @ 50 Finally Squaring Off INFOSYS Future Due to INFOSYS 4500 Put Loss 11 Initially 192500.00 32500.00 -7500.00 50 50 3850.00 650.00 -230000.00 -2500.00 50 50 -4600.00 -50.00 190000.00 -26250.00 50 50 0.00 3800.00 3750.00 -220000.00 50 50 75.00 -4400.00

Buying HLL 180 Call Selling HLL 190 Put Finally Due to Buying HLL 180 Call Due to Selling HLL 190 Put Profit 12 Initially Selling HLL 180 Put Selling HLL 190 Call Finally HLL 180 Put Expired at 184 HLL 190 Call Expired at 184 Profit 13 Initially Buying INFOSYS 4400 Call Selling INFOSYS 4600 Call Finally Due to INFOSYS 4400 Call Due to INFOSYS 4600 Call Profit 14 Initially Buying INFOSYS 4400 Call Buying INFOSYS 4400 Put Finally Due to INFOSYS 4400 Call

-24000.00 34000.00 10000.00 -10000.00 10000.00

2000 2000

-12.00 17.00

2000 2000

5.00 -5.00

12000.00 6000.00 18000.00

2000 2000

6.00 3.00

2000 2000

0.00 0.00

-4500.00 3000.00

50 50

-90.00 60.00

14250.00 -4250.00 8500.00

50 50

285.00 -85.00

-6000.00 -5250.00

50 50

-120.00 -105.00

14250.00

50

285.00

Due to INFOSYS 4400 Put

-4250.00

50

-85.00

Break Even for Call is 4280 and for Put is 4505. He will make profit when INFOSYS remains between 4280 and 4505. Profit Range : 4280 to 4505 15 Initially Selling HLL 180 Call Selling HLL 180 Put Finally Break Even for Call is 192 and for Put is 170. She will make profit when HLL remains between 170 and 192. Profit Range : 170 to 192 16 Initially Buying ARVIND Future @ 44 Selling ARVIND 50 Call Finally Due to ARVIND Future at 38 ARVIND 50 Call Expired at 38 Loss 17 Initially Buying SATYAM Future @ 286 Selling SATYAM 300 Call Buying SATYAM 280 PUT Finally Due to SATYAM Future at close SATYAM 300 CALL expired at 292 SATYAM 280 PUT expired at 292 Profit 350400.00 8400.00 1200 1200 1200 292.00 0.00 0.00 -343200.00 1200 6000.00 -4800.00 1200 1200 -286.00 5.00 -4.00 163400.00 -12900.00 4300 4300 38.00 0.00 -189200.00 4300 12900.00 4300 -44.00 3.00 24000.00 20000.00 2000 2000 12.00 10.00

18

Initially Selling INFOSYS 5000 PUT Selling INFOSYS Future Finally INFOSYS 5000 PUT Expired at 5050 Buying INFOSYS Future Profit -252500.00 16750.00 50 50 0.00 -5050.00 4250.00 265000.00 50 50 85.00 5300.00

19

Initially Buying HLL 130 Call Buying HLL 130 Put Finally HLL 130 Call expired at 119 Due to Buying HLL 130 Put Profit -8000.00 -12000.00 22000.00 2000.00 2000 2000 0.00 11.00 2000 2000 -4.00 -6.00

20

Initially Selling ACC Future Selling ACC 230 PUT Finally Buying ACC Future Due to ACC 230 PUT Profit -328500.00 1500 -16500.00 24000.00 1500 -219.00 -11.00 357000.00 12000.00 1500 1500 238.00 8.00

Permitted Lot Sizes of Contracts As On 12th June, 2004.

No. 1 2 Underlying Symbol NIFTY CNXIT Derivatives on Individual Securities 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 Market Lot 200 100

S&P CNX Nifty CNX IT Associated Cement Co. Ltd. Andhra Bank Arvind Mills Ltd. Bajaj Auto Ltd. Bank of Baroda Bank of India Bharat Electronics Ltd. Bharat Heavy Electricals Ltd. Bharat Petroleum Corporation Ltd. Canara Bank Cipla Ltd. Dr. Reddy's Laboratories Ltd. GAIL (India) Ltd. Grasim Industries Ltd. Gujarat Ambuja Cement Ltd. HCL Technologies Ltd. HDFC Bank Ltd. Hero Honda Motors Ltd. Hindalco Industries Ltd. Hindustan Lever Ltd. Hindustan Petroleum Corporation Ltd. ICICI Bank Ltd. I-FLEX Solutions Ltd. Infosys Technologies Ltd. Indian Petrochemicals Corpn. Ltd. Indian Oil Corporation Ltd. ITC Ltd. Mahindra & Mahindra Ltd. Maruti Udyog Ltd. Mastek Ltd. Mahanagar Telephone Nigam Ltd. National Aluminium Co. Ltd.

ACC ANDHRABANK ARVINDMILL BAJAJAUTO BANKBARODA BANKINDIA BEL BHEL BPCL CANBK CIPLA DRREDDY GAIL GRASIM GUJAMBCEM HCLTECH

1500 4600 4300 400 1400 3800 550 600 550 1600 1000 200 1500 350 1100 1300 600 800 400 300 2000 650 1400 300 50 1100 600 300 625 400 1600 1600 1150

Housing Development Finance Corporation Ltd. HDFC

HDFCBANK HEROHONDA HINDALC0 HINDLEVER HINDPETRO ICICIBANK I-FLEX INFOSYSTCH IPCL IOC ITC M&M MARUTI MASTEK MTNL NATIONALUM

34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51

NIIT Ltd. Oil & Natural Gas Corp. Ltd. Oriental Bank of Commerce Punjab National Bank Polaris Software Lab Ltd. Ranbaxy Laboratories Ltd. Reliance Energy Ltd. Reliance Industries Ltd. Satyam Computer Services Ltd. State Bank of India Shipping Corporation of India Ltd. Syndicate Bank Tata Power Co. Ltd. Tata Tea Ltd. Tata Motors Ltd. Tata Iron and Steel Co. Ltd. Union Bank of India Wipro Ltd.

NIIT ONGC ORIENTBANK PNB POLARIS RANBAXY REL RELIANCE SATYAMCOMP SBIN SCI SYNDIBANK TATAPOWER TATATEA TATAMOTORS TISCO UNIONBANK WIPRO

1500 300 1200 1200 1400 400 550 600 1200 500 1600 7600 800 550 825 900 4200 200