Future and Options in Derevative Mod1

WELINGKAR INSTITUTE OF MANAGEMENT DEVELOPMENT & RESEARCH

SUMMER PROJECT

ON

“Future & Options in derivatives“

By

MMS 2009 – 11 SEMESTER III

SPECIALISATION: FINANCE

ROLL NO: 48

Welingkar Institute of Management Development & Research page 1

ACKNOWLEDGEMENTACKNOWLEDGEMENT

I wish to express my sincere gratitude to all those who helped in various capabilities in

understanding this study and preparing this project.

I am very much indebted to Mr. Suhas Wairagade, DSK INVESTMENT SOLUTIONS, sub

broker ship with SBICAP SECURITIES LTD for their valuable suggestions and continual

support and as they guided, encouraged and inspired me to put my best efforts in the project. His

constant support kept me motivated.

Finally, I would like to express my gratitude towards the support staff of ‘SBICAP Securities Ltd’

for their immense help, co-operation and encouragement throughout the project.

Vivek Sanjayrao Balwir

Date: MMS (Finance)

Place: 2009-2011


CONTENT

OBJECTIVE OF PROJECT 5

RESEARCH METHODOLOGY 7

BREIF COMPANY PROFILE 9

INTRODUCTION TO DERIVATIVES 14

INTRODUCTION TO FUTURES & OPTIONS 22

DATA COLLECTION AND ANALYSIS 27

CASE ANALYSIS 33

FINDING 40

CONCLUSION 43

SUGGESTIONS 45

BIBLIOGRAPHY 46


CHAPTER- 1

OBJECTVE OF PROJECT


Objective of project

The entire project is based on the Analytical and Quantitative method. The project is concern with the Derivatives. The topic selected for research is “To understand and study Trading Strategies in Derivatives”.

A crucial first step that you must take before you start investing is to define your objectives. You do so by identifying your return goals and your risk preferences. You already know that you cannot state your objectives only in terms of return because there is a relationship between risk and return. So you cannot wish to make substantial returns if you do not have the willingness to tolerate high levels of risk.

Return objectives for different investors usually vary among the following: capital appreciation, current income, and total return. Capital appreciation is the goal for those investors who are willing to take risk for the sake of making large capital gains (increase of value of the stocks in the portfolio) over time. With current income, investors are interested in generating periodic income. This is usually for the purpose of providing extra money to assist with the living expenses. This usually involves little risk.

Finally, total return is a blend between capital appreciation and current income. Here the investor desires to generate income as well as accumulate capital gains. With total return, moderate risk is undertaken. As the return objective dictates the level of risk that needs to be taken, it also helps guide the construction of an investor's portfolio. For example, a portfolio aiming for capital appreciation will comprise mainly of common stocks since they have the potential for the highest gains (as well as carry the highest risk). A portfolio of a risk-averse person interested in preserving his/her capital and looking for income will contain mainly corporate and government bonds.

So before you start investing it is essential that you assess your goals and objectives so that you can construct a portfolio that best meets your desires

To study and understand the concept of “derivatives market.” The study analyzes the various strategies of derivatives market segment. To study trading segment “derivatives market.” To study how and why to invest To analyze the available data i.e. fact and figures affecting investment. To analyze and interpret the data i.e. strategies. To identify the factors of Future and Options. Find out Misconceptions about Derivatives and View to overcome them.


CHAPTER- 2

RESEARCH METHODOLOGY


RESEARCH METHODOLOGY

Research in common parlance refers to a search for common knowledge. Once can also define research as a scientific and systematic search for pertinent information on a specific topic. Research is an academic activity and as such the term should be used in term should be used in a technical sense.

Data Collection:

The task of data collection begins after a research problem has been defined and plan chalked out. There are two types of data viz. Primary data, Secondary data. The Primary data those which are collected afresh and for the first time, and thus happen to be original in character. The Secondary data, on the other hand, are those which have already been collected by some one else and which have been passed through the statistical process.In research data is divided into two major parts i.e. Primary Data & Secondary Data. There different sources and methods of data collection follows:

Primary data collection:

The primary data is collected through Personal interview of company manager, and open discussion with company employees, information provided by the company.

Secondary Data Collection:

The secondary data collected in project through Manuals Internet Books and newspapers company websites, company literature NCFM modules.


CHAPTER- 3

BRIEF COMPANY PROFILE


Company Profile

SBICAP Securities Ltd (SSL) is a 100% subsidiary of SBI Capital Markets Ltd which is one of the oldest players in the Indian Capital Market and has a dominant position in the Indian primary capital markets. SBI Capital Markets Ltd. commenced broking activities in March 2001 to fulfill the secondary market needs of Financial Institutions, FIIs, Mutual Funds, Banks, Corporate, High Net worth Individual, Non-residential Investors and Retail domestic investors. SBICAP Securities Ltd. (SSL) is a company, which has been formed to take over the broking operations of SBI Capital Markets Ltd. SSL commenced operations in the first quarter of financial year of 2006-2007

SBICAPSEC is the 100 per cent subsidiary of SBI capital markets Limited, which has a share holding of 86.16 per cent by State Bank of India and Asian Development Bank, which owns 13.84 per cent.

Product and Services Offered:

Sr. No. Product and Services

1 Equity

2 Derivative.

3 Mutual Fund.

4 IPO.

5 Depositories


SSL is registered with the Securities Exchange Board of India for its various services, a summary of which is as under:

SSL Institutional Equities Division combines the efforts of Research and Sales & Trading departments to best serve clients' needs. They believe it is there unflinching commitment to providing superior client service that makes them stand out. SSL have a dedicated research team, which is engaged in analyzing the Indian economy and corporate sectors to identify equity investment ideas. They staunchly practice the value-investing philosophy and advise investors to take a long-term view of equity investments. Consistent delivery of high quality advice on individual stocks, sector trends and investment strategy has established them as a reliable research unit amongst leading Indian as well as International Investors. SSL’s sales & trading team, comprising top equity professionals, translates the research findings into actionable advice for clients, based on their specific needs. Each sales personnel have significant experience in equity research. Sophisticated computerized tools are used to understand client investment profile and objectives, which ensures proactive and timely service.

SSL’s Team constituted by experienced professionals has entrenched knowledge and proven credentials in the business with cross product knowledge. The key strengths of the team are:

Expertise in industry sectors. Deep understanding of the capital markets. Strong networking with buys side institutions. Ability to structure transaction and products suitable to needs of the clients.


Registered with/as Registration no.

SEBI -Stock Broker-NSE INB231052938

SEBI- Stock Broker –BSE INB011053031

SEBI- Stock Broker-NSE-

F&OINF231052938

SEBI- Depository

ParticipantIN-DP-CDSL-370-2006

SEBI – Portfolio Manager INP000002098

Key Executives:

SBI Organization:


Mr. S. Vishvanathan – ChairmanMrs. Swati Desai - Managing DirectorShri S H Visweswariah - Whole time Director.Dr Manoj Vaish - Independent DirectorSmt. Bharati Rao - non-Executive Director.Shri M.K. Nag - non-Executive Director

Investment Rationale

Each investment alternative has its own strengths and weaknesses. Some options seek to achieve superior returns (like equity), but with corresponding higher risk. Other provide safety (like PPF) but at the expense of liquidity and growth. Other options such as FDs offer safety and liquidity, but at the cost of return. Mutual funds seek to combine the advantages of investing in arch of these alternatives while dispensing with the shortcomings.

Indian stock market is semi-efficient by nature and, is considered as one of the most respected stock markets, where information is quickly and widely disseminated, thereby allowing each security’s price to adjust rapidly in an unbiased manner to new information so that, it reflects the nearest investment value. And mainly after the introduction of electronic trading system, the information flow has become much faster. But sometimes, in developing countries like India, sentiments play major role in price movements, or say, fluctuations, where investors find it difficult to predict the future with certainty. Some of the events affect economy as a whole, while some events are sector specific. Even in one particular sector, some companies or major market player are more sensitive to the event. So, the new investors taking exposure in the market should be well aware about the maximum potential loss, i.e. Value at risk.


CHAPTER- 4

INTRODUCTION TO DEREVATIVES


“DERIVATIVES”

A derivative is a product whose value is defined from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner, the underlying asset can be equity, forex, commodity or any other asset.

For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by the date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the “underlying”.

In the Indian context the securities Contract (Regulation) Act, 1956 (SC(R) A) defines “derivatives” to include:-

1) A security derived from a debt instruments, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security.

2) A contract, which derives its value from the prices, or index of prices, of underlying securities.

The need of a derivatives market

The derivatives market performs a number of economic functions:

1. They help in transferring risks from risk adverse people to risk oriented people

2. They help in the discovery of future as well as current prices

3. They catalyze entrepreneurial activity

4. They increase the volume traded in markets because of participation of risk adverse people in

greater numbers

5. They increase savings and investment in the long run


TYPES OF DERIVATIVES:


Forward

Swaps

Options

Futures

Type of

Derivatives

Instrument’

The most commonly used derivative contracts are forwards, futures and options, which we shall discuss in detail later. Here we take a brief look at various derivatives contracts that have come to be used.

Futures: A future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the farmers are standardized exchange traded contracts.

Options: Options are of two types – call and put. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying assets, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying assets at a given price on or before a given date.

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

Leaps: The acronym LEAPS mean long-term equity anticipation securities these are options having a maturity of up to three years.

Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average or a basket of assets. Equity index options are a form of basket options.

Swaps: Swaps are private agreement between two parties to exchange cash flow in future according to prearranged formula. They can be as portfolio of future contracts. Two commonly used swaps are:

Interest rate swaps: These entail swapping only the interest related cash flow between the parties in the same currency.

Currency swaps: These entail swapping both principal and interest between the parties, with the cash flow in one direction being in a different currency then those in opposite direction.


The participants in a derivatives market:

Hedgers:- Hedgers use futures or options markets to reduce or eliminate the risk associated with price of an asset.

Speculators:- Speculators use futures and options contracts to get extra leverage in betting on future movements in the price of an asset. They can increase both the potential gains and potential losses by usage of derivatives in a speculative venture.

Arbitrageurs:-Arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. If, for example, they see the futures price of an asset getting out of line with the cash price, they will take offsetting positions in the two markets to lock in a profit

INDIA: GROWTH OF DERIVATIVES

The Indian financial market took a giant leap ahead with the introduction of derivatives trading on the stock exchanges. The derivatives trading in India commenced with the introduction of index futures in Jun 2000. The advent of stock futures and options in 2001 resulted in dramatic increase in the volumes of derivatives. In less than three years, the volume in futures and options segment rose more than that of the cash market. Since then, the volumes in the F&O segment have witnessed huge growth. Currently, the volumes in F&O are consistently around four to five times more that the cash market volumes. This is itself the huge popularity of these instruments among the Retail and Institutional Investors.

Going ahead, the derivatives markets see a further rise with the increase in knowledge levels among the investor about these products. They also act as very useful hedging tool for institutional investor who would like to protect their holdings against any negative surprise. With the government liberalizing norms for Mutual Funds participation in derivative segment, the participation is expected to rise further in the future. The mutual fund industry is also launching derivative funds where the primary focus would be to generate returns through investments in derivatives.

Factors driving the growth of derivatives:

Over the last three decades, the derivatives market has seen a phenomenal growth. A large variety of derivatives contracts have been launched at exchanges across the world. Some of the factors driving the growth of financial derivatives are,


Increase volatility in asset prices in financial markets. Increased integration of national financial markets with the international market. Marked improvement in communication facilities and sharp decline in their costs Development of more sophisticated risk management tools, providing economic

agents a wider choice of risk management strategies. Innovations in the derivatives markets, which optimally combine the risk and returns

over a large number of financial assets leading to higher return, reduced risk as well as transaction costs as compared to individual Financial assets

Comparative Analysis - World Exchanges (Jun 2007)

The position of contracts traded on NSE as against the total Contracts Traded on the all Exchanges of the world Exchange,

On 2nd position in Stock Futures with 6,241,247 contracts On 4th position in Index Futures with 8,437,382 contracts On 9th position in Index Options with 1,911,398 contracts On 15th position in Stock Options with 264,487 contracts

Equities vs. Futures & Options

NSE started trading in the equities segment (Capital Market segment) on November 3, 1994 and within a short span of 1 year became the largest exchange in India in terms of volumes transacted.The National Stock Exchange of India Limited (NSE) commenced trading in derivatives with the launch of index futures on June 12, 2000. The futures contracts are based on the popular benchmark S&P CNX Nifty Index

The Exchange introduced trading in Index Options (also based on Nifty) on June 4, 2001. NSE also became the first exchange to launch trading in options on individual securities from July 2, 2001. Futures on individual securities were introduced on November 9, 2001. Futures and Options on individual securities are available on 118 securities stipulated by SEBI.

The Exchange has also introduced trading in Futures and Options contracts based on the CNX-IT index from August 29, 2003.


NSE – Business Growth in Derivatives (Turnover – Rs. in Cr)

Year Turnover (Rs. cr.)2009-10 176636652008-09 110104822007-08 130904782006-07 73562422005-06 48241742004-05 25469822003-04 21306102002-03 4398622001-02 1019262000-01 2365


Volume Growth in Futures & Options segments

Year Futures Rs in Cr. Option Rs in Cr.2009-10 9129635 8534029.42008-09 7049754 3960728.72007-08 11369231 1721247.42006-07 6370541 9857012005-06 4305452 5187222004-05 2256203 2907792003-04 1860385 2700232002-03 330485 1093772001-02 72998 289282000-01 2365 0

The above graph depicts the picture of volume growth in Futures and Options segments for India. The volume growth of Futures is very high as compared to Options.


CHAPTER- 5

INTRODUCTION TO FUTURES AND OPTIONS


INTRODUCTION TO FUTURES AND OPTIONS

In recent years, derivatives have become increasingly important in the field of finance. While futures and options are now actively traded on many exchanges, forward contracts are popular on the OTC market.

Introduction to Futures:

Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or which can be used for reference purposes in settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 99% of futures transactions are offset this way. This standardized item in a futures contract is:

Quantity of the underlying Quality of the underlying The date and the month of delivery The units of price quotation and minimum price change. Location of settlement.

What are futures contract?

Futures contract is a financial contract obligating the buyer to purchase an asset (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. The futures markets are characterized by the ability to use very high leverage relative to stock markets.


How does the futures market solve the problems of forward markets?

Futures markets feature a series of innovations in how trading is organized:

1) Futures contracts trade at an exchange with price-time priority. All buyers and sellers come to one exchange. This reduces search costs and improves liquidity. This harnesses the gains that are commonly obtained in going from a non-transparent club market (based on telephones) to an anonymous, electronic exchange which is open to participation. The anonymity of the exchange environment largely eliminates cartel formation.

2) Futures contracts are standardized - all buyers or sellers are constrained to only choose from a small list of tradable contracts defined by the exchange. This avoids the illiquidity that goes along with the unlimited customization of forward contracts.

3) A new credit enhancement institution, the clearing corporation, eliminates counterparty risk on futures markets. The clearing corporation interposes itself into every transaction, buying from the seller and selling to the buyer. This is called novation. This insulates each from the credit risk of the other. In futures markets, unlike in forward markets, increasing the time to expiration does not increase the counterparty risk. Novation at the clearing corporation makes it possible to have safe trading between strangers. This is what enables large-scale participation into the futures market - in contrast with small clubs which trade by telephone and makes futures markets liquid.

Futures Terminology:

Spot price: The price at which an asset trades in the spot market.

Futures price: The price at which the futures contract trades in the futures market.

Contract cycle: The period over which a contract trades. The index futures contracts on the NSE have one-month, two-months and three-month expiry cycles which expire on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three-month expiry is introduced for trading.

Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist.

Contract size: The amount of asset that has to be delivered less than one contract. For instance, the contract size on NSE’s futures market is 200 Nifties.

Basis: In the context of financial futures, basis can be defined as the futures price minus the spot price. There will be a different basis for each delivery month for each contract. In


a normal market, basis will be positive. This reflects that futures prices normally exceed spot prices.

Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.

Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin.

Making-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor’s gain or loss depending upon the futures closing price. This is called marking-to-market.

Introduction to Options:

In this section, we look at the next derivatives product to be traded on the NSE, namely options. Options are fundamentally different from forward and futures contracts. An option gives the holder of the option the right to do something. The holder does not have to exercise this right. In contrast, in a forward or futures contract, the two parties have committed themselves to doing something. Whereas it costs nothing (expect margin requirements) to enter into a future contract, the purchase of an option requires an up-front payment.

Option Terminology:

Index option: These options have the index as the underlying. Some options are European while others are American. Like index futures contracts, index options contracts are also cash settled.

Stock options: Stock options are options on individual stocks. Options currently trade on

over 500 stocks in the United States. A contract gives the holder the right to buy or sell shares at the specified price.

Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer

. Writer of an option: The writer of a call/put option is the one who receives the option

premium and is thereby obliged to sell/buy the asset if the buyer exercises on him. There are two basic types of options, call options and put options.

Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price.


Put option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price.

Option price/premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium.

Expiration date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity.

Strike price: The price specified in the options contract is known as the strike price or the exercise price.


CHAPTER- 6

DATA COLLECTION AND DATA ANALYSIS


DATA COLLECTION AND DATA ANALYSIS

DIFFERENT STRATEGIES IN FUTURES & OPTIONS

What are Strategies? Strategies are specific game plans created by you based on your idea of how the market will move. Strategies are generally combinations of various products – futures, calls and puts and enable you to realize unlimited profits, limited profits, unlimited losses or limited losses depending on your profit appetite and risk appetite.

How are Strategies formulated? The simplest starting point of a Strategy could be having a clear view about the market or a script. There could be strategies of an advanced nature that are independent of views, but it would be correct to say that most investors create strategies based on views.

What views could be handled through Strategies?

There could be four simple views: bullish view, bearish view, volatile view and neutral view. Bullish and bearish views are simple enough to comprehend. Volatile view is where you believe that the market or scrip could move rapidly, but you are not clear of the direction (whether up or down). You are however sure that the movement will be significant in one direction or the other. Neutral view is the reverse of the Volatile view where you believe that the market or scrip in question will not move much in any direction

Bullish Strategies

Various bullish strategies possible Buy a Future Buy a Call Option Sell a Put Option Create a Bull Spread using Calls Create a Bull Spread using Puts

Let us discuss each of these using some examples.

Buy a Futures ContractIf you buy a Futures Contract, you will need to invest a small margin (generally 15 to 30% of the Contract value). If the underlying index or scrip moves up, the associated Futures will also move up. You can then gain the entire upward movement at the investment of a small margin. For example, if you buy Nifty Futures at a price of Rs 4,100 that moves up to 4,150 in say 10 days time you gain 50 points. Now if you have invested only 20%, i.e. 820, your gain is over 6.09% in 10 days time.


The danger of the Futures value falling is very important. You should have a clear stop loss strategy and if you’re Nifty Futures in the above example were to fall from 4,100 to say 4,080; you should sell out and book your losses before they mount.

The graph of a Buy Futures Strategy appears below:

Buy a Call Option

If you buy a Call Option, your Option Premium is your cost which you will pay on the day of entering into the transaction. This is also the maximum loss that you can ever incur. If you buy a Satyam May 260 Call Option for Rs.21, the maximum loss is Rs.21. If Satyam closes above Rs.260 on the expiry day, you will be paid the difference between the closing price and the strike price of Rs.260. For example, if Satyam closes at Rs.300, you will get Rs.40. After setting off the cost of Rs.21, your net profit is Rs.19.

The Call buyer has a limited loss, unlimited profit profile. No margins are applicable on the buyer. The premium will be paid in cash upfront. If the Satyam scrip moves nowhere, the buyer is adversely impacted. As time passes, the value of the Option will fall. Thus if Satyam is currently at around Rs 260 and remains around that price till the end of May, the value of the Option which is currently Rs 21 would have fallen to nearly zero by that time. Thus time affects the Call buyer adversely.


4050 4100 4150

0

50

NIFFTY

-50

PR

OF

IT

The graph of a Buy Call position appears below

Sell a Put Option

Another bullish strategy is to sell a Put Option. As a Put Seller, you will receive Premium. For example, if you sell Reliance May 300 Put Option for Rs 18; you will earn an Income of Rs 18 on the day of the transaction. You will however face a risk that you might have to pay the difference between 300 and the closing price of Reliance scrip on the last Thursday of May. For example, if Reliance were to close on that day at Rs 275, you will be asked to pay Rs 25. After setting of the Premium received of Rs 18, the net loss will be Rs 7. If on the other hand, Reliance closes above Rs 300 (as per your bullish view), the entire income of Rs 18 would belong to you.

As a Put Seller, you are required to put up Margins. These margins are calculated by the exchange using a software program called Span. The margins are likely to be between 20 to 35% of the Contract Value. As a Put Seller, you have a limited profit, unlimited loss profile which is a high risk strategy. If time passes and Reliance remains wherever it is (say Rs 300), you will be very happy. Passage of time helps the Sellers as value of the Option declines over time


0

-50

50

100

150

360

325

290

255

220

185

PAY

OFF

STRIKE PRICE

The profile of the Put Seller would appear as under:

Bull Spreads

First of all, Spreads are strategies, which combine two or more Calls (or alternatively two or more Puts). Another series of Strategies goes by the name Combinations where Calls and Puts are combined.Bull Spreads are those class of strategies that enable you benefit from a bullish phase on the index or scrip in question. Bull spreads allow you to create a limited profit, limited loss model of payoff, which you might be very comfortable with.

Bull Spread using Calls/ Puts

Bull spreads can be created using Calls or using Puts. You need to buy one Call with a lower strike price and sell another Call with a higher strike price and a spread position is created. Interestingly, you can also buy a Put with a lower strike price and sell another with a higher strike price to achieve a similar payoff profile.

Bearish Strategies

Various bearish strategies possible Sell Scrip Futures Sell Index Futures Buy Put Option


Sell Call Option Bear Spreads Combinations of Options and Futures

Let us discuss each one of them now.

Sell Scrip Future or Index Futures:-

In the current Indian system, when you sell Scrip Futures, you are not required to deliver the underlying scrip. You will be required to deposit a certain margin with the exchange on sale of Scrip Futures. If the Scrip actually falls (as per your belief), you can buy back the Futures and make a profit. For example, Satyam Futures are quoting at Rs 250 and you sell them today as you are bearish. You could buy them back after 10 days at say Rs 230 (if they fall as per your expectations), generating a profit of Rs 20. Question of delivering Satyam does not arise in the present set up.

You will be required to place a margin with the exchange which could be around 25% (an illustrative percentage). If you accordingly place a margin of Rs 62.50, a return of Rs 20 in 10 days time works out to a wonderful 30% plus return.

Obviously, if Satyam Futures move up (instead of down) you face an unlimited risk of losses. You should therefore operate with a stop loss strategy and buy back Futures if they move in reverse gear.

You could adopt the same strategy with Index Futures if you are bearish on the market as a whole. Similar returns and risks are attached to this strategy.

Buy Put Option The Put Option will rise in value as the scrip (or index) drops. If you buy a Put Option and the scrip falls (as you believe), you can sell it at a later date. The advantage of a Put Option (as against Futures) is that your losses are limited to the Premium you pay on purchase of the Put Option.

For example, a Satyam 260 Put may quote at Rs 21 when Satyam is quoting at Rs 264. If Satyam falls to Rs 244 in 8 days, the Put will move up to say Rs 31. You can make a profit of Rs 10 in the process.

No margins are applicable on you when you buy the Put. You need to pay the Premium in cash at the time of purchase.

Sell Call OptionIf you are moderately bearish (or neutral or bearish), you can consider selling a Call. You will receive a Premium when you sell a Call. If the underlying Scrip (or Index) falls as you expect, the Call value will also fall at which point you should buy it back.


For example, if Satyam is quoting at Rs 264 and the Satyam 260 Call is quoting at Rs 18, you might well find that in 8 days when Satyam falls to Rs 244, the Call might be quoting at Rs 7. When you buy it back at Rs 7, you will make a profit of Rs 11.

However, if Satyam moves up instead of down, the Call will move up in value. You might be required to buy it back at a loss. You are exposed to an unlimited loss, but your profits are limited to the Premium you collect on sale of the Call. You will receive the Premium on the date of sale of the Option. You will however be required to keep a margin with the exchange. This margin can change on a day to day basis depending on various factors, predominantly the price of the scrip itself.

Bear SpreadsIn a bear spread, you buy a Call with a high strike price and sell a Call with a lower strike price. For example, you could buy a Satyam 300 Call at say Rs 5 and sell a Satyam 260 Call at Rs 26. You will receive a Premium of Rs 26 and pay a Premium of Rs 5, thus earning a Net Premium of Rs 21. If Satyam falls to Rs 260 or lower, you will keep the entire Premium of Rs 21. On the other hand if Satyam rises to Rs 300 (or above) you will have to pay Rs 40. After set off of the Income of Rs 21, your maximum loss will be Rs 19.

S BSatyam Closing Price

Profit on 260 Strike Call (Gross)

Profit on 300 Strike Call (Gross)

Premium Received on Day One

Net Profit

250 0 0 21 21255 0 0 21 21260 0 0 21 21270 -10 0 21 11281 -21 0 21 0290 -30 0 21 -9300 -40 0 21 -19310 -50 10 21 -19


The pay off profile appears as under:In a bear spread, your profits and losses are both limited. Thus, you are safe from an unexpected rise in Satyam as compared to a clean Option sale.

Combination of Futures and Options:-

If you sell Futures in a bearish framework, you run the risk of unlimited losses in case the scrip (or index) rises. You can protect this unlimited loss position by buying a Call. This combination will result effectively in a payoff similar to that of buying a Put.

You can decide the strike price of the Call depending on your comfort level. For example, Satyam is quoting at Rs 264 currently and you are bearish. You sell Satyam Futures at say Rs 265. If Satyam moves up, you will make losses. However, you do not want unlimited loss. You could buy a Satyam 300 Call by paying a small Premium of Rs 5. This will arrest your maximum loss to Rs 35.

If Satyam moves up beyond the Rs 300 level, you will receive compensation from the Call, which will offset your loss on Futures. For example, if Satyam moves to Rs 312, you will make a loss of Rs 47 on Futures (312 – 265) but make a profit of Rs 12 on the Call (312 – 300). For this comfort, you shell out a small Premium of Rs 5 which is a cost.


CHAPTER- 7

CASE ANALYSIS


“CASE ANALYSIS”

Futures Contract:-

Case:-1st

Client name: - Mrs. Sonali Pritesh Bedmutha

The investor traded as follows;

She purchases the future of the BHEL of expire on 28/06/2010;

Date Securities Qty. bought

Qty. sold Gross rate

Expenses Net rate Total

28/06/2010 BHEL 125 2483.2 155.20 2484.4 310555.2

28/06/2010 BHEL 125 2482.5 155.15 2483.74 310157.3

The above trade is type of intraday i.e. the trade is completed in one trading session. The investor is in loss of Rs. 397.86. She invest Rs.62111.4 (20% of Rs. 310555.2) as the margin money for a day and has a loss of Rs.397.86, it means she had a loss @ 0.64%. Other than the future contract if she invests in other field e.g. cash market she makes a loss @ 0.13%, which is much less than the loss in the future contract.

Case:-2nd

Client name: Mr. Pankaj Ramdas Patel

The Investor traded as follows;

Date Securities Qty.

Bought

Qty.

Sold

Gross

Rate

Expenses Net Rate Total

14/06/2010 NIFFTY 50 5145 128.63 5147.57 257378.6

14/06/2010 NIFFTY 50 5180 129.5 5177.41 258870.5

The above trade is type of intraday trade i.e. the transaction is completed in a trading session. The investor earns the profit of Rs. 1491.88. He invests the margin money Rs.51475.73 (20% of


Rs.257378.6) for a day & earns Rs.1491.88, it means he earn @2.90% after the all charges. Other than the derivatives if he invests in cash market i.e. in equity then he earn Rs.1491.88 on investment of Rs.212295.00 in one day, the rate of return is 0.58%, which is much less than he earn in future contract.

Case:-3rd

Client name: - Mr. Jayesh Laxshman Wani


Date Securities Qty. Bought

Qty. Sold

Gross rate

Exp. Net rate Total

25/06/10 RCOM 2000 188 188 188.094 376188

30/06/10 RCOM 2000 188.40 188.40 188.50 376988.4

30/06/10 RCOM 2000 188.40 188.40 188.50 376988.4

30/06/10 RCOM 2000 192.5 192.5 192.6 385192.5

30/06/10 RCOM 2000 192.5 192.5 192.6 385192.5

30/06/10 RCOM 2000 196.50 196.50 196.598 392803.5

30/06/10 RCOM 2000 196.50 196.50 196.598 392803.5

30/06/10 RCOM 2000 197 197 197.099 393803

30/06/10 RCOM 2000 197 197 197.099 393803

30/06/10 RCOM 2000 197.5 197.5 197.599 394802.5

In above trade the investor sell five lot of RCOM (Reliance Communication) by date 30/06/2010 out of which four are bought on 30/06/2010 and one is standing by date 25/10/2010. From the above trade he earns the net profit of Rs.69434.7, after deducting the expenses.

It means he invest Rs.380109.96 i.e. 20% of Rs.1900550, on which he earn the profit of Rs.67465.7. If we calculate the rate of return in percentage it comes to 17.75%. If the investor invests any where other than the future the rate of return is much less than the return in future contract. If he invest in cash market and earn same amount of profit i.e. Rs.67465.7, but the rate of return is much less, which comes to 3.55%.


Case:-4th

Client name: - Mr. Dinesh Shah.


Date Securities Qty. bought

Qty. sold

Gross rate

Exp. Net rate Total

02/06/2010 DLF 1000 266.5 133.25 266.63 266633.3

02/06/2010 DLF 2000 267.2 267.2 267.33534667.2

02/06/2010 DLF 1000 267.5 133.75 267.63 267633.8

02/06/2010 DLF 1000 269 134.5 269.13 269134.5

02/06/2010 DLF 1000 270.5 135.25 270.64 270635.3

02/06/2010 DLF 1000 267.5 133.75 267.37 267366.3

02/06/2010 DLF 1000 268 134 267.87 267866

02/06/2010 DLF 1000 268.5 134.25 268.37 268365.8

02/06/2010 DLF 1000 270 135 269.87 269865

02/06/2010 DLF 1000 271 135.5 270.86 270864.5

02/06/2010 DLF 1000 272 136 271.86 271864

In the above trade, the investor buys six lot of DLF ltd., with expiry of 24/06/2010 and sells all lot in trading session. The investor earn net profit of Rs 6455.4, after deducting the all the charges. He invests the margin money of Rs. 268274.1 i.e. 20% of Rs. 1341370.00 and earns the profit of Rs. 6455.4. It means that he earn @2.41%. If he invests in other field or in some other investment, rate of return is much less than rate of return which he earn in future contract. If he invests in cash market, then the rate of return is @0.48%.


Option Contract:-Case:-1st

Client name:-Mr. Manohar Ramdas Bhandari

Date Securities Qty.

bought


Exp. Net rate Total

27/07/08 NIFFTY 50 8.90 100 10.9 545

28/07/08 NIFFTY 50 4.65 100 2.65 132.5

In the above trade the investor buy Call of the NIFFTY 4300 of expiry 31/07/2008. The net rate at which he bought the call is 4309.1136 i.e. margin money plus strike price, he assume market goes up i.e. NIFFTY goes towards 4300, if that possible then he must earn maximum profit in option contract. But hear the price of NIFFTY goes down, so due to this price of the call goes down and investor suffer loss. But in option there is minimum loss and maximum profit.

In above trade investor invests only the margin money to buy the call of NIFFTY, the amount is Rs545 on which he losses Rs. 412.5. The loss is minimum than the loss he will bear if he invest in cash market.

Case:-2nd

Client name:-Mr. Snehal Bhaiyyaji Pisudde.

Date Securities

Qty. bought


Exp Net rate

Total

24/06/2010 NIFFTY 50 92 100 94 4700

24/06/2010 NIFFTY 50 99 100 97 4850

In the above trade caller buy a put option with strike of 5400 i.e. PE 5400 at option price 92. During this market goes down and his option price increases to 99. He sold a Put Option at 99. During this trading, he made a profit of Rs.150, after deducting brokering charges.


CHAPTER- 8

FINDINGS


FINDINGS1) Derivatives provided seven additional trading instruments to the investors.

2) Derivatives, as their name implies, are contracts they are based on or derived from some underlying assets, reference rate, or index. Most common financial derivatives, described later, can be classified as one, or a combination, of four types: swaps, forwards, futures, and options that are based on interest rates or currencies.

3) Without clearly define risk management strategy, use of financial derivatives can be dangerous. It can be threaten the accomplishment of a firm’s long range objectives and result in unsafe and unsound practices that could lead to the organization’s insolvency. But when used wisely, financial derivatives can increase shareholder value by providing a means to better control a firm’s risk exposures and cash flows.

4) Financial derivatives can be used in two ways: to hedge against the unwanted risk or to speculated by taking a position in anticipation of a market movement.

5) Financial derivatives have changed the face of finance by creating new ways to understand, measure, and manage risks. The freedom to manage risk effectively must not be taken away.

6) Different trading strategies can be used by investors under different market trends i.e. bullish, bearish, range bound and volatile market. But it is not easy to make profits in cash market in different market trends

7) Derivatives offer organizations the opportunity to break financial risks into smaller components and then to buy and sell those components to best meet specific risk management objectives. Moreover, under a market-oriented philosophy, derivatives allows for the free trading of individual risk components, thereby improving market efficiency. Using financial derivatives should be considered a part of any business’s risk management strategy to ensure that value enhancing investment opportunity could be pursued.

8) From the simple forward agreement, financial future contracts were developed. Futures are similar to forwards, except that futures are standardized by Exchange clearinghouse, which facilitated anonymous trading in more competitive and liquid market. In addition futures contracts are marked to market daily, which greatly decreases counter-party risk. The other party to the transaction will be unable to meet its obligation on the maturity dates.


9) Derivatives also help to improve market efficiencies because risk can be isolated and sold to those who are willing to accept them at the least cost. Using derivatives breaks risk into pieces that can be managed independently. Corporations can keep the risk they are most comfortable managing and transfer those they do not want to other companies that are more willing to accept them. From a market-orientated prospective, derivatives offer the free trading of financial risks.

10) Most of the investors have not sufficient knowledge of derivative instruments, and hence they deal in cash market (equity market) only.


CHAPTER- 9

CONCLUSION


CONCLUSION:

The project was done in order to understand and study various trading strategies used in derivatives. It included the study of various instruments like forward, future and options.

On the basis of the analysis done, I conclude the following –

Derivatives are the contracts derived form some underlying stock or index. Most of common Derivative instruments are futures, options.

Various trading strategies like bullish, bearish, neutral and volatile strategies can be used by the investors according to the market trends.

Derivatives have become very important in the field finance. They are very important financial instruments for risk management as they allow risks to be separated and traded. Derivatives are used to shift risk and act as a form of insurance.

There are very few people knowing exactly what derivatives is all about.

In my concluding part I would like to say that Derivatives could be a very effective tool to take advantage of a rising, falling and range bound underlying. But for that awareness is to be created about the terminology of derivatives.

But as it is said “High risk high return” future and option are best way for hedging risk for high & high returns.


CHAPTER-8SuggestionCHAPTER-8Suggestion

SUGGESTION

1) Market sentiment at the time on purchase: It is often that timing is everything but the longer your time horizon, the less important is timing of your purchase. Market sentiment can be gauged by the general direction of various market indices, the number of companies’ exceeding or not meeting earnings & what the investment community (analyst, brokers, traders, investors, commentators) are saying about equities in general or specific equities that pertain to the one you are considering.

2) Industry of the company: Many industries have are cyclical in nature. Thus a company may report excellent earning and posses strong fundamentals moving forwards, but due to it’s cyclical nature will decline over a given time period. You should also evaluate the growth prospectus of the industry. For instance, wireless is as area that is expected to see a lot of growth in coming years. Be careful though, as only a few companies often dominated sectors that are in their infancy in the long term future.

3) The concept of derivatives is not very simple. An investor should therefore have sound knowledge of technical terms in Derivatives before dealing in Future market.

4) An investor can use different strategies like bullish, bearish, neutral and volatile strategies in different market trends i.e. bullish, bearish, range bound and volatile market.

5) The investor should also note that the price of future contracts depends on many factors which are uncontrollable. Therefore he should take care of such factors.


BIBLIOGRAPHY

Reference Book:

NCFM Module – Derivatives Market (Dealer and Equity ) Module- NSE India

Financial Management -Ravi. M. Kisore.

Websites:

www.sbicap securities.com

www.nseindia.com

www.derivativesindia.com

www.bseindia.com

www.stock-option-trading.com

www.moneycontrol.com


http://www.stock-option-trading.com/

http://www.bseindia.com/

http://www.derivativesindia.com/

http://www.sbicap/

Documents

Future and Options in Derevative Mod1