Khushboo Stock Market Overview

8/14/2019 Khushboo Stock Market Overview

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ACKNOWLEDGEMENT

It is my great pleasure to present this report. I thank all those people whohelped me to make this project, by providing necessary information.

I would like to express my gratitude towards Mr. Nayan Thakkar of Kunvarjigroup who spent his most valuable time and provided with all the necessarydetails regarding the company.

I would also like to thank Ms. Sheetal Panchal and Mr. Kunal Shah, whoshared their knowledge and expertise.

I would also like to thank Mr. Taral Pathak and Mr. Mayank Joshipura of

AESPGIBM for their guidance throughout the preparation of the project andfor their valued suggestion.

At last I would like to thank all those people who helped me bring thisproject to fruitism.

Date:

Place: Signature


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EXECUTIVE SUMMARY

This project mainly focuses on Share market as a whole, its history anddevelopment.

Herein, I discuss the basic concepts of the share market, what is equitymarket, commodities market and derivatives market, how they function.

It discusses Kunvarji as a stock broking company, and its services.

Lastly, it includes an analysis on The Historic Market Crash of May 2006.


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KUNVARJI COMMODITIES & FINSTOCK PVT LTD.

The group is doing the business activities in the field of Shares and Stockfor more than 10 years and in the field of Commodities for more than 2 year.

The activities include those of trading as well as broking.

The company's sister concern, Kunvarji Commodities Brokers Pvt. Ltd. is amember of NCDEX, MCX, NMCE and ACEL.

Kunvarji Commodities Brokers Pvt. Ltd. (India) a company which is pioneerservice provider in the field of an organized commodities and derivativessector with wide range of clients at large.

The trading in commodity futures and derivatives has an immense potentialin India and worldwide. In the international market, the commodity futuretrading holds a big part of total turnover in the allied markets.

Kunvarji Commodities Brokers Pvt. Ltd. having wide business with 24branches spread across the state of Gujarat, Maharashtra and Rajasthan.

It is an active member of Multi Commodity Exchange of India Ltd. (MCX)and National Commodities & Derivatives Exchange Ltd. (NCDEX), andAhmedabad Commodities Exchange Limited (ACEL) which are totallyprofessional and since they work with the best technology, they can adoptthe best international practices for trading in the commodities andderivative

The Kunvarji Fin stock Pvt. Ltd. is acting as a Member of National StockExchange of India, NSE FO, BSE and ASE.

The KFPL is hopeful to take benefits of existing clients and can develop the

business of broking in shares and stock with the help of its rich experience.

In nut shell, Kunvarji are very well established enterprises with widecoverage to host the investors.


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SPREAD OF BUSINESS:

Date of Incorporation: 28th, August 2003

No. of Branches: 24Branches across the state of Gujarat,Maharashtra & Rajasthan

Active Trading Users: 164

Avg. Daily Volume: Rs. 950 crores (Approx 200 Million US $)

ASSOCIATE CONCERNS:

Kunvarji Finance Pvt. Ltd. Kunvarji Fin stock Pvt. Ltd. Kunvarji Financial Brokers Pvt. Ltd. Kunvarji Brokers Pvt. Ltd. Kunvarji international commodities Pvt. Ltd. (DMCC) Dubai. Kunvarji Commodities Brokers Pvt. Ltd.

REGISTERED OFFICE:

310/311 SHYAMAK COMPLEXOPP. SAHJANAND COLLEGE,NEAR L COLONY,AMBAWADI,AHMEDABAD 380 0015PH NO: 079-30089130-42


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Track Record:

KCBPL stands for service quality and Innovation. Its share in the overallcommodity activity as improved over the years.

KCBPL enjoys pioneer position in broking business in India in commodityfutures and derivatives.

Infrastructure

Office Area - 16000 Sq. Ft Number of Branches -24 Qualified employees -134

Client Network

Corporate Clients - 35

Individual Clients - 3500

Coverage Of Business

Ahmedabad 3 Branches 14 Users Mehsana 3 Users Patan 4 Users Deesa 5 Users Bhabhar 6 Users Bhuj 4 Users Rajkot 4 Users Baroda 2 Users Bhavnagar 3 Users Surendranagar 3 Users Single Users: Mansa, Jetpur, Gondal, Surat, Nadiad


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Technology & Connectivity

Number of V-Sat - 26 Total V-Sat Users - 108

Internet Connections - 2000

Total Users - 350

Services Offered

Information for Trading and Arbitrage opportunities in variouscommodities

Daily Market Outlook Online Accounting Position on Website 14 Hours a day, Trading Opportunities Dematerialization of Commodities Stock


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At present the firm has above 8000 registered clients, 24 V-sats, 350 userids. Average daily volume of over 950 crores (200 $ mn approx) for the groupbranches and dealing offices spread across whole Gujarat.

The group has all the ingredients for providing best services viz.professionally qualified work force, pin point guidance and mostprofessional advice, transparency, advanced technical support to cope upwith the entire changing scenario.

The two guiding regulation to success till now have been :

Regulation 1 Maximization of wealth of clients with true integrity.

Regulation 2 Always remember Regulation 1.


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Turnover At NCDEX

Consistent increase in turnover along with trade increase in commodities isshown in the graph.

November 9.13December 9.92 January 12.13February 12.36March 17.68April 20.43

May 26.15

percentage share at NCDEX

9.139.82

12.13

12.3617.68

20.43

26.15novdec

jan

feb

mar

apr

may


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TURNOVER AT MCX:

Consistent increase in the turnover along with the increase in commoditiesof the firm is shown in the chart below

November 4.13December 5.12 January 9.03February 21.45March 29.63April 32.63may 38.05

4.13 5.129.03

21.45

29.6332.63

38.05 novemberdecember

january

february

march

april

may


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INTRODUCTION TO COMMODITY MARKET

WHAT IS A COMMODITY?

The dictionary defines commodities as Something useful that can be turnedto commercial or other advantage or an article, of trade or commerce,especially an agricultural or mining product that can be processed andresold

Therefore commodities really refer to things which in day to day life, wesimply take for granted. Like the wheat in our bread, the cotton in our

clothes, the gold in our ornaments, the petrol in our cars and so on.However, shat many dont know is that these very ordinary items are alsoone of the finest investment avenues available.

WHAT ARE COMMODITIES FUTURES?

The commodity futures are the part and parcel of the commodity market,

but it does form a distinctive market within the wider commodity market.

The risks that will be dealt with are risks that originate in the commoditymarkets. The tool that will be used to manage that risk is commodityfutures contracts.

The futures markets trade huge numbers of contracts daily. Many futurescontracts are thus extremely liquid. If the number and size of contracts aretaken into account, future market trades greater quantity (volume) than thecash or spot markets.

The futures markets do not really fulfill the role of acting as a conduct forthe cash commodity. They are financial markets that play a financial role.


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WHAT ARE COMMODITY FUTURES USED FOR?

It is estimated that around 60 to 70 percent of all trades transacted onfutures exchanges are done for the purpose of hedging. Although hedging isthe most important use of futures contracts, their use is obviously notlimited to that. They are there to take risk for profit.

That is why speculators are drawn to the futures markets like bees to ahoney jar. Speculators play a very important role in the whole marketmechanism. They bring liquidity to the markets.

Commodity futures contracts are also used to diversify portfolios.

Producers and their representatives (cooperatives, govt organizations) ofcommodities use commodity futures to protect the selling price of theircommodity. Consumers and their representatives of the commodity usecommodity futures to fix their purchasing price within an acceptable level.

Other than the actual producers and consumers, there are participants withinvestment interest in commodities. These participants seek to capitalize onthe profit opportunity and assume higher risks. Generally, these investorsare called SPECULATORS

There is a kind of participant who looks at imperfection in pricing of thecommodity between different markets. These imperfections are often shortlived and caused by restrictions in the markets, flow of capital, or physicalasset. These participant, called arbitrageurs assume relative low level ofrisk compared with speculators


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ACCESSIBILITY OF THE COMMODITY FUTURESMARKET

What may not be so generally known is that the futures markets areextremely accessible and can be utilized by virtually every business. Theyare often more accessible than other derivatives, simply because they offerrisk management possibilities for much smaller quantities. This opens thedoor to effective risk management even for the smaller business.

THE ORIGIN OF COMMODITY FUTURES TRADING

Futures trading must have originated from the execution of a pre-harvestagreement between the farmer and the person who needs the grain.

The practice of buying futures contracts for a lower price and selling themat higher price and buying for lower prices become a part of the futuresmarket.

Agriculture started with food crops. Futures trading must have originatedfrom the execution of a prior to harvest agreement between the farmer andthe person who needs the grain. What first started as oral agreements latergrew to be contracts. Then came advancing amounts for contracts surety.

When contracts became a normal practice, they were assigned the value ofthe commodities themselves.

Also, these contracts started getting to be sold and bought like commodities.That is, if the person who got into a agreement with the farmer didnt needthe commodity anymore he could exchange the contracts with someone whoneeded the grain.

Likewise, the farmer who reached the agreement and did not want to sell hisgrain that moment could assign the contact to some other farmer ready to

sell. In the meantime, owing to some other farmer ready to sell his grain atthat moment could assign the contract to some other farmer ready to sell. Inthe meantime to change in market and weather, there could be an increaseor decrease in the price.If due to any reason there is a shortage in the availability of the commoditythen the selling price increases.


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However if the supply increases the buying contract price decreases. It isthis situation that has attracted people to the future markets, bringing inpeople who do not have their own commodity to sell or even those who donot really need to buy. Thus the practice of buying for lesser prices hasbecome a part of the futures market. Seeing this opportunity to make biggerprofits when compared to common investment methods, many people, evennon-farmers, non buyers and even those who didnt have a real requirementare lured to the future market.

HOW TRADING BEGAN INTERNATIONALLY?

Though it is said that commodity trading formally started in Japan in the17th century, there is evidence to suggest that a form of futures trading incommodities existed in china 6000 years earlier. In the US, the futuresmarkets were developed initially to help agricultural producers andconsumers manage the price risks they faced while harvesting, marketingand processing food crops each year. The modern futures industry stillserves those markets.

The worlds oldest established futures exchange, the Chicago Board of

Trade, was founded in 1848 by 82 Chicago merchants. The first of whatwere then called to arrive contracts were flour, timothy seed and hay,which came into use in 1849. Forward contracts on corn came into use in1851 and gained popularity among merchants and food processors.

Meanwhile, what is now the largest futures exchange in the US theChicago Mercantile Exchange, was founded as the Chicago Butter and EggBoard in 1898. At that time, trading was offered in-you guessed it-butterand eggs.


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COMMODITIES MARKET WORLD WIDE PICTURE

Commodities unlike stock/share, which mostly have an impact on thecountry in which it is being listed or traded, can leave a long lastingimpression in almost all the countries in which it is traded. A group oftraders can never be in command of influencing a large price fluctuationsin commodities, as the prices are not determined by that particular sect/ orgroup but by other factors i.e. international demand, supply, totalproduction, consumption expected, international regulation andinternational state of affairs etc.

The cost of living index/wholesale price is determined by the price

variations in the commodities which are consumed by the general publicand the industries. The inflation or deflation are mostly linked with thecommodity price instability, they have epitomized themselves as a verysturdy force in the international state of affairs.

Now almost all type of commodities are being traded that too in a moreorganized manner, for instance CBOT has switched over to electronictrading platform in the year 2000 and very recently it has switched over itsclearing operations to the same mode, at NYMEX the trading takes placeboth in Open Out Cry and Electronic Mode, at TOCOM (Tokyo CommodityExchange) the trading is computerized and like wise all the international

exchanges the following the suit.


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LEADING EXCHANGES AROUND THE WORLD:

EXCHANGES PLACE TRADED COMMODITIES

CBOT (Chicago Board ofTrade)

Chicago USA Soya (Bean, Oil and Meal),Corn, Wheat, Rice, Goldand Silver.

CME (Chicago MercantileExchange)

Chicago USA Milk, Live cattle, Butter,Urea, Ammonium Nitrate,and Phosphate.

NYBOT (New York Board ofTrade)

New York USA Cocoa, Coffee, Cotton,Sugar, and Citrus (FrozenOrange Juice) Crop.

LME (London MetalExchange)

London UK Aluminum and its alloys,Copper, Lead, Nickel, Tinand Zinc.

TOCOM (Tokyo CommoditiesExchange)

Tokyo Japan Gold, Silver, Platinum,Palladium, Aluminum,Gasoline, Kerosene, Crudeand Rubber.

LIFFE (London InternationalFinancial Futures and

Options Exchange)

London UK Cocoa, Coffee (Robusta),Sugar (White), Wheat,

Corn and Rapeseed.SICOM (SingaporeCommodity Exchange)

Singapore Rubber and Coffee.

KITCO New York USAQuebec Canada

Gold, Silver, Palladiumand Platinum.

NYMEX (New YorkMercantile Exchange)

New York USA Crude oil (Brent andSweet), Heating oil,Natural Gas, Electricity,Propane, Coal, Gold,Silver, Palladium,Platinum, Copper and

Aluminum.


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THE EVOLUTION OF COMMODITY TRADING IN INDIA

THE BEGINNING OF COMMODITY FUTURES TRADING IN INDIA

Commodity futures markets in India have a long history. The first organizedfutures market appeared in 1921, when the Cotton Exchange, which dealtin various types of cotton, was created in Bombay. A second exchange, theSeeds Traders Association Ltd, also in Bombay was created in 1926. This

exchange traded oilseeds and their products like castor seeds, groundnutsand groundnut oil.

Many other exchanges followed, trading in commodities such as raw jute,jute products, black pepper, turmeric, potatoes, sugar, food grains andsilver. Several exchanges traded in the same commodities and some of thesehad formal trading links.

A complete regulatory framework for futures was drafted, including rules fortrading in futures, a system for the licensing of brokers and a clearing

house structure. Not only futures, but also options on a number ofcommodities were traded on the exchanges; for example, options on cottonwere traded up to one year out, until all options were banned in 1939.


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In the 1940s, forward and futures contracts as well as options wereoutlawed as part of the governments drive to contain inflation or trading inthese contracts was made impossible through price controls.

This situation prevailed until 1952, when the government passed theForward Contract (Regulation) Act, which controls all transferable forwardcontracts and futures up to this day. The Act again allowed futures trade ina number of commodities (but excluded some essential foods like sugar andfood grains).

It provided that forward and futures markets should normally be self-regulating through governing bodies of recognized associations in whichthe government has the right to place representatives.

During the 1960s, the central government banned or suspended futurestrading in several commodities including cotton, raw jute, edible oil seedsand their products. In the 1970s, futures trading in non-edible oil seeds likecastor seed and linseed were forbidden. The reason for this crackdown infutures markets was that government felt that these markets helped driveup prices for commodities, by giving free reign to speculators.

Restrictive measures were directed at combating speculation, which affectedthe activities of 31 recognized associations, which were supposed toregulate trade and commodities futures.

The government policies softened somewhat in the late 1970s when futurestrade in jaggery was allowed. Two government appointed comities theDatwala Committee in 1966 and the Khusro Committee in 1979 recommended the revival of futures trading in a wide range of commodities,but little action resulted.

Contracts in most commodities are actively traded for periods up to sixmonths out and as should be the case for mature future markets, mostcontracts are used for hedging purposes and not for physical trade. This

means that a large majority of positions are closed out before maturity andphysical delivery is relatively rare.

The Indian economy is going through a process of liberalization and isopening up to the world market. Partly, as a result, Indian exporters areincreasingly confronted with highly competitive world markets in which theyare forced not only to work on slimmer margins but also to sell furtherforwards in order not to lose markets.


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The rupee gas becomes fully convertible for commercial purposes. Againstthis background, the role of commodity futures market is being recognizedby the government, through the Forward Market Commission (FMC) to

assist them in this internationalization process.

India has recently seen three National Level Electronic Exchangesfacilitating commodity trading.

National Commodity Exchange (www.ncdex.com) Multi Commodity Exchange (www.mcxindia.com) National Multi Commodity of India (www.nmce.com)

Besides this, there are at least 20 other Regional Commodity Exchangesalso in India.

Rajdhani Oils and Oilseeds Exchange Ltd., Delhi (www.roel.com) Ahmedabad Commodity Exchange Ltd. (www.acecastorfuture.com) Bhatinda Om and Oil Exchange Ltd. Bikaner Commodity Exchange Ltd. (www.bcel.org) Esugarindia Ltd. (www.esugarindia.com) First commodity Exchange of India Ltd, Kochi (www.fceikochi.com) Haryana Commodities Ltd. (www.hissarcommodities.com) India pepper and Spices Trade Association., Kochi (www.ipsta.com) National Board of Trade; Indore (www.nbotind.org) Surendranagar Cotton Oil and Oilseeds Association Ltd. The Bombay Commodity Exchange Ltd. (www.booe.com) The Central India Commercial Exchange Ltd; Gwalior The Chamber of Commerce ; Hapur The Coffee Futures Exchange India ltd; Bangalore (www.cofei.com) The East India Cotton Association; Mumbai (www.eicaexchange.com) The Meerut Agro Commodities Exchange Co. Ltd.

The Rajkot Seeds Oil and Bullion Merchants Association Ltd.(www.rajkotexchange.com) The Spice and Oilseeds Exchange Ltd; Sangli Vijay Beopar Chamber Ltd; Muzaffarnagar.
http://www.ncdex.com/http://www.mcxindia.com/http://www.nmce.com/http://www.roel.com/http://www.acecastorfuture.com/http://www.bcel.org/http://www.esugarindia.com/http://www.fceikochi.com/http://www.hissarcommodities.com/http://www.ipsta.com/http://www.nbotind.org/http://www.booe.com/http://www.cofei.com/http://www.eicaexchange.com/http://www.rajkotexchange.com/http://www.rajkotexchange.com/http://www.eicaexchange.com/http://www.cofei.com/http://www.booe.com/http://www.nbotind.org/http://www.ipsta.com/http://www.hissarcommodities.com/http://www.fceikochi.com/http://www.esugarindia.com/http://www.bcel.org/http://www.acecastorfuture.com/http://www.roel.com/http://www.nmce.com/http://www.mcxindia.com/http://www.ncdex.com/


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THE FUTURES EXCHANGES

(MCX)- MULTI COMMODITY EXCHANGE OF INDIA

Highlights

Key Shareholders Financial Technologies (India) Ltd. State Bank of India State Bank of Indore State Bank of Hyderabad Bank of Baroda Bank of Saurashtra Union Bank of India Bank of India Canara Bank Corporation Bank HDFC Bank SBI Life Insurance Co.

Strategic Alliance with Prominent Industry Associations Bombay Bullion Association Bombay metal Exchange Solvent Extractors Association and Pulses Importer Association UPSAI IPSTA

International Alliances MOUs with the Tokyo Commodity Exchange (TOCOM) and the

Baltic Exchange, London. The New York Mercantile Exchange(NYMEX)

Joint Venture to set up The Dubai Gold and CommodityExchange


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Daily mark to market, real time price and trade information

dissemination

MCX presently has over 1000 trading members spread in more than275 centers in India.


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(NCDEX) THE NATIONAL COMMODITY ANDDERIVATIVES EXCHANGE LTD.

NCDEX is a public limited companyincorporated on April 23, 2003 under theCompanies Act, 1956.

It obtained its Certificate for Commencementof Business on May 9, 2003. It has commencedits operations on December 15, 2003

NCDEX is located in Mumbai and offersfacilities to its members in more than 550centers throughout India the reach

will gradually be expanded to more centers.

NCDEX is the only commodity exchange in the country promoted bynational level institutions. This unique parentage enables it to offer abouquet of benefits, which are currently in short supply in thecommodity markets. The institutional promoters of NCDEX are

prominent player

NCDEX is a nation-level, technology driven de-mutualized on-linecommodity exchange with an independent Board of Directors andprofessionals not having any vested interest in commodity markets. It iscommitted to provide a world-class commodity exchange platform formarket participants to trade in a wide spectrum of commodity derivativesdriven by best global practices, professionalism and transparency.


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NCDEX currently facilitates trading of 48 commodities

Cashew, Castor Seed, Chana, Chili, Coffee - Arabica,Coffee - Robusta, Common Parboiled Rice,

Common Raw Rice, Cotton Seed Oilcake,Crude Palm Oil, Expeller Mustard Oil,Groundnut (in shell), Groundnut Expeller Oil,Grade A Parboiled Rice, Grade A Raw Rice,Guar gum, Guar Seeds, Gur, Jeera,

Jute sacking bags, Indian 28 mm Cotton,Indian 31 mm Cotton, Lemon Tur,Maharashtra Lal Tur, Masoor Grain Bold,Medium Staple Cotton, Mentha Oil,Mulberry Green Cocoons, Mulberry Raw Silk, Rapeseed - Mustard Seed,Pepper, Raw Jute, RBD Palmolein, Refined Soy Oil, Rubber, Sesame

Seeds,Soy Bean, Sponge Iron, Sugar, Turmeric, Urad (Black Matpe),V-797 Kapas, Wheat, Yellow Peas, Yellow Red Maize,Yellow Soybean Meal, Electrolytic Copper Cathode, Aluminium IngotNickel Cathode, Zinc Ingot, Mild Steel Ingots, Sponge Iron,Gold, Silver, Brent Crude Oil, Furnace Oil.

At subsequent phases trading in more commodities would be facilitated.


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Highlights

Key Shareholders.

NSE (National Stock Exchange) Canara Bank Punjab National Bank ICICI Bank Ltd. CRISIL (Credit Rating Information Service of India Ltd.) IFFCO (Indian Farmers Fertilizers Co-operative Ltd.) LIC (Life Insurance Corporation of India) NABARD (National Bank for Agricultural and Rural

Development)

Strategic Alliance with prominent industry associations In talks with GAIL & BPCL to promote gas futures

International Alliances MOUs with The Dalian Commodity Exchange, The International

Petroleum Exchange (IPE) & The Tokyo Grain Exchange

Daily mark to market, real time price and trade informationdissemination

NCDEX presently has over 720 trading members spread in more than450 centers in India.


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LIKELY PLAYERS IN THE COMMODITY MARKET

At the Indian commodity exchanges, where futures trading is currentlyongoing, half of the trade is estimated to be speculative, half of which isconducted by traders or what the international trading community calls asthe scalpers (day traders buy and sell during same day, trying not to keepany positions overnight). These scalpers earn through their daily tradingtransactions and contribute significantly to the liquidity of the exchange.The remaining half of the trade is by way of hedging, with traders being themost active.

The various categories of users of these commodity exchanges in India arediscussed below:

Farmers in India rarely use futures markets directly. Indian farmers benefitindirectly from using co-operatives or other intermediaries or simply frombetter deals with traders using futures markets.

Traders, both large and small are the main users of futures contracts inIndia. For oil seeds, pepper and gur, there is an active participation of towndealers. Castor seeds and pepper, exporters are active in the exchanges.

Virtually, all speculators in these exchanges are relatively small either theyare day-traders as explained above or are individuals placing their dealsthrough brokers. Large institutional investors such as banks and NBFCsare absent. Their participation in commodity exchanges is not allowedunder the Reserve Bank of India regulations, which stipulates prudentialnorms for banks and non banking financial institutions.

Processors and manufacturers use the exchanges to a limited extent for tworeasons:

First, some manufacturers, especially in the oil sector, are so large that theyare unable to lay off a significant part of their risks on domestic exchanges,which suffer from chronic illiquidity.

Secondly, the range of the commodity futures contracts offered is too smallresulting in incomplete risk management. For example, many firms do not


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find castor seeds contract useful as few manufacturers use castor oil and itis an imperfect risk management instrument for other oils.

Foreign trading firms participated in some of the commodity exchanges untiltheir participation was banned. But, the current scenario of development incommodity futures trading will bring the issue of allowing them toparticipate in this field too. This will result in commodity linked mutualfunds to spring up across the country.

ADVANTAGES OF THE FUTURES MARKET FORVARIOUS PLAYERS

Farmers Get an extensive market opened for them Can decide the market even before harvest Can sell the commodity to the customer without any agents Get an opportunity to trade, knowing the national and

international trends and standards Get an opportunity to gain by leveraging the futures market There is an opportunity to keep the commodity in thewarehouse and use the warehouse receipts to deal with

financial needs as it is an extensive document Can avoid deliberate in price in the name of quality Farmers can trade even if they are computer illiterate by the

help of renown broking house

Traders / Stockiest Can trade by parking only the margin amount Can hedge their underlying by selling the same in the futures

market and save from any losses from the price fluctuation For those who have kept their commodity in the Central

Warehouse, loans are available on the basis of stock. Thebenefit is that you can keep the commodity somewhere withoutblocking the working capital


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Corporates / Exporters

Can get a better price discovery Can buy goods without agents Can hedge themselves by offsetting their exposure in the future

market and minimize their risk Can take positions by paying only the margin value instead of

whole value of the contract Can assure the quality of the goods because of standardized

future contacts.

Arbitrageurs / SpeculatorsCan get benefit by an arbitrage between

Spot to Future Inter Commodity Exchanges (MCX & NCDEX) Spread Trading

FUTURES MARKET V/S FORWARD MARKET

FORWARD CONTRACTS

Forward contracts are agreements to purchase or sell a specified amount ofa commodity on a fixed future date at a pre determined price. Physicaldelivery is expected. If, at maturity (the future date has been agreed to inthe contract), the actual price (the spot price) is higher than the price in theforward contract, the buyer makes a profit and the seller suffers a

corresponding loss.


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FUTURES CONTRACT

Future contracts are exchange traded agreements to purchase or sell agiven quantity of a commodity at a predetermined price at a predeterminedtime. But, unlike forward contracts, physical delivery in fulfillment of thisagreement is not necessarily implied, the contract can be used to make or totake physical delivery, but usually, it is offset on or before maturity (theclosing date of the contract) by an equivalent reverse transaction.

On organized commodity exchanges, where most futures contracts aretraded, this involves the buying at different times of two identical contractsfor the purchase and sale of the commodity in question, each cancelingthe other out. This is called the closing out of the position and is possiblebecause all transactions are guaranteed through a central organism, the

clearing house, which automatically assumes the position of thecounterpart to both sides of the transaction. Thus, a producer who wishesto hedge has an obligation not Vis-a Vis a consumer or a speculator, butvis-a vis a clearing house. Likewise, consumers obtain a position Vis-a Visthe clearing house.

FOUR IMPORTANT FEATURES THAT DISTINGUISH FUTURESCONTRACT FROM A FORWARD CONTRACT:

Contract terms (amounts, grades and delivery terms) arestandardized

Transactions are almost always handled by organized exchangesthrough clearing house systems.

Most futures contracts are marked to market everyday, using thesettlement price of the day. Hence, if the futures price movesadversely for a holder of a futures contract, that holder is obliged topay into the clearing house a sum equal to the value of the adversemovement (a margin call). This prohibits users of the market fromcarrying large unrealized losses over a long period, and thus reducesthe risk of default. In the case of profitable price movements,clearing members (including intermediaries such as brokerages), but

not necessarily their clients, receive the profits of the days futurestrading

Futures contracts require depositing small amounts of initialmargin money in the exchange as collateral. Due to this, futurescontacts significantly reduce the credit of default risk contained inthe forward transactions.


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MECHANICS OF FUTURES TRADING

Essentially, futures contracts try to predict what the value of an index orcommodity will be at some date in the future. Speculators in the futuresmarket can use different strategies to take advantage of rising anddeclining prices. The most common are known as Going Long, GoingShort and Spreads.

GOING LONG

When an investor goes long i.e. enters a contract by agreeing to buy the

underlying at a set price it means that he or she is trying profit from ananticipated future price increase.

GOING SHORT

A speculator, who goes short, i.e. enters into a futures contract by ageingto sell the underlying at a set price is looking to make a profit fromdeclining price levels. By selling high now, the contract can berepurchased in the future at a lower price, thus generating a profit for thespeculator.

SPREAD TRADING

Going long and going short are positions that involve the buying or sellingof a contract now in order to take advantage of rising or declining prices inthe future. Another common strategy used by futures traders is calledspreads.

Spreads involve taking advantage of the price difference between twodifferent contracts of the same commodity. Spreading is considered to beone of the most conservative forms of trading in the futures marketbecause it is much safer than the trading of long/short futures contracts.

Spread-trading is a more sophisticated trading tool than just purchasingor selling futures or option contracts.

There are mainly three different types of spreads:

Calendar Spreads


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Inter-Exchange Spreads Inter Commodity Spreads

It is important that you understand that when you are trading a spread,you are speculating on the price difference or spread between the twocontracts. Spreaders are focused on the price relationship between the twocontracts. A spread position is not to be looked at as two separatetrades, but rather as one trade.The success or failure of the trade is determined by the change in the pricedifference between the two contracts or commodities. It is much obviousfor one side of the trade to make money, and the other side to lose money.It is much obvious for one side of the trade to make money, and the otherside to lose money. It is the perception of the spread trader that the

winning side makes more than the losing side.

One might ask, Why dont you just put on the wining side forget aboutspreading with the losing side? The answer is simple the spread traderdoes not know which side of the trade will be the prime mover and impactthe spread value.

CALENDER SPREADS

The calendar spread is perhaps the easiest to understand and the most

commonly used type of spread in the industry. A spread trader in acalendar attempts to profit from the price difference between two futurescontracts of the same commodity, traded on the same exchange, but withdifferent expiry dates. The trader putting on this spread believes that theprice differences are too close or too close or too far apart to suggestfurther expansion or contraction in the prevailing spread:

EXAMPLE:

Mr. X bought a March contract of sugar at Rs.2100 and sold April sugar at

Rs.2125 with a spread of Rs.25 for March over the April contract.

At the expiry, March sugar was at Rs. 2115, and April sugar was at Rs.2130 spread has narrow down to Rs. 15

Hence, sold March sugar Rs. 2115 and bought April sugar Rs. 2130,resulting into a net profit of Rs. 10


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Why would a spreader put on the trade? Because he would have reason tobelieve that the price of March sugar would gain on or get closer to theApril price.

As you can see in this example the above mentioned trade was profitable,but one side of the spread lost money.

INTER EXCHANGE SPREAD (ARBITRAGE)

It is a spread or arbitrage in prices for the same commodity in two differentexchanges. The spread may be into existence due to the factors of :

Price difference: during volatile market situations due to priceelasticity the prices may go either side of the equation. Arbitrageurs,enters to take positions in opposite direction i.e. buy in oneexchange and a simultaneous sell in the other exchange. As andwhen the market stabilizes, the prices return to the normal paritylevels where in the arbitrageur reversed their respective exposures inthe two exchanges to leave them with risk less profit from the seriesof transactions.

Distance: globalization have erased the international boundaries oftrade though, but primarily at the market levels price differencesremain due to duties, freight, insurance and other levies as per therules of trade. Very often it is observed by the traders that even afterthe loading of these factors, the prices in the futures market are overor under valued from the price parity levels. Immediately thearbitrageurs steps in to take advantage of the situation and keeps adoing this till the time market returns to the existing norms ofparity.

Time: operational hours differences between two exchanges locatedon two geographical parts of the world lend opportunity for theinvestors to move their trades profitably in both the exchanges.Typically this is the case with the Crude oil, Gold and Silver futurescontracts. Whilst the Indian exchanges close their session by 23:55hours IST, US markets are open till 01:30 hours IST followed byJapanese markets which start trading by 07:00 hours IST.Movements in the price during this intermediate time is chased bythe Indian market in the opening session align itself with the


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international market scenario and thus portraying a spreadopportunity between two exchanges till they finally coverage to aparity level in existence.

INTER COMMODITY SPREADS

Inter commodity spreads are the most difficult to understand and the mostrisky to trade, therefore not used as much as the inter market spread. Aspreader of inter commodity spreads is spreading two different but relatedcommodities, in the same or different delivery months. Examples of intercommodity spreads are

Cattle / Hogs Gold / silver Heating oil / Crude oil T-Bills / T- Bonds Canadian Dollar / Swiss Franc

This is just a small example of the inter commodity spreads available totrade


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Risk Free Returns

Hedging arbitrage

Hedging

Hedging in futures contracts provides an effective tool to manage pricerisks and it is always associated with an opposite transaction that

involves physical cash transaction.

What Makes Hedge Works?

Spot and Futures price for the same commodity tend to go up and downtogether. Losses in one side are cancelled out by gains on the other.

EXAMPLE:

Let Us Take Example of Client-A, which is seller of the goldClient-B, buyer of Gold.

Client-A Plans to sell 1 Kg. Gold in December 2005. It expects futures pricesto be lower and feels that Rs. 7000 per 10 gm will be a good price to get inDecember.

So, Client-A decides to lock in 1kg. At a price of Rs. 7000 on the futuremarket for December contract.


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Scenario-1:

The prediction of Client-A come true. The spot price for December 1st is Rs.6980 per 10 gm.

SPOT MARKET FUTURES MARKET

PRICE Rs. 6980 Locked in atRs.7000/-for 1 kgCurrent price @ Rs.6980/-

SALE Sold 1 kg. in the spot @

Rs. 6980/-

Squares off 1 kg. @ Rs.

6980/-

RESULT Loss of Rs. 20/- againstbudget

Gain of Rs. 20/- per kg.from spot against thebudget. Bought @ Rs.6980 and sold @ Rs.7000/-

Scenario-2:

The predictions of Client-A has gone wrong. Spot prices for December 1stare Rs. 7020 per 10 gm.

SPOT MARKET FUTURE MARKET

PRICE Rs. 7020/- Locked in at Rs. 7000/-for 1 kg.

SALES Sold entire 1 kg. in thespot market @ Rs.7020/-

Squared off 1 kg. @ Rs.7020/-

RESULT Books Rs. 20/- profitagainst the budget

Bought at Rs. 7020/-and sold at Rs. 7000/-therefore books a loss ofRs. 20/-


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By a stockiest using futures market

SPOT MARKET FUTURES MARKET

01/01/2006 A stockiest purchases,say, 10 tones of Castorseed in the physicalmarket @ Rs. 1600/-p.q.

To hedge price-risk, hewould simultaneouslysell 10 contracts of onetone each in the futuresmarket at the prevailingprice. Assuming theruling price in June2006 contract is Rs.1750/- p.q.

01/05/2006 The stockiest sells hisstock in the month ofMay when the spotprice is Rs. 1500/- p.q.

The stockiest liquidateshis contract in thefutures market byentering into purchasecontract @ Rs.1625/-p.q.

RESULT Loss = Rs. 25 + Loss on A/c gain = Rs.125/- of carryingStocks.

The stockiest is able to lock in a spread/ Badla of Rs. 150/- p.q. i.e. about9% for about 6 months.

Looking at the gain / loss in the two segments, we find that the stockiest isable to hedge his price by operating simultaneously in the two markets andtaking opposite positions.He gains in the futures market if he loses in the spot market; but would losein futures market if he gains in the spot market. Similarly, processors,exporters, and importers can also hedge their price risks.


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FOR IMPORTER

When spot prices decreases faster than the future price.

SPOT GOLD GOLD FUTURE

OCT 2005 The spot gold is @ Rs.5850 per 10 gms

Sell gold Future @ 5900per 10 gms

JAN 2006 Sell spot gold @ 5750per 10 gms

Buy back gold future @Rs. 5850 per 10 gms

RESULT Loss Rs. 50 per 10 gms Gain Rs. 50 per 10 gms

If the importer had not hedged his position, he would have, had to sell thegold at Rs. 5750 per 10 gms, accounting for a loss for Rs. 100 per 10 gmsBy cover his position at the futures market he minimized his losses.

FUTURES TRADING A LUCRATIVE BUSINESS

Futures trading in castor seed have been going on for a long time in India.In this context, it would be best to understand futures trading taking castorseed contracts as an example.

XYZ mill sells castor oil in the export market for December shipment atRs.100 per kilo.

Their cost sheet is as follows:

Sale price Rs.100Cost of castor seed Rs. 60(Present spot price)Labour Rs. 20Overheads Rs. 10Profit Rs. 10


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They are unable to find a castor seed supplier who would offer them therequired quantity for the December delivery.

They therefore hedge their castor seed moves up to Rs. 80 per kilo byDecember.

Spot price of castor seed moves up to Rs. 80 per kilo by December.

XYZ mill buys physical castor seed in the spot market at Rs.80 per kilo andsettles in the futures market at a price of Rs. Per kilo.

Thus their cost sheet would now be as follows:

Sale price Rs. 100

Cost of castor seed Rs. 80(Present spot price)Labour Rs. 20Overheads Rs. 10Loss Rs. 10Add: profit on futures Rs. 20Net profit Rs. 10

Due to hedging in the futures market, the profit of the mills remains intact.


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ARBITRAGE

The simultaneous purchase and selling of an asset in order to profitfrom a differential in the price. This usually takes place on differentexchanges or marketplaces. Also known as a "risk less profit".

Say a domestic stock trades also on a foreign exchange in anothercountry, where it hasn't adjusted for the constantly changingexchange rate. A trader purchases the stock where it isundervalued and short sells the stock where it is overvalued, thusprofiting from the difference. Arbitrage is recommended forexperienced investors only.

Market Arbitrage

Purchasing and selling the same security at the same time in differentmarkets to take advantage of a price difference between the two separatemarkets.

An arbitrageur would short sell the higher priced stock and buy the lowerpriced one. The profit is the spread between the two assets.

EXAMPLE:

If we buy Jeera from NCDEX at rate Rs. 6488and than Sell it in MCX atrate Rs. 6589.85, that is arbitrage. The Rs. 101.85 we gain that representsan arbitrage profit.


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NEED OF COMMODITIES IN A PORTFOLIO:

COMMODITIES AS A HEDGING TOOL Hedge against inflation Hedge against a currency fluctuation Hedge against event risk

COMMODITIES AS AN INVESTMENT AVENUE Growing popularity as an investment tool Global underlying broadly difficult to manipulate Pure play demand/supply/inventory/trading pattern driven High degree of cyclicality/seasonality Extremely high leverage instrument due to low margins (4-5%) Established as an asset class world wide option to invest direct in commodities than investing in

commodities stocks

INDIAN EXPERIENCE / COMMODITY STOCKS Commodities account for about 38% (ask) of Nifty Market Cap.

(as on 31/03/2006)


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COMMODITY GROUPS

COMMODITY GROUPS AVAILABLE FOR TRADING

ENERGY

OIL

SEEDS

PULSES

SPICES OTHERS

PLANTATI

ONS,

FIBRES &

PETRO

CHEMICAL

CEREALS

BULLION

BASE

METAL

COMMOD

ITY

FUTURES

MARKET


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COMMODITY FUTURE TRADING REGULATIONS

REGULATORY FRAMEWORK

The ministry of consumers affairs, food and public distribution governs allcommodity exchanges in India through the forwards markets commission(FMC).

The FMC is a regulatory body set up under the forward contracts(regulation) act, 1952 (FCRA). The FCRA lays down the general provisionsin relation to the administration of the commodity exchanges and otherregulatory provisions pertaining to commodity trading in India. All

exchanges dealing in trading of commodities are required to obtainregistration from FMC.

PERMISSIBLE BUSINESS ACTIVITIES

Only futures trading in commodity is permitted on the exchange. Options ingoods are presently prohibited under the FCRA. Further, only thecommodities notified under the FCRA can be traded on the commodityexchange. Presently, futures trading is permitted in all the commodities.These commodities can be broadly classified under the following categories:

Agro products Precious metals and base metals Energy

At present there are 22 commodity exchanges in India providing futurestrading in commodities. However currently only 4 exchanges have beenaccorded a national commodity exchange status as under:

National Commodity and Derivatives Exchange Limited (NCDEX) Multi commodity Exchange of India Limited (MCX) National Multi Commodity Exchange (NMCE) National Board of Trade (NBOT)


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The aforesaid exchanges are entitled to commence trades in all permittedcommodities prescribed under the FCRA.

NCDEX & MCX are located in Mumbai and provide active platforms formetals and agro commodities futures. NMCE is located in Ahmedabad andpresently the trading volumes of commodities at NMCE are limited toNCDEX & MCX.

These exchanges are expected to be role model to other exchanges and arelikely to compete for trade not only among them but also with the existingexchange.

MEMBERSHIP OF THE COMMODITY EXCHANGE

Any person desiring to trade over the commodity exchange, is required toregister with the exchange as a member. Unlike the stock brokingregulations, in case of commodity trading membership, no SEBIregistrations are required and the relevant commodity exchange is the soleauthority to sanction registration. However, recently there has been newsarticles proposing that as application would also required to be made to theFMC for seeking trading membership registration with the exchange; theprocedures for registration with the FMC is however not clarified.

In order to regulate the activities of its members, each of the stockexchanges have formulated its own bye-laws, rules and regulations.Presently, the following memberships are offered by the commodityexchanges:

Trading cum clearing membership entitling a member to executetransactions on the exchange and also a right to clear the trades on its own.

Professional clearing membership providing only clearing rights to the

members


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ENTITLEMENT TO MEMBERSHIP:

Stock broker

A stock broker registered with NSE/BSE can also obtain membershipof the commodity exchange. However, the SCRA does not permit a stockbroker to undertake business in commodity derivatives in the same entity inwhich stock broking is carried out. For this purpose the SCRA prescribessetting up a separate company for undertaking commodities trades.

NBFC

As regards trading in commodities by NBFC, RBI would not permit aNBFC to undertake any activities which would result in the NBFC beinggoverned by multiple regulators (i.e. the commodities exchanges and theFMC).

BANKS

Banks are currently not permitted to engage in buying or selling orbartering of goods except engaging in bullion trades.

FDI IMPLICATIONS ON ESTABLISHING THE NEW ENTITY

From a FDI perspective, currently commodity broking unlike stock brokingis not specifically covered under the list of nineteen permitted NBFCactivities wherein investment is permitted under the automatic routesubject to adherence to the stipulated minimum capitalization norms.Based on informal talks the regulatory authorities have informed thatcommodity broking would nor form part of stock broking for FDI purposesand not subjected to minimum capitalization norms.


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PROSPERING INDIAN COMMODITIES MARKET (PRESENT SCENARIO)

The exchange, National Commodity and Derivative Exchange which is justtwo and a half years old, is Asia's third-largest commodities exchange afterTokyo and Shanghai and the 14th-largest in the world. It is unlisted andtrades $1.2 billion worth of products daily.

Goldman Sachs Group, the large U.S. securities firm, plans to buy a stakein the National Commodity & Derivatives Exchange, reflecting growinginterest in the surge in commodity trading in India.

Among its institutional shareholders are four state-owned companies, the

National Stock Exchange, ICICI Bank and Crisil, a rating agency. ICICIBank, which owns 15 percent of the exchange, is selling less than half itsstake to Goldman Sachs.

Strong economic growth and rising income levels in India have bolsteredinvestments in commodities, making the country attractive for investors inthe trading exchanges.

Earlier this year, Fidelity International paid $49 million for 9 percent in theMulti Commodity Exchange of India, which is primarily a metals-tradingoperation.

About 80 percent of the trades in the National Commodity & DerivativesExchange are currently in agricultural commodities like sugar, wheat andvegetables.

But the share of energy commodities, like Brent blend crude oil, naturalgas, coal and electricity is rising significantly.

With India one of the world's largest consumers of energy, the rising energycommodities trade has undoubtedly been an attraction.

There is also significant potential in bullion. India is the world's largestconsumer of gold and is expected to soon turn into a price-setter in thecommodity.

Currently, foreign investors and overseas institutions are not allowed totrade on the commodities exchanges but there are indications thatregulators might relax the rules for some commodities.


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COMMODITY MARKET V/S. EQUITY MARKET

Commodity trading

Three national platforms for screen based trading Upfront margin between 5-10% Low downside risk Less volatile, providing an efficient portfolio diversification

option. Short selling is allowed across the board

Equity trading

Two national platforms for screen based trading Upfront margin between 25-30% High downside risk More volatile Short selling is restricted to a few scripts where futures are

there.


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BOMBAY STOCK EXCHANGE (BSE)

For the premier Stock Exchange that pioneered the stock broking activity inIndia, 125 years of experience seem to be a proud milestone. A lot haschanged since 1875 when 318 persons became members of what today iscalled "Bombay Stock Exchange Limited" by paying a princely amount ofRe1.

Since then, the stock market in the country has passed through both goodand bad periods. The journey in the 20th century has not been an easy one.Till the decade of eighties, there was no measure or scale that couldprecisely measure the various ups and downs in the Indian stock market.

Bombay Stock Exchange Limited (BSE) in 1986 came out with a Stock Indexthat subsequently became the barometer of the Indian Stock Market.

SENSEX, first compiled in 1986 was calculated on a "Market Capitalization-Weighted" methodology of 30 component stocks representing a sample oflarge, well-established and financially sound companies. The base year ofSENSEX is 1978-79. The index is widely reported in both domestic andinternational markets through print as well as electronic media. SENSEXisnot only scientifically designed but also based on globally acceptedconstruction and review methodology. From September 2003, the SENSEXis calculated on a free-float market capitalization methodology. The "free-

float Market Capitalization-Weighted"methodology is a widely followed indexconstruction methodology on which majority of global equity benchmarksare based.

The growth of equity markets in India has been phenomenal in the decadegone by. Right from early nineties the stock market witnessed heightenedactivity in terms of various bull and bear runs. More recently, the bourses inIndia witnessed a similar frenzy in the 'TMT' sectors. The SENSEX capturedall these happenings in the most judicial manner. One can identify thebooms and bust of the Indian equity market through SENSEX.

The launch of SENSEX in 1986 was later followed up in January 1989 byintroduction of BSE National Index (Base: 1983-84 = 100). It comprised of100 stocks listed at five major stock exchanges in India at Mumbai,Calcutta, Delhi, Ahmedabad and Madras. The BSE National Index wasrenamed as BSE-100 Index from October 14, 1996 and since then it iscalculated taking into consideration only the prices of stocks listed at BSE.The Exchange launched dollar-linked version of BSE-100 index i.e. Dollex-100 on May 22, 2006.


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With a view to provide a better representation of the increased number ofcompanies listed, increased market capitalization and the new industrygroups, the Exchange constructed and launched on 27th May, 1994, twonew index series viz., the 'BSE-200' and the 'DOLLEX-200' indices. Sincethen, BSE has come a long way in attuning itself to the varied needs ofinvestors and market participants.

In order to fulfill the need of the market participants for still broader,segment-specific and sector-specific indices, the Exchange has continuouslybeen increasing the range of its indices. The launch of BSE-200 Index in1994 was followed by the launch of BSE-500 Index and 5 sectoral indices incountry's first free-float based index - the BSE TECkIndex.

The Exchange shifted all its indices to a free-float methodology (except BSE

PSU index) in a phased manner.

The Exchange also disseminates the Price-Earnings Ratio, the Price to BookValue Ratio and the Dividend Yield Percentage on day-to-day basis of all itsmajor indices.


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NATIONAL STOCK EXCHANGE:

The trading on stock exchanges in India used to take place through openoutcry without use of information technology for immediate matching orrecording of trades. This was time consuming and inefficient. this imposedlimits on trading limits on trading volumes and efficiency.

In order to provide efficiency, liquidity and transparency, NSE introduced anation wide on line fully automated screen based trading system (SBTS)

where a member can punch into the computer quantities of securities andthe prices at which he likes to transact and the transaction is executed assoon as it finds a matching sale or buy order from a counter party.

NSE was incorporated in 1992 and was given recognition as a stockexchange in April 1993. It started operations in June 1994, with trading onthe Wholesale Debt Market Segment. Subsequently it launched the CapitalMarket Segment in November 1994 as a trading platform for equities and theFutures and Options Segment in June 2000 for various derivativeinstruments.

NSE became the leading stock exchange in the country, impacting thefortunes of other exchanges and forcing them to adopt SBTS also. TodayIndia can boast that almost 100% trading take place through electronicorder matching. Technology was used to carry the trading platform from thetrading hall of stock exchanges to the premises of brokers. NSE carried thetrading platform further to PCs at the residence of investors. This made ahuge difference in terms of equal access to investors through the internetand to handheld devices through WAP for convenience of mobile investors.

This made a huge difference in terms of equal access to investors in a

geographically vast country like India.

Trading volumes in the equity segment have grown rapidly with averagedaily turnover increasing from Rs.17 crores during 1994-95 to Rs.4, 328crores during 2003-04. During the year 2003-04, NSE reported a turnoverof Rs.1, 099,535 crores in the equities segment accounting for 68.60% ofthe total Indian securities market.
http://nseindia.com/content/equities/eq_businessgrowth.htmhttp://nseindia.com/content/equities/eq_businessgrowth.htm


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CLEARING AND SETTLEMENT

The clearing and settlement mechanism in Indian securities market haswitnessed significant changes and several innovations during the lastdecade.

Till recently, the stock exchanges in India were following a system ofaccount period settlement for cash market transactions. T+2 rollingsettlement have now been introduced for all securities.

Due to setting up of Clearing Corporations, the market has full confidencethat settlements will take place on time and will be completed irrespective ofpossible default by isolated trading members. Two depositories viz.,

National Securities Depositories Ltd. (NSDL) Central Depository Services Ltd. (CDSL)

Provide electronic transfer of securities and more than 99% of turnover issettled in dematerialized form. The pay-in and pay-out of securities isaffected on the same day for all settlements.

Partners

CLEARINGMEMBERS

CLEARINGBANKS

DEPOSITORIES

PROFESSIONALCLEARINGMEMBERS

CUSTODIANS
http://nseindia.com/content/nsccl/nsccl_clgmembers.htmhttp://nseindia.com/content/nsccl/nsccl_clgmembers.htmhttp://nseindia.com/content/nsccl/nsccl_clgbanks.htmhttp://nseindia.com/content/nsccl/nsccl_clgbanks.htmhttp://nseindia.com/content/nsccl/nsccl_depository.htmhttp://nseindia.com/content/nsccl/nsccl_pcms.htmhttp://nseindia.com/content/nsccl/nsccl_pcms.htmhttp://nseindia.com/content/nsccl/nsccl_pcms.htmhttp://nseindia.com/content/nsccl/nsccl_custodians.htmhttp://nseindia.com/content/nsccl/nsccl_custodians.htmhttp://nseindia.com/content/nsccl/nsccl_pcms.htmhttp://nseindia.com/content/nsccl/nsccl_pcms.htmhttp://nseindia.com/content/nsccl/nsccl_pcms.htmhttp://nseindia.com/content/nsccl/nsccl_depository.htmhttp://nseindia.com/content/nsccl/nsccl_clgbanks.htmhttp://nseindia.com/content/nsccl/nsccl_clgbanks.htmhttp://nseindia.com/content/nsccl/nsccl_clgmembers.htmhttp://nseindia.com/content/nsccl/nsccl_clgmembers.htm


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TRANSACTION CYCLE

PLACING

ORDER

DECISIO

N TO

TRADE

FUNDS/TRADE

SECURITI

ES

SETTLEM

ENTCLEARIN

G OF OF

TRADESTRADES

A person holding assets (securities/funds), either to meet his liquidity needsof to reshuffle his holding in response to changes in his perception aboutrisk and return of the assets, decides to buy or sell the securities. He selectsa broker and instructs him to place buy/sell order on an exchange. Theorder is converted to a trade as soon as it finds a matching sell/buy order.

EXECUTI

ON


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At the end of the trade cycle, the trades are netted to determine theobligations of the trading members to deliver securities/funds as per

settlement schedule.

Buyer/seller deliveries funds/securities and receives securities/funds andacquires ownership of the securities. A securities transaction cycle ispresented in the above figure

SETTLEMENT CYCLE:

At the end of each trading day, concluded or locked-in trades are receivedfrom NSE by NSCCL. NSCCL determines the cumulative obligations of eachmember and electronically transfers the data to Clearing Members (CMs). Alltrades concluded during a particular trading period are settled together.


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NORMAL MARKET

In a rolling settlement, trade day is T day, T+1 day and T+2 day for NSCCL.

At NSE, trades in rolling settlement are settled on a T+2 basis i.e. on the 2ndworking day. Typically trades taking place on Monday are settled onWednesday, Tuesdays trades settled on Thursday and so on. A tabularrepresentation of the settlement cycle for rolling settlement is given below:

ACTIVITY DAY

TRADING Rolling settlementtrading

T

CLEARING Custodial confirmation T+1 working days

Delivery generation T+1 working days

SETTLEMENT Securities and fundspay in

T+2 working days

Securities and fundspay out

T+2 working days

Valuation of shortages

based on closing prices

At T+1 closing prices

POST SETTLEMENT Auction T+3 working days

Bad delivery reporting T+4 working days

Auction settlement T+ 5 working days

Rectified bad deliverypay in and pay out

T+6 working days

Re-bad deliveryreporting and pick up

T+8 working days

Close out of re-baddelivery and funds pay-in and pay-out

T+9 working days


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INTRODUCTION TO DERIVATIVES:

Inroduction of derivatives in the Indian capital market is beginning of anexciting era. Index futures were introduced as the first exchange tradedderivatives product in the Indian capital markets in june 2000. the tradingand risk management systems set up by SEBI are today internationalbenchmarks. With introduction of index options, individuals stock futuresand options and interest rate futures, the Indian derivatives market hasbecome a vibrant and dynamic part of the capital markets.

Derivatives worldwide are recognized as risk management products. Theseproducts have a long history in India in the unorganized sector, especially incurrency and commodity markets. The availability of these products onorganized exchange have provided the market participants with a safeefficient and transparent market.

Derivatives have been a key factor in creation of new and innovativefinancial products. These products by unbundling and bundling variousrisks and return parameters are meeting the specific and growing needs ofinvestors and issuers.

MEANING:

Derivative is a product which derives its value from some underlying. Thisunderlying can be securities, currency, commodities or even anotherderivative. The derivative does not have indepent of the underlying.Forwards, futures, options and swaps are amongst the more popular ofderivatives products today used across the financial markets. Following is abrief introduction to various derivative contracts.

FORWARD CONTRACTS:

A forward contract is a bi-partite contract, to be performed in the future atthe terms decided at the time of entering into the contracts. These terms arein respect of value of transaction, place of settlement, date and time ofsettlement, what is being bought/sold etc.


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Forward contracts offer tremendous flexibility to the parties to design thecontract in terms of the price, quantity, quality (in case of commodities).Delivery time and place, in somemarkets some markets some of the termsare decided by convention though the parties have the flexibility to adjustthe terms to suit their requirements. For example in markets a spottransaction is settled after two working days. However parties free to decidefree to decide any other delivery date also.

Forward contracts suffer from relatively poor liquidity as compared toactively traded futures. As the contract is bi-partite, the closing of theposition requires a party to approach the same party with whom the originalcontract was entered into. Sometimes as the choices are limited this maylimited this may result in not getting the best price. This alternate is to

enter into an equal and opposite contract with another party. While thiscloses the price risk, the counter party risk goes up.

FUTURES CONTRACTS:

Futures contracts are organized which are traded on the exchanges. Theterms like quantity, quality (in case of commodities) delivery time and place,value of one contract etc. are standardized and traded on the exchanges arevery liquid in nature. In futures market, clearing corporation house reducesthe credit risk by either it self becoming the counter party to every trade

(through novation) or by giving a guarantee to do settlement in case anycounter party fails to honor the contract.

Also each contract is seetled with the clearing corporation. This enables theclearing corporation to do net settlement, cancelling all equal and oppositecontracts for each party thereby further reducing the credit risk as well thesize of settlement.


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Forward / Future contracts

Features Forward contract Future contract

Trading Not traded onexchange

Traded on exchange

Settlement Directly between thetwo parties

Through the clearingsystem of the exchange

Contract specifications May differ from tradeto trade. Highflexibility in decidingthe terms

Contracts are specified

Counterparty risk ofcredit risk Each party takes creditrisk on the other The counterparty riskis transferred toclearing system.Clearing system takescredit risk on theclearing system.

Liquidity Poor liquidity ascontracts are tailormade

High liquidity ascontracts arestandardized. Andtraded on the

exchange.

Price discovery Poor, as markets arefragmented

Better, as traded on atransparent exchange


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SWAPS:

A swap represents an exchange of obligations. The two most common typesof swaps are interest rate swaps and currency swaps. Lately creditswaps are also becoming popular.

EQUITY DERIVATIVES IN INDIA _ AN OVERVIEW

DERIVATIVES TRADING

Derivatives trading broadly can be classified into two categories, those that

are traded on the exchange and those traded one to one or over thecounter. They are hence known as

Exchange traded derivatives OTC (Over The Counter) Derivatives

OTC equity derivatives

Traditionally equity derivatives have a long history in India in the OTCmarket.

Options of various kinds (called Teji and Mandi and Fatak) inunorganized markets were traded as early as 1900 in Mumbai.

The SCRA however banned all kind of options in 1956.DERIVATIVE MARKETS TODAY

The prohibition on options in SCRA was removed in 1995. foreigncurrency options in currency pairs other than Rupee were the firstoptions permitted by RBI.

The Reserve Bank of India has permitted options, interest rate swaps,currency swaps and other risk reductions OTC derivative products.

Besides the Forward Markets Commission has allowed the setting upof commodities futures exchanges. Today they have 18 commodityexchanges most of which trade futures e.g. the Indian Pepper andSpice Traders Association (IPSTA) and the Coffee Owners FuturesExchange of India (COFEI).

In 2000 an amendment to the SCRA expanded the definition ofsecurities to included derivatives thereby enabling stock exchanges totrade derivative products


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The year 2000 heralded the introduction of exchange traded equityderivatives in India for the first time.

EQUITY DERIVATIVES EXCHANGES IN INDIA

IN THE EQUITY MARKETS BOTH THE National Stock Exchange ofIndia Ltd. (NSE) and The Stock Exchange, Mumbai (BSE) have set uptheir derivative segments.

Both the exchanges have set up an in house segment instead ofsetting up a separate exchange for derivatives.

BSEs derivatives segment, started with Sensex futures as its firstproduct.

NSEs Futures and Options segment was launched with Nifty futuresas the first product. The market share of NSE is very large comparedto that BSE.

MEMBERSHIP:

Membership for the new segment in both the exchanges is notautomatic and has to be separately applied for.

All members have to be separately registered with SEBI before theycan be accepted.

Both the exchanges have specified certain Net worth, deposit andannual membership requirements for both Clearing and Tradingmembers.

TRADING SYSTEMS

NSEs trading system for its futures and options segment is calledNEAT F&O. it is based on the NEAT system for the cash segment.

BSEs trading system for its derivatives segment is called DTSS. It isbuilt on a platform different from the BOLT system though most of thefeatures are common.


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SETTLEMENT AND RISK MANAGEMENT SYSTEMS

Systems for settlement and risk management are required to satisfythe conditions specified by L.C. Gupta Committee and the J.R. Vermacommittee subject to modifications made by SEBI from time to time.

These include upfront margins, daily settlement, online surveillanceand position monitoring and risk management using the Value-atRisk concept (VAR).

OPTIONS BASICS:

Options are one of the widely used derivative tools just like the futuresmarkets and it is the integral part of Risk Management. Options demandbroad based understanding of the derivatives segment.

OPTION TERMINOLOGY

Option is a contract giving the buyer the right, but not the obligation, to buyor sell an underlying asset at a specific price on or before a certain date. An


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option, just like a stock or bond, is a security. It is also a binding contractwith strictly defined terms and properties.

CALLS

The right to sell a stock or a commodity future at a given price before agiven date. Calls are similar to having long positions on stock. The owner ofthe call option is speculating that the rice of the underlying will go up and istherefore bullish.

PUTS

The right to sell a stock or a commodity at a given price before a given dateis defined as a Put option. Puts are similar to having short positions on the

stock. The owner of the Put option is speculating that the price of the stockwill go down and is therefore bearish.

PLAIN VANILLA OPTIONS

The simple calls and Puts discussed above are referred to as plain vanillaoptions. They are termed so since are standardized options available fortrading on the exchange.

OPTION PRICE

The price which the option buyer pays to the option seller. It is also referredto as the Option premium.

EXPIRATION DATE

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

STRIKE PRICE

The price specified in the Options contracts is known as the strike price orthe exercise price.

AMERICAN OPTIONS


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American options are options that can be exercised at any time up to theexpiration date. Most exchange traded options are American.

EUROPEAN OPTIONS

European options are options that can be exercised only on the expirationdate itself. European options are easier to analyze than American options,and properties of an American options are frequently deduced from those ofits European counterpart.

IN THE MONEY OPTION

An in-the-money (ITM) option is an option that would lead to a positive cashflow to the holder if it were exercised immediately. A call option on the index

is said to be in-the-money when the current index stands at a level higherthan the strike price (i.e. spot price-strike price). If the index is much higherthan the strike price, the call is said to be deep ITM. In the case of a put, theput is ITM if the index is below the strike price.

AT THE MONEY OPTION

An at-the-money (ATM) option is an option that would lead to zero cash-flowif it were exercised immediately. An option on the index is at-the-moneywhen the current index equals the strike price (i.e. spot price=strike price).

OUT OF THE MONEY OPTION

An out-of-money (OTM) option that would lead to a negative cash flow if itwere exercised immediately. A call option on the index is out-of-the-moneywhen the current index stands at a level which is less than the strike price(i.e. spot price < strike price). If the index is much lower than the strikeprice, the call is said to be deep OTM. In the case of a Put, the put is OTM ifthe index is above the strike price.


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PARTICIPANTS OF OPTION MARKET

There are four types of participants in Options markets depending on theposition they take:

Buyers of calls Sellers of calls Buyers of puts Seller of puts

People who buy options are called holders and those who sell options arecalled writers; furthermore, buyers are said to have long positions, andsellers are said to have short positions.

Here is an important distinction between buyers and sellers

Call holders and put holders (buyers) are not obliged to buy or sell. Theyhave the choice to exercise their rights if they choose.

Call writers and put writers (sellers) however are obliged to buy or sell. Thismeans that a seller may be required to make good on their promise to buyor sell.

The European option can be exercised only on the maturity date, while

American option can be exercised before or on the maturity date.

In most exchanges trading starts with European options, as they are easy toexecute and keep track of. This is the case in the BSE and the NSE.

Cash settled options are those where the buyer is paid the differencebetween stock price and exercise price (call) or between exercise price andstock price (put).

Delivery settled options are those where the buyer takes delivery ofundertaking (calls) or offers delivery of undertaking (puts)


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CALL OPTIONS

The following example would clarify the basics on call options

Example:

An investor buys one European call option on one share of ReliancePetroleum at a premium of Rs. 2 per share on 31st July. The strike price isRs. 60 and the contract matures on 30th September. The payoffs for theinvestor, on the basis of fluctuating spot prices at any time are shown bythe payoff table. It may be clear from the graph that even in the worst casescenario; the investor would only lose a maximum of Rs. 2 per share whichhe/she had paid for the premium. The upside to it has an unlimited profitsopportunity.

On the other hand the seller of the call option has a payoff chart completelyreverse of the call option buyer. The maximum loss that he can have isunlimited though a profit of Rs. 2 per share would be made on the premiumpayment by the buyer.

Payoff from Call Buying / Long (Rs.)

S XT C PAYOFF NETPROFIT

57 60 2 0 -258 60 2 0 -259 60 2 0 -260 60 2 0 -261 60 2 1 -162 60 2 2 063 60 2 3 164 60 2 4 265 60 2 5 366 60 2 6 4

A European call option gives the following payoff to the investor: max (S XT, 0).The seller gets a payoff of: max (S XT, 0) or min (XT S, 0)


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S = stock priceXT = exercise price at time TC = European call option premium payoff Max (S XT, 0)

Exercising the call option and what are its implications for the buyerand the seller?

The call option gives the buyer a right to buy the requisite shares on aspecific date at a specific price. This puts the seller under the obligation tosell the shares on that specific date and specific price. The call buyerexercises his option only when he/she feels it is profitable. This process iscalled Exercising the Option. This leads us to the fact that if the spot priceis lower than the strike price then it might be profitable for the investor tobuy the share in the open market and forgo the premium paid.

The implications for a buyer are that it is his/her decision whether toexercise the option or not. In case the investor expects prices to rise farabove the strike price in the future then he/she would surely be interestedin buying call options.

On the other hand, if the seller feels that his shares are not giving thedesired returns and they are not going to perform any better in the future, a

Payoof From Call Bying / Long

-4

-20

2

4

6

1 2 3 4 5 6 7 8 9 10

PL

57 5961

63

65

Pro

fit/Loss

Spot Price

Payoff from Call Buying / Long


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premium can be charged and returns from selling the call option can beused to make up for the underlying asset.

In the real world, most of the deals are closed with another counter orreverse deal. There is no requirement to exchange the underlying assetsthen as investor gets out of the contract just before its expiry.


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PUT OPTIONS:

The European Put option is the reverse of the call option deal. Here, there isa contract to sell a particular number of underlying assets on a particulardate at a specific price. An example would help understand the situation alittle better

Example:

An investor buys one European Put option on one share of ReliancePetroleum at a premium of Rs. 2 per share on 31st July. The strike price isRs. 60 and the contract matures on 30th September. The payoff table showsthe fluctuations of net profit with a change in the spot price.

Payoff from Put buying/Long (Rs.)

S XT P PAYOFF NETPROFIT

55 60 2 5 356 60 2 4 257 60 2 3 158 60 2 2 059 60 2 1 -160 60 2 0 -2

61 60 2 0 -262 60 2 0 -263 60 2 0 -264 60 2 0 -2

The payoff for the put buyer is max (XT S, 0)

The payoff for a put writer is max (XT S, 0) or minus (S XT, 0)


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These are the two basic options that from the whole gamut of transactionsin the options trading. These in combination with the other derivativescreate a whole world of instruments to choose from depending on the kindof requirement and the kind of market expectations.

Exotic Options are often mistaken to be another kind of option. They arenothing but non-standard derivatives and are not a third type of option.


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MARKET PLAYERS

HEDGERSThe objective of these kinds of traders is to reduce the risk. They are not inthe derivatives market to make profits. They are in it to safeguard theirexisting positions. Apart from equity markets, hedging is common in theforeign exchange markets where fluctuations in the exchange rate have tobe taken care of in the foreign currency transactions or could be in thecommodities market where spiraling oil prices have to be tamed using thesecurity in derivative instruments.

SPECULATORSThey are traders with a view and objective of making profits. They are willingto take risks and they bet upon whether the markets would go up or comedown.

ARBITRAGEURSRisk less profit making is the prime goal of Arbitrageurs. Buying in onemarket and selling in another, buying two products in the same, market arecommon. They could be making money even without putting their ownmoney in and such opportunities come up in the market but last for very

short time frames. This is because as soon as the situation arisesarbitrageurs take advantage and demand-supply forces drive the marketsback to normal.

OPTIONS UNDERLYING

Stocks Foreign currencies Stock indices Commodities And other Futures options

Are options on the futures contracts or underlying assets are futurescontracts. The futures contract generally matures shortly after the optionsexpiration


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OPTIONS PRICING

Prices of options are commonly depending upon six factors. Unlike futureswhich derives there prices primarily from prices of the underlying. Optionsprices are far more complex. The table below helps understand the affect ofeach of these factors and gives a broad picture of option pricing keeping allother factors constant. The table presents the case of European as well asAmerican Options.

EFFECT OF INCREASE IN THE RELEVANT PARAMETRE ON OPTIONPRICES

EUROPEAN OPTIONSBuying

AMERICAN OPTIONSBuying

PARAMETERS CALL PUT CALL PUT

Spot prices(S)

Strike price(XT)Time toexpiration (T)

? ?

Volatility

Risk FreeInterest Rates(r)Dividends (D)


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Spot prices

In case of a call option the payoff for the buyer is max (S XT, 0) therefore ,more the spot price more is the payoff and it is favorable for the buyer. It isthe other way round for the seller, more the spot price higher is the chanceof his going into a loss.

In case of a put option, the payoff for the buyer is max (XT S, 0) therefore,more the spot price more are the chances of going into a loss. It is thereverse for Put Writing.

Strike price

In case of a call option the payoff for the buyer is shown above. As per thisrelationship a higher strike price would reduce the profits for the holder ofthe call option.

Time to Expiration :

More the time to expiration more favorable is the option. This can only existin case of American option as in case of European options the optionscontract matures only on the date of maturity.

Volatility:

More the volatility, higher is the probability of the option generating higherreturns to the buyer. The downside in both the cases of call and put is fixedbut the gains can be unlimited. If the price falls heavily in case of a callbuyer then the maximum that he loses is the premium paid falls heavily incase of a call buyer then the maximum that he loses is the premium paidand nothing more than that. More so he/she can buy the same shares fromthe spot market at a lower price. Similar is the case of the put option buyer.

Risk free rate of interest:

In reality the r and the stock market are inversely related. But theoreticallyspeaking, when all other variables are fixed and interest rate increases thisleads to a double effect: Increase in expected growth rate of stock pricesdiscounting factor increases making the price fall.

In case of the put option both these factors increase and lead to a decline inthe put value. A higher expected growth leads to a higher price taking the


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buyer to the position of loss in the payoff chart. The discounting factorincreases and the future value become lesser.

In case of a call option these effects work in the opposite direction. The firsteffect is positive as at a higher value in the future the call option would beexercised and would give a profit. The second effect is negative as is that ofdiscounting. The first effect is far more dominant than the second one, andthe overall effect is favorable on the call option.

Dividends:

When dividends are announced then the stock prices on ex-dividend arereduced. This is favorable for the put option and unfavorable for the calloption.


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Bull spreads

Simple option positions carry unlimited profits, limited losses for buyersand limited profits, unlimited losses for sellers (writers). Spreads create alimited profit, limited loss profile for users. By limiting losses, you arelimiting your risks and by limiting profits you are reducing your costs.

Those spreads which will generate gains in a bullish market are bullspreads.

How is a bull spread created?

one can create a bull spread by using two calls or two puts. If you are usingcalls, you should buy a call with a lower strike price and sell another call

with a higher strike price.

Example:

CALL STRIKE PRICE PREMIUM PAY/RECEIVE

Satyam May buy 260 24 Pay

Satyam May sell 300 5 Receive

Net 19 pay

When should one enter into a bull spread like above?

If you are bullish on Satyam which is quoted around Rs. 260. you believe itwill rise during the month of may. However, you do not foresee Satyamrising beyond in that period.

If you simply buy a call with a strike price of Rs. 260, the premium of Rs. 24

that you are paying is for unlimited gains which include the possibility ofSatyam moving beyond Rs. 300 also. However, if you believe that Satyamwill not move beyond Rs. 300, why should you pay a premium for thisupward move?

You might therefore decide to sell a call with a strike price of Rs. 300. byselling this call, you earn a premium of Rs. 5. You are sacrificing any gains

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Khushboo Stock Market Overview