Description
The study is limited to “Derivatives” with special reference to futures and options in the Indian context and the Hyderabad stock exchange has been taken as a representative sample for the study. The study can’t be said as totally perfect. Any alteration may come. The study has only made a humble attempt at evaluating derivatives market only in Indian context. The study is not based on the international perspective of derivatives markets, which exists in NASDAQ, NYSE etc.
A STUDY ON FUTURES AND POTIONS
Project submitted in partial fulfillment for the award of the
degree of
MASTER OF BUSINESS ADMINISTRATION
DECLARATION
I hereby declare that this Project Report titled, “A STUDY ON THE
DERIATIES! s"b#itted by #e to the Depart#e$t O% &USINESS
AD'INISTRATION, (((( a$d is a bo$a)ide *or+ "$der ta+e$ by #e
a$d it is $ot s"b#itted to a$y other U$i,ersity or I$stit"tio$ )or the
a*ard o) a$y de-ree diplo#a . certi)icate or p"blished a$y ti#e
be)ore.
Name and Address of the Student Signature of the student
Date :
A/0NO12ED3E'ENT
I wish to express my sincere deep sense of gratitude and also thank my
guide XXX, aculty of inance for his significant suggestions and help in
e!ery aspect to accomplish the pro"ect work. #is persisting
encouragement, e!erlasting patience and keen interest in discussions
ha!e $enefited me to the extent that cannot $e spanned $y words.
I take my pleasure to acknowledge XXXX for the facilities pro!ided and
constant encouragement.
inally I express $ows to e!eryone who are in!ol!ed with this pro"ect.
CONTENTS
INTRODUCTION
METHODOLOGY
? FUTURES
? OPTIONS
ANALYSIS OF THE STUDY
SUMMARY AND CONCLUSIONS
BIBLIOGRAPHY
INTRODUCTION
NATURE OF THE PROBLEM:
The turnover of the stock exchanges has been tremendously
increasing from last 10 years. The number of trades and the number of
investors, who are participating, have increased. The investors are willing to
reduce their risk, so they are seeking for the risk management tools.
Prior to !"# abolishing the "$%&$ system, the investors had
this system as a source of reducing the risk, as it has many problems like no
strong margining system, unclear expiration date and generating counter party
risk. #n view of this problem !"# abolished the "$%&$ system.
$fter the abolition of the "$%&$ system, the investors are
seeking for a hedging system, which could reduce their portfolio risk. !"#
thought the introduction of the derivatives trading, as a first step it has set up a
'( member committee under the chairmanship of %r.&.).*upta to develop the
appropriate regulatory framework for derivative trading in #ndia, !"# accepted
the recommendations of the committee on +ay 11, 1,,- and approved the
phased introduction of the derivatives trading beginning with stock index
futures.
There are many investors who are willing to trade in the
derivative segment, because of its advantages like limited loss and unlimited
profit by paying the small premiums.
IMPORTANCE OF THE STUDY:
To evaluate the profit.loss position of option holder and option writer.
OBJECTIVES OF THE STUDY:
? To analy/e the derivatives market in #ndia.
? To analy/e the operations of futures and options.
? To find out the profit.loss position of the option writer and option holder.
? To study about risk management with the help of derivatives.
SCOPE OF THE STUDY:
The study is limited to 0%erivatives1 with special reference to futures
and options in the #ndian context and the 2yderabad stock exchange has been
taken as a representative sample for the study. The study can3t be said as totally
perfect. $ny alteration may come. The study has only made a humble attempt
at evaluating derivatives market only in #ndian context. The study is not based
on the international perspective of derivatives markets, which exists in
4$%$5, 46! etc.
LIMITATIONS OF THE STUDY:
The following are the limitations of this study.
? The scrip chosen for analysis is T$T! "$47 89 #4%#$ and the contract
taken is +arch '00: ending one;month contract.
? The data collected is completely restricted to the T$T! "$47 89 #4%#$
of +arch '00:< hence this analysis cannot be taken as universal.
METHODOLOGY
The emergence of the market for derivative products, most
notably forwards, futures and options, can be traced back to the willingness of
risk;averse economic agents to guard themselves against uncertainties arising
out of fluctuations in asset prices. "y their very nature, the financial markets are
marked by a very high degree of volatility. Through the use of derivative
products, it is possible to partially or fully transfer price risks by locking=in
asset prices. $s instruments of risk management, these generally do not
influence the fluctuations in the underlying asset prices. 2owever, by locking;in
asset prices, derivative products minimi/e the impact of fluctuations in asset
prices on the profitability and cash flow situation of risk;averse investors.
%erivatives are risk management instruments, which derive their
value from an underlying asset. The underlying asset can be bullion, index,
share, bonds, currency, interest etc. "anks, securities firms, companies and
investors to hedge risks, to gain access to cheaper money and to make profit,
use derivatives. %erivatives are likely to grow even at a faster rate in future.
DEFINITION:
%erivative is a product whose value is derived from the value of
an underlying asset in a contractual manner. The underlying asset can be e>uity,
forex, commodity or any other asset.
ecurities )ontracts ?@egulationA $ct, 1,:B ?)?@A $A defines 0derivative1 to
include =
1. $ security derived from a debt instrument, share, loan whether
secured or unsecured, risk instrument or contract for differences or any other
form of security.
'. $ contract which derives its value from the prices, or index of prices,
of underlying securities.
PARTICIPANTS:
The following three broad categories of participants in the derivatives market.
HEDGERS:
2edgers face risk associated with the price of an asset. They use futures
or options markets to reduce or eliminate this risk.
SPECULATORS:
peculators wish to bet on future movements in the price of an asset.
9utures and options contracts can give them an extra leverage< that is, they can
increase both the potential gains and potential losses in a speculative venture.
ARBITRAGEURS:
$rbitrageurs are in business to take advantage of a discrepancy between
prices in two different markets. #f, 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.
FUNCTIONS OF DERIVATIVES MARKET:
The following are the various functions that are performed by the derivatives
markets. They areC
? Prices in an organi/ed derivatives market reflect the perception of market
participants about the future and lead the prices of underlying to the perceived
future level.
? %erivatives market helps to transfer risks from those who have them but may
not like them to those who have an appetite for them.
? %erivative trading acts as a catalyst for new entrepreneurial activity.
? %erivatives markets help increase savings and investment in the long run.
TYPES OF DERIVATIVES:
The following are the various types of derivatives. They areC
FORWARDS:
$ forward contract is a customi/ed contract between two entities, where
settlement takes place on a specific date in the future at today3s pre;agreed
price.
FUTURESC
$ 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.
OPTIONSC
8ptions are of two types ; calls and puts. )alls give the buyer the right
but not the obligation to buy a given >uantity of the underlying asset, 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 >uantity of the underlying asset at a given price on or
before a given date.
WARRANTSC
8ptions generally have lives of upto one year< the majority of options
traded on options exchanges having a maximum maturity of nine months.
&onger;dated options are called warrants and are generally traded over;the;
counter.
LEAPSC
The acronym &!$P means &ong;Term !>uity $nticipation ecurities.
These are options having a maturity of upto three years.
BASKETSC
"asket options are options on portfolios of underlying assets. The
underlying asset is usually a moving average of a basket of assets. !>uity index
options are a form of basket options.
SWAPSC
waps are private agreements between two parties to exchange cash
flows in the future according to a prearranged formula. They can be regarded as
portfolios of forward contracts. The two commonly used swaps areC
#nterest rate swapsC
These entail swapping only the interest related cash flows between the
parties in the same currency.
% )urrency swapsC
These entail swapping both principal and interest between the parties,
with the cash flows in one direction being in a different currency than those in
the opposite %irection.
SWAPTIONS:
waptions are options to buy or sell a swap that will become operative at
the expiry of the options. Thus a swaption is an option on a forward swap.
RATIONALE BEHIND THE DEVELOPMENT OF
DERIVATIVES:
2olding portfolio of securities is associated with the risk of the
possibility that the investor may reali/e his returns, which would be much lesser
than what he expected to get. There are various factors, which affect the
returnsC
1. Price or dividend ?interestA.
'. ome are internal to the firm like =
? #ndustrial policy
? +anagement capabilities
? )onsumer3s preference
? &abor strike, etc.
These forces are to a large extent controllable and are termed as non
ystematic risks. $n investor can easily manage such non;systematic by having
a well = diversified portfolio spread across the companies, industries and groups
so that a loss in one may easily be compensated with a gain in other.
There are yet other types of influences which are external to the firm,
cannot be controlled and affect large number of securities. They are termed as
systematic risk. They areC
1. !conomic
'. Political
D. ociological changes are sources of systematic risk.
9or instance, inflation, interest rate, etc. their effect is to cause prices of
nearly all individual stocks to move together in the same manner. Ee therefore
>uite often find stock prices falling from time to time in spite of company3s
earnings rising and vice versa.
@ationale behind the development of derivatives market is to manage
this systematic risk, li>uidity and li>uidity in the sense of being able to buy and
sell relatively large amounts >uickly without substantial price concessions.
#n debt market, a large position of the total risk of securities is
systematic. %ebt instruments are also finite life securities with limited
marketability due to their small si/e relative to many common stocks. Those
factors favour for the purpose of both portfolio hedging and speculation, the
introduction of a derivative security that is on some broader market rather than
an individual security.
#ndia has vibrant securities market with strong retail participation that
has rolled over the years. #t was until recently basically cash market with a
facility to carry forward positions in actively traded F$3 group scrips from one
settlement to another by paying the re>uired margins and borrowing some
money and securities in a separate carry forward session held for this purpose.
2owever, a need was felt to introduce financial products like in other financial
markets world over which are characteri/ed with high degree of derivative
products in #ndia.
%erivative products allow the user to transfer this price risk by looking
in the asset price there by minimi/ing the impact of fluctuations in the asset
price on his balance sheet and have assured cash flows.
%erivatives are risk management instruments, which derive their value
from an underlying asset. The underlying asset can be bullion, index, shares,
bonds, currency etc.
DERIVATIVE SEGMENT AT NATIONAL STOCK
EXCHANGE:
The derivatives segment on the exchange commenced with GP )4H
4ifty #ndex futures on Iune 1', '000J.The 9G8 segment of 4! provides
trading facilities for the following derivative segmentC
1. #ndex "ased 9utures
'. #ndex "ased 8ptions
D. #ndividual tock 8ptions
(. #ndividual tock 9utures
COMPANY NAME
CODE LOT SIZE
$"" &td. $"" '00
$ssociated )ement )o. &td. $)) J:0
$llahabad "ank $&"7 '
0
$ndhra "ank $4%2@$"$47 'D00
$rvind +ills &td. $@K#4%+#&& '1:0
$shok &eyland &td $287&!6 ,::0
"ajaj $uto &td. "$I$I$LT8 '00
"ank of "aroda "$47"$@8%$ 1(00
"ank of #ndia "$47#4%#$ 1,00
"harat !lectronics &td. "!& ::0
"harat 9orge )o &td "2$@$T98@* '00
"harti Tele;Kentures &td "2$@T# 1000
"harat 2eavy !lectricals &td. "2!& D00
"harat Petroleum )orporation &td. "P)& ::0
)adila 2ealthcare &imited )$%#&$2) :00
)anara "ank )$4"7 1B00
)entury Textiles &td )!4TL@6T!H -:0
)hennai Petroleum )orp &td. )2!44P!T@8 ,:0
)ipla &td. )#P&$ 1000
7ochi @efineries &td
)8)2#4@!94 1D00
)olgate Palmolive ?#A &td. )8&*$T! 10:0
%abur #ndia &td. %$"L@ 1-00
*$#& ?#ndiaA &td. *$#& 1:00
*reat !astern hipping )o. &td. *!2#PP#4* 1D:0
*laxosmithkline Pharma &td. *&$H8 D00
*rasim #ndustries &td. *@$#+ 1J:
*ujarat $mbuja )ement &td. *LI$+")!+ ::0
2)& Technologies &td. 2)&T!)2 B:0
2ousing %evelopment 9inance
)orporation &td.
2%9) D00
2%9) "ank &td. 2%9)"$47 (00
2ero 2onda +otors &td. 2!@8284%$ (00
2indalco #ndustries &td. 2#4%$&)0 1:0
2industan &ever &td. 2#4%&!K!@ '000
2industan Petroleum )orporation &td. 2#4%P!T@8 B:0
#)#)# "ank &td. #)#)#"$47 J00
#ndustrial development bank of #ndia
&td.
#%"# '(00
#ndian 2otels )o. &td. #4%28T!& D:0
#ndian @ayon $nd #ndustries &td #4%@$684 :00
#nfosys Technologies &td. #4986T)2 100
#ndian 8verseas "ank #8" ',:0
#ndian 8il )orporation &td. #8) B00
#T) &td. #T) 1:0
Iet $irways ?#ndiaA &td. I!T$#@E$6 '00
Iindal teel G Power &td I#4%$&T!& ':0
Iaiprakash 2ydro;Power &td. IP26%@8 B':0
)ummins #ndia &td 7#@&87)L+ 1,00
&#) 2ousing 9inance &td &#)2*9#4 -:0
+ahindra G +ahindra &td. +G+ B':
+atrix &aboratories &td. +$T@#H&$" 1':0
+angalore @efinery and
Petrochemicals &td.
+@P& (0
+ahanagar Telephone 4igam &td. +T4& 1B00
4ational $luminium )o. &td. 4$T#84$&L+ 11:0
4eyveli &ignite )orporation &td. 4!6K!&#&#* ',:0
4icolas Piramal #ndia &td 4#)8&$P#@ ,:0
4ational Thermal Power )orporation
&td.
4TP) D':0
8il G 4atural *as )orp. &td. 84*) D00
8riental "ank of )ommerce 8@#!4T"$47 B00
Patni )omputer ystem &td P$T4# B:0
Punjab 4ational "ank P4" B00
@anbaxy &aboratories &td. @$4"$H6 '00
@eliance !nergy &td. @!& ::0
@eliance )apital &td @!&)$P#T$& 1100
@eliance #ndustries &td. @!&#$4)! B00
atyam )omputer ervices &td. $T6$+)8+P B00
tate "ank of #ndia "#4 :00
hipping )orporation of #ndia &td. )# 1B00
iemens &td #!+!4 1:0
terlite #ndustries ?#A &td T!@ D:0
un Pharmaceuticals #ndia &td. L4P2$@+$0
yndicate "ank 64%#"$47 D-00
Tata )hemicals &td T$T$)2!+ 1D:0
Tata )onsultancy ervices &td T) ':0
Tata Power )o. &td. T$T$P8E!@ -00
Tata Tea &td. T$T$T!$ ::0
Tata +otors &td. T$T$+8T8@ -':
Tata #ron and teel )o. &td. T#)8 BJ:
Lnion "ank of #ndia L4#84"$47 '100
LT# "ank &td. LT#"$47 ,00
Kijaya "ank K#I$6$"$47 D0
Kidesh anchar 4igam &td K4& 10:0
Eipro &td. E#P@8 D00
Eockhardt &td. E8)7P2$@+$ B00
REGULATORY FRAMEWORK:
The trading of derivatives is governed by the provisions contained in the
) ? @ A $, the !"# $ct, the and the regulations framed there under the rules
and byelaws of stock exchanges.
@egulation for %erivative TradingC
!"# set up a '( member committed under )hairmanship of
%r.&.).*upta develop the appropriate regulatory framework for derivative
trading in #ndia. The committee submitted its report in +arch 1,,-. 8n +ay
11, 1,,- !"# accepted the recommendations of the committee and approved
the phased introduction of %erivatives trading in #ndia beginning with tock
#ndex 9utures. !"# also approved he 0uggestive bye;laws1 recommended by
the committee for regulation and control of trading and settlement of
%erivatives contracts.
The provisions in the ) ?@A $ govern the trading in the securities. The
amendment of the ) ?@A $ to include 0%!@#K$T#K!1 within the ambit of
Fecurities3 in the ) ?@ A $ made trading in %erivatives possible within the
framework of the $ct.
1. $ny exchange fulfilling the eligibility criteria as prescribed in the &.).
*upta committee report may apply to !"# for grant of recognition
under ection ( of the ) ?@A $, 1,:B to start %erivatives Trading. The
derivatives exchange.segment should have a separate governing council
and representation of trading . clearing members shall be limited to
maximum of (0M of the total members of the governing council. The
exchange shall regulate the sales practices of its members and will
obtain approval of !"# before start of Trading in any derivative
contract.
'. The exchange shall have minimum :0 members.
D. The members of an existing segment of the exchange will not
automatically become the members of the derivative segment. The
members of the derivative segment need to fulfill the eligibility
conditions as lay down by the &.).*upta )ommittee.
(. The clearing and settlement of derivates trades shall be through a !"#
approved )learing )orporation . )learing house. )learing )orporation .
)learing 2ouse complying with the eligibility conditions as lay down
"y the committee have to apply to !"# for grant of approval.
:. %erivatives broker.dealers and )learing members are re>uired to seek
registration from !"#.
B. The +inimum contract value shall not be less than @s.' &akh.
!xchanges should also submit details of the futures contract they
purpose to introduce.
J. The trading members are re>uired to have >ualified approved user and
sales person who have passed a certification programme approved by
!"#.
FUTURES
%!9#4#T#84C
$ 9utures contract is an agreement between two parties to buy or sell an
asset at a certain time in the future at a certain price. To facilitate li>uidity in
the futures contract, the exchange specifies certain standard features of the
contract. The standardi/ed items on a futures contract areC
? 5uantity of the underlying
? 5uality of the underlying
? The date and the month of delivery
? The units of price >uotations and minimum price change
? &ocations of settlement
TYPES OF FUTURES:
8n the basis of the underlying asset they derive, the futures are divided
into two typesC
? Stock !t!"#$:
The stock futures are the futures that have the underlying asset as the
individual securities. The settlement of the stock futures is of cash settlement
and the settlement price of the future is the closing price of the underlying
security.
? I%&#' !t!"#$:
#ndex futures are the futures, which have the underlying asset as an
#ndex. The #ndex futures are also cash settled. The settlement price of the
#ndex futures shall be the closing value of the underlying index on the expiry
date of the contract.
P("t)#$ )% t*# F!t!"#$ Co%t"(ct:
There are two parties in a future contract, the "uyer and the eller. The
buyer of the futures contract is one who is LONG on the futures contract and
the seller of the futures contract is one who is SHORT on the futures contract.
The pay off for the buyer and the seller of the futures contract are as follows.
PAYOFF FOR A BUYER OF FUTURES:
CASE +:
The buyer bought the future contract at ?9A< if the futures price goes to
!1 then the buyer gets the profit of ?9PA.
CASE ,:
The buyer gets loss when the future price goes less than ?9A, if the
futures price goes to !' then the buyer gets the loss of ?9&A.
PAYOFF FOR A SELLER OF FUTURES:
9 = 9LTL@! P@#)!
!1, !' = !TT&!+!4T P@#)!.
CASE +:
The eller sold the future contract at ?fA< if the futures price goes to !1
then the eller gets the profit of ?9PA.
CASE ,:
The eller gets loss when the future price goes greater than ?9A, if the
futures price goes to !' then the eller gets the loss of ?9&A.
MARGINS:
+argins are the deposits, which reduce counter party risk, arise in a
futures contract. These margins are collected in order to eliminate the counter
party risk. There are three types of marginsC
I%)t)(- M(".)%:
Ehenever a futures contract is signed, both buyer and seller are re>uired
to post initial margin. "oth buyer and seller are re>uired to make security
deposits that are intended to guarantee that they will infact be able to fulfill their
obligation. These deposits are #nitial margins and they are often referred as
performance margins. The amount of margin is roughly :M to 1:M of total
purchase price of futures contract.
M("k)%. to M("k#t M(".)%:
The process of adjusting the e>uity in an investor3s account in order to
reflect the change in the settlement price of futures contract is known as +T+
+argin.
M()%t#%(%c# /(".)%:
The investor must keep the futures account e>uity e>ual to or greater
than certain percentage of the amount deposited as #nitial +argin. #f the e>uity
goes less than that percentage of #nitial margin, then the investor receives a call
for an additional deposit of cash known as +aintenance +argin to bring the
e>uity up to the #nitial margin.
Ro-# o M(".)%$:
The role of margins in the futures contract is explained in the following
example.
sold a atyam 9ebruary futures contract to " at @s.D00< the following
table shows the effect of margins on the contract. The contract si/e of atyam
is 1'00. The initial margin amount is say @s.'0000, the maintenance margin is
B:M of #nitial margin.
%$6 P@#)! 89 $T6$+ !99!)T 84
"L6!@ ?"A
!99!)T 84
!&&!@ ?A
@!+$@7
1 D00.00
+T+
P.&
"al.in +argin
+T+
P.&
"al.in +argin
)ontract is
entered and
initial margin
is deposited.
'
D
(
D11?price increasedA
'-J
D0:
N1D,'00
;'-,-00
N1:,(00
N'1,B00
;1D,'00
N1D,'00
N'-,-00
;'1,B00
" got profit
and got
loss,
deposited
maintenance
margin.
" got loss and
deposited
maintenance
margin.
" got profit,
got loss.
)ontract
settled at D0:,
totally " got
profit and
got loss.
P")c)%. t*# F!t!"#$:
The fair value of the futures contract is derived from a model known as
the )ost of )arry model. This model gives the fair value of the futures contract.
Co$t o C(""0 Mo&#-:
9O ?1Nr;>A
t
Ehere
F 1 F!t!"#$ P")c#
S 1 S2ot 2")c# o t*# U%&#"-0)%.
" 1 Co$t o F)%(%c)%.
3 1 E'2#ct#& D)4)&#%& Y)#-&
T 1 Ho-&)%. P#")o&5
FUTURES TERMINOLOGY:
S2ot 2")c#:
The price at which an asset trades in the spot market.
F!t!"#$ 2")c#:
The price at which the futures contract trades in the futures market.
Co%t"(ct c0c-#:
The period over which a contract trades. The index futures contracts on
the 4! have one;month, two;months and three;month expiry cycles which
expire on the last Thursday of the month. Thus a Ianuary expiration contract
expires on the last Thursday of Ianuary and a 9ebruary expiration contract
ceases trading on the last Thursday of 9ebruary. 8n the 9riday following the last
Thursday, a new contract having a three;month expiry is introduced for trading.
E'2)"0 &(t#:
#t 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.
Co%t"(ct $)6#:
The amount of asset that has to be delivered under one contract. 9or
instance, the contract si/e on 4!3s futures market is '00 4ifties.
B($)$:
#n the context of financial futures, basis can be defined as the futures
price minus the spot price. There will be a different basis for each delivery
month for each contract. #n a normal market, basis will be positive. This
reflects that futures prices normally exceed spot prices.
Co$t o c(""0:
The relationship between futures prices and spot prices can be
summari/ed 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.
O2#% I%t#"#$t:
Total outstanding long or short positions in the market at any specific
time. $s total long positions for market would be e>ual to short positions, for
calculation of open interest, only one side of the contract is counted.
OPTIONS
%!9#4#T#84C
8ption is a type of contract between two persons where one grants the
other the right to buy a specific asset at a specific price within a specified time
period. $lternatively the contract may grant the other person the right to sell a
specific asset at a specific price within a specific time period. #n order to have
this right, the option buyer has to pay the seller of the option premium.
The assets on which options can be derived are stocks, commodities,
indexes etc. #f the underlying asset is the financial asset, then the options are
financial options like stock options, currency options, index options etc, and if
the underlying asset is the non;financial asset the options are non;financial
options like commodity options.
PROPERTIES OF OPTIONS:
8ptions have several uni>ue properties that set them apart from other
securities. The following are the properties of optionsC
? &imited &oss
? 2igh &everage Potential
? &imited &ife
PARTIES IN AN OPTION CONTRACT:
+5 B!0#" o t*# O2t)o%:
The buyer of an option is one who by paying option premium
buys the right but not the obligation to exercise his option on
seller.writer.
,5 W")t#"7S#--#" o t*# O2t)o%:
The writer of a call.put options is the one who receives the
option premium and is there by obligated to sell.buy the asset if the
buyer exercises the option on him.
.
TYPES OF OPTIONS:
The options are classified into various types on the basis of various
variables. The following are the various types of optionsC
#A O% t*# 8($)$ o t*# U%&#"-0)%. ($$#t:
8n the basis of the underlying asset the options are divided into two typesC
? INDEX OPTIONS:
The #ndex options have the underlying asset as the index.
? STOCK OPTIONS:
$ stock option gives the buyer of the option the right to buy.sell stock at
a specified price. tock options are options on the individual stocks, there
are currently more than :0 stocks are trading in this segment.
II5 O% t*# 8($)$ o t*# /("k#t /o4#/#%t:
8n the basis of the market movement the options are divided into two
types. They areC
? CALL OPTION:
$ call options is bought by an investor when he seems that the stock
price moves upwards. $ call option gives the holder of the option the right
but not the obligation to buy an asset by a certain date for a certain price.
? PUT OPTION:
$ put option is bought by an investor when he seems that the stock price
moves downwards. $ put option gives the holder of the option right but not
the obligation to sell an asset by a certain date for a certain price.
III5 O% t*# 8($)$ o #'#"c)$# o O2t)o%:
8n the basis of the exercising of the option, the options are classified
into two categories.
? AMERICAN OPTION:
$merican options are options that can be exercised at any time up to the
expiration date, most exchange;traded options are $merican.
? EUROPEAN OPTION:
!uropean options are options that can be exercised only on the
expiration date itself. !uropean options are easier to analy/e than $merican
options.
PAY9OFF PROFILE FOR BUYER OF A CALL OPTION:
The pay;off of a buyer options depends on the spot price of the
underlying asset. The following graph shows the pay;off of buyer of a call
optionC
S
9
St")k#
2")c#
OTM 9
O!t o t*#
Mo%#0
SP 9 P"#/)!/7Lo$$ ATM 9 At t*# Mo%#0
E+ 9 S2ot 2")c# + ITM 9 I% T*# Mo%#0
E, 9 S2ot 2")c# ,
SR 9 2"o)t (t $2ot 2")c# E+
CASE +: :S2ot 2")c# ; St")k# P")c#<
$s the spot price ?!1A of the underlying asset is more than strike price
?A. The buyer gets the profit of ?@A, if price increases more than !1 than
profit also increase more than @.
CASE ,: :S2o"t 2")c# = St")k# P")c#<
$s the spot price ?!'A of the underlying asset is less than strike price ?sA.
The buyer gets loss of ?PA, if price goes down less than !' than also his loss is
limited to his premium ?PA.
PAY 1 OFF PROFILE FOR SELLER OF A CALL OPTION:
The pay;off of seller of the call option depends on the spot price of the
underlying asset. The following graph shows the pay;off of seller of a call
optionC
S 9 St")k# 2")c# ITM 9 I% t*# Mo%#0
SP 9 P"#/)!/72"o)t ATM 9 At t*# Mo%#0
E+ 9 S2ot 2")c# + OTM 9 O!t o T*# Mo%#0
E, 9 S2ot 2")c# ,
SR 9 2"o)t (t $2ot 2")c# E+
CASE +: :S2ot 2")c# = St")k# 2")c#<
$s the spot price ?!1A of the underlying asset is less than strike price ?A.
The seller gets the profit of ?PA, if the price decreases less than !1 than also
profit of the seller does not exceed ?PA.
CASE ,: :S2ot 2")c# ; St")k# 2")c#<
$s the spot price ?!'A of the underlying asset is more than strike price
?A. The seller gets loss of ?@A, if price goes more less than !' than the loss of
the seller also increase more than ?@A.
PAY9OFF PROFILE FOR BUYER OF A PUT OPTION:
The payoff of buyer of the option depends on the spot price of the
underlying asset. The following graph shows the pay off of the buyer of a call
optionC
S 9 St")k# 2")c# ITM 9 I% T*# Mo%#0
SP 9 P"#/)!/72"o)t OTM 9 O!t o T*# Mo%#0
E+ 9 S2ot 2")c# + ATM 9 At T*# Mo%#0
E, 9 S2ot 2")c# ,
SR 9 2"o)t (t $2ot 2")c# E+
CASE +: :S2ot 2")c# = St")k# 2")c#<
$s the spot price ?!1A of the underlying asset is less than strike price ?A.
The buyer gets the profit of ?@A, if price decreases less than !1 than the profit
also increases more than ?@A.
CASE ,: :S2ot 2")c# ; St")k# 2")c#<
$s the spot price ?!'A of the underlying asset is more than strike price
?sA, the buyer gets loss of ?PA, if price goes more than !' than the loss of the
buyer is limited to his premium ?PA.
PAY9OFF PROFILE FOR SELLER OF A PUT OPTION:
The pay off of seller of the option depends on the spot price of the
underlying asset. The following graph shows the pay;off of seller of a put
optionC
S 9 St")k# 2")c# ITM 9 I% T*# Mo%#0
SP 9 P"#/)!/72"o)t ATM 9 At T*# Mo%#0
E+ 9 S2ot 2")c# + OTM 9 O!t o T*# Mo%#0
E, 9 S2ot 2")c# ,
SR 9 2"o)t (t $2ot 2")c# E+
CASE +: :S2ot 2")c# = St")k# 2")c#<
$s the spot price ?!1A of the underlying asset is less than strike price ?A,
the seller gets the loss of ?@A, if price decreases less than !1 than the loss also
increases more than ?@A.
CASE ,: :S2ot 2")c# ; St")k# 2")c#<
$s the spot price ?!'A of the underlying asset is more than strike price
?A, the seller gets profit of ?PA, if price goes more than !' than the profit of
the seller is limited to his premium ?PA.
FACTORS AFFECTING THE PRICE OF AN OPTION:
The following are the various factors that affect the price of an option.
They areC
Stock 2")c#:
The pay;off from a call option is the amount by which the stock price
exceeds the strike price. )all options therefore become more valuable as the
stock price increases and vice versa. The pay;off from a put option is the
amount< by which the strike price exceeds the stock price. Put options therefore
become more valuable as the stock price increases and vice versa.
St")k# 2")c#:
#n the case of a call, as the strike price increases, the stock price has to
make a larger upward move for the option to go in;the =money. Therefore, for a
call, as the strike price increases, options become less valuable and as strike
price decreases, options become more valuable.
T)/# to #'2)"(t)o%:
"oth Put and )all $merican options become more valuable as the time
to expiration increases.
Vo-(t)-)t0:
The volatility of n a stock price is a measure of uncertain about future
stock price movements. $s volatility increases, the chance that the stock will do
very well or very poor increases. The value of both )alls and Puts therefore
increase as volatility increase.
R)$k9"## )%t#"#$t "(t#:
The put option prices decline as the risk = free rate increases where as
the prices of calls always increase as the risk = free interest rate increases.
D)4)&#%&$:
%ividends have the effect of reducing the stock price on the ex dividend
date. This has a negative effect on the value of call options and a positive affect
on the value of put options.
PRICING OPTIONS
The "lack choles formulas for the prices of !uropean )alls and puts on a non;
dividend paying stock areC
CALL OPTION:
C > SN
+<9X#
9"t
N,<
PUT OPTION:
P > X#
9"t
N:9D,<9SN :9D,<
C 1 VALUE OF CALL OPTION
S 1 SPOT PRICE OF STOCK
X 1 STRIKE PRICE
" 9 ANNUAL RISK FREE RETURN
t 1 CONTRACT CYCLE
D+ 1 :-%:$7'< ?:"? <7,< t<7
D, 1 D+9
O2t)o%$ T#"/)%o-o.0:
St")k# P")c#:
The price specified in the options contract is known as the trike price
or !xercise price.
O2t)o% P"#/)!/:
8ption premium is the price paid by the option buyer to the option
seller.
E'2)"(t)o% D(t#:
The date specified in the options contract is known as the expiration
date.
I%9T*#9Mo%#0 O2t)o%:
$n in the money option is an option that would lead to a positive cash
inflow to the holder if it is exercised immediately.
At9T*#9Mo%#0 O2t)o%:
$n at the money option is an option that would lead to /ero cash flow if
it is exercised immediately.
O!t9O9T*#9Mo%#0 O2t)o%:
$n out of the money option is an option that would lead to a negative
cash flow if it is exercised immediately.
I%t")%$)c V(-!# o (% O2t)o%:
The intrinsic value of an option is #T+, if option is #T+. #f the option is
8T+, its intrinsic value is P!@8.
T)/# V(-!# o (% O2t)o%:
The time value of an option is the difference between its premium and
its intrinsic value.
DESCRIPTION OF THE METHOD:
The following are the steps involved in the study.
+5 S#-#ct)o% o t*# $c")2:
The scrip selection is done on a random basis and the scrip selected is
@!&#$4)! )8++L4#)$T#84. The lot si/e of the scrip is :00.
Profitability position of the option holder and option writer is studied.
,5 D(t( co--#ct)o%:
The data of the @!&#$4)! )8++L4#)$T#84 has been collected
from the 0The !conomic Times1 and the internet. The data consists of the
+arch contract and the period of data collection is from D0
th
%ecember '00- to
D1
st
Ianuary '00-.
@5 A%(-0$)$:
The analysis consists of the tabulation of the data assessing the
profitability positions of the option holder and the option writer, representing
the data with graphs and making the interpretations using the data.
ANALYSIS
ANALYSIS
The objective of this analysis is to evaluate the profit.loss position of
option holder and option writer. This analysis is based on the sample data,
taken @!&#$4)! )8++L4#)$T#84 scrip. This analysis considered the
+arch ending contract of the "#. The lot si/e of "# is :00. The time period
in which this analysis is done is from D0.1'.'00J To D1.01.'00-
P")c# o SBI )% t*# C($* M("k#t5
DATE
'AR0ET
PRI/E
&'(Dec(
') *+,.-
&-(Dec(
') )-..*,
-(/an(
'+ *0,.*
1(/an(
'+ )'*..
&(/an(
'+ )-).-
.(/an(
'+ )-&..,
)(/an(
'+ )1*.*
+(/an(
'+ )1..',
0(/an(
'+ )1'.+,
-'(/an(
'+ ).1.-
--(/an(
'+ )&*.0
-.("an(
'+ )&..-
-,(/an(
'+ )&-.),
-*(/an(
'+ )1+
-)(/an(
'+ )1*.1
-+(/an(
'+
)1).+
1-(/an(
'+ )11.)
11(/an(
'+ *0&.1,
1&(/an(
'+ *,).)
1.(/an(
'+ **...
1+(2ar(
'+ **,.*
10(/an(
'+ *.-.)
&'(/an(
'+ **-.',
&-(/an(
'+ *,..+
The closing price of "# at the end of the contract period is B
.-0 and this is
considered as settlement price.
The following table explains the amount of transaction between option holder
and option writer.
? The first column explains the trading date.
? The second column explains the market price in cash segment on that date.
? The call column explains the call.put options which are considered. !very
call.put has three sub columns.
? The first column consists of the premium value per share of the contracts,
second column consists of the volume of the contract, and the third column
consists of total premium value paid by the buyer.
?
NET PAYOFF FOR CALL OPTION HOLDERS AND WRITERS
2A3456
73I85 8A99S
:;9<25
=>'''?
7352I<2
=>'''?
73;I6
6;
#;9D53
=>'''?
N56
73;I6 6;
#;9D53
=>'''?
N56
73;I6
6; @<A53
=>'''?
*,..+ *.' -00., &*&..-, 10,1.* (*+-.,, *+-.,,
*,..+ **' -.*& 1-*''.&, ' (1-*''.&, 1-*''.&,
*,..+ *+' 1''+ ,-+&-.,& ' (,-+&-.,1, ,-+&-.,1,
*,..+ )'' &10) +,*'&.., ' (+,*'&.., +,*'&..,
*,..+ )1' &)0*., ).++-.0& ' ().++-.01, ).++-.01,
*,..+ ).' 1&'0., &'1'+.. ' (&'1'+.. &'1'+..
OBSERVATIONS AND FINDINGS:
? ix call options are considered with six different strike prices.
? The current market price on the expiry date is @s.B.-0 and this is
considered as final settlement price.
? The premium paid by the option holders whose strike price is far and greater
than the current market price have paid high amounts of premium than those
who are near to the current market price.
? The call option holders whose strike price is less than the current market
price are said to be #n;The;+oney. The calls with strike price B(0 are said
to be #n;The;+oney, since, if they exercise they will get profits.
? The call option holders whose strike price is less than the current market
price are said to be 8ut;8f;The;+oney. The calls with strike price of BB0,
B-0,J00,J'0,J(0 are said to be 8ut;8f;The;+oney, since, if they exercise,
they will get losses.
FINDINGS:
The premium of the options with strike price of J00 and J'0 is high, since most
of the period of the contract the cash market is moving around J00 mark.
FINDINGS:
? The contracts with strike price BB0, B-0, J00, J'0, J(0 get no profit, since
their strike price is more than the settlement price.
? The contract with strike price B(0 gets the profit.
NET PAY OFF OF PUT OPTION HOLDERS AND WRITERS5
2A3456
73I85 7<6S
:;9<25
=>'''?
7352I<2
=>'''?
73;I6 6;
#;9D53
=>'''?
N56 73;I6
6; #;9D53
=>'''?
N56 73;I6
6; B3I653
=>'''?
*,..+ *'' 1, .).*1, ' (.).*1, .).*1,
*,..+ *.' &1&., 00&., ' (00&., 00&.,
*,..+ **' -1&0., 0,'*.,), *..,.. (&'*-.-), &'*-.-),
*,..+ *+' -&00., 1-+0. &,1*).. -&&)&.. (-&&)&..
*,..+ )'' -+,+ &'+)-.1+ +&0+-.* ,&--'.&1, (,&--'.&1,
*,..+ )1' -.*+., 1&)1).+& 0,).*.1 )1'-+.&), ()1'-+.&),
OBSERVATIONS AND FINDINGS:
? ix put options are considered with six different strike prices.
? The current market price on the expiry date is @s.B.-0 and this is
considered as the final settlement price.
? The premium paid by the option holders whose strike price is far and greater
than the current market price have paid high amount of premium than those
who are near to the current market price.
? The put option holders whose strike price is more than the current market
price are said to be #n;The;+oney. The puts with strike price
BB0,B-0,J00,J'0 are said to be #n;The;+oney, since, if they exercise they
will get profits.
? The put option holders whose strike price is less than the current market
price are said to be 8ut;8f;The;+oney. The puts with strike price of
B00,B(0 are said to be 8ut;8f;The;+oney, since, if they exercise their puts,
they will get losses.
FINDINGS:
? The premium of the option with strike price J00 is higher when compared to
other strike prices. This is because of the movement of the cash market
price of the "# between B(0 and J'0.
FINDINGS:
? The put option holders whose strike price is more than the settlement price
are #n;The;+oney.
? The put options whose strike price is less than the settlement price are 8ut;
8f;The;+oney.
DATA OF SBI THE FUTURES OF THE JANUARY MONTH
DA65
<6<35S 89;SINC 73I85
=3s.?
8AS# 89;SINC 73I85
=3s.?
&'(Dec(
') *+0.* *+,.-
&-(Dec(
') )1'.*, )-..*,
-(/an(
'+ )''.*, *0,.*
1(/an(
'+ )-'.0 )'*..
&(/an(
'+ )1'.+, )-).-
.(/an(
'+ )-*.+, )-&..,
)(/an(
'+ )10.1 )1*.*
+(/an(
'+ )1+.1, )1..',
0(/an(
'+ )1&.&, )1'.+,
-'(/an(
'+ ).,.& ).1.-
--(/an(
'+ ).-.&, )&*.0
-.(/an(
'+ )&+.0, )&..-
-,(/an(
'+ )&,.) )&-.),
-*(/an(
'+ )&&.-, )1+
-)(/an(
'+ )&'.), )1*.1
-+(/an(
'+ )&1.& )1).+
1-(/an(
'+ )1,.1, )11.)
11(/an(
'+ *0, *0&.1,
1&(/an(
'+ **'.- *,).)
1.(/an(
'+ ***.) **...
1+(/an(
'+ **).), **,.*
10(/an(
'+ *.1.) *.-.)
&'(/an(
'+ **1.', **-.',
&-(/an(
'+ *,,.0, *,..+
OBSERVATIONS AND FINDINGS:
The cash market price of the "# is moving along with the futures price.
? #f the buy price of the futures is less than the settlement price, then the buyer
of the futures get profit.
? #f the selling price of the futures is less than the settlement price, then the
seller incur losses.
SUMMARY,
CONCLUSIONS
AND
RECOMMENDATINONS
SUMMARY
? %erivatives market is an innovation to cash market. $pproximately its daily
turnover reaches to the e>ual stage of cash market.
? Presently the available scrips in futures are -, and in options segment are
B'.
? #n cash market the profit.loss of the investor depends on the market price of
the underlying asset. The investor may incur huge profits or he may incur
huge losses. "ut in derivatives segment the investor enjoys huge profits
with limited downside.
? #n cash market the investor has to pay the total money, but in derivatives the
investor has to pay premiums or margins, which are some percentage of
total money.
? %erivatives are mostly used for hedging purpose.
? #n derivative segment the profit.loss of the option holder.option writer is
purely depended on the fluctuations of the underlying asset.
CONCLUSIONS
? #n bullish market the call option writer incurs more losses so the investor is
suggested to go for a call option to hold, where as the put option holder
suffers in a bullish market, so he is suggested to write a put option.
? #n bearish market the call option holder will incur more losses so the
investor is suggested to go for a call option to write, where as the put option
writer will get more losses, so he is suggested to hold a put option.
? #n the above analysis the market price of tate "ank of #ndia is having low
volatility, so the call option writers enjoy more profits to holders.
RECOMMENDATIONS
? The derivative market is newly started in #ndia and it is not known by every
investor, so !"# has to take steps to create awareness among the investors
about the derivative segment.
? #n order to increase the derivatives market in #ndia, !"# should revise
some of their regulations like contract si/e, participation of 9## in the
derivatives market.
? )ontract si/e should be minimi/ed because small investors cannot afford
this much of huge premiums.
? !"# has to take further steps in the risk management mechanism.
? !"# has to take measures to use effectively the derivatives segment as a
tool of hedging.
BIBLIOGRAPHY
BIBLIOGRAPHY
BOOKS:
FUTURES AND OPTIONS 9 N5D5VOHRAA B5R5BAGRI
DERIVATIVES CORE MODULE
WORKBOOK 9 NCFM MATERIAL
FUTURES AND OPTIONS 9 R5MAHAJAN
WEBSITES:
BBB5%$#)%&)(5co/
BBB5#3!)t0/($t#"5co/
BBB52#%)%$!-("o%-)%#5co/
NEWS EDITIONS:
THE ECONOMIC TIMES
BUSINESS LINE
doc_866901588.doc
The study is limited to “Derivatives” with special reference to futures and options in the Indian context and the Hyderabad stock exchange has been taken as a representative sample for the study. The study can’t be said as totally perfect. Any alteration may come. The study has only made a humble attempt at evaluating derivatives market only in Indian context. The study is not based on the international perspective of derivatives markets, which exists in NASDAQ, NYSE etc.
A STUDY ON FUTURES AND POTIONS
Project submitted in partial fulfillment for the award of the
degree of
MASTER OF BUSINESS ADMINISTRATION
DECLARATION
I hereby declare that this Project Report titled, “A STUDY ON THE
DERIATIES! s"b#itted by #e to the Depart#e$t O% &USINESS
AD'INISTRATION, (((( a$d is a bo$a)ide *or+ "$der ta+e$ by #e
a$d it is $ot s"b#itted to a$y other U$i,ersity or I$stit"tio$ )or the
a*ard o) a$y de-ree diplo#a . certi)icate or p"blished a$y ti#e
be)ore.
Name and Address of the Student Signature of the student
Date :
A/0NO12ED3E'ENT
I wish to express my sincere deep sense of gratitude and also thank my
guide XXX, aculty of inance for his significant suggestions and help in
e!ery aspect to accomplish the pro"ect work. #is persisting
encouragement, e!erlasting patience and keen interest in discussions
ha!e $enefited me to the extent that cannot $e spanned $y words.
I take my pleasure to acknowledge XXXX for the facilities pro!ided and
constant encouragement.
inally I express $ows to e!eryone who are in!ol!ed with this pro"ect.
CONTENTS
INTRODUCTION
METHODOLOGY
? FUTURES
? OPTIONS
ANALYSIS OF THE STUDY
SUMMARY AND CONCLUSIONS
BIBLIOGRAPHY
INTRODUCTION
NATURE OF THE PROBLEM:
The turnover of the stock exchanges has been tremendously
increasing from last 10 years. The number of trades and the number of
investors, who are participating, have increased. The investors are willing to
reduce their risk, so they are seeking for the risk management tools.
Prior to !"# abolishing the "$%&$ system, the investors had
this system as a source of reducing the risk, as it has many problems like no
strong margining system, unclear expiration date and generating counter party
risk. #n view of this problem !"# abolished the "$%&$ system.
$fter the abolition of the "$%&$ system, the investors are
seeking for a hedging system, which could reduce their portfolio risk. !"#
thought the introduction of the derivatives trading, as a first step it has set up a
'( member committee under the chairmanship of %r.&.).*upta to develop the
appropriate regulatory framework for derivative trading in #ndia, !"# accepted
the recommendations of the committee on +ay 11, 1,,- and approved the
phased introduction of the derivatives trading beginning with stock index
futures.
There are many investors who are willing to trade in the
derivative segment, because of its advantages like limited loss and unlimited
profit by paying the small premiums.
IMPORTANCE OF THE STUDY:
To evaluate the profit.loss position of option holder and option writer.
OBJECTIVES OF THE STUDY:
? To analy/e the derivatives market in #ndia.
? To analy/e the operations of futures and options.
? To find out the profit.loss position of the option writer and option holder.
? To study about risk management with the help of derivatives.
SCOPE OF THE STUDY:
The study is limited to 0%erivatives1 with special reference to futures
and options in the #ndian context and the 2yderabad stock exchange has been
taken as a representative sample for the study. The study can3t be said as totally
perfect. $ny alteration may come. The study has only made a humble attempt
at evaluating derivatives market only in #ndian context. The study is not based
on the international perspective of derivatives markets, which exists in
4$%$5, 46! etc.
LIMITATIONS OF THE STUDY:
The following are the limitations of this study.
? The scrip chosen for analysis is T$T! "$47 89 #4%#$ and the contract
taken is +arch '00: ending one;month contract.
? The data collected is completely restricted to the T$T! "$47 89 #4%#$
of +arch '00:< hence this analysis cannot be taken as universal.
METHODOLOGY
The emergence of the market for derivative products, most
notably forwards, futures and options, can be traced back to the willingness of
risk;averse economic agents to guard themselves against uncertainties arising
out of fluctuations in asset prices. "y their very nature, the financial markets are
marked by a very high degree of volatility. Through the use of derivative
products, it is possible to partially or fully transfer price risks by locking=in
asset prices. $s instruments of risk management, these generally do not
influence the fluctuations in the underlying asset prices. 2owever, by locking;in
asset prices, derivative products minimi/e the impact of fluctuations in asset
prices on the profitability and cash flow situation of risk;averse investors.
%erivatives are risk management instruments, which derive their
value from an underlying asset. The underlying asset can be bullion, index,
share, bonds, currency, interest etc. "anks, securities firms, companies and
investors to hedge risks, to gain access to cheaper money and to make profit,
use derivatives. %erivatives are likely to grow even at a faster rate in future.
DEFINITION:
%erivative is a product whose value is derived from the value of
an underlying asset in a contractual manner. The underlying asset can be e>uity,
forex, commodity or any other asset.
ecurities )ontracts ?@egulationA $ct, 1,:B ?)?@A $A defines 0derivative1 to
include =
1. $ security derived from a debt instrument, share, loan whether
secured or unsecured, risk instrument or contract for differences or any other
form of security.
'. $ contract which derives its value from the prices, or index of prices,
of underlying securities.
PARTICIPANTS:
The following three broad categories of participants in the derivatives market.
HEDGERS:
2edgers face risk associated with the price of an asset. They use futures
or options markets to reduce or eliminate this risk.
SPECULATORS:
peculators wish to bet on future movements in the price of an asset.
9utures and options contracts can give them an extra leverage< that is, they can
increase both the potential gains and potential losses in a speculative venture.
ARBITRAGEURS:
$rbitrageurs are in business to take advantage of a discrepancy between
prices in two different markets. #f, 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.
FUNCTIONS OF DERIVATIVES MARKET:
The following are the various functions that are performed by the derivatives
markets. They areC
? Prices in an organi/ed derivatives market reflect the perception of market
participants about the future and lead the prices of underlying to the perceived
future level.
? %erivatives market helps to transfer risks from those who have them but may
not like them to those who have an appetite for them.
? %erivative trading acts as a catalyst for new entrepreneurial activity.
? %erivatives markets help increase savings and investment in the long run.
TYPES OF DERIVATIVES:
The following are the various types of derivatives. They areC
FORWARDS:
$ forward contract is a customi/ed contract between two entities, where
settlement takes place on a specific date in the future at today3s pre;agreed
price.
FUTURESC
$ 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.
OPTIONSC
8ptions are of two types ; calls and puts. )alls give the buyer the right
but not the obligation to buy a given >uantity of the underlying asset, 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 >uantity of the underlying asset at a given price on or
before a given date.
WARRANTSC
8ptions generally have lives of upto one year< the majority of options
traded on options exchanges having a maximum maturity of nine months.
&onger;dated options are called warrants and are generally traded over;the;
counter.
LEAPSC
The acronym &!$P means &ong;Term !>uity $nticipation ecurities.
These are options having a maturity of upto three years.
BASKETSC
"asket options are options on portfolios of underlying assets. The
underlying asset is usually a moving average of a basket of assets. !>uity index
options are a form of basket options.
SWAPSC
waps are private agreements between two parties to exchange cash
flows in the future according to a prearranged formula. They can be regarded as
portfolios of forward contracts. The two commonly used swaps areC
#nterest rate swapsC
These entail swapping only the interest related cash flows between the
parties in the same currency.
% )urrency swapsC
These entail swapping both principal and interest between the parties,
with the cash flows in one direction being in a different currency than those in
the opposite %irection.
SWAPTIONS:
waptions are options to buy or sell a swap that will become operative at
the expiry of the options. Thus a swaption is an option on a forward swap.
RATIONALE BEHIND THE DEVELOPMENT OF
DERIVATIVES:
2olding portfolio of securities is associated with the risk of the
possibility that the investor may reali/e his returns, which would be much lesser
than what he expected to get. There are various factors, which affect the
returnsC
1. Price or dividend ?interestA.
'. ome are internal to the firm like =
? #ndustrial policy
? +anagement capabilities
? )onsumer3s preference
? &abor strike, etc.
These forces are to a large extent controllable and are termed as non
ystematic risks. $n investor can easily manage such non;systematic by having
a well = diversified portfolio spread across the companies, industries and groups
so that a loss in one may easily be compensated with a gain in other.
There are yet other types of influences which are external to the firm,
cannot be controlled and affect large number of securities. They are termed as
systematic risk. They areC
1. !conomic
'. Political
D. ociological changes are sources of systematic risk.
9or instance, inflation, interest rate, etc. their effect is to cause prices of
nearly all individual stocks to move together in the same manner. Ee therefore
>uite often find stock prices falling from time to time in spite of company3s
earnings rising and vice versa.
@ationale behind the development of derivatives market is to manage
this systematic risk, li>uidity and li>uidity in the sense of being able to buy and
sell relatively large amounts >uickly without substantial price concessions.
#n debt market, a large position of the total risk of securities is
systematic. %ebt instruments are also finite life securities with limited
marketability due to their small si/e relative to many common stocks. Those
factors favour for the purpose of both portfolio hedging and speculation, the
introduction of a derivative security that is on some broader market rather than
an individual security.
#ndia has vibrant securities market with strong retail participation that
has rolled over the years. #t was until recently basically cash market with a
facility to carry forward positions in actively traded F$3 group scrips from one
settlement to another by paying the re>uired margins and borrowing some
money and securities in a separate carry forward session held for this purpose.
2owever, a need was felt to introduce financial products like in other financial
markets world over which are characteri/ed with high degree of derivative
products in #ndia.
%erivative products allow the user to transfer this price risk by looking
in the asset price there by minimi/ing the impact of fluctuations in the asset
price on his balance sheet and have assured cash flows.
%erivatives are risk management instruments, which derive their value
from an underlying asset. The underlying asset can be bullion, index, shares,
bonds, currency etc.
DERIVATIVE SEGMENT AT NATIONAL STOCK
EXCHANGE:
The derivatives segment on the exchange commenced with GP )4H
4ifty #ndex futures on Iune 1', '000J.The 9G8 segment of 4! provides
trading facilities for the following derivative segmentC
1. #ndex "ased 9utures
'. #ndex "ased 8ptions
D. #ndividual tock 8ptions
(. #ndividual tock 9utures
COMPANY NAME
CODE LOT SIZE
$"" &td. $"" '00
$ssociated )ement )o. &td. $)) J:0
$llahabad "ank $&"7 '
0$ndhra "ank $4%2@$"$47 'D00
$rvind +ills &td. $@K#4%+#&& '1:0
$shok &eyland &td $287&!6 ,::0
"ajaj $uto &td. "$I$I$LT8 '00
"ank of "aroda "$47"$@8%$ 1(00
"ank of #ndia "$47#4%#$ 1,00
"harat !lectronics &td. "!& ::0
"harat 9orge )o &td "2$@$T98@* '00
"harti Tele;Kentures &td "2$@T# 1000
"harat 2eavy !lectricals &td. "2!& D00
"harat Petroleum )orporation &td. "P)& ::0
)adila 2ealthcare &imited )$%#&$2) :00
)anara "ank )$4"7 1B00
)entury Textiles &td )!4TL@6T!H -:0
)hennai Petroleum )orp &td. )2!44P!T@8 ,:0
)ipla &td. )#P&$ 1000
7ochi @efineries &td
)8)2#4@!94 1D00
)olgate Palmolive ?#A &td. )8&*$T! 10:0
%abur #ndia &td. %$"L@ 1-00
*$#& ?#ndiaA &td. *$#& 1:00
*reat !astern hipping )o. &td. *!2#PP#4* 1D:0
*laxosmithkline Pharma &td. *&$H8 D00
*rasim #ndustries &td. *@$#+ 1J:
*ujarat $mbuja )ement &td. *LI$+")!+ ::0
2)& Technologies &td. 2)&T!)2 B:0
2ousing %evelopment 9inance
)orporation &td.
2%9) D00
2%9) "ank &td. 2%9)"$47 (00
2ero 2onda +otors &td. 2!@8284%$ (00
2indalco #ndustries &td. 2#4%$&)0 1:0
2industan &ever &td. 2#4%&!K!@ '000
2industan Petroleum )orporation &td. 2#4%P!T@8 B:0
#)#)# "ank &td. #)#)#"$47 J00
#ndustrial development bank of #ndia
&td.
#%"# '(00
#ndian 2otels )o. &td. #4%28T!& D:0
#ndian @ayon $nd #ndustries &td #4%@$684 :00
#nfosys Technologies &td. #4986T)2 100
#ndian 8verseas "ank #8" ',:0
#ndian 8il )orporation &td. #8) B00
#T) &td. #T) 1:0
Iet $irways ?#ndiaA &td. I!T$#@E$6 '00
Iindal teel G Power &td I#4%$&T!& ':0
Iaiprakash 2ydro;Power &td. IP26%@8 B':0
)ummins #ndia &td 7#@&87)L+ 1,00
&#) 2ousing 9inance &td &#)2*9#4 -:0
+ahindra G +ahindra &td. +G+ B':
+atrix &aboratories &td. +$T@#H&$" 1':0
+angalore @efinery and
Petrochemicals &td.
+@P& (
0+ahanagar Telephone 4igam &td. +T4& 1B00
4ational $luminium )o. &td. 4$T#84$&L+ 11:0
4eyveli &ignite )orporation &td. 4!6K!&#&#* ',:0
4icolas Piramal #ndia &td 4#)8&$P#@ ,:0
4ational Thermal Power )orporation
&td.
4TP) D':0
8il G 4atural *as )orp. &td. 84*) D00
8riental "ank of )ommerce 8@#!4T"$47 B00
Patni )omputer ystem &td P$T4# B:0
Punjab 4ational "ank P4" B00
@anbaxy &aboratories &td. @$4"$H6 '00
@eliance !nergy &td. @!& ::0
@eliance )apital &td @!&)$P#T$& 1100
@eliance #ndustries &td. @!&#$4)! B00
atyam )omputer ervices &td. $T6$+)8+P B00
tate "ank of #ndia "#4 :00
hipping )orporation of #ndia &td. )# 1B00
iemens &td #!+!4 1:0
terlite #ndustries ?#A &td T!@ D:0
un Pharmaceuticals #ndia &td. L4P2$@+$
0yndicate "ank 64%#"$47 D-00
Tata )hemicals &td T$T$)2!+ 1D:0
Tata )onsultancy ervices &td T) ':0
Tata Power )o. &td. T$T$P8E!@ -00
Tata Tea &td. T$T$T!$ ::0
Tata +otors &td. T$T$+8T8@ -':
Tata #ron and teel )o. &td. T#)8 BJ:
Lnion "ank of #ndia L4#84"$47 '100
LT# "ank &td. LT#"$47 ,00
Kijaya "ank K#I$6$"$47 D
0Kidesh anchar 4igam &td K4& 10:0
Eipro &td. E#P@8 D00
Eockhardt &td. E8)7P2$@+$ B00
REGULATORY FRAMEWORK:
The trading of derivatives is governed by the provisions contained in the
) ? @ A $, the !"# $ct, the and the regulations framed there under the rules
and byelaws of stock exchanges.
@egulation for %erivative TradingC
!"# set up a '( member committed under )hairmanship of
%r.&.).*upta develop the appropriate regulatory framework for derivative
trading in #ndia. The committee submitted its report in +arch 1,,-. 8n +ay
11, 1,,- !"# accepted the recommendations of the committee and approved
the phased introduction of %erivatives trading in #ndia beginning with tock
#ndex 9utures. !"# also approved he 0uggestive bye;laws1 recommended by
the committee for regulation and control of trading and settlement of
%erivatives contracts.
The provisions in the ) ?@A $ govern the trading in the securities. The
amendment of the ) ?@A $ to include 0%!@#K$T#K!1 within the ambit of
Fecurities3 in the ) ?@ A $ made trading in %erivatives possible within the
framework of the $ct.
1. $ny exchange fulfilling the eligibility criteria as prescribed in the &.).
*upta committee report may apply to !"# for grant of recognition
under ection ( of the ) ?@A $, 1,:B to start %erivatives Trading. The
derivatives exchange.segment should have a separate governing council
and representation of trading . clearing members shall be limited to
maximum of (0M of the total members of the governing council. The
exchange shall regulate the sales practices of its members and will
obtain approval of !"# before start of Trading in any derivative
contract.
'. The exchange shall have minimum :0 members.
D. The members of an existing segment of the exchange will not
automatically become the members of the derivative segment. The
members of the derivative segment need to fulfill the eligibility
conditions as lay down by the &.).*upta )ommittee.
(. The clearing and settlement of derivates trades shall be through a !"#
approved )learing )orporation . )learing house. )learing )orporation .
)learing 2ouse complying with the eligibility conditions as lay down
"y the committee have to apply to !"# for grant of approval.
:. %erivatives broker.dealers and )learing members are re>uired to seek
registration from !"#.
B. The +inimum contract value shall not be less than @s.' &akh.
!xchanges should also submit details of the futures contract they
purpose to introduce.
J. The trading members are re>uired to have >ualified approved user and
sales person who have passed a certification programme approved by
!"#.
FUTURES
%!9#4#T#84C
$ 9utures contract is an agreement between two parties to buy or sell an
asset at a certain time in the future at a certain price. To facilitate li>uidity in
the futures contract, the exchange specifies certain standard features of the
contract. The standardi/ed items on a futures contract areC
? 5uantity of the underlying
? 5uality of the underlying
? The date and the month of delivery
? The units of price >uotations and minimum price change
? &ocations of settlement
TYPES OF FUTURES:
8n the basis of the underlying asset they derive, the futures are divided
into two typesC
? Stock !t!"#$:
The stock futures are the futures that have the underlying asset as the
individual securities. The settlement of the stock futures is of cash settlement
and the settlement price of the future is the closing price of the underlying
security.
? I%&#' !t!"#$:
#ndex futures are the futures, which have the underlying asset as an
#ndex. The #ndex futures are also cash settled. The settlement price of the
#ndex futures shall be the closing value of the underlying index on the expiry
date of the contract.
P("t)#$ )% t*# F!t!"#$ Co%t"(ct:
There are two parties in a future contract, the "uyer and the eller. The
buyer of the futures contract is one who is LONG on the futures contract and
the seller of the futures contract is one who is SHORT on the futures contract.
The pay off for the buyer and the seller of the futures contract are as follows.
PAYOFF FOR A BUYER OF FUTURES:
CASE +:
The buyer bought the future contract at ?9A< if the futures price goes to
!1 then the buyer gets the profit of ?9PA.
CASE ,:
The buyer gets loss when the future price goes less than ?9A, if the
futures price goes to !' then the buyer gets the loss of ?9&A.
PAYOFF FOR A SELLER OF FUTURES:
9 = 9LTL@! P@#)!
!1, !' = !TT&!+!4T P@#)!.
CASE +:
The eller sold the future contract at ?fA< if the futures price goes to !1
then the eller gets the profit of ?9PA.
CASE ,:
The eller gets loss when the future price goes greater than ?9A, if the
futures price goes to !' then the eller gets the loss of ?9&A.
MARGINS:
+argins are the deposits, which reduce counter party risk, arise in a
futures contract. These margins are collected in order to eliminate the counter
party risk. There are three types of marginsC
I%)t)(- M(".)%:
Ehenever a futures contract is signed, both buyer and seller are re>uired
to post initial margin. "oth buyer and seller are re>uired to make security
deposits that are intended to guarantee that they will infact be able to fulfill their
obligation. These deposits are #nitial margins and they are often referred as
performance margins. The amount of margin is roughly :M to 1:M of total
purchase price of futures contract.
M("k)%. to M("k#t M(".)%:
The process of adjusting the e>uity in an investor3s account in order to
reflect the change in the settlement price of futures contract is known as +T+
+argin.
M()%t#%(%c# /(".)%:
The investor must keep the futures account e>uity e>ual to or greater
than certain percentage of the amount deposited as #nitial +argin. #f the e>uity
goes less than that percentage of #nitial margin, then the investor receives a call
for an additional deposit of cash known as +aintenance +argin to bring the
e>uity up to the #nitial margin.
Ro-# o M(".)%$:
The role of margins in the futures contract is explained in the following
example.
sold a atyam 9ebruary futures contract to " at @s.D00< the following
table shows the effect of margins on the contract. The contract si/e of atyam
is 1'00. The initial margin amount is say @s.'0000, the maintenance margin is
B:M of #nitial margin.
%$6 P@#)! 89 $T6$+ !99!)T 84
"L6!@ ?"A
!99!)T 84
!&&!@ ?A
@!+$@7
1 D00.00
+T+
P.&
"al.in +argin
+T+
P.&
"al.in +argin
)ontract is
entered and
initial margin
is deposited.
'
D
(
D11?price increasedA
'-J
D0:
N1D,'00
;'-,-00
N1:,(00
N'1,B00
;1D,'00
N1D,'00
N'-,-00
;'1,B00
" got profit
and got
loss,
deposited
maintenance
margin.
" got loss and
deposited
maintenance
margin.
" got profit,
got loss.
)ontract
settled at D0:,
totally " got
profit and
got loss.
P")c)%. t*# F!t!"#$:
The fair value of the futures contract is derived from a model known as
the )ost of )arry model. This model gives the fair value of the futures contract.
Co$t o C(""0 Mo&#-:
9O ?1Nr;>A
t
Ehere
F 1 F!t!"#$ P")c#
S 1 S2ot 2")c# o t*# U%&#"-0)%.
" 1 Co$t o F)%(%c)%.
3 1 E'2#ct#& D)4)&#%& Y)#-&
T 1 Ho-&)%. P#")o&5
FUTURES TERMINOLOGY:
S2ot 2")c#:
The price at which an asset trades in the spot market.
F!t!"#$ 2")c#:
The price at which the futures contract trades in the futures market.
Co%t"(ct c0c-#:
The period over which a contract trades. The index futures contracts on
the 4! have one;month, two;months and three;month expiry cycles which
expire on the last Thursday of the month. Thus a Ianuary expiration contract
expires on the last Thursday of Ianuary and a 9ebruary expiration contract
ceases trading on the last Thursday of 9ebruary. 8n the 9riday following the last
Thursday, a new contract having a three;month expiry is introduced for trading.
E'2)"0 &(t#:
#t 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.
Co%t"(ct $)6#:
The amount of asset that has to be delivered under one contract. 9or
instance, the contract si/e on 4!3s futures market is '00 4ifties.
B($)$:
#n the context of financial futures, basis can be defined as the futures
price minus the spot price. There will be a different basis for each delivery
month for each contract. #n a normal market, basis will be positive. This
reflects that futures prices normally exceed spot prices.
Co$t o c(""0:
The relationship between futures prices and spot prices can be
summari/ed 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.
O2#% I%t#"#$t:
Total outstanding long or short positions in the market at any specific
time. $s total long positions for market would be e>ual to short positions, for
calculation of open interest, only one side of the contract is counted.
OPTIONS
%!9#4#T#84C
8ption is a type of contract between two persons where one grants the
other the right to buy a specific asset at a specific price within a specified time
period. $lternatively the contract may grant the other person the right to sell a
specific asset at a specific price within a specific time period. #n order to have
this right, the option buyer has to pay the seller of the option premium.
The assets on which options can be derived are stocks, commodities,
indexes etc. #f the underlying asset is the financial asset, then the options are
financial options like stock options, currency options, index options etc, and if
the underlying asset is the non;financial asset the options are non;financial
options like commodity options.
PROPERTIES OF OPTIONS:
8ptions have several uni>ue properties that set them apart from other
securities. The following are the properties of optionsC
? &imited &oss
? 2igh &everage Potential
? &imited &ife
PARTIES IN AN OPTION CONTRACT:
+5 B!0#" o t*# O2t)o%:
The buyer of an option is one who by paying option premium
buys the right but not the obligation to exercise his option on
seller.writer.
,5 W")t#"7S#--#" o t*# O2t)o%:
The writer of a call.put options is the one who receives the
option premium and is there by obligated to sell.buy the asset if the
buyer exercises the option on him.
.
TYPES OF OPTIONS:
The options are classified into various types on the basis of various
variables. The following are the various types of optionsC
#A O% t*# 8($)$ o t*# U%&#"-0)%. ($$#t:
8n the basis of the underlying asset the options are divided into two typesC
? INDEX OPTIONS:
The #ndex options have the underlying asset as the index.
? STOCK OPTIONS:
$ stock option gives the buyer of the option the right to buy.sell stock at
a specified price. tock options are options on the individual stocks, there
are currently more than :0 stocks are trading in this segment.
II5 O% t*# 8($)$ o t*# /("k#t /o4#/#%t:
8n the basis of the market movement the options are divided into two
types. They areC
? CALL OPTION:
$ call options is bought by an investor when he seems that the stock
price moves upwards. $ call option gives the holder of the option the right
but not the obligation to buy an asset by a certain date for a certain price.
? PUT OPTION:
$ put option is bought by an investor when he seems that the stock price
moves downwards. $ put option gives the holder of the option right but not
the obligation to sell an asset by a certain date for a certain price.
III5 O% t*# 8($)$ o #'#"c)$# o O2t)o%:
8n the basis of the exercising of the option, the options are classified
into two categories.
? AMERICAN OPTION:
$merican options are options that can be exercised at any time up to the
expiration date, most exchange;traded options are $merican.
? EUROPEAN OPTION:
!uropean options are options that can be exercised only on the
expiration date itself. !uropean options are easier to analy/e than $merican
options.
PAY9OFF PROFILE FOR BUYER OF A CALL OPTION:
The pay;off of a buyer options depends on the spot price of the
underlying asset. The following graph shows the pay;off of buyer of a call
optionC
S
9
St")k#
2")c#
OTM 9
O!t o t*#
Mo%#0
SP 9 P"#/)!/7Lo$$ ATM 9 At t*# Mo%#0
E+ 9 S2ot 2")c# + ITM 9 I% T*# Mo%#0
E, 9 S2ot 2")c# ,
SR 9 2"o)t (t $2ot 2")c# E+
CASE +: :S2ot 2")c# ; St")k# P")c#<
$s the spot price ?!1A of the underlying asset is more than strike price
?A. The buyer gets the profit of ?@A, if price increases more than !1 than
profit also increase more than @.
CASE ,: :S2o"t 2")c# = St")k# P")c#<
$s the spot price ?!'A of the underlying asset is less than strike price ?sA.
The buyer gets loss of ?PA, if price goes down less than !' than also his loss is
limited to his premium ?PA.
PAY 1 OFF PROFILE FOR SELLER OF A CALL OPTION:
The pay;off of seller of the call option depends on the spot price of the
underlying asset. The following graph shows the pay;off of seller of a call
optionC
S 9 St")k# 2")c# ITM 9 I% t*# Mo%#0
SP 9 P"#/)!/72"o)t ATM 9 At t*# Mo%#0
E+ 9 S2ot 2")c# + OTM 9 O!t o T*# Mo%#0
E, 9 S2ot 2")c# ,
SR 9 2"o)t (t $2ot 2")c# E+
CASE +: :S2ot 2")c# = St")k# 2")c#<
$s the spot price ?!1A of the underlying asset is less than strike price ?A.
The seller gets the profit of ?PA, if the price decreases less than !1 than also
profit of the seller does not exceed ?PA.
CASE ,: :S2ot 2")c# ; St")k# 2")c#<
$s the spot price ?!'A of the underlying asset is more than strike price
?A. The seller gets loss of ?@A, if price goes more less than !' than the loss of
the seller also increase more than ?@A.
PAY9OFF PROFILE FOR BUYER OF A PUT OPTION:
The payoff of buyer of the option depends on the spot price of the
underlying asset. The following graph shows the pay off of the buyer of a call
optionC
S 9 St")k# 2")c# ITM 9 I% T*# Mo%#0
SP 9 P"#/)!/72"o)t OTM 9 O!t o T*# Mo%#0
E+ 9 S2ot 2")c# + ATM 9 At T*# Mo%#0
E, 9 S2ot 2")c# ,
SR 9 2"o)t (t $2ot 2")c# E+
CASE +: :S2ot 2")c# = St")k# 2")c#<
$s the spot price ?!1A of the underlying asset is less than strike price ?A.
The buyer gets the profit of ?@A, if price decreases less than !1 than the profit
also increases more than ?@A.
CASE ,: :S2ot 2")c# ; St")k# 2")c#<
$s the spot price ?!'A of the underlying asset is more than strike price
?sA, the buyer gets loss of ?PA, if price goes more than !' than the loss of the
buyer is limited to his premium ?PA.
PAY9OFF PROFILE FOR SELLER OF A PUT OPTION:
The pay off of seller of the option depends on the spot price of the
underlying asset. The following graph shows the pay;off of seller of a put
optionC
S 9 St")k# 2")c# ITM 9 I% T*# Mo%#0
SP 9 P"#/)!/72"o)t ATM 9 At T*# Mo%#0
E+ 9 S2ot 2")c# + OTM 9 O!t o T*# Mo%#0
E, 9 S2ot 2")c# ,
SR 9 2"o)t (t $2ot 2")c# E+
CASE +: :S2ot 2")c# = St")k# 2")c#<
$s the spot price ?!1A of the underlying asset is less than strike price ?A,
the seller gets the loss of ?@A, if price decreases less than !1 than the loss also
increases more than ?@A.
CASE ,: :S2ot 2")c# ; St")k# 2")c#<
$s the spot price ?!'A of the underlying asset is more than strike price
?A, the seller gets profit of ?PA, if price goes more than !' than the profit of
the seller is limited to his premium ?PA.
FACTORS AFFECTING THE PRICE OF AN OPTION:
The following are the various factors that affect the price of an option.
They areC
Stock 2")c#:
The pay;off from a call option is the amount by which the stock price
exceeds the strike price. )all options therefore become more valuable as the
stock price increases and vice versa. The pay;off from a put option is the
amount< by which the strike price exceeds the stock price. Put options therefore
become more valuable as the stock price increases and vice versa.
St")k# 2")c#:
#n the case of a call, as the strike price increases, the stock price has to
make a larger upward move for the option to go in;the =money. Therefore, for a
call, as the strike price increases, options become less valuable and as strike
price decreases, options become more valuable.
T)/# to #'2)"(t)o%:
"oth Put and )all $merican options become more valuable as the time
to expiration increases.
Vo-(t)-)t0:
The volatility of n a stock price is a measure of uncertain about future
stock price movements. $s volatility increases, the chance that the stock will do
very well or very poor increases. The value of both )alls and Puts therefore
increase as volatility increase.
R)$k9"## )%t#"#$t "(t#:
The put option prices decline as the risk = free rate increases where as
the prices of calls always increase as the risk = free interest rate increases.
D)4)&#%&$:
%ividends have the effect of reducing the stock price on the ex dividend
date. This has a negative effect on the value of call options and a positive affect
on the value of put options.
PRICING OPTIONS
The "lack choles formulas for the prices of !uropean )alls and puts on a non;
dividend paying stock areC
CALL OPTION:
C > SN
+<9X#9"t
N
,<PUT OPTION:
P > X#
9"t
N:9D,<9SN :9D,<
C 1 VALUE OF CALL OPTION
S 1 SPOT PRICE OF STOCK
X 1 STRIKE PRICE
" 9 ANNUAL RISK FREE RETURN
t 1 CONTRACT CYCLE
D+ 1 :-%:$7'< ?:"? <7,< t<7
D, 1 D+9
O2t)o%$ T#"/)%o-o.0:
St")k# P")c#:
The price specified in the options contract is known as the trike price
or !xercise price.
O2t)o% P"#/)!/:
8ption premium is the price paid by the option buyer to the option
seller.
E'2)"(t)o% D(t#:
The date specified in the options contract is known as the expiration
date.
I%9T*#9Mo%#0 O2t)o%:
$n in the money option is an option that would lead to a positive cash
inflow to the holder if it is exercised immediately.
At9T*#9Mo%#0 O2t)o%:
$n at the money option is an option that would lead to /ero cash flow if
it is exercised immediately.
O!t9O9T*#9Mo%#0 O2t)o%:
$n out of the money option is an option that would lead to a negative
cash flow if it is exercised immediately.
I%t")%$)c V(-!# o (% O2t)o%:
The intrinsic value of an option is #T+, if option is #T+. #f the option is
8T+, its intrinsic value is P!@8.
T)/# V(-!# o (% O2t)o%:
The time value of an option is the difference between its premium and
its intrinsic value.
DESCRIPTION OF THE METHOD:
The following are the steps involved in the study.
+5 S#-#ct)o% o t*# $c")2:
The scrip selection is done on a random basis and the scrip selected is
@!&#$4)! )8++L4#)$T#84. The lot si/e of the scrip is :00.
Profitability position of the option holder and option writer is studied.
,5 D(t( co--#ct)o%:
The data of the @!&#$4)! )8++L4#)$T#84 has been collected
from the 0The !conomic Times1 and the internet. The data consists of the
+arch contract and the period of data collection is from D0
th
%ecember '00- to
D1
st
Ianuary '00-.
@5 A%(-0$)$:
The analysis consists of the tabulation of the data assessing the
profitability positions of the option holder and the option writer, representing
the data with graphs and making the interpretations using the data.
ANALYSIS
ANALYSIS
The objective of this analysis is to evaluate the profit.loss position of
option holder and option writer. This analysis is based on the sample data,
taken @!&#$4)! )8++L4#)$T#84 scrip. This analysis considered the
+arch ending contract of the "#. The lot si/e of "# is :00. The time period
in which this analysis is done is from D0.1'.'00J To D1.01.'00-
P")c# o SBI )% t*# C($* M("k#t5
DATE
'AR0ET
PRI/E
&'(Dec(
') *+,.-
&-(Dec(
') )-..*,
-(/an(
'+ *0,.*
1(/an(
'+ )'*..
&(/an(
'+ )-).-
.(/an(
'+ )-&..,
)(/an(
'+ )1*.*
+(/an(
'+ )1..',
0(/an(
'+ )1'.+,
-'(/an(
'+ ).1.-
--(/an(
'+ )&*.0
-.("an(
'+ )&..-
-,(/an(
'+ )&-.),
-*(/an(
'+ )1+
-)(/an(
'+ )1*.1
-+(/an(
'+
)1).+
1-(/an(
'+ )11.)
11(/an(
'+ *0&.1,
1&(/an(
'+ *,).)
1.(/an(
'+ **...
1+(2ar(
'+ **,.*
10(/an(
'+ *.-.)
&'(/an(
'+ **-.',
&-(/an(
'+ *,..+
The closing price of "# at the end of the contract period is B
.-0 and this isconsidered as settlement price.
The following table explains the amount of transaction between option holder
and option writer.
? The first column explains the trading date.
? The second column explains the market price in cash segment on that date.
? The call column explains the call.put options which are considered. !very
call.put has three sub columns.
? The first column consists of the premium value per share of the contracts,
second column consists of the volume of the contract, and the third column
consists of total premium value paid by the buyer.
?
NET PAYOFF FOR CALL OPTION HOLDERS AND WRITERS
2A3456
73I85 8A99S
:;9<25
=>'''?
7352I<2
=>'''?
73;I6
6;
#;9D53
=>'''?
N56
73;I6 6;
#;9D53
=>'''?
N56
73;I6
6; @<A53
=>'''?
*,..+ *.' -00., &*&..-, 10,1.* (*+-.,, *+-.,,
*,..+ **' -.*& 1-*''.&, ' (1-*''.&, 1-*''.&,
*,..+ *+' 1''+ ,-+&-.,& ' (,-+&-.,1, ,-+&-.,1,
*,..+ )'' &10) +,*'&.., ' (+,*'&.., +,*'&..,
*,..+ )1' &)0*., ).++-.0& ' ().++-.01, ).++-.01,
*,..+ ).' 1&'0., &'1'+.. ' (&'1'+.. &'1'+..
OBSERVATIONS AND FINDINGS:
? ix call options are considered with six different strike prices.
? The current market price on the expiry date is @s.B
.-0 and this isconsidered as final settlement price.
? The premium paid by the option holders whose strike price is far and greater
than the current market price have paid high amounts of premium than those
who are near to the current market price.
? The call option holders whose strike price is less than the current market
price are said to be #n;The;+oney. The calls with strike price B(0 are said
to be #n;The;+oney, since, if they exercise they will get profits.
? The call option holders whose strike price is less than the current market
price are said to be 8ut;8f;The;+oney. The calls with strike price of BB0,
B-0,J00,J'0,J(0 are said to be 8ut;8f;The;+oney, since, if they exercise,
they will get losses.
FINDINGS:
The premium of the options with strike price of J00 and J'0 is high, since most
of the period of the contract the cash market is moving around J00 mark.
FINDINGS:
? The contracts with strike price BB0, B-0, J00, J'0, J(0 get no profit, since
their strike price is more than the settlement price.
? The contract with strike price B(0 gets the profit.
NET PAY OFF OF PUT OPTION HOLDERS AND WRITERS5
2A3456
73I85 7<6S
:;9<25
=>'''?
7352I<2
=>'''?
73;I6 6;
#;9D53
=>'''?
N56 73;I6
6; #;9D53
=>'''?
N56 73;I6
6; B3I653
=>'''?
*,..+ *'' 1, .).*1, ' (.).*1, .).*1,
*,..+ *.' &1&., 00&., ' (00&., 00&.,
*,..+ **' -1&0., 0,'*.,), *..,.. (&'*-.-), &'*-.-),
*,..+ *+' -&00., 1-+0. &,1*).. -&&)&.. (-&&)&..
*,..+ )'' -+,+ &'+)-.1+ +&0+-.* ,&--'.&1, (,&--'.&1,
*,..+ )1' -.*+., 1&)1).+& 0,).*.1 )1'-+.&), ()1'-+.&),
OBSERVATIONS AND FINDINGS:
? ix put options are considered with six different strike prices.
? The current market price on the expiry date is @s.B
.-0 and this isconsidered as the final settlement price.
? The premium paid by the option holders whose strike price is far and greater
than the current market price have paid high amount of premium than those
who are near to the current market price.
? The put option holders whose strike price is more than the current market
price are said to be #n;The;+oney. The puts with strike price
BB0,B-0,J00,J'0 are said to be #n;The;+oney, since, if they exercise they
will get profits.
? The put option holders whose strike price is less than the current market
price are said to be 8ut;8f;The;+oney. The puts with strike price of
B00,B(0 are said to be 8ut;8f;The;+oney, since, if they exercise their puts,
they will get losses.
FINDINGS:
? The premium of the option with strike price J00 is higher when compared to
other strike prices. This is because of the movement of the cash market
price of the "# between B(0 and J'0.
FINDINGS:
? The put option holders whose strike price is more than the settlement price
are #n;The;+oney.
? The put options whose strike price is less than the settlement price are 8ut;
8f;The;+oney.
DATA OF SBI THE FUTURES OF THE JANUARY MONTH
DA65
<6<35S 89;SINC 73I85
=3s.?
8AS# 89;SINC 73I85
=3s.?
&'(Dec(
') *+0.* *+,.-
&-(Dec(
') )1'.*, )-..*,
-(/an(
'+ )''.*, *0,.*
1(/an(
'+ )-'.0 )'*..
&(/an(
'+ )1'.+, )-).-
.(/an(
'+ )-*.+, )-&..,
)(/an(
'+ )10.1 )1*.*
+(/an(
'+ )1+.1, )1..',
0(/an(
'+ )1&.&, )1'.+,
-'(/an(
'+ ).,.& ).1.-
--(/an(
'+ ).-.&, )&*.0
-.(/an(
'+ )&+.0, )&..-
-,(/an(
'+ )&,.) )&-.),
-*(/an(
'+ )&&.-, )1+
-)(/an(
'+ )&'.), )1*.1
-+(/an(
'+ )&1.& )1).+
1-(/an(
'+ )1,.1, )11.)
11(/an(
'+ *0, *0&.1,
1&(/an(
'+ **'.- *,).)
1.(/an(
'+ ***.) **...
1+(/an(
'+ **).), **,.*
10(/an(
'+ *.1.) *.-.)
&'(/an(
'+ **1.', **-.',
&-(/an(
'+ *,,.0, *,..+
OBSERVATIONS AND FINDINGS:
The cash market price of the "# is moving along with the futures price.
? #f the buy price of the futures is less than the settlement price, then the buyer
of the futures get profit.
? #f the selling price of the futures is less than the settlement price, then the
seller incur losses.
SUMMARY,
CONCLUSIONS
AND
RECOMMENDATINONS
SUMMARY
? %erivatives market is an innovation to cash market. $pproximately its daily
turnover reaches to the e>ual stage of cash market.
? Presently the available scrips in futures are -, and in options segment are
B'.
? #n cash market the profit.loss of the investor depends on the market price of
the underlying asset. The investor may incur huge profits or he may incur
huge losses. "ut in derivatives segment the investor enjoys huge profits
with limited downside.
? #n cash market the investor has to pay the total money, but in derivatives the
investor has to pay premiums or margins, which are some percentage of
total money.
? %erivatives are mostly used for hedging purpose.
? #n derivative segment the profit.loss of the option holder.option writer is
purely depended on the fluctuations of the underlying asset.
CONCLUSIONS
? #n bullish market the call option writer incurs more losses so the investor is
suggested to go for a call option to hold, where as the put option holder
suffers in a bullish market, so he is suggested to write a put option.
? #n bearish market the call option holder will incur more losses so the
investor is suggested to go for a call option to write, where as the put option
writer will get more losses, so he is suggested to hold a put option.
? #n the above analysis the market price of tate "ank of #ndia is having low
volatility, so the call option writers enjoy more profits to holders.
RECOMMENDATIONS
? The derivative market is newly started in #ndia and it is not known by every
investor, so !"# has to take steps to create awareness among the investors
about the derivative segment.
? #n order to increase the derivatives market in #ndia, !"# should revise
some of their regulations like contract si/e, participation of 9## in the
derivatives market.
? )ontract si/e should be minimi/ed because small investors cannot afford
this much of huge premiums.
? !"# has to take further steps in the risk management mechanism.
? !"# has to take measures to use effectively the derivatives segment as a
tool of hedging.
BIBLIOGRAPHY
BIBLIOGRAPHY
BOOKS:
FUTURES AND OPTIONS 9 N5D5VOHRAA B5R5BAGRI
DERIVATIVES CORE MODULE
WORKBOOK 9 NCFM MATERIAL
FUTURES AND OPTIONS 9 R5MAHAJAN
WEBSITES:
BBB5%$#)%&)(5co/
BBB5#3!)t0/($t#"5co/
BBB52#%)%$!-("o%-)%#5co/
NEWS EDITIONS:
THE ECONOMIC TIMES
BUSINESS LINE
doc_866901588.doc