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A

Report On

EQUITIES–Cash & Derivatives

PREPARED BY:
NILESH KUMAR

PROJECT TRAINEE

AT ANAND RATHI, HYDERABAD

DATE 25-07-2009

Page | 1
A
Report On
EQUITIES–Cash & Derivatives
PREPARED BY:
NILESH KUMAR
2008/MBA/32

A Report submitted in partial fulfillment of the


requirements of PGPM (2008 – 2010)
Muenchen International Business School
PUNE

Company Guide Faculty Guide


Mr.Pavan Mantri Prof D.S.Kadam
Branch manager Principal Director
ANAND RATHI, MIBS PUNE
HYDERABAD

Page | 2
DECLARATION

I hereby declare that this training


program entitled “A study on Equity
market in ANANDRATHI “
EQUITIES–Cash & Derivatives ”
is my work, carried out under the
guidance of my guide Mr.Pavan
Mantri. This report neither full nor in
part has ever been submitted for award
of any other degree of either this
university or any other university.

NILESH KUMAR

PGPM /MBA
Page | 3
(2008-2010)

CERTIFICATE

Page | 4
ACKNOWLEDGM
ENT

I gratefully acknowledge the expert


support and guidance extended to me by
ANANDRATHI and the guidance of Mr.
Pavan Mantri as regards this project and
the subsequent report. There impartial
and enlightened guidance and the
sophisticated communication and the
commodities knowledge has been on
immense help and has been paramount in
this project and report maintaining and
further meeting the requisite standards
and the dead lines.

Page | 5
.

NILESH KUMAR

PGPM/MBA

(2008-2009)

Executive
Summary

In few years Share Market has emerged as a


tool for ensuring one’s financial well being.
Share Markets have not only contributed to
the India growth story but have also helped
families tap into the success of Indian
Industry. As information and awareness is
rising more and more people are enjoying the
benefits of investing in Share Markets. once
people are aware of Share Market investment
opportunities, the number who decide to invest
in Share Markets increases to as many as one
in every five people.

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This Project gave
me a great learning experience and at the same
time it gave me enough scope to implement my
analytical ability.

The first part gives an insight about Share


Market and its various aspects, the Company
Profile, Objective of the study, Research
Methodology. One can have a brief knowledge
about Share market and its basics through the
project.

The second part of


the Project consists of Friday market analysis
collected from past records This Project
covers the topic of “ FRIDAY MARKET
INVESTING PLAN ” The data collected has
been well organized and presented. I hope the
research findings and conclusion will be of use.

ANAND RATHI SECURITIES: A


BRIEF PROFILE

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Anand Rathi
(AR) is a leading full service securities firm
providing the entire gamut of financial
services. The firm, founded in 1994 by Mr.
Anand Rathi, today has a pan India presence
with 450 locations as well as an international
presence through offices in Dubai and
Bangkok. AR provides a breadth of financial
and advisory services including wealth
management, investment banking, corporate
advisory, brokerage & distribution of equities,
commodities, mutual funds and insurance,
structured products - all of which are supported
by powerful research teams.

The firm's philosophy is entirely client centric,


with a clear focus on providing long term value
addition to clients, while maintaining the
highest standards of excellence, ethics and
professionalism. The entire firm activities are
divided across distinct client groups:
Individuals, Private Clients, Corporate and
Institutions and was recently ranked by Asia
Money 2006 poll amongst South Asia's top 5
wealth managers for the ultra-rich.

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In year 2007 Citigroup Venture Capital
International joined the group as a financial
partner.

MILESTONES

• 1994:
Started activities in consulting and
Institutional equity sales with staff of 14.

• 1995:
Set up a research desk and empanelled
with major institutional investors.

• 1997:
Introduced investment banking
businesses
Retail brokerage services launched

• 1999:
Lead managed first IPO and executed
first M & A deal

• 2001:
Initiated Wealth Management Services
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• 2002:
Retail business expansion recommences
with ownership model

• 2003:
Wealth Management assets cross Rs1500
crores
Insurance broking launched

Launch of Wealth Management services in


Dubai
Retail Branch network exceeds 50

• 2004:
Commodities brokerage and real estate
services introduced
Wealth Management assets cross
Rs3000crores
Institutional equities business re launched
and senior research team put in place
Retail Branch network expands across
100 locations within India

• 2005:
Real Estate Private Equity Fund
Launched

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Retail Branch network expands across
200 locations within India

• 2006:
AR Middle East, WOS acquires
membership of Dubai Gold &
Commodity Exchange (DGCX)
Ranked amongst South Asia's top 5
wealth managers for the ultra-rich by
Asia Money 2006 poll
Ranked 6th in FY2006 for All India
Broker Performance in equity
distribution in the High Net worth
Individuals (HNI) Category
Ranked 9th in the Retail Category having
more than 5% market share
Completes its presence in all States
across the country with offices at 300+
locations within India

• 2007:
Citigroup Venture Capital International
picks up 19.9% equity stake
Retail customer base crosses 200
thousand

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Establishes presence in over 450
locations

• 2009

Started with Currency Derivatives which

deals only in

USD & INR

MANAGEMENT TEAM

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Our senior Management comprises a diverse talent pool that
brings together rich experience from across industry as well as
financial services.
Mr. Anand Rathi - Group Chairman
Chartered Accountant
Past President, BSE
Held several Senior Management positions with one of India's
largest industrial groups
Mr. Pradeep Gupta - Vice Chairman
Plus 17 years of experience in Financial Services
Mr. Amit Rathi - Managing Director
Chartered Accountant & MBA
Plus 11 years of experience in Financial Service

Table of Contents
1. History of BSE………………………………………... 14
- Services…………………………………………… 15
- Awards……………………………………………. 17
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- Vision……………………………………………... 17
2. History of NSE………………………………………... 18
3. Role of SEBI…………………………………………… 19
4. Introduction……………………………………………… 20
- Listed Securities………………………………………22
- Permitted Securities………………………………… 22
- Tick Size………………………………………… 22
- Computation of closing price of scrip’s in the Cash
. Segment…………………………………………… 23
5. Compulsory Rolling Settlement (CRS) Segment………. 23
- Trading and settlement cycle for scrip’s under CRS...26
6. Settlement…………………………………………………….
- Demat pay-in………………………………………. 30
- Auto delivery facility………………………………. 30
- Pay-in of securities in physical form…………………31
- Funds Pay-in………………………………………….32
- Securities Pay-out………………………………..…...32
- Funds Payout…..……………………………………...33
- Dematerialization of shares…………………………...33
- Merits of Dematerialization.…………………………..34
- Rematerialization. …………………………………34
7. Open interest in derivative market……………………………….35
- What is open interest……………………………………..35
- Rising market and increasing open interest…………......36
- Rising market and decreasing open interest……………..36
- falling marker and increasing open interest……………. ..37
- falling marker and decreasing open interest……………...37
- sideways marker and increasing open interest……………38
8. The index number…………………………………………… 38
- desirable attribute of an index…………………………..39
- capturing behavior of portfolios……………………… ..40
- including liquid stocks………………………………….40
- maintaining professionally……………………………..41
– impact cost…………………………………………….. 41

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9. Futures and options………………………………………….42
- trading underlying versus trading single stock futures.. 43
- derivative market at nse………………………………..44
- index derivatives………………………………………45
10. Future terminology…………………………………………..45
– business growth of futures and options market
. turnover(rs. Crore)……………………………………49
11. Eligibility for any stock to enter in derivative market…….50
- trading mechanism…………………………………..50
- volumes………………………………………………51
- index derivatives for hedging………………………..51
– pricing futures……………………………………….52
– initial margin……………………………………….. 53
- initial margin charged on f & o market……………..54
12. Convergence of futures price to spot price…………………54
- mark to market (mtm) margin……………………….56
– open interest calculation with example……………...57
13. Options………………………………………………………..58
- option terminology…………………………………..59
- strategies in futures and options……………………..62
14. Buying a call option………………………………………….63
– buying a put…………………………………………66
- writing the call options………………………………68
- writing the buy options………………………………70
15. Firday market analysis……………………………………….73
16. Conclusion………………………………………………….....79
17. Suggestions …………………………………………………..81
18. Bibliography………………………………………………….84

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Bombay Stock Exchange Limited (the Exchange)

is the oldest stock exchange in Asia with a rich heritage. Popularly known

as "BSE", it was established as "The Native Share & Stock Brokers

Association" in 1875. It is the first stock exchange in the country to obtain

permanent recognition in 1956 from the Government of India under the

Securities Contracts (Regulation) Act, 1956.The Exchange's pivotal and

pre-eminent role in the development of the Indian capital market is widely

recognized and its index, SENSEX, is tracked worldwide.

• India's oldest and first stock exchange: Mumbai (Bombay) Stock

Exchange. Established in 1875. More than 6,000 stocks listed.

• Total number of stock exchanges in India: 22

• They are in: Ahmedabad, Bangalore, Calcutta, Chennai, Delhi

etc.

• There is also a National Stock Exchange (NSE) which is located in

Mumbai.

• There is also an Over the Counter Exchange of India (OTCEI)

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which allows listing of small and medium sized companies.

• The regulatory agency which oversees the functioning of stock

markets is the Securities and Exchange Board of India (SEBI),

which is also located in Bombay.

Today, BSE is the world's number 1

exchange in terms of the number of listed companies and the world's

5th in transaction numbers. The market capitalization as on

December 31, 2007 stood at USD 1.79 trillion.

SERVICES

BSE also has a wide range of services to empower investors and facilitate
smooth transactions:

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TRADIN
G

Trading on the BOLT System is conducted


from Monday to Friday between 9:55 a.m. and
3:30 p.m. The scrip’s traded on the Exchange
have been classified into 'A', 'B1', 'B2','T', ‘S',
‘TS' 'F' ,'G' and 'Z' groups.

The Exchange has for the guidance and benefit


of the investors have classified the scrip’s in
the Equity Segment into 'A', 'B1', 'B2','T', ‘S',
‘TS' and 'Z' groups on certain qualitative and
quantitative parameters which include number
of trades, value traded, etc.

The “F” Group represents the Fixed Income


Securities.

The “T” Group represents scrip's which are


settled on a trade to trade basis as a
surveillance measure.

The “S” Group represent scrip’s forming part


of the “ BSE-Indonext” segment . The “TS”
Group consist of scrip’s in the “ BSE-
Indonext” segment which are settled on a trade
to trade basis as a surveillance measure.

Trading in Govt. Securities for retail investors


is done under "G" group.

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The 'Z' group was introduced by the Exchange
in July 1999 and includes the companies which
have failed to comply with the listing
requirements of the Exchange and/or have
failed to resolve investor complaints or have
not made the required arrangements with both
the Depositories, viz., Central Depository
Services (I) Ltd. (CDSL) and National
Securities Depository Ltd. (NSDL) for
dematerialization of their securities.

The Exchange also provides a facility to the


market participants for on-line trading of odd-
lot securities in physical form in 'A', 'B1', 'B2'
‘T','S', ‘TS' and 'Z' groups and Rights
renunciations in all the groups of scrip’s in the
Equity Segment.

With effect from December 31, 2001, trading


in all securities listed in equity segment of the
Exchange takes place in one market segment,
viz., Compulsory Rolling Settlement Segment
(CRS).

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The scrip’s of the companies which are in
demat can be traded in market lot of one but
the securities of companies which are still in
the physical form are traded on the Exchange
in the market lot of generally either 50 or 100.
However, the investors having quantities of
securities less than the market lot are required
to sell them as "Odd Lots". The facility of
trading in odd lots of securities not only offers
an exit route to investors to dispose of their odd
lots of securities but also provides them an
opportunity to consolidate their securities into
market lots.

This facility of selling physical shares in


compulsory demat scrips is called an Exit
Route Scheme. This facility can also be used
by small investors for selling upto 500 shares
in physical form in respect of scrips of
companies where trades are required to be
compulsorily settled by all investors in demat
mode.

Listed Securities:

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The securities of companies which have signed
Listing Agreement with the Exchange are
traded at the Exchange as "Listed Securities".
Baring a few scrip’s, all scrip’s traded in the
Equity Segment at the Exchange fall in this
category.

Permitted Securities:

To facilitate the market participants to trade in


securities of the companies which are actively
traded at other Regional Stock Exchanges but
are not listed on the Exchange, the Exchange
has in April 2002 decided to permit trading in
such securities as “Permitted Securities"
provided they meet the relevant norms
specified by the Exchange.

Tick Size:

Tick size is the minimum differences in rates


between two orders on the same side i.e., buy
or sell, entered on the system for particular
scrip. Trading in scrip’s listed on the Exchange
is done with the tick size of 5 paise.

However, in order to increase


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the liquidity and enable the market participants
to put orders at finer rates, the Exchange has
reduced the tick size from 5 paise to 1 paise in
case of units of mutual funds, securities traded
in "F" group and equity shares having closing
price upto Rs. 15/- on the last trading day of
the calendar month. Accordingly, the tick size
in various scrip’s quoting upto Rs.15/- is
revised to 1 paise on the first trading day of
month. The tick size so revised on the first
trading day of month remains unchanged
during the month even if the prices of scrip’s
undergo change.

Computation of closing price of


scrip’s in the Cash Segment:

The closing price of scrip's is computed by the


Exchange on the basis of weighted average
price of all trades executed during the last 30
minutes of the continuous trading session.
However, if there is no trade recorded during
the last 30 minutes, then the last traded price of
scrip in the continuous trading session is taken
as the official closing price.

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Compulsory Rolling Settlement
(CRS) Segment:

As per the directive by SEBI, all transactions in


all groups of securities in the Equity Segment
and Fixed Income securities listed on the
Exchange are required to be settled on T+2
basis w.e.f. from April 1, 2003. The settlement
calendar, which indicates the dates of the
various settlement related activities, is drawn
by the Exchange in advance and is circulated
among the market participants.

Under
rolling settlements, the trades done on a
particular day are settled after a given number
of business days. A T+2 settlement cycle means
that the final settlement of transactions done on
T, i.e., trade day by exchange of monies and
securities between the buyers and sellers
respectively takes place on second business day
(excluding Saturdays, Sundays, bank and
Exchange trading holidays) after the trade day.

The transactions in securities of companies


which have made arrangements for

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dematerialization of their securities are settled
only in demat mode on T+2 on net basis, i.e.,
buy and sell positions of a member-broker in
the same scrip are netted and the net quantity
and value is required to be settled. However,
transactions in securities of companies, which
are in "Z" group or have been placed under
"trade to trade" by the Exchange as a
surveillance measure (“T” and “TS” group) ,
are settled only on a gross basis and the facility
of netting of buy and sell transactions in such
scrip’s is not available.

The Exchange has introduced a new segment


named “BSE Indonext” w.e.f. January 7, 2005.
“S” group consists of scrips from “B1” & “B2”
group on BSE and companies exclusively listed
on regional stock exchanges having capital of 3
crores to 30 crores. All trades in this segment
are done through BOLT system under S group.

The transactions in 'F' group securities


representing "Fixed Income Securities" and "
G" group representing Govt. Securities for
retail investors are also settled at the Exchange
on T+2 basis.

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In case of Rolling Settlements, pay-in and pay-
out of both funds and securities is completed
on the same day.

The
members are required to make payment for
securities sold and/ or deliver securities
purchased to their clients within one working
day (excluding Saturday, Sunday, bank &
Exchange trading holidays) after the pay-out of
the funds and securities for the concerned
settlement is completed by the Exchange. This
is the timeframe permitted to the members of
the Exchange to settle their funds/ securities
obligations with their clients as per the
Byelaws of the Exchange.

The following table summarizes the steps in


the trading and settlement cycle for scrip’s
under CRS

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DAY ACTIVITY

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T at
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T+1

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T+2 ri
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T+3

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T+4

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Thus, the pay-in
and pay-out of funds and securities takes places
on the second business day (i.e., excluding
Saturday, Sundays and bank & Exchange
trading holidays) of the day of the execution of
the trade.

* 6A/7A : A mechanism whereby the


obligation of settling the transactions done by a
member-broker on behalf of a client is passed
on to a custodian based on confirmation of
latter. The custodian can confirm the trades
done by the members on-line and upto 11 a.m.
on the next trading day. The late confirmation
of transactions by the custodian after 11:00
a.m. upto 12:15 p.m., on the next trading day
is, however, permitted subject to payment of
charges for late confirmation @ 0.01% of the
value of trades confirmed or Rs. 10,000/-,
whichever is less.

The settlement of the trades (money and


securities) done by a member-broker on his
own account or on behalf of his individual,
corporate or institutional clients may be either

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through the member-broker himself or through
a SEBI registered custodian appointed by
him/client. In case the delivery/payment in
respect of a transaction executed by a member-
broker is to be given or taken by a registered
custodian, then the latter has to confirm the
trade done by a member-broker on the BOLT
System through 6A-7A entry. For this purpose,
the custodians have been given connectivity to
BOLT System and have also been admitted as
clearing member of the Clearing House. In case
a transaction done by a member-broker is not
confirmed by a registered custodian within the
time permitted, the liability for pay-in of funds
or securities in respect of the same devolves on
the concerned member-broker.
The following statements can be downloaded
by the members in their back offices on a daily
basis.

a. Statements giving details of the daily


transactions entered into by the members.

b. Statements giving details of margins


payable by the member-brokers in
respect of the trades executed by them.

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c. Statements of securities and fund
obligation.

d. Delivery/Receive orders for delivery


/receipt of securities.

The Exchange
generates Delivery and Receive Orders for
transactions done by the members in A, B1,
B2, S and F and G group scrip’s after netting
purchase and sale transactions in each scrip
whereas Delivery and Receive Orders for “T”,
“TS”,"C" & "Z" group scrip’s and scrip’s
which are traded on the Exchange on "trade to
trade" basis are generated on gross basis, i.e.,
without netting of purchase and sell
transactions in a scrip. However, the funds
obligations for the members are netted for
transactions across all groups of securities.

The Delivery Order/Receive Order provides


information like the scrip and quantity of
securities to be delivered/received by the
members through the Clearing House. The
Money Statement provides scrip wise/item
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wise details of payments/receipts of monies by
the members in the settlement. The
Delivery/Receive Orders and Money
Statement, as stated earlier, can be downloaded
by the members in their back office.

Settlement

Pay-in and Pay-out for 'A', 'B1', 'B2',


‘T’, ‘S’, ‘TS’, 'C', "F", "G" & 'Z' group
of securities

The trades done on BOLT/Exchange by the


members in all the securities in CRS are now
settled on the Exchange by payment of monies
and delivery of securities on T+2 basis. All
deliveries of securities are required to be routed
through the Clearing House,

The Pay-in /Pay-out of funds based on the


money statement and that of securities based
on Delivery Order/ Receive Order issued by
the Exchange are settled on T+2 day.

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Demat pay-in :

The members can effect pay-in of demat


securities to the Clearing House through either
of the Depositories i.e. the National Securities
Depository Ltd. (NSDL) or Central Depository
Services (I) Ltd. (CDSL). The members are
required to give instructions to their respective
Depository Participants (DPs) specifying
details such as settlement no., effective pay-in
date, quantity, etc.

Members may also effect pay-in directly from


the clients' beneficiary accounts through
CDSL. For this, the clients are required to
mention the settlement details and clearing
member ID through whom they have sold the
securities. Thus, in such cases the Clearing
Members are not required to give any delivery
instructions from their accounts.

In case, if a member-broker fails to deliver the


securities, then the value of shares delivered
short is recovered from him at the
standard/closing rate of the scrip’s on the
trading day.
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Auto delivery facility :

Instead of issuing Delivery instructions for


their securities delivery obligations in demat
mode in various scrip’s in a settlement /auction,
a facility has been made available to the
members of automatically generating Delivery
instructions on their behalf from their CM Pool
accounts maintained with NSDL and CM
Principal Accounts maintained with CDSL.
This auto delivery facility is available for CRS
(Normal & Auction) and for trade to trade
settlements. This facility is, however, not
available for delivery of non-pari passu shares
and shares having multiple ISINs. The
members wishing to avail of this facility have
to submit an authority letter to the Clearing
House. This auto delivery facility is currently
available for Clearing Member (CM) Pool
accounts and Principal accounts maintained by
the members with the respective depositories .

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Pay-in of securities in physical
form:

In case of delivery of securities in physical


form, the members have to deliver the
securities to the Clearing Hose in special
closed pouches along with the relevant details
like distinctive numbers, scrip code, quantity,
etc., on a floppy. The data submitted by the
members on floppies is matched against the
master file data on the Clearing House
computer systems. If there is no discrepancy,
then the securities are accepted.

Funds Pay-in:

The bank accounts of members maintained


with the clearing banks, viz., Bank of India,
HDFC Bank Ltd., Oriental Bank of
Commerce., Standard Chartered Bank,
Centurion Bank Ltd., UTI Bank Ltd., ICICI

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Bank, Indusind Bank Ltd., Union Bank of India
and Hongkong Shanghai Banking Corporation
Ltd. are directly debited through computerized
posting for their funds settlement obligations.

In case of those members, whose funds pay-in


obligations are not cleared at the scheduled
time, action such as levy of penalty and/or
deactivation of BOLT TWSs, is initiated as per
penalty norms prescribed .

Securities Pay-out:

In case of demat securities, the same are


credited by the Clearing House in the
Pool/Principal Accounts of the member-
brokers. The Exchange has also provided a
facility to the member-brokers for transfer of
pay-out securities directly to the clients'
beneficiary owner accounts without routing the
same through their Pool/Principal accounts in
NSDL/ CDSL. For this, the concerned
member-brokers are required to give a client
wise break up file which is uploaded by the
member-brokers from their offices to the

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Clearing House. Based on the break up given
by the member-brokers, the Clearing House
instructs depositories, viz., CDSL & NSDL to
credit the securities to the Beneficiary Owners
(BO) Accounts of the clients. In case delivery
of securities received from one depository is to
be credited to an account in the other
depository, the Clearing House does an inter
depository transfer to give effect to such
transfers.
In case of physical securities,
the Receiving Members are required to collect
the same from the Clearing House on the pay-
out day.

Funds Payout:

The bank accounts of the members having pay-


out of funds are credited by the Clearing House
with the Clearing Banks on the pay-in day
itself
In case, if a member-broker fails to deliver the
securities, then the value of shares delivered
short is recovered from him at the

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standard/closing rate of the scrips on the
trading day.

Dematerialization of shares:

Dematerialization as the name suggests, is a

term used for conversion of shares from their

physical form to electronic form. This

conversion is done by NSDL and CDSL. The

CDSL acts as a depository for BSE, whereas

the NSDL acts as a depository for NSE. After

dematerialization, shares cease to exist in their

physical form.

Merits of dematerialization:

 No risk of being fake or stolen shares.

 No stamp duty while transfer of shares.

 Free from tedious paperwork as it was in the

physical form.

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 Stock exchanges have now discarded the

concept of marketable lots, small lots and

odd lots.

Rematerialization:

Rematerialization is the reverse of

dematerialization. It means to convert the

electronically held shares back into physical form.

You have the complete freedom of conversion

from electronic form to physical form whenever

you want to do so.

OPEN INTEREST IN
DERIVATIVE MARKET

Open interest means the total number of


open contracts on a security, that is, the number

Page | 43
of future contracts or options contracts that
have not been exercised, expired or full filled
by delivery. Hence we can say that the open
interest position at the end of each day
represents the net increase or decrease in the
number of contracts for that day. However, it is
to be noted that open interest is not the same as
trading volume. Trading volume represents the
total number of contracts that are traded during
a day, inclusive of both squared –off (closed)
positions and new positions. Thus, for any day,
the trading volume will always be higher than
the open interest.

What is open interest?

Every trade in the exchange would have


an impact on the open interest for that day. Say,
for example, “A” buys one contract of Nifty on
Monday while “B” buys two on the same day.
Open interest at the end of the day will be
three. On Tuesday, while “A” sells his one
contract to “C”, “B” buys another Nifty
contract. The open interest at the end of the day
is now four. In other words, if both parties to

Page | 44
the trade initiate a new position, it increases the
open interest by one contract.
But if the traders square
off their existing positions, Open interest will
decrease by the same number of contracts.

However, if one of the parties to the


transaction squares off his position while the
other creates one open interest will remain
unchanged. Open interest, thus, mirrors the
flow of money into the derivatives market,
which makes it a vital indicator of market
direction. Here is how you interpret open
interest.

RISING MARKET AND INCREASING


OPEN INTEREST

If the markets are on an uptrend and open


interest is also increasing, it it’s a bullish
signal. It implies the entry of new players into
the market, who are creating fresh long

Page | 45
positions and suggests the flow of extra money
into the market.

RISING MARKET AND DECREASING


OPEN INTEREST

If despite a rise in market, the open


interest decreases, it can be interpreted as a
precursor to a trend reversal. The lack of
additions to open interest shows that the
markets are rising on the back of short-sellers
covering their existing positions. This also
implies that money is flowing out of the
market, given that open interest is decreasing.

FALLING MARKET AND INCREASING


OPEN INTEREST

When open interest records an increase in


value amidst falling market, it could be a
bearish signal. Though a rise in open interest
means that new money is probably being used
Page | 46
for creating fresh short positions, which will
lead to a further downtrend.

FALLING MARKET AND


DECREASING OPEN INTEREST

If open interest decreases in a falling


market, it can be attributed to the forced
squaring- off of long – positions by traders. It,
thus, represents a trend reversal, since the
downtrend in the market is likely to reverse
after the long positions have been squared off.
Thus, in a falling market, a declining open
interest can be considered a signal indicating
the strengthening of the market.

SIDEWAYS MARKET AND


INCRESING OPEN INTEREST

If the open
interest decreases in a sideways market, we can
Page | 47
say that flat market trends will continue for
some more time. A decrease in open interest
only represents the squaring-off of old
positions and lack of any new positions might
result in a sideways or weak trends in the
market.

Though open interest is a good barometer


of where the markets are heading; it is only an
indicator that helps us trade intelligently it
cannot be considered foolproof.

THE INDEX NUMBER

An index is a number which


measures the change in a set of values over a
period of time. A stock index represents the
change in value of a set of stocks which
constitute the index. More specifically, a stock
index number is the current relative value of a
weighted average of the prices of a pre-defined
group of equities. It is a relative value to the
weighted average of prices at some arbitrarily
chosen starting date or base period. The

Page | 48
starting value or base of the index is usually set
to a number such as 100 or 1000. for example
the base value of the Nifty was set to 1000 on
the start date of November 3, 1994.

A good stock market index is on which


captures the behavior of the overall equity
market. It should represent the market, it
should be well diversified and yet highly
liquid. Movements of the index should
represent the returns obtained by “typical”
portfolios in the country.
A market index is very important for its use
 As a barometer for market behavior,
 As a benchmark portfolio performance,
 As an underlying in derivative
instruments like index futures,
 In passive fund management by index
funds
 Also acts a barometer for lot of elements
such as liquidity in the market, the
growth of the economy, the investor’s
confidence, government policies etc.

Page | 49
DESIRABLE ATTRIBUTE OF AN
INDEX

A good market index should have the following


attributes:

 It should capture the behavior of a large


variety of different portfolios in the
market.
 The stocks included in the index should
be highly liquid.
 It should be professionally maintained.

Capturing Behavior Of Portfolios

A good market index should accurately


reflect the behavior of the overall market as
well as of different portfolios. This is achieved
by diversification in such a manner that a
portfolio is not vulnerable to any individual
stock or industry risk. A well diversified index
is more representative of the market. However
there is diminishing returns form

Page | 50
diversification, there is very little gain by
diversifying beyond a point; the more serious
problem lies in the stocks that are included in
the index when it is diversified. We end up
including illiquid stocks, which actually
worsen the index. Since an illiquid stock does
not reflect the current price behavior of the
market, its inclusion in index results in an
index, which reflects, delayed or stale price
behavior rather than current price behavior of
the market.

Including Liquid Stocks

Liquidity is much more than trading


frequency, it is about ability to transact at a
price, which is very close to the current market
price. For example, a stock is considered liquid
if one can buy some shares at around Rs.120.05
and sell at around Rs.119.95, when the market
price is ruling at Rs.120. a liquid stock has very
tight bid ask spread.

Maintaining Professionally

Page | 51
It is now clear that an index should
contain as many stocks with as little impact
cost as possible. This necessarily means that
the same set of stocks would not satisfy these
criteria at all times, a good index methodology
must therefore incorporate a steady pace of
change in the index set. It is crucial that such
changes are made at a steady pace. It is very
healthy to make a few changes every year, each
of which is small and does not dramatically
alter the character of the index, on a regular
basis, the index set should be reviewed, and
brought inline with the current state of market,
to meet the application needs of users, a time
series of the index sold be available.

Impact cost

Market impact cost is a measure of the


liquidity of the market. It reflects the costs
faced when actually trading an index. For a
stock to qualify for possible inclusion into the
index, it has to have market impact cost of
below 0.75% when doing Nifty trades of half a
crores rupees. The market impact cost on a
Page | 52
trade of Rs.3 million of the full Nifty works out
to be about 0.05%. This means that if Nifty is
at 4000, a buy order goes through at 4002, i.e.
4000+ (4000*0.0005) and a sell order gets
3998 i.e. 4000-(4000*0.0005)

FUTURES AND OPTIONS

An option is different form futures in


several ways. At practical level, the option
buyer faces an interesting situation. He pays for
the options in full at the time it is purchased.
After this, he only has an upside. There is no
possibility of the options position generating
any further losses to him. This is different
form futures, which is free to enter into, but
can generate very large losses. This
characteristic makes options attractive to many
occasional market participants, who cannot put
in the time to closely monitor their futures
positions.
Buying put options is buying insurance.
To buy a put option on Nifty is to buy
insurance which reimburses the full extent to
Page | 53
which Nifty drops below the strike price of the
put option. This is attractive to many people,
and to mutual funds creating “guaranteed
return products”.

TRADING UNDERLYING VERSUS


TRADING SINGLE STOCK
FUTURES

The single stock futures market in India


has been a great success story across the world.
NSE ranks first in the world in terms of
number of contracts traded in single stock
futures. One of the reasons for the success

Page | 54
could be the ease of trading and settling these
contracts.
To trade securities, a customer must open
a security trading account with a securities
broker and a demat account with a securities
depository. Buying security involves putting up
all the money upfront. With the purchase of
shares of a company, the holder becomes a part
owner of the company. The shareholder
typically receives the rights and privileges
associated with the security, which may include
the receipt of dividends, invitation to the
annual shareholders meeting and the power to
vote.
Selling securities involves buying the
security before selling it. Even in cases where
short selling is permitted, it is assumed that the
securities broker owns the security and then
“lends” it to the trader so that he can sell it,
besides, even if permitted, short sales on
security can only be executed on an up tick.

To trade futures, a customer must open a


futures trading account with a derivatives
broker. Buying futures simply involves putting

Page | 55
in the margin money. They enable the futures
traders to take a position in the underlying
security without having to open an account
with a securities broker. With the purchase of
futures on a security, the holder essentially
makes a legally binding promise or obligation
to buy the underlying security at some point in
the future. Security futures do not represent
ownership in a corporation and the holder is
therefore not regarded as a shareholder.

DERIVATIVE MARKET AT NSE

The derivatives trading on the NSE


commenced with S&P CNX Nifty Index
futures on June 12, 2000. The trading in index
options commenced on June 4, 2001 and
trading in options on individual securities
commenced on July 2, 2001. Single stock
futures were launched on November9, 2001.
Today, both in terms of volume and turnover,
The mini derivative Futures & Options
contract on S&P CNX Nifty was
introduced for trading on January 1,
Page | 56
2008 while the long term option
contracts on S&P CNX Nifty were
introduced for trading on March 3
2008

NSE is the largest derivatives exchange


in India.
Currently, the
derivatives contracts have a maximum of 3-
month expiration cycles. Three contracts are
available for trading, with 1 month, 2 months
and 3 months expiry.
A new contract is introduced on the next
trading day following the expiry of the near
month contract.

INDEX DERIVATIVES

Index derivatives are derivative contracts


which have the index as the underlying. The
most popular index derivatives contract the
world over is index futures and index options.
NSE’s market index, the S&P CNX Nifty was
scientifically designed to enable the launch of
Page | 57
index- based products like index derivatives
and index funds. The first derivative contract to
be traded on NSE’s market was the index
futures contract with the Nifty as the
underlying. This was followed by Nifty options
and thereafter by sectoral indexes, CNX IT and
BANK Nifty contracts.

FUTURES TERMINOLOGY

SPOT PRICE: The price at which an asset


trades in the spot market

FUTURES PRICE: The price at which the


futures contract trades in the futures market.

CONTRACT CYCLE: The period over


which a contract trades. The index futures
contracts on the NSE have one month, two
months and three months expiry cycles which
expire on the last Thursday of the month. Thus
a January expiration contract expires on the last
Thursday of January.

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

CONTRACT SIZE: The amount of asset that


has to be delivered under one contract. For
instance, the contract size on NSE’s futures
market is 200 Nifties.

BASIS: In the context of financial futures,


basis can be defined as the futures price minus
the spot price, there will be a different basis for
each delivery month for each contract. In a
normal market, basis will be positive; this
reflects that futures prices normally exceed
spot prices.

COST OF CARRY: the relationship between


futures prices and spot prices can be
summarized in terms of what is known as the
cost of carry. This measures the storage cost

Page | 59
plus the interest that is paid to finance the asset
less the income earned on the asset.

INITIAL MARGIN: the amount that must be


deposited in the margin account at the time
a futures contract is first entered into is known
as initial margin.

MARKET TO MARKET: in the futures


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

MAINTENANCE MARGIN: This is


somewhat lower than the initial margin. This is
set to ensure that the balance in the margin
account never becomes negative. If the balance
in the margin account falls below the
maintenance margin, the investor receives a
margin call and is expected to top up the
margin account to the initial margin level
before trading commences on the next day.

Page | 60
A futures contract is different from the
underlying stock in the following ways:

 When we buy a stock, we pay the full


value of the transaction (i.e. the number
of shares multiplied by market price of
each share) whereas in futures we pay
only the margin which is a fraction of the
total transaction value.

 There is no time limit of settlement in


cash market but in case of futures
contracts, they are dated. An Indian
futures settlement currently takes place
on the last Thursday of every month. So
the current month’s futures expire on the
month’s last Thursday. If a trader has to
carry his position to the next month, he
has to shift his position to the next
month’s future.

 One can only go long in the spot market.


We cannot short sell unless we borrow
the stock, something which is neither
Page | 61
cheaper nor convenient whereas one can
go long or short on the futures depending
on his short term view of the markets.

 The cash market has a lot of none, i.e. a


person can buy any stock in the multiple
of one unit where as a futures contract is
the smallest unit which one can trade in
the futures market.

 There is no way of taking a position on


the index through the cash market
whereas futures facilitate trading of index
futures.

A futures contract price


is the sum of cash price and the monthly cost of
carry. The cost of carry should always be
positive because a futures trade is really a
carried forward product similar to the erstwhile
badla. But just as badla rates sometimes
become negative when the market sentiment is
bearish, the cost of carry can also similarly be
negative when the sentiment is poor.
Page | 62
Business growth of futures and options
market: Turnover (Rs.crore)

Mont Index Index Stock Stock


h futures options options futures
Jun-00 35 0 0 0
Jun-01 590 195 0 0
Jun-02 2,123 389 4,642 16,178
Jun-03 9,348 1,942 15,042 46,505
Jun-04 64,017 8,473 7,424 78,392
Jun-05 77,218 16,133 14,799 1,63,096
Jun-06 2,43,572 57,969 11,306 2,43,950
Jun-07 2,40,797 92,503 21,928 4,51,314
Jun-08 3,77,939 3,08,709 21,430 3,75,987

Source: NCFM Derivative Module Work Book

ELIGIBILITY FOR ANY STOCK TO


ENTER IN DERIVATIVE MARKET

Page | 63
 Non promoter holding (free float
capitalization) should not be less than
Rs.750 crores for the last 6 months.
 Daily Average Trading value should not
be less than 5 crores in last 6 months
 It must be traded least 90% of Trading
days in last 6 months.
 Non Promoter Holding must at least be
30%
 BETA should not be more than 4 (for
previous 6 months)

TRADING MECHANISM

The futures and options trading system of


NSE, called NEAT-F&O trading system,
provides a fully automated screen-based
trading for Nifty futures & options and stock
futures & options on a nation wide basis and an
online monitoring and surveillance
mechanism. It supports an anonymous order
driven market which provides complete
transparency of trading operations and operates

Page | 64
on strict price-time priority. It is similar to that
of trading of equities in the cash market
segment. The NEAT-F&O trading system is
accessed by two types of users. The trading
members have access to functions such as
order entry, order matching, order and trade
management. It provides tremendous flexibility
to users in terms of kinds of orders that can be
placed on the system. various conditions like
Immediate or Cancel, Limit/Market price, Stop
loss, etc. can be built into an order. The
clearing members use the trader workstation
for the purpose of monitoring the trading
members for whom they clear the trades.
Additionally, they can enter and set limits to
positions, which a trading member can take.

VOLUMES

The trading volumes on NSE’s


derivatives market have seen a steady increase
since the launch of the first derivatives
contract, i.e. index futures in June 2000. The
average daily turnover at NSE now exceeds

Page | 65
Rs.35000 crores. A total of 216,883,573
contracts with a total turnover of Rs.
7,356,271 crores were traded during 2006-
2007.

INDEX DERIVATIVES FOR HEDGING

To understand the use and functioning of


the index derivatives markets, it is necessary to
understand the underlying index. By looking at
an index, we know how the market is faring.
Index derivatives allow people to cheaply alter
their risk exposure to an index (hedging) and to
implement forecasts about index movements
(speculation). Hedging using index derivatives
has become a central part of risk management
in the modern economy.

Pricing the Futures

A futures price can be


simply derived by applying the cost of carry
logic, by which the fair value of a futures
Page | 66
contract can be determined. Every time the
observed price deviates form the fair value,
arbitragers would enter into trades to capture
the arbitrage profit. This in turn would push the
futures price back to its fair value. The cost of
carry model used for pricing futures is as
follows:

F=SerT

Where:

r= cost of financing continuously compounded


interest rate

T= Time till expiration in years

e= 2.71828

Example:

Security XYZ ltd trades in the spot market at


Rs. 1150. Money can be invested at 11% p.a.
The fair value of a one month futures contract
on XYZ is calculated as follows:

Page | 67
F = SerT

=1150*e0.11*1/12

=1160

INITIAL MARGIN

 At the inception of a contract every client


is required to pay initial margin. This
margin is must to every trading member.
 Initial margins are charged on Trade by
Trade basis
 Initial margins are charged by NSCCL
 Initial margins are charged for the
purpose of recovery and safe guard
against the fluctuation in the market.
 A future value is calculated on cost of
carry model.

Page | 68
INITIAL MARGINS CHARGED ON
F&O MARKET

Index futures: 5%
Index options: 3%
Stock options: 7.5%

CONVERGENCE OF FUTURES PRICE


TO SPOT PRICE

As the delivery month of a futures


contract is approached, the futures price
converges to the spot price of the underlying
asset. When the delivery period is reached, the
futures price equals or is very close to the spot
price.
To see why this so, we first suppose that
the futures price is above the spot price during
the delivery period. Traders then have a clear
arbitrage opportunity:

 Short a futures contract


 Buy the asset
 Make the delivery
Page | 69
These steps are
certain to lead to a profit equal to the amount
by which the futures price exceeds the spot
price. As traders exploit this arbitrage
opportunity, the futures price will fall. Suppose
next that the futures price is below the spot
price during the delivery period. Companies
interested in acquiring the asset will find it
attractive to enter into a long futures contract
and then wait for delivery to be made. As they
do so, the futures price will tend to rise.

The result is that


the futures price is very close to the spot price
during the delivery period.

The convergence of the


futures price to the spot price when
future price is above the spot price
can be pictorially represented as
follow:

Page | 70
Figure: A
The convergence of the futures
price to the spot price when future
price is below the spot price can be
pictorially represented as follows:

Page | 71
Figure: B

MARK TO MARKET (MTM) MARGINS

 MTM margins is charged on continuous


Basis t the end of each day on Daily basis
of cumulative net out standing open
position.

 CM (clearing member) is responsible to


collect and settle the daily MTM Margins

Page | 72
(Profits/loss) from their trading members
according to their open positions.

 TM (Trading Member) are responsible to


collect and settle the daily MTM margins
for pay in/ pay out of their clients
according to the clients open position.

 For calculating MTM margin future last


½ hour average price is takes, if it is not
traded on that day or last half hour MTM
is calculated on theoretical price model.

 MTM margin balance at he year end


shown in current asset account.

OPEN INTEREST CALCULATION

Open interest means out standing orders of


(long position + short position)
Contracts in a particular point of time.

Page | 73
OPEN INTEREST CALCULATION
(EXAMPLE)

200(Total buy)-400(total sell) = 200 short (net


position)

Client Open Position

Client A 400(Total buy) - 200(total sell) =


200 long net position

Client B 200(total buy) - 400(total sell) =


200 short net position

Client C 500(total buy) - 400(total sell) =


100 long net position

= 500 long + short

Trading Member Total Open Position = 700


long+ short

Clearing member open position: All trading


member open position and custodial
participants
Page | 74
open positions

OPTIONS

An option is a contract, or a provision of


a contract, that gives one party (the option
holder) the right, but not the obligation, to
perform a specified transaction with another
party (the option issuer or option writer)
according at specified terms. The owner of a
property might sell another party an option to
purchase the property any time during the next
three months at a specified price. For every
buyer of an option there must be a seller. The
seller is often referred to a s the writer. As with
futures, options are brought into existence by
being traded, if none is traded, none exists;
conversely, there is no limit to the number of
option contracts that can be in existence at any
time. As with futures, the process of closing out
options positions will cause contracts to cease
to exist, diminishing the total number.

Page | 75
Thus an option is the right to buy or sell a
specified amount of a financial instrument at a
pre- arranged price on, or before, a particular
date.

There are two options which can be exercised:

 Call option, a right to buy is referred to


as a call option.
 Put option, the right to sell is referred as
a put option.

OPTION TERMINOLOGY

INDEX OPTIONS: these options have the


index as the underlying. Some options are
European while others are American. European
style options can be exercised only on the
maturity date of the option, which is known as
the expiry date. An American style option can
be exercised at any time up to, and including,
the expiry date. It is to be noted that the
distinction has nothing to do with geography.

Page | 76
Both type of the option are traded through out
the world

STOCK OPTIONS: Stock options are


options on individual stocks. A contract gives
the holder the right to buy or sell shares at the
specified price.

BUYER OF AN OPTION: the buyer of an


option is the one who by paying the option
premium buys the right but not the obligation
to exercise his options on the seller/writer.

WRITER OF AN OPTION: The writer of a


call/put option is the one who receives the
option premium and is thereby obliged to
sell/buy the asset if the buyer exercised on him.

Page | 77
STRIKE PRICE: the price specified in the
options contract is known as the strike price or
the exercise price.

IN THE MONEY OPTION: An in the


money option is an option that would lead to a
positive cash flow to the holder if it were
exercised immediately. A call option on the
index is said to be in-the-money (ITM) when
the current index stands at a level higher than
the strike price (i.e. spot price> strike price). If
the index is much higher than the strike price,
the call is said to be deep ITM.. In the case of a
put, the put is ITM if the index is below the
strike price.

AT THE MONEY OPTION: An at the


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

Page | 78
OUT OF THE MONEY OPTION: An out
of the money (OTM) option is an option that
would lead to a negative cash flow if it were
exercised immediately. A call option on the
index is out of the money when 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 strike price, the
call is said to be deep OTM. In the case of a
put, the put is OTM if the index is above the
strike price.

INTRINSIC VALUE OF AN OPTION:


The option premium can be broken down into
two components- intrinsic value and time
value. The intrinsic value of a call is the
amount the option is ITM, if it is ITM. If the
call is OTM, its intrinsic value is zero.

TIME VALUE OF AN OPTION: The time


value of an option is the difference between its
premium and its intrinsic value. Usually, the
maximum time value exists when the option is
ATM. The longer the time to expiration, the
greater is an option’s time value, or else equal.
Page | 79
At expiration, an option should have no time
value.

STRATEGIES IN FUTURES
AND OPTIONS

The following are the four basic


strategies in options market which can be
further designed in combination of one or more
of the basic strategies, but all the complex
strategies are based on the following 4 basic
kind of strategies, so the understanding of these
4 strategies is very essential before we go any
further:

BUYING A CALL OPTION

Page | 80
A buyer of the option paying a premium
(price) for the option to buy a specified
quantity at a specified price any time prior to
the maturity of the option.

We can consider the live example of


taking a call option of GMR Infrastructure at a
strike price of Rs.500, a call can be taken upto
a duration of 3 months form now. Here we
have taken a call at the strike price of Rs.500,
at a premium of Rs. 25 on 01-06-2009.

The following is the tabulation of the payoffs at


expiration.

STOCK PRICE ON GROSS PAYOFF ON NET PAYOFF ON


EXPIRY OPTION OPTION
400 0 -25
450 0 -25
500 0 -25
550 50 25
600 100 75
650 150 125
700 200 175
750 250 225
Table: A
Page | 81
The following is the graphical representation of
the above strategy:

CALL OPTION PAYOFF

300
250
200
PAYOFF

150 GROSS PAYOFF

100 NET PAYOFF

50
0
-50
400 450 500 550 600 650 700 750
PRICE

Figure: C

In the above example when GMR falls to


a price of Rs.400, the buyer of the option can
purchase the share form the market at Rs.400
with out exercising the right to buy the stock at
Rs.500. However, on that he incurs a loss of
Rs.25 as the premium being paid for the option
remaining unexercised. But suppose that the

Page | 82
share prices rise to Rs.750 then the holder of
the option has the right to purchase that share
at a price of Rs.500 form the seller of the
option. In this case any price level above
Rs.525 (500+25), which is the breakeven point,
results in a profit for the buyer of the option.
Investment in the above option is
Rs.25*1000=Rs.25000.

In the above diagram we can notice that


the payoffs are one to one after the price of the
underlying security rises above the exercise
price. When the security price is less than the
exercise price, the option is referred to as out of
the money.
Form the above figure it can be seen that
the investor who is already long i.e. holds a
stock bears a loss only to the extent of Rs.25
because no matter if the share price fall below
Rs.500 the investor is not holding any stock.
Once the investor is either long or short the
stock he can adopt any of these strategies to
hedge his risk.
The above strategy was applied in the
month of June

Page | 83
The following are the updates

DATE STRIKE OPEN HIGH LOW


PRICE
01-06-2009 500 27 27 23
15-06-2009 500 54 64.75 52.45
21-06-2009 500 99 104.50 99
27-06-2009 500 200.90 249 200.90
Table: B

As it can be seen from the above table


that the call option price of the stock has given
a fantastic return of over 900% on investment
of Rs.25000 only. Here the risk of the above
investment was limited only to Rs.25000

BUYING A PUT
The second strategy is the put strategy where
the buyer of the put option has to pay a
premium(price) for the option to sell a
specified quantity at a specified price any time
prior to the maturity of the option. Here we
take the example of buying a put option on the
stock of AIR DECCAN. The exercise price was
Rs.140. The premium paid on the above option

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was Rs.4.10 on 04-06-2009. investment in the
above strategy is Rs.4.10*2500=Rs.10,250.

The pay off form a put can be illustrated.


Notice that the payoffs are one to one when the
price of the security is less than the exercise
price.

PRICE GROSS PAYOFF NET PAYOFF


110 30 24.9
120 20 14.9
130 10 4.9
140 0 -4.1
150 0 -4.1
160 0 -4.1
170 0 -4.1
Table: C

Following are the update of the above option

DATE STRIKE OPEN HIGH LOW


PRICE
04-06-2009 140 4.40 4.40 4.40

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07-06-2009 140 4.00 4.00 4.00
08-06-2009 140 4.90 8.75 4.90
27-06-2009 140 6.75 6.75 6.75
Table: D

The following is the graphical representation of


the above strategy:

PUT OPTION PAYOFF

35
30
25
20
PAYOFF

15 GROSS PAYOFF
10 NET PAYOFF
5
0
-5
-10
110 120 130 140 150 160 170
PRICE

Figure: D

A put option is a contact giving its owner


the right to sell a fixed amount of a specified
underlying asset at a price at any time on or
before a fixed date. On the expiration date, the
value of the put on a per share basis will be the

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larger of the exercise price minus the stock
price or zero.

In the above diagram we can notice how


the down side risk is minimized if the stock is
volatile and the share prices may fall.

Here an investor will get profits only if the


stock falls below Rs.134.9
In this option the investor has gained 64.6%
with in a month.

WRITING THE CALL OPTIONS

A call option gives the buyer the right to


buy the underlying asset at the strike price
specified in the option. For selling the option,
the writer of the option charges a premium. The
profit/loss that the buyer makes on the option
depends on the spot price of the underlying.
Whatever is the buyer’s profit is the seller’s
loss. If upon expiration, the spot price exceeds
the strike price, the buyer will exercise the
option on the writer. Hence as the spot price

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increases the writer of the option starts making
losses. Higher the spot price more is the loss he
makes, if upon expiration the spot price of the
underlying is less than the strike price, the
buyer lets his option expire unexercised and the
writer gets to keep the premium.

As the options are always costly at the


beginning of the month we have written a call
option on CAIRN INDIA LIMITED ON 1st of
June at a strike price of Rs.140 with a premium
of Rs.8.5,

Following is the payoff chart for the above


option:

PRICE GROSS PAYOFF NET PAYOFF


110 0 8.5
120 0 8.5
130 0 8.5
140 0 8.5
150 -10 -1.5
160 -20 -11.5
170 -30 -21.5
Table: E

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Following are the updates of the option rates in
the market:

DATE STRIKE OPEN HIGH LOW


PRICE
01-Jun-2009 140.00 8.5 8.5 8.5
12-Jun-2009 140.00 2.4 4.2 2.1
20-Jun-2009 140 4.35 4.85 2.35
28-Jun-2009 140 4.30 4.90 4.2
Table: F
The following is the graphical representation of
the above strategy:

CALL WRITTING PAYOFF CHART

15
10
5
0
PAYOFF

-5
GROSS PAYOFF
-10
-15 NET PAYOFF
-20
-25
-30
-35
110 120 130 140 150 160 170
PRICE

Figure: E

From the above we can notice that the


liability is potentially unlimited when a
150 investor are writing options.

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Here we can see that the investment in
this option is nil, as the call writer will get the
premium at which he is writing. The net return
on this option at the expiry period was
Rs.10,624.

WRITING OF PUT OPTIONS

A put option gives the buyer the right to


sell the underlying asset at the strike price
specified in the option. For selling the option,
the writer of the option charges a premium, the
profit/loss that the buyer makes on the option
depends on the spot price of the underlying.
Whatever is the buyer’s profit is the seller’s
loss. If upon expiration, the spot price of the
underlying happens to be below the strike
price, the buyer will exercise the option on the
writer. If upon the expiration the spot price of
the underlying is more than the strike price, the
buyer lets his option expire un-exercised and
the writer gets to keep the premium.

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The put writer will first get a premium of
amount Rs.9375

Following is the payoff chart of writing the put


option

PRICE GROSS PAYOFF NET PAYOFF


650 -150 -125
700 -100 -75
750 -50 -25
800 0 25
850 0 25
900 0 25
Table: G

The following is the graphical representation of


the above strategy:

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WRITING PUT OPTION PAYOFF

50

PAYOFF
-50 GROSS PAYOFF

-100 NET PAYOFF

-150

-200
650 700 750 800 850 900
PRICE

Figure: F

As with the written call, the upside is limited to


the premium of the option (the initial price).
The downside is limited to the minimum asset
price-which is zero. We can clearly see from
these diagrams that the investor, depending
upon his risk appetite and the outlook about the
market conditions, can minimize his losses.

The net return on this option at the expiry


period was Rs.8, 212.5

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FIRDAY MARKET ANALYSIS

DIFFERENC
DATE 1 2 3 4 5 E

06-Mar 8198 8104 8348 8047 8326 128


13-Mar 8344 8481 8793 8481 8757 413
20-Mar 9002 8951 9000 8867 8967 -35
1003 1012 1004
27-Mar 10003 7 8 9913 8 45
1106 1134 1094 1102
17-Apr 10947 8 0 6 3 76
1115 1136 1107 1132
24-Apr 11135 0 3 0 9 194
1209 1218 1176 1187
08-May 12117 2 1 5 6 -241
1194 1221 1194 1217
15-May 11872 9 9 9 2 300
1366 1393 1361 1388
22-May 13736 3 7 1 7 151
1432 1472 1432 1462
29-May 14296 0 7 0 5 329

PRE'S
1 CLOSED
2 Open
3 HIGH
4 LOW
5 CLOSING

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Conclusions according to my
study

 Volatile markets are characterized by


wide price fluctuations and heavy
trading.
 Inverters get time to pay money ie
clearing of cheque will be on monday.
 Settlement day or closing day of
week.
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In my study its
says that to invest on Thursday and
withdraw on firday . stock broker says
Monday as black monday

CONCLUSIONS

1) Derivatives in equity specially are more


suited to provide for hedging and more
cost effective. It has less risky and more
profitable.

2) As the stock Index Futures and Options


are available, the FII’s buying /selling
operations can be performed at greater
speed and less cost and without adding
too much to market volatility.

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3) Most of investors are trading not only in
derivatives for hedging, but also for other
purposes.

4) Derivatives do not create any new risk.


They simply manipulate risks and
transfer them to those who are willing to
bear these risks.

5) Hedging through derivatives reduces the


risk of owning a specified asset, which
may be share currency etc.

6) All derivative instruments are very


simple to operate. Treasury managers
and portfolio managers can hedge all
risks without going through the tedious
process of hedging each day and
amount/share separately.

7) Derivatives also offer high liquidity. Just


as derivatives can be contracted easily, it
is also possible for companies to get out
of positions in case that market reacts

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otherwise. This also does not involve
much cost.

8) Derivatives are not only desirable but


also necessary to hedge the complex
exposure and volatility that the financial
companies generally face in the capital
markets today.

9) All derivative products are low cost


products. Companies can hedge a
substantial portion of their balance sheet
exposure, with a low margin requirement.
There is no

assured route for success. This is a fact which is

universally applicable and so in case of

investment. There is no short cut formula which

could be applied instantly and make money out

of it instantly in the stock market. Therefore, a

good investment takes time, patience, hard

work and perseverance to achieve success.

Over the next ten – twenty years, Indian capital

market and stock market may offer some of the


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best and lucrative opportunities to make big

money as compared to other investment

avenues.

SUGGESTIONS

1. There is a need to educate the investor in


futures and options market, due to its
complex nature an investor fails to
understand the risk reward of a particular
strategy, which may result into losses for
the investor.

2. An investor must also be thought as to


which strategy must be applied at what
situation, as application of appropriate
strategy at appropriate situation will
results into profitable transactions

3. An investor must also be suggested to


write certain derivative exams conducted
by leading financial organization in the

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country for proper understanding of the
derivative market.

4. The research reports must be made more


explanatory which must show the risk
covered in a particular strategy and the
return which the investor can expect, it
must be accompanied by payoff chart
along with the line graph of the strategy
suggested.

5. Anand Rathi Securities can conduct


certain investor education camps in
collaboration with leading media
channels, which will serve both the
purpose which are brand advertisement
and investor awareness.

6. There is a need to start derivative trading


at all stock exchanges in all over India.
As of now it’s limited to BSE and NSE.

7. A formal mechanism should be


established for co-ordination between

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SEBI and RBI in respect of all financial
derivatives

8. Administrative machinery of existing


stock exchanges should be strengthened
wherever necessary. Tight supervision is
essential for successful derivative
trading.

9. SEBI has to implement more powerful


rules and regulations and implement
certain measures for taking strict action
against all illegal transactions.

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BIBLIOGRAPHY

• WWW.GOOGLE.COM
• WWW.WIKIPEDIA.COM
• WWW.BSEINDIA.COM
• WWW.NSEINDIA.COM
• WWW.ANANDRATHI.COM
• WWW.MONEYCONTROL.COM

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