A REPORT

ON
STUDY OF DERIVATIVES (FUTURES AND OPTIONS)

BY
K NAGESH GOUD
(17N31E00A9)

KARVY STOCK BROKING LIMITED

 ABSTRACT

I, NAGESH GOUD (17N31E00A9), has done internship at KARVY STOCK BROKING

LTD., HYDERABAD. The firm has given me the opportunity to work in the financial
department by gaining knowledge about the stock market and learning about the Equity and
derivatives including futures, options, currency and swaps.

The project involves the study of materials provided by KARVY on financial market, as well
as understanding the types of derivatives that are being used as a toll for hedging.

FIRST PHRASEThe main objective of project is to understand the different products being
traded in Indian stock market and different financial services provided by KARVY Stock
Broking Ltd. The study is mainly focused on the study of Derivatives market.

SECOND PHRASE included obtaining knowledge regarding Futures and Options in

Derivative market. The main players in the derivative market. The different terminologies. As
a part of it I have obtained some data to know about the pricing models in Futures and
Options market.And also, how futures and options are used for hedging, settlement process
strategies. With the data gathered I was able to understand the trends and techniques of how
the price fluctuates with the activities of trading in the market.

THIRD PHRASEWith the data gathered I was able to understand the trends and techniques
of how the price fluctuates and regarding pay offs through graphs in different cases with the
activities of trading in the market and also regarding the settlement.
 AUTHORIZATION

This is to certify that this report is submitted in partial fulfilment of the

requirements of MBA program of MALLA REDDY COLLEGE OF
ENGINEERING & TECHNOLOGY , Hyderabad.

This report document titled: "STUDY ON DERIVATIVES MARKET" is done

by K NAGESH GOUD(17N31E00A9) as a part of the completion of the study
at KARVY STOCK BROKING Ltd. during internship program from 5th March
2019 to 20th April 2019 under the guidance of Mr. SREEDHAR
CHALAMALASETTY (Branch Manager), Mr. RAJESH SIR (COMPANY
GUIDE) and ASSISTANT PROFFESOR Mr. N RAJESH BABU (Faculty
guide).

K NAGESH GOUD

MALLA REDDY COLLEGE OF ENGINEERING & TECHNOLOGY

(17N31E00A9)
ACKNOWLEDGEMENT:

The satisfaction, which accompanies the successful completion of any task, is

incomplete without the mention of names of those people who made it possible,
because success is epitome of hard work, perseverance, zeal, determination and
the most encouraging guidance and advice which serves as a beacon of light and
crowns our efforts with success. Hence it becomes imperative to thank them by
acknowledging their valuable inputs.

I wish to express my gratitude to KARVY STOCK BROKING Ltd for giving

me an opportunity to be a part of their esteemed organization and enhance my
knowledge by granting permission to do summer training project under their
guidance.

My deep sense of gratitude and sincere appreciation to my company guides, Mr.

SRIDHAR SIR (BRANCH MANAGER), Mr. KARUNAKAR (HR), Mr.
VISHAL ANAND (COMPANY GUIDE) and Mr. RAJESH SIR
(COMPANY GUIDE) continuous support, advice and encouragement, without
which this report could never have been completed.
I am grateful, to my faculty guide Asst. Prof N RAJESH BABU For his
valuable suggestions, comments, feedback and support throughout the
internship.

I am also obliged to thank my parents for their moral support which helped me
in conclusion of my project successfully.
Last but not least I thank the Almighty for giving me strength and courage
morally and physically so as to make this project a successful one.
 TABLE OF CONTENTS:

S No. TOPIC
1 Introduction
1.1 Scope of study
1.2 objectives of study
1.3 limitations of the study
2 Industry profile
3 Company overview
3.1Karvy group of companies
3.2major companies
3.3 Financial performance
3.4Market share
4 Main text
4.1Introduction of derivatives
4.2Factors driving growth of derivatives
4.3Historical view of Futures and Options
4.4Risks involved in derivatives
4.5Major players and contract periods
4.7Members of F&O
5 FUTURES AND OPTIONS
5.1 Introduction of futures
5.2 Features of futures
5.3Futures terminology
5.4 Types of futures& payoffs
5.5How future market works
5.6Pricing of futures
5.7Introduction to options
5.8 Parties to contract
5.9 Types of options
5.10Options terminology
5.11Pay off charts for options
5.13Eligible criteria to trade in F&O
5.14Trading mechanism of F&O
5.15Open interest
6 Span Margins of Equity futures
7 Observations and suggestions
8 Conclusions
9 Reference links
 LIST OF ILLUSTRATIONS

Graph 1, Table 1 & Long Futures Pay off

Graph 2
Graph 3, Table 2 & Short Futures Pay off
Graph 4
Graph 5, Table 3 & Long Call Pay off
Graph 6
Graph 7, Table 4 & Short Call Pay off
Graph 8
Graph 9, Table 5 & Long Put Pay off
Graph 10
Graph 10, Table 6 & Short Put Pay off
Graph 11

1. INTRODUCTION
The derivative is a financial instrument which derives its value from the underlying asset. The
underlying asset can be Equity, commodity, currency, bonds, or security. Derivatives are
mostly used for hedging the risk which is associated with owning the underlying asset. In
other way it is to transfer the price risk (inherent in fluctuations of the asset prices) from one
party to another; they facilitate the allocation of risk to those who are willing to take it. In so
doing, derivatives help mitigates the risk arising from the future uncertainty of prices.

Financial derivatives came into spotlight in the year 1970 period due to growing
instability in the financial markets. However, since their emergence, these accounted for
about two-third of totals transactions in derivatives products. In recent years, the market for
financial derivatives has grown tremendously in terms of variety of instruments available,
there complexity & also turn over. In the class of equity derivatives Futures & options on
stock also turn over. In the class of equity derivatives, futures & options on stock indicates
gained more popularly than individual stocks.

To understand how a derivative contract work let’s take an example. On November 1,

2009 a rice farmer may wish to sell his harvest at a future date (say January 1, 2010) for a
pre-determined fixed price to eliminate the risk of change in prices by that date. Such a
transaction is an example of a derivatives contract. The price of this derivative is driven by
the spot price of rice which is the "underlying".

Derivatives can either be traded over-the-counter (OTC) or on an exchange. OTC

derivatives constitute the greater proportion of derivatives in existence and are unregulated,
whereas derivatives traded on exchanges are standardized. OTC derivatives generally have
greater risk for the counterparty than do standardized derivatives.

1.1SCOPE OF THE STUDY

 The scope of the study is limited to “DERIVATIVES” with the special reference to
Indian context and the National stock exchange has been taken as a representative
sample for the study. The study includes futures and options.
 My analysis part is limited to selecting the investment option it means that whether
we have to invest cash market or in derivatives market.
 I have taken only four different organizations from four different industries to analyse
and interpret the results.
  Based upon four criteria’s only open interest is evaluated for analysing the trend of
market as well as price movement.
 This study mainly covers the area of hedging and speculation. The main aim of the
study is to prove how risks in investing in equity shares can be reduced and how to
make maximum return to the other investment.

1.2 OBJECTIVES OF THE STUDY

The objectives for my research are as below

 Tocalculate the risk and return of investment in futures and investment in options
 To identifies the market trend and price movement based upon the open interest
changes
 To analyse the role of futures and options in Indian financial system
 To understand about the derivatives market.
 To know why derivatives is considered safer than cash market.
 To construct portfolio and analyses the risk return relationship.
 To hedge the most profitable portfolio.

1.3 LIMITATIONS

The limitations of the study are as under:

 Share market is so much volatile and it is difficult to forecast anything about it
whether you trade through online or offline

 The time available to conduct the study was only 3 months. It being a wide topic had
a limited time to understand the whole derivatives market.

2. INDUSTRY PROFILE

Stock Market is the place where shares of public listed companies are traded. The primary
market is where companies float shares to the general public in an Initial Public Offering
(IPO) to raise capital. Once new securities have been sold in the primary market, they are
traded in the secondary market. In secondary market, one investor will buy shares from
another at prevailing market price or whatever price both the buyer and seller agree upon. In
India, the primary and secondary market are governed by the Security and Exchange Board
of India(SEBI).

A stock exchange facilitates stock brokers to trade company stocks and other
securities. A stock may be bought or sold only if it is listed on an exchange. Thus, it is the
meeting place of the stock buyers and sellers. India's premier stock exchanges are the
Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).

Most of the trading in the Indian stock market takes place on its two stock exchanges:
the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). The BSE has
been in existence since 1875. The NSE, on the other hand, was founded in 1992 and started
trading in 1994. However, both exchanges follow the same trading mechanism, trading hours,
settlement process, etc. Overall BSE has around 8900 stocks listed in that only 3000 stocks
will be traded daily. It is the World's busy stock exchange with a median trade speed of 6
microseconds. BSE is the world's 11th largest stock Exchange. NSE is a platform where the
shares of company are traded. The NSE's index value, NIFTY is arrived at by taking the
market capitalization value of 50 companies from various industries. It is also called NIFTY
50. Almost all the significant firms of India are listed on both the exchanges. NSE enjoys a
dominant share in spot trading, with about 70% of the market share, as of 2009, and almost a
complete monopoly in derivatives trading, with about a 98% share in this market, also as of
2009. Both exchanges compete for the order flow that leads to reduced costs, market
efficiency and innovation. The presence of arbitrageurs keeps the prices on the two stock
exchanges within a very tight range.

Trading at both the exchanges takes place through an open electronic limit order
book, in which order matching is done by the trading computer. There are no market makers
or specialists and the entire process is order-driven, which means that market orders placed
by investors are automatically matched with the best limit orders. As a result, buyers and
sellers remain anonymous. The advantage of an order driven market is that it brings more
transparency, by displaying all buy and sell orders in the trading system. However, in the
absence of market makers, there is no guarantee that orders will be executed.
 All orders in the trading system need to be placed through brokers, many of which
provide online trading facility to retail customers. Institutional investors can also take
advantage of the direct market access (DMA) option, in which they use trading terminals
provided by brokers for placing orders directly into the stock market trading system.
Different brokers have different brokerage charges. Karvy charges 0.03% for Intraday and
0.3% in case of delivery.

Equity spot markets follow a T+2 rolling settlement. This means that any trade taking
place on Monday, gets settled by Wednesday. All trading on stock exchanges takes place
between 9:15 am and 3:30 pm, Monday through Friday. Delivery of shares must be made in
dematerialized form, and each exchange has its own clearing house, which assumes all
settlement risk, by serving as a central counterparty.

The two prominent Indian market indexes are SENSEX and NIFTY. Sensex is the
oldest market index for equities, it includes shares of 30 firms listed on the BSE. It represents
about 45% of the index's free-float market capitalization. Another index is the Nifty, it
includes 50 shares listed on the NSE. It represents about 62% of its free-float market
capitalization.

3. COMPANY OVERVIEW
The Karvy group was formed in year 1983 at Hyderabad, India and is now headed by Mr C.
Parthasaradhi as Chairman. The group has more than 30000 employees, spanning 900 offices
in about 400 cities and towns. Karvy is one of the leading financial services conglomerate.
Karvy ranks among the top players in almost all the fields it operates. Karvy stock broking
limited, a member of National stock exchange of India and Bombay stock exchange in India,
ranks among top 5 stock brokers. Over 600000 active accounts, ranks among the top 5
Depository participant in India.

Karvy offers the entire spectrum of financial services, via stock broking, depository
participant, distribution of financial products including mutual funds, bonds, commodities
broking, personal finance, advisory services, merchant banking and corporate finance, wealth
management and NBFC. Karvy provides non-financial services including Date management
services, International BPO, Data analytics and Market Research.

3.1 Karvy Group of companies:

• Karvy Stock broking ltd
Equity broking, Depository participant, Distribution of Financial products, Wealth
management, Currency derivatives, portfolio management services.
• Karvy com trade ltd
Commodities broking
• Karvy capital ltd
NBFC and Portfolio manager
• Karvy Investment advisory services ltd
Investment advisory services
• Karvy holdings ltd
Core Investment Company
• Karvy middle east ltd
Wealth Management products for NRI's
• Karvy financial services ltd
Non-Banking financial services
• Karvy Insurance Repository ltd
• Karvy Forex and currencies private ltd
• Karvy Consultants ltd
• Karvy Computer share private ltd
• Karvy Data management services ltd
 • Karvy Investor services ltd

3.2 Major Competitors

• ICICI Direct
• IIFL
• Angel Broking
• India Bulls
• MotilalOswal securities

3.3 Financial performance

 The total paid-up capital INR 2.26 crores.

 The company have secured loans in amount of 395 crores
 Net profit after tax in year 2015-16 is INR1160.08 lakhs.
 Company’s net worth in 2016 ending is INR 42462 lakhs

Profit and loss statement of past three years (Amount in lakhs)

Particulars FY 2013-14 FY 2014-15 FY 2015-16

Gross Income 29401.86 35797.88 35203.66
Profit before tax 5517.65 5880.45 1808.75
Profit after tax 3634.64 3860.45 1160.08
Earnings per share 6.07 5 1.35

3.4 Market share:

1. Karvy has 10 lakhs Demat accounts, holding stocks. 220000 are the average number
of traders per day through Karvy.
2. Karvy stands at 4th place among top stock brokers in India.
3. Turnover wise Karvy is in first place in stock broking business
4. Karvy stock broking has 460 branches in 25 states.

Client base of Karvy in year 2016-17 in NSE is 1746090 and BSE 3936800.

4.MAIN TEXT

4.1 INTRODUCTION OF DERIVATIVES:

DEFINITION
 Derivative is a product whose value is derived from the value of one or more basic
variables, called bases (underlying asset, index, or reference rate), in a contractual
manner. The underlying asset can be equity, forex, commodity or any other asset. For
example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk
of a change in prices by that date. Such a transaction is an example of a derivative. The
price of this derivative is driven by the spot price of wheat which is the "underlying".

4.2 FACTORS DRIVING THE GROWTH OF DERIVATIVES

Over the last three decades, the derivatives market has seen a phenomenal growth. A
large variety of derivative contracts have been launched at exchanges across the world. Some
of the factors driving thegrowth of financial derivatives are:
1. Increased volatility in asset prices in financial markets,
2. Increased integration of national financial markets with the international markets,
3. Marked improvement in communication facilities and sharp decline in their costs,
4. Development of more sophisticated risk management tools, providing economic agents a
wider choice of risk management strategies, and
5. Innovations in the derivatives markets, which optimally combine the risks and returns over
a large number of financial assets leading to higher returns, reduced risk as well as
transactions costs as compared to individual financial assets.

4.3 HISTORICAL VIEW OF FUTURES AND OPTIONS

Early forward contracts in the US addressed merchants' concerns about ensuring that there
were buyers and sellers for commodities. However, 'credit risk" remained a serious problem.
To deal with this problem, a group of Chicago businessmen formed the Chicago Board of
Trade (CBOT) in 1848. The primary intention of the CBOT was to provide a centralized
location known in advance for buyers and sellers to negotiate forward contracts. In 1865, the
CBOT went one step further and listed the first 'exchange traded" derivatives contract in the
US, these contracts were called 'futures contracts". In 1919, Chicago Butter and Egg Board, a
spin-off of CBOT, was reorganized to allow futures trading. Its name was changed to Chicago
Mercantile Exchange (CME). The CBOT and the CME remain the two largest organized
futures exchanges, indeed the two largest "financial" exchanges of any kind in the world
today. The first stock index futures contract was traded at Kansas City Board of Trade.
Currently the most popular stock index futures contract in the world is based on S&P 500
index, traded on Chicago Mercantile Exchange. Index futures, futures on T-bills and Euro-
Dollar futures are the three most popular futures contracts traded today. Other popular
international exchanges that trade derivatives are LIFFE in England, DTB in Germany, SGX
in Singapore, TIFFE in Japan, MATIF in France, Euro ex etc.

INDEX FUTURES (JUNE 12, 2000)

INDEX OPTIONS (JUNE 4, 2001)

STOCK OPTIONS (JULY 2, 2001)

STOCK FUTURES (NOVEMBER 9, 2001)

Flow of futures and options in NSE

4.4 Risks involved in Derivatives:

Derivatives are used to separate risks from traditional instruments and transfer these risks to
parties willing to bear these risks. The fundamental risks involved in derivative business
includes

 Credit Risk: This is the risk of failure of a counterpart to perform its obligation as
per the contract. Also known as default or counterpart risk, it differs with different
instruments.
 Market Risk: Market risk is a risk of financial loss as result of adverse movements
of prices of the underlying asset/instrument.
 Liquidity Risk: The inability of a firm to arrange a transaction at prevailing market
prices is termed as liquidity risk. A firm faces two types of liquidity risks:
o Related to liquidity of separate products.
o Related to the funding of activities of the firm including derivatives.
  Legal Risk: Derivatives cut across judicial boundaries, therefore the legal aspects
associated with
The deal should be looked into carefully.

4.5 MAJOR PLAYERS IN DERIVATIVE MARKET:

There are three major players in their derivatives trading.

 Hedgers.
 Speculators.
 Arbitrageurs.

Hedgers:They are the kind of people who have the risk associated with owning the
underlying asset and based on this view, they use derivative instruments to reduce the risk of
owning the underlying asset.

In general Hedging means reduction of risk. An investor who looks to reduce his risk is
known as a Hedger. A Hedger would typically look at reducing his asset exposure to price
volatility and in a derivative market, would usually take up a position that is opposite to the
risk he is otherwise exposed to.

Hedgers primarily look at limiting their exposure risk. This is done by using derivative tools
and “insuring” limited losses in case of unfavourable movements in the underlying asset.

Speculators:They try to predict the future movements in the prices of the underlying asset
and take position in derivative contracts.

speculators hypothesize expected price movements and take accordant positions that
maximize profit. Speculators are extremely high-risk takers who are in the Derivative
markets merely for the purpose of making profits. They need to effectively forecast market
trends to take positions that don’t in any way guarantee safely of invested capital or returns.

Arbitrageurs:They take advantage of a price difference of a product in two different

markets.

An arbitrageur is a type of investor who attempts to profit from price inefficiencies in the
market by making simultaneous trades that offset each other to capture risk-free profits. An
arbitrageur would, for example, seek out price discrepancies between stocks listed on more
than one exchange by buying the undervalued shares on one exchange while short selling the
same number of overvalued shares on another exchange, thus capturing risk-free profits as
the prices on the two exchanges converge.

4.6 Contract Periods:

At any point of time there will be always be available nearly 3months contract periods
in Indian Markets.

They are

1. Near Month
2. Next Month
3. Far Month

For example, in the month of September 2008 one can enter into September futures contract
or October futures contract or November futures contract. The last Thursday of the month
specified There are three types of members in the futures and options segment. They are
trading members, trading cum clearing member and professional clearing members.

in the contract shall be the final settlement date for the contract at both NSE as well as BSE It
is also known as Expiry Date.
Settlement:

The settlement of all derivative contracts is in cash mode. There is daily as well as final
settlement. Outstanding positions of a contract can remain open till the last Thursday of the
month. As long as the position is open, the same will be marked to market at the daily
settlement price, the difference will be credited or debited accordingly and the position shall
be brought forward to the next day at the daily settlement price. Any position which remains
open at the end of the final settlement day (i.e. last Thursday) shall closed out by the
exchanged at the final settlement price which will be the closing spot value of the underlying
asset.

Margins:

There are two types of margins collected on the open position, viz., initial margin which is
collected upfront which is named as “SPAN MARGIN” and mark to market margin, which is
to be paid on next day. As per SEBI guidelines it is mandatory for clients to give margins,
fail in which the outstanding positions or required to be closed out.

4.7 Members of F & O segment:

Trading members are the members of the derivatives segment and carrying on the transaction
on the respective exchange.

The clearing members are the members of the clearing corporation who deal with payments
of margin as well as final settlements.

The professional clearing member is a clearing member who is not a trading member.
Typically, banks and custodians become professional clearing members.

It is mandatory for every member of the derivatives segment to have approved users who
passed SEBI approved derivatives certification test, to spread awareness among investors.

4. FUTURES AND OPTIONS:

5.1. INTRODUCTION TO FUTURES

A futures contract is an agreement between two parties to buy or sell an asset at a certain time
in the future at a certain price. The futures contracts are standardized and exchange traded. To
facilitate liquidity in the futures contracts, the exchange specifies certain standard features of
the contract. It is a standardized contract with standard underlying instrument, a standard
quantity and quality of the underlying instrument that can be delivered, (or which can be used
for reference purposes in settlement) and a standard timing of such settlement.
The standardized items in a futures contract are:
 Quantity of the underlying
 Quality of the underlying
 The date and the month of delivery
 The units of price quotation and minimum price change
 Location of settlement
 Futures contracts in physical commodities such as wheat, cotton, gold, silver, cattle,
etc. have existed for a long time. Futures in financial assets, currencies, and interest-
bearing instruments like treasury bills and bonds and other innovations like futures
contracts in stock indexes are relatively new developments.

 The futures market described as continuous auction markets and exchanges providing
the latest information about supply and demand with respect to individual
commodities, financial instruments and currencies, etc

 Futures exchanges are where buyers and sellers of an expanding list of commodities;
financial instruments and currencies come together to trade. Trading has also been
initiated in options on futures contracts. Thus, option buyers participate in futures
markets with different risk. The option buyer knows the exact risk, which is unknown
to the futures trader.

For example:
Suppose you decide to buy a certain quantity of goods. As the buyer, you enter into an
agreement with the company to receive a specific quantity of goods at a certain price
every month for the next year. This contract made with the company is similar to a
futures contract, in that you have agreed to receive a product at a future date, with the
price and terms for delivery already set. You have secured your price for now and the
next year - even if the price of goods rises during that time. By entering into this
agreement with the company, you have reduced your risk of higher prices.
So, a futures contract is an agreement between two parties:
 A short position - the party who agrees to deliver a commodity
 A long position - the party who agrees to receive a commodity.
In every futures contract, everything is specified: the quantity and quality of the
commodity, the specific price per unit, and the date and method of delivery. The “price” of
a futures contract is represented by the agreed-upon price of the underlying commodity or
financial instrument that will be delivered in the future.

5.2Features of Futures Contracts:

The principal features of the contract are as follows:

 Organized Exchanges: Unlike forward contracts which are traded in an over – the -
counter market, futures are traded on organized exchanges with a designated physical
location where trading takes place. This provides a ready, liquid market which futures
can be bought and sold at any time like in a stock market.

 Standardization: In the case of forward contracts the number of commodities to be

delivered and the maturity date are negotiated between the buyer and seller and can be
tailor made to buyer’s requirement. In a futures contract both these are standardized
by the exchange on which the contract is traded.

 Clearing House: The exchange acts a clearinghouse to all contracts struck on the
trading floor. For instance, a contract is struck between capital A and B.
uponentering into the records of the exchange, this is immediately replaced by two
contracts, one between A and the clearing house and another between B and the
clearing house. In other words, the exchange interposes itself in every contract and
deal, where it is a buyer to seller, and seller to buyer. The advantage of this is that A
and B do not have to undertake any exercise to investigate each other’s credit
worthiness. It also guarantees financial integrity of the market. The enforce the
delivery for the delivery of contracts held for until maturity and protects itself from
default risk by imposing margin requirements on traders and enforcing this through a
system called marking – to – market.
  Actual delivery is rare:In most of the forward contracts, the commodity is actually
delivered by the seller and is accepted by the buyer. Forward contracts are entered
into for acquiring or disposing of a commodity in the future for a gain at a price
known today. In contrast to this, in most futures markets, actual delivery takes place
is less than one percent of the contracts traded. Futures are used as a device to hedge
against price risk and as a way of betting against price movements rather than a means
of physical acquisition of the underlying asset. To achieve, this most of the contracts
entered into are nullified by the matching contract in the opposite direction before
maturity of the first.

 Margins: In order to avoid unhealthy competition among clearing members is

reducing margins to attract customers, a mandatory minimum margin are obtained by
the members from the customers. Such a stop insures the market against serious
liquidity crises arising out of possible defaults by the clearing members. The
members collect margins from their clients has may be stipulated by the stock
exchanges from time to time and pass the margins to the clearing house on the net
basis i.e. at a stipulated percentage of the net purchase and sale position.

5.3Future Terminology:
A. Spot Price:
The price at which the underlying asset is available for cash in the stock market.

B. Futures Contract Price:

The price at which the underlying asset will be available at a future date. Futures
contract can be classified into two types mainly:
 Index Futures
 Stock Futures

C. Contract Cycle: Exchange will decide over what period the contracts will be
available for trading. At any given point of time the maximum number of contracts
available for trading will be three-
 Near month
 Mid-month
 Far month

D. Expiry Date:
 In equity derivatives, contracts will expire on last Thursday of every month. As soon
as the near month contract expires, a new contract for the far month is available for
trading.

E. Contract Value:
The minimum contract value for a derivative contract is Rs.5,00,000.

F. Contract size/Lot size:

If the contract value goes below 5,00,000 or above 10,00,000 then the exchange
changes the lot size to contract value of Rs.5,00,000

G. Margin:
Margin is the amount paid by both the buyer and the seller of the future contract to the
broker to enter into a future contract.

H. Mark to Market:
In Mark to Market the margins are adjusted on a daily basis with changes in the price
of futures contract, whether it’s positive or negative.

I. Cost of Carry:
The difference between the cash market price and futures market price.

J. Premium or Discount:
If the price in the future market is more than the cash price of underlying asset - then
the future is said to be trading at Premium. If the price in the future market is less than
the cash price of underlying asset - then the future is said to be trading at Discount.
5.4TYPES OF FUTURES

On the basis of the underlying asset they derive, the futures are divided into two types:

 Index Futures: It is a futures contract on the value of particular stock market index,
such as NIFTY.

 Stock Futures: It is a future contract on the value of particular stock, such as

TATAMOTORS.

5.4 PARTIES IN THE FUTURES CONTRACT

There are two parties in a futures contract, the buyers and the seller. The buyer of the futures
contract is one who is LONG on the futures contract and the seller of the futures contract is
who is SHORT on the futures contract.

The pay-off for the buyers and the seller of the futures of the contracts are as follows:

PAY-OFF FOR BUYER OF FUTURES: LONG FUTURES

P
PROFIT

E
2 F E
LOSS 1

Graph 1
CASE 1: - The buyers bought the futures contract at (F); if the futures
PriceGoes to E1 then the buyer gets the profit of (FP).

CASE 2: -The buyers gets loss when the futures price less then (F); if
The Futures price goes to E2 then the buyer the loss of (FL).

Illustration:

Suppose a person goes long in a future contract of TATAMOTORS at Rs. 500. That means
that he has agreed to buy the underlying at Rs. 500 on expiry. Now, if on expiry, the price
of underlying is Rs. 550, then this person will buy at Rs. 500, as per the future contract
and will immediately be able to sell the underlying in the cash market at Rs. 550, thereby
making the profit Rs. 50. Similarly, if the price of the underlying falls to Rs. 420 at expiry,
he would have to buy at Rs. 500, as per the future contract, and if sell as per the same in
cash market, he would have incurred a loss of Rs. 80.

The below table and pay off chart show long future pay offs:
 Long on TATAMOTORS future at 500
Market price at Long futures
expiry Pay off
400 -100
420 -80
440 -60
460 -40
480 -20
500 0
520 20
540 40
560 60
580 80
600 100

TABLE:1

Graph 2
PAY-OFF FOR A SELLER OF FUTURES: SHORT FUTURES

P
PROFIT

E
2
E F
1

LOSS

Graph 3

F = FUTURES PRICE

E1, E2 = SETTLEMENT PRICE

CASE 1: -The seller sold the future contract at (F); if the future goes to

E1Then the seller gets the profit of (FP).

CASE 2: -The seller gets loss when the future price goes greater than (F);

If the future price goes to E2 then the seller gets the loss of (FL).

Illustration:

As one person goes long, some other person has to go short, otherwise a deal will not take
place. The profit and losses for short futures position will be exactly opposite of the long
future position. This is shown in the below table and chart

Table 2

Short on TATAMOTORS future at 500

 Market price at Long futures
expiry Pay off
400 100
420 80
440 60
460 40
480 20
500 0
520 -20
540 -40
560 -60
580 -80
600 -100

Graph 4

5.5 HOW THE FUTURE MARKET WORKS?

The futures market is a centralized marketplace for buyers and sellers from around the
world who meet and enter into futures contracts. Pricing can be based on an open outcry
system, or bids and offers can be matched electronically. The futures contract will state the
price that will be paid and the date of delivery. Almost all futures contracts end without the
actual physical delivery of the commodity.

5.6PRICING OF FUTURES
The Fair value of the futures contract is derived from a model knows as the cost of carry
model. This model gives the fair value of the contract.
Cost of Carry:
F = S (1+r-q) t
Where,
F- Futures price
S- Spot price of the underlying
r- Cost of financing
q- Expected Dividend yield
t - Holding Period.
Suppose, we buy an index in cash market at 8000 level i.e. purchase of all the stocks
constituting the index in the same proportion as they are in the index, cost of financing is
12% and the return on index is 7% per annum. Given this statistic, fair price of index three
months down the line should be:
=Spot price (1+cost of financing-holding period return) ^ (time to expiration/365)
=8000 (1+0.12-0.04) ^ (90/365)
=8,153.26
If index future is trading above 8,153, we can buy index stocks in cash market and
simultaneously sell index futures to lock the gains equivalent to the difference between
future price and future fair price (the cost of transaction, taxes, margins etc. are not
considered while calculating the future fair value).

NOTE: Cost of borrowing of funds, return expectations on the held asset etc. are different
for the different market participant.

5.7 INTRODUCTION TO OPTIONS

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

DEFINITION
Options are of two types -CALL OPTION

-PUT OPTION

Calls give the buyer the right but not the obligation to buy a given quantity of the underlying
asset, at a given price on or before a given future date. Puts give the buyers the right, but not
the obligation to sell a given quantity of the underlying asset at a given price on or before a
given date.

PROPERTIES OF OPTION

Options have several unique properties that set them apart from other securities. The
following are the properties of option:

 Limited Loss
 High leverages potential
 Limited Life

5.8PARTIES IN AN OPTION CONTRACT

There are two participants in Option Contract.

Buyer/Holder/Owner of an Option:

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

Seller/writer of an Option:

The writer of a call/put option is the one who receives the option premium and is thereby
obliged to sell/buy the asset if the buyer exercises on him.

CHARACTERISTICS OF OPTIONS:

The following are the main characteristics of options:

1. Options holders do not receive any dividend or interest.

2. Options only capital gains.
3. Options holder can enjoy a tax advantage.
 4. Options holders are traded an O.T.C and in all recognized stock exchanges.
5. Options holders can control their rights on the underlying asset.
6. Options create the possibility of gaining a windfall profit.
7. Options holders can enjoy a much wider risk-return combinations.
8. Options can reduce the total portfolio transaction costs.
9. Options enable with the investors to gain a better return with a limited amount of
investment.

5.9TYPES OF OPTIONS

The Options are classified into various types on the basis of various variables. The following
are the various types of options.

1. On the basis of the underlying asset:

On the basis of the underlying asset the options are divided in to two types:

Index options:

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

Stock options:

Stock Options are options on individual stocks. Options currently trade on over 500 stocks in
the United States. A contract gives the holder the right to buy or sell shares at the specified
price.

2.On the basis of the market movements:

On the basis of the market movements the options are divided into two types. They are:

Call Option:

A call Option gives the holder the right but not the obligation to buy an asset by a certain
date for a certain price. It is brought by an investor when he seems that the stock price moves
upwards.
Put Option:

A put option gives the holder the right but not the obligation to sell an asset by a certain date
for a certain price. It is bought by an investor when he seems that the stock price moves
downwards.

3.On the basis of exercise of option:

On the basis of the exercise of the Option, the options are classified into two Categories.

American Option:

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

European Option:

European options are options that can be exercised only on the expiration date itself.
European options are easier to analyse than American options, and properties of an American
option are frequently deduced from those of its European counterpart.

5.10 OPTIONS TERMINOLOGY

Option price/premium:

Option price is the price which the option buyer pays to the option seller. It is also

referred to as the option premium.

Expiration date:

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

Strike price:

The price specified in the option contract is known as the strike price or the exercise price.

In the money (ITM) option

This option would give the holder a positive cash flow if it were exercised immediately. A
call option is said to be ITM, when spot price is higher than strike price. And a put option is
said to be ITM when spot price is lower than strike price. In example, call option is in the
money.
At the money (ATM) option
At the money option would lead to zero cash flow if it were exercised immediately.
Therefore, for both call and put ATM options strike price is equal to spot price.
Out of the money (OTM) option
This option would give the holder a negative cash flow if it were exercised immediately. A
call option is said to be ITM, when spot price is lower than strike price. And a put option is
said to be ITM when spot price is higher than strike price. In example, put option is out of the
money.

Intrinsic value
Option premium is consisting of two components – Intrinsic value and time value
For an option, intrinsic value refers to the amount by which is option in the money i.e. the
amount an option buyer will realize, before adjusting for premium paid, if he exercises the
option instantly. Therefore, only ITM option has intrinsic value whereas ATM and OTM
options have zero intrinsic value. The intrinsic value of an option can never be negative.
Thus, for call option which is ITM, intrinsic value is the excess of spot price (S) over the
exercise price (X). Thus, intrinsic value of call option can be calculated as S-X, with
minimum value possible as zero because no one would like to exercise his right under no
advantage condition.
Similarly, for put option which is ITM, intrinsic value is the excess of exercise price (X) over
the strike price (S). Thus, intrinsic value of put option can be calculated by as X-S, with
minimum value possible as zero.
Intrinsic value and time value for calls:
In the case of a call, intrinsic value is the amount by which the underlying futures price
exceeds the strike price:
Futures Price – Strike Price = Intrinsic Value
(must be positive or 0)

Illustration: June CME Live Cattle futures are trading at 82.50 cents/lb. and the June 80
CME Live Cattle call option is trading at 3.50 cents/lb. What are the time value and intrinsic
value components of the premium?
Futures Price – Strike Price = Intrinsic Value
82.50 – 80.00 = 2.50
Time value represents the amount option traders are willing to pay over intrinsic value, given
the amount of time left to expiration for the futures to advance in the case of
calls, or decline in the case of puts.
Options Premium – Intrinsic Value = Time Value
3.50 – 2.50 = 1.00
Time Value + Intrinsic Value = Premium
1.00 + 2.50 = 3.50

Intrinsic value and time value for puts:

In the case of a put, intrinsic value is the amount by which the underlying futures price is
below the strike price:
Intrinsic Value = Strike Price – Futures Price (must be positive or 0)
Time Value = Put Option Premium – Intrinsic Value
Put Option Premium = Put Time Value + Put Intrinsic Value

Illustration: What are the time value and intrinsic value of a CME Eurodollar 95.00 put if
the underlying futures are trading at 94.98 and the option premium is 0.03?
Strike Price – Futures Price = Intrinsic Value
95.00 – 94.98 = 0.02
There are 0.02 points of intrinsic value.
Options Premium – Intrinsic Value = Time Value
0.03 – 0.02 = 0.01
There is 0.01 point of time value.

5.11PAY OFF CHARTS FOR OPTIONS

Long on option
Buyer of an option is said to be “long on option”. He would have a right and no obligation
with regard to buying/sel0ling the underlying asset in the contract. When you are long on
equity option contract:
1. You have the right to exercise that option.
2. Your potential loss is limited to the premium amount paid for buying the option.
3. Profit would depend on the level of underlying asset price at the time of
exercise/expiry of the contract.

Short on option
Seller of an option is said to be “short on option”. He would have obligation but no right with
regard to selling/buying the underlying asset in the contract. When you are short (i.e., the
writer of) an equity option contract:
1. Your maximum profit is the premium received.
2. Your potential loss is unlimited.

PAY-OFF PROFILE FOR BUYER OF A CALL OPTION: LONG CALL

The Pay-off of a buyer options depends on a spot price of an underlying asset. The
following graph shows the pay-off of buyers of a call option.

PROFIT
R

ITM

ATM E
1
OTM

E LOSS P
2

Graph 5

S= Strike price ITM = In the Money

Sp = premium/loss ATM = At the Money

E1 = Spot price 1 OTM = Out of the Money

E2 = Spot price 2 SR = Profit at spot price E1

CASE 1:(Spot Price > Strike price)

As the Spot price (E1) of the underlying asset is more than strike price (S).

The buyer gets profit of (SR), if price increases more than E 1 then profit also increase more
than (SR)

CASE 2:(Spot Price < Strike Price)

As a spot price (E2) of the underlying asset is less than strike price (S)

The buyer gets loss of (SP); if price goes down less than E 2 then also his loss is limited to his
premium (SP)

Illustration:

Long call on Nifty:

Spot price = 9,143
Strike price = 9,200
Premium = 118.35
If Nifty closes at 9,100 you will NOT exercise the right to buy the underlying asset as Nifty is
available in the market at a price lower than strike price. In such situation your loss will be
equal to the premium paid, which in this case is 118.3. If Nifty closes above 9,200 then you
will exercise your right to reduce your loss and accordingly higher the Nifty closes at expiry,
your profit will increase.

The table below shows the profit/loss for long call position.

Nifty at Expiry Premium paid Buy Nifty at Sell Nifty at Payoff for Long
Call position
A B C D=A+B+C
9100 -118.35 -9100 9100 -118.35
9150 -118.35 -9150 9150 -118.35
9200 -118.35 -9200 9200 -118.35
9250 -118.35 -9200 9250 -68.35
9300 -118.35 -9200 9300 -18.35
9350 -118.35 -9200 9350 31.65
9400 -118.35 -9200 9400 81.65
9450 -118.35 -9200 9450 131.65
9500 -118.35 -9200 9500 181.65
9550 -118.35 -9200 9550 231.65
 Table 3

Graph 6

PAY-OFF PROFILE FOR SELLER OF A CALL OPTION: SHORT CALL

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 option:

 PROFIT

P
ITM ATM
E
2
E
1
S
OTM

LOSS

Graph 7

S= Strike price ITM = In the Money

SP = Premium / profit ATM = At The money

E1 = Spot Price 1 OTM = Out of the Money

E2 = Spot Price 2 SR = loss at spot price E2

CASE 1:(Spot price < Strike price) As the spot price (E1) of the underlying is less than strike
price (S). The seller gets the profit of (SP), if the price decreases less than E1 then also profit
of the seller does not exceed (SP).

CASE 2:(Spot price > Strike price)

As the spot price (E2) of the underlying asset is more than strike price (S) the Seller gets loss
of (SR), if price goes more than E2 then the loss of the seller also increases more than (SR).
Illustration:

Short call on Nifty:

Spot price = 9143.4

Strike price = 9200
Premium = 118.35

If we have understood long call pay off, short call payoff chart will be just the water image of
the long call pay off. Thus at 9,100 Nifty, when long call position makes a loss of Rs. 118.35,
short call position will make a profit of 118.35. As Nifty start rising short call position will go
deeper into loses.
The table below shows the profit/loss for short call position.

Nifty Premium Buy Sell Payoff for

at received Nifty Nifty short call
Expiry at at position
A B C D=A+B+C
9100 118.35 -9100 9100 118.35
9150 118.35 -9100 9100 118.35
9200 118.35 -9200 9200 118.35
9250 118.35 -9250 9200 68.35
9300 118.35 -9300 9200 18.35
9350 118.35 -9350 9200 -31.65
9400 118.35 -9400 9200 -81.65
9450 118.35 -9450 9200 -131.65
9500 118.35 -9500 9200 -181.65
9550 118.35 -9550 9200 -231.65

Table 4
 Graph 8

PAY-OFF PROFILE FOR BUYER OF A PUT OPTION: LONG PUT

The Pay-off of the 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 option.

PROFIT
R

ITM
S
E
2
E ATM
1
OTM

P LOSS

GRAPH 9
S = Strike price ITM = In the Money

SP = Premium / loss ATM = At the Money

E1 = Spot price 1 OTM = Out of the Money

E2 = Spot price 2

SR = Profit at spot price E1

CASE 1:(Spot price < Strike price)

As the spot price (E1) of the underlying asset is less than strike price (S). The buyer gets the
profit (SR), if price decreases less than E1 then profit also increases more than (SR).

CASE 2:(Spot price > Strike price)

As the spot price (E2) of the underlying asset is more than strike price (S),

The buyer gets loss of (SP), if price goes more than E 2 than the loss of the buyer is limited to
his premium (SP).

Illustration:

Long put on Nifty:

Spot price = 9143.4

Strike price = 9200
Premium = 118.35

When Nifty goes below 9200 at expiry, you will buy Nifty from market at lower price and
sell at strike price. If nifty stays above 6200, you will let the option expire. The maximum
loss in this case will be equal to the premium paid; i.e. Rs. 141.50. Below 9200 as lower will
be the closing price of Nifty, higher the profit you will earn.
The table below shows the profit/loss for long put position.

Nifty Premium Buy Sell Payoff for Long put

at paid Nifty Nifty position
Expiry at at
A B C D=A+B+C
8850 -141.5 -8850 9200 208.5
8900 -141.5 -8900 9200 158.5
8950 -141.5 -8950 9200 108.5
9000 -141.5 -9000 9200 58.5
9050 -141.5 -9050 9200 8.5
 9150 -141.5 -9150 9200 -91.5
9200 -141.5 -9200 9200 -141.5
9250 -141.5 -9250 9250 -141.5
9300 -141.5 -9300 9300 -141.5
9350 -141.5 -9350 9350 -141.5

Table 5

Graph 10

PAY-OFF PROFILE FOR SELLER OF A PUT OPTION: SHORT PUT

The pay-off of a 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 option.
 PROFIT
P
ITM
ATM
E
1
E
2
S
OTM

LOSS

Graph 10

S = Strike price ITM = In the Money

SP = Premium/profit ATM = At the Money

E1 = Spot price 1 OTM = Out of the Money

E2 = Spot price 2 SR = Loss at spot price E1

CASE 1:(Spot price < Strike price)

As the spot price (E1) of the underlying asset is less than strike price (S), the seller gets the
loss of (SR), if price decreases less than E1 than the loss also increases more than (SR).

CASE 2:(Spot price > Strike price)

As the spot price (E2) of the underlying asset is more than strike price (S), the seller gets
profit of (SP), of price goes more than E 2 than the profit of seller is limited to his premium
(SP).

Illustration:

Short put on Nifty

Spot price = 9143.4
Strike price = 9200
Premium = 118.35
When long put makes profit, short put make loss.
The table below shows the profit/loss for short put position.

Nifty at Premium Buy Sell Payoff for Short put

Expiry Received Nifty at Nifty at position
A B C D=A+B+C
8850 141.5 -9200 8850 -208.5
8900 141.5 -9200 8900 -158.5
8950 141.5 -9200 8950 -108.5
9000 141.5 -9200 9000 -58.5
9050 141.5 -9200 9050 -8.5
9150 141.5 -9200 9150 91.5
9200 141.5 -9200 9200 141.5
9250 141.5 -9250 9250 141.5
9300 141.5 -9300 9300 141.5
9350 141.5 -9350 9350 141.5
Table 6

Graph 11
5.12FACTORS AFFECTING THE PRICE OF AN OPTION
The following are the various factors that affect the price of an option they are:

Stock Price: The pay-off from a call option is an amount by which the stock price exceeds
the strike price. Call 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.

Strike price: In case of a call, as a 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 option becomes less valuable and as strike price decreases, option become more
valuable.

Time to expiration: Both put and call American options become more valuable as a time to
expiration increases.

Volatility: The volatility of a stock price is measured of uncertain about future stock price
movements. As volatility increases the chance that the stock will do very well or very poor
increases. The value of both calls and puts therefore increases as volatility increase.

Risk- free interest rate: The put option prices decline as the risk-free rate increases where as
the price of call always increases as the risk-free interest rate increases.

Dividends: Dividends have the effect of reducing the stock price on the X- dividend rate.
This has a negative effect on the value of call options and a positive effect on the value of put
options.

5.13 ELIGIBILITY CRITERIA FOR SECURITIES/INDICES TRADED

IN F&O
Eligibility criteria of stocks
1. The stock is chosen from amongst the top 500 stocks in terms of average daily market
capitalization and average daily traded value in 206 the previous six months on a
rolling basis.
2. The stock's median quarter-sigma order size over the last six months should be not
less than Rs. 1 lakh. For this purpose, a stock's quarter sigma order size should mean
the order size (in value terms) required to cause a change in the stock price equal to
one-quarter of a standard deviation.
 3. The market wide position limit in the stock should not be less than Rs.50 crore. The
market wide position limit (number of shares) is valued taking the closing prices of
stocks in the underlying cash market on the date of expiry of contract in the month.
The market wide position limit of open position (in terms of the number of underlying
stock) on futures and option contracts on a particular underlying stock should be
lower of:- 20% of the number of shares held by non-promoters in the relevant
underlying security i.e. free-float holding.
4. If an existing security fails to meet the eligibility criteria for three months
Consecutively then no fresh month contract will be issued on that security.
5. However, the existing unexpired contracts can be permitted to trade till expiry and
new strikes can also be introduced in the existing contract months.
6. For unlisted companies coming out with initial public offering, if the net public offer
is Rs.500 crores or more, then the exchange may consider introducing stock options
and stock futures on such stocks at the time of its listing in the cash market.

Eligibility criteria of indices

The exchange may consider introducing derivative contracts on an index if the stocks
contributing to 80% weightage of the index are individually eligible for derivative trading.
However, no single ineligible stocks in the index should have a weightage of more than 5% in
the index. The above criteria is applied every month, if the index fails to meet the eligibility
criteria for three months consecutively, then no fresh month contract would be issued on that
index, However, the existing unexpired contacts will be permitted to trade till expiry and new
strikes can also be introduced in the existing contracts.

5.14 TRADING MECHANISM OF FUTURES AND OPTIONS

The futures and options trading system of NSE, called NEAT-F&O trading system,
provides a fully automated screen-based trading for Index futures &options and Stock futures
& options on a nationwide basis and an online monitoring and surveillance mechanism. It
supports an anonymous order driven market which provides complete transparency of trading
operations and operates on strict price-time priority. It is similar to that of trading of equities
in the Cash Market (CM) segment. The NEAT-F&O trading system is accessed by two types
of users. The Trading Members (TM) 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
(CM) use the trader workstation for the purpose of monitoring the trading member(s) for
whom they clear the trades. Additionally, they can enter and set limits to positions, which a
trading member can take.

5.15 OPEN INTEREST

Open Interest (OI) is the number of contracts outstanding in the marketplace. Open
Interest only applies to futures and option contracts. Changes in open interest either confirms
price action or acts as a warning of a potentially weakening trend.

Rules of Open Interest

Now, there are certain rules to open interest that must be understood and remembered. They
have been written in many different publications, so here I have included an excellent version
of these rules written by chartist Martin Pring in his book “Martin Pring on Market
Momentum”.
1. If prices are rising and open interest is increasing at a rate faster than its five-year
seasonal average, this is a bullish sign. More participants are entering the market,
involving additional buying, and any purchases are generally aggressive in nature.
2. If the open-interest numbers flatten following a rising trend in both price and open
interest, take this as a warning sign of an impending top.
3. High open interest at market tops is a bearish signal if the price drop is sudden, since
this will force many ‘weak’ longs to liquidate. Occasionally, such conditions set off a
self-feeding, downward spiral.
4. An unusually high or record open interest in a bull market is a danger signal. When a
rising trend of open interest begins to reverse, expect a bear trend to get underway.
5. A breakout from a trading range will be much stronger if open interest rises during the
consolidation. This is because many traders will be caught on the wrong side of the
market when the breakout finally takes place. When the price moves out of the trading
range, these traders are forced to abandon their positions. It is possible to take this
rule one step further and say the greater the rise in open interest during the
consolidation, the greater the potential for the subsequent move.
 6. Rising prices and a decline in open interest at a rate greater than the seasonal norm is
bearish. This market condition develops because short covering and not fundamental
demand is fueling the rising price trend. In these circumstances money is flowing out
of the market. Consequently, when the short covering has run its course, prices will
decline.
7. If prices are declining and the open interest rises more than the seasonal average, this
indicates that new short positions are being opened. As long as this process continues
it is a bearish factor, but once the shorts begin to cover it turns bullish.
8. A decline in both price and open interest indicates liquidation by discouraged traders
with long positions. As long as this trend continues, it is a bearish sign. Once open
interest stabilizes at a low level, the liquidation is over and prices are then in a
position to rally again.

General Rules for Volume and Open Interest

Let’s summarize these with an easy-to-read chart:

Relation between open interest and price trend

Overall, open interest tends to increase when new money is poured into the
market, meaning that speculators are betting more aggressively on the current market
direction. Thus, an increase in total open interest is generally supportive of the current trend,
and tends to point to a continuation of the trend, unless sentiment changes based on an influx
of new information. Conversely, overall open interest tends to decrease when speculators are
pulling money out of the market, showing a change in sentiment, especially if open interest
has been rising before. In a steady uptrend or downtrend, open interest should (ideally)
increase. This implies that longs are in control during an uptrend, or shorts are dominating in
a downtrend. Decreasing open interest serves as a potential warning sign that the current
price trend may be lacking real power, as no significant amount of money has entered the
market.
Therefore, as a general rule of thumb, rising open interest should point to a
continuation of the current price move, whether in an uptrend or downtrend. Declining or flat
open interest signals that the trend is waning and is probably near its end.

Interpreting open interest

Open Interest is a helpful tool in analyzing the strength of a price move. There are four main
interpretations of Open Interest:

 If price increases and Open Interest increases, then there is strength behind the
price move higher.
 If price decreases and Open Interest increases, then there is strength behind the
price move lower.

 If price increases and Open Interest decreases, then there is weakness behind the
price move higher.

 If price decreases and Open Interest decreases, then there is weakness behind the
price move lower.

6.Span Margins of Equity futures

 Exp
Total margn Total Mgn SpMgn Exp Mgn Total Mgn
Market marg per Per Shr PerLt PerLt PerLt
Symbol
Lot in % share

NFIBEAM
 7. OBSERVATIONS & SUGGESTIONS
1. If an investor wants to hedge with portfolios, it must consist of scrips from different
industries, since they are convenient and represent true nature of the securities market as a
whole.
2. The hedging tool to reduce the losses that may arise from the market risk. Its primary
objective is loss minimization, not profit maximization. The profit from futures or shares
will be offset from the losses from futures or shares, as the case may be. as a result, a
3. Hedger will earn a lower return compared to that of an non-hedger. But the non-hedger
faces a high risk than a hedger.
4. The hedger will have to be a strategic thinker and also one who think positively. He
should be able to comprehend market trends and fluctuations. Otherwise, the strategies
adopted by him earn him earn losses. A lot more awareness needed about the stock market
and investment pattern, both in spot and future market.

8. CONCLUSIONS

1) The hedging provides a safe position on an underlying security. The loss gets shifted
to a counter party. Thus, the hedging covers the loss and risk. Sometimes, the market
performs against the expectation.
2) If the trader is not sure about the direction of the movement of the profits of the
current position, he can counter position in the future contract and reduces the level of
risks.
3) Derivative trading provides lot of opportunities in the market but the investor should
have a deep insight of derivatives and use of different product combinations.
4) An investor should book profit than anticipating more profits because unlike equity
markets small price movement in equity may show some adverse impact on the
premium amount under Futures and options.
5) Short positions should be handled carefully because of unlimited loss liability with
limited profits.
6) Investor should try to hedge his/her positions to minimize losses rather anticipating
huge profits.

9. REFERENCE LINKS:
1. www.nseindia.com
2. www.bseindia.com
3. NISM reference book on derivatives
4. Materials provided by KARVY on Indian Financial Market
5. https://www.moneycontrol.com/news/business/stocks/-1740263.html
6. https://www.investopedia.com/ask/answers/070615/what-difference-between-
derivatives-and-options.asp
7. Futures and Options Week: According to figures published in F&O Week October 10,
2005. See also FOW Website
8. www.tradingview.com
9. https://economictimes.indiatimes.com/definition/Derivatives
10. https://www.thebalance.com/what-are-derivatives-3305833
11. http://www.candlestickforum.com/PPF/Parameters/16_1734_/candlestick.asp
12. www.karvyonline.com