Derivative Trading India

DERIVATIVE TRADING INDIA
21-Aug-12
Never put all eggs in a single basket

himanshurastogi44@gmail.com
CONTENTS
Introduction Development of Derivative market About Derivative Features & Uses Risk & Rewards Challenges Questions & Answers
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21-Aug-12
Derivative market in India

SEBI set up a committee in 1996 to develop appropriate regulatory framework for derivatives trading in India. SEBI constituted another group in June 1998 under the Chairmanship of Prof. J. R. Verma & L.C. Gupta to recommend measures for risk containment in the derivatives market. Derivatives trading on the Exchange commenced on June 12, 2000.
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Developments in the derivative market

have been around for as long as the people have been trading with one another. a group of Chicago businessmen formed the Chicago Board of Trade (CBOT) in 1848. The first stock index futures contract was trades at Kansas City Board of Trade. Currently the most popular futures contract in the world is based on S&P 500 index, traded on Chicago Mercantile Exchange.
Derivatives in India
The futures contract at NSE is based on S&P CNX Nifty # Index. It has a maximum of 3-month expiration cycle. Three contracts are available for trading I.e. with 1 month, 2 months and 3 months expiry.
B. Size of Derivative Exchanges

Top-8 Derivative Exchanges (volume)
900 800 700
Top-8 Equity Index Futures (value)

9,000 8,000 7,000
billion US$
KSE: 855m (2001) ; 1930m (2002) Value $1,800 bn (#5) BM&F: 101m (2002) Value $3,200 bn (#4)
KSE: market-cap $216 bn (#14 ; 10% Tokyo, 60% Sydney) Cash trading $593 bn (#12 ; 40% Tokyo, 200% Sydney) Futures trading $1680 bn (#3 ; 200% Nikkei)
million contracts
600 500 400 300 200 100 0
6,000 5,000 4,000 3,000
2,000
1,000 0
KSE Eurex Euronext CME CBOE CBOT AMEX BM&F CME Eurex KSE CME Eurex Euronext Euronext Osaka S&P500 DAX KOSPI Nasdaq STOXXCAC40 FTSE Nikkei
Top-8 Interest Rate Futures (volume)

180 160 140
million contracts
Top-8 Currency Futures Exchanges (value)

900 800 700
billion US$
BM&F: DI-futures 44m (2001) ; 71m (2002) Value $1,180 bn (DI) + $680 bn (DDI) + $850 bn (US$ futures) Brazil: government dom debt $180 bn
KOFEX: $75 bn USD futures trading (#7) KTB futures trading $1,120 bn (#6) + OTC KTB cash trading $39 bn (Israel, Ireland) Korea: government dom debt $100 bn
120 100 80 60 40 20 0
600 500 400 300 200 100 0
CME Euronext BM&F Euronext SGX KOFEX Mexder BM&F Euro$ Euribor DI-future Sterling Euro$ KTB Interest DDI-$
BM&F US$
CME Euro
CME Yen
CME CHF
CME CAD
Sources: FIBV (2001) ; KSE, KOFEX, BM&F (2002)
CME KOFEX GBP US$
CME MXP
What is a derivative
Derivatives are financial contracts of predetermined fixed duration, whose values are derived from the value of an underlying primary financial instrument, commodity or index, such as: interest rates, exchange rates, commodities, and equities
21-Aug-12
Features of derivatives
Derivatives are contracts that have no independent value They derive their value from their underlying assets They are used as risk shifting or hedging instruments
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Uses of Derivatives

To hedge or insure risks; i.e., shift risk. To reflect a view on the future direction of the market, i.e., to speculate. To lock in an arbitrage profit To change the nature of an asset or liability. To change the nature of an investment without incurring the costs of selling one portfolio and buying another.
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Common financial derivatives

forward contracts futures options swaps
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Players in the derivative market (1)

Hedgers:
Hedgers face risk associated with the price
of an asset. They use futures or options

markets to reduce or eliminate this risk.
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Speculators : They are people who wish to bet on future movements in the price of the asset. Future and Options contracts can give them an extra leverage; that is, they can increase both the potential gains and losses in a speculative venture.

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

Top-8 Derivative Exchanges (volume)
900 800 700
Top-8 Equity Index Futures (value)

9,000 8,000 7,000
billion US$
KSE: 855m (2001) ; 1930m (2002) Value $1,800 bn (#5) BM&F: 101m (2002) Value $3,200 bn (#4)
KSE: market-cap $216 bn (#14 ; 10% Tokyo, 60% Sydney) Cash trading $593 bn (#12 ; 40% Tokyo, 200% Sydney) Futures trading $1680 bn (#3 ; 200% Nikkei)
million contracts
600 500 400 300 200 100 0
6,000 5,000 4,000 3,000
2,000
1,000 0
KSE Eurex Euronext CME CBOE CBOT AMEX BM&F CME Eurex KSE CME Eurex Euronext Euronext Osaka S&P500 DAX KOSPI Nasdaq STOXXCAC40 FTSE Nikkei
Top-8 Interest Rate Futures (volume)

180 160 140
million contracts
Top-8 Currency Futures Exchanges (value)

900 800 700
billion US$
BM&F: DI-futures 44m (2001) ; 71m (2002) Value $1,180 bn (DI) + $680 bn (DDI) + $850 bn (US$ futures) Brazil: government dom debt $180 bn
KOFEX: $75 bn USD futures trading (#7) KTB futures trading $1,120 bn (#6) + OTC KTB cash trading $39 bn (Israel, Ireland) Korea: government dom debt $100 bn
120 100 80 60 40 20 0
600 500 400 300 200 100 0

CME Yen
CME Euronext BM&F Euronext SGX KOFEX Mexder BM&F BM&F CME 21-Aug-12 himanshurastogi44@gmail.com Euro Euro$ Euribor DI-future Sterling Euro$ KTB Interest DDI-$ US$
CME CHF
CME CAD
Sources: FIBV (2001) ; KSE, KOFEX, BM&F (2002)
CME KOFEX GBP US$
14 MXP
CME
F. Future challenges
1. Official regulation of rapidly expanding OTC derivative markets may need to be aligned across institutions to limit arbitrage and enhance transparency. 2. Prudential supervision of off-balance sheet exposure may need to be strengthened with reporting requirements and systemic risk analysis. 3. Derivatives exposure data may need to be considered in order to accurately assess BOP and reserve positions. 4. Proper valuation and full disclosure (strong IAS39) may reveal solvency issues of financial institutions. 5. Capital requirements for derivatives may need to be enhanced to limit regulatory arbitrage and leverage. 6. Derivatives as zero-sum risk-transfer tools may create conflict with managed FX and credit policies. 7. Derivatives driven by distortionary taxation and weak underlying issues may substitute for cash markets. 8. Management of counter-party risk may need to be enhanced (ISDA master, central clearing and counterparty). 9. Margin systems could be tightened for leveraged members (dynamic, insurance). 21-Aug-12 himanshurastogi44@gmail.com 15
Others Public Sector Banks
Financial Institutions
Foreign Banks
21-Aug-12
Private Banks himanshurastogi44@gmail.com
16
Questions & solutions
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Q:1
In Nov 1996, government led L. C. Gupta Committee helped develop regulatory framework for derivatives trading in India by recommending derivatives to be declared as securities. This helped catalyze entrepreneurial activity and transfer risks from risk adverse people to risk oriented people.
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Again the J.R.Verma committee recommendations to develop settlement and risk management systems for derivatives including upfront margins, daily settlement, online surveillance and position monitoring and risk management marked a new development. These structural changes in the equity derivative market made it organized and transparent.
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Risk factor in Derivatives

More leverage Less transparency Dubious accounting (not reliable) Regulatory arbitrage Rising CP exposure Hidden systemic risk Tail-risk future exposure Weak capital requirements
Q:2
Problems evolve after introduction of derivative:
Leverage of economy debt Credit risk large notional value Intrest rate risk Also attribute increased volatility to highly speculative and levered participants.
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Lack of knowledge among investors Absence of sound infrastructure Technology limits
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YES it should have been introduced, some rewards are:

Market efficiency Risk sharing and transfer Low transaction costs Capital intermediation Liquidity enhancement Price discovery Cash market development Hedging tools Regulatory savings
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Q:3
Issues which need to be addressed for accelerating growth of derivative market are: If any loss arises from derivative trading it would be treated as speculative loss and will be set off only against speculative income. (Note: Income arises from derivative trading should be treated same as capital gain/loss) Retail investors were having lots of myths and misconceptions about derivative trading . The contract size was fixed at Rs 0.2 mn and it was fixed in order to curb too much speculation from small investor who had little knowledge about derivatives.
According to me the measures taken by RBI,SEBI and stock exchange are adequate. the other measures which can be taken are : To make the investors more and more aware about derivatives trading and also telling them that this is safe for them to invest their money There must be proper arrangements which need to be made for doing trading in derivative market. There must be some tax regulations i.e if an individual earns more profit then the limit which is fixed by the government then he /she should need to pay a fix amount of tax also.
Thanks for being patience
21-Aug-12
26

Derivative Trading India

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DERIVATIVE TRADING INDIA

Never put all eggs in a single basket

Derivative market in India

Developments in the derivative market

B. Size of Derivative Exchanges

Top-8 Equity Index Futures (value)

600 500 400 300 200 100 0

6,000 5,000 4,000 3,000

Top-8 Interest Rate Futures (volume)

Top-8 Currency Futures Exchanges (value)

600 500 400 300 200 100 0

Sources: FIBV (2001) ; KSE, KOFEX, BM&F (2002)

CME KOFEX GBP US$

Common financial derivatives

Players in the derivative market (1)

of an asset. They use futures or options

Players in the derivative market (2)

Players in the derivative market (3)

B. Size of Derivative Exchanges

Top-8 Equity Index Futures (value)

600 500 400 300 200 100 0

6,000 5,000 4,000 3,000

Top-8 Interest Rate Futures (volume)

Top-8 Currency Futures Exchanges (value)

600 500 400 300 200 100 0

Sources: FIBV (2001) ; KSE, KOFEX, BM&F (2002)

CME KOFEX GBP US$

Others Public Sector Banks

Private Banks himanshurastogi44@gmail.com

Questions & solutions

Risk factor in Derivatives

Lack of knowledge among investors Absence of sound infrastructure Technology limits

YES it should have been introduced, some rewards are:

Thanks for being patience

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