INTRODUCTION:

The emergence of the market for derivatives products, most notable forwards, futures,
options and swaps can be traced back to the willingness of risk-averse economic agents to guard
themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the
financial markets can be subject to a very high degree of volatility. Through the use of derivatives
products, it is possible to partially or fully transfer price risks by locking-in asset prices.

As instrument of risk management, derivative products generally do not influence the

fluctuations in the underling asset prices. However, by locking in asset prices, derivative products
minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of
risk-averse investor.

With the approval of the derivatives bill in union cabinet, the investors are now in the
position to trade through futures and options, which provides the investors a greater hedging
facility. Derivatives product initially emerged as hedging devices against fluctuations in commodity
prices, and commodity linked derivatives offer organization the opportunity to break financial risks
into smaller components and then to buy and sell those components to best meet specific risk
management objectives.

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,
especially among institutional investors, who are major users of index-linked derivatives. Even
small investors find these useful due to high correlation of popular index’s with various portfolios
ease of use the lower costs associated with index derivatives vis-à-vis derivatives products based
on individuals securities is another reason for there their growing use.

1
 INDUSTRY PROFILE

HISTORY OF THE STOCK EXCHANGE:

The only stock exchanges operating in the 19 th century were those of Bombay set up in
1875 and Ahmadabad set up in [Link] were organized as voluntary non profit making
organization of brokers to regulate and protect their interests. Before the controls on securities
trading become a central subject under the constitution in 1950,it was a state subject and the
Bombay securities contract (control) Act of 1952 used to regulate trading in securities. Under this
Act, the Bombay stock exchange in 1972 and the Ahmadabad in 1973.

During the war boom, a number of stock exchanges were organized in Bombay,
Ahmadabad and other centers, but they were not organized. Soon after it become a central subject,
central legislation proposed on a committee headed by [Link] went into the bill securities
regulation. On the basis of committee’s recommendations and the public discussion the securities
contract (regulation) Act become law in 1956.

Definition of the stock exchange:

“Stock exchange means any body or individuals whether incorporated or not, constituted
for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in
securities.
It is an association of member brokers for the purpose of self regulation and protecting
the interest of its members. It can operate only if the government recognizes it. Under the
securities contract (regulation) act 1956, the recognition is granted under section 3 of the act by
central finance ministry.

By-laws
Beside the above act, the securities contract (regulations) rules were also made in 1975 to
regulate certain matters of trading of stock exchanges, which are concerned with following
subjects.

2
 Opening/closing of stock exchanges, timing of trading, regulation of bank transfer,
regulation of carryover business, control of settlement, and other actives of stock exchanges,
fixation of margins, fixation of market prices or making prices, regulation of taravani business
(jobbing), regulation of broker trading, brokerage charges, trading rules on exchanges, arbitration
and settlement of disputes, settlement and clearing of the trading.
Regulations of stock exchanges:

The securities contract (regulation) is the basis for operations of the stock exchange o
India. One exchange can leally without the government permission or recognition. Stock exchanges
are given monopoly in certain areas under section 19 of the above act is to ensure that the control
and regulation are facilitated. Recognition can be granted to a stock exchange provided certain
conditions are satisfied and the necessary information is supplied to the government. Recognition
can be withdrawn, if necessary. Where there is no stock exchange, the government can license
some to the brokers to perform the function of a stock exchange in its absence.
SECURITIES EXCHANGE BOARD OF INDIA (SEBI)
SEBI was set up an autonomous regulatory authority by the government of India in 1988
“to perform the interest of investors in securities and to promote the development of and to regulate
the securities the securities markets and for matters connected therewith or incidental thereto”. It is
empowered by to acts namely the SEBI Act, 1982 and the securities contract (regulation) Act, 1956
to perform the function of protecting investor’s rights and regulating the capital market.
Current diversification:
1. DEPOSITORY PARTICIPANT:
The exchange has also become a Depository Participant with National Securities
Depository Limited (NSDL) and Central Depository Services Limited (CDSL).Our own DP is fully
operational and the execution time will come down substantially. The trades of all the Exchanges
having On-line trading which gets into National depository can also be settled at Hyderabad by this
exchange itself. The exchange has about 15,000 B.O accounts.
2. Floating of a Subsidiary Company for the Membership of Major Stock Exchanges of the
Country:

3
 NATIONAL STOCK EXCHANGE (NSE):

The NSE was incorporated in NOVEMBER 1994 with an equity capital of Rs.25 Crores.
The International Securities Consultancy (ISC) of Hong Kong has helped in setting up NSE.
ISC has prepared the detailed business plans and installation of hardware and software
systems. The promotions for NSE were financial institutions, insurance companies, banks and
SEBI capital market ltd, Infrastructure leasing and financial services ltd. and Stock Holding
Corporation Ltd.
It has been set up to strengthen the move towards professionalism of the capital market as
well as provide nation wide securities trading facilities to [Link] is not an exchange in the
traditional sense where the brokers own and manage the exchange. A two tier administrative setup
involving a company board and a governing board of the exchange is envisaged.
NSE is a national market for shares, PSU bonds, debentures and government securities
since infrastructure and trading facilities are provided.
The genesis of the NSE lies in the recommendations of the Pherwani Committee (1991).It
has been setup to strengthen the move towards professionalization of the capital market as well as
provide nation wide securities trading facilities to investors.

The National Stock Exchange of India Limited has genesis in the report of the High
Powered Study Group on Establishment of New Stock Exchanges, which recommended promotion
of a National Stock Exchange by financial institutions (FI’s) to provide access to investors from all
across the country on an equal footing. Based on the recommendations, NSE was promoted by
leading Financial Institutions at the behest of the Government of India and was incorporated in
November 1992 as a tax-paying company unlike other stock exchanges in the country. On its
recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956 in April 1993,
NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994.
The Capital Market (Equities) segment commenced operations in November 1994 and
operations in Derivatives segment commenced in June 2000.

4
 NSE's mission is setting the agenda for change in the securities markets in India.
The NSE was set-up with the main objectives of:
 Establishing a nation-wide trading facility for equities and debt instruments.

 Ensuring equal access to investors all over the country through an appropriate communication
network.

 Providing a fair, efficient and transparent securities market to investors using electronic trading
systems.

 Enabling shorter settlement cycles and book entry settlements systems, and

 Meeting the current international standards of securities markets.

The standards set by NSE in terms of market practices and technology, have become industry
benchmarks and are being emulated by other market participants. NSE is more than a mere market
facilitator. It's that force which is guiding the industry towards new horizons and greater
opportunities.
NSE INDICES

Major Indices:

S&P CNX Nifty

CNX Nifty Junior

CNX 100

S&P CNX 500

Nifty Midcap 50

Sectoral Indices:
5
 CNX IT Index

CNX Bank Index

CNX FMCG Index

CNX PSE Index

CNX MNC Index

CNX Service Sector Index

S&P CNX Industry Indices

CNX Energy Index

CNX Pharmacy Index

CNX Infrastructure Index

CNX PSU BANK Index

CNX Realty Index

NSE-Nifty:
The NSE on April22, 1996 launched a new equity index. The NSE-50 the new index
which replaces the existing NSE-100, is expected to serve as an appropriate index for the new
segment of futures and options.
“Nifty” means National Index for Fifty Stocks.
The NSE-50 comprises 50 companies that represent 20 broad industry groups with an
aggregate market capitalization of around Rs. 1, 70,000 crores. All the companies included in the
Index have a market capitalization in excess of Rs. 500 crores. Each and should have traded for
85% of trading days at an impact cost of less than 1.5%.
The base period for the index is the close of price on NOV3rd, 1995 which makes one
year of completion of operation of NSE’s, capital market segment. The base value of the index has
been set at 1000.

NSE-Midcap Index:

6
 The NSE Midcap index or the Junior Nifty comprises 50 stocks that represents 21
board Industry groups and will provide proper representation of the Midcap. All stocks in the index
should have market capitalization of greater than Rs.200 crores and should have traded 85% of the
trading days an impact cost of less 2.5%.
The base period for the index is Nov 4, 1996 which signifies 2 years for completion of
operations of the capital market segment of the operations. The base value of the index has been set
at 1000.
Average daily turnover of the present scenario 258212(lacks) and number of average
daily trades 2160(lacks).
At present, there are 24 stock exchanges recognized under the securities contract
(regulation) Act, 1956. They are
Name of The Stock Exchange Year

Bombay Stock Exchange. 1875

Ahmadabad share and stock brokers association. 1957

Calcutta stock exchange association Ltd. 1957

Delhi stock exchange association Ltd. 1957

Madras stock exchange association Ltd. 1957

Indore stock brokers association. 1958

Bangalore stock exchange. 1963

Hyderabad stock exchange. 1943

Cochin stock exchange. 1978

Pune stock exchange. 1982

U.P. stock exchange. 1982

Ludhiana stock exchange. 1983

Jaipur stock exchange. 1983-84

Gawhati stock exchange. 1984

Mangalore stock exchange. 1985

Maghad stock exchange Ltd., Patna. 1986

Bhuvaneshwar stock exchange association Ltd. 1989

Over the counter exchange of India, Bombay. 1989

Saurastra Kuth stock exchange Ltd. 1990

7
 Vadodard stock exchange Ltd. 1991

Coimbatore stock exchange Ltd. 1991

The Meerut stock exchange. 1991

National stock exchange. 1991

Integrated stock exchange. 1999

BOMBAY STOCK EXCHANGE (BSE):

This stock exchange, in Mumbai popularly known as “BSE” was established in 1875 as
“The native share and stock brokers association”, as a voluntary non-profit making association .It
has evolved over the years into its present status as the premier stock exchange in the country. It
may be noted that the stock exchange is the oldest one in Asia, even older than the Tokyo Stock
Exchange, this was founded in 1878.

A governing board comprising of 9 elected directors, 2 SEBI nominees, 7 public

representatives and an executive director is the apex body, which decides the policies and regulates
the affairs of the exchange.

The executive director as the Chief Executive Officer (CEO) is responsible for the day-
to-day administration of the exchange. The average daily turnover of the exchange during the year
2000-01(April-March) was Rs.3984.19 Crores and average no of daily trades was 5.69 lacks.

However the average daily turnover of the exchange during the year 2000-01 has
declined to Rs1244.10 Crores and average daily trades during the period to 5.17 lacks.

The average daily turnover of the exchange during the year 2002-03 has declined and
the no of average daily trades during the period is also decreased.

8
 The ban on all the deferral products like BLESS AND ALBM in the Indian capital
markets by SEBI with effect from July 2, 2001, abolition of account period settlements,
introduction of compulsory rolling settlements in all scripts traded on the exchanges with effect
from Dec 31, 2001, etc., have adversely impacted the liquidity and consequently there is a
considerable decline in the daily turnover at the exchange. The average daily turnover of the
exchange in the present scenario is 110363(laces) and the no of average daily trades is 1057(laces)

BSE Indices:
In order to enable the market participants, analysts etc., to track the various ups and downs
in Indian stock market, the exchange had introduced in 1986 an equity stock index called BSE-
SENSEX that subsequently became the barometer of the moments of the share prices in the Indian
stock market. It is a “market capitalization –weighted” index of 30 component stocks representing a
sample of large, well established and leading companies. The base year of sensex is 1978-79.
The Sensex is widely reported in both domestic and international markets through print as
well as electronic media.
Sensex is calculated using a market capitalization weighted method. As per this
methodology, the level of index reflects the total market value of all 30-component stocks from
different industries related to particular base period. The total value of a company is determined by
multiplying the price of its stock by the number of shares outstanding.

Statisticians call an index of a set of combined variables (such as price number of shares)
Composite index. An Indexed number is used to represent the results of this calculation in order to
make the value easier to work with and track over a time. IT is much easier to graph a chart base on
indexed values then one based on actual values world over majority of the well known indices are
constructed using “Market capitalization weighted method”. The divisor is only link to original
base period value of the sensex.
New base year average=old base year average*(new market value/old market value)

9
BSE INDICES:
Major Indices:
SENSEX

MIDCAP

SMLCAP

BSE-100

BSE-200

BSE-500

BSE IPO

B Sectoral Indices:
 BSE Auto Index
 BSE BANKEX
 BSE Capital Goods Index
 BSE Consumer Durables Index
 BSE FMCG Index
 BSE Healthcare Index
 BSE IT Index
 BSE Metal Index
 BSE Oil & Gas Index
 BSE Power Index
 BSE Realty Index

Stock market & its sensitivity in India:

10
 There are number of factors which influence the prices of shares on a stock exchange.
Some factors are related to the concerned company, some to the general economic situation in the
country.

Company wide factors:

1. Financial position of the company

2. Role of financial institutions

3. Speculation activities

4. Demand& supply position

General economic factors:

1. Economic system

2. Blue chip companies

3. Strategic alliances

4. Geographic factors

5. International factors

REGULATORY FRAME WORK OF STOCK EXCHANGE:

11
 A comprehensive legal framework was provided by the “Securities Contract Regulation
Act, 1956” and “Securities Exchange Board of India 1952”. Three tier regulatory structure
comprising

 Ministry of finance

 The Securities And Exchange Board of India

 Governing body.

MEMBERS OF THE STOCK EXCHANGE:

The securities contract regulation act 1956 has provided uniform regulation for the
admission of members in the stock exchanges. The qualifications for becoming a member of a
recognized stock exchange are given below:

 The minimum age prescribed for the members is 21 years.

 He should be an Indian citizen.

 He should be neither a bankrupt nor a compound with the creditors.

 He should not be convicted for fraud or dishonesty.

 He should not be engaged in any other business connected with a company.

 He should not be a defaulter of any other stock exchange.

 The minimum required education is a pass in 12th standard examination.

Risk:
As per Webster’s Ninth New collegiate dictionary, the meaning of “Risk” is possibility of
loss or injury, PERIL, a dangerous element of factor; the chance or loss or perils to the subject
matter of an insurance contract; the degree of probability of such loss.
According to Harold Skipper there is no universal definition of risk. Risk is commonly used
to refer to insured items, to causes of loss and to the chance of loss.

From the management’s perspectives, risk has three connotations; risk as opportunity;
risk as uncertainty; and risk as hazard. When we look at risk as an opportunity, the inherent
relationship between risk and return becomes obvious, to put it differently, greater the risk, the
greater the potential return and by extension, the greater the potential for loss. But when we look at

12
risk as an uncertainty it refers to the distribution of all possible outcomes, both positive and
negative. When the same is looked upon as hazard, the negative return becomes obvious.

All proactive companies deal with these three elements of risk by installing management
techniques to reduce the probability of negative returns without incurring too much cost and
thereby enhance the scope for realizing the hoped for returns. It is in this context, that the derivative
products have evolved as one of the effective tools to hedge the financial losses.

With the Indian rupee being convertible, since March 1994, the risk in the foreign exchange
market has become more pronounced and the need to take risk or protect oneself from these risks
has become evident. Many countries have already made their currencies convertible and some are
in the process of doing so. In the context of such scenario of free foreign exchange markets,
uncertainty of currency rates and their volatility has made it imperative for the dealers in the
foreign exchange to expose themselves to the risk. Risk is inherent in the foreign dealings due to
the following reasons.

1. Trade across countries involves dealings with parties – exporter or importer – who are unknown
and whose creditworthiness is uncertain.
2. Foreign dealings also involve countries whose credibility and creditworthiness is not certain.

Exchange risk is due to fluctuations in the rate of exchange in conversion of one currency
into another and likely changes interest rates which might affect the forward rates. Forward cover
of any currency which the banks provide will take into account possible changes in interest rates,
inflation rates and the intrinsic strength of country and the currency. Exchange risk will basically
depend on the economic strength of the country and its foreign exchange reserves, as the volatility
of the exchange rate depend on them.

Exchange risk simply means that the rate at which a currency is exchanged for another
currency may be uncertain volatile and the amount that an exporter receives in domestic currency
or an importer has to pay in terms of domestic will unpredictable and uncertain

13
EXCHANGE MANAGEMENT IN INDIA:

The rupee was devalued twice in July 1991 and the depreciation of the rupee was continued
in the free market thereafter. The rupee dollar rate was Rs17.1274 in March 1990 which fell to
Rs32.6456 in February 1993 and thereafter. It stabilized around Rs31.3727 since March 1994 when
current account convertibility was introduced by the government. Since then the rupee depreciated
slowly and reached Rs.48 per dollar at one time and is stabilized around Rs46 by mid 2003.
The experiment with limited convertibility was successful and the government was
emboldened to launch the full convertibility on trade account in March 1994. Since then there was
unification of the dual exchange rate into a single floating rate which imparted considerable
strength to the rupee. Now the external value of the rupee is determined by the market forces fully.

Full convertible of rupee:

As referred to earlier the convertibility on trade account was launched on March 1993 and
exporters have become convertible at free market rates up to 100% of them.
Risk in foreign exchange market:
There are different types of exchange risks in the foreign exchange market which are set out
briefly below:
1. Creditriskofcustomer:
Credit rating by international banks and international credit rating agencies will help reducing this
risk. In India, ECGC and banks do take this risk for the exporter.

2. Country risk: This is slightly different from the currency risk and arises out of the policies of
economic and political nature and there external payments position and their export earnings to
service the foreign creditors, convertibility or otherwise of their currencies, etc.

3. Currency risk: This risk arises out of the volatility or otherwise of the currency and its strength
or weakness in terms of other currencies and interest rates and relative degrees of inflation in the
respective countries which influence the exchange rates.

14
 It also depends on the hot money flows and speculative short terms flows as between
countries which will destabilize the exchange rates. The currency risk is generally covered by
banks on the guarantee of the ECGC in some cases or by the EXIM bank.

4. Market risk: Risks of commodities their quality and the change of government policies of
taxation etc., are borne by the exporter or the ECGC in some cases. It will thus be seen that some
risk cannot be avoided or passed on by the exporter and infect many more risks are to be borne by
the importer than by the exporters, as the government policy in India wants to encourage the
exporter from the country.

 Risk mitigation through derivatives

Although Indian market is far from being complete in an academic sense (in terms of
implementation of measures for risk mitigation), some steps were initiated in that direction. OTC
rupee derivatives in the form of forward rate agreements/ interest rate swaps were introduced in
India in July 1999. Since the introduction of FRAS /IRS transactions have recorded substantial
increase. In terms of number of contracts and outstanding notional principal amount, IRS contract
have jumped from about 200 contracts amounting to rupees 4000 crore in March, 2000 to 6500
contracts for rupees 150,000 crore in December 2002. Though in a majority of these contracts, the
market players have used NSE-MIBOR as the benchmark rate, they have also been using other
benchmark as Mumbai inter bank forward offered rate (MIFOR), Mumbai inter bank offered
currency swaps (MIOCS), Mumbai inter bank overnight index swaps (MIOIS), primary action
treasury bill rates etc. As and derivatives both over the counter type as well as exchange traded
ones get enabled, this will open up a range of possibilities for efficient pricing, hedging and
managing of interest ate risks. But it also arises a set of new issues like counter party risks, liquidity
risk etc., which, although not unfamiliar, but will be important in this altered milieu. For optimizing
the capital charges, the clearing and settlement of contracts should increasingly be through a
centralized counterparty. Such arrangements not only reduce counter party risk but also
considerably simplify documentation and settlement operations which reduce operational risk and
settlement costs.

In June 2000 derivatives have been allowed on stock exchanges also (at NSE and BSE).
The available products are: index futures and options, basket futures and options, stock futures and
15
options. As between, index/ basket derivatives and stock derivatives are more popular. Further, as
between futures and options, futures are more popular. As between stock exchanges, derivatives
have large volumes on NSE.

Factors generally attributed as the major driving force behind growth of financial
derivatives are:
a. Increased volatility in asset prices in financial markets.

b. Increased integration of national financial markets with the international markets.

c. Market improvement in communication facilities and sharp decline in their costs.

d. Development of more sophisticated risk management tools, providing economic agents a wider
choice of risk management strategies.

16
COMPANY PROFILE:

Reliance Capital Ltd is a part of The Reliance - Anil Dhirubhai Ambani Group, and is
ranked among The 25 most valuable private companies in India. Reliance Capital is one of India's
leading and fastest growing private sector financial services companies, and ranks among the top 3
private sector financial services and banking groups, in terms of net worth. Reliance Capital has
interests in asset management and mutual Funds, life and general insurance, private equity and
proprietary investments, stock broking, depository services, distribution of financial products,
consumer finance and others activities in financial services.

The Reliance Anil Dhirubhai Ambani Group is one of India's top 2 business houses, and has
a market capitalization of over Rs.2,90,000 crore (US$ 75 billion), net worth in excess of Rs.55,000
crore (US$ 14 billion), cash flows of Rs. 11,000 crore (US$ 2.8 billion) and net profit of Rs. 7,700
crore (US$ 1.9 billion).
Chairman's Profile:

[Link] Ambani, Regarded as one of the foremost corporate leaders of contemporary

India, is the chairman of all listed companies of the Reliance ADAG namely, Reliance
Communications, Reliance Capital, Reliance Natural Resources and Reliance Power.

He is also Chairman of the Board of Governors of Dhirubhai Ambani Institute of

Information and Communication Technology, Gandhi Nagar, Gujarat. Till recently, he also held the
post of Vice Chairman and Managing Director in Reliance Industries Limited (RIL), India's largest
private sector [Link] Dhirubhai Ambani joined Reliance in 1983 as Co-Chief Executive
Officer, and was centrally involved in every aspect of the company's management over the next 22
years.

KEY PEOPLE IN THE COMPANY:

Chairman : Mr. Anil Ambani
Managing Director: [Link] Gurgani
C.E.O : [Link] Bhali
17
 The Reliance Capital Company Outline:

RELIANCE
CAPITAL

RELIANCE RELIANCE RELIANCE RELIANCE

MUTUAL MONEY LIFE GENERAL
FUNDS INSURNACE INSURANCE

Reliance Money:

Reliance Money is a group company of Reliance Capital; one of India's leading and fastest
growing private sector financial services companies, ranking among The top 3 private sector
financial services and banking companies, in terms of net worth. Reliance Capital is a part of The
Reliance Anil Dhirubhai Ambani Group.

Reliance Money is a comprehensive electronic transaction platform offering a wide range of

asset classes. Its Endeavour is to change the way India transacts in financial markets and avails
financial services. Reliance Money is a single window, enabling you to access, amongst others in
Equities, Equity & Commodities Derivatives, Mutual Funds, IPOs, and Life & General Insurance
products, Offshore Investments, Money Transfer, Money Changing and Credit Cards.

Reliance Securities Ltd is promoted by Reliance Capital Ltd and is a part of the Reliance -
Anil Dhirubhai Ambani Group, and is ranked among the 15 most valuable private companies in
India. Reliance Capital is one of India's leading and fastest growing private sector financial
services companies, and ranks among the top 3 private sector financial services and banking
groups, in terms of net worth. Reliance Capital has interests in asset management and mutual funds,
life and general insurance, private equity and proprietary investments, stock broking, depository
services, distribution of financial products, consumer finance and other activities in financial
services.

18
 The Reliance Anil Dhirubhai Ambani Group is one of India's top 3 business houses, and has
a market capitalization of over Rs.2,90,000 crore (US$ 75 billion), net worth in excess of Rs.40,000
crore (US$ 10 billion), cash flows of Rs. 9,000 crore (US$ 2.2 billion), net profit of Rs. 5,000
crore (US$ 1.3 billion) and zero net debt. As Portfolio Managers, we Endeavour that every
portfolio created by us reflects the values on which Reliance Money has been built. A commitment
towards transparency and service. Add to that, a strong research driven investment process.

The Organization Hierarchy:

RELIANCE MONEY
RELIANCE MONEY
(Head Office Mumbai)
(Head Office Mumbai)

TIRUPATI
TIRUPATI

Cluster Head
Cluster Head

Centre Manager
Centre Manager

Business Development
Business Development
Executives
Executives

VISION STATEMENT

To be globally respected wealth creator with an emphasis on customers care and a culture of
good corporate governance.

MISSION

To Create and nurture a world class, high performance environment aimed at delighting our
customers.

CONCEPT BEHIND Reliance Money:

19
 Reliance Money provides a comprehensive platform, offering an investment avenue for a
wide range of asset classes. Its Endeavour is to change The way India transacts in financial markets
and avails financial services.

Reliance Money offers a single window facility, enabling you to access, amongst others.
Equity, Equity and Commodity Derivatives Offshore Investments, IPO’s, Mutual Funds, Life
Insurance & General Insurance Products.

Why Reliance Money?

Reliance Money is the most cost-effective, convenient and secure way to transact in a wide
range of financial products and services.

The highlights of Reliance Money’s offering are:

Cost-effective: The fee charged by the affiliates of Reliance Money, through whom the
transactions can be placed, is among the lowest charged in the present scenario. As an introductory
offer, pay a flat fee of just Rs. 500/- valid for 2 months or specified transactional value*.

Convenience: You have the flexibility to access Reliance Money services in multiple ways:
through The Internet, Transaction Kiosks, Call & Transact (Phone) or seek assistance through our
Business Partners.

Security: Reliance Money provides secure access through an electronic token that flashes a unique
security number every 32 seconds (and ensures that the number used for the earlier transaction is
discarded). This number works as a third level password that keeps you account extra safe.

Single window for multiple products: Reliance Money, through its affiliates/partners, facilitates
transactions in Equity, Equity & Commodity Derivatives, Offshore Investments**, Mutual Funds,
IPO’s. Life Insurance and General Insurance products. 3 in 1 integrated access: Reliance Money
offers integrated access to your banking, trading and demat account. You can transact without the
hassle of writing cheques.

20
Demat Account with Reliance Capital: Through Reliance Money, you get a hassle-free demat
account with Reliance Capital. The Annual Maintenance Charge for The Demat Account is just Rs.
50/- per annum.

Other Services:

# through the portal [Link], Reliance Money provides:

 Reliable research, including views of external experts with an enviable track record.
 Live news from Reuters and Dow Jones.
 CEOs’ / experts’ views on the economy and financial markets.
 The Personal Finance section provides tools that help you plan your investments,
retirement, tax, etc.
 Analyses your risk profile through The Risk Analyser.
 Get a suitable investment Portfolio using The Asset Allocator

Requirements for opening D-MAT cum trading account with Reliance Money:

1. pan card copy

2. add proof/ tell bill/ e- bill/ voter id/ bank pass book/ passport

3. cancelled cheques of ICICI/ IDBI/HDFC/AXIS The company accepts The cheques of

others banks also but it will take The time of 3-4days because The company has The tie ups
with These banks only

4. payment cheques: (for opening The account initial charges) for people who are in The
corporate list Rs 500 for clients not in The corporate list Rs 750

Brokerage card:

 500 for 2 months 1 crore (90 lakhs for intra trade & 10 lakhs for delivery)

 1350 for 6 months 3 crores (2.70 lakhs for intra trade & .30 lakhs for delivery)

 2500 for 12 months 6 crore (5.40 lakhs for intra day & .60 lakhs for delivery)

 PR 500 for 12 months with The limit of 5 lakhs (both intraday & delivery)

21
Secured log in with Reliance money:

 Unique user id (different for each & every client)

 User password (which you need to change every 15 days)

 Security key (which changes in every 32 seconds and generate numbers randomly)

Brokerage:

 Reliance money is working on the zero brokerage concepts, because of which education
cess as well as service tax will be NIL.

 As per The SEBI guidelines any brokerage company can't charge zero brokerage so it
charges 0.01% of brokerage in The name of transaction cost.

 Others than this The security transaction tax (STT) is also being charged @

 On Delivery: 0.125% On Intra day: 0.0125%

 Other than this holding charges are also being charged on sale of securities @Rs 12 on

 1 Scrip & 1 Order (irrespective of the fact as to how much big be the value of the complete
order).

 Comparison of Reliance money's facilities & charges with other companies DMAT account
facilities and charges is being shown in the following excel sheet.

22
THE BENEFITS:

A safe and convenient way to hold securities;

 Immediate transfer of securities;

 No stamp duty on transfer of securities;

 Elimination of risks associated with physical certificates such as bad delivery, fake
securities, delays, Thefts etc.;

 Reduction in paperwork involved in transfer of securities;

 Reduction in transaction cost;

 No odd lot problem, even one share can be sold;

 Nomination facility;

 Change in address recorded with DP gets registered with all companies in which investor
holds securities electronically eliminating The need to correspond with each of Them
separately;

 Transmission of securities is done by DP eliminating correspondence with companies;

 Automatic credit into demat account of shares, arising out of bonus / split / consolidation /
merger etc.

 Holding investments in equity and debt instruments in a single account.

 Reduce brokerage charges.

 Enables quick ownership of securities on settlement resulting in increased liquidity,

Picture: 1.3 The Reliance money Brokerage structure

Reliance Money

BROKERAGE

ONLINE OFFLINE

RECHARGE VOUCHER RECHARGE VOUCHER

+
FRANCHISEE FEE
23
FRANCHISEE FEE RS. 15/ TRANSACTION

Reliance has the concept of Recharge Vouchers

RECHARGE VOUCHER:
Rs. 500 12 Month 5 Lac Limit
Rs. 500 2 Months 1 Crore
Rs. 1350 6 Months 6 Crore
Rs. 2550 12 Months 12 Crore

Account Opening Charges :

For Regular Customers : Rs. 750.00

For Govt. Employees / Corporate : Rs. 500.00

Offer:

One Year Trading Account Fee by Reliance of Rs. 500.00 & 12 Months. Validity / 5 Lakhs.

Managing Savings:

This offering may be best suited for professionals and executives who are hard pressed for
time and unable to manage their savings efficiently.

“We are taking PMS to the masses. It would be a pan-India roll out and the launch would
happen in mid-January 2008. Nobody has taken PMS to the masses,” Mr. Sudip Bandyopadhyay,
Chief Executive of Reliance Money, told Business Line. PMS has so far been marketed to only high
net worth individuals, who could invest sums of Rs 1 crore or above.

Shariah Growth:

An Open ended scheme and a relatively protective investment option with investments
predominantly in select large-cap stocks. The objective of this option is to ensure liquidity and
lower impact cost leading to the construction of a relatively more stable portfolio. The portfolio
management process will also focus on using cash as an investment tool. However investments can
also be made in few mid-cap and small-cap stocks.

24
Investment Objective – Generate capital appreciation in medium to long term through investments
in equities and equity related instruments comprising predominantly large cap companies. This
scheme will be benchmarked to the BSE 200.

Parameters Driving Investment Decision – The portfolio strives at all times to achieve an overall
70% allocation to large cap companies. Again the portfolio will limit the exposure to any sector to
be less than 25% of the portfolio size and to any scrip to be less than 10%.

Growth:

A Moderate fund with growth approach and investments predominantly in large-cap stocks.
The objective is to ensure liquidity and lower impact cost leading to the construction of a relatively
more stable portfolio. The portfolio management process will also focus on using cash as an
investment tool and derivative protection.

Investment Objective – Generate capital appreciation in medium to long term through investments
in equities and equity related instruments comprising predominantly large cap companies. This
scheme will be benchmarked to the NSE 50stocks

Parameters Driving Investment Decision – The portfolio strives at all times to achieve an overall
70% allocation to large cap companies. Again the portfolio will limit the exposure to any sector to
be less than 25% of the portfolio size and to any scrip to be less than 10%.

Value:

A highly flexible investment option, which offers a diversified investment portfolio across
both large-cap and mid-cap stocks. This option follows a moderately aggressive approach to
portfolio construction. The portfolio management process will also focus on using cash as an
investment tool and derivatives for protection of portfolio.

Investment Objective – The objective of this scheme is wealth creation by delivering superior
returns over long term (18 months) through investments in value & growth stocks. This will be
benchmarked with BSE 200.

25
Risk Factor:

(a) Investments in securities are subject to market risks and include price fluctuation risks. There
are no assurances or guarantees that the objectives of any of the Schemes will be achieved. The
investments may not be suited to all categories of investors.

(b) The past performance of the Portfolio Manager in any Scheme/option is not indicative of the
future performance in the same Scheme/option or in any other scheme /option either existing or that
may be offered. There is no assurance that past performances indicated in earlier Schemes/options
will be repeated. Investors are not being offered any guaranteed or indicative returns through any of
the Schemes.

(c) The names of the Schemes/option do not in any manner indicate their prospects or returns. The
performance in the equity Schemes/options may be adversely affected by the performance of
individual company’s changes in the market place and industry specific and macro economic
factors.

Characteristics of equity

Equity is unsecured and a high risk-return investment when you invest your money in a
debt investment such as a bank deposit, bonds, etc., you are promised a fixed amount of interest on
your investment and return of capital. This isn’t the case with an equity investment. By becoming
an owner, you bear the risk of the company not being successful. However, the rewards for bearing
this risk are high. You, as an equity shareholder, are entitled to a share in the profits of the
company’s business as well as any appreciation in the perceived value of the shares.

The risks and rewards of investing in equity are clearly apparent from the Bombay
Stock Exchange Sensitive Index (BSE Sensex), which is a popular stock market index. This index
reflects the movement of the share prices on the stock markets. The Sensex rises and/or falls
continuously during trading hours. Rises indicate gains and falls indicate losses. True equity money
is unsecured and directly reflects the faith of the investor in the business, its management and the
commitment of its principals to it.

26
Equity remains in perpetual existence:

The perpetual existence of a company implies that the death, disability, retirement or
termination of a shareholder, director or officer, will not affect the existence of the company. For
an equity shareholder, this is convenient since he does not need to renew/renegotiate the terms of
his investment (like in the case of a fixed tenure debt investment). He also has the option to sell his
equity holding through the stock exchange if he no longer wants to remain invested in the
company.

Limited liability:

Another extremely important feature of equity is its limited liability, which means that,
as a part-owner of the company, you are not personally liable if the company is not able to pay its
debts. In case of other entities such as partnerships, if the partnership goes bankrupt, the partners
are personally liable towards the creditors/lenders and they may have to sell off their personal
assets like their house, car, furniture, etc., to make good the loss. In case of holding equity shares,
the maximum value you can lose is the value of your investment. Even if a company of which you
are a shareholder goes bankrupt, you can never lose your personal assets.

ABOUT EQUITY:

Equity is a share in the ownership of a company. It represents a claim on the company’s

assets and earnings. As you acquire more stock, your ownership stake in the company increases.
The terms share, equity and stock mean the same thing and can be used interchangeably. Holding a
company’s stock means that you are one of the many owners (shareholders) of a company, and, as
such, you have a claim (to the extent of your holding) to everything the company owns. Yes, this
means that technically, you own a portion of every piece of furniture; every trademark; every
contract, etc. of the company. As an owner, you are entitled to your share of the company’s
earnings as well as any voting rights attached to the stock.

27
INCOME FROM EQUITY INVESTING:

Capital Appreciation:

Equity shares of companies are listed and traded on a stock exchange (the Bombay Stock
Exchange or the National Stock Exchange).

The market prices of these shares are continuously moving up or down depending on the
interest in the company’s stock, it’s business potential, etc. As an equity shareholder, you can
profit/lose from the market price rise/fall.

For instance, if you have purchased the equity shares of Company ABC at Rs 25 per
share and the market price of the share rises to Rs 30, you can sell the shares at this price to make a
profit. This is called ‘capital appreciation’. However, if the market price falls to below Rs 25, you
would lose. This loss would be notional till you actually sell at this price and book the loss.

Bonus shares:

When you purchase shares of a company, you become a shareholder of the company.
When the company is doing well, it may declare a ‘bonus issue’. This means that the company will
issue fresh equity shares to its existing shareholders, for free. As a shareholder, you will be entitled
to receive bonus shares in proportion to your holding in the company. For instance, if the company
declares a bonus in the ratio of 1:2 (this means it will issue one share for every two shares you
hold) and if you hold 100 shares, you will be entitled to 50 shares as a bonus. When you sell your
bonus shares in the stock market, the market price at which you sell your bonus, minus brokerage
charges and necessary taxes (Service Tax, Securities Transaction Tax, etc.), will be your profit i.e.
capital appreciation. In this case, there will be no cost of purchase since you have received the
bonus for free. For instance, if the company declares a ‘bonus issue’ in the ratio of 1:2 (this means
it will issue one bonus share for every two shares you hold) and if you hold 100 shares, you will be
entitled to 50 shares as a ‘bonus shares’. The cost of these shares will be nil. In this case, if you sell
your bonus shares in the market at say, Rs 35, your capital appreciation will be the entire Rs 35 per
share minus brokerage, taxes, etc.

28
Rights shares:

Another way a company offers benefits to its shareholders is by offering ‘rights shares’.
This means that the company will offer fresh equity shares to its existing shareholders at a price,
which is lower than the current market price of the share. For instance, if the current market price
of the company’s share is Rs 35, it will offer shares at below this price, say Rs 25. As a
shareholder, you will be entitled to receive ‘rights shares’ in proportion to your holding in the
company.

For instance, if the company declares a ‘rights issue’ in the ratio of 1:2 (this means it
will issue one share for every two shares you hold) and if you hold 100 shares, you will be entitled
to 50 shares as a ‘rights shares’. This implies that to obtain the ‘rights shares’, you will have to pay
Rs 1,250 (50 shares you are entitled to x Rs 25 per share).

In this case, if you sell your rights shares in the market at say, Rs 35, your capital
appreciation will be Rs 10 per share minus incidental selling costs.

However, if you don’t want to subscribe to the rights offered to you, you can sell your
rights entitlements. The price that you receive to sell your rights entitlements will depend on the
rights offer price, the current market price and the demand for the company’s shares. For instance,
taking the above example forward, if you decide to sell your rights entitlements of 50 shares and
you receive Rs 2.50 per share, you will get a total of Rs 125. This will be your profit after
deducting incidental selling expenses.

Dividend Income:

Companies report their profits earned on a quarterly basis. Based on the quantum of
profits, companies declare dividends to distribute a portion of these profits to their shareholders.
Dividends are declared as a percentage of the share’s face value. For instance, if a company
declares a dividend of 10 per cent and its share has a face value of Rs 10, it implies that it will pay
Re 1 per share as dividend (Rs 10 x 10 per cent). As a shareholder, you will be entitled to dividend
to the extent of your share holding.

29
 For instance, in this case if you hold 500 shares, you will get a dividend of Rs 500 (500
shares x Re 1 per share). However, dividend income is uncertain. Companies don’t declare
dividends regularly. Dividends are declared only when there are profits available for distribution.

Reasons for issuing equity

To expand its business, a company, at some point, needs to raise money. To do this, it can
either borrow by taking a loan or raise funds by offering prospective investors a stake in the
company --- which is known as issuing stock. A company usually borrows from banks and/or
financial institutions. This is called ‘debt financing’.

On the other hand, issuing stock is called ‘equity financing’. While raising loans is used
for temporary cash requirements (such as borrowing to fund a project), issuing stock is used to raise
funds of a permanent nature. While a lender gets interest for the loan given to the company, an
equity shareholder gets a share in the investment options available with Reliance Money online
portal are as below:

1. Equity (Stock) Trading at BSE, NSE and NSE F&O

2. IPO Investment
3. Derivatives Trading
4. Forex Trading
5. Commodity Trading(Gold, Silver, Crude etc....) at MCX, NCDEX and NMCE (FAQ's)
6. Mutual Fund Investment
7. Life & General Insurance
8. 'Pure Swiss' Gold Coins (99.99% pure, 24 carat)

30
HISTORY OF DERIVATIVE MARKETS
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 [Link] primary intention of the CBOT was to provide a centralized location known
in advance for buyers and sellers to negotiate forward contracts. In1865, 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. During
the mid eighties, financial futures became the most active derivative instruments generating
volumes many times more than the commodity futures. 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, Eurex etc.

INTRODUCTION TO DERIVATIVES

The emergence of the market for derivative products, most notably forwards, futures
and options, can be traced back to the willingness of risk-averse economic agents to guard
themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the
financial markets are marked by a very high degree of volatility. Through the use of derivative
products, it is possible to partially or fully transfer price risks by locking-in asset prices. As
instruments of risk management, these generally do not influence the fluctuations in the underlying
asset prices. However, by locking in asset prices, derivative products minimize the impact of
fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors.

31
DERIVATIVES DEFINED

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".
In the Indian context the Securities Contracts (Regulation) Act 1956 (SC(R) A) defines
"derivative" to include-

1. A security derived from a debt instrument, share, loan whether secured or unsecured, risk
instrument or contract for differences or any other form of security.
2. A contract which derives its value from the prices, or index of prices, of underlying
securities.
Derivatives are securities under the SC(R) A and hence the trading of derivatives is governed by
the regulatory framework under the SC(R) A.

Example: A manufacture has received order for supply of his products after six months. Price of
the product has been fixed. Production of goods will have to start after four months. He fears that,
in case the price of raw material goes up in the meanwhile, he will suffer a loss on the order.
To protect himself against the possible risk, he buys the raw material in the futures market
for delivery and payment after four months at an agreed price, say,Rs.100 per unit.

Example: Another person who produces the raw material. He does not have advanced orders. He
knows that his products will be ready after four months. He roughly knows the estimated cost of his
products. He does not know what will be the price of his products after four months. If the price
goes down, he will suffer a loss. To protect himself against the possible loss, he makes the future
sale of his products, at an agreed price, say, Rs.100 per unit. At the end of four months, he delivers
the products and receives the payment at the rate of Rs.100 per unit of contracted quantity. The
actual price may be more or less than the contracted price at the end of the contracted period.

32
 A businessman may not be interested in such speculative gains or losses. His main
concern is to make profits from his main business and not through rise and fall of prices.

In the above examples, at the end of the one year, ruling price may be more than Rs.100 or
less than Rs.100. If the price is higher (sayRs.125), the buyers is gainer for the pays Rs.100 and
gets shares worth Rs.125, and the seller is the loser for he gets Rs.100 for shares worth Rs.125 at
the time of delivery. On the other hand, in case the price is lower (say Rs.75), the purchaser is loser,
and the seller is the gainer. There is the method to cut a part of such loss by buying a “futures”
contract with an “option”, on payments of fee.

From the above example it is clear that one’s gain is another’s loss. That is why derivatives
are a ‘zero sum game’. The mechanism helps in distribution of risks among the market players.

DERIVATIVES FUNCTIONS:
The following are the various functions that are performed by the derivatives market. They are

 Derivatives market help to transfer risks from those who have them but may not like
them to those who want them.
 Derivatives trading act as catalyst for new entrepreneurial activity.
 Derivatives market helps increase savings and investments in the long run.

ECONOMIC FUNCTION OF THE DERIVATIVEMARKET

In spite of the fear and criticism with which the derivative markets are commonly
looked at, these markets perform a number of economic functions.
1. Prices in an organized derivatives market reflect the perception of market participants about
the future and lead the prices of underlying to the perceived future level. The prices of derivatives
converge with the prices of the underlying at the expiration of the derivative contract. Thus
derivatives help in discovery of future as well as current prices.
2. The derivatives market helps to transfer risks from those who have them but may not like
them to those who have an appetite for them.
33
 3. Derivatives, due to their inherent nature, are linked to the underlying cash markets. With the
introduction of derivatives, the underlying market witnesses higher trading volumes because of
participation by more players who would not otherwise participate for lack of an arrangement to
transfer risk.
ADVANTAGES OF DERIVATIVES:
 Transactional efficiency-greater liquidity and lower cost
 Price discovery-dissemination of price information
 Risk management- transfer of risks

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 the growth 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.

 Dr. L. C. Gupta Committee recommendations:

The securities and exchange board of India (SEBI) appointed with [Link] as its
chairman on 18th November, 1996 to develop regulatory frame work for derivatives trading in India
and to suggest buy-laws for regulation and control of trading and settlement of derivatives
contracts. The committee was also to focus on the financial derivatives and equity derivatives. The
committee submitted its report in March 1998.

34
 The committee recommended introduction of derivatives market in a phased manner with
the introduction of index futures and SEBI appointed a group with [Link] as its chairman
to recommended measures for risk containment in the derivative market in India.

The board of SEBI in its meeting held on may 11, 1998 accepted the recommendation and
approved the introduction of derivatives trading in India beginning with stock index futures. The
board also approved the “suggestive bye-laws” recommended by the [Link] committee for
regulation and control of trading and settlement of derivatives contracts. SEBI circulated the
contents of the report in June 1998.

The [Link] committee had conducted a wide market survey with contract of several entities
relevant to derivatives trading like brokers, mutual funds, banks/FIIs, FIIs and merchant banks. The
committee observation was that there is widespread recognition of the needs for derivatives
products including equity, interest rate and currency derivatives products. However stock index
future is the most preferred product followed by stock index options. Options on individual stocks
are the third I the order of preference. The participants took interviews, mostly stated that their
objective in derivative trading would be hedging. But there were also a few interested in derivatives
dealing for speculation or dealing.

The recommendations of [Link] committee at a glance:

1. Stock index futures to be the starting point of equity derivatives.

2. SEBI to approve rules, buy-laws and regulations of the derivatives exchange level regulations.
3. SEBI need not be involved in framing exchange level regulations.
4. SEBI should create a special derivatives cell as it involves special knowledge and a derivatives
advisory council may be created a tap outside exports for independent advice.
5. Legal restrictions on institutions, including mutual funds, on use of derivatives should be
removed.
6. Existing stock exchanges with cash trading to be allowed to trade derivatives if they meet
prescribed eligibility conditions-importantly a separate governing council and at least 50
members.
7. Two categories of members – clearing members and non clearing members, with the later
depending on the former for settlement of trades. This is to bring in more traders.
35
8. Broker members, dealers and salespersons in the derivatives market must have passed a
certificate program to be registered with SEBI.
9. Co-ordination between SEBI and the RBI of financial derivatives market must have passed a
certificate program registered with the SEBI.
10. Clearing corporation to be the centre piece of the derivative market, both for implementing the
margin systems and providing trade guarantee.
11. Minimum net worth requirement of Rs.3 crore for participants, maximum exposure limits for
each broker/dealer on gross basis and capital adequacy requirement to be prescribed.
12. Mark to market margins to be collected before next day’s trading starts.
13. As a conservative measure, margins for derivatives purposes not to take into account positions
in cash and futures, market and across all stock exchanges.
14. Margin to be systematically collected and not left to discretion of brokers/dealers.
15. Much stricter regulation for derivatives as compared to cash trading.
16. Strengthen cash market with uniform settlement cycles among all SEs and regulatory over
weight.

17. Proper supervision of sales practices withy regulation of every client with the dealer/broker and
risk disclosure as the corner stone.

The important recommendations of [Link] committee

Need for coordinated development:

To quote from the report of the committee- “the committee’s main concerns is with equity
based derivatives but it has tried to examine the need for financial derivatives in a broader
perspective. Financial transactions and asset-liability positions are exposed to three broad types of
price risks, viz;

Equities, market risk, also called systematic risk (which can not be diversified away because
the stock market as a hole may up or down from time to time).

36
 Interest rate risk (as in the case of fixed income securities, like treasury bond holding,
whose market price could fall heavily it interest rates shot up),and

Exchange rate risk (where the position involves a foreign currency, as in the case of
imports, exports, foreign loans or investments).

The above classification of price risk explains the emergence of (a) equity futures, (b)
interest rate futures, (c) currency futures, respectively. Equity futures have been the last to emerge.

The recent report of the RBI appointed committee on capital account convertibility (Tara
pore Committee) has expressed the view that time is ripe for introduction of futures in currencies
and interest rates to facilitate various users to have access to a wide spectrum of cost-efficient
hedge mechanism. In the some context, the Tara pore Committee has also opinioned that a system
of trading in futures….is more transparent and cost efficient than the existing system (of forward
contracts). Having a common trading infrastructure will have important advantages. The
committee, therefore, feels that the attempt should be to develop an integrate market structure.
Chronology of derivatives market in India

14 Dec 1995 NSE asked SEBI for permission to trade index futures

18 Nov, 1996 Formed [Link] committee to design a policy framework for

index futures

7 July, 1999 RBI gave permission for OTC forward rate agreements (FRA)
interest rate swaps

24 May, 2000 SIMEX choose NIFTY for trading futures and options on an
Indian
Index

25 May, 2000
SEBI gave permission to NSE and BSE to do index future
trading
37
 9 June, 2000

Trading of BSE Sensex futures commenced at BSE

12 June, 2000

Trading of NIFTY futures commenced at NSE

25Sep, 2000

NIFTY futures trading commenced at SGX

June, 2001

Index options introduced

July, 2001

Stock options introduced

Nov, 2001

Stock futures introduced

Derivatives market today:

Foreign currency options in currency pairs other than rupee were the first options
permitted by RBI.

The RBI has permitted options, interest rate swaps, currency swaps, and other risk
reduction OTC derivative products.

Beside the forward market to currencies has been a vibrant market in India for
several decades.

In addition the forward markets commission has allowed the setting up of

commodities futures exchanges. Today we have 18 commodities exchanges most of which
trade futures e.g. the Indian Paper and Spice Trader Association (IPSTA) and the Coffee
Owners Futures Exchange of India (COFEI).
38
 The year 2000 heralded the introduction of exchange traded equity derivative
products.

 Types of derivatives

There are four most commonly traded derivative instruments: Forwards, Futures,
Options, and Swaps. Futures and options are actively traded on many exchanges. Forward
contracts and swaps and certain kind of options are mostly traded as over the counter (OTC)
products.

DERIVATIVE PRODUCTS:
Derivative contracts have several variants. The most common variants are forwards,
futures, options and swaps. We take a brief look at various derivatives contracts that have come to
be used.

Forwards:
A forward contract is a customized contract between two entities, where settlement takes
place on a specific date in the future at today's pre-agreed price.
Futures:
39
 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. Futures contracts are special types of forward contracts in the
sense that the former are standardized exchange-traded contracts.
Options:
Options are of two types - calls and puts. 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 buyer 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.

Warrants:
Options generally have lives of up to one year, the majority of options traded on options
exchanges having a maximum maturity of nine months. Longer-dated options are called warrants
and are generally traded over-the-counter.
LEAPS:
The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options
having a maturity of up to three years.

Baskets:
Basket options are options on portfolios of underlying assets. The underlying asset is
usually a moving average of a basket of assets. Equity index options are a form of basket options.
Swaps:
Swaps are private agreements between two parties to exchange cash flows in the future
according to a prearranged formula. They can be regarded as portfolios of forward contracts. The
two commonly used swaps are:
Interest rate swaps: These entail swapping only the interest related cash flows
between the parties in the same currency.
Currency swaps: These entail swapping both principal and interest between the parties,
with the cash flows in one direction
Being in a different currency than those in the opposite direction.

Swaptions:

40
 Swaptions are options to buy or sell a swap that will become operative at the expiry of the
options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the
swaptions market has receiver swaptions and payer swaptions. A receiver swaption is an option to
receive fixed and pay floating. A payer swaption is an option to pay fixed and receive floating.

PARTICIPANTS IN THE DERIVATIVES MARKETS

The following two broad categories of participants trade in the derivatives market.
COMMISSION BROKERS: commission brokers are following the instructions of
their clients and charge a commission for doing so.
LOCALS: locals are trading on their own account. Locals are classified in three types

1) Hedgers: Hedgers face risk associated with the price of an asset. They use futures or options
markets to reduce or eliminate this risk.
2) Speculators: Speculators wish to bet on future movements in the price of an asset. Futures
and options contracts can give them an extra leverage; that is, they can increase both the potential
gains and potential losses in a speculative venture. Speculators can be classified three types
 Scalpers: scalpers are watching for very short term trends and attempt to profit from small
changes in the contract price. They usually hold their positions for only a few minutes.
 Day traders: day traders are unwilling to take the risk that adverse news will occur over
night. They are holding their positions for less than one trading day.
 Position traders: they hope to make significant profits from major movements in the
market. Position traders hold their positions for much longer periods of time.
3) Arbitrageurs: Arbitrageurs are in business to take advantage of a discrepancy between prices
in two different markets. If, for example, they see the futures price of an asset getting out of line
with the cash price, they will take offsetting positions in the two markets to lock in a profit.

NSE's DERIVATIVES MARKET

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 November
9, 2001. Today, both in terms of volume and turnover, NSE is the largest derivatives exchange in
41
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.
THE S&P CNX NIFTY:
What makes a good stock market index for use in an index futures and index options market?
Several issues play a role in terms of the choice of index. We will discuss how the S&P CNX Nifty
addresses some of these issues.

Diversification:
As mentioned earlier, a stock market index should be well diversified, thus ensuring that
hedgers or speculators are not vulnerable to individual-company or industry risk.
Liquidity of the index:
The index should be easy to trade on the cash market. This is partly related to the choice of
stocks in the index. High liquidity of index components implies that the information in the index is
less noisy.
Operational issues:
The index should be professionally maintained, with a steady evolution of securities in the
index to keep pace with changes in the economy. The calculations involved in the index should be
accurate and reliable. When a stock trades at multiple venues, index computation should be done
using prices from the most liquid market.

The S&P CNX Nifty is a market capitalization index based upon solid economic research.
It was designed not only as a barometer of market movement but also to be a foundation of the new
world of financial products based on the index like index futures, index options and index funds. A
trillion calculations were expended to evolve the rules inside the S&P CNX Nifty index.

The results of this work are remarkably simple:

(a) The correct size to use is 50
(b) Stocks considered for the S&P CNX Nifty must be liquid by the 'impact cost’ criterion.
(c) The largest 50 stocks that meet the criterion go into the index.

42
 S&P CNX Nifty is a contrast to the adhoc methods that have gone into index construction
in the preceding years, where indexes were made out of intuition and lacked a scientific basis. The
research that led up to S&P CNX Nifty is well-respected internationally as a pioneering effort in
better understanding how to make a stock market index. The Nifty is uniquely equipped as an index
for the index derivatives market owing to its
(a) Low market impact cost and
(b) High hedging effectiveness.
The good diversification of Nifty generates low initial margin requirement. Finally, Nifty is
calculated using NSE prices, the most liquid exchange in India, thus making it easier to do arbitrage
for index derivatives.

TRADING:
In this chapter we shall take a brief look at the trading system for NSE's futures and
options market. However, the best way to get a feel of the trading system is to actually watch the
screen and observe trading.

FUTURES AND OPTIONS TRADING SYSTEM

The futures & 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 as well as an online monitoring and surveillance mechanism. It
supports an order driven market and provides complete transparency of trading operations. It is
similar to that of trading of equities in the cash market segment. The software for the F&O market
has been developed to facilitate efficient and transparent trading in futures and options instruments.
Keeping in view the familiarity of trading members with the current capital market trading system,
modifications have been performed in the existing capital market trading system so as to make it
suitable for trading futures and options.

Entities in the trading system:

There are four entities in the trading system. Trading members, clearing members, professional
clearing members and participants.

43
 1) Trading members: Trading members are members of NSE. They can trade either on their
own account or on behalf of their clients including participants. The exchange assigns a trading
member ID to each trading member. Each trading member can have more than one user. The
number of users allowed for each trading member is notified by the exchange from time to time.
Each user of a trading member must be registered with the exchange and is assigned an unique user
ID. The unique trading member ID functions as a reference for all orders/trades of different users.
This ID is common for all users of a particular trading member. It is the responsibility of the
trading member to maintain adequate control over persons having access to the firm’s User IDs.
2) Clearing members: Clearing members are members of NSCCL. They carryout risk
management activities and confirmation/inquiry of trades through the trading system.
3) Professional clearing members: A professional clearing members is a clearing member who is
not a trading member. Typically, banks and custodians become professional clearing members and
clear and settle for their trading members.
4) Participants: A participant is a client of trading members like financial institutions. These
clients may trade through multiple trading members but settle through a single clearing member.

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 Nifty, it has to
have market impact cost of below 0.75% when doing Nifty trades of half a crore rupees. The
market impact cost on a trade of Rs.3 million of the full Nifty works out to be about 0.05%. This
means that if Nifty is at 2000, a buy order goes through at 2001, i.e.2000 + (2000*0.0005) and a
sell order gets 1999, i.e. 2000-(2000*0.0005).

Hedging effectiveness

Hedging effectiveness is a measure of the extent to which an index correlates with a

portfolio, whatever the portfolio may be.
Nifty correlates better with all kinds of portfolios in India as compared to other indexes.
This holds good for all kinds of portfolios, not just those that contain index stocks. Similarly, the

44
CNX IT and BANK Nifty contracts which NSE trades in correlate well with information
technology and banking sector portfolios.
Nifty, CNX IT, BANK Nifty, CNX Nifty Junior, CNX 100, Nifty Midcap 50 and Mini Nifty 50
indices are owned, computed and maintained by India Index Services & Products Limited (IISL), a
company setup by NSE and CRISIL with technical assistance from Standard & Poor's.

Participants and functions

NSE admits members on its derivatives segment in accordance with the rules and
regulations of the exchange and the norms specified by SEBI. NSE follows 2-tier membership
structure stipulated by SEBI to enable wider participation. Those interested in taking membership
on F&O segment are required to take membership of CM and F&O segment or CM, WDM and
F&O segment. Trading and clearing members are admitted separately. Essentially, a clearing
member (CM) does clearing for all his trading members (TMs), undertakes risk management and
performs actual settlement. There are three types of CMs:

 Self Clearing Member:

A SCM clears and settles trades executed by him only either on his own account or on
account of his clients.

• Trading Member Clearing Member:

TM-CM is a CM who is also a TM. TM-CM may clear and settle his own proprietary trades
and client's trades as well as clear and settle for other TMs.
• Professional Clearing Member:
PCM is a CM who is not a TM. Typically, banks or custodians could become a PCM and clear
and settle for TMs.

Trading mechanism
The futures and options trading system of NSE, called NEAT-F&O trading
45
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, and
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.

MARKET INDEX

To understand the use and functioning of the index derivatives markets, it is necessary to
understand the underlying index. In the following section, we take a look at index related issues.
Traditionally, indexes have been used as information sources.
By looking at an index, we know how the market is faring. In recent years, indexes
have come to the forefront owing to direct applications in finance in the form of index funds and
index derivatives. 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.

UNDERSTANDING 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 because it is expressed relative to the weighted average of prices at
some arbitrarily chosen starting date or base period. The 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
46
1000 on the start date of November 3, 1995. A good stock market index is one 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
1. As a barometer for market behavior,
2. As a benchmark portfolio performance,
3. As an underlying in derivative instruments like index futures, and
4. In passive fund management by index funds
Every stock price moves for two possible reasons:
1. News about the company (e.g. a product launch, or the closure of a factory)
2. News about the country (e.g. budget announcements)

TYPES OF INDEXES

Most of the commonly followed stock market indexes are of the following
Two Types:
1. Market capitalization weighted index or price weighted index.
2. in a market capitalization weighted index,
Each stock in the index affects the index value in proportion to the market value of all shares
outstanding.
A price weighted index is one that gives a weight to each stock that is proportional to its stock
price. Indexes can also be equally weighted. Recently, major indices in the world like the S&P 500
and the FTSE-100 have shifted to a new method of index calculation called the "Free float"
method. We take a look at a few methods of index calculation.

Index derivatives

47
 Index derivatives are derivative contracts which have the index as the underlying. The
most popular index a derivative contracts 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 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, derivative contracts on sectoral indexes like CNX IT
and BANK Nifty contracts. Trading on index derivatives were further introduced on CNX Nifty
Junior, CNX 100, Nifty Midcap 50 and Mini Nifty 50.

Index funds
An index fund is a fund that tries to replicate the index returns. It does so by investing in
index stocks in the proportions in which these stocks exist in the index. The goal of the index fund
is to achieve the same performance as the index it tracks. For instance, a Nifty index fund would
seek to get the same return as the Nifty index. Since the Nifty has 50 stocks, the fund would buy all
50 stocks in the proportion in which they exist in the Nifty.
Once invested, the fund will track the index, i.e. if the Nifty goes up; the value of the fund
will go up to the same extent as the Nifty. If the Nifty falls, the value of the index fund will fall to
the same extent as the Nifty. The most useful kind of market index is one where the weight
attached to a stock is proportional to its market capitalization, as in the case of Nifty. Index funds
are easy to construct for this kind of index since the index fund does not need to trade in response
to price fluctuations. Trading is only required in response to issuance of shares, mergers, etc.

Exchange Traded Funds

Exchange Traded Funds (ETFs) are innovative products, which first came into existence in
the USA in 1993. They have gained prominence over the last few years with over $300 billion
invested as of end 2001 in about 360 ETFs globally. About 60% of trading volume on the
American Stock Exchange is from ETFs.
Among the popular ones are SPDRs (Spiders) based on the S&P 500 Index, QQQs
(Cubes) based on the Nasdaq-100 Index, ISHARES based on MSCI Indices and TRAHK (Tracks)
based on the Hang Seng Index. ETFs provide exposure to an index or a basket of securities that
48
trade on the exchange like a single stock. They have a number of advantages over traditional open-
ended funds as they can be bought and sold on the exchange at prices that are usually close to the
actual intra-day NAV of the scheme. They are an innovation to traditional mutual funds as they
provide investors a fund that closely tracks the performance of an index with the ability to buy/sell
on an intra-day basis. Unlike listed closed-ended funds, which trade at substantial premium or more
frequently at discounts to NAV, ETFs are structured in a manner which allows to create new units
and redeem outstanding units directly with the fund, thereby ensuring that ETFs trade close to their
actual NAVs.
The first ETF in India, "Nifty BEEs" (Nifty Benchmark Exchange Traded Scheme) based
on S&P CNX Nifty, was launched in December 2001 by Benchmark Mutual Fund. It is bought and
sold like any other stock on NSE and has all characteristics of an index fund. It would provide
returns that closely correspond to the total return of stocks included in Nifty.

INTRODUCTION TO FORWADS, FUTURES AND OPTIONS

In recent years, derivatives have become increasingly important in the field of finance.
While futures and options are now actively traded on many exchanges, forward contracts are
popular on the OTC market.

FORWARD CONTRACTS
A forward contract is an agreement to buy or sell an asset on a specified date for a specified
price. One of the parties to the contract assumes a long position and agrees to buy the underlying
asset on a certain specified future date for a certain specified price. The other party assumes a short
position and agrees to sell the asset on the same date for the same price. Other contract details like
delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The
forward contracts are normally traded outside the exchanges.

The salient features of forward contracts are:

• They are bilateral contracts and hence exposed to counter - party risk.

49
• Each contract is custom designed, and hence is unique in terms of contract size, expiration date
and the asset type and quality.
• The contract price is generally not available in public domain.
• On the expiration date, the contract has to be settled by delivery of the asset.
• If the party wishes to reverse the contract, it has to compulsorily go to the same counter-party,
which often results in high prices being charged.
However forward contracts in certain markets have become very standardized, as in the
case of foreign exchange, thereby reducing transaction costs and increasing transactions volume.
This process of standardization reaches its limit in the organized futures market.
Forward contracts are very useful in hedging and speculation. The classic hedging
application would be that of an exporter who expects to receive payment in dollars three months
later. He is exposed to the risk of exchange rate fluctuations. By using the currency forward market
to sell dollars forward, he can lock on to a rate today and reduce his uncertainty. Similarly an
importer who is required to make a payment in dollars two months hence can reduce his exposure
to exchange rate fluctuations by buying dollars forward. If a speculator has information or analysis,
which forecasts an upturn in a price, then he can go long on the forward market instead of the cash
market. The speculator would go long on the forward, wait for the price to raise, and then take a
reversing transaction to book profits. Speculators may well be required to deposit a margin upfront.
However, this is generally a relatively small proportion of the value of the assets underlying the
forward contract. The use of forward markets here supplies leverage to the speculator.

LIMITATIONS OF FORWARD MARKETS

Forward markets world-wide are afflicted by several problems:
• Lack of centralization of trading,
• Illiquidity, and
• Counterparty risk
In the first two of these, the basic problem is that of too much flexibility and generality.
The forward market is like a real estate market in that any two consenting adults can form contracts
against each other. This often makes them design terms of the deal which are very convenient in
that specific situation, but makes the contracts non-tradable.
Counterparty risk arises from the possibility of default by any one party to the
transaction. When one of the two sides to the transaction declares bankruptcy, the other suffers.

50
Even when forward markets trade standardized contracts, and hence avoid the problem of
illiquidity, still the counterparty risk remains a very serious issue.

INTRODUCTION TO FUTURES

Futures markets were designed to solve the problems that exist in forward markets. 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. But unlike forward contracts, 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. A futures
contract may be offset prior to maturity by entering into an equal and opposite transaction. More
than 99% of futures transactions are offset this way.
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
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.

PRICING FUTURES
Pricing of futures contract is very simple. Using the cost-of-carry logic, we calculate the fair
value of a futures contract. Every time the observed price deviates from 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 given below:
51
Where:
r = Cost of financing (using continuously compounded interest rate)
T = Time till expiration in years
e = 2.71828
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 and a February
expiration contract ceases trading on the last Thursday of February. On the Friday following the
last Thursday, a new contract having a three- month expiry is introduced for trading.

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. Also called as lot size.
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 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.

 Marking-to-market:

52
 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.

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 requirements) to enter into a futures contract,
the purchase of an option requires an up-front payment.
OPTION TERMINOLOGY:
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.

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 option on the seller/writer.

 Writer of an option:
53
 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. There are two basic types of options, call
options and put options.

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.
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.
 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 options contract is known as the strike price or the exercise price.
American options:
American options are options that can be exercised at any time up to the expiration date. Most
exchange-traded options are American.
European options:
European options are options that can be exercised only on the expiration date itself.
European options are easier to analyze than American options, and properties of an American
option are frequently deduced from those of its European counterpart.

 In-the-money option:
An in-the-money (ITM) 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 when
the current index stands at a level higher than the strike price (i.e. spot price > strike price).

54
 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 (ATM) 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).
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. Putting it another way, the intrinsic value of a call is Max [0, (St — K)]
which means the intrinsic value of a call is the greater of 0 or (St — K). Similarly, the intrinsic
value of a put is Max [0, K — St], i.e. the greater of 0 or (K — St). K is the strike price and St is the
spot price.
Time value of an option:
The time value of an option is the difference between its premium and its intrinsic value. Both
calls and puts have time value. An option that is OTM or ATM has only time 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, all else equal. At expiration, an option should have no time value.

FUTURES AND OPTIONS:

An interesting question to ask at this stage is - when would one use options instead of
futures? Options are different from futures in several interesting senses. At a practical level, the
option buyer faces an interesting situation. He pays for the option 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 (other than the funds already paid for the option).
55
 This is different from 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
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".
INDEX DERIVATIVES

Index derivatives are derivative contracts which derive their value from an underlying index.
The two most popular index derivatives are index futures and index options. Index derivatives have
become very popular worldwide. Index derivatives offer various advantages and hence have
become very popular.

 Institutional and large equity-holders need portfolio-hedging facility.

Index-derivatives are more suited to them and more cost-effective than derivatives based on
individual stocks. Pension funds in the US are known to use stock index futures for risk hedging
purposes.
 Index derivatives offer ease of use for hedging any portfolio irrespective of its composition.
 Stock index is difficult to manipulate as compared to individual stock prices, more so in India,
and the possibility of cornering is reduced. This is partly because an individual stock has a limited
supply, which can be cornered.
 Stock index, being an average, is much less volatile than individual stock prices. This implies
much lower capital adequacy and margin requirements.
 Index derivatives are cash settled, and hence do not suffer from settlement delays and problems
related to bad delivery, forged/fake certificates.

56
 TRADING STRATEGIES

BULL SPREADS
One of the most popular types of spreads is a bull spread. Bull spread can be created by
buying a call option on a stock with a certain strike price and selling a call option on the same stock
with a higher strike price. Both options have the same expiration date. The profits from the two
option positions taken separately are shown by the dashed lines. The profit from the whole strategy
is the sum of profits given by the dashed lines and is indicated by the solid line. Because a call
price always decreases as the strike price increases, the value of the option sold is always less than
the value of the option bought. A bull spread, when created from calls, therefore requires an initial
investment.

Profit form bull spread created using call options.

Profit is calculated subtracting the initial investment form the payoff. Suppose that K1 is the strike
price of the call option bought, k2 is the strike price of the call option sold, and ST is the stock price
on the expiration date of the options.
The total payoff that will be realized form a bull spread in different circumstances.
1. If the stock price does well and is greater than the higher strike price, the payoff is the
difference between the two strike prices, or K2_k1.
2. If the stock price does on the expiration date lies between the two strikes prices, the
payoff is ST_K1.
57
 3. If the stock price on the expiration date is below the lower strike price, the payoff is zero.

“A bull spread strategy limits the investor’s upsides as well as downside risk”. The strategy can be
described by saying that the investor has a call option with a strike price equal to K1 and has
chosen to give up some upside potential by selling a call option with strike price K2 ( K2 > K1 ).
Payoff from a bull spread created using calls:-

Stock price
Payoff from long Total payoff
Payoff from short
Range call option
call option

ST ≥ K 2 ST _ K 1 -( ST _ K2) K2 _ K1
K1 < ST < K2 ST _ K 1 0 ST _ K 1
ST ≤ K 1 0 0 0

Three types of bull spreads can be distinguished:

1. Both the calls are initially out of the money.
2. One call is initially in the money; the other call is initially out of the money.
3. Both calls are initially in the money.
GOAL:
The investor intends to reduce the cost of the purchased call with the option premium, which
is collect from the call that is written at higher strike price. However, the resulting trade-off is a
limit on the potential profit.
Example:
An investor buys for $3 a call with a strike price of $30 and sells for $1 a call with a strike
price of $35. The payoff from this bull spread strategy is $5 if the stock price is above $35 and zero
if it is below $30. If the stock price is between $30 and $35, the payoff is the amount buy which the
stock price exceeds $30. The cost of the strategy is $3-$1=$2. The profit is therefore as follows.

58
 Stock price range Profit

ST ≤ 30 -2
30 < ST < 35 ST - 32
ST ≥ 35 3

Bull spreads can also be created by buying a put with a low strike price and selling a put with a
high strike price.

BEAR SPREADS
An investor who enters into a bear spread is hoping that the stock price will decline. Bear
spreads can be created by buying a put with one strike price and selling a put with another strike
price. The strike price of the option purchased is greater than the strike price of the option sold.
(This is in contrast to a bull spread, where the strike price of the option purchased is always less
than the strike price of the option sold.) The profit from the spread is shown by the solid line. A
bear spread created from puts involves an initial cash outflow because the price of the put sold is
less than the price of the put purchased.

Stock price Payoff from long Total payoff

Payoff from short
59
 Range call option call option
ST ≥ K 2 0 0 0
K1 < ST < K2 K 2 _ ST 0 K 2 _ ST
ST ≤ K 1 K 2 _ ST -(K1 _ ST) K2 _ K1

Assume that the strike prices are K1 and K2, with k1 < K2. Table shows the payoff that will be
realized from a bear spread in different circumstances.
 If the stock price is less than k1 the payoff is K2 _ k1.
 If the stock price greater than K2, the payoff is zero.
 If the stock price is between k1 and K2, the payoff is k2 _ ST.

The profit is calculated by subtracting the initial cost form the payoff.
Example:
An inventor buys for $3 a put with a strike price of $35 and sells for $1 a put with a strike
price of $30. The payoff from this bear spread strategy is zero if the stock price is above $35, and
$5 if it is below $30. If the stock price is between $30. If the stock price is between $30 and $35,
the payoff is 35-ST. The options cost $3 - $1 = $2 up front. The profit is therefore as follows:

Stock price range Profit

ST ≤ 30 +3
30 < ST < 35 33 _ ST
ST ≥ 35 -2

Bear spreads can be created using calls instead of puts. The investor buys a call with a high
strike price and sells a call with a low strike price.

BUTTERFLY SPREADS
60
 A Butterfly spread involves positions in options with three different strike prices. It can be
created by buying a call option with a relatively low strike price, K1, buying a call option with a
relatively high strike price, K3, and selling two call option with a strike price, K2, halfway between
K1 and K3. Generally K2 is close to the current stock price. The pattern of profits from the strategy
is shown in diagram. A butterfly spread leads to a profit if the stock price stays close to K2, but
gives rise to a small loss if there is a significant stock price move in either direction. It is therefore
an appropriate strategy for an investor who feels that large stock price moves are unlikely. The
strategy requires a small investment initially. The payoff from a butterfly spread is shown in table.
Payoff from a butterfly spread.

Stock price payoff form Payoff Payoff Total payoff*

Range second long form form
call second short
long call calls
- 0 0 0 0
< < - 0 0 -
< < - 0 -2( - ) -
> - - -2( - ) 0

Profit from butterfly spread using call options.

61
 Butterfly spreads can be created using put options. The investor buys a put with a low
strike price, buys a put with a high strike price, and sells two puts with an intermediate strike price,
as illustrated in diagram. The butterfly spread in the example just considered would be created by
buying a put with a strike price of $55, buying a put with a strike price of $65, and selling two puts
with a strike price of $60. If all options are European, the use of put option results in exactly the
same spreada as the use of acall options. Put – call parity can be used to show that the initial
investment is the same in both cases.
A butterfly spread can be sold or shorted by following the reverse strategy. Options are sold with
a strike price of K1 and K3, and two options with the middle strike price K2 are purchased. This strategy
produces a modest profit if there is a significant movement in the stock price.

NEED FOR THE STUDY

62
 Previously cash markets were more popular. It had unlimited gains as well as unlimited

losses. To minimize the losses derivate contacts have been introduced in India. Volume of trading

of derivatives in derivatives market is increasing to the level of stock market. Due to the increase in

the number of traders, the number of broking services has shot up. Reliance Securities Ltd (RSL)

has been providing services in trading since 2001 and is playing vital role in trading of derivatives.

Since most of the traders are unaware of how to buy and sell futures and options of a particular

company, they seek the help of broking companies.

Also, they are ignorant of different trading strategies which will be profitable to them.

Broking services give advice to the traders which will enhance their gains. This will help them to

garner the traders under them. Due to increase in number of broking services in the country, it has

become important for RSL to increase the number of traders under them. So it has important for

RSL to give appropriate advice on trading strategies according to the prices of particular

companies’ futures and options. There is a need to study derivatives market and to educate

investors about derivatives markets and its advantages.

Reliance securities a leading stock exchange where in the companies are performing

well; the investors especially the retail investors aren’t able to access information concerning the

opportunities available in derivatives market. This study is an attempt to explore into the

opportunities available for the investors in the derivatives market and also analyses the role of

different players in creating awareness of various features of the derivatives market.

63
OBJECTIVES OF THE STUDY:

 To study about various trading strategies of derivatives

 To find out profit / loss of the option holder and option writer

 To find out options position in NSE

64
METHODOLOGY:

Data sources: primary 2data, secondary data

Data collection: primary data: Is collected from the Reliance Money

Secondary data: Is collected from futures options and other derivatives by John [Link],(sixth
edition), Financial Derivatives, [Link] Eastern Economy Edition.

PROFIT /LOSS OF PUT OPTOIN BUYER/WRITER OF TATA STEEL

65
 Table-1.1

spot strike whether lot size buyer writer

price price premium exercised profit/loss profit/loss
679 640 8.80 NO 500 -4400 4400
679 660 15.25 NO 500 -7625 7625
679 680 24.15 NO 500 -12075 12075
679 700 32.55 YES 500 -16275 16275
679 720 32.55 YES 500 -16275 16275

INTERPRETATION:

The put whose strike price is greater than market price the investor will get profit and
they come to exercise the option.
In the above table strike price 700,720 is gretaerthan market price [Link] the
difference between strike price and spot price is not more than the premium. So the option buyer
will not get profit

FINDINGS:

From the above table we can find option holder is loser and option writer is gainer.

SUGGESTION:

The put whose strike price is greater than market price the investor will get profit but in
the above table strike price 700,720 is greater than market price But the difference between strike
price and spot price is not more than the premium so option holder will not get profit so that the

investor is suggested to take short position in put option to get good returns.

PROFIT /LOSS OF CALL OPTOIN BUYER/WRITER OF TATA STEEL

66
 Table-1.2

spot strike whether lot size buyer writer

price price premium exercised profit/loss profit/loss
679 640 49.50 YES 500 -24750 +24750
679 660 36.25 YES 500 -18125 +18125
679 680 25.00 YES 500 -12500 +12500
679 700 16.25 NO 500 -8125 +8125
679 720 11.00 NO 500 -5500 +5500

INTERPRETATION:

If the difference between spot price and strike price is more than premium the option holder
come to exercise the option, in the above table option strike price 640,660were less than the stock
price, but the difference is not more than premium. So, he faces the losses.

FINDINGS:

From the above table we can find option writer is gainer and option holder is loser.

SUGGESTION:

Generally, in Bullish trend call option holder will get more profit and in Bearish trend call
option writer will get more profit, now the market is in bearish trend. So that, the investor is
suggested to take the short position in call option to get good returns.

PROFIT /LOSS OF PUT OPTOIN BUYER/WRITER OF MAHINDHRA &

MAHINDHRA

67
 Table-2.1

spot strike whether lot buyer writer

price price premium exercised size profit/loss profit/loss
740 700 12.35 NO 250 -3088 3088
740 720 19.75 NO 250 -4938 4938
740 740 30.60 NO 250 -7650 7650
740 760 42.10 YES 250 -10525 10525
740 780 4.10 YES 250 -1025 1025

INTERPRETATION:

The put whose strike price is greater than market price the investor will get profit and
they come to exercise the option.
In the above table strike price 760,780is gretaerthan market price [Link] the difference
between strike price and spot price is not more than the premium. So the option buyer will not get
profit

FINDINGS:

From the above table we can find option holder is loser and option writer is gainer.

SUGGESTION:

The put whose strike price is greater than market price the investor will get profit but in the
above table strike price 760,780is greater than market price But the difference between strike price
and spot price is not more than the premium so option holder will not get profit so that the investor

is suggested to take short position in put option to get good returns.

68
 PROFIT /LOSS OF CALL OPTOIN BUYER/WRITER OF MAHINDHRA &
MAHINDHRA

Table-2.2

spot Strike whether lot buyer writer

price price premium exercised size profit/loss profit/loss
740 700 45.70 YES 250 -11425 11425
740 720 32.60 YES 250 -8150 8150
740 740 23.70 NO 250 -5925 5925
740 760 16.05 NO 250 -4013 4013
740 780 9.60 NO 250 -2400 2400

INTERPRETATION:

If the difference b/n spot price and strike price is more than premium the option holder
come to exercise the option, in the above table option strike prices 700,720,740 were less than the
stock price, but the difference is not more than the premium. So he faced the losses.
In the above table option buyer face the losses of the total premium at the same time option
writer will enjoy the total premium.

FINDINGS:

From the above table we can find option writer is gainer and option holder is loser.

SUGGESTION:

Generally, in bullish trend call option holder will get more profit and in bearish trend call
option writer will get more profit. Now the market is in bearish trend. So that,
The investor is suggested to take the short position in call option to get good returns.

69
PROFIT /LOSS OF PUT OPTOIN BUYER/WRITER OF ICICI

Table-3.1

spot strike whether lot buyer writer

price price premium exercised size profit/loss profit/loss
1149 1100 18.50 YES 250 -4625 4625
1149 1120 25.30 YES 250 -6325 6325
1149 1140 33.40 YES 250 -8350 8350
1149 1160 42.80 NO 250 -10700 10700
1149 1180 55.25 NO 250 -13813 13813

INTERPRETATION:

From the above table we can find the option 1100, 120, 1140 were “out of the money option”
and remaining is “In the money option”

FINDINGS :

In the above table we can find the option holder is loser and option writer is gainer.

SUGGESTION

The investor is suggested to take short position in put option to get good returns.

70
PROFIT /LOSS OF CALL OPTOIN BUYER/WRITER OF ICICI

Table-3.2

Spot strike price whether lot buyer writer

price premium exercised size profit/loss profit/loss
1149 1100 72.00 NO 250 -18,000 18,000
1149 1120 58.15 NO 250 -14,538 14,538
1149 1140 47.70 NO 250 -11,925 11,925
1149 1160 43.20 YES 250 -10,000 10,000
1149 1180 39.00 YES 250 -9,750 9,750

INTERPRETATION:

Take all options were out of the money options. So, the option holder will not get the
profit.
In the above table option writer will get the profit, because of spot price is less than strike
price. So, the total premium was enjoyed by the option writer.

FINDINGS

From the above table we can find option writer is gainer and option holder is loser.

SUGGESTION:

Generally, in bullish trend call option holder will get more profit and in bearish trend call
option writer will get more profit. Now the market is in bearish trend. So that, the investor is
suggested to take the short position in call option to get good returns.

71
PROFIT /LOSS OF PUT OPTOIN BUYER/WRITER OF SBI

Table-4.1

Spot strike whether lot size buyer writer

price price premium exercised profit/loss profit/loss
3250 3100 187.05 NO 125 -5450 5450
3250 3150 153.00 NO 125 -7131 7131
3250 3200 127.00 NO 125 -9513 9513
3250 3250 101.55 NO 125 -12694 12694
3250 3300 75.95 YES 125 -15463 15463

INTERPRETATION:

The put whose strike price is greater than market price the investor will get profit and
they come to exercise the option.

In the above table strike prices 3300 were greater than the spot prices. But the difference
b/n strike and spot price is not more than premium, so the option buyer will not get profit.

FINDINGS:

From the above table we can find option holder is loser and option writer is gainer.

SUGGESTION:

The investor is suggested to take short position in put option to get good returns

72
PROFIT /LOSS OF CALL OPTOIN BUYER/WRITER OF HDFC

Table-4.2

Spot strike whether lot buyer writer

price price premium exercised size profit/loss profit/loss
3250 3100 187.05 YES 125 -2,338 2,338
3250 3150 153.00 YES 125 -9125 9125
3250 3200 127.00 YES 125 -15875 15875
3250 3250 101.55 YES 125 -12694 12694
3250 3300 75.95 NO 125 -9494 9494

INTERPRETATION:

If the difference b/n spot price and strike price is more than premium the option holder
come to exercise the option, in the above table 3100,3150,3200,3250 strike prices are In-the option
(i.e. spot price > strike price) but the difference is not more than premium. So he faces the losses.

From the table 3300 strike prices are “out of the money option” so option holder will not get
the profits. So he losses the total premium and writer will enjoy the total premium.

FINDINGS:

From the above table we can find option writer is gainer and option holder is loser.

SUGGESTION:

Now the market is in bearish trend. So that, the investor is suggested to take the short
position in call option to get good returns.

73
 PROFIT /LOSS OF PUT OPTOIN BUYER/WRITER OF
RELIANCE CAPITAL

Table-5.1

Spot strike whether lot buyer writer

price price premium exercised size profit/loss profit/loss
859 800 10.65 YES 500 -5325 5325
859 820 16.20 YES 500 -8100 8100
859 840 25.00 YES 500 -12500 12500
859 860 34.70 NO 500 -17350 17350
859 880 45.40 NO 500 -22700 22700

INTERPRETATION:

Strike price is greater than the market price, the investor will get profit and they come to
exercise the option. All strike prices are “In the money option”.
In the above table option buyer will not get the profits and option writer will get the profits.

FINDINGS:

From the above table we can find option holder is loser and option writer is gainer.

SUGGESTION:

The put whose strike price is greater than the market price the investor will get profit.

But the above table all strike prices are more than the market price. So that the investor is
suggested to take short position in put option to get good returns.

74
 PROFIT /LOSS OF CALL OPTOIN BUYER/WRITER OF
RELIANCE CAPITAL

Table: 5.2

Spot strike whether lot buyer writer

price price premium exercised size profit/loss profit/loss
859 800 72.65 YES 500 -36325 36325
859 820 60.30 YES 500 -30150 30150
859 840 47.55 YES 500 -23725 23725
859 860 39.05 NO 500 -19525 19525
859 880 30.50 NO 500 -15250 15250

INTERPRETATION:

Take all options were “out of the money option” so, the option holder will not get the profit
and option writer will get the profit, because of spot price is less than the stock price. So the total
premium was enjoyed by the option writer.

FINDINGS:

From the above table we can find option writer is gainer and option holder is loser

SUGGESTIONS:

Generally, in bullish trend call option holder will get more profit and in bearish trend call
option writer will get more profit. Now the market is in bearish trend. So that the investor is
suggested to take the short position in call option to get good returns.

SPREADS FOR HDFC BANK

75
 Generally, a spread consists of an investor purchasing an option of one type (call or
put) and writing an option of the same type, but with a different strike prices or expiration date.
Here five kinds of spreads are existing in this context, they are

1. Bull spread
2. Bear spread
3. Butterfly spread
4. Long straddle spread
5. Short straddle spread

BULL CALL SPREAD

In this context the investor buys at a given strike price and writes another with the same
expiration date, but at a hither strike price.

Goal: The investor intends to reduce the cost of the purchased call with the option premium,
which is collect from the call that is written at higher strike price. However, the resulting trade-off
is a limit on the potential profit.

Strategy: The investor purchases a SBI bank call with strike price Rs.3200 with premium Rs.
122.40 currently, the investor also writes a call with strike price of Rs. 3300 with a premium of Rs.
77.10

Long call strike price Rs.3200 with premium Rs. 122.40

Short call strike price Rs.1590 with premium Rs.77.10

Table: 6.1

SPOT STRIKE CASH CASH LONG SHORT PROFIT/LOSS

PRICE PRICE FLOW FLOW CALL CALL
LONG SHORT PAY PAY
CALL CALL OFF OFF
3250 3000 0 350 -122.40 +272.9 +150.0
3250 3050 0 300 -122.40 +222.9 +100.5
3250 3100 0 250 -122.40 +172.9 +50.5
3250 3150 0 200 -122.40 +122.9 -0.5
3250 3200 50 150 -72.40 +72.9 -0.5
3250 3250 100 100 -27.40 +22.9 -0.5
3250 3300 150 50 +27.6 -27.1 +0.5
3250 3350 200 0 +77.6 -77.10 -0.5

76
THIS GRAPH INDICATES THE PAYOFF FROM THE BULL CALL
SPREAD OF HDFC BANK

CHART: 1.1

BEAR CALL SPREAD

77
 In a bear spread, the investor buys at a given strike price and writes another with the same
expiration date, but at a lower strike price.

Goal: the investor intends to reduce the cost of the purchased call with option premium, which is
collects from the call that is written at a lower strike price. However, the resulting trade-off is limit
on the potential profit.

Strategy: The investor purchases a SBI bank call option with a strike price of Rs. 3350 with a
premium of Rs.60.00currently the investor also writes call option with strike price of Rs. 3300 with
a premium of Rs. 77.10

Long call strike price Rs. 3350 with premium of Rs. 60.00
Short call strike price Rs. 3300 with premium of Rs. 77.10
Table: 6.2

SPOT STRIKE CASH CASH LONG SHORT PROFIT/LOSS

PRICE PRICE FLOW FLOW CALL CALL
LONG SHORT PAY PAY
CALL CALL OFF OFF
3250 3050 0 250 -60.00 +172.9 +112.9
3250 3100 0 200 -60.00 +122.9 +62.9
3250 3150 0 150 -60.00 +72.9 +12.9
3250 3200 0 100 -60.00 +22.9 -37.1
3250 3250 0 50 -60.00 -27.10 -32.9
3250 3300 0 0 -60.00 -77.10 -17.1
3250 3350 0 0 -60.00 -77.10 -17.1
3250 3400 50 0 -10 -77.10 -67.1

78
THIS GRAPH INDICATES THE PAYOFF FROM BEAR CALL SPREAD OF
HDFC BANK

CHART-2.1

79
 BUTTERFLY SPREAD

A butterfly spread involves positions in options with different strike price. It can create by
buying a call option with a relatively low strike price, X: buying a call option with a relatively high
strike price. Z: selling the call options at half of the X and Z which called as Y.

Strategy: The investor purchases a SBI bank call option with the strike prices of Rs.3200 and 3350
with the premium of 122.40 and 60.00. Currently the investor also sells a call option at strike of
Rs.3300 with the premium of Rs.77.10

Long call strike price of Rs.3200 with the premium of Rs.122.40

Short call strike price of Rs.3350 with the premium of Rs.60.00

Long call strike price of Rs.3300 with the premium of Rs.77.10

Table-6.3

SPOT STRIK CASH CASH CASH LONG SHORT LONG PROFIT/

PRICE E FLOW FLOW FLOW CALL CALL CALL LOSS
PRICE LONG SHORT LONG PAY PAY PAY
CALL CALL CALL OFF OFF OFF
3250 3050 0 250 0 -60 +172.9 -122.40 -9.5
3250 3100 0 200 0 -60 +122.9 -122.40 -59.5
3250 3150 0 150 0 -60 +72.9 -122.40 -109.5
3250 3200 0 100 0 -60 +22.9 -122.40 -159.5
3250 3250 0 50 50 -60 -27.10 -72.40 -105.3
3250 3300 0 0 100 -60 -77.10 -22.40 -5.3
3250 3350 0 0 150 -60 -77.10 +27.6 -10.5
3250 3400 50 0 200 -10 -77.10 +77.6 -10.5

80
THIS GRAPH INDICATES THE PAYOFF FROM BUTTERFLY SPREAD
OF HDFC BANK

CHART-3.1

LONG STRADDLE

81
 In .this straddle, the investor purchases a call and put with the same strike price and
expiration dates.

Strategy:
The investor purchases a SBI bank call option with the strike price of Rs.3200 with the
premium of Rs.122.40and the investor also purchases a put option with the strike price of Rs.3200
with the premium of Rs.79.40

Long call strike price of Rs.3200 with the premium of Rs.122.40

Long put strike price of Rs.3200 with the premium of Rs.79.40

Table-6.4

Spot price Strike price Long call Long put Long straddle
3250 3050 --122.40 +70.6 -51.8
3250 3100 -122.40 +20.6 -101.8
3250 3150 -122.40 +29.40 -93.00
3250 3200 -122.40 -79.40 -201.8
3250 3250 -72.40 -79.40 -151.8
3250 3300 -22.40 -79.40 -100.8
3250 3350 +27.6 -79.40 -51.8
3250 3400 +77.6 -79.40 -1.8

THIS GRAPH INDICATES THE PAY OFF FROM LONG STRADDLE OF

HDFC BANK
82
 CHART-4.1

SHORT STRADDLE

83
 In this straddle, the investor writes a call and put option with the same strike price and
expiration date.
Strategy:
The investor sells a SBI bank call option with strike price of Rs.3300 with the premium of
Rs.77.10 the investor also sells a put option with the strike price of Rs.3300 with the premium of
Rs.129.00

Short call strike price of Rs. 3300 with the premium of Rs.77.10
Short put strike of Rs. 3300 with premium of Rs. 129.00

Table-6.5

Spot price Strike price Short call Short put Short straddle
3250 3050 +172.9 -129.00 +43.9
3250 3100 +122.9 -129.00 -6.1
3250 3150 +72.9 -129.00 -56.1
3250 3200 +22.9 -129.00 -106.1
3250 3250 -27.10 -129.00 -156.1
3250 3300 -77.10 -129.00 -206.1
3250 3350 -77.10 -79.00 -156.1
3250 3400 -77.10 -29.00 106.1

THIS GRAPH INDICATES THE PAYOFF FROM SHORT STRADDLE OF

HDFC BANK

84
CHART-5.1

FINDINGS

85
  Option writer (Seller) is a gainer and option holder (buyer) is a loser.

 Short straddle is good strategies to the investor to get good returns.

 Bull spread and Bear spreads is not favorable to the investors.

 Butterfly spread is not favorable to the investors.

 Long straddle is not favorable to the investors.

 Last trading day of the week for the underlaying assets had shown bullish trend.

SUGGESTIONS

86
 In bearish market the investor is suggested to exercise the put option to minimize losses.
 In bullish market the investor is suggested to exercise the call option to maximize
profits.
 In the cash market the profit / loss of the investor depends on the current market price so
the investor may get unlimited profit and at the same time he may get unlimited losses.
But in derivatives market the investors enjoys unlimited profits by bearing losses.
 Generally, in the long call or long put the investor will face losses, if the stock price is
close to the strike price at expiration of the option, but in short call or short put the
investor will get the profit, if the stock price is close to the strike price at expiration of
the option. So, the investor is suggested to think before to choose the option, by
visualizing the direction in which the stock price will move to get profit.

CONCLUSION

87
 From the analysis, it is known that unlimited losses which are common in equity

trading can be hedged by using derivatives. By entering the Derivative Markets the investors

can convert their unlimited loss prone investments into limited loss investments and at the same

time they will have the chance of gaining unlimited profits.

BIBLIOGRAPHY

88
 Name of the books Author name Edition name Publication

Options,Futures&Other [Link] Sixth edition

Derivatives

Financial Derivatives [Link] Eastern Economy PHI

Edition Prentice-Hall India

 NEWSPAPERS

ECONOMIC TIMES

BUSINESS LINE

 WEBSITES

[Link] [Link]

[Link] [Link]

[Link] [Link]

[Link] [Link]

89