a project on awareness of derivative strategies

EXECUTIVE SUMMARY

Firstly I am giving an overview of the Indian Derivative market and sharing some of the strategies used. Then at the last I am giving my suggestions and recommendations.

With over 25 million shareholders, India has the third largest investor base in the world after USA and Japan. Over 7500 companies are listed on the Indian stock exchanges (more than the number of companies listed in developed markets of Japan, UK, Germany, France, Australia, Switzerland, Canada and Hong Kong.). The Indian capital market is significant in terms of the degree of development, volume of trading, transparency and its tremendous growth potential. India’s market capitalization was the highest among the emerging markets. Total market capitalization of The Bombay Stock Exchange (BSE), which, as on July 31, 1997, was US$ 175 billion has grown by 37.5% percent every twelve months and was over US$ 834 billion as of January, 2007. Bombay Stock Exchanges (BSE), one of the oldest in the world, accounts for the largest number of listed companies transacting their shares on a nationwide online trading system. The two major exchanges namely the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) ranked no. 3 & 5 in the world, calculated by the number of daily transactions done on the exchanges. The Total Turnover of Indian Financial Markets crossed US$ 2256 billion in 2006 – An increase of 82% from US $ 1237 billion in 2004 in a short span of 2 years only. Turnover in the Spot and Derivatives segment both in NSE & BSE was higher by 45% into 2006 as compared to 2005. With daily average volume of US $ 9.4 billion, the Sensex has posted excellent returns in the recent years.

Derivatives trading in the stock market have been a subject of enthusiasm of research in the field of finance the most desired instruments that allow market participants to manage risk in the modern securities trading are known as derivatives. The derivatives are defined as the future contracts whose value depends upon the underlying assets. If derivatives are introduced in the stock market, the underlying asset may be anything as component of stock market like, stock prices or market indices, interest rates, etc. The main logic behind derivatives trading is that derivatives reduce the risk by providing an additional channel to invest with lower trading cost and it facilitates the investors to extend their settlement through the future contracts. It provides extra liquidity in the stock market.

Derivatives are assets, which derive their values from an underlying asset. These underlying assets are of various categories like

• Commodities including grains, coffee beans, etc.• Precious metals like gold and silver.• Foreign exchange rate.• Bonds of different types, including medium to long-term negotiable debt securities

issued by governments, companies, etc.• Short-term debt securities such as T-bills.

• Over-The-Counter (OTC) money market products such as loans or deposits.• Equities

For example, a dollar forward is a derivative contract, which gives the buyer a right & an obligation to buy dollars at some future date. The prices of the derivatives are driven by the spot prices of these underlying assets.However, the most important use of derivatives is in transferring market risk, called Hedging, which is a protection against losses resulting from unforeseen price or volatility changes. Thus, derivatives are a very important tool of risk management.

There are various derivative products traded. They are;1. Forwards2. Futures3. Options4. Swaps

A person who is ready to take risk and want to gain more should invest in the derivative market.

On the other hand RBI has to play an important role in derivative market. Also SEBI must encourage investment in derivative market so that the investors get the benefit out of it. Sorry to say that today even educated persons are not willing to invest in derivative market because they have the fear of high risk. So, SEBI should take necessary steps for improvement in Derivative Market so that more investors can invest in Derivative market.

TABLE OF CONTENTS

PARTICULARS PAGE NO:

ACKNOWLEDGEMENT

Executive Summary

Certificate

Chapter 1: Introduction Of The Project 01-02

1.1 Significance of the Study 01

1.2 Scope 01

1.3 Objectives of the Study 01

1.4 Literature Review 01-02

Chapter 2: Introduction To The Industry 03-06

2.1 History of The Stock Broking Industry 03

2.2 Development 03-04

2.2.1 BSE 04

2.2.2 NSE 04-05

2.2.3 MCX 05-06

2.2.4 NCDEX 06

Chapter 3: Introduction to the Company 07-73

3.1 Stock Market Basic 09

3.2 Why People invest in Stock Market 09

3.2.1 Stock Market Index 10

3.2.2 Market Segment 10

3.3 Introduction to Derivatives 11

3.4 History of Derivatives 12-15

3.5 Types Of Derivatives Market 16

3.6 Types of derivatives 17

3.6.1 Forward Contract 17-18

3.6.2 Future Contract 18-21

3.6.3 Options 23

3.6.4 Swaps 23-24

3.6.5 Other Kinds Of Derivatives 24

3.7 Indian Derivatives Market 25-26

3.8 Futures Trading 27-30

3.8.1 Futures Terminology 27-28

3.8.2 Futures Payoffs 29-30

3.9 Option Strategies 31-73

3.9.1 Option Terminology 31-32

Chapter 3: Research Methodology 74-76

4.1 Problem Statement 74

4.2 Research Objective 74

4.3 Research Design 74

4.4 Research source of data 74-75

4.5 Sampling Process 75

4.6 Limitation Of The Study 75-76

Chapter 5: Data Analysis and Interpretation 77-88

Chapter 6: Conclusion and Recommendations 89

BIBLIOGRAPHY 90

Questionnaire 91-93

Chapter 1: Introduction Of The Project

A Derivative is a financial instrument whose value depends on other, more basic, underlying variables. The variables underlying could be prices of traded securities and stock, prices of gold or copper.

Derivatives have become increasingly important in the field of finance, Options and Futures are traded actively on many exchanges, Forward contracts, Swap and different types of options are regularly traded outside exchanges by financial intuitions, banks and their corporate clients in what are termed as over-the-counter markets – in other words, there is no single market place or organized exchanges.

1.1 Significance of the Study

The study has been done to know the different types of derivatives, also to know the derivative market in India and know the main F&O strategise used. This study also covers the recent developments in the derivative market taking into account the trading in past years. Through this study I came to know the trading done in derivatives and their use in the stock markets.

1.2 Scope

The project covers the derivatives market and its instruments. For better understanding various strategies with different situations and actions have been given. It also includes the analysis of the survey, which is being conducted to know the awareness of the Derivative Market and its Strategies in the city.

1.3 Objectives of the Study

• To understand the concept of the Derivatives and Derivative Trading.• To know different types of Financial Derivatives• To know the role of derivatives trading in India.• To analyse the Derivatives with special reference to Futures & Options• To analyse derivatives via its main strategies

1.4 Literature Review

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

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minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors.

Derivative products initially emerged, as hedging devices against fluctuations in commodity prices and commodity-linked derivatives remained the sole form of such products for almost three hundred years. The financial derivatives came into spotlight in post-1970 period due to growing instability in the financial markets. However, since their emergence, these products have become very popular and by 1990s, they accounted for about two-thirds of total transactions in derivative products. In recent years, the market for financial derivatives has grown tremendously both in terms of variety of instruments available, their complexity and also turnover. In the class of equity derivatives, futures and options on stock indices have gained more popularity than on 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 the popular indices with various portfolios and ease of use. The lower costs associated with index derivatives vis-a-vis derivative products based on individual securities is another reason for their growing use. As in the present scenario, Derivative Trading is fast gaining momentum, hence I have chosen this topic.

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Chapter 2: Introduction To The Industry

2.1 History of The Stock Broking Industry

Indian Stock Markets are one of the oldest in Asia. Its history dates back to nearly 200 years ago. The earliest records of security dealings in India are meagre and obscure. By 1830's business on corporate stocks and shares in Bank and Cotton presses took place in Bombay. Though the trading list was broader in 1839, there were only half a dozen brokers recognized by banks and merchants during 1840 and 1850. The1850's witnessed a rapid development of commercial enterprise and brokerage business attracted many men into the field and by 1860 the number of brokers increased into 60. In 1860-61 the American Civil War broke out and cotton supply from United States of Europe was stopped; thus, the 'Share Mania' in India begun. The number of brokers increased to about 200 to 250. However, at the end of the American Civil War, in1865, a disastrous slump began (for example, Bank of Bombay Share which had touched Rs 2850 could only be sold at Rs. 87). At the end of the American Civil War, the brokers who thrived out of Civil War in 1874, found a place in a street (now appropriately called as Dalal Street) where they would conveniently assemble and transact business. In 1887, they formally established in Bombay, the "Native Share and Stock Brokers' Association" (which is alternatively known as "The Stock Exchange"). In 1895, the Stock Exchange acquired a premise in the same street and it was inaugurated in1899. Thus, the Stock Exchange at Bombay was consolidated. Thus in the same way, gradually with the passage of time number of exchanges were increased and at currently it reached to the figure of 24 stock exchanges

2.2 Development

An important early event in the development of the stock market in India was the formation of the Native Share and Stock Brokers’ Association at Bombay in 1875, the precursor of the present-day Bombay Stock Exchange. This was followed by the formation of associations /exchanges in Ahmedabad (1894), Calcutta (1908), and Madras (1937). IN addition, a large number of ephemeral exchanges emerged mainly in buoyant periods to recede into oblivion during depressing times subsequently. In order to check such aberrations and promote a more orderly development of the stock market, the central government introduced a legislation called the Securities Contracts (Regulation) Act, 1956. Under this legislation, it is mandatory on the part of stock exchanges to seek government recognition. As of January 2002 there were 23 stock exchanges recognized by the central Government. They are located at Ahemdabad, Bangalore, Baroda, Bhubaneshwar, Calcutta, Chenni,(the Madrasstock Exchanges ), Cochin, Coimbatore, Delhi, Guwahati, Hyderbad, Indore, Jaipur,Kanpur, Ludhiana, Mangalore, Mumbai(the National Stock Exchange or NSE),Mumbai (The Stock Exchange), popularly called the Bombay Stock Exchange, Mumbai (OTC Exchange of India), Mumbai (The Inter-connected Stock Exchange of India), Patna, Pune, and Rajkot. Of

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course, the principle bourses are the National Stock Exchange and The Bombay Stock Exchange, accounting for the bulk of the business done on the Indian stock market. While the recognized stock exchanges have been accorded a privileged position, they are subject to governmental supervision and control. The rules of a recognized stock exchanges relating to the managerial powers of the governing body, admission, suspension, expulsion, and re-admission of its members, appointment of authorized representatives and clerks, so on and so forth have to be approved by the government. These rules can be amended, varied or rescinded only with the prior approval of the government.

2.2.1 BSE (BOMBAY STOCK EXCHANGE)

The Stock Exchange, Mumbai, popularly known as "BSE" was established in 1875 as "The Native Share and Stock Brokers Association". It is the oldest one in Asia, even older than the Tokyo Stock Exchange, which was established in 1878. It’s a voluntary non-profit making Association of Persons (AOP) and is currently engaged in the process of converting itself into demutualised and corporate entity. It has evolved over the years into its present status as the premier Stock Exchange in the country. It is the first Stock Exchange in the Country to have obtained permanent recognition in 1956 from the Govt. of India under the Securities Contracts (Regulation) Act, 1956.

A Governing Board having 20 directors is the apex body, which decides the policies and regulates the affairs of the Exchange. The Governing Board consists of 9 elected directors, who are from the broking community (one third of them retire ever year by rotation), three SEBI nominees, six public representatives and an Executive Director & Chief Executive Officer and a Chief Operating Officer.

2.2.2 NSE (NATIONAL STOCK EXCHANGE)

NSE was incorporated in 1992 and was given recognition as a stock exchange in April 1993. It started operations in June 1994, with trading on the Wholesale Debt Market Segment. Subsequently it launched the Capital Market

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Segment in November 1994 as a trading platform for equities and the Futures and Options Segment in June 2000 for various derivative instruments.

NSE has been able to take the stock market to the doorsteps of the investors. The technology has been harnessed to deliver the services to the investors across the country at the cheapest possible cost. It provides a nation-wide, screen-based, automated trading system, with a high degree of transparency and equal access to investors irrespective of geographical location. The high level of information dissemination through on-line system has helped in integrating retail investors on a nation-wide basis. The standards set by the exchange in terms of market practices, Products, technology and service standards have become industry benchmarks and are being replicated by other market participants. Within a very short span of time, NSE has been able to achieve all the objectives for which it was set up. It has been playing a leading role as a change agent in transforming the Indian Capital Markets to its present form. The Indian Capital Markets are a far cry from what they used to be a decade ago in terms of market practices, infrastructure, technology, risk management, clearing and settlement and investor service.

2.2.3 MCX (MULTI COMMODITY EXCHANGE)

Headquartered in Mumbai, Multi Commodity Exchange of India Ltd (MCX) is a state-of-the-art electronic commodity futures exchange. The demutualised Exchange has permanent recognition from the Government of India to facilitate online trading, and clearing and settlement operations for commodity futures across the country.

Having started operations in November 2003, today, MCX holds a market share of over 85%* (as on March 31, 2012 MCX had a market share of 86%) of the Indian commodity futures market. The Exchange has more than 2,170 registered members operating through over 3, 46,000 including CTCL trading terminals spread over 1,577 cities and towns across India. MCX was the third largest^ commodity futures exchange in the world, in terms of the number of contracts traded in CY2011

MCX offers more than 40 commodities across various segments such as bullion, ferrous and non-ferrous metals, energy, and a number of agri-commodities on its platform. The Exchange introduces standardised commodity futures contracts on its platform. These contracts in futures

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exchanges provide an anonymous trading environment for ideal price discovery. The Exchange is the world's largest exchange# in Silver and Gold, second largest in Natural Gas and the third largest in Crude Oil with respect to the number of futures contracts traded.

2.2.4 NCDEX (NATIONAL COMMODITIES AND DERIVATIVES CHANGE)

National Commodity & Derivatives Exchange Limited (NCDEX) is a professionally managed on-line multi commodity exchange. The shareholders of NCDEX comprises of large national level institutions, large public sector bank and companies.

NCDEX is a public limited company incorporated on April 23, 2003 under the Companies Act, 1956. It obtained its Certificate for Commencement of Business on May 9, 2003. It commenced its operations on December 15, 2003.

NCDEX is a nation-level, technology driven de-mutualised on-line commodity exchange with an independent Board of Directors and professional management - both not having any vested interest in commodity markets. It is committed to provide a world-class commodity exchange platform for market participants to trade in a wide spectrum of commodity derivatives driven by best global practices, professionalism and transparency.

NCDEX is regulated by Forward Markets Commission. NCDEX is subjected to various laws of the land like the Forward Contracts (Regulation) Act, Companies Act, Stamp Act, Contract Act and various other legislations.

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Chapter 3: Introduction To The Company

Angel Broking's tryst with excellence in customer relations began in 1987. Today, Angel has emerged as one of the most respected Stock-Broking and Wealth Management Companies in India. With its unique retail-focused stock trading business model, Angel is committed to providing ‘Real Value for Money’ to all its clients.

The Angel Group is a member of the Bombay Stock Exchange (BSE), National Stock Exchange (NSE) and the two leading Commodity Exchanges in the country: NCDEX & MCX. Angel is also registered as a Depository Participant with CDSL.

Angel Broking presence is in Nation- wide network of 21 regional hubs in 124 cities with 6800+ sub brokers & business associates and 5.9 lakh + clients and over 750 Client Relationship Managers. With its unique retail-focused stock trading business model, Angel is committed to providing ‘Real Value for Money’ to all its clients.

Angel Vision

To provide best value for money to investors through innovative products, trading/investments strategies, state of the art technology and personalized service.

Angels Motto

To have complete harmony between quality-in-process and continuous improvement to deliver exceptional service that will delight our Customers and Clients.

Angel Broking’s Business

Equity Trading Commodities Portfolio Management Services Mutual Funds Life Insurance IPO Depository Services Investment Advisory

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Angel Group

Angel Broking Ltd. Angel Commodities Broking Ltd. Angel Securities Ltd.

Trading platforms

Angel Dieto Features:

Diet is a high speed trading terminal on your desktop Streaming quotes for real time rates across multiple

exchanges Options to open market watch in excel to facilitate analysis

on live data Facility to process Bulk order and Grid order entry Get market status at a glance with Heat Map Online fund transfer from more than 30 banks. Intraday, Continuous and Historical charts with 63 technical

indicators Integrated market watch along with alert facility Integrated back office to access account information

Angel Tradeo Features:

Trade is a easy to access online trading platform Multiple exchanges along with charting facility Can be accessed in proxy and firewall environments Facility to select between Streaming and Lite mode Online Fund Transfer facility Integrated Market Watch Integrated back office to access account information

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3.1 Stock Market Basic.

Companies are started by individuals or may be a small circle of people. They pool their money or obtain loans, raising funds to launch the business. A choice is made to organize the business as a sole proprietorship where one person or a married couple owns everything, or as a partnership with others who may wish to invest money. Later they may choose to "incorporate". As a Corporation, the owners are not personally responsible or liable for any debts of the company if the company doesn't succeed. Corporations issue official-looking sheets of paper that represent ownership of the company. These are called stock certificates, and each certificate represents a set number of shares. The total number of shares will vary from one company to another, as each makes its own choice about how many pieces of ownership to divide the corporation into. One corporation may have only 2,500 shares, while another, such as IBM or the Ford Motor Company, may issue over a billion Shares. Companies sell stock (pieces of ownership) to raise money and provide funding for the expansion and growth of the business. The business founders give up part of their ownership in exchange for this needed cash. The expectation is that even though the owners have surrendered a portion of the company to the Public, their remaining share of stock will become increasingly valuable as the business grows. Corporations are not allowed to sell shares of stock on the open Stock market without the approval of the Securities and Exchange Commission (SEC). This transition from a privately held corporation to a publicly traded one is called going public, and this first sale of stock to the public is called an initial public offering, or IPO.

3.2 Why People invest in Stock MarketWhen you buy stock in a corporation, you own part of that company. This gives you a vote at annual shareholder meetings, and a right to a share of future profits. When a company pays out profits to the shareholder, the money received is called a "Dividend". The corporation's board of directors choose when to declare a dividend and how much to pay. Most older and larger companies pay a regular dividend; most newer and smaller companies do not. The average investor buys stock hoping that the stock's price will rise, so the shares can be sold at a profit. This will happen if more investors want to buy stock in a company than wish to sell. The potential of a small dividend check is of little concern. What is usually responsible for increased interest in a company's stock is the prospect of the company's sales and profits going up. A company who is a leader in a hot industry will usually see its share price rise dramatically. Investors take the risk of the price falling because they hope to make more money in the market than they can with safe investments such as bank CD's or government bonds.

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3.2.1 Stock Market IndexIn the stock market world, you need a way to compare the movement of the market, up and down, from day to day, and from year to year. An index is just a benchmark or yardstick expressed as a number that makes it possible to do this comparison. For e.g. S&P CNX Nifty is the index of NSE and SENSEX is the index of BSE.

3.2.2 Market SegmentSecurities markets provide a channel for allocation of savings to those who have a productive need for them. The securities market has two interdependent and inseparable segments: (i) Primary market and (ii) Secondary market.

i. Primary MarketPrimary market provides an opportunity to the issuers of securities, both Government and corporations, to raise resources to meet their requirements of investment. Securities, in the form of equity or debt, can be issued in domestic /international markets at face value, discount or premium. The primary market issuance is done either through public issues or private placement. Under Companies Act, 1956, an issue is referred as public if it results in allotment of securities to 50 investors or more. However, when the issuer makes an issue of securities to a select group of persons not exceeding 49 and which is neither a rights issue nor a public issue it is called a private placement.

ii. Secondary MarketSecondary market refers to a market where securities are traded after being offered to the public in the primary market or listed on the Stock Exchange. Secondary market comprises of equity, derivatives and the debt markets. The secondary market is operated through two mediums, namely, the Over-the-Counter (OTC) market and the Exchange-Traded market. OTC markets are informal markets where trades are negotiated.

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3.3 Introduction to Derivatives

According to dictionary, derivative means ‘something which is derived from another source’. Therefore, derivative is not primary, and hence not independent. In financial terms, derivative is a product whose value is derived from the value of one or more basic variables. These basic variable are called bases, which may be value of underlying asset, a reference rate etc. the underlying asset can be equity, foreign exchange, commodity or any asset.

For example: - the value of any asset, say share of any company, at a future datedepends upon the share’s current price. Here, the share is underlying asset, the current price of the share is the bases and the future value of the share is the derivative. Similarly, the future rate of the foreign exchange depends upon its spot rate of exchange. In this case, the future exchange rate is the derivative and the spot exchange rate is the base.

The term ‘Derivative’ stands for a contract whose price is derived from or is dependent upon an underlying asset. The underlying asset could be a financial asset such as currency, stock and market index, an interest bearing security or a physical commodity. Today, around the world, derivative contracts are traded on electricity, weather, temperature and even volatility. According to the Securities Contract Regulation Act, (1956) the term “derivative” includes:

i. 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;

ii. A contract which derives its value from the prices, or index of prices, of underlying securities.

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3.4 History of Derivatives

The history of derivatives is quite colourful and surprisingly a lot longer than most people think. Forward delivery contracts, stating what is to be delivered for a fixed price at a specified place on a specified date, existed in ancient Greece and Rome. Roman emperors entered forward contracts to provide the masses with their supply of Egyptian grain. These contracts were also undertaken between farmers and merchants to eliminate risk arising out of uncertain future prices of grains. Thus, forward contracts have existed for centuries for hedging price risk.

The first organized commodity exchange came into existence in the early 1700’s in Japan. The first formal commodities exchange, the Chicago Board of Trade (CBOT), was formed in 1848 in the US to deal with the problem of ‘credit risk’ and to provide centralised location to negotiate forward contracts. From ‘forward’ trading in commodities emerged the commodity ‘futures’. The first type of futures contract was called ‘to arrive at’. Trading in futures began on the CBOT in the 1860’s. In 1865, CBOT listed the first ‘exchange traded’ derivatives contract, known as the futures contracts. Futures trading grew out of the need for hedging the price risk involved in many commercial operations. The Chicago Mercantile Exchange (CME), a spin-off of CBOT, was formed in 1919, though it did exist before in 1874 under the names of ‘Chicago Produce Exchange’ (CPE) and ‘Chicago Egg and Butter Board’ (CEBB). The first financial futures to emerge were the currency in 1972 in the US. The first foreign currency futures were traded on May 16, 1972, on International Monetary Market (IMM), a division of CME. The currency futures traded on the IMM are the British Pound, the Canadian Dollar, the Japanese Yen, the Swiss Franc, the German Mark, the Australian Dollar, and the Euro dollar. Currency futures were followed soon by interest rate futures. 30Interest rate futures contracts were traded for the first time on the CBOT on October 20, 1975. Stock index futures and options emerged in 1982. The first stock index futures contracts were traded on Kansas City Board of Trade on February 24, 1982.The first of the several networks, which offered a trading link between two exchanges, was formed between the Singapore International Monetary Exchange (SIMEX) and the CME on September 7, 1984.

Options are as old as futures. Their history also dates back to ancient Greece and Rome. Options are very popular with speculators in the tulip craze of seventeenth century Holland. Tulips, the brightly coloured flowers, were a symbol of affluence; owing to a high demand, tulip bulb prices shot up. Dutch growers and dealers traded in tulip bulb options. There was so much speculation that people even mortgaged their homes and businesses. These speculators were wiped out when the tulip craze collapsed in 1637 as there was no mechanism to guarantee the performance of the option terms.

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The first call and put options were invented by an American financier, Russell Sage, in 1872. These options were traded over the counter. Agricultural commodities options were traded in the nineteenth century in England and the US. Options on shares were available in the US on the over the counter (OTC) market only until 1973 without much knowledge of valuation. A group of firms known as Put and Call brokers and Dealers Association was set up in early 1900’s to provide a mechanism for bringing buyers and sellers together. On April 26, 1973, the Chicago Board options Exchange (CBOE) was set up at CBOT for the purpose of trading stock options. It was in 1973 again that black, Merton, and Scholes invented the famous Black-Scholes Option Formula. This model helped in assessing the fair price of an option which led to an increased interest in trading of options. With the options markets becoming increasingly popular, the American Stock Exchange (AMEX) and the Philadelphia Stock Exchange (PHLX) began trading in options in 1975.

The market for futures and options grew at a rapid pace in the eighties and nineties. The collapse of the Bretton Woods regime of fixed parties and the introduction of floating rates for currencies in the international financial markets paved the way for development of a number of financial derivatives which served as effective risk management tools to cope with market uncertainties.

The CBOT and the CME are two largest financial exchanges in the world on which futures contracts are traded. The CBOT now offers 48 futures and option contracts (with the annual volume at more than 211 million in 2001).The CBOE is the largest exchange for trading stock options. The CBOE trades options on the S&P 100 and the S&P 500 stock indices. The Philadelphia Stock Exchange is the premier exchange for trading foreign options. The most traded stock indices include S&P 500, the Dow Jones Industrial Average, the Nasdaq 100, and the Nikkei 225. The US indices and the Nikkei 225 trade almost round the clock. The N225 is also traded on the Chicago Mercantile Exchange.

3.4.1 Emergence Of The Derivative Trading In India

The first step towards introduction of derivatives trading in India was the promulgation of the Securities Laws (Amendment) Ordinance, 1995, which withdrew the prohibition on options in securities. The market for derivatives, however, did not take off, as there was no regulatory framework to govern trading of derivatives. SEBI set up a 24 – member committee under the chairmanship of Dr. L.C.Gupta on November 18, 1996 to develop appropriate regulatory framework for derivatives trading in India. The committee submitted its report on March 17, 1998 prescribing necessary pre-conditions for introduction of derivatives trading in India.

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The committee recommended that derivatives should be declared as ‘securities’ so that regulatory framework applicable to trading of ‘securities’ could also govern trading of securities. SEBI also set up a group in June 1998 under the chairmanship of Prof. J.R.Verma, to recommend measures for risk containment in derivative market in India. The report, which was submitted in October 1998, worked out the operational details of margining system, methodology for charging initial margins, broker net worth, deposit requirement and real - time monitoring requirements. The SCRA was amended in December 1999 to include derivatives within the ambit of ‘securities’ and the regulatory framework were developed for governing derivatives trading. The act also made it clear that derivatives shall be legal and valid only if such contracts are traded on a recognized stock exchange, thus precluding OTC derivatives. The government also rescinded in March 2000, the three decade old notification, which prohibited forward trading in securities. Derivatives trading commenced in India in June 2000 after SEBI granted the final approval to this effect in May 2001. SEBI permitted the derivative segments of two stock exchanges, NSE and BSE, and their clearing house/corporation to commence trading and settlement in approved derivatives contracts. To begin with, SEBI approved trading in index futures contracts based on S&P CNX Nifty and BSE–30 (Sensex) index. This was followed by approval for trading in options based on these two indices and options on individual securities. The trading in BSE Sensex options commenced on June 4, 2001 and the trading in options on individual securities commenced in July 2001. Futures contracts on individual stocks were launched in November 2001. The derivatives trading on 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. The index futures and options contract on NSE are based on S&P CNX Trading and settlement in derivative contracts is done in accordance with the rules, byelaws, and regulations of the respective exchanges and their clearing house/corporation duly approved by SEBI and notified in the official gazette. Foreign Institutional Investors (FIIs) are permitted to trade in all Exchange traded derivative products.

3.4.2 Participants in a Derivative Market

The derivatives market is similar to any other financial market and has following three broad categories of participants:

Hedgers: These are investors with a present or anticipated exposure to the underlying asset which is subject to price risks. Hedgers use the derivatives markets primarily for price risk management of assets and portfolios.

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Speculators: These are individuals who take a view on the future direction of the markets. They take a view whether prices would rise or fall in future and accordingly buy or sell futures and options to try and make a profit from the future price movements of the underlying asset.

Arbitrageurs: They take positions in financial markets to earn riskless profits. The arbitrageurs take short and long positions in the same or different contracts at the same time to create a position which can generate a riskless profit.

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Derivatives Market

Exchange Traded Derivatives Over The Counter Derivatives

National Stock Exchange Bombay Stock ExchangeNational Commodity & Derivative Exchange

Index Future Index Options Stock Options Stock Future

3.5 Types Of Derivatives Market

Figure.1 Types of Derivatives Market

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Derivatives

Forward Future Option Swaps

Figure.2 Types of Derivative

3.6 Types of derivatives

3.6.1 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.

Basic Features Of Forward Contract

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

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.

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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 often confused with futures contracts. The confusion is primarily because both serve essentially the same economic functions of allocating risk in the presence of future price uncertainty. However futures are a significant improvement over the forward contracts as they eliminate counterparty risk and offer more liquidity.

3.6.2 Future Contract

In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a pre-set price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. The settlement price, normally, converges towards the futures price on the delivery date. A futures contract gives the holder the right and the obligation to buy or sell, which differs from an options contract, which gives the buyer the right, but not the obligation, and the option writer (seller) the obligation, but not the right. To exit the commitment, the holder of a futures position has to sell his long position or buy back his short position, effectively closing out the futures position and its contract obligations. Futures contracts are exchange traded derivatives. The exchange acts as counterparty on all contracts, sets margin requirements, etc.

Basic Features Of Future Contract

1. Standardization:

Futures contracts ensure their liquidity by being highly standardized, usually by specifying:

The underlying. This can be anything from a barrel of sweet crude oil to a short term interest rate.

The type of settlement, either cash settlement or physical settlement.

The amount and units of the underlying asset per contract. This can be the notional amount of bonds, a fixed number of barrels of oil, units of foreign currency, the notional amount of the deposit over which the short term interest rate is traded, etc..

The currency in which the futures contract is quoted.

The grade of the deliverable. In case of bonds, this specifies which bonds can be delivered. In case of physical commodities,

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this specifies not only the quality of the underlying goods but also the manner and location of delivery. The delivery month.

The last trading date.

Other details such as the tick, the minimum permissible price fluctuation.

2. Margin

Although the value of a contract at time of trading should be zero, its price constantly fluctuates. This renders the owner liable to adverse changes in value, and creates a credit risk to the exchange, who always acts as counterparty. To minimize this risk, the exchange demands that contract owners post a form of collateral, commonly known as Margin requirements are waived or reduced in some cases for hedgers who have physical ownership of the covered commodity or spread traders who have offsetting contracts balancing the position.

Initial Margin: is paid by both buyer and seller. It represents the loss on that contract, as determined by historical price changes, which is not likely to be exceeded on a usual day's trading. It may be 5% or 10% of total contract price.

Mark to market Margin: Because a series of adverse price changes may exhaust the initial margin, a further margin, usually called variation or maintenance margin, is required by the exchange. This is calculated by the futures contract, i.e. agreeing on a price at the end of each day, called the "settlement" or mark-to-market price of the contract. To understand the original practice, consider that a futures trader, when taking a position, deposits money with the exchange, called a "margin". This is intended to protect the exchange against loss. At the end of every trading day, the contract is marked to its present market value. If the trader is on the winning side of a deal, his contract has increased in value that day, and the exchange pays this profit into his account. On the other hand, if he is on the losing side, the exchange will debit his account. If he cannot pay, then the margin is used as the collateral from which the loss is paid.

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3. SettlementSettlement is the act of consummating the contract, and can be done in one of two ways, as specified per type of futures contract:

Physical delivery - the amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. In practice, it occurs only on a minority of contracts. Most are cancelled out by purchasing a covering position - that is, buying a contract to cancel out an earlier sale (covering a short), or selling a contract to liquidate an earlier purchase (covering a long).

Cash settlement - a cash payment is made based on the underlying reference rate, such as a short term interest rate index such as Euribor, or the closing value of a stock market index. A futures contract might also opt to settle against an index based on trade in a related spot market.

Expiry is the time when the final prices of the future are determined. For many equity index and interest rate futures contracts, this happens on the Last Thursday of certain trading month. On this day the t+2 futures contract becomes the t forward contract.

4. Pricing Of Future ContractIn a futures contract, for no arbitrage to be possible, the price paid on delivery (the forward price) must be the same as the cost (including interest) of buying and storing the asset. In other words, the rational forward price represents the expected future value of the underlying discounted at the risk free rate. Thus, for a simple, non-dividend paying

asset, the value of the future/forward, , will be found by

discounting the present value at time to maturity by the rate of risk-free return .

This relationship may be modified for storage costs, dividends, dividend yields, and convenience yields. Any deviation from this equality allows for arbitrage as follows.

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In the case where the forward price is higher:

i. The arbitrageur sells the futures contract and buys the underlying today (on the spot market) with borrowed money.

ii. On the delivery date, the arbitrageur hands over the underlying, and receives the agreed forward price.

iii. He then repays the lender the borrowed amount plus interest.

iv. The difference between the two amounts is the arbitrage profit.

In the case where the forward price is lower:

i. The arbitrageur buys the futures contract and sells the underlying today (on the spot market); he invests the proceeds.

ii. On the delivery date, he cashes in the matured investment, which has appreciated at the risk free rate.

iii. He then receives the underlying and pays the agreed forward price using the matured investment. [If he was short the underlying, he returns it now.]

iv. The difference between the two amounts is the arbitrage profit.

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Table 1-Distinction between Futures and Forwards Contracts

FEATUREFORWARD CONTRACT

FUTURE CONTRACT

OperationalMechanism

Traded directly between twoparties (not traded on theexchanges).

Traded on the exchanges.

ContractSpecifications

Differ from trade to trade.Contracts are standardized contracts.

Counter-partyRisk

Exists.

Exists. However, assumed by the clearing corp., which becomes the counter party toall the trades or unconditionally guarantees their settlement.

LiquidationProfile

Low, as contracts are tailormade contracts catering to theneeds of the needs of theparties.

High, as contracts are standardizedexchange traded contracts.

Price discoveryNot efficient, as markets arescattered.

Efficient, as markets are centralized andall buyers and sellers come to a commonplatform to discover the price.

Examples Currency market in India.

Commodities, futures, Index Futures andIndividual stock Futures in India.

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3.6.3 OptionsA derivative transaction that gives the option holder the right but not the obligation to buy or sell the underlying asset at a price, called the strike price, during a period or on a specific date in exchange for payment of a premium is known as ‘option’. Underlying asset refers to any asset that is traded. The price at which the underlying is traded is called the ‘strike price’.

There are two types of options i.e., Call Option & Put Option.

Call Option:

A contract that gives its owner the right but not the obligation to buy an underlying asset stock or any financial asset, at a specified price on or before a specified date is known as a ‘Call option’. The owner makes a profit provided he sells at a higher current price and buys at a lower future price.

Put Option:

A contract that gives its owner the right but not the obligation to sell an underlying asset stock or any financial asset, at a specified price on or before a specified date is known as a ‘Put option’. The owner makes a profit provided he buys at a lower current price and sells at a higher future price. Hence, no option will be exercised if the future price does not increase. Put and calls are almost always written on equities, although occasionally preference shares, bonds and warrants become the subject of options.

3.6.4 Swaps

Swaps are transactions which obligates the two parties to the contract to exchange a series of cash flows at specified intervals known as payment or settlement dates. They can be regarded as portfolios of forward's contracts. A contract whereby two parties agree to exchange (swap) payments, based on some notional principle amount is called as a ‘SWAP’. In case of swap, only the payment flows are exchanged and not the principle amount. The two commonly used swaps are:

Interest Rate Swaps:Interest rate swaps is an arrangement by which one party agrees to exchange his series of fixed rate interest payments to a party in exchange for his variable rate interest payments. The fixed rate payer takes a short position in the forward contract whereas the floating rate payer takes a long position in the forward contract.

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Currency Swaps:Currency swaps is an arrangement in which both the principle amount and the interest on loan in one currency are swapped for the principle and the interest payments on loan in another currency. The parties to the swap contract of currency generally hail from two different countries. This arrangement allows the counter parties to borrow easily and cheaply in their home currencies. Under a currency swap, cash flows to be exchanged are determined at the spot rate at a time when swap is done. Such cash flows are supposed to remain unaffected by subsequent changes in the exchange rates.

Financial Swap:Financial swaps constitute a funding technique which permit a borrower to access one market and then exchange the liability for another type of liability. It also allows the investors to exchange one type of asset for another type of asset with a preferred income stream.

3.6.5 OTHER KINDS OF DERIVATIVES

The other kind of derivatives, which are not, much popular are as follows:

Baskets Baskets options are option on portfolio of underlying asset. Equity Index Options are most popular form of baskets.

Leaps Normally option contracts are for a period of 1 to 12 months. However, exchange may introduce option contracts with a maturity period of 2-3 years. These long-term option contracts are popularly known as Leaps or Long term Equity Anticipation Securities.

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.

Swaptions 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.

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3.7 Indian Derivatives Market

Starting from a controlled economy, India has moved towards a world where prices fluctuate every day. The introduction of risk management instruments in India gained momentum in the last few years due to liberalisation process and Reserve Bank of India’s (RBI) efforts in creating currency forward market. Derivatives are an integral part of liberalisation process to manage risk. NSE gauging the market requirements initiated the process of setting up derivative markets in India. In July 1999, derivatives trading commenced in India

Table 2. Chronology of instruments

1991 Liberalisation process initiated

14 December 1995 NSE asked SEBI for permission to trade index futures.

18 November 1996SEBI setup L.C.Gupta Committee to draft a policy framework for index futures.

11 May 1998 L.C.Gupta Committee submitted report.

7 July 1999RBI gave permission for OTC forward rate agreements (FRAs) and interest rate swaps.

24 May 2000SIMEX chose Nifty for trading futures and options on an Indian index.

25 May 2000SEBI gave permission to NSE and BSE to do index futurestrading.

9 June 2000 Trading of BSE Sensex futures commenced at BSE.

12 June 2000 Trading of Nifty futures commenced at NSE.

25 September 2000 Nifty futures trading commenced at SGX.

2 June 2001 Individual Stock Options & Derivatives

4 June 2001The NSE introduced trading on index options based on the S&PCNX Nifty on

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November 9, 2001 Trading on Stock futures commences on the NSE

August 29, 2008 Currency derivatives trading commences on the NSE

August 31, 2009 Interest rate derivatives trading commences on the NSE

February 2010 Launch of Currency Futures on additional currency pairs

October 28, 2010 Introduction of European style Stock Options

October 29, 2010 Introduction of Currency Options

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3.8 Futures Trading

Future Contracts:A futures contact is an agreement between two parties – a buyer and a seller – wherein the former agrees to purchase from the latter, a number of shares or an index at a certain time in the future (expiry date) for a pre-determined price, which is agreed upon when the transaction takes place. As futures contracts are standardised in terms of expiry dates and contract sizes, they can be freely traded on exchanges. A buyer may not know the identity of the seller and vice versa. Further, every contract is guaranteed and honoured by the stock exchange, or more precisely, the clearing house or the clearing corporation of the stock exchange, which is an agency designated to settle trades of investors on the stock exchanges.

3.8.1 Futures Terminology

Spot price: The price at which an underlying asset trades in the spot market.

Futures price: The price that is agreed upon at the time of the contract for the delivery of an asset at a specific future date.

Contract cycle: It is the period over which a contract trades. The index futures contracts on the NSE have one-month, two-month and three-month 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: Is the date on which the final settlement of the contract takes place.

Contract size: The amount of asset that has to be delivered under one contract. This is also called as the lot size.

Basis: Basis is 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: 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.

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

Maintenance margin: Investors are required to place margins with their trading members before they are allowed to trade. 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.

3.8.2 Futures Payoffs

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Profit

Loss

0

2220

Fig.3 Payoff for a buyer of Nifty futures

Nifty

Futures contracts have linear or symmetrical payoffs. It implies that the losses as well as profits for the buyer and the seller of a futures contract are unlimited. These linear payoffs are fascinating as they can be combined with options and the underlying to generate various complex payoffs.

Payoff for buyer of futures: Long futures

The payoff for a person who buys a futures contract is similar to the payoff for a person who holds an asset. He has a potentially unlimited upside as well as a potentially unlimited downside. Take the case of a speculator who buys a two-month Nifty index futures contract when the Nifty stands at 2220. The underlying asset in this case is the Nifty portfolio. When the index moves up, the long futures position starts making profits, and when the index moves down it starts making losses.

The figure above shows the profits/losses for a long futures position. The investor bought futures when the index was at 2220. If the index goes up, his futures position starts making profit. If the index falls, his futures position starts showing losses.

Payoff for seller of futures: Short futures

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Profit

Loss

0

2220

Fig.4 Payoff for a seller of Nifty futures

Nifty

The payoff for a person who sells a futures contract is similar to the payoff for a person who shorts an asset. He has a potentially unlimited upside as well as a potentially unlimited downside. Take the case of a speculator who sells a two-month Nifty index futures contract when the Nifty stands at 2220. The underlying asset in this case is the Nifty portfolio. When the index moves down, the short futures position starts making profits, and when the index moves up, it starts making losses.

The figure shows the profits/losses for a short futures position. The investor sold futures when the index was at 2220. If the index goes down, his futures position starts making profit. If the index rises, his futures position starts showing losses.

3.9 Option Strategies

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An Option is a contract written by a seller that conveys to the buyer the right – but not the obligation – to buy or sell a particular asset, at a particular price in future. Option can be used for hedging, taking a future direction of the market, for arbitrage or for implementing strategies which can help in generating income for investors under various market conditions.

3.9.1 Option Terminology

Index options: These options have the index as the underlying. In India, they have a European style settlement. E.g. Nifty options, Mini Nifty options etc.

Stock options: Stock Options on individual stocks. A stock option premium buys the right but not the obligation to exercise his option on the seller/writer.

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/ seller of an option: The writer/seller 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.

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 buyers pays to the option seller. It is also referred to as the option premium.

Expiration date: The data 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.

European options: European options are options that can be exercised only on the expiration date itself.

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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. 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-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 is OTM if the index is above the strike price.

Strategy 1: Long Call

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For aggressive investors who are very bullish about the prospects for a stock/index, buying calls can be an excellent way to capture the upside potential with limited downside risk.

Buying a call is the most basic of all options strategies. It constitutes the first option strategies. It constitutes the first options trade for someone already familiar with buying/selling stocks and would a call is an easy strategy to understand. When you buy it means you are bullish and except the underlying stock/index to rise in future

When to use: Investor is very bullish on the stock

Risk: Limited to the premium

Reward : Unlimited

Breakeven: Strike Price + Premium

Example:

Mr.XYZ is bullish on Nifty on 24th June, when the Nifty is at 4191.10. He buys a call option with a strike price of Rs.4600 at a premium of Rs. 36.35, expiring on 31st July. If the Nifty goes above 4636.35, Mr. XYZ will make a net profit (after deducting the premium) on exercising the option. In case the Nifty stays at or falls below 4600, he can forego the option (it will expire worthless) with a maximum loss of the premium.

Strategy: Buy Call Option

Current Nifty Index 4191.10

Call Option Strike Price (Rs.) 4600

Mr. XYZ Premium (Rs.) 36.35

Break Even Point (Rs.) (Strike Price + Premium)

4636.35

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Profit

Loss

Break Even Point

0

36

Strike Price

4636.35

Fig.5 Long Call

4600Nifty

Payoff Schedule

On expiryNifty closes at

Net Payoff fromthe Call Options(Rs.)

4100.00 -36.354300.00 -36.354500.00 -36.354636.35 04700.00 63.654900.00 263.655100.00 463.655300.00 663.65

Analysis: This Strategy limits the downside risk to the extent of premium paid by Mr.XYZ (Rs 36.65). But the potential return is unlimited in case of rise in Nifty. A long call option is the simplest way to benefit if you believe that the market will make an upwards moveStrategy 2: Short Call

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When an investor is bearish about a stock /index and expects the prices to fall you do the opposite. When an investor is very bearish about the stock /index and expects the price to fall, he can sell call options. The position offers limited profit potential and the possibility of large losses on big advances in underlying prices.

A call option means an option to buy. Buying a call option means an investor expects the underlying price of a stock/index to rise in future. Selling a call option is just opposite of buying a call option. Here the seller of the option feels the underlying price of a stock/index is set to fall in the future.

When to use:Investor is very bearish on the stock/index

Risk: Unlimited

Reward : Limited to the premium

Breakeven: Strike Price + Premium

Example:

Mr. XYZ is bearish about Nifty and expects it to fall he sells a call option with a strike price of Rs. 2600 at a premium of Rs. 154, when the current Nifty is at 2694. If the Nifty stays at 2600 or below, the call an Mr. XYZ can retain the entire premium of Rs. 154.

Strategy: Sell Call Option

Current Nifty Index 2694

Call Option Strike Price (Rs.) 2600

Mr. XYZ receives Premium (Rs.) 154

Break Even Point (Rs.) (Strike Price + Premium)*

2754

* Breakeven point is from the point of the call option buyer

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Profit

Loss

Break Even Point

0

154

Strike Price

2754

Fig.6 Short Call

2600

Nifty

Payoff Schedule


Net Payoff fromthe Call Options(Rs.)

2400 -36.352500 -36.352600 -36.352700 02754 63.652800 263.652900 463.653000 663.65

Analysis: This Strategy is used when the investor is very aggressive and has a strong expectation of price fall. This is a risky strategy since as the stock price/index rises, the short call losses money more and more quickly and losses can be significant if the stock price/index falls below the strike price.

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Strategy 3: Long Put

When an investor is bearish he can buy a Put Option. A Put Option gives the buyer of the Put a right to sell the stock (to the Put seller) at a pre-specified price and there by limit his risk.

A Long Put is a Bearish strategy. To take advantage of a falling market an investor can buy Put options.

When to use:Investor is bearish about the stock/index.

Risk:

Losses limited to amount of premium paid. (Maximum loss if stock/index expires at or above the option strike price).

Reward : Profit potential is unlimited

Breakeven: Stock Price – Premium

Example:

Mr. XYZ is bearish on Nifty on 24th June, when the Nifty is at 2694. He buys a Put option, with a strike price Rs.2600 at a premium of Rs.52, expiring on 31st July. If the Nifty goes below 2548, Mr. XYZ will make a profit on exercising the option. In case the Nifty rises above 26000, he can forego the option (it will expire worthless) with a maximum loss of the premium.

Strategy: Sell Call Option

Current Nifty Index 2694

Put Option Strike Price (Rs.) 2600

Mr. XYZ Pays Premium (Rs.) 52

Break Even Point (Rs.) (Strike Price - Premium)*

2548

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Profit

Loss

Break Even Point0

52

Strike Price

2548

Fig.7 Long Put

Nifty

2600

Payoff Schedule

On expiry Nifty closes at Net Payoff from Put Option (Rs.)

2300 2482400 1482500 482548 02600 -522700 -522800 -52

2900 -52

Analysis: A Bearish investor can profit from declining stock price by buying Puts. He limits his risk to the amount of premium paid but his profit potential remains unlimited. This is one of the widely used strategy when an investor is bearish.

Strategy 4: Short Put

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An investor Sells Put when he is Bullish about the stock expects the stock price to rise or stay sideways at the minimum. When Put is sold a premium is earned. If the stock prices increases beyond the strike price, the short put position will make a profit for the seller by the amount of the premium, since the buyer will not exercise the Put option and the Put seller can retain the premium.

When to use:Investor is very Bullish on the stock/index

Risk: Put Strike Price – Put Premium

Reward: Limited to the premium received

Breakeven: Put Strike Price - Premium

Example:

Mr. XYZ is bullish on Nifty when it is at 4191.10. He sells a Put option with a strike price of Rs. 4100 at a premium of Rs. 170.50 expiring on 31st July.

Strategy: Sell Put Option

Current Nifty Index 4191.10

Put Option Strike Price (Rs.) 4100

Mr. XYZ receives Premium (Rs.) 170.5

Break Even Point (Rs.) (Strike Price - Premium)*

3929.5

* Breakeven Point is from the point of Put Option Buyer.

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Profit

Loss

Nifty0

170.5

Strike Price

4100

Fig.8 Short Put

Break Even Point

3929.5

Payoff Schedule

On expiry Nifty closes at Net Payoff from Put Option (Rs.)

3400.00 -529.50

3500.00 -429.50

3700.00 -229.50

3900.00 -29.50

3929.50 0

4100.00 170.50

4300.00 170.50

4500.00 170.50

Analysis: Selling Put can lead to regular income in a rising or range bound markets. But should be done carefully since the potential losses can be significant in case the price of the stock/index falls. This strategy can be considered as an income generating strategy.

Strategy 5: Covered Call

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The covered call is a strategy in which an investor sells a Call Option on a stock he owns. The Call Option which is sold in usually an OTM call. The Call would not get exercised unless the stock price increases above the strike price. Till then the investor in the stock can retain the Premium with him. This becomes his income from the stock.

When to use:Investor has a short-term neutral to moderately bullish view on the stock he holds

Risk:

If the Stock Price falls to zero, the investor loses the entire value of the stock but retains the premium. So maximum risk = Stock Price Paid – Call Premium

If the stock rises beyond the strike price the investor gives up all the gains on the stock.

Reward :Limited to ( Call Strike Price – Stock Price Paid ) + Premium received

Breakeven: Stock Price paid – Premium Received

Example:

Mr. A bought XYZ Ltd. For Rs 3850 and simultaneously sells a Call option at a strike price of Rs 4000. Which means Mr. A does not think that the price of XYZ Ltd. Will rise above Rs.4000, Mr. A does not mind getting exercised at that price and exiting the stock at Rs.4000

Strategy: Sell Put Option

Mr. A buys the stock XYZ Ltd.

Market Price (Rs.) 3850

Call Options Strike Price (Rs.) 4000

Mr. A receives Premium (Rs.) 80

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Profit

Loss

Nifty0

2300

Strike Price

4000

Fig.9 Covered Call

Break Even Point

3770

Break Even Point (Rs.) (Stock Price paid - Premium received)

3770

Payoff Schedule

XYZ Ltd. price closes at (Rs.) Net Payoff (Rs.)

3600 -1703700 -703740 -303770 03800 303900 1304000 2304100 2304200 2304300 230

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Analysis: The income increases as the stock rises, but gets capped after the stock reaches the strike price.

Strategy 6: Protective Call / Synthetic Long Put

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This is a strategy where in an investor has gone short on a stock and buys a call to hedge. An investor shorts a stock and buys an ATM or slightly OTM Call. The net effect of this is that the investor creates a pay-off like a Long Put, but instead of having a net debit (paying premium) for a Long Put, he creates a net credit (receives money on shorting the stock). In case the stock price falls the investor gains in the downward fall in the price. However, in case there is an unexpected rise in the price of the stock the loss is limited.

When to use:

If the investor is of the view that the markets will go down (bearish) but wants to protect against any unexpected rise in the price of the stock.

Risk:Limited. Maximum Risk is Call Strike Price – Stock Price + Premium

Reward :Maximum is Stock Price –Call Premium

Breakeven: Stock Price – Call Premium

Example:

Suppose ABC Ltd. is trading at Rs. 4457 in June. An investor Mr. A buys a Rs 4500 call for Rs. 100 while shorting the stock at Rs. 4457. The net credit to the investor is Rs. 4357 (Rs. 4457 – Rs. 100).

Strategy: Short Stock + Buy Call Option

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Profit

Loss

Nifty0

143

Strike Price

4500

Fig.10 Protective Call

Break Even Point

4357

Sells Stock (Mr. A receives)

Current Market Price (Rs.) 4457

Buys Call Strike Price (Rs.) 4500

Mr. A Pays Premium (Rs.) 100

Break Even Point (Rs.) (Stock Price - Call Premium received)

3770

Payoff Schedule

ABC Ltd. closes at (Rs.) on expiry

Payoff from the Stock (Rs.)

Net Payoff from the Call Option

(Rs.)Net Payoff (Rs.)

4100 357 -100 2574150 307 -100 2074200 257 -100 1574300 157 -100 574350 107 -100 7

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4357 100 -100 04400 57 -100 -434457 0 -100 -1004600 -143 0 -1434700 -243 100 -1434800 -343 200 -1434900 -443 300 -1435000 -543 400 -143

Analysis: The pay-off from the Long Call will increase thereby compensating for the loss in value of the short stock position. This strategy hedges the upside in the stock position while retaining downside profit potential.

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Strategy 7: Covered Put

A Covered Put is a neutral to Bearish strategy. You do this strategy when you feel the price of a stock/index is going to remain range bound or move down. Covered Put writing involves a short in a stock / index along with a short Put on the options on the stock/index.

The Put that is sold is generally an OTM Put. The investor shorts a stock because he is bearish about it, but does not mind buying it back once the price reaches (falls to) a target price. This target price is the price at which the investor shorts the Put (Put strike price). Selling a Put means, buying the stock at the strike price if exercised. If the stock falls below the Put strike, the investor will be exercised and will have to buy the stock at the strike price (which is anyway his target price to repurchase the stock). The investor makes a profit because he has shorted the stock and purchasing it at the strike price simply closes the short stock position at a profit. And the investor keeps the Premium on the Put sold. The investor is covered here because he shorted the stock in the first place.

When to use:If the investor is of theview that the markets are moderatelybearish.

Risk:Unlimited if the price of the stockrises substantially

Reward :Maximum is (Sale Price of the Stock – Strike Price) + Put Premium

Breakeven: Sale Price of Stock + Put Premium

Example:

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Suppose ABC Ltd. is trading at Rs 4500 in June. An investor, Mr. A, shorts Rs 4300 Put by selling a July Put for Rs. 24 while shorting an ABC Ltd. stock. The net credit received by Mr. A is Rs. 4500 + Rs. 24 = Rs. 4524.

Strategy : Short Stock + Short Put Option

Sells Stock (Mr. Areceives)

Current Market Price (Rs.) 4500

Sells Put Strike Price (Rs.) 4300


Break Even Point (Rs.) (Sale price of Stock + PutPremium)

4524

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Profit

Loss

Nifty0

224

Fig.11 Covered Put

Break Even Point

Strike Price

4300

4524

Payoff Schedule

ABC Ltd. closes at (Rs.)

Payoff from the Stock (Rs.)

Net Payoff from the Put Option

(Rs.)Net Payoff (Rs.)

4000 500 -276 224

4100 400 -176 224

4200 300 -76 224

4300 200 24 224

4400 100 24 124

4450 50 24 74

4500 0 24 24

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4524 -24 24 0

4550 -50 24 -26

4600 -100 24 -76

4635 -135 24 -111

4650 -160 24 -136

Analysis: If the stock price does not change, the investor gets to keep the Premium. He can use this strategy as an income in a neutral market.

Strategy 8: Long Straddle

A Straddle is a volatility strategy and is used when the stock price / index is expected to show large movements. This strategy involves buying a call as well as put on the same stock / index for the same maturity and strike price, to take advantage of a movement in either direction, a soaring or plummeting value of the stock / index. If the price of the stock / index increases, the call is exercised while the put expires worthless and if the price of the stock / index decreases, the put is exercised, the call expires worthless.

When to use:The investor thinks that the underlying stock / index will experience significant volatility in the near term.

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Risk: Limited to the initial premium paid.

Reward : Unlimited

Breakeven:

Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid

Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

Example:

Suppose Nifty is at 4450 on 27th April. An investor, Mr. A enters a long straddle by buying a May Rs 4500 Nifty Put for Rs. 85 and a May Rs. 4500 Nifty Call for Rs. 122. The net debit taken to enter the trade is Rs 207, which is also his maximum possible loss.

Strategy : Buy Put + Buy Call

Nifty index Current Market Price (Rs.) 4450

Call and Put Strike Price (Rs.) 4500

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Profit

Loss

Nifty0

207

Fig.12 Long Straddle

Break Even Point

Strike Price

4500

4707

Break Even Point

4293

Mr. A paysTotal Premium (Call + Put) (Rs.)

207

Break Even Point (Rs.)4707(U)

Break Even Point (Rs.)4293(L)

Payoff Schedule


Net Payoff from Put

purchased (Rs.)

Net Payoff from Call

purchased (Rs.)Net Payoff (Rs.)

3800 615 -122 4933900 515 -122 3934000 415 -122 2934100 315 -122 1934200 215 -122 934234 181 -122 594293 122 -122 0

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4300 115 -122 -74400 15 -122 -1074500 -85 -122 -2074600 -85 -22 -1074700 -85 78 -74707 -85 85 04766 -85 144 594800 -85 178 934900 -85 278 1935000 -85 378 2935100 -85 478 3935200 -85 578 4935300 -85 678 593

Analysis: The stock / index show volatility to cover the cost of the trade, profits are to be made. With Straddles, the investor is direction neutral. All that he is looking out for is the stock / index to break out exponentially in either direction.

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Strategy 9: Short Straddle

A Short Straddle is the opposite of Long Straddle. It is a strategy to be adopted when the investor feels the market will not show much movement. He sells a Call and a Put on the same stock / index for the same maturity and strike price. It creates a net income for the investor. If the stock / index does not move much in either direction, the investor retains the Premium as neither the Call nor the Put will be exercised. However, in case the stock / index moves in either direction, up or down significantly, the investor’s losses can be significant.

When to use:The investor thinks that the underlying stock / index will experience very little volatility in the near term.

Risk: Unlimited

Reward : Limited to the premium received

Breakeven:

Upper Breakeven Point = Strike Price of Short Call + Net Premium Paid

Lower Breakeven Point = Strike Price of Short Put - Net Premium Paid

stays close to Example:

Suppose Nifty is at 4450 on 27th April. An investor, Mr. A, enters into a short straddle by selling a May Rs 4500 Nifty Put for Rs. 85 and a May Rs. 4500 Nifty Call for Rs. 122. The net credit received is Rs. 207, which is also his maximum possible profit.



Call and Put Strike Price (Rs.) 4500

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Profit

Loss

Nifty0

207

Fig.13 Short Straddle

Break Even Point

Strike Price

4500

4707

Break Even Point

4293

Mr. A paysTotal Premium (Call + Put) (Rs.)

207

Break Even Point (Rs.)*4707(U)

Break Even Point (Rs.)*4293(L)

* From buyer’s point of view

Payoff Schedule


Net Payoff from Put

Sold (Rs.)


Sold (Rs.)Net Payoff (Rs.)

3900 -615 122 -4933800 -515 122 -3934000 -415 122 -2934100 -315 122 -193

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4200 -215 122 -934234 -181 122 -594293 -122 122 04300 -115 122 74400 -15 122 1074500 85 122 2074600 85 22 1074700 85 -78 74707 85 -85 04766 85 -144 -594800 85 -178 -934900 85 -278 -1935000 85 -378 -293

Analysis: This is a risky strategy and should be carefully adopted and only when the expected volatility in the market is limited. If the stock / index value stays close to the strike price on expiry of the contracts, maximum gain, which is the Premium received is made.

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Strategy 10: Long Strangle

A Strangle is a slight modification to the Straddle to make it cheaper to execute. This strategy involves the simultaneous buying of a slightly out-of-the-money (OTM) put and a slightly out-of-the-money (OTM) call of the same underlying stock / index and expiration date. Here again the investor is directional neutral but is looking for an increased volatility in the stock / index and the prices moving significantly in either direction.

When to use:The investor thinks that the underlying stock / index will experience very high volatility in the near term.

Risk:Limited to the initial premiumpaid

Reward : Unlimited

Breakeven:

Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid

Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

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Example:Suppose Nifty is at 4500 in May. An investor, Mr. A, executes a Long Strangle by buying a Rs. 4300 Nifty Put for a premium of Rs. 23 and a Rs 4700 Nifty Call for Rs 43. The net debit taken to enter the trade is Rs. 66, which is also his maxi mum possible loss.



Buy Call Option Strike Price (Rs.) 4700

Mr. A pays Premium (Rs.) 43

Break Even Point (Rs.) 4766

Buy Put Option Strike Price (Rs.) 4300

Mr. A pays Premium (Rs.) 23


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Profit

Loss

Nifty0

66

Fig.14 Long Strangle

4234

Break Even Point 4766

Break Even Point

Strike Price4300 4500 4700

Strike Price

Payoff Schedule


Net Payoff from Put

Purchased (Rs.)


Purchased (Rs.)Net Payoff (Rs.)

3800 477 -43 4343900 377 -43 3344000 277 -43 2344100 177 -43 1344200 77 -43 344234 43 -43 04300 -23 -43 -664400 -23 -43 -664500 -23 -43 -664600 -23 -43 -664700 -23 -43 -664766 -23 23 04800 -23 57 344900 -23 157 1345000 -23 257 2345100 -23 357 334

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5200 -23 457 4345300 -23 557 534

Analysis: As OTM options are purchased for both Calls and Puts it makes the cost of executing a Strangle cheaper as compared to a Straddle, where generally ATM strikes are purchased. Since the initial cost of a Strangle is cheaper than a Straddle, the returns could potentially be higher. However, for a Strangle to make money, it would require greater movement on the upside or downside for the stock / index

Strategy 11: Short Strangle

A Short Strangle is a slight modification to the Short Straddle. It tries to improve the profitability of the trade for the Seller of the options by widening the breakeven points so that there is a much greater movement required in the underlying stock / index, for the Call and Put option to be worth exercising.

When to use:

This options trading strategy is taken when the options investor thinks that the underlying stock will experience little volatility in the near term.

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Risk: Unlimited

Reward : Limited to the premium received

Breakeven:

Upper Breakeven Point = Strike Price of Short Call + Net Premium Paid

Lower Breakeven Point = Strike Price of Short Put - Net Premium Paid

Example:Suppose Nifty is at 4500 in May. An investor, Mr. A, executes a Short Strangle by selling a Rs. 4300 Nifty Put for a premium of Rs. 23 and a Rs. 4700 Nifty Call for Rs 43. The net credit is Rs. 66, which is also his maximum possible gain.



Sell Call Option Strike Price (Rs.) 4700

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Profit

Loss

Nifty0

66

Fig.15 Short Strangle

4234

Break Even Point

4766

Break Even Point

Strike Price

4300 4500 4700

Strike Price






Payoff Schedule


Net Payoff from Put

Sold (Rs.)


Sold (Rs.)Net Payoff (Rs.)

3800 -477 43 -4343900 -377 43 -3344000 -277 43 -2344100 -177 43 -134

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4200 -77 43 -344234 -43 43 04300 23 43 664400 23 43 664500 23 43 664600 23 43 664700 23 43 664766 23 -23 04800 23 -57 -344900 23 -157 -1345000 23 -257 -2345100 23 -357 -3345200 23 -457 -4345300 23 -557 -534

Analysis: This strategy involves the simultaneous selling of a slightly out-of-the-money (OTM) put and a slightly out-of-the-money (OTM) call of the same underlying stock and expiration date. This typically means that since OTM call and put are sold, the net credit received by the seller is less as compared to a Short Straddle, but the break even points are also widened. The underlying stock has to move significantly for the Call and the Put to be worth exercising. If the underlying stock does not show much of a movement, the seller of the Strangle gets to keep the Premium.

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Strategy 12: Bull Call Spread Strategy: Buy Call Option, Sell Call Option

A bull call spread is constructed by buying an in-the-money (ITM) call option, and selling another out-of-the-money (OTM) call option. Often the call with the lower strike price will be in-the-money while the Call with the higher strike price is out-of-the-money. Both calls must have the same underlying security and expiration month.

When to use: Investor is moderately bullish.

Risk:

Limited to any initial premium paid in establishing the position. Maximum loss occurs where the underlying falls to the level of the lower strike or below.

Reward :

Limited to the difference between the two strikes minus net premium cost. Maximum profit occurs where the underlying rises to the level of the higher strike or above

Breakeven:Strike Price of Purchased call + Net Debit Paid

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Example:

Mr. XYZ buys a Nifty Call with a Strike price Rs. 4100 at a premium of Rs. 170.45 and he sells a Nifty Call option with a strike price Rs. 4400 at a premium of Rs. 35.40. The net debit here is Rs. 135.05 which is also his maximum loss.

Strategy : Buy a Call with a lower strike (ITM) + Sell a Call with a higher strike (OTM)

Nifty index Current Value 4191.10

Buy ITM Call Option Strike Price (Rs.) 4100

Mr. XYZ Pays Premium (Rs.) 170.45

Sell OTM Call Option Strike Price (Rs.) 4400

Mr. XYZ Receives Premium (Rs.) 35.40

Net Premium Paid (Rs.) 135.05

Break Even Point (Rs.) 4235.05

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Profit

Loss

Nifty0

164.95

Fig.16 Bull Call Spread

Strike Price

4100

4400

Strike Price

135.05

Payoff ScheduleOn expiry

Nifty Closesat


Buy (Rs.)

Net Payoff fromCall Sold (Rs.)

Net payoff(Rs.)

3500.00 -170.45 35.40 -135.053600.00 -170.45 35.40 -135.053700.00 -170.45 35.40 -135.053800.00 -170.45 35.40 -135.053900.00 -170.45 35.40 -135.054000.00 -170.45 35.40 -135.054100.00 -170.45 35.40 -135.054200.00 -70.45 35.40 -35.054235.05 -35.40 35.40 04300.00 29.55 35.40 64.954400.00 129.55 35.40 164.954500.00 229.55 -64.60 164.954600.00 329.55 -164.60 164.954700.00 429.55 -264.60 164.954800.00 529.55 -364.60 164.95

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4900.00 629.55 -464.60 164.955000.00 729.55 -564.60 164.955100.00 829. 55 -664.60 164.955200.00 929.55 -764.60 164.95

Analysis: The net effect of the strategy is to bring down the cost and breakeven on a Buy Call (Long Call) Strategy. This strategy is exercised when investor is moderately bullish to bullish, because the investor will make a profit only when the stock price / index rises. If the stock price falls to the lower (bought) strike, the investor makes the maximum loss (cost of the trade) and if the stock price rises to the higher (sold) strike, the investor makes the maximum profit.

Strategy 13: Bull Put Spread Strategy: Sell Put Option, Buy Put Option

A bull put spread can be profitable when the stock / index is either range bound or rising. The concept is to protect the downside of a Put sold by buying a lower strike Put, which acts as insurance for the Put sold. The lower strike Put purchased is further

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OTM than the higher strike Put sold ensuring that the investor receives a net credit, because the Put purchased (further OTM) is cheaper than the Put sold.

When to use: Investor is moderately bullish.

Risk:

Limited. Maximum loss occurs where the underlying falls to the level of the lower strike or below

Reward :

Limited to the net premium credit. Maximum profit occurs where underlying rises to the level of the higher strike or above.

Breakeven:Strike Price of Short Put - Net remiumReceived

Example:

Mr. XYZ sells a Nifty Put option with a strike price of Rs. 4000 at a premium of Rs. 21.45 and buys a further OTM Nifty Put option with a strike price Rs. 3800 at a premium of Rs. 3.00 when the current Nifty is at 4191.10, with both options expiring on 31st July.

Strategy : Sell a Put + Buy a Put

Nifty index Current Value 4191.10

Sell Put Option Strike Price (Rs.) 4000

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Profit

Loss

Nifty0

18.45

Fig.17 Bull Put Spread

Strike Price

3800

4000

Strike Price

181.55

Mr. XYZ receives Premium (Rs.) 21.45


Mr. XYZ Pays Premium (Rs.) 3.00

Net Premium Paid (Rs.) 18.45

Break Even Point (Rs.) 3981.55

The payoff schedule

On expiry Nifty closes at

Net Payoff from Put Buy(Rs)

Net Payoff from Put Sold(Rs)

Net Payoff (Rs)

3500.00 297.00 -478.55 -181.553600.00 197.00 -378.55 -181.55

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3700.00 97.00 -278.55 -181.553800.00 -3.00 -178.55 -181.553900.00 -3.00 -78.55 -81.553981.55 -3.00 3.00 0.004000.00 -3.00 21.45 18.454100.00 -3.00 21.45 18.454200.00 -3.00 21.45 18.454300.00 -3.00 21.45 18.454400.00 -3.00 21.45 18.454500.00 -3.00 21.45 18.454600.00 -3.00 21.45 18.454700.00 -3.00 21.45 18.454800.00 -3.00 21.45 18.45

Analysis: If the stock / index rises, both Puts expire worthless and the investor can retain the Premium. If the stock / index falls, then the investor’s breakeven is the higher strike less the net credit received. Provided the stock remains above that level, the investor makes a profit. Otherwise he could make a loss.

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Strategy 14: Bear Call Spread Strategy: Sell ITM Call, Buy OTM Call

The Bear Call Spread strategy can be adopted when the investor feels that the stock / index is either range bound or falling. The concept is to protect the downside of a Call Sold by buying a Call of a higher strike price to insure the Call sold. In this strategy the investor receives a net credit because the Call he buys is of a higher strike price than the Call sold. The strategy requires the investor to buy out-of-the-money (OTM) call options while simultaneously selling in-the-money (ITM) call options on the same underlying stock index.

When to use:When the investor is mildly bearish on market.

Risk:Limited to the difference between the two strikes minus the net premium.

Reward :

Limited to the net premium received for the position i.e., premium received for the short call minus the premium paid for the long call.

Breakeven: Lower Strike + Net credit

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Example:

Mr. XYZ is bearish on Nifty. He sells an ITM call option with strike price of Rs. 2600 at a premium of Rs. 154 and buys an OTM call option with strike price Rs. 2800 at a premium of Rs. 49.

Strategy : Sell a Put + Buy a Put

Nifty index Current Value 2694

Sell Call Option Strike Price (Rs.) 2600


Buy Call Option Strike Price (Rs.) 2800


Net Premium received (Rs.)

105


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Profit

Loss

Nifty0

105

Fig.18 Bear Call Spread

Strike Price

2600

2800

Strike Price

95

Payoff Schedule

On expiryNifty Closes

atNet Payoff from Call Sold (Rs.)

Net Payoff from Call bought (Rs.) Net Payoff (Rs.)

2100 154 -49 1052200 154 -49 1052300 154 -49 1052400 154 -49 1052500 154 -49 1052600 154 -49 1052700 54 -49 52705 49 -49 02800 -46 -49 -952900 -146 51 -953000 -246 151 -953100 -346 251 -953200 -446 351 -953300 -546 451 -95

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Analysis: If the stock / index rises then the breakeven is the lower strike plus the net credit. Provided the stock remains below that level, the investor makes a profit. Otherwise he could make a loss.

Strategy 15: Bear Put Spread Strategy: Buy Put, Sell Put

This strategy requires the investor to buy an in-the-money (higher) put option and sell an out-of-the-money (lower) put option on the same stock with the same expiration date. This strategy creates a net debit for the investor. The net effect of the strategy is to bring down the cost and raise the breakeven on buying a Put (Long Put).

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When to use:When you are moderately bearish on market direction

Risk:

Limited to the net amount paid for the spread. I.e. the premium paid for long position less premium received for short position.

Reward :

Limited to the difference between the two strike prices minus the net premium paid for the position.

Breakeven:Strike Price of Long Put - Net Premium Paid

Example:

Nifty is presently at 2694. Mr. XYZ expects Nifty to fall. He buys one Nifty ITM Put with a strike price Rs. 2800 at a premium of Rs. 132 and sells one Nifty OTM Put with strike price Rs. 2600 at a premium Rs. 52.

Strategy : BUY A PUT with a higher strike (ITM) + SELL A PUT with a lower strike (OTM)

Nifty index Current Value 2694

Buy ITM Put Option Strike Price (Rs.) 2800

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Profit

Loss

Nifty0

120

Fig.19 Bear Put Spread

Strike Price

2600

2800

Strike Price

80


Sell OTM Put Option Strike Price (Rs.) 2600


Net Premium Paid (Rs.) 80


Payoff Schedule

On expiry Nifty closes at

Net Payoff from Put Buy (Rs.)

Net Payoff from Put Sold (Rs.)

Net payoff(Rs.)

2200 468 -348 120

2300 368 -248 1202400 268 -148 120

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2500 168 -48 1202600 68 52 1202720 -52 52 02700 -32 52 202800 -132 52 -802900 -132 52 -803000 -132 52 -803100 -132 52 -80

Analysis: The strategy needs a Bearish outlook since the investor will make money only when the stock price / index falls. The bought Puts will have the effect of capping the investor’s downside. While the Puts sold will reduce the investors costs, risk and raise breakeven point (from Put exercise point of view).

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Chapter 4: Research Methodology

4.1 Problem Statement:

The topic, which is selected for the study, is “AWARENESS OF DERIVATIVE STRATEGIES IN INDIA” so the problem statement for this study will be, “AWARENESS ABOUT THE DERIVATIVE AND ITS SCOPE OF IMPROVEMENT.”

4.2 Research Objective:

1. To know the awareness of the people about Derivative Market registered at Navi – Mumbai, Belapur franchise of “Angel Broking Ltd”.

2. To know which one is beneficial for the investor.

3. To find what proportion of the population are investing in such derivatives along with their investment pattern and product preferences.

4.3 Research Design:

The research design specifies the methods and procedures for conducting a particular study. The type of research design applied here are “Random” in nature as the objective is to check the position of the Derivative Market at Navi-Mumbai, Belapur franchise of “Angel Broking Ltd”. The objectives of the study have restricted the choice of research design up to descriptive research design. This survey will help the firm to know - how the investors invest in the derivative segment, the Strategies they use & which factors affect their investing behaviour.

4.4 Research source of data:

There are two types of sources of data which is being used for the studies

Primary Source of Data:

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Preparing a Questionnaire is collecting the primary source of data & it was collected by interviewing the investors.

Secondary Source of Data:

For having the detailed study about this topic, it is necessary to have some of the secondary information, which is collected from the following:

Books Magazines & Journals. Websites. Newspapers, etc.

Methods of Data Collection:

The study to be conducted is about the awareness of the Derivative Market in the Navi Mumbai City so the method of data collection used id “SURVEY METHOD”.

4.5 Sampling Process

It is very true that to do the research with the whole universe. As we know that it is feasible to go to population survey because of the (n) number of customers and their scattered location. So for this purpose sample size has to be determined well in advance and selection of sample also must be scientific so that it represents the whole universe.

So far as our research is concerned, we have taken sample size of 100 respondents.

Sample UniverseNavi-Mumbai, Belapur, Angel Broking (Franchisee)

Sampling Technique Random SamplingSample Size 100 people

Sampling Unit

Under GraduateGraduatePost GraduateProfessional Degree holderOthers

4.6 Limitation Of The Study

The limitations of the study are as follow:

Personal Bias:

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Individuals may have personal bias towards particular investment option so they may not give correct information and due to which the conclusion may be derived.

Time Limit:The time duration given for the research is less.

Area:The area was limited to Navi-Mumbai, Belapur franchise of “Angel Broking Ltd” only, so we cannot know the degree of the literacy outside the city and other branches.

Sample Size:The last limitation is Sample Size, which is of 100 only; due to which we may not get the proper results.

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Chapter 5: Data Analysis and Interpretation

Q1.Are you trading in derivative market?

Options No. of Correspondents PercentageYes 40 40No 60 60Total 100 100

Objective: To know that whether the investors are trading in derivative market or not

Graph:

Inference: From the above graph out of 100 investors, only 40% investor’s means 40 respondents are trading in derivative market and 60% means 60 respondents are not trading in derivative market

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Q2. Gender

Options No. of Correspondents PercentageMale 24 60Female 16 40Total 40 100

Objective: To know the age of the investors who are trading in derivative market

Graph:

Inference: From the above graph we can see that 60% are males’ investors and 40% are female investors.

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Q3. Age

Graph:

Inference: Out of total respondents 5% are of the group of ’20-25’ and for ’35’ years above and 70% are of ’31-35’years

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Options No. of Correspondents PercentageBelow 20 years 0 020-25 years 2 526-30 years 8 2031-35 years 28 70Above 35 years 2 5Total 40 100

Q4. Education Qualification

Options No. of Correspondents PercentageUnder Graduate 0 0Graduate 0 0Post Graduate 8 20Professional Degree holder 16 40Others 16 40Total 40 100

Objective: To know the qualification of the investors who are trading in derivative market

Graph:

Inference: Out of the total only 20% of Postgraduates, 40% of both Professional Degrees Holder and Others.

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Q5. Annual Income

Options No. of Correspondents PercentageBelow 1,50,000 32 801,50,000 - 3,00,000 8 203,00,000 – 5,00,000 0 0Above 5,00,000 0 0Total 40 100

Objective: To know the annual-income of the investors who are trading in derivative market

Graph:

Inference: Around 80% of the total investors are below the income group of Rs. 1,50,000 and rest 20% belong to the range between 1,50,000 – 3,00,000.

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Q6.If No is the reply in the Q1 question, reasons for not investing in derivative market?

Options No. of Correspondents

Percentage

Lack of knowledge 15 25Lack of awareness 16 27Very risky / Counter party risk 18 30Huge amount of investment 5 8Other 6 10Total 60 100

Objective: To know the reply of the investors who are not trading in derivative market

Graph:

Inference: From the above representation we can denote that 30% think that it’s Very risky where as 8% think there is a “Huge Investment Requirement” to trade in derivative market.

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Q7. Which of the following Derivative instruments do you deal in?

Options No. of Correspondents PercentageStock Futures 0 0Stock Index Futures 8 20Stock Options 20 50Stock Index Options 12 30Swaps 0 0Currency 0 0Total 40 100

Objective: To know the interest of the investors for the derivative instruments

Graph:

Inference: From the above representation 50% investors have invested in “Stock Options”, 30% in “Stock Index Options” and 20% in “Stock Index Futures”.

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Q8. How much percentage of your income you trade in derivative market?

Options No. of Correspondents PercentageLess than 5% 4 105%-10% 8 2011%-15% 12 3016%-20% 12 30More than 20% 4 10Total 40 100

Objective: To know the range of income invested of the investors who are trading in derivative market

Graph:

Inference: From the above representation investors invest maximum between the range of 11% to 20%

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Q9. You participate in Derivative market as?

Options No. of Correspondents PercentageHedger 4 10Speculator 8 20Arbitrageur 0 0Others 28 70Not Applicable 0 0Total 40 100

Objective: To know the investors who are trading in derivative market

Graph:

Inference: From the above representation we can classify that 10% are Hedgers, 20% are Speculators and 70% are general investors.

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Q10. Do you use any strategies while trading in Derivatives?

Options No. of Correspondents PercentageYes 24 60No 16 40Total 40 100

Objective: To know the investors who are trading in derivative market, use any strategies while investing.

Graph:

Inference: From the above representation 24 people use strategies while investing in derivatives where as 16 don’t.

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Q11. What is the rate of return expected by you from derivative market?

Objective: To know the expected returns of investors who are trading in derivative market.

Graph:

Inference: From the above representation expected range lies mostly between 14% and 23%.

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Options No. of Correspondents PercentageLess than 5% 1 105%-10% 2 2014%-17% 3 3018%-23% 3 30More than 23% 1 10Total 10 100

Q12. Are you satisfied with the current performance of the derivative market?

Objective: To know the satisfaction of the investors who are trading in derivative market.

Graph:

Inference: From the above representation Most of the investors did not wanted to comment about the current performance of the derivative market.

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Options No. of Correspondents PercentageStrongly disagree 0 0Disagree 0 0Neutral 40 100Agree 0 0Strongly agree 0 0Total 40 100

Chapter 6: Conclusion and Recommendations

Conclusions:

Most of the investors of Angel broking, Belapur franchise are not trading in derivative markets.

Most of the investors over there are majorly use equity as their investment tool.

People mainly don’t invest in Derivatives due to “Lack of Knowledge”.

People generally want to take trading decisions independently or under the guidance of Friends or Well Known Stock Broking Houses.

Literature and Self Experience can be taken as the best method to impart education about derivatives.

Recommendations:

Only few people are investing in Derivatives market as shown above. So Angel broking has to add much more efforts to attract and convince its customer to invest in Derivative Market.

Angel Broking, Belapur franchise needs to make its marketing team strong and also it should increase marketing activities such as promotional campaigns.

Angel Broking, Belapur franchise should educate the investors about Derivatives & Commodities by organizing classes, corporate presentations, taking part in consumer fairs, organizing events.

Angel Broking, Belapur franchise should turn existing customers (who are trading in Equity only) towards Derivatives.

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Angel Broking, Belapur franchise can also use Newspapers and Local New Channels as a medium of advertising.

Angel Broking, Belapur franchise may also use its helpline number for giving education on Derivatives. Company may appoint special team for giving education & attracting people towards trading on Derivatives.

BIBLIOGRAPHY

Books referred:

Derivatives FAQ by Ajay Shah

NSE’s Certification in Financial Markets: - Derivatives Core module

Financial Markets & Services by Gordon & Natarajan

Reports:

Regulatory Framework for Financial Derivatives in India by Dr.L.C.GUPTA

Websites visited:

www.nse-india.com

www.bseindia.com

www.sebi.gov.in

www.ncdex.com

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http://www.ncdex.com/

http://www.sebi.gov.in/

http://www.bseindia.com/

http://www.nse-india.com/

Questionnaire

Q1. Please mention your name below?

_____________________________________

Q2. Are you trading in derivative market?

Yes No

Q3. Gender

Male Female

Q4. Age

Below 20 years

20 – 25 years

26 – 30 years

31-35 years

Above 35 years

Q5. Education Qualification

Under Graduate

Graduate

Post Graduate

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Professional Degree holder

Others

Q6. Annual Income

Below 1, 50,000

1, 50,000 - 3, 00,000

3, 00,000 – 5, 00,000

Above 5, 00,000

Q7. If ‘No’ is the reply in the Q2 question, reasons for not investing in derivative market?

Lack of knowledge

Lack of awareness

Very risky / counter party risk

Huge amount of investment

Other

Q8. Which of the following Derivative instruments do you deal in?

Stock Futures

Stock Index Futures

Stock Options

Stock Index Options

Swaps

Currency

Q9. How much percentage of your income you trade in Derivative market?

Less than 5%

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5%-10%

11%-15%

16%-20%

More than 20%

Q10. You participate in Derivative market as?

Hedger

Speculator

Arbitrageur

Others

Q11. Do you use any strategies while trading in Derivatives?

Yes No

Q12. What is the rate of return expected by you from derivative market?

Less than 5%

5%-10%

14%-17%

18%-23%

More than 23%

Q13. Are you satisfied with the current performance of the derivative market?

Strongly disagree

Disagree

Neutral

Agree

Strongly agree

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a project on awareness of derivative strategies

Documents

starts making losses

american civil war

chicago mercantile exchange

indian capital markets

multi commodity exchange

philadelphia stock exchange

net credit received

stock index