A Project Report ON A Study on Derivatives (Future & Options)

AT INDIABULLS SECURITIES LTD

Secunderabad

MASTER OF BUSINESS ADMINISTRATION

Submitted By: PENJARLA PRAVEEN [HALLTICKET NO: 141509672049]

Project submitted in partial fulfilment for award of the degree of

PENDEKANTI INSTITUTE OF MANAGEMENT (Affiliated to Osmania University) Ibrahimbagh, Hyderabad. (2009-2011)

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DECLARATION

I hereby declare that, the project report entitled A Study on DERIVATIVES (FUTURES & OPTIONS) with special reference to INDIABULLS SECURITIES LTD, is an original work done and submitted by me for the partial fulfilment of the requirement for the award of degree of masters of business administration for the academic year 2009 -2011. I also further declare that this project has neither has been reproduced nor been submitted elsewhere to any other university for any other purpose, to the best of my knowledge and belief.

Date: Place: P.PRAVEEN

ABSTRACT
The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. 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. Financial derivatives came into spotlight in the 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 in terms of variety of instruments available, their complexity and also turnover. In the class of equity derivatives the world over, 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 indexes with various portfolios and ease of use. This project deals mainly with futures and options, the terminologies involved, difference between them , their eligibility criteria, how are they traded, how futures and options are used for hedging, settlement process strategies, and the softwares used.

ACKNOWLEDGEMENT

I am thankful to the management of A STUDY ON DERIVATOVES (FUTURES & OPTIONS) for my project work. However, in particular, I would like to thank Mr.S.JAGADISHWAR Associate Vice President Indiabulls Securities limited and Mr.S.SATISH KUMAR for appraising me of the situation with necessary background helps to complete this project work. And also I am very thankful to Mr. G. SAMUEL, PRINCIPAL, PENDEKANTI INSTITUTE OF MANAGEMENT, HYDERABAD. I am deeply indebted to my guide Dr.

G.SATISH head of the department taking under sparking his variable time throughout the project work.

TABLE OF CONTENT
S.NO
1. 1.1 1.2 1.3 1.4 1.6 1.6 2. 2.1 2.2 2.3 2.4 2.5 2.6 2.7 3. 4. 4.1 4.2 4.3 5. 5.1 5.2 5.3 6.
//

CONTENT
INTRODUCTION INTRODUCTION SCOPE OF THE STUDY STATEMENT OF THE PROBLEMS OBJECTIVES OF THE STUDY LIMITATIONS RESEARCH METHODOLOGY LITERATURE REVIEW INTRODUCTION OF DERIVATIVES HISTORICAL VIEW OF FUTURES & OPTIONS FUTURES OPTIONS ELIGIBILITY CRITERIA FOR SECURITIES OF TRADED TRADING MECHANISM OF FUTURES & OPTIONS STEPS INVOLVED IN FUTURES &OPTIONS TRADING COMPANY PROFILE DATA ANALYSIS & INTERPRETATION ANALYSIS OF FUTURE RELATION OF FP AND WITH SP ANALYSIS OF OPTIONS SUMMARY AND CONCLUSION RESULTS & DISCUSSIONS SUGGESTIONS CONCLUSION BIBILOGRAPHY

Pg,no
7-11

12-42

43-54 55-65

66-69

LIST OF TABLES
S.NO 1. 2. CONTENTS T1--Data for FUTSTK-WIPRO from 01-12-2010 to 30-12-2010 T2--Data for FUTSTK-WIPRO from 01-12-2010 to 30-12-2010 Pg. No 56 58

LIST OF FIGURES
S.NO 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. CONTENTS MAJOR PLAYERS IN DERIVATIVE MARKET: PAY-OFF FOR A BUYER OF FUTURES PAY-OFF FOR A SELLER OF FUTURES PAY-OFF PROFILE FOR BUYER OF A CALL OPTION PAY-OFF PROFILE FOR SELLER OF A CALL OPTION PAY-OFF PROFILE FOR BUYER OF A PUT OPTION PAY-OFF PROFILE FOR SELLER OF A PUT OPTION Indiabulls Group ORGANISATIONAL STRUCTURE POWER INDIA BULLS Pg. No 16 23 24 29 30 32 33 44 46 53

CHAPTER-1 INTRODUCTION

1.1 INTRODUCTION
Derivatives are a wide group of financial securities defined on the basis of other financial securities, i.e., the price of a derivative is dependent on the price of another security, called the underlying. These underlying securities are usually shares or bonds, although they can be various other financial products, even other derivatives. As a quick example, lets consider the derivative called a call option, defined on a common share. The buyer of such a product gets the right to buy the common share by a future date. But she might not want to do sotheres no obligation to buy it, just the choice, the option. Lets now flesh out some of the details. The price at which she can buy the underlying is called the strike price, and the date after which this option expires is called the strike date. In other words, the buyer of a call option has the right, but not the obligation to take a long position in the underlying at the strike price on or before the strike date. Call options are further classified as being European, if this right can only be exercised on the strike date and American, if it can be exercised any time up and until the strike date. Derivatives are amongst the widely traded financial securities in the world. Turnover in the futures and options markets are usually many times the cash (underlying) markets. Our treatment of derivatives in this module is somewhat limited: we provide a short introduction about of the major types of derivatives traded in the markets and their pricing. Financial derivatives came into spotlight in the year 1970 period due to growing instability in the financial markets. However since their emergence, these accounted for about twothird of totals transactions in derivatives products. In recent years, the market for financial derivatives has grown tremendously in terms of variety of instruments available, there complexity & also turn over. In the class of equity derivatives Futures & options on stock also turn over. In the class of equity derivatives, futures & options on stock indicates gained more popularly than individual stocks.

1.2 SCOPE OF THE STUDY

The scope of the study is limited to DERIVATIVES with the special reference to Indian context and the National stock exchange has been taken as a representative sample for the study. The study includes futures and options. My analysis part is limited to selecting the investment option it means that whether we have to invest cash market or derivatives market. I have taken only four different organizations from four different industries to analyze and interpret the results. Based upon four criterias only open interest is evaluated for analyzing the trend of market as well as price movement. The study is not Based on the international perspective of derivatives markets, which exists in NASDAQ, CBOT etc. This study mainly covers the area of hedging and speculation. The main aim of the study is to prove how risks in investing in equity shares can be reduced and how to make maximum return to the other investment.

1.3 STATEMENT OF THE PROBLEM

The main problem in the derivatives is we cant able to decide that time and derivative product which is more risky and return depend upon the time and product only we can earn more returns with taking more risk. In this following project I came to know that based upon some valuations and time conditions we can easily identify that which product is more efficient for earning more returns. In this research I used only two derivative products they are FUTURES and OPTIONS. Another one is OPEN INTEREST concept it is very new to market. This additional work proposes based upon open interest and volume we can tell the when the market is bullish as well as bearish and identifies that price movements easily when they are going to rise and when they are coming fall depends upon price volume changes.
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1.4 OBJECTIVES OF THE STUDY

The objectives for my research are as below To calculate the risk and return of investment in futures and investment in options To identifies the market trend and price movement based upon the open interest changes To analyze the role of futures and options in Indian financial system To understand about the derivatives market. To know why derivatives is considered safer than cash market. To construct portfolio and analyses the risk return relationship. To hedge the most profitable portfolio.

1.5 LIMITATIONS
Share market is so much volatile and it is difficult to forecast any thing about it whether you trade through online or offline The time available to conduct the study was only 2 months. It being a wide topic had a limited time.

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1.6 RESEARCH METHODOLOGY

Research Methodology is a systematic procedure of collecting information in order to analyse and verify a phenomenon. the collection of information is done in two principle sources. They are as follows 1. Primary Data 2. Secondary Data Primary Data: It is the information collected directly without any references. In this study it is gathered through interviews with concerned officers and staff, either individually or collectively, sum of the information has been verified or supplemented with personal observation in trading times and conducting personal interviews with the concerned officers of INDIABULLS SECURITIES LTD. Secondary Data: The secondary data was collected from already published sources such as, NSE websites, internal records, reference from text books and journal relating to derivatives. The data collection includes: a) Collection of required data from NSE and BSE websites b) Reference from text books and journals relating to Indian stock market system and financial derivatives.

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CHAPTER-2 LITERATURE REVIEW

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CONCEPTUAL AND THEORITICAL REVIEW 2.1 INTRODUCTION OF DERIVATIVES

DEFINITION Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the "underlying". FACTORS DRIVING THE GROWTH OF DERIVATIVES Over the last three decades, the derivatives market has seen a phenomenal growth. A large variety of derivative contracts have been launched at exchanges across the world. Some of the factors driving the growth of financial derivatives are: 1. Increased volatility in asset prices in financial markets, 2. Increased integration of national financial markets with the international markets, 3. Marked improvement in communication facilities and sharp decline in their costs, 4. Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies, and 5. Innovations in the derivatives markets, which optimally combine the risk and returns over a large number of financial assets leading to higher returns, reduced risk as well as transactions costs as compared to individual financial assets.

2.2 HISTORICAL VIEW OF FUTURES AND OPTIONS

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

INDEX FUTURES (JUNE 12, 2000)

INDEX OPTIONS (JUNE 4, 2001)

STOCK OPTIONS (JULY 2, 2001)

STOCK FUTURES (NOVEMBER 9, 2001) Flow of futures and options in NSE

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Risks involved in Derivatives: Derivatives are used to separate risks from traditional instruments and transfer these risks to parties willing to bear these risks. The fundamental risks involved in derivative business includes A. Credit Risk: This is the risk of failure of a counterpart to perform its obligation as per the contract. Also known as default or counterpart risk, it differs with different instruments. B. Market Risk: Market risk is a risk of financial loss as result of adverse movements of prices of the underlying asset/instrument. C. Liquidity Risk: The inability of a firm to arrange a transaction at prevailing market prices is termed as liquidity risk. A firm faces two types of liquidity risks: Related to liquidity of separate products. Related to the funding of activities of the firm including derivatives. D. Legal Risk: Derivatives cut across judicial boundaries, therefore the legal aspects associated with The deal should be looked into carefully. MAJOR PLAYERS IN DERIVATIVE MARKET: There are three major players in their derivatives trading. 1. Hedgers. 2. Speculators. 3. Arbitrageurs.

Hedgers: The party, which manages the risk, is known as Hedger. Hedgers seek to protect themselves against price changes in a commodity in which they have an interest.

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Speculators: They are traders with a view and objective of making profits. They are willing to take risks and they but upon whether the markets would go up or come down. Arbitrageurs: Risk less profit making is the prime goal of arbitrageurs. They could be making money even with out putting their own money in, and such opportunities often come up in the market but last for very short time frames. They are specialized in making purchases and sales in different markets at the same time and profits by the difference in prices between the two centres.

MAJOR PLAYERS IN DERIVATIVE MARKET

HEDGERS

SPECULATORS

ARBITRAGEURS

Fig 1: MAJOR PLAYERS IN DERIVATIVE MARKET:

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Contract Periods: At any point of time there will be always be available nearly 3months contract periods in Indian Markets. These were 1) Near Month 2) Next Month 3) Far Month For example in the month of September 2008 one can enter into September futures contract or October futures contract or November futures contract. The last Thursday of the month specified in the contract shall be the final settlement date for the contract at both NSE as well as BSE It is also know as Expiry Date. Settlement: The settlement of all derivative contracts is in cash mode. There is daily as well as final settlement. Outstanding positions of a contract can remain open till the last Thursday of the month. As long as the position is open, the same will be marked to market at the daily settlement price, the difference will be credited or debited accordingly and the position shall be brought forward to the next day at the daily settlement price. Any position which remains open at the end of the final settlement day (i.e. last Thursday) shall closed out by the exchanged at the final settlement price which will be the closing spot value of the underlying asset. Margins: There are two types of margins collected on the open position, viz., initial margin which is collected upfront which is named as SPAN MARGIN and mark to market margin, which is to be

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paid on next day. As per SEBI guidelines it is mandatory for clients to give margins, fail in which the outstanding positions or required to be closed out.

Members of F & O segment:

There are three types of members in the futures and options segment. They are trading members, trading cum clearing member and professional clearing members. Trading members are the members of the derivatives segment and carrying on the transaction on the respective exchange. The clearing members are the members of the clearing corporation who deal with payments of margin as well as final settlements. The professional clearing member is a clearing member who is not a trading member. Typically, banks and custodians become professional clearing members. It is mandatory for every member of the derivatives segment to have approved users who passed SEBI approved derivatives certification test, to spread awareness among investors.

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

instruments like treasury bills and bonds and other innovations like futures contracts in stock indexes are relatively new developments. The futures market described as continuous auction markets and exchanges providing the latest information about supply and demand with respect to individual commodities, financial instruments and currencies, etc Futures exchanges are where buyers and sellers of an expanding list of commodities; financial instruments and currencies come together to trade. Trading has also been initiated in options on futures contracts. Thus, option buyers participate in futures markets with different risk. The option buyer knows the exact risk, which is unknown to the futures trader. Future Contract

Suppose you decide to buy a certain quantity of goods. As the buyer, you enter into an agreement with the company to receive a specific quantity of goods at a certain price every month for the next year. This contract made with the company is similar to a
futures contract, in that you have agreed to receive a product at a future date, with the price and terms for delivery already set. You have secured your price for now and the next year - even if the price of goods rises during that time. By entering into this agreement with the company, you have reduced your risk of higher prices.

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 So, a futures contract is an agreement between two parties: a short position - the party who agrees to deliver a commodity - and a long position - the party who agrees to receive a commodity. In every futures contract, everything is specified: the quantity and quality of the commodity, the specific price per unit, and the date and method of delivery. The price of a futures contract is represented by the agreed-upon price of the underlying commodity or financial instrument that will be delivered in the future. Features of Futures Contracts: The principal features of the contract are as fallows. Organized Exchanges: Unlike forward contracts which are traded in an over the - counter market, futures are traded on organized exchanges with a designated physical location where trading takes place. This provides a ready, liquid market which futures can be bought and sold at any time like in a stock market. Standardization: In the case of forward contracts the amount of commodities to be

delivered and the maturity date are negotiated between the buyer and seller and can be tailor made to buyers requirement. In a futures contract both these are standardized by the

exchange on which the contract is traded.

Clearing House: The exchange acts a clearinghouse to all contracts struck on the trading

floor. For instance a contract is struck between capital A and B. upon entering into the records of the exchange, this is immediately replaced by two contracts, one between A and the clearing house and another between B and the clearing house. In other words the exchange interposes itself in every contract and deal, where it is a buyer to seller, and seller to buyer. The advantage of this is that A and B do not have to undertake any exercise to investigate each others credit worthiness. It also guarantees financial integrity of the market. The enforce the delivery for the delivery of contracts held for until maturity and protects itself
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from default risk by imposing margin requirements on traders and enforcing this through a system called marking to market.
Actual delivery is rare:

In most of the forward contracts, the commodity is actually

delivered by the seller and is accepted by the buyer. Forward contracts are entered into for acquiring or disposing of a commodity in the future for a gain at a price known today. In contrast to this, in most futures markets, actual delivery takes place in less than one present of the contracts traded. Futures are used as a device to hedge against price risk and as a way of betting against price movements rather than a means of physical acquisition of the underlying asset. To achieve, this most of the contracts entered into are nullified by the matching contract in the opposite direction before maturity of the first.
Margins: In order to avoid unhealthy competition among clearing members in reducing

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

FUTURES TERMINOLOGY
Spot price: The price at which an asset trades in the spot market. Futures price: The price at which the futures contract trades in the futures market. Contract cycle: The period over which a contract trades. The index futures contracts on the NSE have one- month, two-months and three months expiry cycles which expire on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February

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expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three- month expiry is introduced for trading. Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist. Contract size: The amount of asset that has to be delivered under one contract. Also called as lot size. Basis: In the context of financial futures, basis can be defined as the futures price minus the spot price. There will be a different basis for each delivery month for each contract. In a normal market, basis will be positive. This reflects that futures prices normally exceed spot prices. Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset. Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin. Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called marking-to-market. Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day.

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TYPES OF FUTURES
On the basis of the underlying asset they derive, the futures are divided into two types: Stock Futures Index Futures

PARTIES IN THE FUTURES CONTRACT There are two parties in a futures contract, the buyers and the seller. The buyer of the futures contract is one who is LONG on the futures contract and the seller of the futures contract is who is SHORT on the futures contract. The pay-off for the buyers and the seller of the futures of the contracts are as follows: Fig-2: PAY-OFF FOR A BUYER OF FUTURES

PROFIT

E2 LOSS

E1

Figure 3.2 CASE 1:- The buyers bought the futures contract at (F); if the futures Price Goes to E1 then the buyer gets the profit of (FP).
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CASE 2:- The buyers gets loss when the futures price less then (F); if The Futures price goes to E2 then the buyer the loss of (FL). Fig: PAY-OFF FOR A SELLER OF FUTURES

P PROFIT

E2 E1 F

LOSS L

Figure 3.3 F = FUTURES PRICE E1, E2 = SATTLEMENT PRICE CASE 1:- The seller sold the future contract at (F); if the future goes to E1 Then the seller gets the profit of (FP). CASE 2:- The seller gets loss when the future price goes greater than (F); If the future price goes to E2 then the seller get the loss of (FL).

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HOW THE FUTURE MARKET WORKS

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

2.4 OPTIONS
INTRODUCTION TO OPTIONS
In this section, we look at the next derivative product to be traded on the NSE, namely options. Options are fundamentally different from forward and futures contracts. An option gives the holder of the option the right to do something. The holder does not have to exercise this right. In contrast, in a forward or futures contract, the two parties have committed themselves to doing something. Whereas it costs nothing (except margin requirement) to enter into a futures contracts, the purchase of an option requires as up-front payment. DEFINITION Options are of two types- calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyers the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.

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PROPERTIES OF OPTION Options have several unique properties that set them apart from other securities. following are the properties of option: Limited Loss High leverages potential Limited Life The

PARTIES IN AN OPTION CONTRACT There are two participants in Option Contract. Buyer/Holder/Owner of an Option: The Buyer of an Option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer. Seller/writer of an Option: The writer of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him. Characteristics of Options: The following are the main characteristics of options: 1. Options holders do not receive any dividend or interest. 2. Options only capital gains. 3. Options holder can enjoy a tax advantage. 4. Options holders are traded an O.T.C and in all recognized stock exchanges. 5. Options holders can control their rights on the underlying asset. 6. Options create the possibility of gaining a windfall profit.
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7. Options holders can enjoy a much wider risk-return combinations. 8. Options can reduce the total portfolio transaction costs. 9. Options enable with the investors to gain a better return with a limited amount of investment.

TYPES OF OPTIONS
The Options are classified into various types on the basis of various variables. The following are the various types of options. 1. On the basis of the underlying asset: On the basis of the underlying asset the option are divided in to two types: Index options: These options have the index as the underlying. Some options are European while others

are American. Like index futures contracts, index options contracts are also cash settled. Stock options: Stock Options are options on individual stocks. Options currently trade on over 500 stocks in the United States. A contract gives the holder the right to buy or sell shares at the specified price. 2. On the basis of the market movements : On the basis of the market movements the option are divided into two types. They are: Call Option: A call Option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. It is brought by an investor when he seems that the stock price moves upwards.

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Put Option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price. It is bought by an investor when he seems that the stock price moves downwards. 3. On the basis of exercise of option: On the basis of the exercise of the Option, the options are classified into two Categories. American Option: American options are options that can be exercised at any time up to the expiration date. Most exchange traded options are American. European Option: European options are options that can be exercised only on the expiration date itself. European options are easier to analyse than American options, and properties of an American option are frequently deduced from those of its European counterpart.

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PAY-OFF PROFILE FOR BUYER OF A CALL OPTION The Pay-off of a buyer options depends on a spot price of an underlying asset. The following graph shows the pay-off of buyers of a call option.

PROFIT ITM

S ATM OTM E1

E2

LOSS

Figure 3.4

S= Sp =

Strike price premium/loss

ITM = In the Money ATM = At the Money OTM = Out of the Money

E1 = Spot price 1 E2 = Spot price 2

SR = Profit at spot price E1

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CASE 1: (Spot Price > Strike price) As the Spot price (E1) of the underlying asset is more than strike price (S). The buyer gets profit of (SR), if price increases more than E1 then profit also increase more than (SR) CASE 2: (Spot Price < Strike Price) As a spot price (E2) of the underlying asset is less than strike price (S) The buyer gets loss of (SP); if price goes down less than E2 then also his loss is limited to his premium (SP)

PAY-OFF PROFILE FOR SELLER OF A CALL OPTION

The pay-off of seller of the call option depends on the spot price of the underlying asset. The following graph shows the pay-off of seller of a call option:

PROFIT ITM E1

P ATM E2 S OTM

R LOSS

Figure 3.5

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S= SP = E1 = E2 = SR =

Strike price Premium / profit Spot Price 1 Spot Price 2 loss at spot price E2

ITM = In the Money ATM = At The money OTM = Out of the Money

CASE 1: (Spot price < Strike price) As the spot price (E1) of the underlying is less than strike price (S). The seller gets the profit of (SP), if the price decreases less than E1 then also profit of the seller does not exceed (SP). CASE 2: (Spot price > Strike price) As the spot price (E2) of the underlying asset is more than strike price (S) the Seller gets loss of (SR), if price goes more than E2 then the loss of the seller also increase more than (SR).

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PAY-OFF PROFILE FOR BUYER OF A PUT OPTION

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

PROFIT

ITM S E1 ATM OTM E2

LOSS

Figure 3.6 S = Strike price SP = Premium / loss E1 = Spot price 1 E2 = Spot price 2 SR = Profit at spot price E1 CASE 1: (Spot price < Strike price) As the spot price (E1) of the underlying asset is less than strike price (S). The buyer gets the profit (SR), if price decreases less than E1 then profit also increases more than (SR).
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ITM = In the Money ATM = At the Money OTM = Out of the Money

CASE 2: (Spot price > Strike price) As the spot price (E2) of the underlying asset is more than strike price (S), The buyer gets loss of (SP), if price goes more than E2 than the loss of the buyer is limited to his premium (SP).

PAY-OFF PROFILE FOR SELLER OF A PUT OPTION

The pay-off of a seller of the option depends on the spot price of the underlying asset. The following graph shows the pay-off of seller of a put option.

PROFIT P ITM ATM E1 OTM R LOSS S E2

Figure 3.7 S = Strike price SP = Premium/profit E1 = Spot price 1 ITM = In the Money ATM = At the Money OTM = Out of the Money

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E2 = Spot price 2 SR = Loss at spot price E1 CASE 1: (Spot price < Strike price) As the spot price (E1) of the underlying asset is less than strike price (S), the seller gets the loss of (SR), if price decreases less than E1 than the loss also increases more than (SR). CASE 2: (Spot price > Strike price) As the spot price (E2) of the underlying asset is more than strike price (S), the seller gets profit of (SP), of price goes more than E2 than the profit of seller is limited to his premium (SP).

FACTORS AFFECTING THE PRICE OF AN OPTION

The following are the various factors that affect the price of an option they are: Stock Price: The pay-off from a call option is an amount by which the stock price exceeds the strike price. Call options therefore become more valuable as the stock price increases and vice versa. The pay-off from a put option is the amount; by which the strike price exceeds the stock price. Put options therefore become more valuable as the stock price increases and vice versa. Strike price: In case of a call, as a strike price increases, the stock price has to make a larger upward move for the option to go in-the money. Therefore, for a call, as the strike price increases option becomes less valuable and as strike price decreases, option become more valuable

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Time to expiration: Both put and call American options become more valuable as a time to expiration increases. Volatility: The volatility of a stock price is measured of uncertain about future stock price movements. As volatility increases the chance that the stock will do very well or very poor increases. The value of both calls and puts therefore increases as volatility increase. Risk- free interest rate: The put option prices decline as the risk-free rate increases where as the price of call always increases as the risk-free interest rate increases. Dividends: Dividends have the effect of reducing the stock price on the X- dividend rate. This has a negative effect on the value of call options and a positive effect on the value of put options.

OPTIONS TERMINOLOGY
Option price/premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium. Expiration date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity.

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Strike price: The price specified in the option contract is known as the strike price or the exercise price. Intrinsic value and time value for calls: In the case of a call, intrinsic value is the amount by which the underlying futures price exceeds the strike price: Futures Price Strike Price = Intrinsic Value (must be positive or 0) Example: June CME Live Cattle futures are trading at 82.50 cents/lb. and the June 80 CME Live Cattle call option is trading at 3.50 cents/lb. What are the time value and intrinsic value components of the premium? Futures Price Strike Price = Intrinsic Value 82.50 80.00 = 2.50 Time value represents the amount option traders are willing to pay over intrinsic value, given the amount of time left to expiration for the futures to advance in the case of calls, or decline in the case of puts. Options Premium Intrinsic Value = Time Value 3.50 2.50 = 1.00 Time Value + Intrinsic Value = Premium 1.00 + 2.50 = 3.50 Intrinsic value and time value for puts: In the case of a put, intrinsic value is the amount by which the underlying futures price is below the strike price: Intrinsic Value = Strike Price Futures Price (must be positive or 0) Time Value = Put Option Premium Intrinsic Value Put Option Premium = Put Time Value + Put Intrinsic Value
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Example: What are the time value and intrinsic value of a CME Eurodollar 95.00 put if the underlying futures are trading at 94.98 and the option premium is 0.03? Strike Price Futures Price = Intrinsic Value 95.00 94.98 = 0.02 There are 0.02 points of intrinsic value. Options Premium Intrinsic Value = Time Value 0.03 0.02 = 0.01

2.5 ELIGIBILITY CRITERIA FOR SECURITIES/INDICES TRADED IN F&O

Eligibility criteria of stocks 1. The stock is chosen from amongst the top 500 stocks in terms of average daily market capitalization and average daily traded value in 206 the previous six months on a rolling basis. 2. The stock's median quarter-sigma order size over the last six months should be not less than Rs. 1 lakh. For this purpose, a stock's quarter sigma order size should mean the order size (in value terms) required to cause a change in the stock price equal to one-quarter of a standard deviation. 3. The market wide position limit in the stock should not be less than Rs.50 crore. The market wide position limit (number of shares) is valued taking the closing prices of stocks in the underlying cash market on the date of expiry of contract in the month. The market wide position limit of open position (in terms of the number of underlying stock) on futures and option contracts on a particular underlying stock should be lower of:- 20% of the number of shares held by non-promoters in the relevant underlying security i.e. free-float holding. 4. If an existing security fails to meet the eligibility criteria for three months consecutively then no fresh month contract will be issued on that security.

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5. However, the existing unexpired contracts can be permitted to trade till expiry and new strikes can also be introduced in the existing contract months. 6. For unlisted companies coming out with initial public offering, if the net public offer is Rs.500 crores or more, then the exchange may consider introducing stock options and stock futures on such stocks at the time of its listing in the cash market. Eligibility criteria of indices The exchange may consider introducing derivative contracts on an index if the stocks contributing to 80% weightage of the index are individually eligible for derivative trading. However, no single ineligible stocks in the index should have a weightage of more than 5% in the index. The above criteria is applied every month, if the index fails to meet the eligibility criteria for three months consecutively, then no fresh month contract would be issued on that index, However, the existing unexpired contacts will be permitted to trade till expiry and new strikes can also be introduced in the existing contracts.

2.6 TRADING MECHANISM OF FUTURES AND OPTIONS

The futures and options trading system of NSE, called NEAT-F&O trading system, provides a fully automated screen-based trading for Index futures &options and Stock futures & options on a nationwide basis and an online monitoring and surveillance mechanism. It supports an anonymous order driven market which provides complete transparency of trading operations and operates on strict price-time priority. It is similar to that of trading of equities in the Cash Market (CM) segment. The NEAT-F&O trading system is accessed by two types of users. The Trading Members (TM) have access to functions such as order entry, order matching, order and trade management. It provides tremendous flexibility to users in terms of kinds of orders that can be placed on the system. Various conditions like Immediate or Cancel, Limit/Market price, Stop loss, etc. can be built into an order. The Clearing Members (CM) use the trader workstation for the purpose of monitoring the trading

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member(s) for whom they clear the trades. Additionally, they can enter and set limits to positions, which a trading member can take.

PRICING FUTURES Forwards/ futures contract are priced using the cost of carry model. The cost of carry model calculates the fair value of futures contract based on the current spot price of the underlying asset. The formula used for pricing futures is given below: F = SerT Where : F = Futures Price S = Spot price of the underlying asset R = Cost of financing (using a continuously compounded interest rate) T = Time till expiration in years E = 2.71828 (The base of natural logarithms)

Example: Security of ABB Ltd trades in the spot market at Rs. 850. Money can be invested at 11% per annum. The fair value of a one-month futures contract on ABB is calculated as follows: 850 * 12 857.80 1 0.1 1 F = SerT = e The presence of arbitrageurs would force the price to equal the fair value of the asset. If the futures price is less than the fair value, one can profit by holding a long position in the futures and a short

39

position in the underlying. Alternatively, if the futures price is more than the fair value, there is a scope to make a profit by holding a short position in the futures and a long position in the

underlying. The increase in demand/ supply of the futures (and spot) contracts will force the futures price to equal the fair value of the asset. PRICING OPTIONS Our brief treatment of options in this module initially looks at pay-off diagrams, which chart the price of the option with changes in the price of the underlying and then describes how call and option prices are related using put-call parity. We then briefly describe the celebrated Black-Scholes formula to price a European option. Payoffs from an option contract refer to the value of the option contract for the parties (buyer and seller) on the date the option is exercised. For the sake of simplicity, we do not consider the initial premium amount while calculating the option payoffs. In case of call options, the option buyer would exercise the option only if the market price on the date of exercise is more than the strike price of the option contract. Otherwise, the option is worthless since it will expire without being exercised. Similarly, a put option buyer would exercise her right if the market price is lower than the exercise price.

The payoff of a call option buyer at expiration is: Max [(Market price of the share Exercise Price), 0] The following figures shows the payoff diagram for call options buyer and seller (assumed exercise price is 100)

The payoff for a buyer of a put option at expiration is: Max [(Exercise price Market price of the share), 0] The payoff diagram for put options buyer and seller (assumed exercise price is 100)

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2.7 STEPS INVOVED IN F & O TRADING PROCESS

1. PLACING THE ORDER For placing an order, if its a buy order press F11 and to place a sell order press F12. The following details have to be entered to place a buy / sell order Client id every client have an unique ID which has to be entered before placing an order.

Quantity of the order

OPTIDX / OPTSTK select the suitable option, whether to trade on index or stock options. MARKET/LIMIT

INDEX choose the index under which you want to trade Trigger price its a stop loss order beyond at which loss is not bearable. An order placed
with a broker to buy or sell at a specified price (or better) after a given stop price has been reached or passed. Disc qty the quantity of the order can be disclosed Strike price the price specified in the options contract is known as the strike price or the exercise price. DAY/IOC its an order CALL/PUT

2. ORDER CONFORMATION Its a confirmation from the exchange that the orders have been executed. It gives the information about online order reference number, exchange order number, trade number, quantity of the order and the client id.

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3. DOCUMENTS SUBMITED TO THE CLIENT CONTRACT NOTE At the end of the day digital contract note is sent to each and every client regarding the details about the each and every transaction done on that specific day, the brokerage amount and taxes levied. CLIENT LEDGER

It gives the details of the clients debts and credits. 4. CLIENT SUPPORT
5. COMPLIANCE POLICY CALLS RECORD: Every order placed through telephone is recorded CONFIRMATION OF ORDERS: Every order which is executed will be intimated to the client SIGNATURES of walking clients have to be verified every time

6. RISK MANAGEMENT SYSTEM (RMS): It specifies the initial margin requirements for each futures and options contract on a daily basis

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CHAPTER-3 COMPANY PROFILE

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INTRODUCTION Indiabulls Group is one of the top business houses in the country with business interests in Real Estate, Infrastructure, and Financial Services, Retail, Multiplex and Power sectors. Indiabulls Group companies are listed in Indian and overseas financial markets. The Net worth of the Group exceeds USD 3 billion. Indiabulls has been conferred the status of a Business Super brand by The Brand Council, Super brands India. Indiabulls Financial Services is an integrated financial services powerhouse providing Consumer Finance, Housing Finance, Commercial Loans, Life Insurance, Asset Management and Advisory services. Indiabulls Financial Services Ltd is amongst 68 companies constituting MSCI Morgan Stanley India Index. Indiabulls Financial is also part of CLSAs model portfolio of 30 Best Companies in Asia. Indiabulls Financial Services in partnership with MMTC Limited, the largest commodity trading company in India, has set up Indias 4th Multi-Commodities Exchange. Indiabulls Real Estate Limited is Indias third largest property company with development projects spread across residential projects, commercial offices, hotels, malls, and Special Economic Zones (SEZs) infrastructure development. Indiabulls Real Estate partnered with Farallon Capital Management LLC of USA to bring the first FDI into real estate. Indiabulls Real Estate is transforming 14 million sqft in 16 cities into premium quality, high-end commercial, residential and retail spaces. Indiabulls Real Estate has diversified significantly in the following business verticals within the Real Estate Space: Real Estate Development, Project Advisory & Facilities Management: Residential, Commercial (Office and Malls) and SEZ Development. Power: Thermal and Hydropower Generation. Indiabulls Securities Limited is Indias leading capital markets company with All-India Presence and an extensive client base. Indiabulls Securities possesses state-of-the-art trading platform, best broking practices and is the pioneer in trading product innovations. Power Indiabulls,
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in-house trading platform, is one of the fastest and most efficient trading platforms in the country. Indiabulls Securities Limited is the first brokerage house to be assigned the highest rating BQ 1 by CRISIL.

Indiabulls GROUP STRUCTURE

Financial services

Securities

Real Estate

Retail

Power

Fig: Indiabulls Group INDIA BULLS SECURITIES Securities Limited is Indias leading capital markets company with All-India Presence and an extensive client base. Indiabulls Securities is the first and only brokerage house in India to be assigned the highest rating BQ 1 by CRISIL. Indiabulls Securities Ltd is listed on NSE, BSE & Luxembourg stock exchange.

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ORGANISATIONAL STRUCTURE

PRODUCTS India bulls Securities Limited (ISL) is the pioneer in Retail Broking Industry having a pan India presence and providing services to a customer base exceeding half a million. ISL is in the business of providing securities broking and advisory services and is a corporate member of capital market, wholesale debt market and derivative segment of NSE and of the capital market and derivative segment of BSE. ISL is the first and only brokerage house to be assigned the highest rating BQ-1 by CRISIL.

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The company through various types of brokerage accounts provides product and services related to purchase and sale of securities listed in NSE and BSE. It also provides depository services, equity research services, mutual fund, and IPO distribution to its clients. The company provides these services through on-line and off-line distribution channel. POWER INDIA BULLS Power Indiabulls (PIB) is an online trading platform which brings you the power of a brokers terminal on your desktop. DEPOSITORY SERVICES Indiabulls is a depository participant with the National Securities Depository Limited and Central Depository Services (India) Limited. IPO ONLINE You can quickly and seamlessly apply to the latest public offerings with just a few clicks. CURRENCY DERIVATIVES Indiabulls offers trading in the Currency Derivatives Segment in National Stock Exchange (NSE) INDIA BULLS SIGNATURE ACCOUNT Indiabulls Signature account provides you the platform to trade in Equity and Derivatives. NRI TRADING: Non-Resident Indians (NRIs) can also enjoy the state-of-the-art online trading Platforms of Indiabulls to trade in Indian Capital

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INDIA BULLS EQUITY ANALYSIS Indiabulls Equity Analysis complements its equity broking and advisory services with high quality comprehensive report which can be accessed online. Power Indiabulls (PIB) is the advanced online trading platform from Indiabulls Securities Limited. PIB provides the best in the class internet trading features and delivers a seamless and rich online trading experience for its users. PIB comes with a whole host of online features for the internet trading users ranging from real-time stock prices, to live trading reports, charting, News Room. PIB provides an integrated online trading platform for the internet trading community to invest in equity, F&O, Online IPO and base their decision on sound fundamental research and technical analysis. It also provides various kinds of trading reports, each developed to cater to internet trading users distinct needs. SETTLEMENT CHARGE Account opening charges : 900 Rs ( NON-REFUNDABLE) No Annual Maintenance Charges ( AMC )

SETTLEMENT CHARGES: INTRADAY Charges: Exposure: 3-5 paisa for 100 Rs 6-12 times DELIVERY 25 -50 paisa for 100 Rs 2 - 4 times

MILESTONES Developed one of the first Internet trading platforms in India Amongst the first to develop in-house real-time CTCL (computer to computer link) with NSE Introduction of integrated accounts with automatic gateways to client Bank accounts
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Development of Products such as Power Indiabulls for high volume Traders

Indiabulls Signature Account for self-directed investors Indiabulls Group Professional Network for information and trading Services

Indiabulls Securities is the first and only brokerage house in India to be the highest rating BQ 1 by CRISIL. Indiabulls Securities Ltd is listed on NSE, BSE & Luxembourg stock exchange.

assigned

WHY (PIB) PIB is the internet based stock trading application, which provides you an unparalleled edge to trade in Indian stock markets. Here are some of the compelling reasons, why you should subscribe for Power Indiabulls (PIB) Integrated market watch for Equities and Derivatives Live Streaming Quotes Fast Order Entry Tic by Tic Live Intraday Charts Technical Analysis Live Market News Customizable Alerts Extensive Reports Real Time Market Statistics

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World Market Summary Introducing Intraday Futures INDIA BULLS SIGNATURE ACCOUNT With Indiabulls Signature account you will always remain on top of your investments. It provides you the platform to trade in Equity and Derivatives. With an unmatched service and nationwide presence, the Indiabulls Signature account comes bundled with a variety of exclusive features. Ease of Trading: With Indiabulls Signature account you have the flexibility to place your orders either by logging on the website, calling at the branch or walking in the branch. Dedicated Service Branch and Relationship Manager : You can get in touch with your Relationship Manager and Service Branch for all your trading related requirements. Power Indiabulls (PIB): You can trade smarter and faster using the Power Indiabulls application. Access the broad spectrum of sophisticated trading tools and get an edge in the stock markets. Online Payment Gateways :Use our online payment gateways facility and get instant credit in your Trading Account. We currently provide online gateway payment facility with four major banks HDFC, ICICI, AXIS and IDBI. IPOS Indiabulls provides you the flexibility to apply in on-going IPOs through either online or offline channels. For applying online, you do not need to fill tedious forms and write cheques. You can apply conveniently in IPOs from the comfort of your home / office through our Website/PIB. For applying offline, you can contact your Relationship Manager/ Service Branch.

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PORTFOLIO TRACKER You can track your investments online through our portfolio tracker functionality. You can conveniently track the daily movement, notional / booked profits and losses in your portfolio. EQUITY ANALYSIS REPORT A qualified and dedicated team of equity analysts at Indiabulls publishes various research reports. You can view these reports to gain insight into the companies of your interest. NEWS ROOM The News Room provides real-time news from stock-markets, corporate sector, economy and other segments that have a bearing on the market sentiment. MARKET STATISTICS This functionality facilitates tracking the market trend by providing you real time data on top gainers, top losers, volume toppers and most volatile stocks. MOBILE POWER INDIABULLS (MPIB) MPIB is a mobile-phone based application, developed exclusively for Indiabulls customers. Using MPIB, you can view the live market rates of your favourite stocks and futures contracts on your mobile device. Thus with MPIB, you can always remain connected with the market, even on the move. ELECTRONIC CONTRACT NOTES ON EMAIL This facility enables you to get digitally signed Electronic Contract Notes on email within 24 hours of executing trades in your Trading Account.

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INTRODUCING INTRADAY FUTURES Intraday Futures Product enables you to take intraday positions in various future contracts at lower margins. These positions have to be necessarily squared-off at the day end. SECURITY TOKEN Security Token, the new age security tool to make your trading experience totally secure by using two factors authentication mechanisms COMPREHENSIVE REPORTS Track your financials and portfolio efficiently through various reports like Ledger Statements, Account Summary, Net Portfolio Report, Daily Transaction Report, Daily Transaction report etc. CURRENCY DERIVATIVES Trade in Currency Derivatives which are similar in nature to Stock or Index Futures contracts. Currency Future Contracts, with INR: USD exchange rate as the underlying, are available with a monthly expiry. DEPOSITORY SERVICES Indiabulls is a depository participant with the National Securities Depository Limited and Central Depository Services (India) Limited for trading and settlement of dematerialized shares. Indiabulls performs clearing services for all securities transactions through its accounts. We offer depository services to create a seamless transaction platform execute trades through Indiabulls Securities and settle these transactions through the Indiabulls Depository Services. Indiabulls Depository Services is part of our value added services for our clients that create multiple interfaces with the client and provide for a solution that takes care of all your needs.

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POWER INDIA BULLS

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TERMINOLOGY INVOLVED IN SOFTWARE SCRIP: Bid - This is the price a market maker is willing to pay for a security (i.e., the Price you will receive if you sell). Ask - This is the price a market maker is willing to accept (i.e., the price you will Pay to buy the security) Open - This is the price of the first trade for the period (e.g., the first trade of the Day). When analysing daily data, the Open is especially important as it is the Consensus price after all interested parties were able to "sleep on it." High - This is the highest price that the security traded during the period. It is the point at which there were more sellers than buyers (i.e., there are always Sellers willing to sell at higher prices, but the High represents the highest price buyers were willing to pay). Low - This is the lowest price that the security traded during the period. It is the Point at which there were more buyers than sellers (i.e., there are always buyers Willing to buy at lower prices, but the Low represents the lowest price sellers were Willing to accept). Close - This is the last price that the security traded during the period. Due to its availability, the Close is the most often used price for analysis. The relationship between the Open (the first price) and the Close (the last price) are considered significant by most technicians. This relationship is emphasized in Candlestick charts. Volume - This is the number of shares (or contracts) that were traded during the period. The relationship between prices and volume (e.g., increasing prices accompanied with increasing volume) is important.

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CHAPTER-4 DATA ANALYSIS & INTERPRETATION

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4.1 ANALYSIS OF FUTURES

LONG FUTURES When the market is in bullish we will take futures as long it means that when the market is going up future price is also going up in this way we will gain returns on that particular future. The calculation of return on future is as below Example The following table consist the future values of WIPRO from 01- 12-10 to 20-12-10 By observing the table the future values of WIPRO is gradually diminish but 16 DEC 2010 again it raises this time if we take long futures it will be beneficial.(marked-to-market settlement) T1--Data for FUTSTK-WIPRO from 01-12-2010 to 30-12-2010: Symbol WIPRO WIPRO WIPRO WIPRO WIPRO WIPRO WIPRO WIPRO WIPRO Date 01-Dec-2010 02- Dec -2010 03- Dec -2010 06- Dec -2010 07- Dec -2010 08- Dec -2010 09- Dec -2010 10- Dec -2010 13- Dec -2010 Expiry 20-DEC-2010 20-DEC-2010 20-DEC-2010 20-DEC-2010 20-DEC-2010 20-DEC-2010 20-DEC-2010 20-DEC-2010 20-DEC-2010 Open 421.00 421.00 425.00 430.00 432.00 436.70 435.00 437.00 453.00 High 421.75 431.40 433.70 436.60 437.00 439.95 441.85 453.90 453.00 Low 412.145 417.75 424.00 428.90 431.95 432.00 431.00 433.05 438.10 Close 414.70 426.05 427.60 430.65 434.95 435.30 437.10 450.95 448.15

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WIPRO WIPRO WIPRO WIPRO

14- Dec -2010 15- Dec -2010 16- Dec -2010 20- Dec -2010

20-DEC-2010 20-DEC-2010 20-DEC-2010 20-DEC-2010

449.90 452.10 458.70 465.10

456.65 459.50 475.50 480.00

444.90 451.00 457.15 462.75

454.40 458.40 470.05 477.60

So lot size of WIPRO is

long futures @ 413 it closes @ 415.15.

Return = lotsize * (closing price-opening price) = = * (415.15-413) * (2.15)

The lotsize is 50 then get the returns Return = 50 * (415.15-413) = 50 * (2.15) = 107.50 Therefore if he put lotsize is 50 then he gets the return Rs.107.50

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SHORT FUTURES When the market is in bearish we will take futures as short it means that when the market is coming down future price is also coming down in this way we will gain returns on that particular future. The calculation of return on short future is as below Example The following table consist the future values of WIPRO from 01-12-10 to 20-12-10 By observing the table the future values of WIPRO are gradually diminish. As indicate the above period we will short futures on any date we will gain returns. For example we will short WIPRO futures @ 450 on 13 DEC it closes same day @ 418 T2--Data for FUTSTK-WIPRO from 01-12-2010 to 30-12-2010: SYMBOL WIPRO WIPRO WIPRO WIPRO WIPRO WIPRO WIPRO WIPRO WIPRO DATE 01-Dec-2010 02- Dec -2010 03- Dec -2010 06- Dec -2010 07- Dec -2010 08- Dec -2010 09- Dec -2010 10- Dec -2010 13- Dec -2010 EXPIRY 30-Dec-2010 30-Dec-2010 30-Dec-2010 30-Dec-2010 30-Dec-2010 30-Dec-2010 30-Dec-2010 30-Dec-2010 30-Dec-2010 OPEN 423.50 421.55 428.40 430.00 432.90 436.90 438.00 439.50 452.10 HIGH 423.50 432.40 434.55 437.25 438.70 449.75 443.00 453.50 454.00 LOW 415.20 419.10 425.40 429.10 432.65 432.90 432.50 434.20 439.05 CLOSE 417.60 428.00 428.85 430.75 437.00 435.90 436.80 451.05 450.02

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WIPRO WIPRO WIPRO WIPRO

14- Dec -2010 15- Dec -2010 16- Dec -2010 20- Dec -2010

30-Dec-2010 30-Dec-2010 30-Dec-2010 30-Dec-2010

449.10 454.00 459.50 469.00

456.75 460.00 476.00 481.30

446.00 452.25 458.10 463.90

454.90 459.05 471.45 478.60

Return = lotsize * ( opening price closing price) = = *(450 418) *(32)

Let us take lotsize is 50 then get the returns Return = 50 * (450-418) = 50 * (32) = 1600 Therefore if he put lotsize is 500 then he gets the return Rs.1600

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4.2 RELATIONSHIP OF FUTURE PRICE WITH SPOT PRICE IF FUTURE PRICE HIGHER THAN THE CASH PRICE Here futures price exceeds the cash price which indicates that the cost of carry is negative and the market under such circumstances is termed as a backwardation market or inverted market. EXAMPLE Suppose the RELIANCE share is trading at Rs.400 in the spot market. While RELIANCE FUTURES is trading at Rs.406.Thus in this circumstances the normal strategy followed by investors is buy the RELIANCE in the spot market and sell in the futures. On expiry, assuming RELIANCE closes at Rs 450, you make Rs.50 by selling the RELIANCE stock and lose Rs.44 by buying back the futures, which is Rs 6 in a month. Thus Futures prices are generally higher than the cash prices, in an overbought market. IF CASH PRICE HIGHER THAN THE FUTURE PRICE Here cash price exceeds the futures price which indicates that the cost of carry is positive and this market is termed as oversold market. This may be due to the fact that the market is cash settled and not delivery settled, so the futures price is more a reflection of sentiment, rather than that of the financing cost. EXAMPLE Now let us assume that the RELIANCE share is trading at Rs.406 in the spot market. While RELIANCE FUTURES is trading at Rs.400.Thus in this circumstances the normal strategy followed by investors is buy the RELIANCE FUTURES and sell the RELIANCE in the spot market. So at expiry if Reliance closes at Rs 450, the investor will buy back the stock at a loss of Rs 44 and make Rs 50 on the settlement of the futures position. This is applied when the cost of carry is high.

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4.3 ANALYSIS OF OPTIONS Here we are discussing four basic strategies in analyzing options they are as below

LONG CALL When we anticipate the market is bullish we prefer LONG CALL strategy. It means that when we purchase call option in the bullish market we will get returns as when the market goes up obviously call option premium also increases. EXAMPLE RNRL call option premium value is on 06-May-2010 is Rs 8 when strike price is 60 Calculation of return as below. Strike price : 60 Premium : 8 Lot size : 200 shares Market action :72 Profit : (72-60-8) * 200 = 800 SHORT CALL When we anticipate the market is bearish we prefer SHORT CALL strategy. It means that when we sell call option in the bearish market we will get returns as when the market comes down obviously call option premium also decreases so we sold at higher premium price. EXAMPLE HCLTECH call option premium value is on 14-May-2010 is Rs 11.45 when strike price is 400 Calculation of return as below. Strike price : 400 Premium : 11.45 Lot size : 200 shares

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Market action :360 Profit : (400-360+11.45) * 200 = 10290 LONG PUT When we anticipate the market is bearish we prefer LONG PUT strategy. It means that when we purchase put option in the bearish market we will get returns as when the market comes down obviously put option premium increases. EXAMPLE NTPC put option premium value is on 02-May-2010 is Rs 6.25 when strike price is 210 Calculation of return as below. Strike price : 210 Premium : 6.25 Lot size : 200 shares Market action :190 Profit : (210-190-6.25) * 200 = 2750 SHORT PUT When we anticipate the market is bullish we prefer SHORT PUT strategy. It means that when we sell put option in the bullish market we will get returns as when the market goes up obviously put option premium decreases but we sold at higher premium . EXAMPLE NIFTY put option premium value is on 06-May-2010 is Rs 29.5 when strike price is 4800 Calculation of return as below. Strike price : 4800 Premium : 29.5 Lot size : 150 shares Market action :4900

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Profit : (4900-4800+29.5) * 150 = 19425

Based upon the above four strategies we conclude that when the market is bullish take LONG CALL /SHORT PUT and when the market is bearish take LONG PUT/SHORT CALL. The following illustration explains that how we will take the strategies when the market is bullish or bearish. IF THE MARKET IS BULLISH BUY STOCK/LONG CALL/SHORT PUT Under this strategy the speculator is bullish in the market. He could do any of the following: BUY STOCK ACC spot price : 150 No of shares : 200 Price : 150*200 = 30,000 Market action : 160 Profit : 2,000 LONG CALL OPTION: Strike price : 150 Premium : 8 Lot size : 200 shares Market action :160 Profit : (160-150-8)*200 = 400 SHORT PUT OPTION: Strike price : 150 Premium : 7 Lot size : 200 shares

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Market action :160 Profit : (160-150+7)*200 = 3400 This shows that investor can earn more in the put option because it gives 35% returns over a investment of 2months as compared to 25% returns over a call option and 6.6% returns over a investment in stocks. But selling put option is always obligation it means when the market comes down due to unfortunate reasons loss is unlimited so prefer always buying the options rather than selling the options.

IF THE MARKET IS BEARISH SELL STOCK/SHORT CALL/LONG PUT Under this strategy the speculator is bearish in the market. He could do any of the following: SELL STOCK BPCL spot price : 560 No of shares : 100 Price : 560*100 = 56,000 Market action : 520 Profit : 4,000 SHORT CALL OPTION: Strike price : 560 Premium : 20 Lot size : 100 shares Market action :520 Profit : (560-520+20)*100 = 6000 ONG PUT OPTION: Strike price : 560

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Premium : 35 Lot size : 200 shares Market action :520 Profit : (560-520-30)*100 = 1000 Return : 50% returns over 2months This shows that investor can earn more in the call option because it gives 100% returns over a investment of 2months as compared to 50% returns over a put option and 7.14% returns selling in the stocks. But selling call option is always obligation it means when the market goes up due to unfortunate reasons loss is unlimited so prefer always buying the options rather than selling the options.

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CHAPTER-5 SUMMARY & COMCLUSION

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5.1 RESULTS AND DISCUSSIONS

The following results are made on the basis of data analysis from the previous Chapter.

The study reveals the effectiveness of risk reduction using hedging strategies. It has found out that risk cannot be avoided. But can only be minimized. Through the study. it has found out that, the hedging provides a safe position on an underlying security. The loss gets shifted to a counter party. Thus the hedging covers the loss and risk. Sometimes, the market performs against the expectation. This will trigger losses. so the hedger should be a strategic and positive thinker. The anticipation of the hedger regarding the trend of the movement in the prices of the underlying security plays a key role in the result of the strategy applied. It has been found that, all the strategies applied on historical data of the period of the study were able to reduce the loss that rose from price risk substantially. If the trader is not sure about the direction of the movement of the profits of the current position, he can counter position in the future contract and reduces the level of risks. The trader can effectively use the strategy for return enhancement provided he has the correct market anticipation. In general, the anticipation of the strategies purely for return enhancement is a risky affair, because, if the anticipation about the performance of the market and the underlying goes wrong, the position taker would end up in higher losses.

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5.2 SUGGESTIONS

If an investor wants to hedge with portfolios, it must consist of scrips from different industries, since they are convenient and represent true nature of the securities market as a whole. The hedging tool to reduce the losses that may arise from the market risk. Its primary objective is loss minimization, not profit maximization .The profit from futures or shares will be offset from the losses from futures or shares, as the case may be. as a result, a Hedger will earn a lower return compared to that of an unhedger. But the unhedger faces a high risk than a hedger. The hedger will have to be a strategic thinker and also one who think positively. He should be able to comprehend market trends and fluctuations. Otherwise, the strategies adopted by him earn him earn losses.

A lot more awareness needed about the stock market and investment pattern, both in spot and future market. The working of BSE Training Institute and NSE Institutes are apprehensible in this regard.

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5.3 CONCLUSION

Derivative trading provides lot of opportunities in the market but the investor should have a deep insight of derivatives and use of different product combinations. An investor should book profit than anticipating more profits because unlike equity markets small price movement in equity may show some adverse impact on the premium amount under Futures and options. Short positions should be handled carefully because of unlimited loss liability with limited profits. Investor should try to hedge his/her positions to minimize losses rather anticipating huge profits. Avoid taking positions in contact where liquidity is low. Avoid taking contracts belonging to underlying equity whose liquidity is low and with less volume, which will lead to unusual stock movement. Investor should follow the principle of strict stock losses to cut down losses. Investor should make a simultaneous use of call options and put options, in case the volatility in share prices is unexpected.

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BIBLIOGRAPHY
BOOKS:

Indian financial system -M.Y.Khan Financial Markets and Services GORDAN and NATRAJAN Derivatives Dealers Module Work Book NCFM

NEWSPAPERS:

Business Line Economic Times The Hindu

Websites:

www.nseindia.com www.bseindia.com www.sebi.gov.in www.derivativesindia.com

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