Derivatives With Reference To Future and Options

Executive Summary
Introduction
India being one of the fast moving economies in the world is registering 9-9.5 percent growth
in its annual GDP. So its obvious that India is a cynosure of all the FIIs in the world.
Investments in to India is mainly trough FDI and through FIIs. In the fiscal year 2006-2007
India has attracted $19 bn. which is 300 percent of previous years FDI.
Mainly the investment of these FIIs is through secondary market. The stock market comes in
the secondary market. It performs activities such as trading in share, securities, guilt edge
securities, bonds, mutual funds and commodities.
Motilal Oswal securities is the well-diversified financial services firm
offering a range of financial products and services such as retail wealth
management (including securities and commodities broking), portfolio
management services, institutional broking, venture capital management
and investment banking services. As a leading Indian domestic brokerage
house, we have a diversified client base that includes retail customers
(including highnet worth individuals), mutual funds, foreign institutional
investors, financial institutions and corporate clients
.
There are various sources which provide information to investor about return and
benefit of each investment. Before investing in diversified portfolio investor undergoes
various analysis some times he takes advice from experts. There are various factors which
affects investors portfolio such as annual income, government policy, natural calamities,
economical changes etc
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Institute Of Management Studies And Research, Hubli
1
Topic:
Derivatives with reference to Future and Options
Name of the Organization:- Motilal Oswal Securities Ltd,Hubli.
Need for the study:Financial Derivatives are quite new to the Indian Financial Market, but the derivatives
market has shown an immense potential which is visible by the growth it has achieved in the
recent past, In the present changing financial environment and an increased exposure towards
financial risks, It is of immense importance to have a good working knowledge of
Derivatives.
The Derivatives market in Hubli is still in a budding stage, It is necessary to study the
derivatives and derivative products and understand the derivative trading in India and try to
gather information regarding the Derivative products with special focused study on Future
and Options.
Objectives of the Study:To study the Derivative products with special reference to Future and Options, and
a detailed study of Options strategies used in Derivatives trading in India.
Sub Objectives:
To study the trading procedures for Derivative products
To study the basic knowledge about derivative market and options
To study the clearing and settlement procedure of Derivatives products
To study the option as a profit making strategy.
To know the use of different strategies available in different market condition.
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Methodology:Methodology explains the methods used in collecting information to carry out the project.
SOURCES OF DATA:
Secondary data
The data was collected through secondary sources. As this project was a descriptive study
conducted, there was no questionnaire used to collect primary data or any other additional
data. The secondary data source is through internet, from website of National Stock
Exchange
Secondary data will be collected from the various books on
Derivatives, Journals, Magazines and Internet.
Sample Design:
Sample unit: Motilal Oswal securities Ltd,Hubli
Sample Size: 2 sectors and 4 companies
The sectors covered under the study are:
1. Automobile sector
a. Maruti Udyog Ltd.
b. Tata Motors.
2. Cement sector
a. ACC
b. Gujarat Ambuja
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INDUSSTRY PROFILE
2. CAPITAL MARKET
Capital is required to bring a business into existence, to keep it alive and see it
growing. Achieving the goal of business requires the performance of such business functions
as production, distribution, marketing, research and development all of which involve
investment of capital. Further, companies require capital not only for meeting their long term
requirements of funds for new projects, modernization, expansion and diversification
programmers also for covering operational expenses.
2.1 Categories of Capital:
1. Long-term capital/fixed capital:
It represents the amount of capital invested in fixed assets. It is a long-term
investment.
2. Short-term capital/working capital:
It represents the amount of capital invested in current assets. Current assets are those
assets, which can be converted into cash with in a year/an accounting period. Working capital
is required for meeting the operating cost of the concern.
3. Export capital:
The amount of capital required for making payment in international trade is called
export capital. The methods of payment in international trade are
Cash with order
Open account
Bills of exchange and
Bankers documentary credits.
4. Venture capital:
Venture capital is the capital invested in highly risky ventures.
Meaning and Definition of Capital Market:
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Generally speaking, capital market is the place wherein funds are raised for companies
for meeting their long-term requirements. Capital market is a market for long-term capital.
Capital market may be defined as the mechanism which co-ordinate the demand and
supply forces of long-term capital. The participants on the demand and supply side of this
market are financial institutions, mutual funds, agents, brokers, dealers, borrowers and
lenders.
Components of Capital Market :
Broadly speaking, capital market is composed of two segments.
1.
The new issues market or Primary market
2.
The secondary market
1.The new issues market or Primary market:

The primary market the existing companies or the new companies offer
shares/debentures to the public for subscription. The primary market also includes the offer of
securities to the existing share holders of the companies on right and bonus basis. In the
primary market the companies acquire long term funds for meeting their requirements like
project financing, expansion, modernizations etc. Primary market creates financial claims. In
this market the public can only buy the shares. Parties involved in the primary market are the
lenders and the borrowers. Merchant bankers, registrars, issue companies, under-writers,
bankers to the issue, public financial institutions, mutual funds etc. are the major players in
the new issue market.
The primary market :
is made up of two components:
Where firms 80 public for the first time (through initial public offerings
IPOs) and
Where firms which already traded raise additional capital (through

seasoned equity offering, or SEOs).
2) The Secondary market:

In the secondary market or stock market old issue are bought and sold. In this market
the public can buy and sell securities. This market does not create financial claims. In this
market fund does not flow between borrowers and lenders but funds flows between lenders
and others/buyers of security. The brokers, the investors, mutual funds and the financial
institution are the important constituents of the secondary market.
2.3. Players in the capital market:
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The players in the capital market are divided into three categories:
Companies issuing securities: As per the SEBI Guidelines, companies intending to issue securities are divided three
categories, viz.
a)
New companies
b)
Existing unlisted companies
c)
Existing listed companies

A company is a new company if it satisfies all the following three conditions.
1.
2.
3.
It has not completed 12 months of commercial operations.

Its audited operative results are not available.
It is set up by entrepreneurs with or without track record.
A company is said to be an existing listed company if its shares are listed in the any
one of the recognized stock exchanges.
Existing closely held or private companies are called existing unlisted companies.
1. Intermediaries:
Intermediaries are institutional or individual agencies who assist in the process of
transforming savings into investment. The major intermediaries I the capital market are:
a) Merchant bankers
b) Under-writers
c) Registrars
d) Brokers
e) Depositories
f) Collecting agents
g) Adverting agencies
h) Agents
i) Stock brokers and Sub-brokers
j) Mutual Funds
2. Investors:
The investors comprising the financial and investment companies and a general
public. Companies are employing funds in the hope of receiving future benefits. All
rational investors prefer return, but most investors are risk averse, attempt to maximize
capital gain. Their preference for dividends is a capital gain depends on their economic
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status and the effect of tax differential on dividends and capital gains. The institutions and
companies raising capital from investors frame the schemes in such a way that these are
suitable to all types of investors. The main objectives of investments are as follows.
A.
Safety: Safety of money is the first objective of an investor.
B.
Profitability: The investor makes investment for earning money. He

would like to invest in those securities where rate of return is higher.
C.
Liquidity: The liquidity refers to the receipt back of investment when

the investor wants it.
D.
Capital appreciation and,
E.
Minimum risk.
2.4. Structure of Capital Market in India:

The structure of Indian capital market has undergone a remarkable transformation over the
last four and a half decades and now comprises an impressive network of financial
institutions and new financial instruments. The secondary market has become more
sophisticated in response to the varied needs of the investors. Provision of long term credit
is entrusted with specialized financial institutions. Of these IDBI, IFCI, UTI, LIC, GIC
etc. Constitute the largest segment. The various constitutes of capital market are:
i.
Equity market
ii.
Debt market
iii.
Government securities market
iv.
Mutual fund schemes.
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2.5. Factors influencing the growth of Capital market:

The growth of the capital market is influenced by several factors, which are listed
below:
The level of savings and investment of the household
sector.
Economic development
Rapid industrialization
Speed in acquiring processing and acting upon

information
Technological advances
Corporate performance
Political stability
Globalization of finance
Increased price volatility
Financial innovation
Advances in financial theory
Regulatory change
Foreign Institutional Investors (FIIs) participation in

the capital market
NRIs investment
Sophistication among investment managers
Emergence of financial intermediaries like Mutual

funds
Development of financial service sectors like merchant

banking leasing venture capital financing
International agreement
Liquidity factors
Agency costs
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Tax asymmetries
COMPANY OVERVIEW
MOTILAL OSWAL SECURITIES LTD.
Motilal Oswal securities is the well-diversified financial services firm
offering a range of financial products and services such as retail wealth
management (including securities and commodities broking), portfolio
management services, institutional broking, venture capital management
and investment banking services. As a leading Indian domestic brokerage
house, we have a diversified client base that includes retail customers
(including highnet worth individuals), mutual funds, foreign institutional
investors, financial institutions and corporate clients. We are
headquartered in Mumbai and as of December 31, 2006, had a network
spread across 363 cities and towns comprising 1,160 Business Locations
operated by our Business Associates and us.
Motilal Oswal Financial Services Limited is holding company and also
provides financing for retail broking customers. We operate through the
following four subsidiaries:
Motilal
Motilal
Motilal
Motilal
Oswal
Oswal
Oswal
Oswal
Securities Limited (MOSL)

Commodities Brokers Private Limited (MOCB)
Venture Capital Advisors Private Limited (MOVC)
Investment Advisors Private Limited (MOIA).
Their business has primarily focused on retail wealth management and

institutional broking. In 2006, we diversified into investment banking and
venture capital management.
Company Vision
To become well-respected global financial services company by
assisting investors create wealth in stock markets word wide
Companies principal business activities include: Retail wealth management
Institutional broking
Investment banking
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Venture capital management and advisory

Motilal Oswal retail wealth management business provides broking and
financing services to our retail customers as well as investment advisory,
financial planning and portfolio management services. As at December 31,
2006,they had 213,624 registered retail equity broking clients (as at March
31, 2006, we had 159,091 such clients) and 3,572 registered commodity
broking clients (as at March 31, 2006, we had 1,536 such clients) whom
they classify into three segments, being mass retail, mid-tier
millionaire and private client group (PCG). They offer their retail clients
investment products across the major asset classes including equities,
derivatives, commodities and the distribution of third-party products such
as mutual fund schemes and primary equity offerings. It distribute these
products through their Business Locations and online channel. Its
institutional broking business offers equity broking services in the cash
and derivative segments to institutional clients in India and overseas. As at
December 31, 2006, It was empanelled with 240 institutional clients
including 150 FIIs. It service these clients through dedicated sales teams
across different time zones.
Its current organisation structure is set forth in the following chart:Motilal
Oswal
Financial
Services Limited
(MOFSL)
Incorporated on May
18,
2005
Motilal
Oswal
Securities
Limited (MOSL)
Incorporated on July 5,
1994
Stock
Broking
(Institutional
& Retail)
Shareholding:
MOFSL 99.95%
Motilal Oswal
Commodi
ties
Brokers
Private
Limited
:
(MOCB)
Incorporated on March
26,
1991
Commodity Broking
Shareholding:
MOFSL 97.55%
Motilal
Oswal
Venture
Capital
Advisors
Private
Limited (MOVC)
Incorporated on April
13,
2006
Private
Equity
Investments
Shareholding:
MOFSL 100.00%
Motilal
Oswal
Investment
Advisors
Private
Limited
(MOIA)
Incorporated on March
20,
2006
Investment & Merchant
Banking
Shareholding:
MOFSL 75.00%
Strengths
Their
principal
strengths
are
as
follows:
1. Large and diverse
distribution network
Their financial products and services are distributed through a
pan-India network. Their business has grown from a single location to a
nationwide network spread across 1,160 Business Locations operated by
them and Their Business Associates in 363 cities and towns. Their
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sell products and services, particularly as they diversify into new business
streams. In addition to their geographical spread, They offer an online
channel to service their customers. They have recently entered into a
strategic alliance with State Bank of India (SBI) to offer our online
brokerage services to SBIs retail banking clients. They have received a
letter of intent from another bank to offer their online brokerage services
to their clients.
2. Strong research and sales teams
They believed that equity as an asset class and business
fundamentals drives the quality of their research and differentiates them
from their competitors. Their research teams are focused on cash
equities,equity derivatives and commodities. As at December 31, 2006,
they had 28 equity research analysts covered 208 companies in 25
sectors and 5 analysts covered 18 commodities. The Asiamoney brokers
poll has consistently recognised and rewarded in various categories.
They believe their our research enables them to identify market trends
and stocks with high growth potential, which facilitates more informed and
timely decision making by their clients. This helps to build and
promote their brand and to acquire and retain their institutional and retail
customers. Their research is complemented by a strong sales and dealing
team. Each member of their institutional sales team has significant
research experience. They believed that experience enables their sales
team to effectively market ideas generated by the research team to their
client base and to build stronger client relationships.
In 2006, Asiamoney rated a member of our sales team as the best sales
person for Indian equities.
3.Experienced top management
Both its Promoters, Mr Motilal Oswal and Mr Raamdeo
Agrawal, are qualified chartered accountants with over two decades of
experience each in the financial services industry. In addition, their top
management team comprises qualified and experienced professionals with
a successful track record. Their managements entrepreneurial spirit,
strong technical expertise, leadership skills, insight into the market and
customer needs provide us with a competitive strength which will help
them to implement business
strategies.
4.Well-established brand
Motilal Oswal is a well-established brand among retail and
institutional investors in India. Their brand is associated with high quality
research and advice as well as corporate values, like integrity and
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excellence in execution. They has been able to leverage their brand

awareness to grow their businesses, build relationships and attract and
retain talented individuals which is important in the financial services
industry.
Wide range of financial products and services:-
Understanding
They offer a portfolio of products to satisfy the diverse
investment and strategic requirements of retail, institutional and corporate
clients. They believed their wide range of products and services enables to
build stronger relationships with, and increase business volumes from,
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their clients. In addition, diverse portfolio reduces their dependence on

any particular product, service or customer and allows us to exploit
synergies across their businesses.
Their Core Purpose and Values
Their mission is to be a well respected and preferred global financial
services organisation enabling wealth creation for all their customers.
Their key corporate values are:
Integrity
Teamwork
Meritocracy
Passion and attitude
Excellence in execution.
Strategies:They are focused on further increasing their market share in a
profitable manner and capturing the significant growth opportunities
across the Indian financial services spectrum. Key elements of strategies
are:Increase market share in retail business
They are currently offering a wide range of products to their retail
clients through multiple channels, which give flexibility to customers. Their
primary focus is to further increase their client base and capture a greater
share of their business.
By continuing to grow our distribution network across India.
They are now focused on increasing their concentration in these
cities and also expanding into smaller cities and towns that are currently
under-serviced by financial services firms. They believed that network
expansion, complemented by client-focused relationship management,
will allow them to add new clients, particularly those in the mid-tier
millionaire segment and help them to grow market share.
By focusing on wealth management solutions and new product
offerings.
Through improved client relationship management, their wealth
management solution offering and convenient and effective
channels of distribution, they expect to grow wealth management
business both in overall terms and on a per Business Location basis.
By leveraging research and advisory capability.
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We intend to further widen our research coverage by increasing the

number of companies and business sectors that we cover. They also
propose to enlarge their team of advisors and dealers to strengthen
relationships with their clients.
Derivatives
INTRODUCTION:
BSE created history on June 9, 2000 by launching the first Exchange traded Index
Derivative Contract i.e. futures on the capital market benchmark index - the BSE Sensex. The
inauguration of trading was done by Prof. J.R. Varma, member of SEBI and chairman of the
committee responsible for formulation of risk containment measures for the Derivatives
market. The first historical trade of 5 contracts of June series was done on June 9, 2000 at
9:55:03 a.m. between M/s Kaji & Maulik Securities Pvt. Ltd. and M/s Emkay Share & Stock
Brokers Ltd. at the rate of 4755.
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In the sequence of product innovation, the exchange commenced trading in Index

Options on Sensex on June 1, 2001. Stock options were introduced on 31 stocks on July 9,
2001 and single stock futures were launched on November 9, 2002.
September 13, 2004 marked another milestone in the history of Indian Capital
Markets, the day on which the Bombay Stock Exchange launched Weekly Options, a unique
product unparallel in derivatives markets, both domestic and international. BSE permitted
trading in weekly contracts in options in the shares of four leading companies namely
Reliance, Satyam, State Bank of India, and Tisco in addition to the flagship index-Sensex.
Indian scenario
INDIAN DERIVATIVES MARKETS
1. Rise of Derivatives
The global economic order that emerged after World War II was a system where many less
developed countries administered prices and centrally allocated resources. Even the developed
economies operated under the Bretton Woods system of fixed exchange rates. The system of
fixed prices came under stress from the 1970s onwards. High inflation and unemployment
rates made interest rates more volatile. The Bretton Woods system was dismantled in 1971,
freeing exchange rates to fluctuate. Less developed countries like India began opening up
their economies and allowing prices to vary with market conditions.
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Price fluctuations make it hard for businesses to estimate their future production costs and
revenues.2 Derivative securities provide them a valuable set of tools for managing this risk.
This article describes the evolution of Indian derivatives markets, the popular derivatives
instruments, and the main users of derivatives in India. I conclude by assessing the outlook for
Indian derivatives markets in the near and medium term.
2. Definition and Uses of Derivatives
A derivative security is a financial contract whose value is derived from the value of
something else, such as a stock price, a commodity price, an exchange rate, an interest rate, or
even an index of prices. In the Appendix, I describe some simple types of derivatives:
forwards, futures, options and swaps.
Derivatives may be traded for a variety of reasons. A derivative enables a trader to
hedge some preexisting risk by taking positions in derivatives markets that offset potential
losses in the underlying or spot market. In India, most derivatives users describe themselves
as hedgers (FitchRatings, 2004) and Indian laws generally require that derivatives be used for
hedging purposes only. Another motive for derivatives trading is speculation (i.e. taking
positions to profit from anticipated price movements). In practice, it may be difficult to
distinguish whether a particular trade was for hedging or speculation, and active markets
require the participation of both hedgers and speculators. A third type of trader, called
arbitrageurs, profit from discrepancies in the relationship of spot and derivatives prices, and
thereby help to keep markets efficient. Jogani and Fernandes (2003) describe Indias long
history in arbitrage trading, with line operators and traders arbitraging prices between
exchanges located in different cities, and between two exchanges in the same city. Their study
of Indian equity derivatives markets in 2002 indicates that markets were inefficient at that
time. They argue that lack of knowledge, market frictions and regulatory impediments have
led to low levels of capital employed.
Price volatility may reflect changes in the underlying demand and supply conditions
and thereby provide useful information about the market. Thus, economists do not view
volatility as necessarily harmful.
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Speculators face the risk of losing money from their derivatives trades, as they do with
other securities. There have been some well-publicized cases of large losses from derivatives
trading. In some instances, these losses stemmed from fraudulent behavior that went
undetected partly because companies did not have adequate risk management systems in
place. In other cases, users failed to understand why and how they were taking positions in the
derivatives.
Derivatives in arbitrage trading in India. However, more recent evidence suggests that
the efficiency of Indian equity derivatives markets may have improved (ISMR, 2004).
3. Exchange-Traded and Over-the-Counter Derivative Instruments
OTC (over-the-counter) contracts, such as forwards and swaps, are bilaterally
negotiated between two parties. The terms of an OTC contract are flexible, and are often
customized to fit the specific requirements of the user. OTC contracts have substantial credit
risk, which is the risk that the counterparty that owes money defaults on the payment. In
India, OTC derivatives are generally prohibited with some exceptions: those that are
specifically allowed by the Reserve Bank of India (RBI) or, in the case of commodities
(which are regulated by the Forward Markets Commission), those that trade informally in
havala or forwards markets.
An exchange-traded contract, such as a futures contract, has a standardized format that
specifies the underlying asset to be delivered, the size of the contract, and the logistics of
delivery. They trade on organized exchanges with prices determined by the interaction of
many buyers and sellers. In India, two exchanges offer derivatives trading: the Bombay Stock
Exchange (BSE) and the National Stock Exchange (NSE). However, NSE now accounts for
virtually all exchange-traded derivatives in India, accounting for more than 99% of volume in
2003-2004. Contract performance is guaranteed by a clearinghouse, which is a wholly owned
subsidiary of the NSE.4 Margin requirements and daily marking-to-market of futures
positions substantially reduce the credit risk of exchangetraded contracts, relative to OTC
contracts.5
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4. Development of Derivative Markets in India

Derivatives markets have been in existence in India in some form or other for a long
time. In the area of commodities, the Bombay Cotton Trade Association started futures trading
in 1875 and, by the early 1900s India had one of the worlds largest futures industry. In 1952
the government banned cash settlement and options trading and derivatives trading shifted to
informal forwards markets. In recent years, government policy has changed, allowing for an
increased role for market-based pricing and less suspicion of derivatives trading. The ban on
futures trading of many commodities was lifted starting in the early 2000s, and national
electronic commodity exchanges were created.
In the equity markets, a system of trading called badla involving some elements of
forwards trading had been in existence for decades.6 However, the system led to a number of
undesirable practices and it was prohibited off and on till the Securities and A clearinghouse
guarantees performance of a contract by becoming buyer to every seller and seller to every
buyer.
Customers post margin (security) deposits with brokers to ensure that they can cover a
specified loss on the position. A futures position is marked-to-market by realizing any trading
losses in cash on the day they occur.
Badla allowed investors to trade single stocks on margin and to carry forward
positions to the next settlement cycle. Earlier, it was possible to carry forward a position
indefinitely but later the maximum carry forward period was 90 days. Unlike a futures or
options, however, in a badla trade there is no fixed expiration date, and contract terms and
margin requirements are not standardized.
Derivatives Exchange Board of India (SEBI) banned it for good in 2001. A series of
reforms of the stock market between 1993 and 1996 paved the way for the development of
exchangetraded equity derivatives markets in India. In 1993, the government created the NSE
in collaboration with state-owned financial institutions. NSE improved the efficiency and
transparency of the stock markets by offering a fully automated screen-based trading system
and real-time price dissemination. In 1995, a prohibition on trading options was lifted. In
1996, the NSE sent a proposal to SEBI for listing exchange-traded derivatives.
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The report of the L. C. Gupta Committee, set up by SEBI, recommended a phased

introduction of derivative products, and bi-level regulation (i.e., self-regulation by exchanges
with SEBI providing a supervisory and advisory role). Another report, by the J. R. Varma
Committee in 1998, worked out various operational details such as the margining systems. In
1999, the Securities Contracts (Regulation) Act of 1956, or SC(R)A, was amended so that
derivatives could be declared securities. This allowed the regulatory framework for trading
securities to be extended to derivatives. The Act considers derivatives to be legal and valid,
but only if they are traded on exchanges.
Finally, a 30-year ban on forward trading was also lifted in 1999. The economic
liberalization of the early nineties facilitated the introduction of derivatives based on interest
rates and foreign exchange. A system of market-determined exchange rates was adopted by
India in March 1993. In August 1994, the rupee was made fully convertible on current
account. These reforms allowed increased integration between domestic and international
markets, and created a need to manage currency risk.
5. Derivatives Users in India
The use of derivatives varies by type of institution. Financial institutions, such as
banks, have assets and liabilities of different maturities and in different currencies, and are
exposed to different risks of default from their borrowers. Thus, they are likely to use
derivatives on interest rates and currencies, and derivatives to manage credit risk.
Nonfinancial institutions are regulated differently from financial institutions, and this affects
their incentives to use derivatives. Indian insurance regulators, for example, are yet to issue
guidelines relating to the use of derivatives by insurance companies.
In India, financial institutions have not been heavy users of exchange-traded
derivatives so far, with their contribution to total value of NSE trades being less than 8% in
October 2005. However, market insiders feel that this may be changing, as indicated by the
growing share of index derivatives (which are used more by institutions than by retail
investors). In contrast to the exchange-traded markets, domestic financial institutions and
mutual funds have shown great interest in OTC fixed income instruments. Transactions
between banks dominate the market for interest rate derivatives, while state-owned banks
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remain a small presence (Chitale, 2003). Corporations are active in the currency forwards and
swaps markets, buying these instruments from banks.
Derivative security or derivative is a contract which specifies the right or obligation
between two parties to receive or deliver future cash flows (or exchange of other securities or
assets) based on some future event.
Another way of defining a derivative is that it is a security whose value is determined
(derived) from one or more other securities, commodities, or events. The value is influenced
by the features of the derivative contract, which may include the timing of the contract
fulfillment, the value of the underlying security or commodity, and other factors such as
volatility.
The payments between the parties may be determined by the future changes of:
The price of some other, independently traded asset in the future (e.g., a common
stock)
The level of some index (e.g., a stock index or heating-degree-days)
The occurrence of some well-specified event (e.g., a company defaulting)
Some derivatives are the right to buy or sell the underlying security or commodity at some
point in the future for a predetermined price. If the price of the underlying security or
commodity moves into the right direction, the owner of the derivative makes money;
otherwise, they lose money. Depending on the definition of the contract, the potential loss or
gain may be much higher than if they had traded the underlying security or commodity
directly.
CLASSIFICATION OF DERIVATIVES:
Derivatives are basically classified based upon the mechanism that is used to trade on them.
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They are:
Over the Counter derivatives
Exchange traded derivatives
The OTC derivatives are between two private parties and are designed to suit the
requirements of the parties concerned.
The Exchange traded ones are standardized ones where the exchange sets the standards for
trading by providing the contract specifications and the clearing corporation provides the
trade guarantee and the settlement activities
The OTC derivatives markets have the fallowing features compared to exchange traded
derivatives:
1. The management of the counter-party (credit) risk is decentralized and located within
the individual institutions,
2. There are no formal centralize limits on individual positions, leverages, or margining.
3. There are no formal rules for risk and burden sharing.
4. there are no formal rules or mechanism for ensuring market stability and integrity, and
for safeguarding the collective interests of market participants, and
5. The OTC contracts are generally are not regulated by regulatory authority and the
exchanges self regulatory originations, although they are affected indirectly by
national legal systems, banking supervision and market surveillance.
Common examples of derivatives are:
Forward contracts
Futures contracts
Options such as stock options
Swaps
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Some less common, but economically intriguing, examples are:

Economic derivatives which pay off according to the state of the economy as
measured by national statistical agencies
Weather derivatives.
Three types of investors trade in derivatives markets.
1) Hedgers: Hedgers enter the derivatives market to lock-in their prices to avoid exposure to
adverse movements in the price of an asset. While such locking may not be extremely
profitable the extent of loss is known and can be minimized.
2) Speculators: Speculators take positions in the market. They actually bet on the direction of
price movements. While profits could be extremely high, potential for losses are also large.
3) Arbitrageurs: Arbitrageurs enter simultaneously into contracts in two or more markets to
lock in risk less profit. In India such gains are minimal as price differences on NSE and the
BSE are extremely small.
FORWARD CONTRACTS
A forward contract is a particularly simple derivative. It is an agreement to buy or to
sell an asset at a certain future time for a certain price. The contract is usually between two
financial institutions and one of its corporate clients. It is not normally traded on exchange.
One of the
parties to a forward 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. The specified price in
a forward contract will be referred to as the delivery price. At the time the contract is entered
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into the price is chosen so that the value of the forward contract to both parties is zero. This
means that it costs nothing to take either a long or short position.
A
forward contract is settled at maturity. The holder of short position delivers the asset to the
holder of long position in return for a cash amount equal to delivery price. A key variable
determining the value of a forward contract at any given time is the market price of the asset.
As already mentioned, a forward contract is worth zero when it is first entered into. Later it
can have a positive or negative value, depending on movements in the price of the asset. For
example, if the price of the asset rises sharply soon after the initiation of contract, the value of
a long position in the forward contract becomes positive and value of a short position of a
forward contract becomes negative.
The main features of forward contracts are
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.
The contract has to be settled by delivery of the asset on expiration date.
In case, the party wishes to reverse the contract, it has to compulsorily go to the same
counter party, which being in a monopoly situation can command the price it wants.
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FUTURES CONTRACT
A futures contract is a form of forward contract, a contract to buy or sell an asset of any kind
at a pre-agreed future point in time that has been standardized for a wide range of uses. It is
traded on a futures exchange. Futures may also differ from forwards in terms of margin and
delivery requirements. To make trading possible, the exchange specifies certain standardized
features of the contract. As the two parties to the contract do not necessarily know each other,
the exchange also provides the mechanism which gives the two parties guarantee that the
contract will be honored.
For example, Coffee grower may enter into a contract with a wholesale buyer to sell Coffee at
a particular price on a future date. The coffee buyer could have a mutually agreed contract
with the seller (Forward Contract) or he / she could buy a contract through a regulated market
like the Coffee Futures Exchange India Limited (COFEI). The National Stock Exchange and
the Bombay Stock Exchange offer such facilities for trading Futures and Options contracts an
underlying financial instrument like stocks/shares.
The types of futures that are traded fall into four fundamentally different categories. The
underlying asset traded may be a physical commodity, foreign currency, an interest-earning
asset or an index, usually a stock index.
A commodity futures contract is an agreement between two parties to buy or sell a specified
quantity and quality of commodity at a certain time in future at a certain price agreed at the
time of entering into the contract on the commodity futures exchange.
A currency future is a transferable futures contract that fixes the price at which a foreign
currency can be bought or sold at a specified future date. Investors use these financial future
contracts to hedge against foreign exchange risk. These financial derivatives can also be used
to speculate and, by incurring a risk, attempt to profit from rising or falling exchange rates.
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Investors can close out the contract at any time prior to the contract's delivery date.
The futures can be on the interbank cash rate or on the forward exchange rate of the currency.
Currency futures are quoted in US-dollars per unit of foreign currency.
An interest rate future is a futures contract with an interest bearing instrument as the
underlying asset. Examples include Treasury-bill futures, Treasury-bond futures, LIBOR
futures, Eurodollar futures.
The attributes in which the futures contracts differ from forwards are:
Forward Contract
Futures Contract
Nature of
Transaction
Buyer and seller make a

custom-tailored agreement
to buy/sell a given amount
of a commodity at a set
price on a future date.
Buyer and seller agree to buy or sell a

standardized amount of a
standardized quality of a commodity
at a set price on, Standardized
Size of
Contract
Negotiable
Standardized
Delivery
Date
Negotiable
Standardized
Security
Deposit
Dependent on credit
relationship between
buyer and seller. May be
zero.
Pricing
Prices are negotiated in

private by buyer and
seller, and are normally
not made public
Both buyer and seller post a

performance bond (funds) with the
exchange. Daily price changes may
require one party to post additional
funds and allow the other party to
withdraw such funds
Prices are determined publicly in
open, competitive, auction-type
market at a registered exchange.
Prices are continuously made public
Getting Out
of Deals
Difficult to do, so most

forwards result in a
physical delivery of goods
Easy to do by entering into an

opposite transaction from that
initially taken
Futures contracts are traded on an exchange. Forward contracts are mutually agreed between
two parties. As expected, the only benefit of entering into a Forwards contract comes from the
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flexibility of having tailor-made contracts. Yet, Forwards are important as prices in Forward
markets serve as indicator of Futures prices. Contracts on Futures markets are fixed in terms
of contract size, product type, product quality, expiry, and mode of settlement. Futures
markets, however, provide liquidity as contracts are traded on a broader client base. Counter
party risk (of non-delivery / non payment) is also eliminated in the Futures market as the
designated clearing house becomes counter party to each trade that is, it acts as buyer to seller
and as a seller to the buyer and guarantees the trades.
What is an Index?
To understand the use and functioning of the index derivatives markets, it is necessary
to understand the underlying index. A stock index represents the change in value of a set of
stocks, which constitute the index. A market index is very important for the market players as
it acts as a barometer for market behavior and as an underlying in derivative instruments such
as index futures.
The Sensex and Nifty

In India the most popular indices have been the BSE Sensex and S&P CNX Nifty. The
BSE Sensex has 30 stocks comprising the index which are selected based on market
capitalization, industry representation, trading frequency etc. It represents 30 large wellestablished and financially sound companies. The Sensex represents a broad spectrum of
companies in a variety of industries. It represents 14 major industry groups. Then there is a
BSE national index and BSE 200. However, trading in index futures has only commenced on
the BSE Sensex.
While the BSE Sensex was the first stock market index in the country, Nifty was launched by
the National Stock Exchange in April 1996 taking the base of November 3, 1995. The Nifty
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index consists of shares of 50 companies with each having a market capitalization of more
than Rs 500 crore.
Futures and stock indices
For understanding of stock index futures a thorough knowledge of the composition of
indexes is essential. Choosing the right index is important in choosing the right contract for
speculation or hedging. Since for speculation, the volatility of the index is important whereas
for hedging the choice of index depends upon the relationship between the stocks being
hedged and the characteristics of the index.
Choosing and understanding the right index is important as the movement of stock
index futures is quite similar to that of the underlying stock index. Volatility of the futures
indexes is generally greater than spot stock indexes.
Everytime an investor takes a long or short position on a stock, he also has an hidden
exposure to the Nifty or Sensex. As most often stock values fall in tune with the entire market
sentiment and rise when the market as a whole is rising.
Retail investors will find the index derivatives useful due to the high correlation of the
index with their portfolio/stock and low cost associated with using index futures for hedging.
Understanding index 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. Index futures are all futures contracts where the
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underlying is the stock index (Nifty or Sensex) and helps a trader to take a view on the market
as a whole.
Index futures permits speculation and if a trader anticipates a major rally in the market
he can simply buy a futures contract and hope for a price rise on the futures contract when the
rally occurs. We shall learn in subsequent lessons how one can leverage ones position by
taking position in the futures market.
In India we have index futures contracts based on S&P CNX Nifty and the BSE
Sensex and near 3 months duration contracts are available at all times. Each contract expires
on the last Thursday of the expiry month and simultaneously a new contract is introduced
for trading after expiry of a contract.
Example:
Futures contracts in Nifty in July 2001
Contract month
July 2007
August 2007
September 2007
Expiry/settlement
July 26
August 30
September 27
On July 27
Contract month
August 2001
September 2001
October 2001
Expiry/settlement
August 30
September 27
October 25
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The permitted lot size is 200 or multiples thereof for the Nifty. That is you buy one
Nifty contract the total deal value will be 200*1100 (Nifty value)= Rs 2,20,000.
In the case of BSE Sensex the market lot is 50. That is you buy one Sensex futures the
total value will be 50*4000 (Sensex value)= Rs 2,00,000.
The index futures symbols are represented as follows:
BSE
BSXJUN2001 (June contract)
BSXJUL2001 (July contract)
BSXAUG2001 (Aug contract)
NSE
FUTDXNIFTY28-JUN2001
FUTDXNIFTY28-JUL2001
FUTDXNIFTY28-AUG2001
Hedging
We have seen how one can take a view on the market with the help of index futures.
The other benefit of trading in index futures is to hedge your portfolio against the risk of
trading. In order to understand how one can protect his portfolio from value erosion let us
take an example.
Illustration:
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Ram enters into a contract with Shyam that six months from now he will sell to Shyam
10 dresses for Rs 4000. The cost of manufacturing for Ram is only Rs 1000 and he will make
a profit of Rs 3000 if the sale is completed.
Cost (Rs)
Selling price
Profit
1000
4000
3000
However, Ram fears that Shyam may not honour his contract six months from now. So
he inserts a new clause in the contract that if Shyam fails to honour the contract he will have
to pay a penalty of Rs 1000. And if Shyam honours the contract Ram will offer a discount of
Rs 1000 as incentive.
Shyam defaults
Shyam honours
1000 (Initial Investment)
3000 (Initial profit)
1000 (penalty from Shyam)
(-1000) discount given to Shyam
- (No gain/loss)
2000 (Net gain)
As we see above if Shyam defaults Ram will get a penalty of Rs 1000 but he will
recover his initial investment. If Shyam honours the contract, Ram will still make a profit of
Rs 2000. Thus, Ram has hedged his risk against default and protected his initial investment.
The example explains the concept of hedging. Let us try understanding how one can
use hedging in a real life scenario.
Stocks carry two types of risk company specific and market risk. While company
risk can be minimized by diversifying your portfolio market risk cannot be diversified but has
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to be hedged. So how does one measure the market risk? Market risk can be known from
Beta.
Beta measures the relationship between movement of the index to the movement of
the stock. The beta measures the percentage impact on the stock prices for 1% change in the
index. Therefore, for a portfolio whose value goes down by 11% when the index goes
down by 10%, the beta would be 1.1. When the index increases by 10%, the value of the
portfolio increases 11%. The idea is to make beta of your portfolio zero to nullify your
losses.
Hedging involves protecting an existing asset position from future adverse price
movements. In order to hedge a position, a market player needs to take an equal and
opposite position in the futures market to the one held in the cash market. Every
portfolio has a hidden exposure to the index, which is denoted by the beta. Assuming you
have a portfolio of Rs 1 million, which has a beta of 1.2, you can factor a complete hedge by
selling Rs 1.2 mn of S&P CNX Nifty futures.
Steps:
1. Determine the beta of the portfolio. If the beta of any stock is not known, it is safe to
assume that it is 1.
2. Short sell the index in such a quantum that the gain on a unit decrease in the index
would offset the losses on the rest of his portfolio. This is achieved by multiplying the
relative volatility of the portfolio by the market value of his holdings.
Therefore in the above scenario we have to shortsell 1.2 * 1 million = 1.2 million worth of
Nifty.
Now let us see the impact on the overall gain/loss that accrues:
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Index up 10% Index down 10%

Gain/(Loss) in Portfolio
Gain/(Loss) in Futures
Net Effect
Rs 120,000
(Rs 120,000)
(Rs 120,000) Rs 120,000

Nil
Nil
As we see, that portfolio is completely insulated from any losses arising out of a fall in
market sentiment. But as a cost, one has to forego any gains that arise out of improvement in
the overall sentiment. Then why does one invest in equities if all the gains will be offset by
losses in futures market. The idea is that everyone expects his portfolio to outperform the
market. Irrespective of whether the market goes up or not, his portfolio value would increase.
The same methodology can be applied to a single stock by deriving the beta of the
scrip and taking a reverse position in the futures market.
Thus, we understand how one can use hedging in the futures market to offset losses in
the cash market.
Speculation
Speculators are those who do not have any position on which they enter in futures and options
market. They only have a particular view on the market, stock, commodity etc. In short,
speculators put their money at risk in the hope of profiting from an anticipated price change.
They consider various factors such as demand supply, market positions, open interests,
economic fundamentals and other data to take their positions.
Illustration:
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Ram is a trader but has no time to track and analyze stocks. However, he fancies his
chances in predicting the market trend. So instead of buying different stocks he buys Sensex
Futures.
On May 1, 2001, he buys 100 Sensex futures @ 3600 on expectations that the index
will rise in future. On June 1, 2001, the Sensex rises to 4000 and at that time he sells an equal
number of contracts to close out his position.
Selling Price : 4000*100
= Rs 4,00,000
Less: Purchase Cost: 3600*100 = Rs 3,60,000

Net gain
Rs 40,000
Ram has made a profit of Rs 40,000 by taking a call on the future value of the Sensex.
However, if the Sensex had fallen he would have made a loss. Similarly, if would have been
bearish he could have sold Sensex futures and made a profit from a falling profit. In index
futures players can have a long-term view of the market up to atleast 3 months.
Arbitrage
An arbitrageur is basically risk averse. He enters into those contracts were he can earn
riskless profits. When markets are imperfect, buying in one market and simultaneously selling
in other market gives riskless profit. Arbitrageurs are always in the look out for such
imperfections.
In the futures market one can take advantages of arbitrage opportunities by buying
from lower priced market and selling at the higher priced market. In index futures arbitrage is
possible between the spot market and the futures market (NSE has provided a special software
for buying all 50 Nifty stocks in the spot market.
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Take the case of the NSE Nifty.
Assume that Nifty is at 1200 and 3 months Nifty futures is at 1300.
The futures price of Nifty futures can be worked out by taking the interest cost of 3
months into account.
If there is a difference then arbitrage opportunity exists.
Let us take the example of single stock to understand the concept better. If Wipro is quoted at
Rs 1000 per share and the 3 months futures of Wipro is Rs 1070 then one can purchase ITC at
Rs 1000 in spot by borrowing @ 12% annum for 3 months and sell Wipro futures for 3
months at Rs 1070.
Sale
= 1070
Cost= 1000+30 = 1030

Arbitrage profit = 40
These kind of imperfections continue to exist in the markets but one has to be alert to the
opportunities as they tend to get exhausted very fast.
Pricing of Index Futures
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The index futures are the most popular futures contracts as they can be used in a
variety of ways by various participants in the market.
How many times have you felt of making risk-less profits by arbitraging between the
underlying and futures markets. If so, you need to know the cost-of-carry model to understand
the dynamics of pricing that constitute the estimation of fair value of futures.
1. The cost of carry model
The cost-of-carry model where the price of the contract is defined as:
F=S+C
where:
F Futures price
S Spot price
C Holding costs or carry costs
If F < S+C or F > S+C, arbitrage opportunities would exist i.e. whenever the futures
price moves away from the fair value, there would be chances for arbitrage.
If Wipro is quoted at Rs 1000 per share and the 3 months futures of Wipro is Rs 1070
then one can purchase Wipro at Rs 1000 in spot by borrowing @ 12% annum for 3 months
and sell Wipro futures for 3 months at Rs 1070.
Here F=1000+30=1030 and is less than prevailing futures price and hence there are
chances of arbitrage.
Sale
= 1070
Cost= 1000+30 = 1030

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Arbitrage profit
40
However, one has to remember that the components of holding cost vary with contracts on
different assets.
2. Futures pricing in case of dividend yield

We have seen how we have to consider the cost of finance to arrive at the futures
index value. However, the cost of finance has to be adjusted for benefits of dividends and
interest income. In the case of equity futures, the holding cost is the cost of financing minus
the dividend returns.
Example:
Suppose a stock portfolio has a value of Rs 100 and has an annual dividend yield of
3% which is earned throughout the year and finance rate=10% the fair value of the stock
index portfolio after one year will be F= Rs 100 + Rs 100 * (0.10 0.03)
Futures price = Rs 107
If the actual futures price of one-year contract is Rs 109. An arbitrageur can buy the
stock at Rs 100, borrowing the fund at the rate of 10% and simultaneously sell futures at Rs
109. At the end of the year, the arbitrageur would collect Rs 3 for dividends, deliver the stock
portfolio at Rs 109 and repay the loan of Rs 100 and interest of Rs 10. The net profit would be
Rs 109 + Rs 3 - Rs 100 - Rs 10 = Rs 2. Thus, we can arrive at the fair value in the case of
dividend yield.
Trading strategies
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1. Speculation
We have seen earlier that trading in index futures helps in taking a view of the market,
hedging, speculation and arbitrage. Now we will see one can trade in index futures and use
forward contracts in each of these instances.
Taking a view of the market
Have you ever felt that the market would go down on a particular day and feared that your
portfolio value would erode?
There are two options available
Option 1: Sell liquid stocks such as Reliance
Option 2: Sell the entire index portfolio
The problem in both the above cases is that it would be very cumbersome and costly
to sell all the stocks in the index. And in the process one could be vulnerable to company
specific risk. So what is the option? The best thing to do is to sell index futures.
Scenario 1:
On July 13, 2001, X feels that the market will rise so he buys 200 Nifties with an expiry date
of July 26 at an index price of 1442 costing Rs 2,88,400 (200*1442).
On July 21 the Nifty futures have risen to 1520 so he squares off his position at 1520.
X makes a profit of Rs 15,600 (200*78)
Scenario 2:
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On July 20, 2001, X feels that the market will fall so he sells 200 Nifties with an expiry date
of July 26 at an index price of 1523 costing Rs 3,04,600 (200*1523).
On July 21 the Nifty futures falls to 1456 so he squares off his position at 1456.
X makes a profit of Rs 13,400 (200*67).
In the above cases X has profited from speculation i.e. he has wagered in the hope of
profiting from an anticipated price change.
2. Hedging
Stock index futures contracts offer investors, portfolio managers, mutual funds etc
several ways to control risk. The total risk is measured by the variance or standard deviation
of its return distribution. A common measure of a stock market risk is the stocks Beta. The
Beta of stocks are available on the www.nseindia.com.
While hedging the cash position one needs to determine the number of futures
contracts to be entered to reduce the risk to the minimum.
Have you ever felt that a stock was intrinsically undervalued? That the profits and the
quality of the company made it worth a lot more as compared with what the market thinks?
Have you ever been a stockpicker and carefully purchased a stock based on a sense
that it was worth more than the market price?
A person who feels like this takes a long position on the cash market. When doing this,
he faces two kinds of risks:
a. His understanding can be wrong, and the company is really not worth more than the market
price or
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b. The entire market moves against him and generates losses even though the underlying idea
was correct.
Everyone has to remember that every buy position on a stock is simultaneously a buy
position on Nifty. A long position is not a focused play on the valuation of a stock. It carries a
long Nifty position along with it, as incidental baggage i.e. a part long position of Nifty.
Let us see how one can hedge positions using index futures:
X holds HLL worth Rs 9 lakh at Rs 290 per share on July 01, 2001. Assuming that the beta
of HLL is 1.13. How much Nifty futures does X have to sell if the index futures is ruling at
1527?
To hedge he needs to sell 9 lakh * 1.13 = Rs 1017000 lakh on the index futures i.e. 666 Nifty
futures.
On July 19, 2001, the Nifty futures is at 1437 and HLL is at 275. X closes both positions
earning Rs 13,389, i.e. his position on HLL drops by Rs 46,551 and his short position on Nifty
gains Rs 59,940 (666*90).
Therefore, the net gain is 59940-46551 = Rs 13,389.
Let us take another example when one has a portfolio of stocks:
Suppose you have a portfolio of Rs 10 crore. The beta of the portfolio is 1.19. The portfolio is
to be hedged by using Nifty futures contracts. To find out the number of contracts in futures
market to neutralise risk . If the index is at 1200 * 200 (market lot) = Rs 2,40,000, The
number of contracts to be sold is:
a. 1.19*10 crore = 496 contracts
2,40,000
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If you sell more than 496 contracts you are overhedged and sell less than 496 contracts you
are underhedged.
Thus, we have seen how one can hedge their portfolio against market risk.
3. Margins
The margining system is based on the JR Verma Committee recommendations. The
actual margining happens on a daily basis while online position monitoring is done on an
intra-day basis.
Daily margining is of two types:
1. Initial margins
2. Mark-to-market profit/loss
The computation of initial margin on the futures market is done using the concept of
Value-at-Risk (VaR). The initial margin amount is large enough to cover a one-day loss that
can be encountered on 99% of the days. VaR methodology seeks to measure the amount of
value that a portfolio may stand to lose within a certain horizon time period (one day for the
clearing corporation) due to potential changes in the underlying asset market price. Initial
margin amount computed using VaR is collected up-front. The daily settlement process called
"mark-to-market" provides for collection of losses that have already occurred (historic
losses) whereas initial margin seeks to safeguard against potential losses on outstanding
positions. The mark-to-market settlement is done in cash.
Let us take a hypothetical trading activity of a client of a NSE futures division to demonstrate
the margins payments that would occur.
A client purchases 200 units of FUTIDX NIFTY 29JUN2001 at Rs 1500.
The initial margin payable as calculated by VaR is 15%.
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Total long position = Rs 3,00,000 (200*1500)

Initial margin (15%) = Rs 45,000
Assuming that the contract will close on Day + 3 the mark-to-market position will look as
follows:
Position on Day 1
Close Price
1400*200
=2,80,000
Payment to
Loss
20,000
Margin released Net cash outflow

(3,00,000-3,000
(45,000-17,000 (20,000-
2,80,000)
be
42,000)
3000)
(17,000)
made
New position on Day 2
Value of new position = 1,400*200= 2,80,000
Margin = 42,000
Close Price
1510*200
Gain
22,000
Addn Margin
Net cash inflow
(3,02,000-3,300
(45,300-18,700 (22,000-
=3,02,000
2,80,000)
Payment to be recd
42,000)
3300)
18,700
Position on Day 3
Value of new position = 1510*200 = Rs 3,02,000
Margin = Rs 3,300
Close Price
Gain
1600*200 =3,20,000 18,000
Net cash inflow

(3,20,000-18,000 + 45,300* = 63,300
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3,02,000)
Payment to be recd
63,300
Margin account*
Initial margin
Rs 45,000
Margin released (Day 1) = (-) Rs 3,000

Position on Day 2
Addn margin
Rs 42,000
= (+) Rs 3,300
Total margin in a/c
Rs 45,300*
Net gain/loss
Day 1 (loss)
(Rs 17,000)
Day 2 Gain
Rs 18,700
Day 3 Gain
Rs 18,000
Total Gain
Rs 19,700
The client has made a profit of Rs 19,700 at the end of Day 3 and the total cash inflow at the
close of trade is Rs 63,300.
Settlement of futures contracts:
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Futures contracts have two types of settlements, the MTM settlement which happens
on a continuous basis at the end of each day, and the final settlement which happens on the
last trading day of the futures contract.
MTM settlement:
All futures contracts for each member are marked-to-market(MTM) to the daily settlement
price of the relevant futures contract at the end of each day. The profits/losses are computed as
the difference between:
The trade price and the days settlement price for contracts executed during the day
but not squared up.
The previous days settlement price and the current days settlement price for brought
forward contracts.
The buy price and the sell price for contracts executed during the day and squared up.
The CMs who have a loss are required to pay the mark-to-market (MTM) loss amount in
cash which is in turn passed on to the CMs who have made a MTM profit. This is known as
daily mark-to-market settlement. CMs are responsible to collect and settle the daily MTM
profits/losses incurred by the TMs and their clients clearing and settling through them.
Similarly, TMs are responsible to collect/pay losses/ profits from/to their clients by the next
day. The pay-in and pay-out of the mark-to-market settlement are effected on the day
following the trade day. In case a futures contract is not traded on a day, or not traded during
the last half hour, a theoretical settlement price is computed.
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Final settlement for futures

On the expiry day of the futures contracts, after the close of trading hours, NSCCL
marks all positions of a CM to the final settlement price and the resulting profit/loss is settled
in cash. Final settlement loss/profit amount is debited/ credited to the relevant CMs clearing
bank account on the day following expiry day of the contract.
All trades in the futures market are cash settled on a T+1 basis and all positions
(buy/sell) which are not closed out will be marked-to-market. The closing price of the index
futures will be the daily settlement price and the position will be carried to the next day at
the settlement price.
The most common way of liquidating an open position is to execute an offsetting
futures transaction by which the initial transaction is squared up. The initial buyer liquidates
his long position by selling identical futures contract.
In index futures the other way of settlement is cash settled at the final settlement. At
the end of the contract period the difference between the contract value and closing index
value is paid.
How to read the futures data sheet?
Understanding and deciphering the prices of futures trade is the first challenge for
anyone planning to venture in futures trading. Economic dailies and exchange websites
www.nseindia.com and www.bseindia.com are some of the sources where one can look for
the daily quotes. Your website has a daily market commentary, which carries end of day
derivatives summary alongwith the quotes.
The first step is start tracking the end of day prices. Closing prices, Trading Volumes
and Open Interest are the three primary data we carry with Index option quotes. The most
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important parameters are the actual prices, the high, low, open, close, last traded prices and
the intra-day prices and to track them one has to have access to real time prices.
The following table shows how futures data will be generally displayed in the business
papers daily.
Series
First High Low Close

Trade
No of
Volume
(No
Value
of
Open
interest
contracts) (Rs
BSXJUN2000 4755 4820 4740 4783.1 146
BSXJUL2000 4900 4900 4800 4830.8 12
BSXAUG2000 4800 4870 4800 4835 2
Total
160
trades
lakh)
348.70
28.98
4.84
38252
in
104
10
2
116
(No
of
contracts)
51
2
1
54
Source: BSE
The first column explains the series that is being traded. For e.g. BSXJUN2000 stands
for the June Sensex futures contract.
The column on volume indicates that (in case of June series) 146 contracts have been
traded in 104 trades.
One contract is equivalent to 50 times the price of the futures, which are traded. For
e.g. In case of the June series above, the first trade at 4755 represents one contract
valued at 4755 x 50 i.e. Rs. 2,37,750/-.
Open interest indicates the total gross outstanding open positions in the market for that
particular series. For e.g. Open interest in the June series is 51 contracts.
The most useful measure of market activity is Open interest, which is also published by
exchanges and used for technical analysis. Open interest indicates the liquidity of a market
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and is the total number of contracts, which are still outstanding in a futures market for a
specified futures contract.
A futures contract is formed when a buyer and a seller take opposite positions in a
transaction. This means that the buyer goes long and the seller goes short. Open interest is
calculated by looking at either the total number of outstanding long or short positions not
both.
OPTIONS
What is an Option?
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An option is a contract giving the buyer the right, but not the obligation, to buy or sell
an underlying asset (a stock or index) at a specific price on or before a certain date (listed
options are all for 100 shares of the particular underlying asset).
In detail an option is a contract whereby the contract buyer has a right to exercise a
feature of the contract (the option) at future date (the exercise date), and the seller has the
obligation to deliver the specified feature of the contract. Since the option gives the buyer a
right and the seller (also known as a writer) an obligation, the buyer has received something
of value. The amount the buyer pays the seller for the option is called the option premium.
The buyer will exercise his right only if it is favorable to him. If it is not, he will not exercise
his right because he has no obligation. Thus, the underlying asset moves from to another only
when the option is exercised. When it moves from one counterpart to another, its price (in
cash) must move in the opposite direction. The amount of price in cash is fixed at the time of
contract and is called the strike price or exercise price.
An option is a security, just like a stock or bond, and constitutes a binding contract
with strictly defined terms and properties.
Listed options have been available since 1973, when the Chicago Board Options Exchange,
still the busiest options exchange in the world, first opened.
The World With and Without Options
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Prior to the founding of the CBOE, investors had few choices of where to invest their
money; they could either be long or short individual stocks, or they could purchase treasury
securities or other bonds.
Once the CBOE opened, the listed option industry began, and investors
now had a world of investment choices previously unavailable.
Options vs. Stocks
In order to better understand the benefits of trading options, one must first understand
some of the similarities and differences between options and stocks.
Similarities:
Listed Options are securities, just like
stocks.
Options trade like stocks, with buyers
making bids and sellers making offers.
Options are actively traded in a listed
market, just like stocks. They can be
bought and sold just like any other security.
Differences:
Options are derivatives, unlike stocks
(i.e, options derive their value from
something else, the underlying security).
Options have expiration dates, while stocks
do not.
There is not a fixed number of options, as
there are with stock shares available.
Stockowners have a share of the company,
with voting and dividend rights. Options
convey no such rights.
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Option Feature
In other contracts, the focus is on underlying asset and each counterpart has right and
obligation (r&o) to perform. For example, in futures contract, the buyer has the right and
obligation to buy; and seller, the right and obligation to sell.
Option contract differs from others in two respects. The primary focus is on r&o, not on
underlying asset. Second, the r&o are separated, with buyer taking the right without
obligation (r w/o o) and seller taking the obligation without right. Thus, the distinguishing
feature of option is the right-without-obligation for the buyer.
In option contract, what the buyer buys is the right, not the underlying asset; and what the
seller sells is the right, not the underlying asset.
Exhibit 1: Option v Other Contracts
The option contract
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For the option purchaser (also called the holder or taker), the option:
Offers the right (but imposes no obligation),
To buy (call option) or sell (put option)
A specific quantity,
Of a given financial underlying.
At an agreed price (exercise or strike price), or calculable value (based on a reference
rate)
Either before maturity date (American option) or at a fixed maturity date (European
option)
For a premium (option price).
The counterparty (option writer / seller) has an obligation to fulfill if the option holder
exercises the option. In return, the option seller receives the option price or premium.
1. We can exercise
the option, taking the
futures position at the
specified price.
We buy an option and

pay a premium for it.
What exactly can we
do with it is;
2. We can offset the

Option, selling it back and
receiving the current
premium value.
3. We can let the
option expires.
Of course, we
lose the premium.
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Call options
Call options give the taker the right, but not the obligation, to buy the underlying
shares at a predetermined price, on or before a predetermined date.
Illustration 1:
Raj purchases 1 Satyam Computer (SATCOM) AUG 150 Call --Premium 8
This contract allows Raj to buy 100 shares of SATCOM at Rs 150 per share at any
time between the current date and the end of next August. For this privilege, Raj pays a fee of
Rs 800 (Rs eight a share for 100 shares). The buyer of a call has purchased the right to buy
and for that he pays a premium.
Now let us see how one can profit from buying an option.
Sam purchases a December call option at Rs 40 for a premium of Rs 15. That is he has
purchased the right to buy that share for Rs 40 in December. If the stock rises above Rs 55
(40+15) he will break even and he will start making a profit. Suppose the stock does not rise
and instead falls he will choose not to exercise the option and forego the premium of Rs 15
and thus limiting his loss to Rs 15.
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Let us take another example of a call option on the Nifty to understand the concept
better.
Nifty is at 1310. The following are Nifty options traded at following quotes.
Option contract
Dec Nifty
Strike price
1325
1345
Call premium
Rs 6,000
Rs 2,000
Jan Nifty
1325
1345
Rs 4,500
Rs 5000
A trader is of the view that the index will go up to 1400 in Jan 2002 but does not want
to take the risk of prices going down. Therefore, he buys 10 options of Jan contracts at 1345.
He pays a premium for buying calls (the right to buy the contract) for 500*10= Rs 5,000/-.
In Jan 2002 the Nifty index goes up to 1365. He sells the options or exercises the
option and takes the difference in spot index price which is (1365-1345) * 200 (market lot) =
4000 per contract. Total profit = 40,000/- (4,000*10).
He had paid Rs 5,000/- premium for buying the call option. So he earns by buying call
option is Rs 35,000/- (40,000-5000).
If the index falls below 1345 the trader will not exercise his right and will opt to
forego his premium of Rs 5,000. So, in the event the index falls further his loss is limited
to the premium he paid upfront, but the profit potential is unlimited.
Call Options-Long & Short Positions
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When you expect prices to rise, then you take a long position by buying calls. You are
bullish. When you expect prices to fall, then you take a short position by selling calls. You
are bearish.
Put Options :
A Put Option gives the holder of the right to sell a specific number of shares of an
agreed security at a fixed price for a period of time. eg: Sam purchases 1 INFTEC (Infosys
Technologies) AUG 3500 Put --Premium 200. This contract allows Sam to sell 100 shares
INFTEC at Rs 3500 per share at any time between the current date and the end of August. To
have this privilege, Sam pays a premium of Rs 20,000 (Rs 200 a share for 100 shares).
The buyer of a put has purchased a right to sell. The owner of a put option has the
right to sell.
Illustration 2: Raj is of the view that the a stock is overpriced and will fall in future, but he
does not want to take the risk in the event of price rising so purchases a put option at Rs 70 on
X. By purchasing the put option Raj has the right to sell the stock at Rs 70 but he has to pay
a fee of Rs 15 (premium).
So he will breakeven only after the stock falls below Rs 55 (70-15) and will start
making profit if the stock falls below Rs 55.
Illustration 3:
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An investor on Dec 15 is of the view that Wipro is overpriced and will fall in future
but does not want to take the risk in the event the prices rise. So he purchases a Put option on
Wipro.
Quotes are as under:
Spot Rs 1040
Jan Put at 1050 Rs 10
Jan Put at 1070 Rs 30
He purchases 1000 Wipro Put at strike price 1070 at Put price of Rs 30/-. He pays Rs
30,000/- as Put premium.
His position in following price position is discussed below.
1. Jan Spot price of Wipro = 1020
2. Jan Spot price of Wipro = 1080
In the first situation the investor is having the right to sell 1000 Wipro shares at Rs
1,070/- the price of which is Rs 1020/-. By exercising the option he earns Rs (1070-1020) =
Rs 50 per Put, which totals Rs 50,000/-. His net income is Rs (50000-30000) = Rs 20,000.
In the second price situation, the price is more in the spot market, so the investor will
not sell at a lower price by exercising the Put. He will have to allow the Put option to expire
unexercised. He looses the premium paid Rs 30,000.
Put Options-Long & Short Positions
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When you expect prices to fall, then you take a long position by buying Puts. You are
bearish. When you expect prices to rise, then you take a short position by selling Puts. You
are bullish.
CALL OPTIONS PUT OPTIONS

If
you
expect
fall
in
price(Bearish)
If you expect a rise in price
(Bullish)
Short
Long
Long
Short
SUMMARY:
CALL OPTION BUYER

Pays premium
CALL OPTION WRITER (Seller)

Receives premium
Right to exercise and buy the
shares
Obligation to sell shares if

exercised
Profits from rising prices
Limited
Profits from falling prices or

remaining neutral
losses,
Potentially
unlimited gain
Potentially unlimited losses,

limited gain
PUT OPTION BUYER
PUT OPTION WRITER (Seller)
Pays premium
Receives premium
Right to exercise and sell shares
Obligation
Profits from falling prices

Limited
losses,
buy
shares
if
exercised
to
Potentially
Profits from rising prices or

remaining neutral
unlimited gain
Potentially
unlimited
losses,
limited gain
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Option styles
Settlement of options is based on the expiry date. However, there are three basic styles
of options you will encounter which affect settlement. The styles have geographical names,
which have nothing to do with the location where a contract is agreed! The styles are:
European: These options give the holder the right, but not the obligation, to buy or sell the
underlying instrument only on the expiry date. This means that the option cannot be
exercised early. Settlement is based on a particular strike price at expiration. Currently, in
India only index options are European in nature.
eg: Sam purchases 1 NIFTY AUG 1110 Call --Premium 20. The exchange will settle
the contract on the last Thursday of August. Since there are no shares for the underlying, the
contract is cash settled.
American: These options give the holder the right, but not the obligation, to buy or sell the
underlying instrument on or before the expiry date. This means that the option can be
exercised early. Settlement is based on a particular strike price at expiration.
Options in stocks that have been recently launched in the Indian market are "American
Options". eg: Sam purchases 1 ACC SEP 145 Call --Premium 12
Here Sam can close the contract any time from the current date till the expiration date,
which is the last Thursday of September.
American style options tend to be more expensive than European style because they
offer greater flexibility to the buyer.
Option Class & Series
Generally, for each underlying, there are a number of options available: For this
reason, we have the terms "class" and "series".
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An option "class" refers to all options of the same type (call or put) and style
(American or European) that also have the same underlying.
eg: All Nifty call options are referred to as one class.
An option series refers to all options that are identical: they are the same type, have the
same underlying, the same expiration date and the same exercise price.
Calls
Puts
.
Wipro
1300
1400
1500
JUL
AUG
SEP
JUL
AUG
SEP
45
35
20
60
45
42
75
65
48
15
25
30
20
28
40
28
35
55
eg: Wipro JUL 1300 refers to one series and trades take place at different
premiums
All calls are of the same option type. Similarly, all puts are of the same option type.
Options of the same type that are also in the same class are said to be of the same class.
Options of the same class and with the same exercise price and the same expiration date are
said to be of the same series
Pricing of options
Options are used as risk management tools and the valuation or pricing of the
instruments is a careful balance of market factors.
There are four major factors affecting the Option premium:
Price of Underlying
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Time to Expiry
Exercise Price Time to Maturity
Volatility of the Underlying
And two less important factors:
Short-Term Interest Rates
Dividends
Review of Options Pricing Factors

The Intrinsic Value of an Option
The intrinsic value of an option is defined as the amount by which an option is in-themoney, or the immediate exercise value of the option when the underlying position is markedto-market.
For a call option: Intrinsic Value = Spot Price - Strike Price
For a put option: Intrinsic Value = Strike Price - Spot Price
The intrinsic value of an option must be positive or zero. It cannot be negative. For a call
option, the strike price must be less than the price of the underlying asset for the call to have
an intrinsic value greater than 0. For a put option, the strike price must be greater than the
underlying asset price for it to have intrinsic value.
Price of underlying
The premium is affected by the price movements in the underlying instrument. For
Call options the right to buy the underlying at a fixed strike price as the underlying price
rises so does its premium. As the underlying price falls so does the cost of the option
premium. For Put options the right to sell the underlying at a fixed strike price as the
underlying price rises, the premium falls; as the underlying price falls the premium cost rises.
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The Time Value of an Option

Generally, the longer the time remaining until an options expiration, the higher its
premium will be. This is because the longer an options lifetime, greater is the possibility that
the underlying share price might move so as to make the option in-the-money. All other
factors affecting an options price remaining the same, the time value portion of an options
premium will decrease (or decay) with the passage of time.
Note: This time decay increases rapidly in the last several weeks of an options life. When an
option expires in-the-money, it is generally worth only its intrinsic value.
Volatility
Volatility is the tendency of the underlying securitys market price to fluctuate either
up or down. It reflects a price changes magnitude; it does not imply a bias toward price
movement in one direction or the other. Thus, it is a major factor in determining an options
premium. The higher the volatility of the underlying stock, the higher the premium because
there is a greater possibility that the option will move in-the-money. Generally, as the
volatility of an under-lying stock increases, the premiums of both calls and puts overlying that
stock increase, and vice versa.
Higher volatility=Higher premium

Lower volatility = Lower premium
Interest rates
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In general interest rates have the least influence on options and equate approximately
to the cost of carry of a futures contract. If the size of the options contract is very large, then
this factor may take on some importance. All other factors being equal as interest rates rise,
premium costs fall and vice versa. The relationship can be thought of as an opportunity cost.
In order to buy an option, the buyer must either borrow funds or use funds on deposit. Either
way the buyer incurs an interest rate cost. If interest rates are rising, then the opportunity cost
of buying options increases and to compensate the buyer premium costs fall. Why should the
buyer be compensated? Because the option writer receiving the premium can place the funds
on deposit and receive more interest than was previously anticipated. The situation is reversed
when interest rates fall premiums rise. This time it is the writer who needs to be
compensated.
OPTIONS PRICING MODELS

There are various option pricing models which traders use to arrive at the right value of the
option. Some of the most popular models have been enumerated below.
1. The Binomial Pricing Model
The binomial model is an options pricing model which was developed by William
Sharpe in 1978. Today, one finds a large variety of pricing models which differ according to
their hypotheses or the underlying instruments upon which they are based (stock options,
currency options, options on interest rates).
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2. The Black & Scholes Model

The Black & Scholes model was published in 1973 by Fisher Black and Myron
Scholes. It is one of the most popular options pricing models. It is noted for its relative
simplicity and its fast mode of calculation: unlike the binomial model, it does not rely on
calculation by iteration.
The intention of this section is to introduce you to the basic premises upon which this
pricing model rests. A complete coverage of this topic is material for an advanced course
The Black-Scholes model is used to calculate a theoretical call price (ignoring
dividends paid during the life of the option) using the five key determinants of an option's
price: stock price, strike price, volatility, time to expiration, and short-term (risk free)
interest rate.
The original formula for calculating the theoretical option price (OP) is as follows:
Where:
The variables are:

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S = stock price
X = strike price
t = time remaining until expiration, expressed as a percent of a year
r = current continuously compounded risk-free interest rate
v = annual volatility of stock price (the standard deviation of the short-term returns over one
year).
ln = natural logarithm
N(x) = standard normal cumulative distribution function
e = the exponential function
Lognormal distribution: The model is based on a lognormal distribution of stock
prices, as opposed to a normal, or bell-shaped, distribution. The lognormal distribution allows
for a stock price distribution of between zero and infinity (ie no negative prices) and has an
upward bias (representing the fact that a stock price can only drop 100 per cent but can rise by
more than 100 per cent).
Risk-neutral valuation: The expected rate of return of the stock (ie the expected rate of
growth of the underlying asset which equals the risk free rate plus a risk premium) is not one
of the variables in the Black-Scholes model (or any other model for option valuation). The
important implication is that the price of an option is completely independent of the expected
growth of the underlying asset. Thus, while any two investors may strongly disagree on the
rate of return they expect on a stock they will, given agreement to the assumptions of
volatility and the risk free rate, always agree on the fair price of the option on that underlying
asset.
The key concept underlying the valuation of all derivatives -- the fact that price of an
option is independent of the risk preferences of investors -- is called risk-neutral valuation. It
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means that all derivatives can be valued by assuming that the return from their underlying
assets is the risk free rate.
Limitation: Dividends are ignored in the basic Black-Scholes formula, but there are a number
of widely used adaptations to the original formula, which I use in my models, which enable it
to handle both discrete and continuous dividends accurately.
However, despite these adaptations the Black-Scholes model has one major limitation:
it cannot be used to accurately price options with an American-style exercise as it only
calculates the option price at one point in time -- at expiration. It does not consider the steps
along the way where there could be the possibility of early exercise of an American option.
As all exchange traded equity options have American-style exercise (ie they can be
exercised at any time as opposed to European options which can only be exercised at
expiration) this is a significant limitation.
The exception to this is an American call on a non-dividend paying asset. In this case
the call is always worth the same as its European equivalent as there is never any advantage in
exercising early.
Advantage: The main advantage of the Black-Scholes model is speed -- it lets you calculate a
very large number of option prices in a very short time. Since, high accuracy is not critical for
American option pricing (eg when animating a chart to show the effects of time decay) using
Black-Scholes is a good option. But, the option of using the binomial model is also advisable
for the relatively few pricing and profitability numbers where accuracy may be important and
speed is irrelevant. You can experiment with the Black-Scholes model using on-line options
pricing calculator.
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The Binomial Model

The binomial model breaks down the time to expiration into potentially a very large
number of time intervals, or steps. A tree of stock prices is initially produced working forward
from the present to expiration. At each step it is assumed that the stock price will move up or
down by an amount calculated using volatility and time to expiration. This produces a
binomial distribution, or recombining tree, of underlying stock prices. The tree represents all
the possible paths that the stock price could take during the life of the option.
At the end of the tree -- ie at expiration of the option -- all the terminal option prices
for each of the final possible stock prices are known as they simply equal their intrinsic
values.
Next the option prices at each step of the tree are calculated working back from
expiration to the present. The option prices at each step are used to derive the option prices at
the next step of the tree using risk neutral valuation based on the probabilities of the stock
prices moving up or down, the risk free rate and the time interval of each step. Any
adjustments to stock prices (at an ex-dividend date) or option prices (as a result of early
exercise of American options) are worked into the calculations at the required point in time.
At the top of the tree you are left with one option price.
Advantage: The big advantage the binomial model has over the Black-Scholes model is that
it can be used to accurately price American options. This is because, with the binomial model
it's possible to check at every point in an option's life (ie at every step of the binomial tree) for
the possibility of early exercise (eg where, due to eg a dividend, or a put being deeply in the
money the option price at that point is less than the its intrinsic value).
Where an early exercise point is found it is assumed that the option holder would elect
to exercise and the option price can be adjusted to equal the intrinsic value at that point. This
then flows into the calculations higher up the tree and so on.
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Limitation: As mentioned before the main disadvantage of the binomial model is its
relatively slow speed. It's great for half a dozen calculations at a time but even with today's
fastest PCs it's not a practical solution for the calculation of thousands of prices in a few
seconds which is what's required for the production of the animated charts in my strategy
evaluation model
STRATEGIES
Bull Market Strategies
Calls in a Bullish Strategy
An investor with a bullish market outlook should buy call options. If you expect the
market price of the underlying asset to rise, then you would rather have the right to purchase
at a specified price and sell later at a higher price than have the obligation to deliver later at a
higher price.
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The investor's profit potential buying a call option is unlimited. The investor's profit is
the the market price less the exercise price less the premium. The greater the increase in price
of the underlying, the greater the investor's profit.
The investor's potential loss is limited. Even if the market takes a drastic decline in
price levels, the holder of a call is under no obligation to exercise the option. He may let the
option expire worthless.
The investor breaks even when the market price equals the exercise price plus the premium.
An increase in volatility will increase the value of your call and increase your return.
Because of the increased likelihood that the option will become in- the-money, an increase in
the underlying volatility (before expiration), will increase the value of a long options position.
As an option holder, your return will also increase.
A simple example will illustrate the above:
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Suppose there is a call option with a strike price of Rs 2000 and the option premium is
Rs 100. The option will be exercised only if the value of the underlying is greater than Rs
2000 (the strike price). If the buyer exercises the call at Rs 2200 then his gain will be Rs 200.
However, this would not be his actual gain for that he will have to deduct the Rs 200
(premium) he has paid.
The profit can be derived as follows
Profit
Market
price
Profit
Market
price
Exercise
Strike
price
price
Premium
Premium.
2200 2000 100 = Rs 100
Puts in a Bullish Strategy

An investor with a bullish market outlook can also go short on a Put option. Basically,
an investor anticipating a bull market could write Put options. If the market price increases
and puts become out-of-the-money, investors with long put positions will let their options
expire worthless.
By writing Puts, profit potential is limited. A Put writer profits when the price of the
underlying asset increases and the option expires worthless. The maximum profit is limited to
the premium received.
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However, the potential loss is unlimited. Because a short put position holder has an
obligation to purchase if exercised. He will be exposed to potentially large losses if the market
moves against his position and declines.
The break-even point occurs when the market price equals the exercise price: minus
the premium. At any price less than the exercise price minus the premium, the investor loses
money on the transaction. At higher prices, his option is profitable.
An increase in volatility will increase the value of your put and decrease your return.
As an option writer, the higher price you will be forced to pay in order to buy back the option
at a later date , lower is the return.
Bullish Call Spread Strategies
A vertical call spread is the simultaneous purchase and sale of identical call options
but with different exercise prices.
To "buy a call spread" is to purchase a call with a lower exercise price and to write a
call with a higher exercise price. The trader pays a net premium for the position.
To "sell a call spread" is the opposite, here the trader buys a call with a higher exercise
price and writes a call with a lower exercise price, receiving a net premium for the position.
An investor with a bullish market outlook should buy a call spread. The "Bull Call
Spread" allows the investor to participate to a limited extent in a bull market, while at the
same time limiting risk exposure.
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To put on a bull spread, the trader needs to buy the lower strike call and sell the higher
strike call. The combination of these two options will result in a bought spread. The cost of
Putting on this position will be the difference between the premium paid for the low strike call
and the premium received for the high strike call.
The investor's profit potential is limited. When both calls are in-the-money, both will
be exercised and the maximum profit will be realised. The investor delivers on his short call
and receives a higher price than he is paid for receiving delivery on his long call.
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The investors's potential loss is limited. At the most, the investor can lose is the net
premium. He pays a higher premium for the lower exercise price call than he receives for
writing the higher exercise price call.
The investor breaks even when the market price equals the lower exercise price plus
the net premium. At the most, an investor can lose is the net premium paid. To recover the
premium, the market price must be as great as the lower exercise price plus the net premium.
An example of a Bullish call spread:
Let's assume that the cash price of a scrip is Rs 100 and you buy a November call
option with a strike price of Rs 90 and pay a premium of Rs 14. At the same time you sell
another November call option on a scrip with a strike price of Rs 110 and receive a premium
of Rs 4. Here you are buying a lower strike price option and selling a higher strike price
option. This would result in a net outflow of Rs 10 at the time of establishing the spread.
Now let us look at the fundamental reason for this position. Since this is a bullish
strategy, the first position established in the spread is the long lower strike price call option
with unlimited profit potential. At the same time to reduce the cost of puchase of the long
position a short position at a higher call strike price is established. While this not only reduces
the outflow in terms of premium but his profit potential as well as risk is limited. Based on the
above figures the maximum profit, maximum loss and breakeven point of this spread would
be as follows:
Maximum profit = Higher strike price - Lower strike price - Net premium
paid
= 110 - 90 - 10 = 10
Maximum Loss = Lower strike premium - Higher strike premium
= 14 - 4 = 10
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Breakeven Price = Lower strike price + Net premium paid

= 90 + 10 = 100
Bullish Put Spread Strategies
A vertical Put spread is the simultaneous purchase and sale of identical Put options but
with different exercise prices.
To "buy a put spread" is to purchase a Put with a higher exercise price and to write a
Put with a lower exercise price. The trader pays a net premium for the position.
To "sell a put spread" is the opposite: the trader buys a Put with a lower exercise price
and writes a put with a higher exercise price, receiving a net premium for the position.
An investor with a bullish market outlook should sell a Put spread. The "vertical bull
put spread" allows the investor to participate to a limited extent in a bull market, while at the
KLE Societys
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To put on a bull spread, a trader sells the higher strike put and buys the lower
strikeput. The bull spread can be created by buying the lower strike and selling the higher
strike of either calls or put. The difference between the premiums paid and received makes up
one leg of the spread.
The investor's profit potential is limited. When the market price reaches or exceeds the
higher exercise price, both options will be out-of-the-money and will expire worthless. The
trader will realize his maximum profit, the net premium
The investor's potential loss is also limited. If the market falls, the options will be inthe-money. The puts will offset one another, but at different exercise prices.
KLE Societys
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The investor breaks-even when the market price equals the lower exercise price less
the net premium. The investor achieves maximum profit i.e the premium received, when the
market price moves up beyond the higher exercise price (both puts are then worthless).
An example of a bullish put spread.
Lets us assume that the cash price of the scrip is Rs 100. You now buy a November put
option on a scrip with a strike price of Rs 90 at a premium of Rs 5 and sell a put option with a
strike price of Rs 110 at a premium of Rs 15.
The first position is a short put at a higher strike price. This has resulted in some
inflow in terms of premium. But here the trader is worried about risk and so caps his risk by
buying another put option at the lower strike price. As such, a part of the premium received
goes off and the ultimate position has limited risk and limited profit potential. Based on the
above figures the maximum profit, maximum loss and breakeven point of this spread would
be as follows:
Maximum profit = Net option premium income or net credit
= 15 - 5 = 10
Maximum loss = Higher strike price - Lower strike price - Net premium received
= 110 - 90 - 10 = 10
Breakeven Price = Higher Strike price - Net premium income
= 110 - 10 = 100
Bear Market Strategies
KLE Societys
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Puts in a Bearish Strategy

When you purchase a put you are long and want the market to fall. A put option is a
bearish position. It will increase in value if the market falls. An investor with a bearish market
outlook shall buy put options. By purchasing put options, the trader has the right to choose
whether to sell the underlying asset at the exercise price. In a falling market, this choice is
preferable to being obligated to buy the underlying at a price higher.
An investor's profit potential is practically unlimited. The higher the fall in price of the
underlying asset, higher the profits.
The investor's potential loss is limited. If the price of the underlying asset rises instead
of falling as the investor has anticipated, he may let the option expire worthless. At the most,
he may lose the premium for the option.
The trader's breakeven point is the exercise price minus the premium. To profit, the
market price must be below the exercise price. Since the trader has paid a premium he must
recover the premium he paid for the option.
KLE Societys
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An increase in volatility will increase the value of your put and increase your return.
An increase in volatility will make it more likely that the price of the underlying instrument
will move. This increases the value of the option.
Calls in a Bearish Strategy
Another option for a bearish investor is to go short on a call with the intent to purchase
it back in the future. By selling a call, you have a net short position and needs to be bought
back before expiration and cancel out your position.
For this an investor needs to write a call option. If the market price falls, long call
holders will let their out-of-the-money options expire worthless, because they could purchase
the underlying asset at the lower market price.
The investor's profit potential is limited because the trader's maximum profit is limited
to the premium received for writing the option.
KLE Societys
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Here the loss potential is unlimited because a short call position holder has an
obligation to sell if exercised, he will be exposed to potentially large losses if the market rises
against his position.
The investor breaks even when the market price equals the exercise price: plus the
premium. At any price greater than the exercise price plus the premium, the trader is losing
money. When the market price equals the exercise price plus the premium, the trader breaks
even.
An increase in volatility will increase the value of your call and decrease your return.
When the option writer has to buy back the option in order to cancel out his position, he will
be forced to pay a higher price due to the increased value of the calls.
Bearish Put Spread Strategies
A vertical put spread is the simultaneous purchase and sale of identical put options but
with different exercise prices.
To "buy a put spread" is to purchase a put with a higher exercise price and to write a
put with a lower exercise price. The trader pays a net premium for the position.
To "sell a put spread" is the opposite. The trader buys a put with a lower exercise price
and writes a put with a higher exercise price, receiving a net premium for the position. To put
on a bear put spread you buy the higher strike put and sell the lower strike put. You sell the
lower strike and buy the higher strike of either calls or puts to set up a bear spread.
An investor with a bearish market outlook should: buy a put spread. The "Bear Put
Spread" allows the investor to participate to a limited extent in a bear market, while at the
KLE Societys
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The investor's profit potential is limited. When the market price falls to or below the
lower exercise price, both options will be in-the-money and the trader will realize his
maximum profit when he recovers the net premium paid for the options.
The investor's potential loss is limited. The trader has offsetting positions at different
exercise prices. If the market rises rather than falls, the options will be out-of-the-money and
expire worthless. Since the trader has paid a net premium
The investor breaks even when the market price equals the higher exercise price less
the net premium. For the strategy to be profitable, the market price must fall. When the
market price falls to the high exercise price less the net premium, the trader breaks even.
When the market falls beyond this point, the trader profits.
An example of a bearish put spread.
Lets assume that the cash price of the scrip is Rs 100. You buy a November put option
on a scrip with a strike price of Rs 110 at a premium of Rs 15 and sell a put option with a
strike price of Rs 90 at a premium of Rs 5.
KLE Societys
77
In this bearish position the put is taken as long on a higher strike price put with the
outgo of some premium. This position has huge profit potential on downside. If the trader
may recover a part of the premium paid by him by writing a lower strike price put option. The
resulting position is a mildly bearish position with limited risk and limited profit profile.
Though the trader has reduced the cost of taking a bearish position, he has also capped the
profit portential as well. The maximum profit, maximum loss and breakeven point of this
spread would be as follows:
Maximum profit = Higher strike price option - Lower strike price option
- Net premium paid
= 110 - 90 - 10 = 10
Maximum loss = Net premium paid
= 15 - 5 = 10
Breakeven Price = Higher strike price - Net premium paid
= 110 - 10 = 100
Bearish Call Spread Strategies

A vertical call spread is the simultaneous purchase and sale of identical call options
but with different exercise prices.
To "buy a call spread" is to purchase a call with a lower exercise price and to write a
call with a higher exercise price. The trader pays a net premium for the position.
To "sell a call spread" is the opposite: the trader buys a call with a higher exercise
price and writes a call with a lower exercise price, receiving a net premium for the position.
KLE Societys
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To put on a bear call spread you sell the lower strike call and buy the higher strike call.
An investor sells the lower strike and buys the higher strike of either calls or puts to put on a
bear spread.
An investor with a bearish market outlook should: sell a call spread. The "Bear Call
Spread" allows the investor to participate to a limited extent in a bear market, while at the
The investor's profit potential is limited. When the market price falls to the lower
exercise price, both out-of-the-money options will expire worthless. The maximum profit that
the trader can realize is the net premium: The premium he receives for the call at the higher
exercise price.
Here the investor's potential loss is limited. If the market rises, the options will offset
one another. At any price greater than the high exercise price, the maximum loss will equal
high exercise price minus low exercise price minus net premium.
KLE Societys
79
The investor breaks even when the market price equals the lower exercise price plus
the net premium. The strategy becomes profitable as the market price declines. Since the
trader is receiving a net premium, the market price does not have to fall as low as the lower
exercise price to breakeven.
An example of a bearish call spread.

Let us assume that the cash price of the scrip is Rs 100. You now buy a November call
option on a scrip with a strike price of Rs 110 at a premium of Rs 5 and sell a call option with
a strike price of Rs 90 at a premium of Rs 15.
In this spread you have to buy a higher strike price call option and sell a lower strike
price option. As the low strike price option is more expensive than the higher strike price
option, it is a net credit startegy. The final position is left with limited risk and limited profit.
The maximum profit, maximum loss and breakeven point of this spread would be as follows:
Maximum profit = Net premium received
= 15 - 5 = 10
KLE Societys
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Maximum loss = Higher strike price option - Lower strike price option Net premium received
= 110 - 90 - 10 = 10
Breakeven Price = Lower strike price + Net premium paid
= 90 + 10 = 100
Key Regulations
In India we have two premier exchanges The National Stock Exchange of India (NSE)
and The Bombay Stock Exchange (BSE) which offer options trading on stock indices as well
as individual securities.
Options on stock indices are European in kind and settled only on the last of expiration
of the underlying. NSE offers index options trading on the NSE Fifty index called the Nifty.
While BSE offers index options on the countrys widely used index Sensex, which consists of
30 stocks.
Options on individual securities are American. The number of stock options contracts
to be traded on the exchanges will be based on the list of securities as specified by Securities
and Exchange Board of India (SEBI). Additions/deletions in the list of securities eligible on
which options contracts shall be made available shall be notified from time to time.
KLE Societys
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Underlying: Underlying for the options on individual securities contracts shall be the
underlying security available for trading in the capital market segment of the exchange.
Security descriptor: The security descriptor for the options on individual securities shall be:
Market type - N
Instrument type - OPTSTK
Underlying - Underlying security
Expiry date - Date of contract expiry
Option type - CA/PA
Exercise style - American Premium Settlement method: Premium Settled; CA - Call

American
PA - Put American.
Trading cycle: The contract cycle and availability of strike prices for options contracts on
individual securities shall be as follows:
Options on individual securities contracts will have a maximum of three-month
trading cycle. New contracts will be introduced on the trading day following the expiry of the
near month contract.
On expiry of the near month contract, new contract shall be introduced at new strike
prices for both call and put options, on the trading day following the expiry of the near month
contract. (See Index futures learning centre for further reading)
Strike price intervals: The exchange shall provide a minimum of five strike prices for every
option type (i.e call & put) during the trading month. There shall be two contracts in-themoney (ITM), two contracts out-of-the-money (OTM) and one contract at-the-money (ATM).
The strike price interval for options on individual securities is given in the accompanying
table.
KLE Societys
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New contracts with new strike prices for existing expiration date will be introduced for
trading on the next working day based on the previous day's underlying close values and as
and when required. In order to fix on the at-the-money strike price for options on individual
securities contracts the closing underlying value shall be rounded off to the nearest multiplier
of the strike price interval. The in-the-money strike price and the out-of-the-money strike
price shall be based on the at-the-money strike price interval.
Expiry day: Options contracts on individual securities as well as index options shall expire
on the last Thursday of the expiry month. If the last Thursday is a trading holiday, the
contracts shall expire on the previous trading day.
Order type: Regular lot order, stop loss order, immediate or cancel, good till day, good till
cancelled, good till date and spread order. Good till cancelled (GTC) orders shall be cancelled
at the end of the period of 7 calendar days from the date of entering an order.
Permitted lot size: The value of the option contracts on individual securities shall not be less
than Rs 2 lakh at the time of its introduction. The permitted lot size for the options contracts
on individual securities shall be in multiples of 100 and fractions if any, shall be rounded off
to the next higher multiple of 100.
Price steps: The price steps in respect of all options contracts admitted to dealings on the
exchange shall be Re 0.05.
Quantity freeze: Orders which may come to the exchange as a quantity freeze shall be the
lesser of the following: 1 per cent of the marketwide position limit stipulated of options on
individual securities as given in (h) below or Notional value of the contract of around Rs 5
crore. In respect of such orders, which have come under quantity freeze, the member shall be
required to confirm to the exchange that there is no inadvertent error in the order entry and
KLE Societys
83
that the order is genuine. On such confirmation, the exchange at its discretion may approve
such order subject to availability of turnover/exposure limits, etc.
Base price: Base price of the options contracts on introduction of new contracts shall be the
theoretical value of the options contract arrived at based on Black-Scholes model of
calculation of options premiums. The base price of the contracts on subsequent trading days
will be the daily close price of the options contracts. However in such of those contracts
where orders could not be placed because of application of price ranges, the bases prices may
be modified at the discretion of the exchange and intimated to the members.
Price ranges: There will be no day minimum/maximum price ranges applicable for the
options contract. The operating ranges and day minimum/maximum ranges for options
contract shall be kept at 99 per cent of the base price. In view of this the members will not be
able to place orders at prices which are beyond 99 per cent of the base price. The base prices
for option contracts may be modified, at the discretion of the exchange, based on the request
received from trading members as mentioned above.
Exposure limits: Gross open positions of a member at any point of time shall not exceed the
exposure limit as detailed hereunder:
Index Options: Exposure Limit shall be 33.33 times the liquid networth.
Option contracts on individual Securities: Exposure Limit shall be 20 times the liquid
networth.
Memberwise position limit: When the open position of a Clearing Member, Trading
Member or Custodial Participant exceeds 15 per cent of the total open interest of the market
or Rs 100 crore, whichever is higher, in all the option contracts on the same underlying, at any
time, including during trading hours.
KLE Societys
84
For option contracts on individual securities, open interest shall be equivalent to the open
positions multiplied by the notional value. Notional Value shall be the previous day's closing
price of the underlying security or such other price as may be specified from time to time.
Market wide position limits: Market wide position limits for option contracts on individual
securities shall be lower of:
*20 times the average number of shares traded daily, during the previous calendar month, in
the relevant underlying security in the underlying segment of the relevant exchange or, 10 per
cent of the number of shares held by non-promoters in the relevant underlying security i.e. 10
per cent of the free float in terms of the number of shares of a company.
The relevant authority shall specify the market wide position limits once every month,
on the expiration day of the near month contract, which shall be applicable till the expiry of
the subsequent month contract.
Exercise settlement: Exercise type shall be American and final settlement in respect of
options on individual securities contracts shall be cash settled for an initial period of 6 months
and as per the provisions of National Securities Clearing Corporation Ltd (NSCCL) as may be
stipulated from time to time.
Reading Stock Option Tables
In India, option tables published in business newspapers and is fairly similar
to the regular stock tables.
The following is the format of the options table published in Indian business
news papers:
KLE Societys
85
NIFTY OPTIONS
Contracts
Exp.Date Str.Price Opt.Type Open High Low Trd.Qty No.of.Cont. Trd.Value
RELIANCE 7/26/01
360
CA
4200
1512000
RELIANCE 7/26/01
360
PA
29
39
29
1200
432000
RELIANCE 7/26/01
380
CA
1200
456000
RELIANCE 7/26/01
380
PA
35
40
35
1200
456000
RELIANCE 7/26/01
340
CA
11400
19
3876000
RELIANCE 7/26/01
340
PA
10
14
10
13800
23
4692000
RELIANCE 7/26/01
320
CA
22
24
16
11400
19
3648000
RELIANCE 7/26/01
320
PA
29400
49
9408000
RELIANCE 8/30/01
360
PA
31
35
31
1200
432000
RELIANCE 8/30/01
340
CA
15
15
15
600
204000
RELIANCE 8/30/01
320
PA
10
10
10
600
192000
RELIANCE 7/26/01
300
CA
38
38
38
600
180000
RELIANCE 7/26/01
300
PA
1200
360000
RELIANCE 7/26/01
280
CA
59
60
53
1800
504000
The first column shows the contract that is being traded i.e Reliance.
KLE Societys
86
The second coloumn displays the date on which the contract will expire i.e. the expiry
date is the last Thursday of the month.
Call options-American are depicted as 'CA' and Put options-American as'PA'.
The Open, High, Low, Close columns display the traded premium rates.
Advantages of option trading
Risk management: Put options allow investors holding shares to hedge against a possible fall
in their value. This can be considered similar to taking out insurance against a fall in the share
price.
Time to decide: By taking a call option the purchase price for the shares is locked in. This
gives the call option holder until the Expiry Day to decide whether or not to exercise the
option and buy the shares. Likewise the taker of a put option has time to decide whether or not
to sell the shares.
Speculation: The ease of trading in and out of an option position makes it possible to trade
options with no intention of ever exercising them. If an investor expects the market to rise,
they may decide to buy call options. If expecting a fall, they may decide to buy put options.
Either way the holder can sell the option prior to expiry to take a profit or limit a loss. Trading
options has a lower cost than shares, as there is no stamp duty payable unless and until
options are exercised.
Leverage: Leverage provides the potential to make a higher return from a smaller initial
outlay than investing directly. However, leverage usually involves more risks than a direct
investment in the underlying shares. Trading in options can allow investors to benefit from a
change in the price of the share without having to pay the full price of the share.
We can see below how one can leverage ones position by just paying the premium.
KLE Societys
87
Bought on Oct 15
Sold on Dec 15
Profit
ROI (Not annualised)
Option Premium
Rs 380
Rs 670
Rs 290
76.3%
Stock
Rs 4000
Rs 4500
Rs 500
12.5%
Income generation: Shareholders can earn extra income over and above dividends by writing
call options against their shares. By writing an option they receive the option premium
upfront. While they get to keep the option premium, there is a possibility that they could be
exercised against and have to deliver their shares to the taker at the exercise price.
Strategies: By combining different options, investors can create a wide range of potential
profit scenarios. To find out more about options strategies read the module on trading
strategies.
ANALYSIS AND INTERPRETATION

SECTOR: AUTOMOBILE
MARUTI UDYOG LTD.
Snapshot
Registered Office 11th Floor, Jeevan Prakash Building 25, Kasturba Gandhi Marg
New Delhi - 110001 Delhi
India
Tel.
23316831 / 23316832 / 23316833
Fax
23318754
Website
www.marutiudyog.com
Chief Executive
Mr. Jagdish Khattar
Name
Secretary Name
Mr. Anil Rustgi
Face Value
5
Market Lot
1
Business Group
Suzuki Group
Name
Incorporation Date Not Available
Industry Name
Auto - Cars & Jeeps
KLE Societys
88
Registrar of
Company
M C S LIMITED
SRI VENKATESH BHAVAN 212 - A SHAHPURJAT BEHIND
PANCHSHEEL CLUB
New Delhi , Delhi , 110049
Tel :- 6213830
Fax no :- 91-11-6473152
National Stock Exchange of India Ltd.
The Stock Exchange, Mumbai
Listed on
BULLISH VERTICAL SPREAD-CALL:

TABLE-1
MARUTI:
Long put with a strike price of rupees 830

Spot
840.9
833.1
772.9
791.75
774.85
792.35
787.2
797.1
801.55
791.75
Premium
-32.77
-18.34
-37.55
-54.56
-36.04
-56.28
-32.67
-23.87
-12.52
-30.85
Value of
option
10.9
3.1
0
0
0
0
0
0
0
0
Profit&
-21.87
-15.24
-37.55
-54.56
-36.04
-56.28
-32.67
-23.87
-12.52
-30.85
Short put with a strike price of rupees 850

Premium
25.45
24.87
29.54
45.65
27.76
43.56
34.87
24.73
14.35
24.82
Value
of
option
0
0
0
0
0
0
0
0
0
0
Profit&
loss
25.45
24.87
29.54
45.65
27.76
43.56
34.87
24.73
14.35
24.82
KLE Societys
89
Total P&
L
3.58
9.63
-8.01
-8.91
-8.28
-12.72
2.2
0.86
1.83
-6.03
796.15
780.1
788.85
789.65
791.65
831.3
821.7
796.65
812.45
820.2
-28.67
0
0
0
0
5.1
1.3
0
-15.56
-18.34
-17.76
-35.48
-32.79
-9.69
-8.32
-17.09
-30.61
-35.48
-32.79
-9.69
-8.32
-11.99
-29.31
-28.67
-15.56
-18.34
-17.76
29.76
27.36
8.08
7.56
15.77
26.87
23.96
12.76
14.28
14.95
0
0
0
0
0
0
0
0
0
0
29.76
27.36
8.08
7.56
15.77
26.87
23.96
12.76
14.28
14.95
Graph:
Analysis:
KLE Societys
90
-5.72
-5.43
-1.61
-0.76
3.78
-2.44
-4.71
-2.8
-4.06
-2.81
In This strategy we buy lower strike price calls options and sells higher strike price
call options.
This strategy preferred to buy call option at the time of bullish trend because as the
spot price of the script increases the value of premium increases.
And when the spot price of the script decreases the value of premium also decreases.
But here the spot price of the MARUTI is goes on decreasing and the spot prices are
less than the strike price so the option holder may go under loss.
Here option holder will get a maximum profit of Rs 9.63 at a spot price of Rs. 833.10
And can get a minimum loss of Rs -0.76 at a spot price of Rs 789.65
BEARISH VERTICAL SPREAD-CALL:

TABLE-2
MARUTI:

Spot
840.9
833.1
772.9
791.75
774.85
792.35
787.2
797.1
801.55
791.75
796.15
780.1
788.85
789.65
791.65
Premium
-25.45
-24.87
-29.54
-45.65
-27.76
-43.56
-34.87
-24.73
-14.35
-24.82
-29.76
-27.36
-8.08
-7.56
-15.77
Value of
option
Profit&
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
-25.45
-24.87
-29.54
-45.65
-27.76
-43.56
-34.87
-24.73
-14.35
-24.82
-29.76
-27.36
-8.08
-7.56
-15.77

Premium
32.77
18.34
37.55
54.56
36.04
56.28
32.67
23.87
12.52
30.85
35.48
32.79
9.69
8.32
17.09
Value
of
option
10.9
3.1
0
0
0
0
0
0
0
0
0
0
0
0
0
Profit&
loss
43.67
21.44
37.55
54.56
36.04
56.28
32.67
23.87
12.52
30.85
35.48
32.79
9.69
8.32
17.09
KLE Societys
91
Total P&
L
18.22
-3.43
8.01
8.91
8.28
12.72
-2.2
-0.86
-1.83
6.03
5.72
5.43
1.61
0.76
1.32
831.3
821.7
796.65
812.45
820.2
-26.87
-23.96
0
0
-12.76
-14.28
-14.95
-26.87
-23.96
-12.76
-14.28
-14.95
30.61
28.67
15.56
18.34
17.76
1.3
0
0
0
0
31.91
28.67
15.56
18.34
17.76
5.04
4.71
2.8
4.06
2.81
Graph:
Analysis:
This graph shows that as the spot price of the MARUTI script increase or decrease the
profit and changes in the same way.
KLE Societys
92
In this strategy the speculator gains the net option premium while creating the spread
since a long call at a higher strike price be lower than the premium received on a short call
with a low strike price.
In this strategy we will buy higher strike price calls and sell at lower strike price
calls.
From the above chart we can get a minimum profit of Rs 0.76 at a spot price 789.65
And we can get a maximum profit of Rs 18.22 at a spot price 840.9
TATA MOTARS:
SNAPSHOT
Registered Office
Bombay House, 24, Homi Mody Street Fort Mumbai - 400001 Maharashtra
India
Website
www.tatamotors.com
Registered Office
Bombay House, 24, Homi Mody Street Fort Mumbai - 400001 Maharashtra
India
Website
www.tatamotors.com
Chief Executive Name
Mr. Ravi Kant
Secretary Name
Mr. H K Sethna
Face Value
10
Market Lot
Lot Size
825
Business Group Name
Tata Group
Incorporation Date
Not Available
Industry Name
Auto - LCVs/HCVs
Listed on
Bangalore Stock Exchange Ltd.

Calcutta Stock Exchange Association Ltd.
Cochin Stock Exchange Ltd.
Delhi Stock Exchange Assoc. Ltd.
KLE Societys
93
Hyderabad Stock Exchange Ltd

Inter-connected Stock Exchange of India
Jaipur Stock Exchange Ltd
London Stock Exchange
Ludhiana Stock Exchange Assoc. Ltd.
Luxembourg Stock Exchange
Madras Stock Exchange Ltd.,
Newyork Stock Exchange
Over The Counter Exchange Of India Ltd.

TATA MOTARS:
TABLE-1
Spot
789.05
775.4
739.9
726.6
738.6
766.85
764.7
773.1
743.65
725.95
748.25
771.7
769.25
775.8
805.1
Premium
-32.65
-24.45
-41.26
-54.77
-42.99
-15.35
-16.2
-18.02
-39.44
-57.35
-35.26
-6.91
-27.68
-24.61
-20.3
Value of
option
9.05
0
0
0
0
0
0
0
0
0
0
0
0
0
25.1
Profit&
-23.6
-24.45
-41.26
-54.77
-42.99
-15.35
-16.2
-18.02
-39.44
-57.35
-35.26
-6.91
-27.68
-24.61
4.8

Premium
28.55
22.76
37.79
49.31
38.52
12.49
13.41
16.56
35.01
51.93
31.85
5.06
24.73
22.36
3.16
Value
of
option
0
0
0
0
0
0
0
0
0
0
0
0
0
0
5.1
Profit&
loss
KLE Societys
94
28.55
22.76
37.79
49.31
38.52
12.49
13.41
16.56
35.01
51.93
31.85
5.06
24.73
22.36
8.26
Total P&
L
4.95
-1.69
-3.47
-5.46
-4.47
-2.86
-2.79
-1.46
-4.43
-5.42
-3.41
-1.85
-2.95
-2.25
13.06
752.55
719.6
716.45
728.2
-40.65
0
0
-42.76
-39.86
-25.54
-25.54
-40.65
-42.76
-39.86
22.54
38.25
35.85
30.75
0
0
0
0
22.54
38.25
35.85
30.75
-3
-2.4
-6.91
-9.11
Graph:
Analysis:
In This strategy we buy lower strike price calls options and sells higher strike price call
options.
KLE Societys
95
But here the spot price of the TATA MOTARS is goes on decreasing and the spot
prices are less than the strike price so the option holder may go under loss.
From the above chart the option holder will get a maximum profit of Rs 13.06 at a
spot price of Rs. 805.01

TATA MOTARS:
Spot
789.05
775.4
739.9
726.6
738.6
766.85
764.7
773.1
743.65
725.95
748.25
771.7
769.25
775.8
805.1
752.55
TABLE-2
Premium
-28.55
-22.76
-37.79
-49.31
-38.52
-12.49
-13.41
-16.56
-35.01
-51.93
-31.85
-5.06
-24.73
-22.36
-3.16
-22.54
Value of
option
0
0
0
0
0
0
0
0
0
0
0
0
0
0
5.1
0
Profit&
-28.55
-22.76
-37.79
-49.31
-38.52
-12.49
-13.41
-16.56
-35.01
-51.93
-31.85
-5.06
-24.73
-22.36
1.94
-22.54
Premium
32.65
24.45
41.26
54.77
42.99
15.35
16.2
18.02
39.44
57.35
35.26
6.91
27.68
24.61
20.3
25.54
Value
of
option
9.05
0
0
0
0
0
0
0
0
0
0
0
0
0
25.1
0
Profit&
loss
KLE Societys
96
41.7
24.45
41.26
54.77
42.99
15.35
16.2
18.02
39.44
57.35
35.26
6.91
27.68
24.61
45.4
25.54
Total P&
L
13.15
1.69
3.47
5.46
4.47
2.86
2.79
1.46
4.43
5.42
3.41
1.85
2.95
2.25
47.34
3
719.6
716.45
728.2
-38.25
-35.85
-30.75
-38.25
-35.85
-30.75
40.65
42.76
39.86
0
0
0
40.65
42.76
39.86
2.4
6.91
9.11
Graph:
Analysis:
This graph shows that as the spot price of the TATA MOTARS script increase or
decrease the profit and changes in the same way.
since a long call at a higher strike price be lower than the premium received on a short call
KLE Societys
97
In this strategy we will buy higher strike price calls and sell at lower strike price calls.
SECTOR: CEMENT
ASSOCIATED CEMENT COMPANIES LTD. (ACC):
SNAPSHOT
Registered Office
Website
Chief Executive
Name
Secretary Name
Face Value
Market Lot
Lot Size
Business Group
Name
Incorporation Date
Industry Name
Listed on
Cement House 121, Maharshi Karve Road, Post Box 11025

Mumbai - 400020 Maharashtra
India
www.acclimited.com
Mr. M L Narula
Mr. A Anjeneyan
10
1
750
ACC Group
31/12/1944
Cement - Major
Ludhiana Stock Exchange Assoc. Ltd.
KLE Societys
98

The Stock Exchange, Ahmedabad
Uttar Pradesh Exchange Assoc Ltd.

TABLE-1
ACC:

Spot
876.3
854.45
811.4
852.5
810.5
833.15
781.15
746.7
749.35
746.95
731.8
723.15
739.35
749.2
752.75
753.7
733.6
734.7
734.75
Premium
Value of
option
Profit&
-85.89
26.3
5.45
0
2.5
0
0
0
0
0
0
0
0
0
0
0
0
0
-79.49
-76.25
-34.86
-47.87
-31.25
-49.24
-109.64
-79.06
-114.22
-111.81
-114.44
-129.83
-138.72
-123.23
-113.61
-110.3
-109.58
-87.65
-8.56
-42.42
-31.25
-46.74
-109.64
-79.06
-114.22
-111.81
-114.44
-129.83
-138.72
-123.23
-113.61
-110.3
-109.58
-87.65
-85.89
-79.49
-76.25

Premium
30.67
45.68
28.59
52.78
95.66
72.4
104.59
98.34
96.76
114.49
123.87
107.94
119.65
118.65
105.67
84.76
80.77
76.94
71.57
Value
of
option
6.3
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
Profit&
loss
36.97
45.68
28.59
52.78
95.66
72.4
104.59
98.34
96.76
114.49
123.87
107.94
119.65
118.65
105.67
84.76
80.77
76.94
71.57
KLE Societys
99
Total P&
L
28.41
3.26
-2.66
6.04
-13.98
-6.66
-9.63
-13.47
-17.68
-15.34
-14.85
-15.29
6.04
8.35
-3.91
-2.89
-5.12
-2.55
-4.68
Graph:
Analysis:
call options.
But here the spot price of the ACC is goes on decreasing and the spot prices are less
than the strike price so the option holder may go under loss.
KLE Societys
100
From the above chart the option holder will get a maximum profit of Rs28.41 at a spot
price of Rs. 876.30

TABLE-2
ACC:

Spot
876.3
854.45
811.4
852.5
810.5
833.15
781.15
746.7
749.35
746.95
731.8
723.15
739.35
749.2
752.75
753.7
733.6
734.7
734.75
Premium
Value of
option
Profit&
-80.77
6.3
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
-76.94
-71.57
-30.67
-45.68
-28.59
-52.78
-95.66
-72.4
-104.59
-98.34
-96.76
-114.49
-123.87
-107.94
-119.65
-118.65
-105.67
-84.76
-24.37
-45.68
-28.59
-52.78
-95.66
-72.4
-104.59
-98.34
-96.76
-114.49
-123.87
-107.94
-119.65
-118.65
-105.67
-84.76
-80.77
-76.94
-71.57

Premium
34.86
47.87
31.25
49.24
109.64
79.06
114.22
111.81
114.44
129.83
138.72
123.23
113.61
110.3
109.58
87.65
85.89
79.49
76.25
Value
of
option
26.3
4.54
0
2.5
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
Profit&
loss
61.16
52.41
31.25
51.74
109.64
79.06
114.22
111.81
114.44
129.83
138.72
123.23
113.61
110.3
109.58
87.65
85.89
79.49
76.25
KLE Societys
101
Total P&
L
36.79
6.73
2.66
-1.04
13.98
6.66
9.63
13.47
17.68
15.34
14.85
15.29
-6.04
-8.35
3.91
2.89
5.12
2.55
4.68
Graph:
Analysis:
This graph shows that as the spot price of the ACC script increase or decrease the
profit and changes in the same way.
since a long call at a higher strike price is lower than the premium received on a short call
calls.
KLE Societys
102
GUJARAT AMBUJA CEMENTS LTD.

SNAPSHOT
Registered Office &
Factory
Website
Chief Executive Name
Secretary Name
Face Value
Market Lot
Lot Size
Business Group Name
Incorporation Date
Industry Name
Registrar of Company
Listed on
Ambuja Nagar P O Taluka-Kodinar, Junagadh District 362715 Gujarat

India
http://www.gujaratambuja.com
Mr. Anil Singhvi
Mr. B L Taparia
2
1
4125
Ambuja Group
Not Available
Cement - Major
Not Available
London Stock Exchange
Uttar Pradesh Exchange Assoc Ltd.
KLE Societys
103

GUJARAT AMBUJA:
TABLE-1
Spot
111.7
109.8
112
113.3
103.8
112.85
110.05
105.4
105.95
106.15
106.05
103.8
107.25
110.85
106.45
108
104.3
102.2
104.5
Premium
Value of
option
Profit&
-8.76
1.17
0
0
3.3
0
2.85
0.05
0
0
0
0
0
0
0.85
0
0
0
-9.09
-8.45
-10.87
-8.76
-5.17
-2.49
-13.44
-4.41
-7.25
-12
-11.48
-11.31
-11.45
-13.73
-10.37
-6.81
-11.24
-9.72
-9.7
-8.76
-5.17
0.81
-13.44
-1.56
-7.2
-12
-11.48
-11.31
-11.45
-13.73
-10.37
-5.96
-11.24
-9.72
-8.76
-9.09
-8.45

Premium
9.96
8.98
6.76
3.76
12.07
3.65
6.57
10.95
12.08
11.67
12.65
11.78
9.23
7.34
10.87
8.65
6.98
7.96
7.56
Value
of
option
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
Profit&
loss
KLE Societys
104
9.96
8.98
6.76
3.76
12.07
3.65
6.57
10.95
12.08
11.67
12.65
11.78
9.23
7.34
10.87
8.65
6.98
7.96
7.56
Total P&
L
0.26
0.22
1.59
4.57
-1.37
2.09
-0.63
-1.05
0.6
0.36
1.2
-1.95
-1.14
1.38
-0.37
-1.07
-1.78
-1.13
-0.89
Graph:
Analysis:
call options.
But here the spot price of the GUJARAT AMBUJA is goes on decreasing and the spot
prices are less than the strike price so the option holder may go under loss.
From the above chart the option holder will get a maximum profit of Rs 2.09 at a spot
price of Rs. 112.85
KLE Societys
105

GUJARAT AMBUJA:
TABLE-2
Spot
111.7
109.8
112
113.3
103.8
112.85
110.05
105.4
105.95
106.15
106.05
103.8
107.25
110.85
106.45
108
104.3
102.2
104.5
Premium
Value of
option
Profit&
-6.98
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
-7.96
-7.56
-9.96
-8.98
-6.76
-3.76
-12.07
-3.65
-6.57
-10.95
-12.08
-11.67
-12.65
-11.78
-9.23
-7.34
-10.87
-8.65
-9.96
-8.98
-6.76
-3.76
-12.07
-3.65
-6.57
-10.95
-12.08
-11.67
-12.65
-11.78
-9.23
-7.34
-10.87
-8.65
-6.98
-7.96
-7.56

Premium
10.87
8.76
5.17
2.49
13.44
4.41
7.25
12
11.48
11.31
11.45
13.73
10.37
6.81
11.24
9.72
8.76
9.09
8.45
Value
of
option
1.7
0
2
3.3
0
2.85
0.05
0
0
0
0
0
0
0
0
0
0
0
0
Profit&
loss
KLE Societys
106
12.57
8.76
7.17
5.79
13.44
7.26
7.3
12
11.48
11.31
11.45
13.73
10.37
6.81
11.24
9.72
8.76
9.09
8.45
Total P&
L
2.61
-0.22
0.41
2.03
1.37
3.61
0.73
1.05
-0.6
-0.36
-1.2
1.95
1.14
-0.53
0.37
1.07
1.78
1.13
0.89
Graph:
Analysis:
This graph shows that as the spot price of the GUJARAT AMBUJA script increase or
decrease the profit and changes in the same way.
since a long call at a higher strike price is lower than the premium received on a short call
calls.
KLE Societys
107
FINDINGS
1. Sector: AUTOMOBILE
Company: MARUTI UDYOG and TATA MOTARS
By using call option the option holder can get a maximum profit in TATA MOTARS and
minimum in MARUTI
2. Sector: CEMENT
Company: ACC and GUJARAT AMBUJA
By using call option and put option the option holder can get a maximum profit in ACC and
minimum in GUJARAT AMBUJA
FINDINGS SUMMURY
COMPANIES
1.Maruti
Udyog
BULLISH CALL SPREAD

Max.
Min.
Max.
Min.
Profit
Profit
Loss
Loss
BEARISH CALLSPREAD
Max.
Min.
Max.
Min.
Profit
Profit
Loss
Loss
9.63
0.86
12.72
0.76
18.22
0.76
3.43
0.86
2.Tata Motors
13.06
4.95
9.11
1.46
47.34
1.46
3.ACC
4.Gujarat
Ambuja
28.41
3.26
17.68
2.55
36.79
2.55
8.35
1.04
4.57
0.22
1.78
0.37
3.61
0.37
1.2
0.22
KLE Societys
108
SUGGESTIONS
1. If the investors go for bullish vertical spread using calls, if the market moves against the
perception of the investor, it is advisable to sell the lower strike call.
2. If the market moves in accordance with the perception of the investor, it is advisable to
buy back the higher strike call and sell a call with higher strike.
3. If the investor go for bearish vertical spread using call, if the market moves against the
perception of the investor, it is advisable to buy back the lower strike.
4. If the market moves according to his perception, it is advisable to buy back lower strike
short position and sell a call with strike lower
KLE Societys
109
LIMITATIONS
1. I have done the performance evaluation only for one year; from this data we
cannot get the results accurately.
2. I have chosen only two sectors, whereas there are numerous sectors available in
stock market.
3. Only some clients were traded in Future and Option segment.
4. Calculation of Option premium is very difficult to understand.
KLE Societys
110
BIBLIOGRAPHY
5. Options & Futures (An Indian perspective)
By- D. C. Patwari and Anshul Bhargav
6. Capital Market and Financial Services
(Theory and Operations) By- P. Subramanian
7. NCFM derivatives NSE India Limited
Web-sites:
www.nseindia.com
www.icicidirect.com
www.bseindia.com
www.google.com
KLE Societys
111

Derivatives With Reference To Future and Options

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Executive Summary

To study the trading procedures for Derivative products

To study the basic knowledge about derivative market and options

To study the clearing and settlement procedure of Derivatives products

To study the option as a profit making strategy.

To know the use of different strategies available in different market condition.

The new issues market or Primary market

The secondary market

1.The new issues market or Primary market:

Where firms which already traded raise additional capital (through

2) The Secondary market:

Existing unlisted companies

Existing listed companies

It has not completed 12 months of commercial operations.

Safety: Safety of money is the first objective of an investor.

Profitability: The investor makes investment for earning money. He

Liquidity: The liquidity refers to the receipt back of investment when

Capital appreciation and,

2.4. Structure of Capital Market in India:

Government securities market

Mutual fund schemes.

2.5. Factors influencing the growth of Capital market:

Speed in acquiring processing and acting upon

Increased price volatility

Advances in financial theory

Foreign Institutional Investors (FIIs) participation in

Sophistication among investment managers

Emergence of financial intermediaries like Mutual

Development of financial service sectors like merchant

Securities Limited (MOSL)

Their business has primarily focused on retail wealth management and

Venture capital management and advisory

excellence in execution. They has been able to leverage their brand

Wide range of financial products and services:-

their clients. In addition, diverse portfolio reduces their dependence on

We intend to further widen our research coverage by increasing the

In the sequence of product innovation, the exchange commenced trading in Index

4. Development of Derivative Markets in India

The report of the L. C. Gupta Committee, set up by SEBI, recommended a phased

Some less common, but economically intriguing, examples are:

Buyer and seller make a

Buyer and seller agree to buy or sell a

Prices are negotiated in

Both buyer and seller post a

Difficult to do, so most

Easy to do by entering into an

The Sensex and Nifty

Understanding index futures

1000 (Initial Investment)

3000 (Initial profit)

1000 (penalty from Shyam)

(-1000) discount given to Shyam

2000 (Net gain)

Index up 10% Index down 10%

(Rs 120,000) Rs 120,000

Less: Purchase Cost: 3600*100 = Rs 3,60,000

Take the case of the NSE Nifty.

Assume that Nifty is at 1200 and 3 months Nifty futures is at 1300.

If there is a difference then arbitrage opportunity exists.

Cost= 1000+30 = 1030

Pricing of Index Futures

Cost= 1000+30 = 1030

2. Futures pricing in case of dividend yield