Madhuri Kumbhalkar, Project On Futures Suaitablity As Trading Instrument

PROJECT REPORT
on
“A STUDY ON THE SUITABILITY OF FINANCIAL DERIVATIVES

AS A TRADING INSTRUMENT FOR SMALL TRADERS, WITH
SPECIFIC REFERENCE TO FUTURES”
Submitted to
Global Business School
For Partial Fulfillment of the Degree of Master in Business Administration (MBA)
Submitted by
Ms. Madhuri T. Kumbhalkar
M.B.A. IV sem.
Under the Guidance of

Prof. Smita Landge
Global Business School

(G. H. Raisoni Group of Institute)
M.B.A. Department
Anjangoan Bari, Amravati
2009–10
INDEX
Sr. No. Chapter Heading Page Number
Executive summary 1
1 Introduction 2
2 Objective 26
3 Company Profile 27
4 Theoretical Background 29
5 Research Methodology 41
6 Data Analysis & Interpretation 42
7 Conclusion 72
8 Findings 74
9 Recommendation 75
10 Limitation 78
Bibliography 79
Annexure 80
Global Business School, Amravati Page 1

Executive Summary
In this project report Researcher has given brief explanation of “A
study on the suitability of financial derivatives as a trading instrument for
small traders, with specific reference to Futures”.
In the first part of the project Researcher tried to study the

financial derivatives with specific reference to Futures as a trading
instrument and number of trading strategies. In the second half Researcher
studied the existing Futures Trader’s Satisfaction and suitability of Futures
as a trading instrument for small traders.
The first step in the research process was to perform

comprehensive secondary research. The available literature to explore prior
studies related to the project topic was reviewed. This gave a broader
perspective to the issues pertaining to this topic and the concerns that were
to be addressed. The literature review helped gaining valuable insight into
the broader picture and which trading strategies are implemented to increase
the profit volume in derivative trading.
The project was carried out for understanding traders behavior and
their responses to Futures Trading. This research helps us in finding out the
customers view regarding Future trading and awareness of Futures.

1.1.1. INTRODUCTION TO DERIVATIVES:
The word “DERIVATIVES” is derived from the word itself derived of an

underlying asset. It is a future image or copy of an underlying asset which may be shares,
stocks, commodities, stock indices, etc. Derivatives are derived from the following
products:
A. Shares
B. Debentures
C. Mutual funds
D. Gold
E. Steel
F. Interest rate
G. Currencies.
A derivative is a type of market where two parties are entered into a contract one
is bullish and other is bearish in the market having opposite views regarding the market.
There cannot be a derivative having same views about the market. In short it is like an
INSURANCE market where investors cover their risk for a particular position. The
emergence of the market for derivative products, most notably forwards, Futures and
options, can be traced back to the willingness of risk-averse economic agents to guard
themselves against uncertainties arising out of fluctuations in asset prices. By their very
nature, the financial markets are marked by a very high degree of volatility. Through the
use of derivative products, it is possible to partially or fully transfer price risks by
locking-in asset prices. As instruments of risk management, these generally do not
influence the fluctuations in the underlying asset prices. However, by locking in asset
prices, derivative products minimize the impact of fluctuations in asset prices on the
profitability and cash flow situation of risk-averse investors.
Ex.:- Consider a hypothetical situation in which ABC trading company has to

import a raw material for manufacturing goods. But this raw material is required only
after 3 months. However in 3 months the prices of raw material may go up or go down
due to foreign exchange fluctuations and at this point of time it cannot be predicted
whether the prices would go up or come down. Thus he is exposed to risks with
fluctuations in forex rates. If he buys the goods in advance then he will incur heavy
interest and storage charges. However, the availability of derivatives solves the problem
of importer. He can buy currency derivatives. Now any loss due to rise in raw material
prices would be offset by profits on the Futures contract and vice versa. Hence the
company can hedge its risk through the use of derivatives.
History of derivatives markets: Early forward contracts in the US addressed merchants'

concerns about ensuring that there were buyers and sellers for commodities. However
credit risk" remained a serious problem. To deal with this problem, a group of Chicago
businessmen formed the Chicago Board of Trade (CBOT) in 1848. The primary intention
of the CBOT was to provide a centralized location known in advance for buyers and
sellers to negotiate forward contracts. In 1865, the CBOT went one step further and
listed the first 'exchange traded" derivatives contract in the US, these contracts were
called 'futures contracts". In 1919, Chicago Butter and Egg Board, a spin-off of CBOT,
was reorganized to allow futures trading. Its name was changed to Chicago Mercantile
Exchange (CME). The CBOT and the CME remain the two largest organized futures
exchanges, indeed the two largest "financial" exchanges of any kind in the world today.
The first stock index futures contract was traded at Kansas City Board of Trade.
Currently the most popular stock index futures contract in the world is based on S&P 500
index, traded on Chicago Mercantile Exchange. During the mid eighties, financial
futures became the most active derivative instruments generating volumes many times
more than the commodity futures. Index futures, futures on T-bills and Euro-Dollar
futures are the three most popular futures contracts traded today. Other popular
international exchanges that trade derivatives are LIFFE in England, DTB in Germany,
SGX in Singapore, TIFFE in Japan, MATIF in France, Eurex etc. In 1999, RBI
introduced derivatives in the local currency Interest Rate markets, which have not really
developed, but with the gradual acceptance of the ALM guidelines by banks, there
should be an instrumental product in hedging their balance sheet liabilities. The first
product which was launched by BSE and NSE in the derivatives market was index
Futures

1.1.2 DERIVATIVES DEFINED
Derivative is a product whose value is derived from the value of one or more
basic variables, called bases (underlying asset, index, or reference rate), in a contractual
manner. The underlying asset can be primary financial instrument, commodity or index,
such as: interest rates, exchange rates, commodities, and equities or any other asset. For
example, wheat farmers may wish to sell their harvest at a future date to eliminate the
risk of a change in prices by that date. Such a transaction is an example of a derivative.
The price of this derivative is driven by the spot price of wheat which is the
"underlying".
DEFINITIONS:
A. In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R)A)
defines "derivative" to include-
1. A security derived from a debt instrument, share, loan whether secured or unsecured,
risk instrument or contract for differences or any other form of security.
2. A contract which derives its value from the prices, or index of prices, of underlying
securities.
Derivatives are securities under the SC(R) A and hence the trading of derivatives is
governed by the regulatory framework under the SC(R) A.
B. According to JOHN C. HUL “A derivatives can be defined as a financial instrument

whose value depends on (or derives from) the values of other, more basic underlying
variables.”
C. According to ROBERT L. MCDONALD “A derivative is simply a financial

instrument (or even more simply an agreement between two people) which has a value
determined by the price of something else.
Derivative products initially emerged as hedging devices against fluctuations in

commodity prices, and commodity-linked derivatives remained the sole form of such
products for almost three hundred years. Financial derivatives came into spotlight in the

post-1970 period due to growing instability in the financial markets. However, since
their emergence, these products have become very popular and by 1990s, they accounted
for about two-thirds of total transactions in derivative products. In recent years, the
market for financial derivatives has grown tremendously in terms of variety of
instruments available, their complexity and also turnover. In the class of equity
derivatives the world over, Futures and options on stock indices have gained more
popularity than on individual stocks, especially among institutional investors, who are
major users of index-linked derivatives. Even small investors find these useful due to
high correlation of the popular indexes with various portfolios and ease of use.
1.1.3 DERIVATIVE CONTRACT TYPES
Derivative contracts have several variants. The most common variants are
forwards, Futures, options and swaps. We take a brief look at various derivatives
contracts that have come to be used.
 Forwards: A forward contract is a customized contract between two entities, where

settlement takes place on a specific date in the future at today's pre-agreed price.
 Futures: A Futures contract is an agreement between two parties to buy or sell an

asset at a certain time in the future at a certain price. Futures contracts are special
types of forward contracts in the sense that the former are standardized exchange-
traded contracts.
 Options: Options are of two types - calls and puts. Calls give the buyer the right but
not the obligation to buy a given quantity of the underlying asset, at a given price on
or before a given future date. Puts give the buyer the right, but not the obligation to
sell a given quantity of the underlying asset at a given price on or before a given date.
 Warrants: Options generally have lives of up to one year, the majority of options
traded on options exchanges having a maximum maturity of nine months. Longer-
dated options are called warrants and are generally traded over-the-counter.
 LEAPS: The acronym LEAPS means Long-Term Equity Anticipation Securities.

These are options having a maturity of up to three years.

 Baskets: Basket options are options on portfolios of underlying assets. The
underlying asset is usually a moving average of a basket of assets. Equity index
options are a form of basket options.
 Swaps: Swaps are private agreements between two parties to exchange cash flows in
the future according to a prearranged formula. They can be regarded as portfolios of
forward contracts. The two commonly used swaps are:
a. Interest rate swaps: These entail swapping only the interest related cash flows
between the parties in the same currency.
b. Currency swaps: These entail swapping both principal and interest between the
parties, with the cash flows in one direction being in a different currency than
those in the opposite direction.
 Swaptions: Swaptions are options to buy or sell a swap that will become operative at
the expiry of the options. Thus a swaptions is an option on a forward swap. Rather
than have calls and puts, the swaptions market has receiver swaptions and payer
swaptions. A receiver swaptions is an option to receive fixed and pay floating. A
payer swaptions is an option to pay fixed and receive floating.
1.1.4 PARTICIPANTS IN THE DERIVATIVES MARKETS
The following three broad categories of participants - hedgers, speculators, and

arbitrageurs trade in the derivatives market.
Derivatives are risk shifting instruments. Initially, they were used to reduce
exposure to changes in foreign exchange rates, interest rates, or stock indexes or
commonly known as risk hedging. Hedging is the most important aspect of derivatives
and also its basic economic purpose. Hedgers face risk associated with the price of an
asset. They use Futures or options markets to reduce or eliminate this risk.
There has to be counter party to hedgers and they are speculators. Speculators
don’t look at derivatives as means of reducing risk but it’s a business for them. Rather he
accepts risks from the hedgers in pursuit of profits. Thus for a sound derivatives market,
both hedgers and speculators are essential. Speculators wish to bet on future movements

in the price of an asset. Futures and options contracts can give them an extra leverage;
that is, they can increase both the potential gains and potential losses in a speculative
venture.
Arbitrageurs are in business to take advantage of a discrepancy between prices in

two different markets. If, for example, they see the Futures price of an asset getting out
of line with the cash price, they will take offsetting positions in the two markets to lock
in a profit.
1.1.5 CRITICISMS
Derivatives are often subject to the following criticisms:
A. Possible large losses: -The use of derivatives can result in large losses because of
the use of leverage, or borrowing. Derivatives allow investors to earn large returns
from small movements in the underlying asset's price. However, investors could lose
large amounts if the price of the underlying moves against them significantly. There
have been several instances of massive losses in derivative markets, such as:
 The need to recapitalize insurer American International Group (AIG) with $85 billion
of debt provided by the US federal government. An AIG subsidiary had lost more
than $18 billion over the preceding three quarters on Credit Default Swaps (CDS) it
had written. It was reported that the recapitalization was necessary because further
losses were foreseeable over the next few quarters.
 The loss of $7.2 Billion by Societe Generale in January 2008 through mis-use of
Futures contracts.
 The loss of US $6.4 billion in the failed fund Amaranth Advisors, which was long
natural gas in September 2006 when the price plummeted.
 The loss of US $4.6 billion in the failed fund Long-Term Capital Management in
1998.
 The bankruptcy of Orange County, CA in 1994, the largest municipal bankruptcy in
U.S. history. On December 6, 1994, Orange County declared Chapter 9 bankruptcy,
from which it emerged in June 1995. The county lost about $1.6 billion through
derivatives trading. Orange County was neither bankrupt nor insolvent at the time;
however, because of the strategy the county employed it was unable to generate the
cash flows needed to maintain services. Orange County is a good example of what
happens when derivatives are used incorrectly and positions liquidated in an

unplanned manner; had they not liquidated they would not have lost any money as
their positions rebounded. Potentially problematic use of interest-rate derivatives by
US municipalities has continued in recent years.
 The Nick Leeson affair in 1994
Members of President Clinton's Working Group on Financial Markets: Larry

Summers, Alan Greenspan, Arthur Levitt, and Robert Rubin, have been criticized for
torpedoing an effort to regulate the derivatives' markets, and thereby helping to bring
down the financial markets in fall 2008. President George W. Bush has also been
criticized because he was President for 8 years preceding the 2008 meltdown and did
nothing to regulate derivative trading. Bush has stated that deregulation was one of
the core tenets of his political philosophy.
B. Counter-party risk: -Derivatives (especially swaps) expose investors to counter-

party risk. For example, suppose a person wanting a fixed interest rate loan for his
business, but finding that banks only offer variable rates, swaps payments with
another business who wants a variable rate, synthetically creating a fixed rate for the
person. However, if the second business goes bankrupt, it can't pay its variable rate
and so the first business will lose its fixed rate and will be paying a variable rate
again. If interest rates have increased, it is possible that the first business may be
adversely affected, because it may not be prepared to pay the higher variable rate.
Different types of derivatives have different levels of risk for this effect. For
example, standardized stock options by law require the party at risk to have a certain
amount deposited with the exchange, showing that they can pay for any losses;
Banks who help businesses swap variable for fixed rates on loans may do credit
checks on both parties. However in private agreements between two companies, for
example, there may not be benchmarks for performing due diligence and risk
analysis.
C. Unsuitably high risk for small/inexperienced investors: -Derivatives pose
unsuitably high amounts of risk for small or inexperienced investors. Because
derivatives offer the possibility of large rewards, they offer an attraction even to
individual investors. However, speculation in derivatives often assumes a great deal
of risk, requiring commensurate experience and market knowledge, especially for the
small investor, a reason why some financial planners advise against the use of these
instruments. Derivatives are complex instruments devised as a form of insurance, to

transfer risk among parties based on their willingness to assume additional risk, or
hedge against it.
D. Large notional value:-Derivatives typically have a large notional value. As such,

there is the danger that their use could result in losses that the investor would be
unable to compensate for. The possibility that this could lead to a chain reaction
ensuing in an economic crisis, has been pointed out by famed investor Warren
Buffett in Berkshire Hathaway's 2002 annual report. Buffett called them 'financial
weapons of mass destruction.' The problem with derivatives is that they control an
increasingly larger notional amount of assets and this may lead to distortions in the
real capital and equities markets. Investors begin to look at the derivatives markets to
make a decision to buy or sell securities and so what was originally meant to be a
market to transfer risk now becomes a leading indicator.
E. Leverage of an economy's debt: - Derivatives massively leverage the debt in an

economy, making it ever more difficult for the underlying real economy to service its
debt obligations, thereby curtailing real economic activity, which can cause a
recession or even depression. In the view of Marriner S. Eccles, U.S. Federal Reserve
Chairman from November, 1934 to February, 1948, too high a level of debt was one
of the primaries causes to the 1920s-30s Great Depression.

1.1.6. BENEFITS
Nevertheless, the use of derivatives also has its benefits:

 Able to transfer the risk to the person who is willing to accept them: Derivatives
facilitate the buying and selling of risk and many people consider this to have a
positive impact on the economic system. Although someone loses money while
someone else gains money with a derivative, under normal circumstances, trading in
derivatives should not adversely affect the economic system because it is not zero
sums in utility.
 Incentive to make profits with minimal amount of risk capital: Derivatives reduce
market risk and increase the willingness to trade in stock market.
 Lower transaction costs: Trading in derivatives involves lower cost of trading and
it also leads to increased volume in the stock market.
 There are other benefits of derivatives according to the available products of

derivatives.

1.2.1 INTRODUCTION TO FUTURES:
In recent years, derivatives have become increasingly important in the field of

finance. While Futures and options are now actively traded on many exchanges, forward
contracts are popular on the OTC market.
A Futures contract is an agreement between two parties to buy or sell an asset at a

certain time in the future at a certain price. But unlike forward contracts, the Futures
contracts are standardized and exchange traded. Futures markets were designed to solve
all the three problems of forward markets that exist in forward markets such as lack of
centralization of trading, illiquidity, and counterparty risk. Futures markets are exactly
like forward markets in terms of basic economics. However, contracts are standardized
and trading is centralized (on a stock exchange). There is no counterparty risk (thanks to
the institution of a clearing corporation which becomes counterparty to both sides of
each transaction and guarantees the trade). In futures markets, unlike in forward markets,
increasing the time to expiration does not increase the counter party risk. Futures markets
are highly liquid as compared to the forward markets.
A Futures contract gives the holder the obligation to buy or sell, which differs
from an option contract, which gives the holder the right, but not the obligation. To
facilitate liquidity in the Futures contracts, the exchange specifies certain standard
features of the contract. It is a standardized contract with standard underlying instrument,
a standard quantity and quality of the underlying instrument that can be delivered, (or
which can be used for reference purposes in settlement) and a standard timing of such
settlement. A Futures contract may be offset prior to maturity by entering into an equal
and opposite transaction. More than 99% of Futures transactions are offset this way.
The standardized items in a Futures contract are:

 Quantity of the underlying
 Quality of the underlying
 The date and the month of delivery
 The units of price quotation and minimum price change
 Location of settlement

1.2.2 WHAT IS FUTURES CONTRACT?
A contractual agreement, generally made on the trading floor of a Futures

exchange, to buy or sell a particular commodity or financial instrument at a
predetermined price in the future. Futures contracts detail the quality and quantity of the
underlying asset; they are standardized to facilitate trading on a Futures exchange.
A legally binding agreement to buy or sell a commodity or financial instrument

in a designated future month at a price agreed upon today by the buyer and seller.
Futures contracts are standardized according to the quality, quantity, and delivery time
and location for each commodity. A Futures contract differs from an option because an
option is the right to buy or sell, while a Futures contract is the promise to actually make
a transaction. A future is part of a class of securities called derivatives, so named because
such securities derive their value from the worth of an underlying investment.
An agreement to take (that is, by the buyer) or make (that is, by the seller)
delivery of a specific commodity on a particular date. The commodities and contracts are
standardized in order that an active resale market will exist. Futures contracts are
available for a variety of items including grains, metals, and foreign currencies.
History of Futures markets: Merton Miller, the 1990 Nobel laureate had said
that 'financial Futures represent the most significant financial innovation of the last
twenty years." The first exchange that traded financial derivatives was launched in
Chicago in the year 1972. A division of the Chicago Mercantile Exchange, it was called
the International Monetary Market (IMM) and traded currency Futures. The brain behind
this was a man called Leo Melamed, acknowledged as the 'father of financial Futures"
who was then the Chairman of the Chicago Mercantile Exchange. Before IMM opened
in 1972, the Chicago Mercantile Exchange sold on tracts whose value was counted in
millions. By 1990, the underlying value of all contracts traded at the Chicago Mercantile
Exchange totaled 50 trillion dollars. These currency Futures paved the way for the
successful marketing of a dizzying array of similar products at the Chicago Mercantile
Exchange, the Chicago Board of Trade, and the Chicago Board Options Exchange. By
the 1990s, these exchanges were trading Futures and options on everything from Asian
and American stock indexes to interest-rate swaps, and their success transformed
Chicago almost overnight into the risk-transfer capital of the world.

1.2.3 FUTURES TERMINOLOGY
Following are some terminologies of Futures.
1. Spot price: The price at which an asset trades in the spot market.
2. Futures price: The price at which the Futures contract trades in the Futures market.
3. Contract cycle: The period over which a contract trades. The index Futures contracts
on the NSE have one- month, two months and three months expiry cycles which
expire on the last Thursday of the month. Thus a January expiration contract expires
on the last Thursday of January and a February expiration contract ceases trading on
the last Thursday of February. On the Friday following the last Thursday, a new
contract having a three- month expiry is introduced for trading.
4. Expiry date: It is the last day on which the contracts expire. Futures and Options
contracts expire on the last Thursday of the expiry month. If the last Thursday is a
trading holiday, the contracts expire on the previous trading day. For E.g. The
January 2008 contracts mature on January 31, 2008.
5. Contract size: The amount of asset that has to be delivered under one contract. Also
called as lot size.
6. Basis: In the context of financial Futures, basis can be defined as the Futures price
minus the spot price. There will be a different basis for each delivery month for each
contract. In a normal market, basis will be positive. This reflects that Futures prices
normally exceed spot prices.
7. Cost of carry: The relationship between Futures prices and spot prices can be
summarized in terms of what is known as the cost of carry. This measures the storage
cost plus the interest that is paid to finance the asset less the income earned on the
asset.
8. Initial margin: The amount that must be deposited in the margin account at the time
a Futures contract is first entered into is known as initial margin. In other words, The
Initial Margin is the sum of money (or collateral) to be deposited by a firm to the

clearing corporation to cover possible future loss in the positions (the set of positions
held is also called the portfolio) held by a firm.
9. Marking-to-market: In the Futures market, at the end of each trading day, the
margin account is adjusted to reflect the investor's gain or loss depending upon the
Futures closing price. This is called marking-to-market. The Mark-to-Market Margin
(MTM margin) on the other hand is the margin collected to offset losses (if any) that
has already been incurred on the positions held by a firm. This is computed as the
difference between the cost of the position held and the current market value of that
position.
10. Maintenance margin: This is somewhat lower than the initial margin. This is set to
ensure that the balance in the margin account never becomes negative. If the balance
in the margin account falls below the maintenance margin, the investor receives a
margin call and is expected to top up the margin account to the initial margin level
before trading commences on the next day.
11. Contract cycle for Equity based products in NSE: Futures contracts have a
maximum of 3-month trading cycle -the near month (one), the next month (two) and
the far month (three), except for the Long dated Options contracts. New contracts are
introduced on the trading day following the expiry of the near month contracts. The
new contracts are introduced for three month duration. This way, at any point in time,
there will be 3 contracts available for trading in the market (for each security) i.e.,
one near month, one mid month and one far month duration respectively. For
example on January 26,2008 there would be three month contracts i.e. Contracts
expiring on January 31,2008,February 28, 2008 and March 27, 2008. On expiration
date i.e. January 31, 2008, new contracts having maturity of April 24, 2008 would be
introduced for trading.

1.2.4 TYPES OF FINANCIAL FUTURES CONTRACTS
In financial futures contracts the underlying asset could be a portfolio of stocks

represented by the S&P 500 i.e. stock index, currencies, T-bills, T-bonds, Eurodollar
deposits, etc.
a. Stock market index futures: A stock market index future is a cash-settled futures
contract on the value of a particular stock market index. Stock market index futures
are futures contracts used to replicate the performance of an underlying stock market
index. They can be used for hedging against an existing equity position, or
speculating on future movements of the index. Presently index futures contracts on
the following indices are available at NSE:
Indices: Nifty 50 CNX IT Index, Bank Nifty Index, CNX Nifty Junior, CNX 100,
Nifty Midcap 50, Mini Nifty and Long dated Options contracts on Nfity 50.
b. Single-stock futures: Single-stock futures are exchange-traded futures contracts

based on an individual underlying security rather than a stock index. Their
performance is similar to that of the underlying equity itself, although as futures
contracts they are usually traded with greater leverage. Another difference is that
holders of long positions in single stock futures typically do not receive dividends
and holders of short positions do not pay dividends. Single-stock futures may be
cash-settled or physically settled by the transfer of the underlying stocks at
expiration, although in the United States only physical settlement is used to avoid
speculation in the market. There are 228 Single stocks for futures contract.
c. Currency future: A currency future, also FX future or foreign exchange future, is a

futures contract to exchange one currency for another at a specified date in the future
at a price (exchange rate) that is fixed on the purchase date; see Foreign exchange
derivative. Typically, one of the currencies is the US dollar. The price of a future is
then in terms of US dollars per unit of other currency. This can be different from the
standard way of quoting in the spot foreign exchange markets. The trade unit of each
contract is then a certain amount of other currency, for instance €125,000. Most
contracts have physical delivery, so for those held at the end of the last trading day,
actual payments are made in each currency. However, most contracts are closed out

before that. Investors can close out the contract at any time prior to the contract's
delivery date.
d. Interest rate future: An interest rate future is a financial derivative (a futures

contract) with an interest-bearing instrument as the underlying asset. Examples
include Treasury-bill futures, Treasury-bond futures and Eurodollar futures. Interest
rate futures are used to hedge against the risk of that interest rates will move in an
adverse direction, causing a cost to the company.
1.2.5. FUTURES TRADERS:
Futures traders are traditionally placed in one of two groups: hedgers, who have
an interest in the underlying asset (which could include an intangible such as an index or
interest rate) and are seeking to hedge out the risk of price changes; and speculators, who
seek to make a profit by predicting market moves and opening a derivative contract
related to the asset "on paper", while they have no practical use for or intent to actually
take or make delivery of the underlying asset. In other words, the investor is seeking
exposure to the asset in a long Futures or the opposite effect via a short Futures contract.
A. HEDGERS: Hedgers are traders who apply strategies to reduce a risk of price
changes, typically include producers and consumers of a commodity or the owner of
an asset or assets subject to certain influences such as an interest rate. If you
primarily trade in futures, you hedge your futures against synthetic futures. A
synthetic in this case is a synthetic future comprising a call and a put position. Long
synthetic futures means long call and short put at the same expiry price. So if you are
long futures in your trade you can hedge by shorting synthetics, and vice versa
B. SPECULATORS: If hedgers are the people who wish to avoid price risk,
speculators are those who are willing to take such risk. Speculators are those who do
not have any position and simply play with the others money. 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. Here if
speculators view is correct he earns profit. In the event of speculator not being
covered, he will lose the position. They consider various factors such as demand

supply, market positions, open interests, economic fundamentals and other data to
take their positions.
Speculation in the Futures market:
1. Speculation is all about taking position in the Futures market without having the
underlying. Speculators operate in the market with motive to make money. They
take:
a. Naked positions: - Position in any future contract.
b. Spread positions: - Opposite positions in two future contracts. This is a

conservative speculative strategy.
2. Speculators bring liquidity to the system, provide insurance to the hedgers and
facilitate the price discovery in the market.
For example, in traditional commodity markets, farmers often sell Futures

contracts for the crops and livestock they produce to guarantee a certain price,
making it easier for them to plan. Similarly, livestock producers often purchase
Futures to cover their feed costs, so that they can plan on a fixed cost for feed. In
modern (financial) markets, "producers" of interest rate swaps or equity derivative
products will use financial Futures or equity index Futures to reduce or remove the
risk on the swap.
An example that has both hedge and speculative notions involves a mutual
fund or separately managed account whose investment objective is to track the
performance of a stock index such as the S&P 500 stock index. The Portfolio
manager often "equities" cash inflows in an easy and cost effective manner by
investing in (opening long) S&P 500 stock index Futures. This gains the portfolio
exposure to the index which is consistent with the fund or account investment
objective without having to buy an appropriate proportion of each of the individual
500 stocks just yet. This also preserves balanced diversification, maintains a higher
degree of the percent of assets invested in the market and helps reduce tracking error
in the performance of the fund/account. When it is economically feasible (an efficient
amount of shares of every individual position within the fund or account can be

purchased), the portfolio manager can close the contract and make purchases of each
individual stock.
The social utility of Futures markets is considered to be mainly in the transfer
of risk, and increased liquidity between traders with different risk and time
preferences, from a hedger to a speculator
1.2.6 HOW TRADERS TRADE:
Each of the types of traders previously described uses a different strategy to achieve his
goals.
A. Scalpers: A scalper trades in and out of the market many times during the day,
hoping to make a small profit on a heavy volume of trades. Scalpers attempt to buy at
the bid price and sell at the ask price, offsetting their trades within seconds of making
the original trade. Scalpers rarely hold a position overnight and often don’t trade or
make predictions on the future direction of the market. Locals and market makers
often employ a scalping strategy, which is the most common source of market
liquidity.
B. Day Traders: A day trader is similar to a scalper in that he or she also typically does
not hold positions overnight and is an active trader during the trading day. Day
traders trade both off and on the floor. A day trader makes fewer trades than a
scalper, generally holds his positions for a longer period of time than a scalper, and
trades based on a prediction on the future direction of the market. Proprietary traders,
locals and public traders are often day traders.
C. Position Traders: A position trader might make one trading decision and then hold
that position for days, weeks or months. Position traders are less concerned with
minor fluctuations and are more focused on long-term trends and market forces.
Public traders and proprietary traders are often position traders.
1.2.7. BASIC TRADING STRATEGIES IN FUTURES:
Dozens of different strategies and variations of strategies are employed by

Futures traders in pursuit of speculative profits. Here is a brief description and
illustration of several basic strategies such as,

A. Long
B. Short
C. Spread
These three Futures Trading strategies are explained as under.
A. LONG:
Buying (Going Long) to Profit from an Expected Price Increase; one who is
expecting the price of a particular commodity or item to increase over from a given
period of time can seek to profit by buying Futures contracts. If correct in forecasting the
direction and timing of the price change, the Futures contract can later be sold for the
higher price, thereby yielding a profit. If the price declines rather than increases, the
trade will result in a loss. Because of leverage, the gain or loss may be greater than the
initial margin deposit.
This example is taken from contract note of Way2Wealth Brokers Pvt.
Ltd. Take a brief review of this contract note in chapter Annexure.
Illustration 1.2.1:
Contract Note No. N/D/0223/103313 [Order no. 50842136 (buy) and 51188455 (sell)]
On 23 Feb., 2010, a Trader feels the market will rise

 Buys a contract of MINIFTY FUT XP: 25/03/2010 at Rs. 4862.10 (Market lot is 20,
Initial margin is 10% i.e. Rs. 9724.20)
On 23 Feb., 2010, MINIFTY FUT XP: 25/03/2010 price has risen to Rs. 4872
 Sells off the position at Rs. 4872. Makes a gross profit of
Rs.198 (9.90×20)

Trade Security Contract Bough Sold Gross Gross Brokerage Amount
time Description t Qty. Qty. Rate Per Total (Rs.) (Rs.)
Security (Rs.)
(Rs.)
10:4 MINIFTY FUT XP: 4862.1 97242.0 97271.1
20 29.17
2 25/03/2010 0 0 7
11:4 MINIFTY FUT XP: 4872.0 97440.0 97410.7
20 29.23
2 25/03/2010 0 0 7
Gross Profit 139.6
Service charges
(10.3% on total 6.02
brokerage)
Net profit (Net CR) 133.58
Illustration 1.2.2:
Contract Note No. N/D/0223/103313 [Order no. 52131173 (buy) and 53103990 (sell)]
On 23 Feb., 2010, a Trader feels the market will rise

 Buys a contract of MINIFTY FUT XP: 25/03/2010 at Rs. 4880.80 (Market lot is 20,
Initial margin is 10% i.e. Rs. 9761.60)
On 23 Feb., 2010, MINIFTY FUT XP: 25/03/2010 price has declined to Rs. 4860.15
 Sells off the position at Rs. 4860.15. Gross loss is of
Rs. 413 (20.65×20)

Security (Rs.)
(Rs.)
14:1 MINIFTY FUT XP: 4880.8 97616.0 97645.2
20 29.28
9 25/03/2010 0 0 8
14:5 MINIFTY FUT XP: 4860.1 97203.0 97173.8
20 29.16
4 25/03/2010 5 0 4
Gross Loss 471.44
Service charges
(10.3% on total 6.02
brokerage)
Net Loss (Net DR.) 477.46
B. SHORT:

Selling (Going short) to Profit from an Expected Price Decrease one who is
expecting the price of a particular commodity or item to decrease over from a given
period of time can seek to profit by selling Futures contracts. The only way ‘going short’
to profit from an expected price decrease differs from ‘going long’ to profit from an
expected price increase is the sequence of the trades. Instead of first buying a Futures
contract, you first sell a Futures contract. If, as expected, the price declines, a profit can
be realized by later purchasing an offsetting Futures contract at the lower price. The gain
per unit will be the amount by which the purchase price is below the earlier selling price.
Illustration 1.2.3:
Contract Note No. N/D/0223/103313 [Order no. 51188455 (sell) and 51847850 (buy)]
On 23 Feb., 2010, a Trader feels the market will bearish.

 Sell a contract of MINIFTY FUT XP: 25/03/2010 at Rs. 4872 (Market lot is 20,
Initial margin is 10% i.e. Rs. 9744)
On 23 Feb., 2010, MINIFTY FUT XP: 25/03/2010 price has declined to Rs. 4860.15
 Buy the position at Rs. 4860 to squares off the position. Gross profit gain of Rs. 240
(12×20)

Security (Rs.)
(Rs.)
10:5 MINIFTY FUT XP: 97410.7

20 4872 97440 29.23
3 25/03/2010 7
20 4860 97200 29.16
5 25/03/2010 6
Gross Profit 181.61
Service charges
(10.3% on total 6.01
brokerage)
Net Profit (Net CR.) 175.6
Investor is wrong. Instead of decreasing, the MINIFTY FUT XP: 25/03/2010

price increases. So, liquidate your short Futures position through an offsetting purchase.
The outcome would be as follows,

Illustration 1.2.4:
Contract Note No. N/D/0223/103313 [Order no. 51188455 (sell) and 51974179 (buy)]
On 23 Feb., 2010, a Trader feels the market will bearish.

 Sell a contract of MINIFTY FUT XP: 25/03/2010 at Rs. 4872 (Market lot is 20,
Initial margin is 10% i.e. Rs. 9744)
On 23 Feb., 2010, MINIFTY FUT XP: 25/03/2010 price has declined to Rs. 4873.
 Buy the position at Rs. 4873 to squares off the position. Gross loss is
Rs. 20 (1×20)

Security (Rs.)
(Rs.)

20 4872 97440 29.23
3 25/03/2010 7
20 4873 97460 29.24
2 25/03/2010 4
Gross Loss 78.47
Service charges
(10.3% on total 6.02
brokerage)
Net Loss (Net DR.) 84.49
C. SPREADS:
While most speculative Futures transactions involve a simple purchase of Futures

contracts to profit from an expected price increase or an equally simple sale to profit
from an expected price decrease numerous other possible strategies exist. Spreads are
one example. A spread, at least in its simplest form, involves buying one Futures contract
and selling another Futures contract. The purpose is to profit from an expected change in
the relationship between the purchase price of one and the selling price of the other.
Illustration 1.2.5.:
As an illustration, assume it's now November, that the March ABC Ltd. Futures
price is presently Rs. 260 and the May ABC Ltd. Futures price is presently Rs. 280, a

difference of Rs. 20. Your analysis of market conditions indicates that, over the next few
months, the price difference between the two contracts will widen to become greater than
Rs. 20. To profit if you are right, you could sell the March Futures contract (the lower
priced contract) and buy the May Futures contract (the higher priced contract). Assume
time and events prove you right and that, by February, the March Futures price has risen
to Rs. 286 and May Futures price is Rs. 308, a difference of Rs. 22. By liquidating both
contracts at this time, you can realize a net gain of Rs. 2 per share. Since each contract
lot is 300 shares, the total gain is Rs. 600 (Rs. 2 × 300 sh.).
November Sell March ABC Ltd. Buy May ABC Ltd. Spread
Futures Futures
Rs. 260 Rs. 280 Rs. 20
February Buy March ABC Ltd. Sell May ABC Ltd.
Futures Futures
Rs. 286 Rs. 308 Rs. 22
Rs. 26 loss Rs. 28 gain Rs. 2
3.2.8. WHY TRADE A FUTURES CONTRACT (Benefits)?
A. Leverage: One of the key benefits of trading in the Futures markets is that it offers
the trader financial leverage. Leverage is the ability of a trader to control large
amounts of a commodity with a comparatively small amount of capital. As such,
leverage magnifies both gains and losses in the Futures market. For example, a trader
bought a contract of MINIFTY FUT XP: 25/03/2010 at Rs. 4862.10 (Market lot is
20, total contract value is Rs. 97242), the required amount to trade, known as “Initial
margin,” might be approximately Rs. 9724.20 (margin is 10% of the contract value),
So for Rs. 9724.20 the trader can purchase a contract that has a delivery value of Rs.
97242.
The benefit of leverage is available because of the margin concept. When you
buy a stock, the amount of money required is equal to the price of the stock. As you
can see, minimum margin requirements represent a very small percentage of a
contract’s total value. To trade a Futures contract, the amount you must deposit in
your account is called initial margin. Based on the closing prices on each day that
you have that open position, your account is either debited or credited daily for you
to maintain your position. For example, assume you bought a contract of MINIFTY
FUT XP: 25/03/2010 at Rs. 4862 (Market lot is 20, total contract value is Rs. 97242),
posted initial margin. At the end of the trading day, the market closed at Rs. 4870,
resulting in a gain of Rs. 8 per index or a total of Rs. 160 (20 x Rs. 8). This amount
will then be credited to your account and is available for withdrawal. Losses, on the
other hand, will be debited. This process is called market-to-market.
Subsequent to posting initial margin, you must maintain a minimum margin
level called maintenance margin. If debits from market losses reduce your account
below the maintenance level, you’ll be asked to deposit enough funds to bring your
account back up to the initial margin level. This request for additional funds is known
as a margin call.
Because margins represent a very small portion of your total market
exposure, Futures positions are considered highly leveraged. Such “leverage,” the
ability to trade contracts with large underlying values, is one reason profits and losses
in Futures can be greater than trading the underlying cash contract. This can be an
attractive feature of Futures trading because little capital is required to control large
positions. At the same time, a bad trade can accrue losses very quickly. In fact, a
trader can lose more than his initial margin when trading Futures. This is why
successful traders must develop a sound trading plan and exercise great discipline in
their trading activities.
B. Liquidity: Another key benefit of Futures trading is liquidity. Liquidity is a

characteristic of a market to absorb large transactions without a substantial change in
the price. Liquid markets easily match a buyer with a seller, enabling traders to
quickly transact their business at a fair price. Some traders often equate liquidity with
trading volume, concluding that only markets with the highest actual number of
contracts traded are the most liquid. Index Futures contracts are considered highly
liquid than other Futures contracts, because index is considered less risky and needs
minimum margin. So, Index Futures are traded more than other Futures contract.
C. Transparency: Futures markets are considered to be “transparent” because the order
flow is open and fair. Everyone has an equal opportunity for the trade. When an order
enters the marketplace, the order fills at the best price for the customer, regardless of
the size of the order. With the advent of electronic trading, transparency has reached
new heights as all transactions can be viewed online in real time. In a very general
sense, transparency makes all market participants equal in terms of market access.
D. Financial Integrity: When making an investment, it is important to have confidence

that the person on the other end of the trade will acknowledge and accept your
transaction. Futures markets give you this confidence through a clearing service
provider system that guarantees the integrity of your trades. Clearing service
providers, in conjunction with their clearing member firms, create a two-tiered
guarantee system to protect the integrity of Futures and options markets. One tier of
the system is that the clearing service provider acts as the counterparty to Futures and
options trades— acting as a buyer to every seller and a seller to every buyer. The
other tier is that clearing firms extend their own guarantee to buyers and sellers who
are not clearing firms. All firms and individuals who do not hold memberships or
ownership interests in the clearinghouse must “clear” their trades through a clearing
firm, which then guarantees these trades to the clearinghouse. This allows all market
participants to rest easier because clearing firms will make good on the trades they
guarantee, even if the original counterparty defaults.
E. Price Risk Transfer: Hedging - Hedging is buying and selling futures contracts to
offset the risks of changing underlying market prices. Thus it helps in reducing the
risk associated with exposures in underlying market by taking a counter position in
the futures market. For example, an investor who has purchased a portfolio of stocks
may have a fear of adverse market conditions in future which may reduce the value
of his portfolio. He can hedge against this risk by shorting the index which is
correlated with his portfolio, say the Nifty 50. In case the markets fall, he would
make a profit by squaring off his short Nifty 50 position. This profit would
compensate for the loss he suffers in his portfolio as a result of the fall in the
markets.

OBJECTIVES:
1. To Study the suitability of Futures as a trading instrument for small traders.
2. To develop an in-depth understanding of derivatives trading.
3. To identify the reasons of small traders behind trading in Futures.
4. To find out the satisfaction level of small traders while investing in derivative vis-à-
vis intra-day equity trading.
NEED
I have done my Summer Internship in the broking firm which helped me to

understand the basics of stock and derivative market. I was inspired during my Summer
Internship to take up this project.
The project should be of help to brokers as it will provide information such as
satisfaction level of small traders while investing in derivative vis-à-vis intra-day equity
trading and reasons of small traders behind trading in Futures. This information will be
useful for brokers to understand the expectations and purposes of investor while
investing which will help them to develop their businesses and competitive advantage. In
this project, the researcher needs to study the suitability of Future derivatives for small
traders and to develop an in-depth understanding of Futures so as to elaborate why and
how is future derivatives a suitable trading tool for small traders which will help small
investors.

COMPANY PROFILE
NAME OF THE COMPANY
Way2Wealth Brokers Private Ltd.
DESCRIPTION
Way2Wealth is a investment consultancy offering investment advisory and facilitation

services to retail investors, corporate and institutions on Mutual Funds, Life Insurance,
Health Insurance, Equities, Derivatives and Fixed Income Investment products
Way2Wealth today has established itself as one of India’s ‘Premier Investments
Consultancy Firms’, known for making investing simpler, more understandable and
profitable for the investors. Way2Wealth offers a wide range of products & services viz:
Equity, Derivatives, Currency Futures, Commodities Trading, IPO's, Insurance
(Life/Non-Life), Mutual Funds, Portfolio Management Services & Depository Services
all under one roof, for the convenience and benefit of their customers. Way2Wealth
services their customer relationships through a team of over 1000 wealth managers
spread across 100 easily accessible 'Investment Outlets' in almost all major towns and
cities in India.
WAY2WEALTH’s MISSION
Way2Wealth is a premier Investment Consultancy Firm, launched with the

mission "To be the pre-eminent destination for personalized financial solutions helping
individuals creates wealth".
WAY2WEALTH’s PHILOSOPHY
Way2Wealth believe that "Their knowledge combined with Their investors trust
and involvement will lead to the growth of wealth and make it an exciting experience".

WAY2WEALTH’s LOGO
Blue symbolizes Knowledge.

Knowledge is limitless, so is the sky and sea, both of which are blue in colour.
Knowledge applied leads to creation of wealth for our Investors.

Red symbolizes Trust.
Red is the color of blood and the heart. Trust is a matter of the heart. Our
knowledge bears fruit only when the investor places his Trust in us.

Yellow symbolizes Excitement and Involvement of the investor.
We strive to make investing an exciting and involving experience for our
investors.

Green symbolizes Growth.
Growth in Nature is visible in the form of plants and trees; all of which are green.
"Knowledge, Trust and Excitement should ultimately lead to Growth of

the investors’ wealth."

APPLICATIONS OF FUTURES:
The phenomenal growth of financial derivatives across the world is attributed the
fulfillment of needs of hedgers, speculators and arbitrageurs by these products. In this
chapter we first look at how trading Futures differs from trading the underlying spot. We
then look at the payoff of these contracts, and finally at how these contracts can be used
by various entities in the economy.
A payoff is the likely profit/loss that would accrue to a market participant with
change in the price of the underlying asset. This is generally depicted in the form of
payoff diagrams which show the price of the underlying asset on the X-axis and the
profits/losses on the Y-axis.
4.1 TRADING UNDERLYING VERSUS TRADING SINGLE STOCK

FUTURES:
The single stock Futures market in India has been a great success story across the
world. NSE ranks first in the world in terms of number of contracts traded in single stock
futures. One of the reasons for the success could be the ease of trading and settling these
contracts.
To trade securities, a customer must open a security trading account with a

securities broker and a demat account with a securities depository. Buying security
involves putting up all the money upfront. With the purchase of shares of a company, the
holder becomes a part owner of the company. The shareholder typically receives the
rights and privileges associated with the security, which may include the receipt of
dividends, invitation to the annual shareholders meeting and the power to vote.
Selling securities involves buying the security before selling it. Even in cases
where short selling is permitted, it is assumed that the securities broker owns the security
and then "lends" it to the trader so that he can sell it. Besides, even if permitted, short
sales on security can only be executed on an up-tick.
To trade Futures, a customer must open a Futures trading account with a

derivatives broker. Buying Futures simply involves putting in the margin money. They
enable the Futures traders to take a position in the underlying security without having to

open an account with a securities broker. With the purchase of Futures on a security, the
holder essentially makes a legally binding promise or obligation to buy the underlying
security at some point in the future (the expiration date of the contract). Security Futures
do not represent ownership in a corporation and the holder is therefore not regarded as a
shareholder. A Futures contract represents a promise to transact at some point in the
future. In this light, a promise to sell security is just as easy to make as a promise to buy
security. Selling security Futures without previously owning them simply obligates the
trader to selling a certain amount of the underlying security at some point in the future. It
can be done just as easily as buying Futures, which obligates the trader to buying a
certain amount of the underlying security at some point in the future. In the following
sections we shall look at some uses of security future.
4.2 FUTURES PAYOFFS:

Futures contracts have linear payoffs. In simple words, it means that the losses
as well as profits for the buyer and the seller of a Futures contract are unlimited. These
linear payoffs are fascinating as they can be combined with options and the underlying to
generate various complex payoffs.
4.2.1 Payoff for buyer of Futures: (Long Futures):

The payoff for a person who buys a Futures contract is similar to the payoff for a
person who holds an asset. He has a potentially unlimited upside as well as a potentially
unlimited downside.
Illustration:
 Scrip : HDFC FUTSTK 25/3/2010 (Market lot is 200)
 Future price : Rs. 1944
The underlying asset in this case is the HDFC Bank share. When the price of
HDFC Bank moves up, the long Futures position starts making profits, and when the
index moves down it starts making losses. See Figure 4.2.1.

100
1945 HDFC FUTSTK

1845
erflgg 2045
100
Loss
Figure 4.2.1 Payoff for a buyer of Nifty Futures
The figure shows the profits/losses for a long Futures position. The investor bought
HDFCBANK FUTSTK at Rs. 1945. If the price goes up i.e. Rs.2045, his Futures
position starts making profit i.e.Rs.100 and if the prices falls up to Rs.1845, his Futures
position starts showing losses i.e. Rs.100.
4.2.2 Payoff for seller of Futures: (Short Futures)
The payoff for a person who sells a Futures contract is similar to the payoff for a
person who shorts an asset. He has a potentially unlimited upside as well as a potentially
unlimited downside. Take the above case of a speculator who sells a HDFCBANK
FUTSTK contract when the HDFC Bank stands at 1945. The underlying asset in this
case is the HDFC BANK scrip. When the prices moves down, the short Futures position
starts making profits, and when the prices moves up, it starts making losses. Figure 4.2.2
shows the payoff diagram for the seller of a Futures contract.

100
1945 HDFC FUTSTK

2045
erflgg 1845
100
Loss
Figure 4.2.2 Payoff for a seller of Nifty Futures
The figure shows the profits/losses for a short Futures position. The investor sold Futures
when the HDFC BANK was at 1945. If the price goes down up to 1845, his Futures
position starts making profit up to Rs. 100. If the price rises up to 2045, his Futures
position starts showing losses up to 100.

4.3. APPLICATION OF FUTURES
Understanding beta
The index model suggested by William Sharpe offers insights into portfolio
diversification. It expresses the excess return on a security or a portfolio as a function of
market factors and non market factors. Market factors are those factors that affect all
stocks and portfolios. These would include factors such as inflation, interest rates,
business cycles etc. Non-market factors would be those factors which are specific to a
company, and do not affect the entire market. For example, A fire breakout in a factory,
a new invention, the death of a key employee, a strike in the factory, etc. The market
factors affect all firms. The unexpected change in these factors causes unexpected
changes in the rates of returns on the entire stock market. Each stock however responds
to these factors to different extents. Beta of a stock measures the sensitivity of the stocks
responsiveness to these market factors. Similarly, Beta of a portfolio, measures the
portfolios responsiveness to these market movements. Given stock beta’s calculating
portfolio beta is simple. It is nothing but the weighted average of the stock betas.
The index has a beta of 1. Hence the movements of returns on a portfolio with a
beta of one will be like the index. If the index moves up by ten percent, my portfolio
value will increase by ten percent. Similarly if the index drops by five percent, my
portfolio value will drop by five percent. A portfolio with a beta of two, responds more
sharply to index movements. If the index moves up by ten percent, the value of a
portfolio with a beta of two will move up by twenty percent. If the index drops by ten
percent, the value of a portfolio with a beta of two will fall by twenty percent. Similarly,
if a portfolio has a beta of 0.75, a ten percent movement in the index will cause a 7.5
percent movement in the value of the portfolio. In short, beta is a measure of the
systematic risk or market risk of a portfolio. Using index Futures contracts, it is possible
to hedge the systematic risk. With this basic understanding, we look at some applications
of index Futures.
We look here at some applications of Futures contracts. We refer to single stock

Futures. However since the index is nothing but a security whose price or level is a

weighted average of securities constituting an index, all strategies that can be
implemented using stock Futures can also be implemented using index Futures
.
4.3.1 Hedging: Long security, Short Futures
Futures can be used as an effective risk-management tool. Take the case of an

investor who holds the shares of a company and gets uncomfortable with market
movements in the short run. Investors see the value of his security falling. In the absence
of stock Futures, he would either suffer the discomfort of a price fall or sell the security
in anticipation of a market upheaval. With security Futures he can minimize his price
risk. All he need do is enter into an offsetting stock Futures position, in this case, take on
a short Futures position. If the price of the security falls any further, he will suffer losses
on the security he holds. However, the losses he suffers on the security will be offset by
the profits he makes on his short Futures position.
Index Futures in particular can be very effectively used to get rid of the market
risk of a portfolio. Every portfolio contains a hidden index exposure or a market
exposure. This statement is true for all portfolios, whether a portfolio is composed of
index securities or not. In the case of portfolios, most of the portfolio risk is accounted
for by index fluctuations (unlike individual securities, where only 30- 60% of the
securities risk is accounted for by index fluctuations). Hence a position LONG
PORTFOLIO + SHORT NIFTY can often become one-tenth as risky as the LONG
PORTFOLIO position!
Suppose we have a portfolio of Rs. 1 million which has a beta of 1.25. Then a
complete hedge is obtained by selling Rs.1.25 million of Nifty Futures.

Illustration 4.3.1.: (Data source: Historical data of stocks from www.nseindia.com)
 Physical Position: Long HDFC BANK
 Futures Position: Short HDFCBANK FUTSTK
An Investor in spot market has brought 200 shares of HDFC Bank at the rate of Rs.
1705.7 on 4th Jan 2010. But he is bearish HDFC Bank in the short term to medium term
and hence decided to hedge his position.
Investor hedged his position by shorting 200 HDFC Bank (1 Lot) of 25 march 2010
future contract at the rate of Rs. 1719.75.
On 11th Feb. 2010,

In Futures market HDFC Bank was Rs.1603.15.
In Cash Market, price was Rs. 1598.
Details are as follows:

 Shares : HDFC Bank
 Exchange : NSE
 Units per lot :
 Lot size : 200
 Spot Price Rs (4th Jan 2010) : Rs. 1705.7
 Spot Price Rs (11th Feb 2010) : Rs. 1598
 Future price (4th Jan 2010) : Rs. 1719.75
 Future price (11th Feb. 2010) : Rs.1603.15
He closes out the futures position on 11 th Feb 2010 and the share holder approximately
gains Rs. 1719.75 – Rs. 1603.15 = Rs. 116.6
Whereas, the stock price of HDFC Bank came down as expected from Rs 1705.7 to Rs.
1598, where Hedger lost Rs 1598 - Rs 1705.7 = Rs 107.7 loss
Total gains / loss:

Physical position: Rs 107.7 × 200 sh. = Rs 21540 loss
Futures position: Rs 116.6 × 200 sh. = Rs 23320 gain
Overall Profit = Rs 23320 (gain) - Rs 21540 (loss) = Rs 1780 Profit.

Trade Security Contract Bought Sold Gross Gross Brokerag Amount
Date Description Qty. Qty. Rate Per Total e (0.03% (Rs.)
Security (Rs.) on total
(Rs.) amt.)
(Rs.)
34114 341242.3
4/1/10 HDFCBANK 200 1705.7 102.34
0 4
200
HDFCBANK 1719.7 34395 343846.8
4/1/10 (1 103.19
FUTSTK 25/3/10 5 0 1
lot)
11/2/1 31960 319504.1
HDFCBANK 200 1598 95.88
0 0 2
200
11/2/1 HDFCBANK 1603.1 32063 320726.1
(1 96.19
0 FUTSTK 25/3/10 5 0 9
lot)
Gross profit 1382.40
Service charges
(10.3% on total 40.95
brokerage)
Net Profit (Net
1341.45
CR.)
So, Investor earned Rs. 1341.45 Net Profit by using hedging strategy.
Conclusion:
Thus we can conclude that by completely hedging the price of Shares of HDFC Bank by
shorting futures contract the share holder has successfully managed to transfer the risk of
decrease in prices of shares. If he had not used hedging technique then he would have
made a loss of Rs 21540.
Warning:
Hedging does not always make money. The best that can be achieved using hedging is
the removal of unwanted exposure, i.e. unnecessary risk. The hedged position will make
less profit than the unhedged position, half the time. One should not enter into a hedging
strategy hoping to make excess profits for sure; all that can come out of hedging is
reduced risk.

4.3.2 Speculation: Bullish security, Long Futures
Take the case of a speculator who has a view on the direction of the market. He
would like to trade based on this view. He believes that a HDFC BANK security that
trades at Rs.1705.7 (0n 4th Jan 2010) is undervalued and expects its price to go up in the
next two-three months. How can he trade based on this belief? In the absence of a
deferral product, he would have to buy the security and hold on to it. Assume he buys
200 shares which cost him one Rs.341140. His hunch proves correct and on 25 th march
2010 the security closes at Rs.1926.15. He makes a profit of Rs.44090 on an investment
of Rs. 341140 for a period of two months and 21 days. This works out to an annual
return of 56.14 percent.
A speculator can take exactly the same position on the security by using Futures
contracts. Let us see how this works.
The Same security is trades at Rs. 1719.75 (on 4 th Jan 2010) in the stock Futures
market. Just for the sake of comparison, assume that the minimum contract value is
Rs.343950. He buys 1 lot of HDFC Bank Futures for which he pays a margin of Rs.
68790 (margin is 20%). On 25th march 2010 security closes at 1926.8. On the day of
expiration, the Futures price converges to the spot price and he makes a profit of
Rs.41410 on an investment of Rs. 68790. This works out to an annual return of 240.79
percent. Because of the leverage they provide, securities Futures form an attractive
option for speculators.
4.3.3 Speculation: Bearish security, Short Futures
Stock Futures can be used by a speculator who believes that a particular security
is over-valued and is likely to see a fall in price. How can he trade based on his opinion?
In the absence of a deferral product, there wasn't much he could do to profit from his
opinion. Today all he needs to do is sell stock Futures.
Let us understand how this works. Simple arbitrage ensures that Futures on an
individual securities move correspondingly with the underlying security, as long as there
is sufficient liquidity in the market for the security. If the security price rises, so will the
Futures price. If the security price falls, so will the Futures price.

Now take the case of the trader who expects to see a fall in the price of ACC. He
sells one two-month contract of Futures on FUTSTK ACC 25/3/2010 at Rs. 966.5 (each
contact for 376 underlying shares). He pays a 20% margin on the same. Two months
later, when the Futures contract expires, FUTSTK ACC closes at 934.85. On the day of
expiration, the spot and the Futures price converges. He has made a clean profit of Rs.32
per share. For the one contract that he bought, this works out to be Rs.12032. (Rs. 32
×376 shares)
4.3.4 Arbitrage: Overpriced Futures: buy spot, sell Futures
As we discussed earlier, the cost-of-carry ensures that the Futures price stay in
tune with the spot price. Whenever the Futures price deviates substantially from its fair
value, arbitrage opportunities arise.
If you notice that Futures on a security that you have been observing seem
overpriced, how can you cash in on this opportunity to earn riskless profits?
On 20th Jan. 2010, ACC trades at Rs.929. Three- month FUTSTK ACC Futures
trade at Rs.940 and seem overpriced. As an arbitrageur, you can make riskless profit by
entering into the following set of transactions.
1. On day one, buy the security on the cash/spot market at Rs.929.

2. Simultaneously, sell the Futures on the security at Rs.940.
3. Take delivery of the security purchased and hold the security for 3 month.
4. On the Futures expiration date i.e. 25 th march 2010, the spot and the Futures price
converge. Now unwind the position.
5. On 25th march 2010, the security closes at Rs.934.85. Sell the security.
6. Futures position expires with profit of Rs.5.15.
7. The result is a riskless profit of Rs. 5.85 on the spot position and Rs.5.15 on the
Futures position.

Trade Security Contract Bought Sold Gross Gross Brokerag Amount
Date Description Qty. Qty. Rate Total e (0.03% (Rs.)
Per (Rs.) on total
Security amt.)
(Rs.) (Rs.)
20/1/1 349408.7
ACC 376 929 349304 104.79
0 9
376
20/1/1 ACC FUTSTK 353333.9
(1 940 353440 106.03
0 25/3/10 7
lot)
25/3/1 934.8 351398.1
ACC 376 351503.6 105.45
0 5 5
376
25/3/1 ACC FUTSTK 934.8 351609.0
(1 351503.6 105.45
0 25/3/10 5 5
lot)
Service charges
(10.3% on total 43.44
brokerage)
Net Profit (Net
3670.84
CR.)
When does it make sense to enter into this arbitrage? If your cost of borrowing
funds to buy the security is less than the arbitrage profit possible, it makes sense for you
to arbitrage. This is termed as cash-and-carry arbitrage. Remember however, that
exploiting an arbitrage opportunity involves trading on the spot and Futures market. In
the real world, one has to build in the transactions costs into the arbitrage strategy.
4.3.5 Arbitrage: Underpriced Futures: buy Futures, sell spot
Whenever the Futures price deviates substantially from its fair value, arbitrage
opportunities arise. It could be the case that you notice the Futures on a security you hold
seem underpriced. How can you cash in on this opportunity to earn riskless profits?
Illustration 4.3.5:
On 14th Jan 2010, ACC Ltd. trades at Rs.955.1. Three month ACC Futures trade at Rs.
881.4 and seem underpriced. As an arbitrageur, you can make riskless profit by entering
into the following set of transactions.
1. On 14th Jan 2010, sell the security in the cash/spot market at Rs.955.
2. Make delivery of the security.
3. Simultaneously, buy the Futures on the security at Rs. 881.4.
4. On the Futures expiration date, the spot and the Futures price converge. Now unwind
the position.
5. On 25th march 2010, ACC closes at Rs.934.85. Buy back the security.
6. The Futures position expires with a profit of Rs.53.45.
7. The result is a riskless profit of Rs.20.15 on the spot position and Rs.53.45 on the
Futures position.
Trade Security Contract Bough Sold Gross Gross Brokerag Amount
Date Description t Qty. Qty. Rate Total e (0.03% (Rs.)
Per (Rs.) on total
Securit amt.)
y (Rs.) (Rs.)
20/1/1 358972.2
ACC 376 955 359080 107.72
0 8
376
20/1/1 ACC FUTSTK 331406. 331505.8
(1 881.4 99.42
0 25/3/10 4 2
lot)
25/3/1 934.8 351503. 351609.0
ACC 376 105.45
0 5 6 5
376
25/3/1 ACC FUTSTK 934.8 351503. 351398.1
(1 105.45
0 25/3/10 5 6 5
lot)
Service charges
(10.3% on total 43.06
brokerage)
Net Profit (Net
27425.35
CR.)
If the returns you get by investing in riskless instruments is more than the return
from the arbitrage trades, it makes sense for you to arbitrage. This is termed as reverse-
cash-and-carry arbitrage. It is this arbitrage activity that ensures that the spot and Futures
prices stay in line with the cost-of-carry. As we can see, exploiting arbitrage involves
trading on the spot market. As more and more players in the market develop the
knowledge and skills to do cash-and-carry and reverse cash-and-carry, we will see
increased volumes and lower spreads in both the cash as well as the derivatives market.

RESEARCH METHODOLOGY
1. Research Design:
Type of research: Exploratory research, in our research the design is exploratory
research. In this research we will discuss the topic with share brokers and investor,
who are regularly concerned with security market.
2. Sampling Design:
a. Type of sampling: Stratified Random Sampling, Expert sampling.
b. Method of sampling: Probability Sampling, Convenience sampling.
c. Sample size: Experts – 25
Small Traders – 100
3. Method of Data Collection:
a. Primary data: Primary data will be collected by survey method in which self
administered questionnaire will be used and interview of experts and traders.
b. Secondary data: Secondary data will be collected through data published in

various publications like newspaper, journals, magazines and internet web-sites.
4. Data Analysis and Interpretations:

Various statistical tools and techniques using tables, charts and graphs have been
used to interpret and analyze collected data. Exploratory data analysis technique is
going to be employed in which graphical and quantitative technique is used.
5. Assumptions:
 The selected sample represents the whole population of small investors.
 The small investors entail low risk taking group of investors who have an annual
income close to Rs. 3.50 lacks.
6. Hypothesis:
H0: Futures is a suitable and beneficial financial instrument for small traders for
investing in financial derivatives.

DATA COLLECTED FROM SMALL TRADERS
1. Age: % of traders belongs to following age group.
DATA COLLECTED:
Age Group in Years No. of traders % of Traders
21 - 25 yr. 15 15%
26 - 30 yr. 20 20%
31 - 35 yr. 20 20%
36 - 40 yr. 30 30%
41 - 45 yr. 7 7%
46 - 50 yr. 5 5%
51 - 56 yr. 3 3%
DATA ANALYSIS:
% of Traders % belongs to following age group.

46 - 50 yr. 3%
5%
41 - 45 yr. 21 - 25 yr.
7% 15%
26 - 30 yr.
20%
36 - 40 yr.
30%
31 - 35 yr.
20%
INTERPRETATION:
Maximum % of traders group i.e. 30 % traders belongs to 36 years to 40 years
whose annual income is more than 3 lacks per annum and their risk taking capacity is
more than the traders group who belongs to 51 – 56 years age group. Minimum % of
traders group i.e. 3% traders belongs to 51 – 56 years age group.

2. How long have you been trading?
DATA COLLECTION:
Trading experience in years No. of Traders.

Less than 1 6
1-3 14
3-5 23
5-7 37
More than 7 20
DATA ANAYLASIS:
No. of Traders.
Less than 1
6%
More than 7 3-Jan

20% 14%
5-Mar
23%
7-May
37%
DATA INTERPRETATION:
On the basis of above analyzed data, it can interpret that maximum trader i.e.
37% traders have 5 to 7 years trading experience.

3. Occupation: % of traders belongs to following different occupations.
DATA COLLECTED:
Occupations No. of Traders % of Traders
Govt. servant 7 7%
Pvt. Servant 40 40%
Businessmen 50 50%
Other 3 3%
DATA ANALYSIS:
% of traders belongs to given occupations

Other Govt. servent
3% 7%
Businessmen Pvt. Servent

50% 40%
INTERPRETATION:
Maximum % of traders group i.e. 70 % traders are Businessmen which includes
small entrepreneurs, shop keepers, etc. Their income level is more than 3.5 lacks per
annum. Minimum % of traders groups i.e. 3% traders are from other occupations i.e.
students, unemployed persons etc.

4. Income: % of traders belongs to following income group.
DATA COLLECTED:
Income levels No. of traders % of traders
Below 1 lack 5 5%
1 - 3 lack 70 70%
3 - 5 lack 25 25%
DATA ANALYSIS:
% of traders belongs to following income group.

Below 1 lack
5%
3 - 5 lack
25%
1 - 3 lack
70%
INTERPRETATION:
In this project sample traders are needed from the group having 1-3 lacks per
annum income level, because this group is considered as a small trader’s group. 70%
small traders are studied in this research which belongs to this group.

5. % people believe in trading or investing?
DATA COLLECTED:
No. of traders % people believe in trading or
Particular investing
Trade 5 5%
Invest 20 20%
Both 75 75%
DATA ANALYSIS:
% people believe in trading or investing

Trade
5%
Invest
20%
Both
75%
INTERPRETATION:
75% Investors believe in both i.e. trading and investing because it is found that
investing is less risky and more profitable than trading. But, trading has its benefits. Two
important of them are liquidity and quick profit generation. But 20% investors believe
only to invest which is more than 5% traders who believe only trading. So it can
conclude that investing is better than trading.

6. % investors who invest according to different ratios of trade : invest.
DATA COLLECTED:
Diff. Ratios of Trade : Invest No. of investors % investors
0:0 15 15%
1:9 20 20%
2:8 30 30%
3:7 10 10%
4:6 20 20%
5:5 10 10%
DATA ANALYSIS:
% investors who invest according to different ratios of trade : invest.
5:05
10% 0:10
14%
4:06
19%
1:09
19%
3:07
10%
2:08
29%
INTERPRETATION:
In the above diagram we can see that % of traders are increasing according to the
ratio of Trade : Invest. But from the ratio of 2:8 the % of traders are tends to decreasing.
30% traders trade and invest in the ratio of 2:8. So it can conclude that 2:8 is the standard
ratio to trade and invest.

7. % traders have knowledge of Futures trading.
DATA COLLECTED:
level of knowledge % traders have knowledge of Futures
Brief Knowledge 23%
Sufficient Knowledge 74%
Concept only 3%
Don't have Knowledge 0
DATA ANALYSIS:
% traders have knowledge of Futures trading

Concept only
3%
Brief Knowledge
23%
Sufficient Knowledge
74%
INTERPRETATION:
Knowledge of Futures instrument is good among the traders. 74% traders have
sufficient knowledge about future trading. Whereas 23% traders have brief knowledge of
future trading and 3% traders know the concept of Futures trading only.

8. % traders generally trade in following instruments.
DATA COLLECTED:
Instruments % traders who trades in following instruments
Futures 2%
Equity 64%
Both 34%
DATA ANALYSIS:
% traders who trades in following instruments

Futures
2%
Both
34%
Equity
64%
INTERPRETATION:
As shown in the above diagram 64% traders’ trade only in Equity and only 2%
traders trade in Futures only. 34% traders trade in both instruments. So it can conclude
that 98% Traders refers Equity as a trading instrument whereas only 36% traders believe
in Futures which is very much less than Equity. There are 5% people believe in trade
only and 2% of 5% i.e. 0.01% people are Futures traders only which belongs to group
having income level more than 3.5 lack. Numbers of Futures traders are very much less
in comparison with Equity traders which show the unsuitability of Futures for small
traders.

9. % Traders who trades in different ratios of Futures: Equity.
DATA COLLECTED:
Futures : Equity % Traders who trades in different ratios of Futures: Equity.
0:4 64%
1:3 23%
2:2 7%
3:1 4%
4:0 2%
DATA ANALYSIS:
% Traders who trades in different ratios of Futures: Equity.

3:01 4:00
4% 2%
2:02
7%
1:03
23%
0:04
64%
INTERPRETATION:
As shown in the above diagram % of traders is 64% which is maximum where
the Futures:Equity ratio is 0:4. % of traders decreases according to increasing ratio of
Future:Equity. i.e. 23% traders trade in ratio of 1:3, 7% traders trade in ratio of 2:2 and
only 2% traders trade in ratio of 4:0. There are 5% people believe in trade only and 2%
of 5% which again come to 0.01% Futures Traders.

10. % of traders who consider following things while trading.
DATA COLLECTED:
Particular % of traders who consider Risk /Return /Both
Risk 20%
Return 10%
Both 70%
DATA ANALYSIS:
% of traders who consider Risk /Return /Both
Risk
20%
Return
10%
Both
70%
INTERPRETATION:
As shown in the above diagram, 10% traders consider only return during trading
and they belong to group having higher income and risk taker. 20% traders only consider
risk while trading which belongs to the group of small traders. And 70% traders consider
both i.e. risk and return which include small traders.

11. % of traders who earned from trading in the last year?
DATA COLLECTED:
Profit % trader earned profit from future trading.
loss 33%
0 - 20 % 42%
21 - 40% 20%
41 - 60% 5%
DATA ANALYSIS:
% trader earned profit from future trading.

41 - 60%
5%
21 - 40% loss
20% 33%
0 - 20 %
42%
INTERPRETATION:
42% traders earned 0-20% profit, 20% traders earned 21-40% profit and only 5%
traders earned 41-60% profit. So, nominal rate of return is 0-20%, which is less than the
associated risk. 33% traders suffered loss in Future Tradings

12. Satisfaction levels: % of traders according to Satisfaction levels.
DATA COLLECTED:
Satisfaction levels % Traders according to Satisfaction levels.
High 0%
Medium 33%
low 47%
Not Satisfied 20%
DATA ANALYSIS:
% Traders according to Satisfaction levels.
Not Satisfied
20%
Medium
33%
low
47%
INTERPRETATION:
As given in the above diagram, 20% Futures are not satisfied, 47% traders are
less satisfied and 33% traders are medium satisfied with Futures. But there is not any
trader who is highly satisfied with Futures. Overall trader’s satisfaction level is low.

Data collected from brokers
1. How long you have been in this profession?
DATA COLLECTED:
Years No. of brokers % of Brokers having experience of future
market
1 yr. - 3 yr. 7 28%
4 yr. – 6 yr. 13 52%
7 yr. - 9 yr. 5 20%
DATA ANALYSIS:
% of Brokers having experience of future market
7 yr. - 9 yr.
20% 1 yr. - 3 yr.
28%
4 yr. - 6 yr.
52%
INTERPRETATION:
In this project, 52% samples are selected from the group of brokers having
experience of 4-6 years, 28% from 1-3years experienced groups and 20 % samples are
from 7-9 years experienced group of brokers.

2. How many clients (Future traders) do you have?
DATA COLLECTED:
% of regular client No. Of brokers % of Brokers having regular clients (Futures Traders)
20% -25% 3 14%
26% - 30% 4 14%
31% - 35% 5 20%
36% - 40% 6 24%
41% - 45% 4 16%
46% - 50% 3 12%
DATA ANALYSIS:
% of Brokers having regular clients (Futures Traders)
46% - 50% 20% -25%

12% 14%
41% - 45% 26% - 30%

16% 14%
31% - 35%
36% - 40% 20%
24%
INTERPRETATION:
As shown in the above diagram 13% brokers have 20%-25% regular clients
which is less than 17% brokers having 46% - 50% regular futures traders. 30%-40%
clients are regular futures traders.

3. Do you find any growth in the no. of clients who trade in Futures market?
DATA COLLECTED:
Responses traders of Futures No. of Brokers % of Brokers experienced the growth in no. of
client (Futures Trader)
Yes 14 56%
No 11 44%
DATA ANALYSIS:
% of Brokers experienced the growth in no. of client (Futures Trader)
No
44%
Yes
56%
INTERPRETATION:
As shown in the above diagram, only 56% growth is found in the no. of Future
trader. So we can say that Future is quite attractive than other trading instruments due to
its benefits which leads to more entries in future segments. Another reason is that revival
of economy from recession. So economy is developing which leads to increasing
profitability industries and indirectly futures segment. So, new futures traders are
participating in futures.

4. If yes, then how much %?
DATA COLLECTED:
% of Growth in No. of Futures No. of traders % Of Brokers who found growth in No.
Traders of Futures Traders
0% growth, 11 44%
5% growth, 2 8%
10% growth, 5 20%
15% growth, 4 16%
20% growth, 1 4%
25% growth , 2 8%
DATA ANALYSIS:
% Of Brokers who Found Growth in No.of futures traders

25% growth ,
8%
20% growth,
4%
15% growth,
16% 0% growth,
44%
10% growth,
20%
INTERPRETATION:
5% growth,
8%
As shown in the above diagram, there are 45% brokers who did not find any
growth in no. of futures clients. But, 10% growth in no. of futures clients is experienced
by maximum brokers i.e. 20% brokers. This % of brokers decreases according to the
decreasing growth in no. of futures clients. That means normal growth is 10% annually.

5. Do you find any growth in the Futures trading?
DATA COLLECTED:
Responses No. of brokers % of Brokers found growth in the Futures Trading.
Yes 8 32%
No 17 68%
DATA ANALYSIS:
% of Brokers found growth in the Futures Trading.
Yes
32%
No
68%
INTERPRETATION:
As shown in the above diagram, there are 68% brokers who did not find any
growth of trading in futures segments. Only 32% brokers found growth in the futures
trading. The major reason behind this growth is recovery of economy from recession.

6. If yes, then how much?
DATA COLLECTED:
No. of brokers % of Brokers Found The growth in Futures
Growth Trading.
0% 17 68%
5% 2 8%
10% 1 4%
15% 1 4%
20% 1 4%
25% 3 12%
DATA ANALYSIS:
Actual % Growth achieved in futures trading; Broker-vise Break up.
80%
70% 68%
60%
50%
40%
30%
20%
12%
10% 8%
4% 4% 4%
0%
0% 5% 10% 15% 20% 25%
% of Brokers Found The growth in Futures Trading.

INTERPRETATION:
As shown in the 6th diagram, there are only 30% brokers who experienced growth
in futures trading. In which maximum brokers i.e. 10% brokers experienced 25% growth
in futures trading. So it can say that normal trading growth is 25%.

7. Do you believe in trading or investing?
DATA COLLECTED:
Particular No. of brokers % of Brokers who believes in Trading and Investing
Trade 0 0%
Invest. 8 32%
Both 17 68%
DATA ANALYSIS:
% of Brokers who believes in Trading and Investing
Invest.
32%
Both
68%
INTERPRETATION:
68% brokers suggest their client to trade and invest and 32% brokers suggest
their client to invest only. But no one broker suggests to their clients to trade. So, it can
conclude that only trading is not good option to increase once income. So, one should
invest and trade to increase his income.

8. Which instrument do you generally suggest your clients for trading?
DATA COLLECTED:
Instrument No. of brokers % Brokers according to their suggestions
Futures 1 4%
Equity 24 96%
Other 0 0%
DATA ANALYSIS:
% Brokers according to their suggetions

Futures
4%
Equity
96%
INTERPRETATION:
As shown in the above diagram, 96% brokers suggest their clients to trade in
Equity only and only 4% brokers suggest their clients (traders having more risk taking
capacity) to trade in Futures only. So we can say that Equity is better than Futures to
trade.

9. According to you, what is the minimum amount that one needs for trading?
DATA COLLECTED:
Amounts No. of brokers % Responses of the Brokers.
1,00,000 Rs. 8 32%
75,000 Rs. 1 4%
50,000 Rs. 9 36%
40,000 Rs. 5 20%
25,000 Rs. 2 8%
DATA ANALYSIS:
% Responces of the Brokers.

25,000 Rs.
8%
40,000 Rs. 1,00,000 Rs.

20% 32%
75,000 Rs.
4%
50,000 Rs.
36%
INTERPRETATION:
As shown in the above diagram 36% brokers gave their opinions that minimum
amount to trade futures is 50,000 Rs. And according to 32% brokers, Rs. 1,00,000 is
minimum amount to trade futures, which is not affordable by small traders ( below the
income level of Rs. 3,50,000 per annum).

10. While trading in Futures what must one consider?
DATA COLLECTED:
Responses No. of brokers % of responses of Brokers
Risk 7 28%
Return 0%
Both 18 72%
DATA ANALYSIS:
% of responces of Brokers
Risk
28%
Both
72%
INTERPRETATION:
As shown in the above diagram, 72% brokers suggest to consider risk and return.
28% brokers suggest to consider only risk but no one brokers suggest to consider return
only.

11. What was the average profit of your clients from Futures trading in the last year?
DATA COLLECTED:
Responses No. of brokers % of responses of Brokers for profit
loss 4 16%
5% - 10% 9 36%
11% - 15% 5 20%
16% - 20% 2 8%
21% - 25% 3 12%
26% - 30% 2 8%
DATA ANALYSIS:
% of responces of Brokers for profit

40%
5% - 10%; 36%
35%
30%
25%
11% - 15%; 20%
20%
loss; 16%
15%
21% - 25%; 12%
10% 16% - 20%; 8% 26% - 30%; 8%
5%
0%
loss 5% - 10% 11% - 15% 16% - 20% 21% - 25% 26% - 30%
INTERPRETATION:
As shown in the above diagram, 36% brokers have futures clients who earned 5%
- 10% profit from futures trading and 20% brokers have futures clients who earned 11% -
15% profit from futures trading. 16% brokers have clients who suffer loss from futures
trading.

12. What is the % of satisfied client and unsatisfied client in respect of Futures trading?
DATA COLLECTED:
Satisfaction levels No. of brokers % of Responses of Brokers for satisfied Futures Traders
Nil 4 16%
1% - 10% 3 12%
11% - 20% 2 8%
21% - 30% 4 16%
31% - 40% 1 4%
41% - 50% 3 12%
51% - 60% 1 4%
61% - 70% 2 8%
71% - 80% 1 4%
81% - 90% 1 4%
91% -100% 3 12%
DATA ANALYSIS:
% of Responces of Brokers for satisfied Futures Traders

18%
Nil; 16% 21% - 30%; 16%
16%
14%
1% - 10%; 12% 41% - 50%; 12% 91% -100%; 12%
12%
10%
11% - 20%; 8% 61% - 70%; 8%
8%
6%
31% - 40%; 4% 51% - 60%; 4% 71% - 80%;81%
4%- 90%; 4%
4%
2%
0%

Responses No. of brokers % of Responses of Brokers for unsatisfied Futures Traders
Nil 1 4%
1% - 10% 3 12%
11% - 20% 0 0%
21% - 30% 4 16%
31% - 40% 0 0%
41% - 50% 2 8%
51% - 60% 3 12%
61% - 70% 1 4%
71% - 80% 2 8%
81% - 90% 2 8%
91% -100% 7 28%
DATA ANALYSIS:
30%
% of Responces of Brokers for unsatisfied Futures Traders
91% -100%; 28%
25%
20%
21% - 30%; 16%
15%
1% - 10%; 12% 51% - 60%; 12%
10%
41% - 50%; 8% 71% - 80%;
81%8%- 90%; 8%
5% Nil; 4% 61% - 70%; 4%
11% - 20%; 0% 31% - 40%; 0%

0%
INTERPRETATION:
As shown in the above two diagram, percentage of satisfied futures traders are
lesser than the percentage of unsatisfied futures traders. There are 28% brokers who 91%
- 100% have unsatisfied futures clients whereas only 12% brokers have 91% - 100%
satisfied futures traders.

13. How was your clients’ trading experience in respect of future trading? (Satisfaction
levels)
DATA COLLECTED:
Satisfaction levels No. of brokers % Responses of Brokers for Satisfaction level of Futures
Traders
Highly Satisfied 0 0%
Moderate Satisfied 6 24%
Not so Satisfied 9 36%
Unsatisfied 10 40%
DATA ANALYSIS:
% Responces of Brokers for Satisfaction level of Futures Traders
Moderate Satisfied
Unsatisfied 24%
40%
Not so Satisfied
36%
INTERPRETATION:
There is no one broker having highly satisfied clients with futures trading.
But 40% brokers have unsatisfied clients and remaining 60% brokers have clients who
are low and moderate satisfied

14. Did you lose any future trading client due to bad experience in Futures trading?
DATA COLLECTED:
Responses No. of brokers % of Brokers who Lose Futures traders
Yes 20 80%
No 5 20%
DATA ANALYSIS:
% of Brokers who Lose Futures traders
No
20%
Yes
80%
INTERPRETATION:
There are 20% brokers who lose futures traders due to bad experience i.e.
unsustainable losses, unsatisfied with profit, etc.

15. Do you have any client who has shifted from Futures trading to other (equity)
trading?
DATA COLLECTED:
Responses No. of brokers % of Brokers having clients who shifted from Futures to
Equity Trading
Yes 18 72%
No 7 28%
DATA ANALYSIS:
% of Brokers having clients who shifted from Futures to Equity Trading
No
28%
Yes
72%
There are 72% brokers who found the clients shifted from futures trading to
equity trading due to various reasons.

16. Do you think future trading is suitable for small traders? Please, mention 3 reasons. If
not, then which is a suitable instrument for small traders?
DATA COLLECTED:
Responses No. of brokers % of Brokers who thinks Futures Trading is not suitable for
small traders
Suitable 1 4%
Not Suitable 24 96%
DATA ANALYSIS:
% of Brokers who thinks Futures Trading is not suitable for small traders
Suitable
4%
Not Suitable
96%
INTERPRETATION:
As shown in the above diagram, 95% brokers gave their opinion that future
trading is suitable for small traders, because small traders could not sustain in futures
market.
*98% brokers have suggested trading in equity only. Remaining 2%

Brokers has suggested for small traders that not to trade or speculate.

* The reasons given by traders and brokers that Futures is not suitable
instrument for small traders.
1. High risk
2. Big lump-sum amount of margins.
3. Profit and losses are not limited and higher comparatively Equity and Option.
4. Small traders are not capable to hold position till to expire.
5. Futures might require max mark to market margins.
6. Futures is a hedging instrument, it is not a trading instrument.
7. Equity and options are better trading instrument than Futures.
8. Futures need maximum money than equity for trading.
E.g.: one needs minimum 5000 Rs. to trade in Equity. But, one needs minimum
25,000 Rs. – 50,000 Rs. to trade in Futures.

CONCLUSIONS:-
Investors must understand that investment in derivatives has an element of risk
and is generally not an appropriate avenue for someone of limited resources/ limited
investment and / or trading experience and low risk tolerance. An investor should
therefore carefully consider whether such trading is suitable for him or her in the light of
his or her financial condition. There can be no guarantee of profits or no exception from
losses while executing orders for purchase and / or sale of derivative contracts.
Small Traders come up with small funds and generally, they have limited
resources/ limited investment and / or trading experience and low risk tolerance. The
profit side i.e. winning side could be days of prosperity for small traders. But in loss,
small trader might vanish from market. He cannot sustain the losses. Because there is no
limit of profit in the Futures contract and there is no limit of losses also. To have a live
sense take an example:
Example 1.
An investor purchased 100 Nifty Futures @ Rs. 4200 on June 10.

 Expiry date is June 26.
 Total Investment: Rs. 4,20,000.
 Initial Margin paid : Rs.42,000
On June 26, suppose, Nifty index closes at 3,800.
 Loss to the investor (4200 – 3780) X 100 = Rs. 42,000
*The entire initial investment (i.e. Rs. 42,000) is lost by the investor.
Example 2.
An investor purchased 100 ABC Ltd. Futures @ Rs. 2500 on June 10.
Expiry date is June 26.
Total Investment: Rs. 2,50,000.
Initial Margin paid: Rs. 37,500
On June 26, suppose, ABC Ltd. shares close at Rs. 2000.
Loss to the investor (2500 – 2000) X 100 = Rs. 50,000
In the first example investors lost entire initial investment and in the second
example he suffered extra loss as well as entire initial investment. In the above example

transaction cost, brokerage, service tax and stamp duty are not considered which is also
added to losses.
‘Futures trading’ is very beneficial in contexts such as leverage, liquidity,

transparency, risk transfer and low transaction cost. However, Small trader cannot
sustain in Futures market during the days of losses. Therefore,
1. ‘Futures’ is not a suitable and beneficial financial instrument for

small traders for investing/trading in financial derivatives.
2. Equity instrument is a suitable trading instrument for small traders.

FINDINGS:
1. Existing small investors are not satisfied with Futures as a trading instrument. There
is negligible growth in the number of traders and trading volumes because of low
satisfaction level of futures trading.
2. Traders in the age group of 36 to 40 years are more interested in Futures trading.
Because they were having sufficient investible funds due to more income level
(above 3.5 lakh), most of them were businessmen or in private service. This is the
segment which is large and ready to take risk and sustain in the Futures market.
3. Mostly, investors prefer to trade (purpose is speculative profit) and invest (purpose is
growth of fund) both, in the ratio of 2:8 of total savings.
4. Only regular traders have sufficient knowledge of future trading. But awareness of
futures trading is less among other traders.
5. Most of the regular traders (including small traders) in the sample, have more than 5
years’ experience of trading only in equities and sometimes they trade futures for
hedging purposes.
6. Generally, annual rate of return in futures trading is 0-20% which is very much less
than the associated risk. Because there is a strong probability of large losses and
trading expenses (brokerage, stamp duty, service tax and transaction cost) which also
leads to reduced overall annual trading profit.
7. Small traders cannot sustain in futures trading because traders must have at least Rs.
50,000 to sustain or to trade effectively in futures market which is difficult for small
traders. If we considered Rs. 50,000 as a fund available for trading, as a thumb rule,
it should be 20% of total savings. Then, total saving amount must be Rs. 2,50,000
which is difficult for small traders. As it effectively comes out to a saving of 71.5%
of total income.

RECOMMENDATION:
Small investors should go for long term investment i.e.to take Delivery and avoid
to trade. But theChapter
investor who can bear risk in respect of Financial Derivatives trading,
can take into consideration of following guidelines i.e. suggestion.
8 RECOMMENDATION
1. Buy low and sell high: This may sound obvious, but since it’s the only way to earn
trading profits. In the futures markets trader can easily do the reverse-sell high and buy
low. Bulls start their trades with a long (buy) position and bears are initially short
(sellers). But to take right decision about to go long or short, you must have strong
prediction of market i.e. it will bearish or bullish.
2. Trade in index based derivatives: Trader will be able to buy or sell the 'entire stock
market' instead of individual securities when he has a general view of the direction in
which the market may move in the next few months. Index based derivatives are settled
in cash and therefore all problems related to bad delivery, forged, fake certificates, etc
can be avoided. Index based derivatives satisfy the hedging requirements of investors.
Investors are required to pay a small fraction of the value of the total contract as margins.
3. Determine the right size for your trading account: The funds Trader trade should
be completely discretionary. In other words, Trader should be sure whether he can afford
to lose whatever he invests in that account and potentially more. Savings for college,
retirement or emergencies should not be included.
4. Set definite risk parameters: Before Traders trade, he should determine how much
of a loss he is willing to accept. He can express this as a rupee figure or as a percent of
the margin amount. In either case, he should always keep some money in reserve. By
setting limits up front, he may lessen the risk of emotions dictating his decisions if the
market happens to turn against him.
5. Pick the right contract(s): There are many futures contracts to choose from and
several things to consider when deciding which ones are right for Trader.
a. Volatility: Futures contracts that experience wider daily trading ranges are
considered more volatile and more risky. Stock Futures and Stock Options have a
higher average daily price range compared to Index based Derivative. Some traders

prefer a more volatile contract because the cost of trading (commission fees, for
example) is the same, yet the potential for a profit can be greater. Of course, the risk
for loss is also greater.
b. Liquidity: Trader should make sure himself that the futures contract which he selects
has enough volume and open interest to ensure that he can exit his position just as
easily as he entered in it. Index based derivative is considered more liquid than
others products.
c. Contract Size: Traders should choose less-sized contracts. Examples of less-sized
Futures contracts include the MINIFTY Futures (lot size is 20), NIFTY Futures and
BANKNIFTY Futures (lot size is 50). While economic factors usually impact both
the full-sized and less-sized contracts, the rupees amount at risk is less with the
smaller contract. Trading smaller contracts allows him to diversify to a degree that
may not otherwise be possible. This reduces his risk exposure to any one market.
d. Margins: Margin levels are a function of contract size and price volatility. While
Trader may be comfortable trading in volatile markets, the size of contract and the
margin requirements may limit his selection of which futures contracts to trade.
e. Diversify: Rather than exposing his entire trading account to a position in one
futures contract, it is more prudent to take smaller positions in several contracts.
Because, diversification helps minimize a risk.
6. Have a trading plan: Before Trader actually enters into a futures position, he must
develop a plan to guide his decision based on careful analysis of the market he plan to
trade. The following are some of the issues to evaluate:
• How much risk is in each trade? How much risk are you willing to accept?
• If the trade turns against my position, at what point should you liquidate the
position?
• What is your goal with each trade?
(To hit a given entry and exit price, to capitalize on an anticipated market indicator,
to ride a trend for a specified period of time?)
7. Stick to it: Perhaps two of the key elements that differentiate successful traders from
the pack are discipline and emotional control. For instance, when the market moves
against a trader, past an exit point he had previously established, a good trader can cut
loose the trade and accept the loss. Half the battle is having a good plan, the other half is

sticking to that plan in the heat of the moment.
8. Begin with simulated trading: While there is no better way to learn when your own
money and emotions are involved, it’s still a good idea to practice first with simulated
trading. For real trading practice trader can take help of online site which provides
platform to fake trade just like real trading such as www.moneybhai.com ,
www.moneycontrole.com , etc.
9. Select a good broker: A broker can play an important role in Traders success. There
are essentially two types of brokers: First brokers provide more in the way of guidance
and research support, but may charge higher commissions to execute trader’s trades.
Another type of brokers leaves all the trading decisions to his client to execute his trades.

LIMITATIONS:
1. Derivatives, as a subject has grown tremendously with different applications in

different domains. This study is limited to financial derivatives and within the domain it
has a predominant focus on Futures.
2. Human Beings are complex in nature. Different people have different reasons for
investing, the same reasons could act as deterrent for others. There are various factors
which influence the investment decision of small traders some of which might have not
been covered due to the peculiar nature of the sample.
3. This study is limited to small traders only. For the sake of research, Small
Traders imply those investors who have an annual income close to Rs. 3.50 lacks. A
deviation of Rs. 25,000/- would be acceptable on either side in selecting the sample.
4. In some cases, the individual in the sample might be prejudiced and therefore the
response could be biased. But due to the size of the sample such incidents would have
negligible impact on the outcome.

BIBLOGRAPHY:-
 www.wikipedia.com
 www.nseindia.com
 Research Methodology by- Zikmund
 Derivative Book of NCFM module
 Trading in futures by –CBOT (e-book)
 www.investopedia.com

ANNEXURE
Questionnaire for Brokers
1. NAME: ______________________________________________________________
2. How long you have been in this profession?

Ans.:- Since ____Years
3. How many clients (Future traders) do you have?

Ans.: _______ Total Clients. _______Daily Trading Clients.
4. Do you find any growth in the no. of clients who trade in futures market?
Yes No
5. If yes, then how much %?

Ans.:_____________%
6. Do you find any growth in the volumes of Futures Trading?

Yes No
7. If yes, then how much?

____________________%

Trade Invest Both
9. Which instrument do you generally suggest your clients for trading?

Futures Equity Other ____________
10. Please state your preference with regards to instruments for trading, as 1, 2, and 3.
Future Equity Other
11. Please mention at least 3 reasons for trading in futures or not trading in Futures?
Yes No
12. According to you, what is the minimum amount that one needs for trading?
_______________________________________________________________________

13. Assuming one has sufficient money to trade, what would be the % allocation in
Futures, Equity, Others?
a. Futures: ____% b. Equity: _____% c. Others: _____%
14. While trading in Futures what must one consider?

Risk only Return only Both
15. What was the average profit of your clients from Futures trading in the last year?
Ans.:- ___________ % (approximately)
16. What is the % of satisfied clients and unsatisfied client with regards to futures
trading? (Approx)
Ans.: ____________%_Satisfied client _______________%_Unsatisfied clients
17. Were your clients satisfied with the Futures trading experience?
Highly Moderate Not so Unsatisfied
satisfied Satisfied satisfied
18. Did you lose any future trading client due to bad experience in Futures trading?
Yes No
19. Do you have any client who has shifted from futures trading to other (equity)
trading?
Yes No
20. Do you think future trading is suitable for small traders? Please, mention 3 reasons. If
not, then which is a suitable instrument for small traders?
Yes No
* 3 reasons:______________________________________________________________
* Suitable instrument:_____________________________________________________

Questionnaire for Investors
1. NAME: ______________________________________________________________
2. Age: _____________________________________________________________
3. Your occupation:
Govt. service Pvt. Service
Business Other
4. Your annual income:

Below 1 lack 1 - 3 lack
3 – 5 lack 5 lack and above
5. Are you a regular trader?

Yes No
6. How long have you been trading?

Ans.:- Since ____Years

Trade Invest Both
8. What % of your income do you direct towards investment & trading, annually?
a) Invest - ____% b) Trade -____%
9. Do you have knowledge of futures trading?

Brief Sufficient Concept only No
knowledge Knowledge
10. In which instruments do you generally trade?

Futures Equity Other
11. Please state your preference with regards to instruments for trading, as 1, 2, and 3.
Futures Equity Other
12. Please mention 3 reasons for trading in futures or Equity?

___________________________________________________________________

13. According to you, what is the minimum amount that one needs for trading in
Futures?
_______________________________________________________________________
_
14. Assuming you have sufficient (100%) money to trade, what would be the %
allocation in Futures, Equity, Others (out of 100%)?
a. Futures: ____%
b. Equity: _____%
c. Others: _____%
15. While trading what do you consider?
Risk Return Both
16. How much profit have you earned from trading in the last year?
Ans.:- ___________ % (approximately)
17. Are you satisfied with the Futures Trading experience?
Highly Moderate Not so Unsatisfied

satisfied Satisfied satisfied

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PROJECT REPORT

“A STUDY ON THE SUITABILITY OF FINANCIAL DERIVATIVES

Under the Guidance of

Global Business School

6 Data Analysis & Interpretation 42

Global Business School, Amravati Page 1

In the first part of the project Researcher tried to study the

The first step in the research process was to perform

Global Business School, Amravati Page 2

The word “DERIVATIVES” is derived from the word itself derived of an

Ex.:- Consider a hypothetical situation in which ABC trading company has to

History of derivatives markets: Early forward contracts in the US addressed merchants'

Global Business School, Amravati Page 4

B. According to JOHN C. HUL “A derivatives can be defined as a financial instrument

C. According to ROBERT L. MCDONALD “A derivative is simply a financial

Derivative products initially emerged as hedging devices against fluctuations in

Global Business School, Amravati Page 5

1.1.3 DERIVATIVE CONTRACT TYPES

 Forwards: A forward contract is a customized contract between two entities, where

 Futures: A Futures contract is an agreement between two parties to buy or sell an

 LEAPS: The acronym LEAPS means Long-Term Equity Anticipation Securities.

Global Business School, Amravati Page 6

1.1.4 PARTICIPANTS IN THE DERIVATIVES MARKETS

The following three broad categories of participants - hedgers, speculators, and

Global Business School, Amravati Page 7

Arbitrageurs are in business to take advantage of a discrepancy between prices in

Derivatives are often subject to the following criticisms:

Global Business School, Amravati Page 8

Members of President Clinton's Working Group on Financial Markets: Larry

B. Counter-party risk: -Derivatives (especially swaps) expose investors to counter-

Global Business School, Amravati Page 9

D. Large notional value:-Derivatives typically have a large notional value. As such,

E. Leverage of an economy's debt: - Derivatives massively leverage the debt in an

Global Business School, Amravati Page 10

Nevertheless, the use of derivatives also has its benefits:

 There are other benefits of derivatives according to the available products of

Global Business School, Amravati Page 11

In recent years, derivatives have become increasingly important in the field of

A Futures contract is an agreement between two parties to buy or sell an asset at a

The standardized items in a Futures contract are:

Global Business School, Amravati Page 12

A contractual agreement, generally made on the trading floor of a Futures

A legally binding agreement to buy or sell a commodity or financial instrument

Global Business School, Amravati Page 13

Following are some terminologies of Futures.

Global Business School, Amravati Page 14

Global Business School, Amravati Page 15

In financial futures contracts the underlying asset could be a portfolio of stocks

b. Single-stock futures: Single-stock futures are exchange-traded futures contracts

c. Currency future: A currency future, also FX future or foreign exchange future, is a

Global Business School, Amravati Page 16

d. Interest rate future: An interest rate future is a financial derivative (a futures

1.2.5. FUTURES TRADERS:

Global Business School, Amravati Page 17

Speculation in the Futures market:

a. Naked positions: - Position in any future contract.

b. Spread positions: - Opposite positions in two future contracts. This is a

For example, in traditional commodity markets, farmers often sell Futures

Global Business School, Amravati Page 18

1.2.6 HOW TRADERS TRADE:

1.2.7. BASIC TRADING STRATEGIES IN FUTURES:

Dozens of different strategies and variations of strategies are employed by