OBJECTIVE OF THE STUDY

Whenever a study is conducted, it is done on the basis of certain objective(s) in mind. A

successful completion of a project is based on the objective(s) of the study that could be
stated as under:

 To understand the basic concept of Derivative “F&O”& how they work in Indian
capital market.
 To know the nuances of derivatives.
 To know that which segment is exposed to more risk.
 To know in which derivative segment investors trade more.

1
 INTRODUCTION TO STOCK EXCHANGE

A stock exchange is a nervous system of the capital market. The changes in the capital
market are brought about by a complex set of factors, all operating on the market
simultaneously.
A stock exchange is a key institution facilitating the issue and sale of various types
of securities. It is a pivot around which every activity of the capital market revolves. In the
absence of stock exchange, the people with savings would hardly invest in corporate
securities for which there would be no liquidity (buying and selling facility). Corporate
investments from the general public would have been thus lower.
A stock exchange is a place or a market where securities, shares, debentures, bonds,
mutual funds of Joint stock companies, central and state government organizations, local
bodies and foreign government are brought and sold. A stock exchange is a platform for the
trade of already issued securities through primary market. It is the essential pillar of the
private sector and corporate economy. It is the open auction market where buyer and sellers
met and involve a competitive price for the securities. It reflects hope aspirations and fears
of people regarding the performance of the economy.

1.2. The Stock Exchange Defined

The supreme court of India has enunciated the roll of stock exchanges in these
words:

"A stock exchange fulfills a vital function in the economic development of a

nation. Its main function is to liquefy capital by enabling a person who has invested

money in, say a factory or railway to convert it in to cash by disposing off his shares in

the enterprises to someone else".

2
 HISTORY OF STOCK EXCHANGES IN INDIA

In INDIA only registered stock exchanges can operate the stock market activities and the
recognition is governed under the provision of securities and contract (Regulation) Act,
1956.

There are 24 Regional stock exchanges in INDIA. Bombay Stock Exchange (BSE)
and National Stock Exchange (NSE) Daily Turnover of all the stock exchanges is
about 30,000 Crore daily. BSE is 131 years old, which was established in the year
1875 where NSE is just 13 year old and was established in 1993. NSE has brought
Screen based Trading System in INDIA.

FEATURES OR CHARACTERISTICS

 Stock exchanges has been an association of individual members called member

broker
 Stock exchanges are formed for the express purpose of regulating and facilitating
the buying and selling of securities by and institution at large.
 Stock exchange operate with due recognition from the govt. under securities and
contract regulation act 1956.
 The member brokers are middlemen who transact on behalf of public for
commission.
 Board of director’s limit given by SEBI.
 SEBI has been set to oversee the orderly development of stock exchange.
 Stock exchange lists the companies who wish to raise the funds of capital from
public.
 Stock exchange facilitates trading in securities of the public sector companies as
well as govt. securities.
 The recognition accorded to a stock exchange is valid for period of five years
subject to satisfactory performance of stock exchange during this period.

3
 FUNCTIONS OF THE STOCK MARKET

1. The stock market is structured to provide liquidity and marketability to the

securities industry. It is a place where stock certificates can be turned into cash at
the prevailing price. This kind of liquidity makes investing in stock attractive.
2. It provides linkage between the savings of household sector and investment in the
corporate sector/economy.
3. It provides the market quotation of shares. Debentures and bonds, which is a sort
of buyers and selling in the market.
4. To ensure that the investors reap full benefit
5. To ensure recognized code of conduct.
6. Stock exchange ensures fair prices and free market
7. To provide update rates for actual and potential investors.
8. Stock exchange indirectly helps in providing employment to million of people.

4
 LIST OF VARIOUS RECOGNIZED STOCK EXCHANGES IN INDIA
S. No. Name of stock exchange Years of Type of organization
establishment
1 Bombay stock exchange 1875 Voluntary Non-profit
organization
2 Ahmedabad stock exchange 1897 Voluntary Non-profit
organization
3 Calcutta stock exchange 1908 Public limited
company
4 M.P. stock exchange, Indore 1930 Voluntary Non-profit
organization
5 Madras stock exchange 1937 Co. limited by
guarantee
6 Hyderabad stock exchange 1943 Co. limited by
guarantee
7 Delhi stock exchange 1947 Public limited
company
8 Bangalore stock exchange 1957 Pvt. converted into
public ltd. co.
9 Cochin stock exchange 1978 Public limited
company
10 U.P. stock exchange, Kanpur 1982 Public limited
company
11 Pune stock exchange 1982 Co. limited by
guarantee
12 Ludhiana stock exchange 1983 Public limited
company
13 Jaipur stock exchange 1983 Public limited
company
14 Guahati stock exchange 1984 Public limited
company
15 Kannaar stock exchange 1985 Public limited
company
16 Magadh stock exchange 1986 Co. limited by
guarantee
17 Bhuvneshwar stock exchange 1989 Co. limited by
guarantee
18 Saurashtra stock exchange, 1989 Co. limited by
Kutch. guarantee

5
19 Vadora stock exchange 1990 N.D.

20 Merrut stock exchange 1991 N.D.

21 O.T.C.I. (Over the counter 1993 Pure demutulised

exchange of India), Mumbai
22 National stock exchange 1995 Pure demutulized

23 Coimbtore stock exchange 1996 N.D.

24 Sikkim stock exchange 1997 N.D.

All the 23 stock exchanges as shown above are regional stock exchanges while
National stock exchange is only Non-Regional stock exchange in Indian economy.

 Who benefit from stock exchange?

Investors:
It provides them liquidity, marketability, safety etc. of investment. Despite
profitability is also a major benefit to the investors.
Companies:
It provides them access to market funds, higher rating and public interest.
Brokers:
They receive commission in lieu of their services to investors.
Economy and Country:
There is larger flow of savings, better growth, and moves industries, higher income.
General public:
It provides all available information relating to different companies to the general
public.

6
THE LUDHIANA STOCK EXCHANGE ASSOCIATION LIMITED (LSEAL):
The ludhiana stock exchange association ltd was established in 1983, by Sh. S.P Oswal &
Sh B.M Munjal, leading industry luminaries, to fulfill a vital need of having a stock
exchange in this region. Since its inception, the stock exchange has grown phenomenally.
The Stock Exchange has played an important role in channelising saving into capital for the
various industrial & commercial units of the State of Punjab & other parts of the country.

INFRRASTRUCTURE:
LSEAL, which started its functions & operation in a small rented building, today has its
own ultra modern six storied large building situated at Feroze Gandhi Market, Ludhiana. It
comprises of more than 300 spacious rooms & a trading hall

NUMBER OF MEMBER:

OPERATIONS OF LSEAL:

7
TURNOVER:
LSEAL is one of the leading stock exchange among the regional stock exchange of the
country, & has been providing trading platform for the investor situated in Punjab, J&k,
Himachal pardesh & Chandigarh .The Trading value in F&O segmented to Rs 49,26,724
million in jan as against Rs 48,75,837 million in jan 06.In total LSEAL record a peak
turnover of Rs 9154 crores during this year.

LISTING:
Listing is one of major functions of a Stock Exchange wherein the securities of the co. are
enlisted for trading purpose. Any co. incorporated under companies act, 1956, coming out
with an IPO, has it share on a stock exchange.
The listing Department of Ludhiana Stock exchange deals with listing of securities, further
listing of issue like bonus & right issue, post-listing compliance of co., which already listed
with Ludhiana Stock Exchange.

SETTLEMENT GUARANTEE:
The Stock Exchange established a Settlement Guarantee Fund (SGF) on April6, 1998.It
provide guarantee of all the genuine trades made through the Screen Based Trading System
of the Stock Exchange.

END OF AN ERA:
The management of the stock exchange apprehended that the smaller regional stock
exchange would not be able to meet the challenges imposed by expansion of bigger stock
exchange like NSE & BSE & might end up loosing their entire business to VSAT counter
of bigger stock exchange .In order to prepare for such an eventuality, Stock Exchange set
up a broking arm in the name of LSE securities ltd. In Jan 2000. &Built
Infrastructure & IT based system to enable its member & investor to trade on NSE & BSE
through the subsidiary route.

THE OPERATION OF THE PURCHASE AND

8
 SALE OF SCRIPS ARE AS FOLLOWS

WALK TO KNOWN BROKER/SUB-BROKER

SEE THE PRICE OF SHARES

IT WILL DISPLAY 3 BEST OFFERS FOR ALL THE SCRIPS LISTED/TRADED

ON THE LSE

DECIDE TO BUY/SELL

ASK YOUR BROKER TO DEAL ON YOUR BEHALF

DEALS AUTOMATICALLY AT THE BEST PRICE FOR YOU

MAKE PAYMENT/MARGIN MONEY/SHARE CERTIFICATE BEFORE PAY IN

DATE

COLLECT THE SALE CONFIRMATION SLIP

VISIT THE SAME COUNTER ON PAYOUT AND COLLECT DELIVERY/PAYMENT

BOARD OF DIRECTORS OF LSEAL

9
Sh. Harjit Singh Sidhu Executive Director

Sh.Rajiv Dewan Public Representative

Sh.G.S.Bains Public Representative

Sh.D.K.Malhotra Public Representative

Prof. Rajinder Bhandari Public Representative

Sh. S.C. Aggarwal, IAS SEBI Nominee

Sh.Har Lal SEBI Nominee

Sh.R.K.Bansal Broker Director

Sh.Sanjeev Gupta Broker Director

LSE SECURITIES LIMITED (LSEL)

10
LSE Securities Ltd. has proved to be a vehicle of growth for LSE. Presently transaction is
not going on here. So LSE is acting only as a broker under the name LSESL. Because of
which LSE at present is still surviving in the era of shutting down of regional stock
exchanges. LSE Securities LTD. a wholly owned subsidiary of LSE was formed with an
objective to achieve accelerated growth and survival of LSE as an institution. The LSE
Securities Ltd. has an authorized and paid up capital of Rs. 5 crores, which is held by
Ludhiana stock exchange association Ltd.

FEATURES OF LSESL:
1. LSESL gives platform to the members, brokers and general investor through
increased volumes and liquidity in trading at the exchange and specially in view of
July 2, 2001 – "introduction of innovative products and encompassing a variety of
activities related to financial market."
2. LSE through its subsidiary company i.e. LSE Securities Ltd. has acquired corporate
membership of BSE and NSE. The membership of NSE was acquired with an
interest free deposit of 2.5 cores on 4/12/1999.

The Scheme had two options:

Option A: for acquiring trading facilities on NSE market,
Option B: for acquiring trading rights

For Options A, members were to deposit Rs. 2.5 crores and Rs. 1 lac infrastructure
development fund (with NSE) and for Option B, members were to deposit Rs. 25,000 in
four installments towards infrastructure fund and Option C was default option with
increased contribution towards infrastructure panel depending upon the time of joining the
scheme.
The membership of BSE was acquired on 10.4.2000 at cost of Rs. 50 lacs towards
infrastructure development fund of BSE and Rs. Lac towards interest free security on BSE.
3. The exchange has introduced a system known as MULTIPLEX {Multiple stock
exchange system} which allows concurrent trading on BSE and NSE through a
single window on a P.C. which has been developed by C.M.C. Ltd. by payment of
Rs. 10 lacs to CMC ltd The MULTIPLEX facility has been extended outside the

11
 exchange through v-sat, fifteen in number. Now unit based server has been
purchased to run MULTIPLEX in addition to exiting K-400 server. On-Line trade
with BSE from Sep 25, 2000.
4. The Ludhiana Stock Exchange Launched trading in "F&O" segment of NSE in
March 2002 through LSBSL.
5. LSE Securities Ltd. IS Depository Participant (DP) of NSDL and the only
depository in the region having on line connectivity with NDSL since 16.08.2000. A
depository participant is a market intermediary through which depository that is
National securities interact with investors and clearing members in respect to Demat
shares of the companies. LSE has also got the DP of CDSL, the second only
depository of India. By which " T+2" settlement" is made possible by demat scrips.

BOARD OF DIRECTORS OF LSE SECURITIES LTD.

(For the term2006-07 )

12
Sh. Anil Kalra Chairman

Sh.Vijay Singhania Vice Chairman

Sh. Naresh Bishnoi Chief Executive Officer

Sh. Harjit Singh Sidhu Director (ex-officio being Executive

Director of LSE)

Sh.Lalit kishore Director

Sh. Dina Nath Sharma Independent Director

Dr. M.A. Zahir Independent Director

Sh. Ajay Chaudhary Independent Director

Sh. Ashwani Kumar Independent Director

Sh. P.C. Garg Independent Director

SOURCE OF FUND FOR THE YEAR 2006-07

13
 OF LSE ASS. Ltd.

1
2
3
4
5

SOURCES

(1) Membership Fee = 0.82%

(2) Listing Fee = 13.27
(3) Interest on deposits = 29.03%
(4) Profit on sale of fixed assets = 3.23%
(5) Other income = 53.65

14
 SOURCES OF FUND FOR THE YEAR 2006-07
OF LSE SEC Ltd.

1
2
3
4
5

SOURCES:
1) Turnover Charge BSE = 5.10%
2) Turnover Charge NSE = 47.18%
3) Interest on Bank deposits = 31.90%
4) Depository Income = 8.99%
5) Other income = 6.83%
________
100

15
 VARIOUS DEPARTMENTS

The main aim of LUDHIANA STOCK EXCHANGE is to ensure the safety and security to
the investments of the investors and to provide the proper services under the prescribed
guidelines of SE 131. So to maintain the proper system of working of exchange, there are so
many different departments in which particular functions are performed, assigned to those
departments. Following in the list of various departments of LSE: -

Operational Departments
I Margin Section

II Clearing House

III Computer Section and information System Department

IV Market Surveillance

Service Departments

V I.G.C. (Investor Grievance Cell)

VI Listing Section

16
VII Accounting Section

VIII Secretarial dept.

IX Legal Department

X Membership Department/Personnel Department

All the section performs specific function. There is nowhere duplication of work; even then
all the sections are interconnected with each other. There is an organized network of
recording of activities performed there. But before studying the inter dependence of section)
here is the details of all department i.e. actually what function is performed by each and
every section.

MARGIN SECTION

Margin Section is an important section. This section apart from dealing in the regulating the
trading of brokers keeps a check on excessive trading in speculation. Margin is the amount,
which is collected from tile brokers for the safety of transactions. As the transactions are to
be finalized on basis, in the mean time the rates may fluctuate which may lead to default. So
to make the transaction safe, daily margins are collected from brokers. When a member gets
registered in the exchange and with securities exchange board of India (SEBI), then before
starting trading he is supposed to deposit some fixed by SEBI as security. Now in SEBIs
rolling settlement prevails. Ultimately margin is the difference between the limit and trade
done by the member. The security deposit by member is called Base Minimum Capital. If
any member wants to do trade up to greater limit then he can deposit Additional Base
Minimum Capital.

CLEARING HOUSE

Clearing house takes care of pay-in and pay-out securities. At this time there is weekly
trading system (Monday to Friday) prevails. And securities are settled by rolling settlement.

17
Means pay-ill and payout of securities is settled on T+3 Basis would commence form 1 st
April 2002. SEBI decide the following activity schedule for exchanges for the T+3 rolling
settlement.

Settlement cycle schedule

Sr. Day Description of Activity Trade

No.
1 T Trade Date
2 T+1 Custodial Confirmation
3 T+3 Securities and Funds pay in and pay-out
4 T+4 Auction of shortage in deliveries
5 T+6 Auction pay-in/pay-out as soon as possible
T is Means TRADING PERIOD.
PAY IN/PAYOUT OF SECURITIES
On trading day brokers buy and sold the securities or scrips and pay-I and pay out of
securities will be completed on T+3 basis e.g. if broker buy/sell shares on Monday then pay
in of securities will be on Wednesday, 11:00A.M. And pay out of scrips will also on
Wednesday up to 4:00 P.M. way pay-in/pay-out of securities cycle will be completed.

AUCTION OF UNDELIVERED SCRIPS

In this in case if broker fails to deliver the scrips on T+3 delivery day. Then it is
responsibility of clearing house to settle the undelivered scrips. Then T+4 cycle will start in
above example auction of pending securities will be conducted on Thursday. In auction
price of securities may fluctuate 20% high or low of that trading day. In this way T+4
schedules is settled.

CLOSE OUT
In case the shares of particular scrips is not available on the date of auction. Then it is
obligation of solicitor (exchange) to give monetary benefit to initiator (buyer) against the
default of defaulter of securities in this manner settlement schedule has completed.

COMPUTER SECTION

18
The growing technicalities and increase in workload has enhanced the importance of
computer section in Ludhiana stock exchange. This department mainly referred to EDP i.e.
electronic data processing section. This section is that backbone of entire stock exchange
would come to halt if this department becomes inactive.
It prepares several reports namely: -
o Scrips wise statement of each member for each settlement period
o Sub broker wise delivery bill receive order (after payout)
o Downloading of delivery order.
o Downloading of receiving order.
o And broker on sub broker wise final settlement.
o HDFC bank entries.
o Scrip wise statement
Computer facilitates easily updating and automatically adopting of new rates, once we
feed new limits the whole calculation to be done through computer will change. Rates
are updated either daily or month wise as per the requirements.

Manual operations:
It has reduced manual work. It has also eliminated approximately the need to keep
check the physical reports, which is a time consuming as well as space consuming and
requires a lot of attention.

Volume and transparency:

This system is very much transparent, as each individual involved knows every
relevant thing. Also volume of shares being traced is very high and increasing
continuously.

Linking chain:
This section acts as a liking, which links each and every department of the LSE with
another and hence helps in working as a whole.

Check and control over scrips and members

19
This section also helps in maintaining check and control over defaulting members and
scrips. In case the member crosses his limit of trading according to his deposited
amount, the computer section switches off his terminal and same step is taken in case
of defaulted scrips.

MARKET SURVEILLANCE SECTION

The main task of this section is to see the market sanctity and maintenance so that the
investors are not cheated. So market surveillance entails scientifically identifying
points in a stock price movement or trading volumes, which don't match with the
company's fundamentals. So the price and volume trends in stock exchange are
checked for abnormalities scientifically.

INVESTORS GRIEVANCE SECTION

LSE has a separate investor's grievance cell, which receives complaints from investors
and follows up the complaints with companies and member broker to ensure their
satisfactory redressal. For providing better services to the investors the stock exchange
has maintained investor protection fund. In this fund Rs. 500 is collected from each
member annually. Apart from this one percent of the total listing fee collected and ten
percent interest covered on company deposits is also transferred do the investor
protection fund.
One more fund investor service fund has been set up 20% listing a fee is transferred to
it. The funds of it are used for maintenance of investor service center, holding of
seminars for investor/brokers benefit, and publication of LSE Bulletin.

The rationales behind establishing investor grievance section are following:

o To safeguard the investor's interest through investors grievance section.
o To participate as monitoring authority in the public and right issue of the
company.
o To ensure that the company listed at the LSE compiles with all the listing
requirements.

20
 o To keep a record of the inquiry base of the listed companies, their annual
financial results and any subsequent increase in the equity base.

LISTING SECTION
This department plays an important role in the Stock Exchange. as it helps the company to
raise money from the capital market. Presently it is mandatory for Regional Company to get
itself listed at LSE. In order to get listed company should have minimum capital of Rs. 3
crores and at least 25% of its equity should be offered to the public for the listing company
is also required to make a deposit 1 % issue price with tile stock Exchange and it can not be
released before tile expiry of six months provided there is a compliance of pre-listings and
post, listing requirements b the company. Company has also to comply with the conditions
enunciated in listing clause.
The schedule of annual Listing fee and up front listing fee payable triennially is given
below:
Paid up capital Annual Listing Fee (Rs.)
Upto 1 crores 7000
1 to 5 crores 10000
5 to 10 crores 18000
10 to 20 crores 36000
20 to 30 crores 54000
Above 50 crores 90000

Companies which have paid up capital of more than Rs. 50 crores will pay additional fee of
Rs. 2800 for every increase of Rs. 5 crores or part there of. The annual listing fees referred
to above be applicable only if the exchange is a Regional Stock Exchange otherwise the
fees will be 50% of the fees indicated above.

ACCOUNTS SECTION
Most of the work in account section of LSE is done manually, although help is taken
through computers for the purpose of making trail balance, Income and Expenditure
statement and Balance Sheet. The annual report of LSE is generally published in August
every year. Some of the important polices of LSE are

21
 o The company follows accrual system of accounting recognizes income and
expenditure accordingly.
o Depreciation is provided on written down, value method in accordance with and din
the manner specified in schedule XIV of the Companies Act 1956.
o Fixed costs are stated at historical costs less depreciation.
o Stock/Inventory (stationery) is valued at cost.
o Interest on funds borrowed which is attributable to construction of fixed assets and
other indirect expenditure during construction is included under work in progress.
The company has the procedure of receiving shares, scrips of various companies as
securities against the performance of the contract. No accounting entries in such transaction
are made in respect of defaulting members by crediting security account and debiting
member's investment a/c. The shares in such cases are valued at prices on the date of
transfer deeds.
Functions of Accounts Section
The account section performs the following function.
o To make and receive payments to the outside agencies, these agencies include
companies listed at LSE and brokers working at LSE.
o To disburse personnel expenses.
o To keep the records of all incoming and outgoing money depreciation of financial
statements at the end of financial year.
o To get their accounts audited from the third party.
Sources of funds of LSE
o Membership fee from brokers at the beginning.
o Initial listing fee from companies i.e. Rs. 1,000/-
o Annual listing fee from companies.
o Annual fee from brokers (Rs. 5000) and their authorized representatives. (Rs. 500
each) as broker member is allowed to have maximum 4 authorized representatives.
o Interest income from deposits of companies for listing, which are made at 1% of
issue amount and minimum capital for this purpose is Rs. 4/- crores. Such deposits

22
 are retained until there is no dispute against the company subject to the minimum of
6 months,
o Annual computer fee from brokers (Rs. 5000)>Library charges from brokers (R.s
200) p.a.)
o Brokers contribution to investor protection fund (Rs. 500 p.a)
o Fines and penalties form brokers.
o Maintenance charges Rs. 13.50 per sq. feet, per quarter from those members having
rooms and those not having rooms all those not having rooms are charges at till rate
of Rs. 1500/- pa.
o Water and electricity charges Rs. 750 per quarter, whose area is less than 200 sq.
feet and 900/- per quarter) which is having area of more than 200 sq. feet. The
members who are not having rooms are charged at the rate of Rs. 300/- (p.a.)
o Interest earned affixed deposits.
Billing of members is done on annual basis for annual fees and other above-
mentioned charges. On 1st April of each year they are to make payment in 180 days up to 30
September. Beyond not they are charged interest on due amount @ 12% p.a. still in case of
nonpayment, broker member is served a show cause notice for 60 days on 1st April next
year. If member fails to, comply with notice then he can be expelled.

Application of funds of LSE

 5% listing fees to SEBI each year.

 20% for providing services to investors out, or listing fee annually to investor
service fund. Administrative expenses (I) Electricity Charges. (II) Security Charges
(III) Telephone Charges (IV) VSAT Charges (V) Printing and stationary
 Salaries
 1% of listing is transferred annually to investor protection fund.

SECRETARIAL SECTION
Duties responsibilities of personnel departments are mentioned as under which are
discharge by the secretarial departments.

23
 o Recruitment of staff.
o Maintain employee record e.g. attendance leave, overtime etc.
o Maintain employee service book up to date and other detail as per the requirements
to auditors at the time of inspection (From date of joining registration)
o Employee welfare scheme like loans.
o Other activities like staff farewell party and Diwali puja.

Although the LSE, has not a separate personnel departments in its organization chart. The
secretarial departments carry out all activities relating personnel, which has the additional
charge of personnel.

LEGAL SECTION
When two broker or outside clients do not settle their claims in Between themselves and
move to court, the legal section comes into the picture to fight for the cause of investors and
against the defaulting members.
Legal section also assists the member investor to settle their disputes through the arbitration
committee investors grievance committee.
Disciplinary committee, defaulting committee, so that there maybe settled at the earlier
without incurring heavy due on amount regarding court fee, advocate fee etc. The objective
of the legal section is to make effective the bylaws and regulation of the stock exchange and
to see that the guidelines, circular and any amendments in rules made by the SEBI are
enforced at appropriate time so that the future complications may be reduced or avoided. As
the name legal section suggests it is clearly mentioned and understood that each of every
matter involving legality is to be solved by the legal department.

PERSONNEL DEPARTMENT
Ludhiana stock exchange does not have a personnel department in its Organization chart.
This department carries out all activities relating to the recruitment of the personnel,
whenever and wherever a vacancy arises, maintenance of attendance register. This

24
department also deals with the appointment or removal of floor clerks or authorized
representatives of brokers. These departments also maintain records of leaves and overtime
of employees.

25
 ACHIEVEMENT OF LUDHIANA STOCK EXCHANGE

Oct 1981 Incorporation of Stock Exchange

Aug 1983 Commencement of operations
Aug 1983 Shifting of operation to own building
Nov 1996 Online Screen Trading
April 1998 Modified carry forward system (MCTS)
and settlement guarantee fund.
Nov 1998 Trading and settlement in demat scrips
Sep 1999 Trading at remote sites through VSAT
counters
Jan 2000 Introduction of rolling settlement
Aug 2000 Commencement of online real time
depository services
Dec 2000 Trading on N.S.E. in C.M. segment
(Through NSEL)
Sep 2000 Trading on B.S.E. in CM segment
(Through LSEL)
July 2001 Introduction of Compulsory rolling
settlement
January 2002 Complete shift of trading CM segment
from ISE To LSE securities Ltd.
Feb 2002 Trading in F&O segment of N.S.E.
April 2002 Rolling settlement cycle prevailing at
LSE on T+3 basis
April 2003 Rolling settlement cycle prevailing at
LSE on T+2 cycle
Oct 2003 Incorporation of LSE commodities
trading services Ltd., a subsidiary of LSE.
Securities Ltd.
March 2004 Introduction of MCX (Multi Commodity
Exchange of India) MCX offers 14
different commodities such as steel,
kappa’s, rubber, black pepper, oil soil
seeds, precious metal etc.
March 2005 There was 27 sub broker of company
Have been trading through VSAT on
NSE and 13 on BSE.

26
27
 INTRODUCTION TO DERIVATIVES
Primary market is used for raising money and secondary market is used for trading in the
securities, which have been used in primary market. But derivative market is quite different
from other markets as the market is used for minimizing risk arising from underlying assets.
The word "derivative" originates from mathematics. It refers to a variable, which
has been derived from another variable.
I.e. X = f (Y)
WHERE X (dependent variable) = DERIVATIVE PRODUCT
Y (independent variable) = UNDERLYING ASSET
A financial derivative is a product that derives value from the market of
another product. Hence derivative market has no independent existence without an
underlying asset. The price of the derivative instrument is contingent on the value of
underlying assets.
As a tool of risk management we can define it as, "a financial contract
whose value is derived from the value of an underlying asset/derivative security ". All
derivatives are based on some cash product.
The underlying assets can be:

a. Any type of agriculture product of grain (not prevailing in India)

b. Price of precious and metals gold
c. Foreign exchange rates
d. Short term as well as long-term bond of securities of different type issued by
govt. and companies etc.
e. O.T.C. money instruments for example loan & deposits.

Example: Wheat farmers may wish to sell their harvest at a future date to eliminate the risk
of change in price by that date. The price of these derivatives is driven from spot price of
wheat.

28
In Indian context, the Securities Contract (regulation) act, 1956[SC(R) A] defines

“derivatives” to include-

a) A security derived from a debt instrument, share, and loan whether secured or
unsecured, risk instrument or contract for difference or any other from of security.
b) A contract, which drives its value from prices or index of prices of underlying
security.

HISTORICAL ASPECT OF DERIVATIVES:

Derivative trading in financial market started in 1972 when "Chicago Mercantile Exchange
opened its International Monetary Market Division (IMM). The IMM provided an outlet for
currency speculators and for those looking to reduce their currency risks. Trading took
place on currency. Futures, which were contracts for specified quantities of given
currencies, the exchange rate was fixed at time of contract later on commodity future
contracts was introduced then followed by interest rate futures.
Looking at the liquidity market, derivatives allow corporate and institutional
investors to effectively manage their portfolios of assets and liabilities through instruments
like stock index futures and options. An equity fund e.g. can reduce its exposure to the
stock market and at a relatively low cost without selling of part of its equity assets by using
stock index futures or index options. Therefore the stock index futures first emerged in
U.S.A. in 1982.

29
 EQUITY DERIVATIVE IN INDIA

DERIVATIVE MARKET
Derivative market broadly can be classified into two categories, those that are traded on the
exchange & those traded to one or over the counter. They are known as
 Exchange traded derivative
 OTC Derivative (over the counter) Equity derivative exchange

PRODUCTS, PARTICIPANTS AND FUNCTIONS

Derivative contracts have several variants. The most common are FORWADS, FUTURES
and OPTIONS AND SWAPS.
The following are the three categories of Participants-Hedgers, Speculators, and
Arbitrageurs.

30
 TYPES OF DERIVATIVES

The most commonly used derivative contract is forwards, futures and options:

(1) FORWARDS: a forward contract is a customized contract between two

entities, where settlement takes place on a specific date in the futures at today's
pre-agreed price.
(2) FUTURES: a future contract is an agreement between two parties to buy or sell
an asset at a certain time the future at the certain price. Futures contracts are the
special types of forward contracts in the sense that are standardized exchange-
traded contracts.
(3) OPTIONS: it is of two types: call and put options.
Underlying asset at a given price on or before a given future date. PUTs give
buyer the right but not the obligation to sell a give quantity of the underlying
asset at a given price on or before a given date.
(4) LEAPS: Normally option contracts are for a period of 1 to 12 months.
However, exchange may introduce option contracts with a maturity period of 2-
3 years. These long-term option contracts are popularly known as Leaps or
Long term Equity Anticipation Securities.
(5) BASKETS: Baskets options are option on portfolio of underlying asset. Equity
Index Options are most popular form of baskets.

31
 THE DERIVATIVE MARKETS PERFORM A NUMBER OF
ECONOMIC FUNCTIONS:

(1) Prices in organized derivative markets reflect the perception of market participants
about the future and lead the prices of underlying to perceived future level. Thus
derivatives help in discovery of future as well current prices.
(2) Derivatives due to their inherent nature are linked to the underlying cash markets.
With the introduction of derivative, the underlying market, witness higher trading
volumes because of participation by more players who would not otherwise
participate for lack of an arrangement to transfer risk.
(3) Derivatives have a history of attracting many bright, creative, well-educated people
with an entrepreneurial attitude. They often energize others to create new business,
new products and new employment opportunities, the benefits of which are
immense.
(4) Derivatives market helps increase savings and investments in the long run transfer
of risk enables market participants to expand their volume of activities.

Participants in derivative market

• Exchange, trading members, clearing members.
• Hedgers, arbitrageurs, speculators.
• Clearing, clearing bank.
• Financial institutions.
• Stock lenders and borrowers.

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 DERIVATIVE TERMINOLOGY

Assignment: means allocation of an option contract, which is exercised, to a short position

in the same opinion contract, at the same strike price, for fulfillment of the obligation, in
accordance with the procedure specified in by the relevant authority from time to time.

Badla: is an indigenous mechanism of postponing the settlement of trade. This product is

peculiar to India markets. This involves Badla financiers, stock lenders and stock traders.
The long buyers and short sellers may postpone settlement of their trade by making
payments and giving delivery by using the services of Badla financiers and stock lenders
who assume their positions for Badla charges. Counterpart risk, unpredictable charges and
high risk due to inadequate margining are inherent limitations of Badla.

Basis: is difference between spot price and future price of the same asset. In normal
markets this basis is always negative, i.e. spot price is always less than future price.A
positive basis provides for arbitrage opportunity.
Basis= Cash price- Future price
Basis can be either positive or negative

Beta: is a measure of the sensitivity of returns on scrip to return on the market index. It
shows how the price of scrip would move with every percentage point change in the market
index.

Contract value:
It is the value arrived at by multiplying the strike price of the option contract with the
regular/market lot size.

Margin: It is the money collected from parties to trade to insure against the default risk.
Some amount of margins is collected upfront and some are collected shortly after the trade.
Failure to pay margins may result in mandatory closure of position.

Offsetting Contract: new matching contract, which offsets an existing contract, is known
as offsetting contract.

33
Option Premium: It is consideration paid by the option buyer to option writer. The
premium has two components intrinsic value and time value. Intrinsic value is the
difference between the spot price of the underlying and exercise price of the contract. Time
value represents the cost of carrying the underlying for the option period, adjusted for any
dividend and option premium.

34
 STRENGTH OF INDIAN CAPITAL MARKET FOR
INTRODUCTION OF DERIVATIVES

1. Large Market Capitalization: India is one of the largest market capitalized country
in Asia with a market capitalization of more than 17, 65,000 corers.
2. High Liquidity: In the underlying securities the daily average traded volume in
Indian capital market today is around 7,500 crores.
3. Trader Guarantee: The first "clearing corporation" (CCL) guaranteeing trades has
become fully functional from July 1996 in the form of National Securities Clearing
Corporation (NSCCL) for which it does the clearing.
4. Strong depository: A strong depository National Securities Depositories Ltd .
(NSDL), which started functioning in the year 1997, has strengthen the securities
settlement in our country.
5. A Good Legal Guardian: SEBI is acting as a good legal guardian for Indian Capital
market.

INSTRUMENTS OF DERIVATIVE TRADING

FORWARD

Derivative FUTURE

OPTION

FORWARD CONTRACT

35
"It is an agreement to buy/sell an asset on a certain future date at an agreed price".
The two parties are:
• Who takes a long position – agreeing to buy
• Who takes a short position—agreeing to sell
The mutually agreed price is known as "delivery price" or "forward price".
The delivery price is chosen in such a way that the value of contract for both parties is zero
at the time of entering the contract, but the contract takes a positive or negative value for
parties as the price of underlying asset moves. It removes the future price risk. It a
speculator has information or analysis, which forecast an upturn in price, and then be can go
long on the forward market instead of cash market.
The speculator would go long on the forward, wait for the price to rise, and
then take a reversing transaction to book profits. Speculator may well be required to deposit
a margin upfront. However, this is generally a relatively small proportion of the value of
assets underlying the forward contract.

E.g. A agrees to deliver 100 equity shares of Reliance to B on

Sept. 30, 2002 at a Rate of Rs.120 per share. Now if the price of share on that date is
Rs. 140 per share, than a who has short position would stand to loss of Rs. (20*200)
= 4000, long position would gain the same amount or vise versa if price quoted is
less than delivery price.
Profit/Loss = ST-E
ST = spot price on maturity date
E = delivery price

Limitations of forward contract

1. No standardization.
2. One party can breach its obligation.
3. Lack of centralization of trading.
4. Lack of liquidity

36
 THE STUDY OF FUTURE & OPTION

F&O deal with future & option. Now it is well known to us that derivative are risk
management instrument, which derive their value from an underlying asset. The underlying
asset can be index, shares, bonds, interest rates, currency etc.
F&O are the two widely used derivative types in the stock market .It is further classified in
 Index –future/option
 Stock –future/option
 Interest rate future

37
 FUTURE CONTRACT

'It is an agreement between buyer and seller for the purchase and sale of a particular
assets at a specific future date; specific size, date of delivery, place and alternative
asset. It takes obligation on both parties to fulfill the contract’.

Features of Future Contract:

1. Standardized contracts e.g. contract size.
2. Between two parties who do not necessarily know each other.
3. Guarantee for performance by a clearing corporation or clearing house.
Clearinghouse is associated with matching, processing, registering, confirming
setting, reconciling and guaranteeing the trades on the future exchanges.
Clearinghouse tries to eliminate risk of default by either party.

Future terminology
Spot price: the price at which an asset trades in the spot market.
Futures price: the price at which the futures contract trades in the futures market.
Contract cycle: the period over which the contract trades. The index futures contracts on
the NSE have one month, and three-month expiry cycles, which expire on the last Thursday
of the month. Thus a January expiration contract expires on the last Thursday of the
January. On the Friday following the last Thursday, a new contract having three-month
expiry is introduced of trading.

38
Expiry date: it is date specified in the futures contract. This is the last day on which the
contract will be traded, at the end of which it will cease to exist.
Contract size: the amount of asset that has to be delivered less than one contract. For
instance, the contract size on NSE's futures market is Nifties.
Basis: in the contract 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.

Initial margin: the amount that must be deposited in the margin account at a time a future
contract is first entered into is known as initial margin.
Maintenance margin: this is somewhat lower than initial margin. This is set to ensure that
the balance in the margin account never becomes negative. If the balance amount 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.

TYPE OF FUTURE CONTRACTS:

In India three types of future derivatives are available for trading at NSE & two at BSE .

Future derivatives that are trading in BSE are:

 Equity index future on SENSEX.

 Stock futures on 41individual securities.

Future derivatives that are trading in NSE are:

 Equity index future on S&P CNX NIFTY.

 Stock futures on 41 individual securities.

 Interest rate future on 91/365 T-bills, ten year notional bond (with coupon rate)

& ten year notional bond (zero coupon rate)

But now there is more than 125 individual securities.

39
40
 INDEX FUTURES

Index futures are futures contracts where the underlying asset is the index. The index
futures provide a hedge against price fluctuations of the securities and hedgers are using it
as an insurance tool. A stock index future contract is an obligation to deliver at settlement
an amount of cash equal to the difference between the stock index value at the clause of the
last trading day of the contract & the price at which the futures contracts was originally
struck. For instance, if the SENSEX index is at 3000 & a lot size of contract is equal to 50,a
contract struck at this level could be worth Rs150000 (3000* 50). If, at the expiration of the
contracts, the SENSEX stock index is at 3100, a cash settlement of Rs5000 is required
[(3100-3000)*50]. In stock index futures, no physical delivery of stock is made.
In India, the BSE was the first stock exchange to introduce Index futures on June
9, 2000 on SENSEX. In NSE the trading of index futures commenced on June 12,2000 on
the S&P CNX NIFTY. The stock index futures are traded on the F&O segment of the both
exchanges.
Both buyers & sellers are required to deposit margin at the time of contract. The
margin amount is based volatility if market indices. In India the initial margin is expected to
be around 8-10%. Usually key sigma (standard deviation) is used or this measurement. This
technique is also called value at risk (VAR). In futures market at the end of each trading day
the margin account is adjusted to reflect the investor’s gains or loss depending up on the
futures closing price & variation may be required or released. This is known as MTM (mark
to market).
In India three types of future derivatives are available for trading at NSE & two at

BSE. Future derivatives that are trading in BSE are:

 Equity index future on SENSEX.

 Stock futures on 41individual securities.

Future derivatives that are trading in NSE are:

 Equity index future on S&P CNX NIFTY.

 Stock futures on 41 individual securities.

41
  Interest rate future on 91/365 T-bills , ten year notional bond (with coupon rate)

& ten year notional bond ( zero coupon rate)

Contract specification

Underlying index S&P CNX NIFTY

Exchange of trading NSE

Security descriptor N FUTIDX NIFTY

Contract size Permitted lot size shall 200 &multiple thereof (minimum
value of Rs.2 lakh.)

Price band Not applicable

Trending cycle The futures contracts will have a maximum of three-month

trading cycle. The near month (one), the next month (two)
& the far month (three). New contracts will be introduced
on the next trading day following the expiry of the near
month contract.

Expiry day The last Thursday of the expiry month of the previous
trading day if the last Thursday is trading holiday.

Settlement basis Mark to market &final settlement will be cash settled on

T +1 basis

Settlement price Daily settlement price will be closing price the futures
contracts for the trading day & the final settlement price
shall be the closing value of the underlying index on the
last trading day.

42
 FORWARD V/S. FUTURES

Features Forward Future

-Operational Traded between Trades on
Mechanism two parties Exchange

-Contract Differ from Standardized

Specifications traded to trade contracts

-Counter party exists such risk No such risk

Risks

-Liquidity Low High

-Settlement At end of period daily

43
 STOCK FUTURE

Stock futures are the contracts where the underlying asset is the individual securities or
stock. In stock futures the investors also require to deposit initial margin, the margin is
decided by the exchange (on the basis of four times changes in security prices in a day) on
the volatility of individual stock. Beside this, exposure margin is also required by the stock
exchange, it can 5% (6% or 7% at specific securities) of all 41 individual securities. In India
settlement of future on individual stock is settled in cash only.
In India the stock future are available on the blue chip securities & these securities
are free from price fluctuation bonds. The securities are approved by SEBI. At present 41
individual securities are available for stock future. NSE & BSE commenced trading in stock
future on individual securities on November 9,2001 & November 2001 respectively.

Contract specification

Underlying Individual securities

Exchange of trading National Stock Exchange
Security descriptor NFUTSK
Contract size 100 or multiples there of (minimum value of Rs.2

lakh)
Price steps Rs.0.05
Price band Not applicable
Trading cycle The contract will have a maximum of three month

trading cycle- the near month (one), the next month

(two), &the far month (three). New contracts will be

introduced on the next trading day following the

expiry of the near month contract.

Expiry day The last Thursday of the expiry month of the previous

trading day if the last is Thursday is trading holiday.

Settlement basis Mark to market & final settlement will be cash settled

on T+1 basis.

44
Settlement price Daily settlement will be the closing price of the future

contracts for the trading day &the settlement price

shall be the closing vale of the underlying index on the

last trading day.

INTEREST RATE FUTURE

Interest rate futures are based on a list of underlying (T-bills, bonds, notes & credit
instrument). The list of underlying is specified by the exchange & approved by SEBI time
to time. Interest rate futures provide a hedge against the interest rate risk. In India, the
interest rate has a downtrend since last four years.

The interest rate future contract shall be for a period of maturity of one year with three-
month continues contract, for the first three-month & fixed quartile contracts for the entire
year. New contract will be introduced on trading day following the expiry the near month
contract.

OPTIONS

Options are fundamentally different from forward and futures. An option gives the
holder/buyers of the option, the right to do something. The holder does not have committed
himself to doing something. In contrast, in a forward or futures contract, the two parties
have committed them self to doing something. Whereas it requires nothing (expect margin
requirement) to enter in to a futures he purchases of an option require an up front payment.

45
Historical background of Option:
Although options have exercised for a long time, they were traded OTD, without much
knowledge of valuation. Today exchange-traded options are actively traded on stocks, stock
indices, and foreign currencies and futures contracts.
The first trading is options began in Europe and U.S. as early as the century. It was
only in early, 1900s that a group of firms set up what is known as the "put and call
brokers and dealers association" with the aim of providing a mechanism for bringing
buyers and sellers together. It someone wanted to buy an option, he or she would contract
one of the member firms. The firm would then attempt to find a seller or writer of option
either from its own client of those of other member firms. If no seller could be found, the
firm would undertake to write the option itself in return of price. The two deficiencies in
above markets were
1. No secondary market
2. No mechanism to guarantee the writer of option would honor it
In 1973, Black, Marton, Scholes invented the Black-Scholes formula. In April 1973, CBOE
was set up specially for the purpose of trading options. The market for options develop so
rapidly that by early 80's number of share underlying the options contract sold each day
exceed the daily volume of share traded on the NYSE. Since then, there has been no
looking back.

What is option?

An options is the right, but not the obligation to buy or sell a specified amount (and
quantity) of a commodity, currency, index or financial instruments

Thus, option like futures, also provide a mechanism by which one can acquire a certain
commodity or other assets, or take position in order to make profits or cover risk for a price.
In this type of contract as well, there are two parties:
(a) The buyer (or the holder, or owner of options)

46
 (b) The seller (or writer of options)
While the buyer takes "long position" the seller take "short position"
So every option contract can either be "call option" or "put option" options are created by
selling and buying and for every option that is buyer and seller.

OPTION

BUYER SELLER

RIGHT OBLIGATION

TO BUY TO SELL TO SELL TO BUY

(CALL) (PUT) (CALL) (PUT)

OPTION TERMINOLOGY
 Buyer of an option: the buyer of an option is the one who by paying the option
premium buys the right but not the obligation exercise his option on the
seller/writer.
 Writer of an option: the writer of a call/put option is the one who receives the
option premium and is thereby obliged to sell/buy the asset if the buyer exercises on
him.

47
  Option price: option price is the price, which the option buyer pays to the option
seller. It is also referred as option premium.
 Expiration date: the date specified in the options contract is known as expiration
date, the exercise date, the strike date or the maturity.
 Strike price: the price specified in the options contract is knows as strike price or
the exercise price.
 American options: these are the options that can be exercised at any time upto the
expiration date. Most exchange-traded options are Americans.
 European options: these are the options that can be exercised only on the
expiration date itself. These are easier or analyze than American option, and
properties of American options are frequently deducted from those of its European
counterpart.
 At-money option: (ATM) option is an option that would lead to zero cash flow if it
were exercised immediately. An option on the index is at-the-money when the
current index equals the strike price.
 Out-of-the money option :( OTM) option is an option that would lead to a negative
cash flow it was exercised immediately. A call option on the index is OTM when the
current index stands at a level, which is less than the strike price (spot price<strike
price). If the index is much lower than the strike price, the call is set to be deep
OTM. In the case of a put, the put is OTM if the index is above the strike price.

TYPES OF OPTIONS

Thus the options are of two types: CALL OPTION AND PUT OPTION.

CALL OPTION:
It gives an owner the write to buy a specified quantity of the underling assets at a
predetermined price i.e. the exercise price, or the specific date i.e. is the date of maturity.
Example

48
Suppose it is January now and the investor buys a March option contract on Reliance
Industries (RIL) Share with an exercise price/strike price Rs. 210. With this he get a right to
buy share on a particular date in March, of course he is under no obligation.
Obviously, if at the expiry date the price in market (spot price on expiry date) is above the
exercise price he'll exercise his option and reverse is also true.

PUT OPTION:
It gives the holder the right to sell a specific quantity of underlying assets at an agreed price
on date of maturity he gets the right to sell.
Example
If an investor buys a March Put Option on RIL shares with an exercise price of Rs. 210 per
share the investor get the right to sell 100 shares @ 210 per share. The investor would
naturally exercise his right if on maturity date price were below 210 and stand to gain and
vice-versa. Buying put options is buying insurance. To buy a put option on Nifty is to buy
insurance: which reimburses the full extent to which-Nifty drops below the strike price of
the put option. This is attractive to many people

INDEX OPTION

Index options are the contracts between two parties that give the right, but not the
obligation, to buy or sell underlying at a stated date & a stated price to the buyer of the
contract. In index option, the underlying is share price index & all contracts are based up on
it. In index option the buyer requires to pay a sum for the buying the contract that is called
‘premium’. The premium is decided by the market forces & not by the stock exchange. All
index option is cash settled & physical delivery is not applicable.

49
Beside the premium the seller of the contract is required to pay 3% margin on contract
value to the exchange to eliminate the risk that is called exposure margin.
In India the options on index started by the BSE & NSE on their index SENSEX and S&P
CNX NIFTY respectively. Trading on S&P CNX
NIFTY commenced at NSE on June 2,2001 .

Contract specification
Underlying index S & P CNX NIFTY

Exchange of trading National Stock Exchange

Security descriptor N OPTIDX NIFTY

Contract size Permitted lot size shall be 200 & multiples

thereof (minimum value Rs.2 lack)

Price band Not applicable

Trading cycle The futures contracts will have a maximum of three month
trading cycle-the near month (one), the next month (two) &
the far month (three).New contracts will be introduced on
the next trading day following the expiry of the near month
contract.
Expiry date The last Thursday of the expiry month of the previous
trading day if the last Thursday is a trading holiday.
Settlement basis Cash settled on T+1 basis.

Daily settlement price Premium value (net).

Final settlement price Closing value of the index on the trading day.

In index option the investor can hedge their risk & make profits. In index options the loss is
limited to premium paid & profit is unlimited of the buyer, on the other hand the profit to
premium received of the writer is limited & loss is unlimited .For Example: Current Nifty is
1400. You buy one contract of nifty near month calls for Rs.30 each. The strike price is
1430 i.e. 2.14% out of money. The premium paid by you will be (Rs.30n *200)
Rs.6000.Given these, your break-even level nifty is 1460 (1430+30).If at expiration nifty
advanced by 5%, i.e.1470, then

50
Nifty 1470

Less strike price 1430

Option value 40 (1470-1430)

Less purchase price 30

Profit per nifty 10

Profit on the contract Rs.2000 (Rs.10 * 200)

51
 STOCK OPTION

Stock options are the contract on the individual scrips means where underlying are
individual scrips. In stock options the buyers of the options have right but not obligation to
buy or sell the underlying asset.
The buyer is required to pay some money at the time of the purchases of the contract to
seller of the contract that is called ‘premium’. And seller requires paying exposure margin
to exchange that is 5% (6%and 7% on specific securities) on the contract value. At present
in India 41 individual scrips are approved by the SEBI for stock option.
The trading on the stock commenced at NSE on July 2, 2001.These contracts are availvable
at BSE & NSE on highly liquid & price band free 41scrips.

Control specification

Underlying Individual securities

Exchange of trading National Stock Exchange

Security descriptor N-OPTSTK

Contract size 100 or multiples thereof (minimum value of Rs.2 lakh)

Price band Not applicable

Trading cycle The futures contracts will have a maximum of three

Expiry day
Settlement basis
Strike price interval
Daily settlement price
month trading cycle- the near month (one),the next
month(two) & the far month(three).new contract will be
introduced on the next trading day following the expiry of
the near month contract.
The last Thursday of the expiry month of the previous
trading day if the last Thursday is trading holiday.
Daily settlement on T+1 basis & final option exercise
settlement on T+2 bases.
Between Rs.2.5 & Rs.100 depending on the price of the
under lying
Premium value (net).

Final settlement price Closing value of the index on the last trading day.
Settlement day Last trading day

52
Buying options can be compared to buying insurance. For Example to cover the risk of
burglary, fire etc. you by insurance & pay premium in the event of any untoward
happening, the insurance cover expires after the specific period of time.

Option-to-option holder in case of—he opt for expiry date.

i.e. How Option Work

CALL OPTIONS
Spot Nifty: 1100
Strike Price: 1150
Day 1 Duration: 3 months
No. of option bought=200
Premium per option: 10
Total premium paid=2000
Spot Nifty: 1200
Buyer exercise the option
Day Profit: No. of option x price
90 Differential-Premium paid=Rs. (200 x
(1200-1150)-2000=Rs.8000)

Spot Nifty: 1000

Buyer foregoes the option
Loss premium paid
Rs. 2000

Operational Mechanism of Derivatives

53
1. Registration with broker: The first step towards trading in the derivatives market is
selection of a proper broker with whom the investor would trade. Investors should complete
all the registration formalities with the broker before commencement of trading in the
derivatives market. The investor should also ensure to deal with a broker (member of the
exchange) who is a SEBI registered broker and possesses a SEBI registration certificate.
2. Client Agreement: The investor should sign the Client Agreement with the broker
before the broker can place any order on his behalf. The client agreement includes
provisions specified by SEBI and the derivatives segment.
3. Unique Client Identification Number: After signing the client agreement, the investor
gets a unique identification number (ID). The broker would key this identification number
in the system at the time of placing the order on behalf of the investor. This ID is broker
specific i.e. if the investor chooses to deal with different brokers, he needs to sign the client
agreement with each one of them and resultantly, he would have different Ids.
4. Risk Disclosure Document: As stipulated in the Byelaws provide his particulars to the
investor. The particulars would include his SEBI registration number, the name of the
employees who would be primarily responsible for the client's affairs, the precise nature of
his liability towards the client in respect of the business done on behalf of the investor. The
broker must also apprise the investor about the risk associated with the business in
derivative trading and the extent of his liability. This information forms part of the Risk
Disclosure document, which the broker issues to the client. The investor should carefully
read the risk disclosure document and understand the risks involved in the derivatives
trading before committing any position in the market. The risk disclosure document has to
be signed by the client and the broker for his records retains a copy of the same.
5. Free Copy of Relevant Regulation: The client is also entitled to a free copy of the
extracts of relevant provisions governing the rights and obligations of clients, relevant
manuals, notifications, circulars and any additions or amendments etc. of the derivatives
segment or of any regulatory authority to the extent it governs the relationship between the
broker and the client.
6. Placing order with the broker: The investor should place orders only after
understanding the monetary implications in the event of execution of the trade. After the

54
trade is executed, the investor can request for a copy of the trade confirmation slip
generated on the systems on execution of the trade. The investor should also obtain from the
broker, a contract note for the trade executed within 24 hours. The contract note should be
time (order receipt and order execution) and price stamped. Execution prices, brokerage and
other charges, if any, should be separately mentioned in the contract note. If desired, the
investor may change an order anytime before the same is executed on the exchange.
7. Margining System in Derivatives: The aim of margin money is to minimize the risk of
default by either counter-party. The payment of margin ensures that the risk is limited to the
previous day's price movement on each outstanding position. The different types of margins
are:
Initial Margin: The basic aim of initial margin is to cover the largest potential loss in
one day. Both buyer and seller have to deposit before the opening of the position in the
futures transaction. This margin is calculated by SPAN by considering the worst-case
scenario.
8. Investor Protection Fund: The derivatives segment has established an "Investor
Protection Fund" which is independent of the cash segment to protect the interest of the
investors in the derivatives market.
9. Arbitration: In case of any dispute between the members and the clients arising out of
the trading or in relation to trading/settlement, the party thereto shall resolve such
complaint, dispute by arbitrations procedure as defined in eh rules and regulations and Bye-
Laws of the respective exchanges.

55
 REGULATORY FRAMEWORK

The trading of derivatives is governed by the provisions contained in the SC (R) A, the
SEBI Act, the rules and regulations framed there under and the rules and bye-laws of stock
exchanges.

Securities contracts (Regulation) Act, 1956

SC(R) A aims at preventing undesirable transactions in securities by regulating the business

of dealing therein and by providing for certain other matters connected therewith. This is
the principal Act, which governs the trading of securities in India. The term "securities" has
been defined in the SC(R) A. As per Section 2(h), the 'Securities' include:
1. Shares, scrips, stock, bonds, debentures, stock or other marketable securities of a
like nature in or of any incorporated company or other body corporate.
2. Derivative
3. Units or any other instrument issued by any collective investment scheme to the
investors in such schemes.
4. Government securities.
5. Such other instruments as may be declared by the Central Government to be
securities
6. Rights or interests in securities
"Derivative" is defined to includes:
• 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.
• A contract, which derives its value from the prices, or index of price, of
underlying securities.
Section 18A provides that notwithstanding anything contained in any other law for
the time being in force, contracts in derivative shall be legal and valid if such
contracts are:
Traded on a recognized stock exchange.
Settled on the clearinghouse of the recognized stock exchange, in accordance with the rules
and byelaws of such stock exchanges.

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 MEMBSHIP CRITERIA

NSE
Clearing member
 Networth-300lakh
 Interest –Free Security Deposit-Rs 25 lakh
 Collateral Security-Rs.25 lakh
In addition for every TM he wishes to clear for the CM has to deposits Rs 10 lakh.
Trading member
 Net worth –Rs100 lakh
 Interest –Free Security Deposits-Rs 8 lakh
 Annual subscription Fees- Rs 1 lakh

BSE
Ciearing member
 Networth-300lakh
 Interest –Free Security Deposit-Rs 25 lakh
 Collateral security Deposits –Rs 25lakh
 Non-refundable Deposit-Rs5 lakh
 Annual subscriptions -Rs 50 thousand
In addition for every TM he wishes to clear for the CM has to deposits Rs.10 lakh with
the following break up.
 Cash –Rs 2.5 lakh
 Cash equivalent –Rs 25
 Collateral security deposit-Rs 5 lakh
Trading member
 net worth –Rs 50 lakh
 Non- refundable Deposit-Rs 3lakh
 Annual Subscription Fees-Rs 25 lakh

The Non –refundable fee paid by the member is exclusive &will be a total of Rs 8 lakh if
the member has both clearing & trading rights.

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 RESEARCH METHODOLOGY

.
The study about "broker perception & investor perception on derivative trading" is
descriptive in nature. So survey method is used for the study.

Sampling Procedure
Random and Convenient sampling
Sources of Data:
The sources of data include primary and secondary data sources.
Primary Sources:
Primary data is collected by structured questionnaire administered by sitting with
guide and discussing problems.
Secondary Sources:
The secondary data is data, which is collected and compiled for the different
purpose, which are used in research for this study.
The secondary data include material collected from:
 Newspaper
 Magazine
 Internet
Data collection instruments
The various method of data gathering involves the use of appropriate recording
forms. These are called 'tools' or 'instruments of data collection.

Collection Instruments:
1. Interview guide
2. Interview schedule
Each tool is used for specific method of data gathering. The tool for data collection
translates the research objectives in to specific term/questions to the response, which will
provide research objective.

58
 The instrument data collection in our study interview schedule mainly. Every
respondent was conducted personally with an interview schedule containing questions.
Interview method was used because it can be explained more easily and clearly and takes
less time to answer.

Methodology
Assumptions:
The research was based on the following assumption:
1. The methodology used for this purpose is survey and questionable method. It is
assumed that this method is more suitable for collection of data.
2. It is assumed that the respondent has sufficient knowledge to ensure questionable.
3. It is assumed that the respondent has filled right and correct option according to their
view.

59
 ANALYSIS OF SURVEY

From my sample size of 50 informants, 35 are trading in derivatives i.e. 70 %. These

are people having average experience of 10 year in cash market and approximately 4-year
experience in derivative trading. My study is based on individual informants as well as
corporate informants.
Out of 35 informants, 6 are the corporate i.e. 17 % and rests are Individuals i.e. 83%.
I want to analyze all the facts, which was exposed in my questionnaire and my personal
meeting. So, I am going to analyze the facts and findings question wise with the views that I
got in personal meetings
:

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1. TO KNOW THE TYPE OF MEMBER THEY ARE?

MEMBER NO. OF RESPONDANTS

CORPORATE 6
INDIVIDUAL 29

NO. OF RESPONDANTS

17%

CORPORATE
INDIVIDUAL

83%

Most are the individual member and few are the corporate members.
Out of 35, only 6’s are corporate member and 29’s are individual member.
So my mostly study is based on individual members.

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 2. TO KNOW THE SEGMENT IN WHICH THEY HAVE THE LARGEST
INVESTMENT?

SEGMENT NO. OF RESPONDANTS

CAPITAL MARKET SEGMENT 20
F & O SEGMENT 0
EQUAL IN BOTH ABOVE 15
CAN’T SAY 0

43% CM
43% SEGMENT
57% 57% EQUAL IN
F&O & CM

Out of 35 informants, 20’s have the largest turnover in the capital segment
i.e. 43% &15% have equal turnover in CM & F&O segment. No informants
have it’s largest turnover in F&O segment because the investor are very less
aware about the derivatives & they do not know about the derivative trading
as they much know about the CM segment

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 3. TO KNOW THE MOST IMPORTANT ADVANTAGE OF DERIVATIVE
TRADING?

ADVANTAGE NO. OF RESPONDANTS

LIQUIDITY 15
VOLATILITY 2
INCREASE IN VOLUME OF TRADING 11
FACILATE HEDGING 7

LIQUIDITY

VOLATILITY
20%
43%

INCREASE IN
31% VOLUME OF
6% TRADING
FACILATE HEDGING

I got mix view on this question. But most of informants i.e. .43% are in the
favor of liquidity & rests are having some different-2 attraction i.e. 31% or
6%. Most of informants say that every instrument has their own merits &
demerits. The informants are saying in the favor of volatility that they can
give you a lot of money that can be used in any other field for some time.

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4. TO KNOW IN WHICH SEGMENT INVESTORS ARE EXPOSED TO MORE RISK?
SEGMENT RESPONSE
CAPITAL MARKET 22
F & O SEGMENT 4
CAN’T SAY 9

26%
CAPITAL MARKET
F & O SEGMENT
11% 63% CAN' SAY

Most of the people think that capital market is more risky that is why
63% people are thinking that capital market is more risky but some
people are also of the view that f & o segment is also risky but 26% are
not able to say anything
.

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 5. TO KNOW THE MARKET SEGMENT DERIVATIVE CUSTOMER TRADE
MORE?

MARKET SEGMENT NO. OF RESPONDANTS

INDEX FUTURE 10
STOCK FUTURE 5
INDEX OPTION 8
STOCK OPTION 12

29% INDEX FUTURE

34%
STOCK FUTURE
INDEX OPTION
14% STOCK OPTION
23%

Mostly informants saying that index future is more popular among the
investor & broker .Out of 35, 10 informants are saying that index futures are
very good and 12 prefer stock option in comparison with other product.
Index futures are exposed more risk & more profit so, mostly informants
engaged in speculative activities.

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6. TO KNOW WHICH TOOL OF DERIVATIVE IS BETTER FOR THEM?

TOOL NO. OF RESPONDANTS

INDEX FUTURE 20
STOCK FUTURE 5
INDEX OPTION 5
STOCK OPTION 5

66%INDEX
FUTURE
10% 7%
17%STOCK
FUTURE
17% 10%INDEX
66% OPTION
7%STOCK
OPTION

I got mix view on this question. But most of informants i.e. .66% is in the
favor of index future & rests are having some different-2 attraction i.e. 17%
or 7%. Most of informants say that every instrument has their own merits &
demerits. The informants are saying in the favor of index future that they
can give you a lot of profits you know your loss in advance & you can know
about the company but some say index future is not so good because Index
very typical by nature.

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7. TO KNOW THEIR VIEW REGARDING THE ADOPTION OF DERIVATIVES IN
INDIA WILL BE A RIGHT STEP TOWARDS SURVIVAL & GROWTH OF CAPITAL
MARKET IN INDIA?

RESPONSE NO. OF RESPONDANTS

YES 35

NO 0

0%

YES
NO

100%

In the answer of this question all informants says yes. Means they are
saying that derivatives trading will improve the growth & efficiency in
the terms of quantity & quality .All informants thinks that it will bring
the revolution in the growth of Indian capital market. It will provide the
insurance against the risks on portfolios.

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 8. TO KNOW AT WHAT RATE DERIVATIVE MARKET WILL GROW IN INDIA?

RATE RESPONSE
HIGH RATE 22
MODERATE 8
CAN’T SAY 5

14%

HIGH RATE
MODERATE
23%
CAN'T SAY
63%

I got mix view on this question. But most of informants i.e. .63% are in
the favor of high rate & rests are having some different-2 attraction i.e.
31% or 6%. Most of informants say that derivative market will grow in
India at a good speed.

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9. TO KNOW THE FUTURE OF F&O SEGMENT IN INDIA?

FUTURE NO. OF REPONDANTS

FLOURISHING 30
DULL 0
CAN’T SAY 5

14%

14% CAN'T SAY

86% FIOURISHING

86%

Mostly informants believe that the future of Indian “F&O” segment is very
bright. 86% of informants are saying that future is flourishing where as 14%
are not having clear about the future of Indian “F&O” segment. Mostly
thinks that this market will attract more & more investors & FIIs

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10. TO KNOW THE AFFECT OF DERIVATIVE TRADING ON COUNTRY’S
ECONOMY?

AFFECT NO. OF RESPONDANTS

ACCELERATES GLOBALIZATION OF 10
INDIAN MARKET
MAKE THE INDIAN MARKET MORE 20
SAFE
INCREASED INVESTMENT BY FIIs 5

57% MAKE
INDIAN
MARKET
14%
29%ACCELER
ATE GLOBAL
29% 57%

14%
INCREASE
INVESTMENT
BY FIIs

I found in my study that the derivatives increase the foreign investment by

the FIIs, & make Indian economy globalize. The derivative trading also
makes the Indian economy globalize. The derivative trading also makes the
Indian market safer from systematic & un- diversified risk. Mostly, 57%
informants are saying that derivative makes market safer from risk on
portfolios and it is provide leverage to the investor. Where, 29%think that it
accelerate globalization of Indian economy because it has been attracted a
huge number of foreign investors. But 14% are thinking that it will only rise
the investment from FIIs. According to me it makes Indian market safe as
well as accelerates the globalization.

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 11. TO KNOW THE AFFECT OF APPROVAL OF 41 SCRIPS FOR INDVIDUAL
STOCK, WHICH ARE NOW MORE THAN 125. IS IT GOOD OR BAD?

REPONSE NO. OF RESPONDANTS

GOOD 35

BAD 0

0%

GOOD
BAD

100%

Entire trader of F&O segment considers that it very good that SEBI has
increased the number of scrips. They think it will provide us more choice &
alternatives for our investments. But mostly think that new scrip will be
high liquid & reliable & has good face & respect in the market.

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 LIMITATIONS OF STUDY

No study is complete in itself, however good it may and every study has some limitations:

 Time is the main constraint of my study.

 Availability of information was not sufficient because of less awareness among

investors/brokers

 Study is based only on NSE because information and trading in BSE is not available
here.

 Sample size is not enough to have a clear opinion.

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 CONCLUSION

The Indian accounting guidelines in this area need to be carefully reviewed. The
international trend is moving the underlying securities as well as associated derivative
instrument to market. Such a practice would bring into the account a Clear picture of the
impact of derivative related operations.

On the basis of overall study on derivatives it was found that derivative products
initially emerged as hedging devices against fluctuation and commodity prices and
commodity linked derivatives remained the soul form of such products. The financial
derivatives came in spotlight in 1972 due to growing in stability in financial market.

I was really surprised to see during my study that a layman or a simple investor
does not even know how to hedge and how to reduce risk on his portfolios. Big
individual investors, institutional investors, mutual funds etc generally perform all these
activities.

No doubt that derivative growth towards the progress of economy is positive. But
the problems confronting the derivative market segment are giving it a low customer
base. The main problems that it confronts are unawareness and bit lot sizes etc. these
problems could be overcome easily by revising lot sizes and also there should be
seminar and general discussions on derivatives at varied places.

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 SUGGESTIONS

1. Lot size: Lot size should be reduced so that the major segment of an India society
i.e. small saving class can come under F & O trading. There is strong need for
revision of lot sizes as the lot sizes of some of the individual scrip’s that were worth
of Rs. 200000 in starting, now same lot size amount to a much larger value.
2. Sub broker: Sub-broker concept should be added and the actual brokers should
give all rights of brokers in F & O segment also.
3. Scrips: More scrips of reputed companies etc. should be introduced in "F & O
segment".
4. Trading period: Trading period should be increased.
5. Training classes or Seminars: There should be proper classes on derivatives for
investors, traders, brokers, students and employees of stock exchanges. Because lack
of knowledge is the main reason of its less development. The first step towards it
should be seminars provide to brokers & LSE employees and secondly seminar to
students.

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 BIBLOGRAPHY

BOOKS:

 INDIAN CAPITAL MARKET by H.S.SIDHU

 INDIAN SECURITIES EXCHANGE

MAGAZINES & NEWSPAPER:

 LSE Bulletin
 NSE news
 ECONOMIC TIMES
 BUISNESS STANDARD

INTERNET SITES:
 WWW.NSEINDIA.COM
 WWW.BSEINDIA.COM
 WWW.SEBI.GOV.IN

MATERIAL PROVIDED BY MY PROJECT GUIDE

75
 QUESTIONNAIRE

DEAR RESPONDENT,
As part of my curriculum of M.B.A. program, I am undergoing summer training at
Ludhiana Stock Exchange. I have been assigned a project, “DERIVATIVES”. Kindly give
your valuable view regarding the same.

1. What type of member you are?

a) Corporate member
b) Individual member

2. In which segment you have larger turnover?

a) Capital market segment
b) “F&O” segment
c) Equal in both
d) Can’t say

3. Which one is the most important advantage of derivative trading?

a) Liquidity
b) Volatility
c) Increase In volume of trade

4. In which market segment you are exposed to more risk?

a) Capital market segment (CM segment)
b) “F&O” segment

5. In which market segment derivative customer trade more?

a) Index futures
b) Stock futures
c) Index options
d) Stock options

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6. Which tool of derivatives according to you is better?
a) Index futures
b) Stock futures
c) Index options
d) Stock options

7. Do u think that adoption of derivatives trading in India will be a right step towards
growth of capital market in India?
a) Yes
b) No

8. What are you perception of growth of derivatives market In India the

likely to grow at?
a) High rate
b) Moderate rate
c) Can’t say

9. What is the future of “F&O” segment in India?

a) Flourishing
b) Dull
c) Can’t Say

10. What will be the affect of derivative trading on country’s economy?

a) Accelerates globalization of Indian markets
b) Make Indian markets safer
c) Inflate the gains of investors
d) Increased investment by FIIs

11. At present SEBI approved more than125 scrips for derivatives .Do you want any
increment in it?
a) Yes
b) No

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Name of Broker_________________________________________
Room No: ________________________________________
Date: _________________________________________

Thanks for your cooperation

78