Executive summary

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 riskaverse investors.

Derivative products initially emerged, as hedging devices against fluctuations in commodity prices and commodity-linked derivatives remained the sole form of such products for almost three hundred years. The financial derivatives came into spotlight in post-1970 period due to growing instability in the financial markets. However, since their emergence, these products have become very popular and by 1990s, they accounted for about two-thirds of total transactions in derivative products. In recent years, the market for financial derivatives has grown tremendously both in terms of variety of instruments available, their complexity and also turnover. In the class of equity derivatives, futures and options on stock indices have gained more popularity than on individual stocks, especially among institutional investors, who are major users of index-linked derivatives. Even small investors find these useful due to high correlation of the popular indices with various portfolios and ease of use. The lower costs associated with index derivatives vis-vis derivative products based on individual securities is another reason for their growing use.

Objectives of study

To understand about derivatives, its importance and its types To know about various types of derivative contracts like future, forward, swap and options.
To know how sharekhan uses derivatives as one of its functions

To know about the use of derivatives in bank To get informed about various terminologies used in the derivative market

Research methodology

Sources of data
Sources of data are means from where information is collected for the study and analysis purpose. There are two sources of data collection, 1. Primary Data 2. Secondary Data. For this project I had only used secondary data. Secondary data- For this project I have also used secondary data. Secondary data are those data which are collected by the other person and which are used by the researcher for his present study. I have used the secondary data to understand the basic concept of derivatives from the reference book N.D. Vohra and B.R. Bagri.

DERIVATIVE FINANCIAL MARKET

CHAPTER 1 INTRODUCTION TO DERIVATIVES

MEANING:
Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the "underlying".

DEFINITION:
The term Derivative has been defined in Securities Contracts (Regulations) Act, as:Derivative includes: (i) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; (ii) a contract which derives its value from the prices, or index of prices, of underlying securities; Derivatives are instruments which make payments calculated using price of interest rates derived from on balance sheets or cash instruments, but do not actually employ those cash instruments to fund payments Derivatives are bilateral contracts or payments exchange system whose value is derived from the value of underlying asset. It is an innovative tradable financial instrument derived from an underlying asset

TYPES OF DERIVATIVES

Forwards: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at todays 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. 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:

Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency. 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.
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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 or a basket of assets. Equity index options are a form of basket option 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.

CHAPTER 2
7

ORIGIN AND HISTORY OF DERIVATIVES

In financial markets, the term derivative is used to refer to a group of instruments that derive their value from some underlying commodity or market. Forwards, futures, swaps and options are all types of derivative instruments and are widely used for hedging or speculative purposes. While trading in derivative products has grown tremendously in recent times, early evidence of these types of instruments can be traced back to ancient Greece.

ORIGIN OF OPTION
Aristotle related a story about how the Greek philosopher Talus profited handsomely from an option-type agreement around the 6th century B.C. According to the story, one-year ahead, Thales forecast the next olive harvest would be an exceptionally good one. As a poor philosopher, he did not have many financial resources at hand. But he used what he had to place a deposit on the local olive presses. As nobody knew for certain whether the harvest would be good or bad, Thales secured the rights to the presses at a relatively low rate. When the harvest proved to be bountiful, and so demand for the presses was high, Thales charged a high price for their use and reaped a considerable profit A critical attribute of Thales arrangement was the fact that its merit did not depend on his forecast for a good harvest being accurate. The deposit gave him the right but not the obligation to hire the presses. If the harvest had failed, his losses were limited to the initial deposit he paid. Thales had purchased an option.

ORIGIN OF FORWARD CONTRACT

There is evidence that the use of a type of forward contract was prevalent among merchants in medieval European trade fairs. When trade began to flourish in the 12th century merchants created a forward contract called alettre de faire (letter of the fair). These letters allowed merchants to trade on the basis of a sample of their goods, thus relieving them of the need to transport large quantities of merchandise along dangerous routes with no guarantee of a buyer at the journeys end. The letter acted as evidence that the full consignment of the specified commodity was being held at a warehouse for future delivery. Eventually, the contracts themselves were traded among the merchants.

ORIGIN OF FUTURES CONTRACT

The first record of organized trading in futures comes from 17th century Japan. Feudal Japanese landlords would ship surplus rice to storage warehouses in the cities and then issue tickets promising future delivery of the rice. The tickets represented the right to take delivery of a certain quantity of rice at a future date at a specified price. These rice tickets were traded on the Dojima rice market near Osaka and in 1730. Trading in rice tickets allowed landlords and merchants to lock the prices at which rice was bought and sold, reducing the risk they faced. The tickets also provided flexibility. Someone holding a rice ticket but not a holder of a rice ticket but not wanting to take delivery could sell it in the market. The rules governing the trading on the Dojima market were similar to those of modern-day futures markets.

CHAPTER 3

NEED AND IMPORTANCE

IMPORTANCE OF DERIVATIVES
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 Managing risk
There are several risks inherent in financial transactions. Derivatives allow you to manage these risks more efficiently by unbundling the risks and allowing either hedging or taking only one risk at a time. Once investor is long on share investor can hedge the systematic risk by going short on share Futures. On the other hand, if investors do not want to take unsystematic risk on anyone share, but wish to take only systematic risk - investor can go long on Index Futures, without buying any individual shares.

Speculation
Derivatives offer an opportunity to make unlimited money by way of speculation. Speculators are of two types. One type is of optimistic variety, and sees a rise in prices in future. He is known as 'bull'. The other type is a pessimist, and he sees a fall in prices, in future. He is known as 'bear'. They undertake 'futures' transactions with the intention of making gains through difference in contracted prices and future cash market price prices. If, in future, their expectations turn out to be true, they gain and if not they lose. Of course, they may limit their losses through options.

High leverage
Leverage opportunities are often expensive and complicated to implement for many investors in the cash market, or are simply not feasible. However, options and futures represent (highly) levered investments in the underlying cash instruments. They require only a small fraction of the investment in the underlying securities. The case is most obvious for futures, where there is essentially no initial investment except margin payments.

Arbitrage
Arbitrageurs profit from price differential existing in two markets by simultaneously operating in two different markets. Arbitrage can be done between two instruments when they are related to each other, but they are temporarily mispriced. For example, the futures price and

10

spot price are related by the interest rate, time to maturity and corporate benefit, if any, in the interregnum. They can also be important for, 1. Efficient Allocation of Risk 2. Lower Cost of Hedging 3. Liquidity
4. Risk Management

NEED FOR DERIVATIVES IN INDIA TODAY

In less than three decades of their coming into vogue, derivatives markets have become the most important markets in the world. Today, derivatives have become part and parcel of the day-today life for ordinary people in major part of the world. Until the advent of NSE, the Indian capital market had no access to the latest trading methods and was using traditional out-dated
11

methods of trading. There was a huge gap between the investors aspirations of the markets and the available means of trading. The opening of Indian economy has precipitated the process of integration of Indias financial markets with the international financial markets. Introduction of risk management instruments in India has gained momentum in last few years thanks to Reserve Bank of Indias efforts in allowing forward contracts, cross currency options etc. which have developed into a very large market. The following point shows the need for the derivative market: 1. To help in transferring risks from risk averse people to risk oriented people 2. To help in the discovery of future as well as current prices 3. To catalyze entrepreneurial activity 4. To increase the volume traded in markets because of participation of risk adverse people in greater numbers. 5. To increase savings and investment in the long run

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THE PARTICIPANTS IN A DERIVATIVES MARKET

Hedgers use futures or options markets to reduce or eliminate the risk associated with price of an asset. Speculators use futures and options contracts to get extra leverage in betting on future movements in the price of an asset. They can increase both the potential gains and potential losses by usage of derivatives 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.

TRADING IN DERIVATIVE WITH RESPECT TO

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SHAREKHAN

CHAPTER 4
Company Profile:

ABOUT SHAREKHAN

SHARE KHAN, a professionally managed Investment advisory services company, developed in the year 1985 by three young entrepreneurs with an intension to Minimization of Risk and Maximization of Return in the field of Indian Capital markets by extensive research work. As a sub member of NSE, BSE, MCX, NCDEX, NSDL and CDSL, which are pioneers in the respective operations, SHARE KHAN is having more than 500 branches in all over India. Share khan, Indias leading stock broker is the retail arm of SSKI, an organization with over eighty years of experience in the stock market with more than 510 share shops in 170 cities and
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big towns, and premier online trading destination www.sharekhan.com. Share khan offers the trade execution facilities for cash as well as derivatives, on BSE and NSE, depository services, commodities trading on the MCX(Multi Commodity Exchange of India Ltd) and NCDEX (National Commodity and Derivative Exchange) and most importantly, investment advice tempered by eighty years of broking experience. Share khan provides the facility to trade in commodities through Share khan Commodities Pvt.Ltd-a wholly owned subsidiary of its parent SSKI. Share khan is the member of two major commodity exchanges MCX and NCDEX.

SSKI (Shripal Shewantilal Kantilal Iswarnath Ltd.)

Apart from Share khan, the SSKI group also comprises of institutional broking and corporate finance. The institutional broking division caters to domestic and foreign institutional investors, while the corporate finance division focuses on niche areas such as infrastructure, telecom and media. SSKI owns 56% in Share khan and the balance ownership is HSBC, First Caryl and Intel Pacific. SSKI has been voted as the top domestic brokerage house in the research category, twice by Euro money survey and four times by Asia money survey. SHARE KHAN is on-par with the investor expectations in providing professional services, namely Online Trading in Equity, Commodities and F&O Framing of Derivative strategies Depository Services (D-MAT) Initial Public Offers (IPO) and Book Buildings Distribution of Mutual Funds Portfolio Management Service (PMS) etc., through its member
Corporate training for executives on NCFM (National Stock Exchange Certificate in Financial

Markets)

15

MANAGEMENT TEAM :

Dinesh Murikya: Owner of the company Tarun Shah: CEO of the company Shankar Vailaya: Director (Operations) Jaideep Arora: Director (Products & Technology) Pathik Gandotra: Head of Research Rishi Kohli : Vice President of Equity Derivatives

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Nikhil Vora : Vice President of Research

SHAREKHAN IS IN MARKET BECAUSE OF:

Investor care is of paramount importance at SHARE KHAN. SHARE KHAN offers large avenues of investment solutions for all classes of investors under one roof.
SHARE KHAN experience is one of prized possession. SHARE KHAN has an

experience of more than 20 years wherein grown phenomenally.

One of the most competitive brokerage structures.

Hassle free trading experience. Timely advice along with research support to the clients through SMS and E-MAILS on EQUITIES, DERIVATIVES, COMMODITIES, IPOs and Mutual Funds. VALUE FOR INVESTOR'S TRUST INTEGRITY AND HONESTY

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SHAREKHAN APPROACH :

UN BIASED INVESTMENT ADVISORY

PERSONALIZED ATTENTION RESEARCH BASED ADVISORY SERVICES Share khan won the award by the vote of consumers around the country, as part of Indias largest consumer study cover 7000 respondents 21 products and services across 21 major cities. The study, initiated by Awaaz Indias first dedicated Consumer Channel and member of the worldwide CNBC Network, and AC Nielsen ORG Marg, was aimed at understanding the brand preferences of the consumers and to decipher what are the most important loyalty criteria for the consume in each vertical. In order to select the award recipient, spontaneous responses, rather than prompted responses were garnered, with an intention to glean unbiased preferences. Opinions were garnered from owners of each of the categories, to get experiential responses, which are likely to be more realistic and grounded in nature. Further, preference also indicates future intentions of repeat purchases.
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The reasons behind the preferences for brands were unveiled by examining the following: Tangible features of product / service Softer, intangible features like imagery, equity driving preference Tactical measures such as promotional / pricing schemes Share khan is honored to be voted as the Most Preferred Stock Broking Brand in India. Our focus has always been to demystify the stock market and empower the investors to take informed decisions, said Jaideep Arora, Director, Share khan. The Award increases Share khans responsibility to persistently delight our customers with user-friendly trading experience and we shall continue our focus to evolve business strategies that keep us aligned with our customers needs.

Products and service profile:

Sharekhan provides 4 in 1 account. - Demat a/c - Trading a/c: for cash calculation - Bank a/c: for fund transfer - Dial and Trade: for query relating trading Products: Mutual fund schemes Insurance Portfolio Management System Shares online and offline Bonds Fixed Deposits Commodities Out of these we have to mostly sell demat accounts and Mutual Funds.
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Demat account: Sharekhan is a depository participant. This means that we can keep the shares in dematerialized form in Sharekhan. But for this one has to the demat account in Sharekhan. Dematerialization is the process by which a client can get physical certificates converted into electronic balances maintained in his account with the DP.

In Sharekhan, under demat account there are two types of terminals. TYPE OF DEMAT ACCOUNT TERMINAL CLASSIC Rs.5000 Rs.10000 TRADETIGER Rs.5000 Rs.10000/25000 Rs.750 Nil Rs.1000 Nil DEPOSIT (Refundable) CHARGES (nonrefundable)

Its core services are: Equities, and Derivatives trading on the National Stock Exchange of India Ltd. (NSE), and Bombay Stock Exchange Ltd. (BSE), Commodities trading on National Commodity and Derivatives Exchange India (NCDEX) and Multi Commodity Exchange of India Ltd. (MCX), Depository services, Online trading services, IPO Services, Dial-n-Trade Portfolio management services,
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 Fundamental and Technical Research services, In addition to this they also provide advisory services and distributions for Mutual funds. Sharekhan Value Line (a monthly publication with reviews of recommendations, Stocks to watch out for etc.) Daily research reports and market review (High Noon & Eagle Eye) Pre-market Report Daily trading calls based on Technical Analysis Cool trading products (Daring Derivatives and Market Strategy) Personalized Advice Live Market Information Sharekhan First Step

Product & service diagram of sharekhan

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ACCOUNT OPENING:
Opening a DP account with Sharekhan
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One can open a Depository Participant (DP) account, either through a Sharekhan branch or through a Sharekhan Franchisee center. There is no fee for opening DP accounts with Sharekhan. However a nominal deposit (refundable) is charged towards services which will be adjusted against all future billings. All investors have to submit their proof of identity and proof of address along with the prescribed account opening form. List of Documents required to open an account with Sharekhan: 1) Proof of Identity You can submit a photo copy of any of the following Voter ID Passport PAN Card MAPIN UID Card Driving License Photo I card issued by Employer registered under MAPIN 2) Copy of Ration Card 3) Address Proof You can submit a photo copy of any of the following Voter ID Card Driving License Passport Ration Card Telephone Bill Electricity Bill Leave-License Bank Passbook Latest Bank Statement Insurance Policy Flat Maintenance Bill 4) A copy of cancelled cheque 5) Nominee photograph, if filled 6) Signed Photograph of all holders

CHAPTER 5 TRADING OF DERIVATIVE IN SHAREKHAN

DERIVATIVE
A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is
23

determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage. Futures contracts, forward contracts, options, and swaps are the most common types of derivatives. Since derivatives are contracts, almost anything can be used as a derivative's underlying asset. Sharekhan does trading in futures contract and options contract with respect to stock exchanges.

FUTURE TRADING
Futures trading is a form of investment which involves speculating on the price of a security going up or down in the future. A security could be a stock (RIL, TISCO, etc), stock index (NSE Nifty Index), commodity (Gold, Silver, etc), currency, etc. Unlike other kinds of investments, such as stocks and bonds, when you trade futures, you do not actually buy anything or own anything. You are speculating on the future direction
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of the price in the security you are trading. This is like a bet on future price direction. The terms buy" and "sell" merely indicate the direction you expect future prices will take. If, for instance, you were speculating on the NSE Nifty Index, you would buy a futures con tract if you thought the price would be going up in the future. You would sell a futures contract if you thought the price would go down. For every trade, there is always a buyer and a seller. Neither person has to own anything to participate. He must only deposit sufficient capital with a brokerage firm to insure that he will be able to pay the losses if his trades lose money.

FUTURES CONTRACT
A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. A futures contract gives the holder the obligation to buy or sell, which differs from an options contract, which gives the holder the right, but not the obligation. In other words, the owner of an options contract may or may not exercise the contract. Whereas in a futures contract, both parties of a "futures contract" must fulfill the contract on the settlement date. In a futures contract the seller delivers the shares/commodity to the buyer, or, if it is a cash-settled future, as in the case of stock futures in India, cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit or close your position in an existing futures contract prior to the settlement date, the holder of a futures position has to offset his position by either selling a long position or buying back a short position, effectively closing out the futures position and its contract obligations. The future s contract is a standardized forward contract, which is an agreement between two parties to buy or sell an asset (which can be of any kind) at a preagreed future point in time specified in the futures contract. Some key features of a futures contract are: 1. Standardization
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A futures contract is highly standardized contract with the following details specified: The underlying asset or instrument. This could be anything from a barrel of crude oil, a ki lo of Gold or a specific stock or share. The type of settlement, either cash settlement or physical settlement. Currently in India most stock futures are settled in cash. The amount and units of the underlying asset per contract. This can be the weight of a commodity like a kilo of Gold, a fixed number of barrels of oil, units of foreign currency, quantity of shares, etc. The currency in which the futures contract is quoted. The grade of the deliverable. In the case of bonds, this specifies which bonds can be delivered. In the case of physical commodities, this specifies not only the quality of the underlying goods but also the manner and location of delivery. The delivery month. The last trading date.

Trading in futures is regulated by the Securities & Exchange Board of India (SEBI). SEBI exists to guard against traders controlling the market in an illegal or unethical manner, and to prevent fraud in the futures market.

FUTURES TERMINOLOGY:
Important terms associated with futures contracts are as follows: 1. SPOT PRICE The price at which an instrument /asset trades in the spot market. 2. FUTURE PRICE The price at which the futures contract trade in the future market. 3. CONTRACT CYCLE The period at which a contract trades. For instance, the index futures contracts typically have one month, two months, and three months expiry cycles that expire on the last Thursday of the month. Thus, a January expiration contract expires on the last Thursday of
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January and a February expiration contract ceases trading on the lst Thursday of February. On the Friday following the last Thursday, a new contract having three month expiry is introduced for trading. 4. EXPIRY DATE It is the date specified in the futures contract.this is the last day on which the contract will be traded, at the end of which it will be cease to exist. 5. CONTRACT SIZE The amount of asset that has to be delivered less than one contract. For instance, the contract size of the NSE future, market is 200 nifties. 6. BASIS Basis is defined as the futures price minus the spot price. There will be different for each contract in a normal market, basis will be positive. This reflects normally exceed spot prices. 7. COST OF CARRY The relationship between futures price and spot price can be summarized in terms of 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 the initial margin. 9. MARKING TO MARKET In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investors gain or loss depending upon the futures closing price. This is called marking to market. 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. PAYOFF FOR FUTURES basis that futures prices

27

A payoff is the likely profit/loss that accrues to a market participant with change in the price of the underlying asset. futures contracts have linear payoffs in simple words, it means that the losses as well as profits, for the buyer and the seller of futures contracts, are unlimited the payoff for futures, that is for buyers (long futures) and sellers (short futures). 12. 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 downside take the case of spectacular who buys a two month nifty index futures contract when the nifty stands at 1220. The underlying asset in this case is the nifty portfolio. When the index moves up, the long futures position starts making profits and when the index moves down it starts making losses. 13. PAYOFF FOR SELLER OF FUTURES: SHORT FUTURES The payoff for a person who sells a futures contract is similar to payoff for a person who shorts an asset he has a potentially unlimited upside as well as downside take the case of a spectacular who sells a two month nifty index futures contract when the nifty stands at 1220. The underlying asset in this case is the nifty portfolio when the index moves down, the Short futures position starts making profits and when the index moves up it starts making losses.

EXAMPLE On January 15,X bought a January nifty futures contract that cost him Rs 538000.for this he had to pay an initial margin of Rs 43040 to his broker. Each nifty futures contract is for the delivery of 200 nifties on January 25,the index closed at 2720.how much profit/loss did he make? SOLUTION X bought one futures contract costing him rs 538000.at a market lot of 200, this means he paid Rs 2690 per nifty future. On the future expiration day, the futures price converges to the spot price. If the index closed at 2720 this must be the futures close price as well. Hence, he would have made a profit of
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(Rs 2720-Rs2690)*200=Rs 6000.

ADVANTAGES & DISADVANTAGES OF FUTURE CONTRACT Advantages:

It offers Lots of liquidity to both the parties Position can be reversed easily Doesnt tie up much capital Proper portfolio management Highly flexible Avoidance of carrying costs Protection against price fluctuations Boon to financial intermediaries
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Disadvantages:
Written for fixed amounts and terms Offers only a partial hedge Subject to basis risk (bond issuer can default)

OPTIONS/ OPTIONS CONTRACT

An option is a contract, which gives the buyer (holder) the right, but not the obligation, to buy or sell specified quantity of the underlying assets, at a specific (strike) price on or before a specified time (expiration date). The underlying may be commodities like wheat/ rice/ cotton/ gold/ oil or financial instruments like equity stocks/ stock index/ bonds etc.

FEATURES
1. Highly flexible: option contracts are highly standardized and so they can be traded only on

organized exchanges such option instruments cannot be made flexible according to the requirements of the writer as well as user. Thus it combines the features of futures as well as forward contracts
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2. Down payment: the option holder must pay a certain amount called premium for holding

the right of exercising this option.

3. Settlement: no money or commodity or share is exchanged when the contract is written

generally this option contract terminates either at the time of exercising the option by the holder or on maturity which is earlier
4. Non-linearity: an option contract does not possess the property of linerarity.it means that

the option holders profit, when the value of asset moves in one direction is not equal to the loss when its value moves in the opposite direction by the same amount.
5. No obligation to buy or sell: the option holder has a right to buy or sell an underlying asset.

He can exercise this right at any time during the currency of the contract. But in no case, he is under the obligation to buy or sell. If he does not buy or sell, the contract will be simply lapsed.

OPTIONS TERMINOLOGY
1. Index Options- These options have the index as the underlying. Some options are

European while others are American. American options can be exercised at any time upto the expiration date. Most exchange traded options are American. European options can be exercised only on the expiration date itself. European options are easier to analyze than American options, and properties of an American option are frequently deduced from those of its European counterpart. like index futures contracts, index options contracts are also cash settled.
1.

Stock Option- Stock options are options on individual stocks. a contract give the holder the right to buy or sell shares at specified price.
1. Underlying - The specific security / asset on which an options contract is

based.

1. Option Premium - This is the price paid by the buyer to the seller to acquire the right to

buy or sell

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1. Strike Price or Exercise Price - The strike or exercise price of an option is the specified/

pre-determined price of the underlying asset at which the same can be bought or sold if the option buyer exercises his right to buy/ sell on or before the expiration day.
1. Expiration date - The date on which the option expires is known as Expiration Date. On

Expiration date, either the option is exercised or it expires worthless.

1. Exercise Date - is the date on which the option is actually exercised. In case of European

Options the exercise date is same as the expiration date while in case of American Options, the options contract may be exercised any day between the purchase of the contract and its expiration date (see European/ American Option)
1. Open Interest - The total number of options contracts outstanding in the market at any

given point of time.

1. Option Holder: is the one who buys an option which can be a call or a put option. He

enjoys the right to buy or sell the underlying asset at a specified price on or before specified time. His upside potential is unlimited while losses are limited to the Premium paid by him to the option writer.
1. Option seller/ writer: is the one who is obligated to buy (in case of Put option) or to sell

(in case of call option), the underlying asset in case the buyer of the option decides to exercise his option. His profits are limited to the premium received from the buyer while his downside is unlimited.
1. Option Class: All listed options of a particular type (i.e., call or put) on a particular

underlying instrument, e.g., all Sensex Call Options (or) all Sensex Put Options
1. Option Series: An option series consists of all the options of a given class with the same

expiration date and strike price. E.g. BSXCMAY3600 is an options series which includes all Sensex Call options that are traded with Strike Price of 3600 & Expiry in May. (BSX Stands for BSE Sensex (underlying index), C is for Call Option , May is expiry date and strike Price is 3600)
1.

Assignment:-When the holder of an option exercises his right to buy/ sell, a randomly

selected option seller is assigned the obligation to honor the underlying contract, and this process is termed as Assignment.
1. European and American Style of options: An American style option is the one which

can be exercised by the buyer on or before the expiration date, i.e. anytime between the day of purchase of the option and the day of its expiry. The European kind of option is the one which can be exercised by the buyer on the expiration day only & not anytime before that
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1. Call Options:- A call option gives the holder (buyer/ one who is long call), the right to

buy specified quantity of the underlying asset at the strike price on or before expiration date The seller (one who is short call) however, has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy. Example: An investor buys One European call option on Infosys at the strike price of Rs. 3500 at a premium of Rs. 100. If the market price of Infosys on the day of expiry is more than Rs. 3500, the option will be exercised. The investor will earn profits once the share price crosses Rs. 3600 (Strike Price + Premium i.e. 3500+100). Suppose stock price is Rs. 3800, the option will be exercised and the investor will buy 1 share of Infosys from the seller of the option at Rs 3500 and sell it in the market at Rs 3800 making a profit of Rs. 200{ (Spot price - Strike price) - Premium}. In another scenario, if at the time of expiry stock price falls below Rs. 3500 say suppose it touches Rs. 3000, the buyer of the call option will choose not to exercise his option. In this case the investor loses the premium (Rs 100), paid which shall be the profit earned by the seller of the call option.
1. Put Options: - A Put option gives the holder (buyer/ one who is long Put), the right to

sell specified quantity of the underlying asset at the strike price on or before a expiry date. The seller of the put option (one who is short Put) however, has the obligation to buy the underlying asset at the strike price if the buyer decides to exercise his option to sell. Example: An investor buys one European Put option on Reliance at the strike price of Rs. 300/-, at a premium of Rs. 25/-. If the market price of Reliance, on the day of expiry is less than Rs. 300, the option can be exercised as it is 'in the money'. The investor's Breakeven point is Rs. 275/ (Strike Price - premium paid) i.e., investor will earn profits if the market falls below 275 Suppose stock price is Rs. 260, the buyer of the Put option immediately buys Reliance share in the market @ Rs. 260/- & exercises his option selling the Reliance share at Rs 300 to the option writer thus making a net profit of Rs. 15 {(Strike price - Spot Price) - Premium paid}. In another scenario, if at the time of expiry, market price of Reliance is Rs 320/ - , the buyer of the Put option will choose not to exercise his option to sell as he can sell in the market at a higher rate. In this case the investor loses the premium paid (i.e. Rs 25/-), which shall be the profit earned by the seller of the Put option. 17. In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cash flow to the holder if it were exercised immediately. A call option on the index is
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said to be in-the-money when the current index stands at a level higher than the strike price (i.e. spot price > strike price). If the index is much higher than the strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the index is below the strike price. 18. At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cash flow if it were exercised immediately. An option on the index is at-the-money when the current index equals the strike price (i.e. spot price = strike price). 19. Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative cash flow if it were exercised immediately. A call option on the index is outof-the-money when the current index stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is much lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the index is above the strike price. 20. Intrinsic value of an option: The option premium can be broken down into two components - intrinsic value and time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero. Putting it another way, the intrinsic value of a call is Max[0, (St K)] which means the intrinsic value of a call is the greater of 0 or (St K). Similarly, the intrinsic value of a put is Max [0, K St], i.e. the greater of 0 or (K St). K is the strike price and St is the spot price. 21. Time value of an option: The time value of an option is the difference between its premium and its intrinsic value. Both calls and puts have time value. An option that is OTM or ATM has only time value. Usually, the maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an option's time value, all else equal. At expiration, an option should have no time value.

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ADVANTAGES & DISADVANTAGES OF OPTIONS CONTRACT Advantages

Beneficial to parties: index-based options help the investment managers to insure the whole portfolio against fall in prices rather than hedging each and every security individually.

Source of additional income: option writing is a source of additional income for the portfolio managers with a large portfolio of securities infact large portfolio managers can guess the future movement of stock prices accurately and enter into option trading

Simple and flexible: option transactions are index based and so all calculations are made on the change in index value. The value at which index points are contracted forms the basis of index calculation hence simple and flexible

Losses are pegged to minimum amount: they are to the extent of premium only. Hence the players in the option market know that their losses are minimum and can be quantified.

Disadvantages
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Written for fixed amounts and terms Not much liquidity Subject to basis risk Offers only a partial hedge

DIFFERENCE BETWEEN FUTURES & OPTIONS

The significant differences in Futures and Options are as under: Futures are agreements/contracts to buy or sell specified quantity of the underlying assets at a price agreed upon by the buyer and seller, on or before a specified time. Both the buyer and seller are obligated to buy/sell the underlying asset. In case of options the buyer enjoys the right and not the obligation, to buy or sell the underlying asset. Futures Contracts have symmetric risk profile for both buyers as well as sellers, whereas options have asymmetric risk profile. In case of Options, for a buyer (or holder of the option), the downside is limited to the premium (option price) he has paid while the profits may be unlimited. For a seller or writer of an option, however, the downside is unlimited while profits are limited to the premium he has received from the buyer. The futures contracts prices are affected mainly by the prices of the underlying asset. Prices of options are however; affected by prices of the underlying asset, time remaining for expiry of the contract and volatility of the underlying asset.
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It costs nothing to enter into a futures contract whereas there is a cost of entering into an options contract, termed as Premium.

CHAPTER 6 VISION, MISSION, QUALITY OBJECTIVES & SWOT ANALYSIS

VISION:
To Become Successful Investment Advisors by developing the strategies which are implement able and leads to provide better returns than Bench mark portfolios.

MISSION:
To educate and empower the individual investor to make better investment decisions through quality advice and superior service. a) Educate and empower i. ii. iii. Research backed advice, which is easy to understand, retail specific, and discipline. Total equity solutions for the entire investment process. Relationship management.

b) Superior service i. ii. iii. iv. v. Integrity Transparency Professionalism Information product, news, operations Hassle free trading
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vi.

Enjoyable experience our goals is to accomplish top most position in both online and offline medium of trade and also to remain a customer centric organization.

Quality objectives:
Objectives represent, what needs to be accomplished in order to reach the goals.

To increase the customer base of investors to invest in all kind of securities. Sharekhan has one among the largest network of outlets of the either trading firms with180 outlets. To retain the existing consumers with research backed advice and personalized care the needs of the consumer.

SWOT ANALYSIS 1) Strength:

It is a pioneer in online trading with a turnover of Rs. 400 crores and more than 800 peoples working in the organization. SSKI the parent company of Sharekhan has more than eight decades of trust and credibility in the Indian stock market. In the Asian money Brokers poll SSKI won the Indias best broking house for 2004 award. Sharekhan provides multi-channel access to all its customers through a strong online presence with www.sharekhan.com, 250 share shops in 130 cities & a call-center based Dial-n-Trade facility. Sharekhan has dedicated research teams for fundamental & technical research. Which constantly track the pulse of the market and provide timely investment advice free of cost to its client which has a strike rate of 70-80%.

2) Weakness: Localized presence due to insufficient investments for country wide expansion. Lack of awareness among customers because of non-aggressive promotional strategies (print media, newspapers, etc.) Lesser emphasis on customer retention. Focuses more on HNIs than retail investors which results in meager market-share as compared to close competitors.

3) Opportunities: With the booming capital market it can successfully launch new services and raise its clients base. It can easily tap the retail investors with small saving through promotional channels like print media, electronic media, etc.
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As interest on fixed deposits with post office and banks are all time low, more and more small investors are entering into stock market. Abolition of long term capital gain tax on share and reduction in short term capital gain is making stock market as hot destination for investment among small investors. Increasing usage of internet through broadband connectivity may boost a whole new breed of investors for trading in securities.

4) Threats: Aggressive promotional strategies by close competitors may hamper sharekhan acceptance by new clients. Lack of sufficient branch-offices for speedy delivery of services. Other players are providing margin funds to investors on easy terms where as there is no such facility in sharekhan. More & more players are venturing into this domain which can further reduce the earnings of sharekhan.

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CHAPTER 7

GUIDELINES

R.B.I GUIDELINES FOR BANK DERIVATIVES

In India, different derivatives instruments are permitted and regulated by regulators, like Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI) and Forward Markets Commission (FMC). Broadly, RBI is empowered to regulate the interest rate derivatives, foreign currency derivatives and credit derivatives. Fein India, different derivatives instruments are permitted and regulated by various regulators, like Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI) and Forward Markets Commission (FMC). Broadly, RBI is empowered to regulate the interest rate derivatives, foreign currency derivatives and credit derivatives.
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BROAD PRINCIPLES FOR UNDERTAKING DERIVATIVE TRANSACTIONS :

The major requirements for undertaking any derivative transaction from the regulatory perspective would include: 1. Market-makers may undertake any derivative structured product (a combination of permitted cash and generic derivative instruments) as long as it is a combination of two or more of the generic instruments permitted by RBI and the market-makers should be in a position to mark to market or demonstrate valuation of these constituent products based on observable market prices. Hence, it may be ensured that structured products do not contain any derivative, which is not allowed on a standalone basis. Moreover, second order derivatives, like swaptions, option on future, compound option etc. are not permitted. 2. A user should not have a net short options position, either on a standalone basis or in a structured product, except to the extent of permitted covered calls and puts. 3. All permitted derivative transactions, including roll over, restructuring and novation shall be contracted only at prevailing market rates. Mark-to-market gain/loss on roll over, restructuring, novation etc. should be cash-settled. 4. All risks arising from derivatives exposures should be analyzed and documented. 5. The management of derivatives activities should be an integral part of the overall risk management policy and mechanism. It is desirable that the board of directors and senior management understand the risks inherent in the derivatives activities being undertaken. 6. Market-makers should have a Suitability and Appropriateness Policyvis--vis users in respect of the products offered, on the lines indicated in these guidelines. 7. Market-makers and users regulated by RBI should not undertake any derivative transaction involving the rupee that partially or fully offset a similar but opposite risk position undertaken by their Subsidiaries/branches/group entities at offshore location(s). 8. Market-makers may maintain cash margin/liquid collateral in respect of derivative transactions undertaken by users on mark-to-market basis irrespective of the latters credit risk assessment.
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Permissible derivative instruments At present, the following types of derivative instruments are permitted, subject to certain conditions: Interest rate derivatives Interest Rate Swap (IRS), Forward Rates Agreement (FRA) and Interest Rate Future (IRF). Foreign Currency derivatives Foreign Currency Forward, Currency Swap and Currency Option.

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CORPORATE GOVERNANCE:
"Corporate governance is maximizing the shareholder value in a corporation while ensuring fairness to all stakeholders, customers, employees, investors, vendors, the government and the society-at-large. Corporate governance is about transparency and raising the trust and confidence of stakeholders in the way the company is run. It is about owners and the managers operating as the trustees on behalf of every shareholder - large or small." a) It is vital, while dealing with potentially complex products, such as derivatives that the board and senior management should understand the nature of the business which the bank is undertaking. This includes an understanding of the nature of the relationship between risk and rewarding particular an appreciation that it is inherently implausible that an apparently low risk business can generate high rewards. b) The board of directors and senior management also need to demonstrate through their actions that they have a strong commitment to an effective control environment throughout the organization. c) The board and senior management, in addition to advocating prudent risk management, should encourage more stable and durable return performance and discourage high, but volatile returns. d) The board of directors and senior management should ensure that the organization of the bank is conducive to managing risk. It is necessary to ensure that clear lines of responsibility and accountability are established for all business activities, including derivative activities. e) The central risk control function at the head office should also ensure that there is sufficient awareness of the risks and the size of exposure of the trading activities in derivatives operations.
f) The compliance risks in all new products and processes should be thoroughly

analyzed and appropriate risk mitigates by way of necessary checks and balances should be put in place before the launching of new products. The Chief Compliance Officer must be involved in the mechanism for approval of new
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products and all such products should be signed off by him. In respect of the products that exist already, there should be a review thereof in the light of these guidelines by the same mechanism and in a similar manner. All new products should be subjected to intensive monitoring for the first six months of introduction to ensure that the indicative parameters of compliance risk are adequately monitored.

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DOCUMENTATION:
Market participants are advised to give top priority to ensure that the documentation requirements in respect of derivative contracts are complete in all respects. The following instructions in this regard may, therefore, be strictly adhered to: (i) For the sake of uniformity and standardization in respect of all derivative products, participants may use ISDA documentation, with suitable modifications. Counterparties are free to modify the ISDA Master Agreement by inserting suitable clauses in the schedule to the ISDA Master to reflect the terms that the counterparties may agree to, including the manner of settlement of transactions and choice of governing law of the Agreement. (ii) It may be mentioned that besides the ISDA Master Agreement, participants should obtain specific confirmation for each transaction which should detail the terms of the contract such as gross amount, rate, value date, etc. duly signed by the authorized signatories. (iii) It is also preferable to make a mention of the Master Agreement in the individual transaction confirmation. (iv) Participants should further evaluate whether the counterparty has the legal capacity, power and authority to enter into derivative transactions. (v) Participants must ensure that ISDA Master Agreement is signed with the counterparty prior to undertaking any derivatives business with them. (vi) Participants shall obtain documentation regarding customer suitability, appropriateness etc. as specified.

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MEASURES SPECIFIED BY SEBI TO PROTECT THE RIGHTS OF INVESTOR IN DERIVATIVES MARKET:

The measures specified by SEBI include: a. Investor's money has to be kept separate at all levels and is permitted to be used only against the liability of the Investor and is not available to the trading member or clearing member or even any other investor. b. The Trading Member is required to provide every investor with a risk disclosure document which will disclose the risks associated with the derivatives trading so that investors can take a conscious decision to trade in derivatives. c. Investor would get the contract note duly time stamped for receipt of the order and execution of the order. The order will be executed with the identity of the client and without client ID order will not be accepted by the system. The investor could also demand the trade confirmation slip with his ID in support of the contract note. This will protect him from the risk of price favour, if any, extended by the Member. d. In the derivative markets all money paid by the Investor towards margins on all open positions is kept in trust with the Clearing House/Clearing Corporation and in the event of default of the Trading or Clearing Member the amounts paid by the client towards margins are segregated and not utilized towards the default of the member. However, in the event of a default of a member, losses suffered by the Investor, if any, on settled / closed out position are compensated from the Investor Protection Fund, as per the rules, bye-laws and regulations of the derivative segment of the exchanges. e. The Exchanges are required to set up arbitration and investor grievances redressal mechanism operative from all the four areas / regions of the country.

ANNEXURE
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SUGGESTION

Increase in no. of branches at local level to increase client Increase presence in the market by increasing promotional activities such as newspaper, print media, TV, etc. Emphasis more on customer retention. Focus on retail investors instead focusing more on HNIs which will increase their market share as compared to their close competitor. Improve customer service. Improve marketing and sales strategies.

CONCLUSION
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From this project I have learn the many terminologies related to derivative. I got to know the guidelines for derivative & corporate governance for derivative market. As I had done the project on sharekhans trading in derivative market. I got to know sharekhan is trading in limited derivative i.e. future & options. For the project I had also give the suggestion. Lastly I will really thank to my guide Prof. Shruti who supported me for doing this project and guided me for doing the project. Even I like to thank my friends for helping me doing the project.

BIBLIOGRAPHY
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1. N.D.Vohra & B.R.Bagri, Future and Options, Tata McGraw Hill, 3rd Edition. 2. www.bseindia.com 3. www.nseindia.com
4. www.sharekhan.com 5. www.derivative.com 6. www.google.com

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